Tax Help: Offer in Compromise - abuse of discretion

William J. and Lois J. DiCindio v. Commissioner.Dkt. No. 7029-03L , TC Memo. 2007-77, 93 TCM 1060, April 2, 2007.

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The IRS's determination to reject a married couple's offer-in-compromise (OIC) and proceed with collection of tax liabilities was not an abuse of discretion. Returning the OIC for additional information was not arbitrary and capricious, and the decision not to process the OIC because the couple failed to provide additional requested information was consistent with the prescribed guidelines and was a reasonable exercise of the IRS's discretion. It was also not an abuse of discretion to reject the couple's OIC because they failed to submit additional information before the court ruled on their pending motion for reconsideration. An extension of any deadlines related to the IRS's processing of the OIC would not have changed the OIC's disposition. --

William J. and Lois J. DiCindio, pro se; Donald M. Brachfeld, for respondent.

MEMORANDUM OPINION
COLVIN, Chief Judge: Respondent sent a Notice of Determination Concerning Collection Action(s)

Under 1 and/or 2 Thereafter petitioners timely filed a petition in which they requested our review of respondent's determination. The issue for decision is whether respondent's determination to reject petitioners' offer-in-compromise (OIC) and proceed with collection was an abuse of discretion. We hold that it was not.
Background

Some of the facts have been stipulated and are so found. Petitioners are married and resided in Edison, New Jersey, at the time the petition was filed.

Respondent issued a Final Notice of Intent to Levy and Notice of Your Right to a Hearing to petitioners on September 5, 2002. Petitioners timely requested a collection due process hearing on October 1, 2002. Petitioners' outstanding tax liability is $463,496 plus statutory additions. Petitioners did not challenge the assessments or the underlying tax liabilities. A settlement officer (SO) from respondent's Appeals Office (Appeals) spoke on the telephone with petitioners' representative on February 4, 2003. The SO told petitioners' representative that collection alternatives such as an OIC or an installment agreement would not be considered because of petitioners' poor compliance record. Respondent issued the notice of determination on April 8, 2003, sustaining the levy.
In the petition, petitioners alleged errors in the notice of determination, specifically that Appeals failed to give them a fair hearing and that Appeals failed to act properly with regard to the collection activity. After the petition was filed, counsel for respondent requested that Appeals discuss collection alternatives with petitioners at a face-to-face hearing. Petitioner3 and respondent's SO met on September 9, 2003, and discussed collection alternatives. Petitioners submitted an OIC on November 6, 2003. On December 1, 2003, the SO sent petitioners a letter requesting that they complete missing items on the form and submit additional information.



Discussion

Petitioners contend that respondent's refusal to consider their offer-in-compromise submitted on November 15, 2005, for the years in issue was an abuse of discretion. We disagree.

Petitioners contend that respondent's rejection of their OIC while a motion for reconsideration was pending before the Court was an abuse of discretion. We disagree.

The granting of a motion to reconsider rests in the discretion of the Court. Louisville & Nashville R. Co. v. Commissioner

[Dec. 34,014] 66 T.C. 962 (1976); Estate of Halas v. Commissioner [Dec. 43,183], 87 T.C. 164, 166-167 (1986). Motions to reconsider will not be granted unless unusual circumstances or substantial error is shown. Estate of Halas v. Commissioner, supra at 574; Vaughn v. Commissioner, supra at 167. Petitioners submitted their offer-in-compromise to respondent on November 15, 2005. However, they failed to respond to respondent's repeated requests for additional information. In April 2006, petitioners requested an extension until August 15, 2006, so that petitioner could file his 2005 income tax return. The Court was not persuaded that petitioners were entitled to an extension of any deadlines related to respondent's processing of the OIC and denied their motion. In the interim, respondent rejected petitioners' OIC.
We have no reason to believe that an extension to August would have changed the disposition of petitioners' offer-in-compromise. The reason for the requested extension was to file petitioner's 2005 income tax return. However, the filing of petitioner's 2005 income tax return was not a requirement of respondent's acceptance of the offer. The OS knew that petitioner had requested an extension for filing his 2005 taxes. The information that the OS needed, however, had to do with additional information to verify and confirm the data on the submitted OIC. Therefore, it was not an abuse of discretion to reject petitioners' OIC on account of their failure to submit additional information before the Court ruled on petitioners' pending motion for reconsideration.

We conclude that respondent may proceed with collection of petitioners' tax liabilities for 1985-89 and 1991-2001 because respondent's rejection of petitioners' offer-in-compromise was not an abuse of discretion.

Alvin S. Brown

tax attorney

703 425-1400

http://www.irstaxattorney.com/

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Tax Attorney: Offer in Compromise - Bankruptcy

Court concluded that IRS was correct in not processing an OIC during bankruptcy.

re 1900 M Restaurant Associates, Inc. Debtor. 1900 M Restaurant Associates, Inc., Appellant v. United States, Appellee., U.S. District Court, D.C.; Civ. 05-570 (EGS), September 20, 2006, 352 BR 1.

Affirming a BC-DC D.C. decision 2005-1 USTC ¶50,313.

[Code Sec. 7122]

The IRS did not violate 11 U.S.C. §525 when it returned a corporation's offer in compromise (OIC) as nonprocessable during the pendency of its chapter 11 bankruptcy proceeding. IRS policy and procedures provided that, because the corporation was in bankruptcy, processing its OIC was not in the government's best interest. Moreover, mandamus relief was not available to the corporation as an alternative means to compel the government to consider its OIC. The IRS owed no clear duty to the corporation to act as required for mandamus relief. Its discretion to compromise carried with it the discretion not to exercise that discretion.




MEMORANDUM OPINION


SULLIVAN, District Court Judge: Before the Court is the appeal of the appellant, 1900 M Restaurant Associates, Inc. ("1900 M Restaurant"), pursuant to 28 U.S.C. §158(a)(1), from an order of the United States Bankruptcy Court for the District of Columbia. By an order dated January 24, 2005, the bankruptcy court granted the United States's motion for summary judgment and dismissed the action. See 1900 M Restaurant Associates, Inc. v. United States (In re 1900 M Restaurant) [2005-1 USTC ¶50,313], 319 B.R. 302 (D.D.C. 2005). This Court agrees with the legal conclusions and the result reached by the bankruptcy court. Therefore, the bankruptcy's court's Order is affirmed.



I. BACKGROUND1

Appellant is a restaurant operating in the District of Columbia under the tradename "Rumors." On April 9, 2003, appellant filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code. The majority of the appellant's obligations consisted of priority tax claims owed to the District and the Internal Revenue Service ("IRS").

On January 26, 2004, appellant submitted an offer-in-compromise ("OIC") to the IRS on IRS Form 656, pursuant to 26 U.S.C. §7122. An OIC is an offer submitted by a taxpayer to pay less than what is owed in federal taxes. On February 6, 2005, appellant's offer was returned as nonprocessable because under IRS procedures, IRS cannot accept for review any OICs from taxpayers with open, pending bankruptcy cases. Further, appellant had not filed several tax returns, the liability for which was the subject of the offer.

When appellant's offer was returned as nonprocessable, appellant filed suit in the bankruptcy court for a declaratory judgment that IRS's policy to return as nonprocessable offers submitted by taxpayers in open bankruptcy proceedings violated 11 U.S.C. §525(a). Appellant requested the bankruptcy court to compel IRS, pursuant to 11 U.S.C. §105, to consider appellant's OIC --not to approve and accept the offer --but to merely consider it.

The parties filed cross motions for summary judgment before the Bankruptcy Court of the District of Columbia. The bankruptcy court granted the government's motion, and dismissed the action. On appeal, appellant presents two issues: (1) whether the bankruptcy court erred as a matter of law in determining that 11 U.S.C. §525(a) does not apply to the IRS when it refused to consider an OIC under 26 U.S.C. §7122 during the pendency of a bankruptcy case; and (2) whether the bankruptcy court erred as a matter of law in determining that 11 U.S.C. §105 is not available to compel the IRS to consider appellant's OIC.

The bankruptcy court held that §525(a) does not apply to the IRS's refusal to consider an OIC submitted under §7122 during the pendency of a bankruptcy case. In re 1900 M Restaurant 2005-1 USTC ¶50,313, 319 B.R. at 305. Specifically, the court determined that a debtor's "right to submit an offer-in-compromise" is not a "license, permit, charter, or franchise" within the ordinary meanings of those words. Id. Further, the court found that it is not a grant either within any of the ordinary meanings of that word. Id.

Then the court turned to the question of whether §105(a) provides an alternative means to compel the government to consider appellant's OIC. After examining the legislative history of §105(a), the court held that §105(a) is similar to the All Writs Statute, 28 U.S.C. §1651. Id. at 306. The court concluded that to the extent that the debtor seeks to compel performance of an alleged duty, the relief the debtor seeks is in the nature of mandamus. Id. The court held that the appellant failed to meet the requirements of a writ of mandamus: (1) appellant has a clear right to relief; (2) the appellee has a clear duty to act; and (3) there is no other adequate remedy available to appellant. Id.

Focusing on the second element, the court found that the IRS had no clear duty to the appellant under §7122 to consider and process its OIC. Id. at 307. Section 7122(a) does not command the Secretary of the IRS to consider an OIC, rather it only provides that the Secretary "may" compromise a tax liability. Id. The court held that a discretion to compromise carries with it the discretion not to exercise the discretion. Id. In short, in exercising the statutory discretion of §7122(a), the Secretary was free to specify what types of offers will be processed. Id. at 309.

Alternatively, the court also held that mandamus is unavailable on an alternative ground. Id. at 311. Because mandamus is an extraordinary remedy that is available only if other relief is inadequate, the court concluded that mandamus is not appropriate here because the appellant already has at its disposal another way to present a payment proposal to the IRS, that is much akin to an OIC. Id. at 312. The court explained that appellant presented to the IRS a proposed plan of reorganization, and that "through this process, [appellant] has received a decision regarding the acceptability to the IRS of the treatment [appellant] proposes. Because [appellant] has already achieved a decision regarding the acceptability of the treatment his plan proposes for the IRS's claims, [it] has achieved [its] end in filing an offer-in-compromise, and mandamus is inappropriate. ... It follows that a decision on the acceptability of [appellant's] plan achieved the end of what [appellant] desired, even though not employing the means [appellant] desired." Id.



II. DISCUSSION




A. Standard of Review


On appeal, a summary judgment decision entered by a bankruptcy court is reviewed de novo both as to conclusions of law and findings of fact. U.S. v. Spicer, 57 F.3d 1152, 1159 (D.C. Cir. 1995). Summary judgment in bankruptcy is governed by Bankruptcy Rule 7056, which incorporates the standard of Rule 56 of the Federal Rules of Civil Procedure. Id.




B. Appellant's Argument


Appellant argues that, notwithstanding the various strengths and/or weaknesses of the appellant's OIC, the IRS summarily rejected it because it refused to consider offers while a bankruptcy proceeding was pending. Appellant argues that IRS's refusal to even consider its offer violates 11 U.S.C. §525(a) because that section prohibits discrimination against individuals in bankruptcy on the sole basis of their bankruptcy. Appellant concedes that it is within IRS's discretion to accept or deny its OIC, but to not even consider and process the offer violate §525(a).

Appellant does concede that an OIC is not a "license, permit, charter, or franchise," as articulated in §525(a), within the ordinary meanings of those terms. However, appellant argues that an OIC is "other similar grant" under §525(a) because the term "grant" is to be interpreted broadly given the legislative history which states that §525(a) is not exhaustive in terms of describing the various forms of discrimination which that statute was intended to prevent. Moreover, the phrase, "other similar grant" is not defined by the Bankruptcy Code. In short, OIC is an "other similar grant," thus, the IRS violated the anti-discriminatory provisions of §525(a) when it refused to even consider appellant's offer due to its open bankruptcy case.

Further, appellant argues that because §525(a) lacks any remedial provisions in its own rights, 11 U.S.C. §105(a) is necessary to remedy the IRS's conduct in this case. It argues that §105(a) provides the bankruptcy courts with broad equitable powers to order "any" type of order that is necessary or appropriate to carry out the provisions of the Bankruptcy Code. Accordingly, because the IRS's policy of refusing to consider appellant's OIC while it is in bankruptcy violates §525(a), §105(a) may be invoked to remedy the IRS's conduct in this case by ordering IRS to consider appellant's OIC.




C. Appellee's Argument


The government argues that §525(a) is not applicable to this case because an OIC is not a "license, permit, charter, franchise or other similar grant." Further, it argues that the case appellant relies on for its argument is clearly distinguishable. The government also points out that legislative history does not support appellant's contention that "other similar grant" should be interpreted broadly to encompass OICs. The government argues that the legislative history is clear that any expansion of §525(a) is limited to licensing-type actions and not just any type of interests and actions. See H.R. Rep. No. 595, 95th Cong., 1st Sess. 367; Sen. Rep. No. 95-989-, 95th Cong., 2nd Sess. 81 ("This section permits further development to prohibit actions by governmental or quasi-governmental organizations that perform licensing functions. ..."). The government contends that IRS does not perform licensing functions and the appellant is in no way being denied an opportunity to engage in its business. In short, the legislative history confirms that §525(a) is not intended to cover the present situation.

Next the government argues the bankruptcy court below correctly determined that §105(a) did not authorize it to order the IRS to consider appellant's OIC. First, §105(a) only authorizes an order that will effectuate another express bankruptcy court provision. Once appellant's argument that the IRS violated §525(a) has failed, there is no other provision. Therefore, the order appellant seeks is one of mandamus under §525(a), and the appellant has failed to meet the required factors for a writ of mandamus to issue in this case.




D. Analysis





1. Offers-in-Compromise


The Internal Revenue Code provides that taxpayers may compromise any civil or criminal tax obligation by submitting an OIC. See 28 U.S.C. §7122. Only the IRS may process an OIC, and only under the various regulations, rules, guidelines, and revenue procedures established under 28 U.S.C. §7122. Section 7122(a) provides:


(a) Authorization. The Secretary may compromise any civil or criminal case arising under the internal revenue law prior to reference to the Department of Justice for prosecution or defense; and the Attorney General or his delegate may compromise any such case after reference to the Department of Justice for prosecution or defense.


An OIC under §7122 "must be submitted according to the procedures, and in the form and manner, prescribed by the Secretary." 26 C.F.R. §301.7122-1(d)(1). An OIC under §7122 is generally submitted on IRS Form 656. The IRS may refuse to process an OIC and return the OIC to the taxpayer if the IRS determines that "the offer was submitted solely to delay collection or was otherwise nonprocessable." 26 C.F.R. §301.7122-1(d)(2). What constitutes a nonprocessable offer is determined by IRS policy.

On July 12, 2004, the Internal Revenue Service Office of Chief Counsel issued a notice explaining IRS's policy of returning OIC of taxpayers currently in bankruptcy as nonprocessable. See CC-2004-25, 2004 IRS Chief Counsel Notice LEXIS 18 (July 12, 2004) ("Notice"). The Notice explained that the Commissioner of IRS had determined that processing OIC of taxpayers in bankruptcy was not in the government's best interest and that IRS would instead consider payment proposals by such taxpayers as part of the plan confirmation process. The plan confirmation process permits IRS to exercise its discretion to accept different treatment of priority claims than is provided for by the Bankruptcy Code. In sum, if a taxpayer is in bankruptcy at the time the OIC is submitted, IRS will return the offer as nonprocessable, therefore, §7122 is unavailing to such a taxpayer.




2. IRS Did Not Violate 11 U.S.C. §525(a) When It Refused to Consider an Offer-In-Compromise Submitted During the Pendency of a Bankruptcy Case.


11 U.S.C. §525(a) is known as the anti-discrimination provision of the Bankruptcy Code. It provides that a government unit may not discriminate against a person with respect to certain grants solely because that person is, or has been, a bankrupt party. Specifically, §525(a) provides:


[A] governmental unit may not deny, revoke, suspend, or refuse to renew a license, permit, charter, franchise, or other similar grant to, condition such a grant to, [or] discriminate with respect to such a grant against ... a person that is or has been a debtor under this title ... solely because such bankrupt or debtor is or has been a debtor under this title. ...


The legislative history of §525 provides in part:


This section is additional debtor protection. It codifies the result of Perez v. Campbell, 402 U.S. 637 (1971), which held that a State would frustrate the Congressional policy of a fresh start for a debtor if it were permitted to refuse to renew a drivers license because a tort judgment resulting from an automobile accident had been unpaid as a result of a discharge in bankruptcy.



In addition, the section is not exhaustive. The enumeration of various forms of discrimination against former bankrupts is not intended to permit other forms of discrimination. The courts have been developing the Perez rule. This section permits further development to prohibit actions by governmental or quasi-governmental organizations that perform licensing functions such as a State bar association or a medical society, or by other organizations that can seriously affect the debtors' livelihood or fresh start, such as exclusions from a union on the basis of discharge of a debt to the union's credit union. ... This section is not so broad as a comparable section proposed by the Bankruptcy Commission, H.R. 31, 94th Cong., 1st Sess. §4-508(1975), which would have extended the prohibition to any discrimination, even by private parties. Nevertheless, it is not limiting either, as noted. The courts will continue to mark the contours of the anti-discrimination provision in pursuit of sound bankruptcy policy.


HR Rep No. 595, 95th Cong, 1st Sess 366-367 (1977); S Rep No. 989, 95th Cong, 2d Sess 81 (1978).

"A fundamental canon of statutory construction is that, unless otherwise defined, words will be interpreted as taking their ordinary, contemporary common meaning." Perrin v. United States, 444 U.S. 37, 42-43. (1979). "The plain language of legislation should be conclusive except in the rare cases in which the literal application of a statute will produce a result demonstrably at odds with the intentions of its drafters." United States v. Ron Pair [89-1 USTC ¶9179], 489 U.S. 235, 242 (1989).

When the actual language and the legislative history of §525(a) are analyzed, it is clear that an OIC is not like a "license, permit, charter, franchise or other similar grant" within the ordinary meanings of those words. In order for an OIC to fit within the statute, appellant must establish that an OIC is a grant and is similar to a license, permit, charter or franchise. This the appellant cannot do. Appellant attempts to stretch the meaning of "other similar grant" to include offers-in-compromise, but essentially it is comparing apples with oranges, and that fact cannot be avoided when one looks closely at Stoltz v. Brattleboro Housing Authority, 315 F.3d 80 (2d Cir. 2002), appellant's primary case.

The Stoltz Court reviewed whether a public housing lease fell under the protections of §525(a). The Court examined the commonly understood definitions of a "grant" and a "lease" to determine whether a lease is a grant similar to a "license, permit, charge, or franchise." Id. The Stolz Court defined grant as: (1) "a transfer of property by deed or writing;" and (2) "an agreement that creates a right of any description other than the one held by the grantor." Id. It defined lease as "a contract by which a rightful possessor of real property conveys the right to use and occupy that property in exchange for consideration." Id. The Court concluded that a public housing lease is a grant by which a public housing authority conveys a public housing tenant the right to use and occupy public housing in exchange for rent. Id. Having determined that a lease is a grant, the Stolz Court next determined whether a public housing lease is a grant "similar" to a "license, permit, charter or franchise" under §525(a). It concluded that it is because the public housing lease, like the other property interests specifically protected under §525(a), is unobtainable from the private sector, and is essential to a debtor's fresh start, which was stressed in the legislative history of §525(a).

In looking at the definition of "grant" as articulated by the Second Circuit, the Court concludes that an OIC is not a grant. An OIC does not constitute a transfer of a property right or an agreement that creates certain rights. In sum, because an OIC is not like a "license, permit, charter, franchise or other similar grant" within the ordinary meanings of those words, the government did not violate 11 U.S.C. §525(a).2




3. 11 U.S.C. §105 Does Not Authorize an Order to the IRS to Consider Appellant's Offer-In-Compromise.


Having determined that the IRS's policy of returning OICs as nonprocessable from taxpayers in bankruptcy proceedings does not violate §525(a), the Court must now turn to whether 11 U.S.C. §105(a) nonetheless permits the Court to order IRS to consider appellant's OIC.

11 U.S.C. §105(a) provides that "[t]he court may issue any order, process, or judgment that is necessary or appropriate to carry out the provision of this title." The legislative history to §105(a) states that it "is similar in effect to the All Writs Statute, 28 U.S.C. §1651 ... The section is repeated here for the sake of continuity from current law and ease of reference, and to cover any powers traditionally exercised by a bankruptcy court that are not encompassed by the All Writs Statute." H.R. Rep. 95-595, 95th Cong., 1st Sess., at 316-17 (1977).

The Court agrees with the bankruptcy court that since there is no other express bankruptcy provision upon which the Court is asked to act, the order appellant seeks is one of mandamus. The "remedy of mandamus is a drastic one, to be invoked only in extraordinary circumstances." Power v. Barnhart, 292 F.3d 781, 784 (D.C. Cir. 2002). Mandamus is available only if: (1) the appellant has a clear right to relief; (2) the appellee has a clear duty to act; and (3) there is no other adequate remedy available to appellant. Id.

"When a statute uses a permissive term such as 'may' rather than a mandatory term such as 'shall,' this choice of language suggests that Congress intends to confer some discretion on the agency, and that courts should accordingly show deference to the agency's determination." Dickson v. Secretary of Defense, 68 F.3d 1396, 1401 (D.C. Cir. 1995). Section 7122 clearly states that the "Secretary may compromise any civil or criminal case...". By using the word "may," Congress vested discretion in the Secretary, and thus, it logically follows that discretion to compromise carries with it discretion not to exercise that discretion. Accordingly, because appellee does not owe a clear duty to act, as required under the second prong of seeking mandamus relief, mandamus is not available here.

Further, the Court adopts the bankruptcy court's reasoning as to why the holdings of In re Mancher, 2003 WL 23169807 (Bkrtcy. W.D. Va. June 5, 2003) and In re Holmes [2003-2 USTC ¶50,685], 298 B.R. 477 (M.D. Ga. 2003) will not be followed. The bankruptcy court explained how the Bankruptcy Code's "fresh start" principle and the common sense realities of bankruptcy reorganization do not require that the government be ordered to consider appellant's OIC under §105(a). Accordingly, having found the bankruptcy court's reasons to be persuasive, and to the extent that the appellant is challenging them in its brief, the Court adopts the bankruptcy court's well-reasoned conclusions.



III. CONCLUSION

The Court concludes that the bankruptcy court correctly determined that the appellee did not violate 11 U.S.C. §525(a) and that appellant is not entitled to the relief it seeks under 11 U.S.C. §105. Accordingly, the bankruptcy court's decision is AFFIRMED.

1 The facts of the case are adopted from the parties' respective statement of material facts as to which there is no genuine dispute filed with their respective cross motions for summary judgment before the bankruptcy court.

2 The Court notes that the only case to hold that the IRS violated §525(a) is In re Mills [2000-1 USTC ¶50,103], 240 B.R. 689 (S.D. W.Va. 1999). Appellant urges the Court to consider the policy rationales relied on by the Mills Court. Rather than looking at the specific language of §525(a) to determine whether an OIC is a grant that is similar to a "license, permit, charter, or franchise," the Mills Court's conclusion emanates from a policy angle. Finding that it is unfair to treat taxpayers in open bankruptcy proceedings differently by not affording them an opportunity open to other taxpayers, the Court held that the government violated the anti-discrimination provision of the Bankruptcy Code. Section 525(a) does address discriminatory treatment of debtors, however, Congress did not prohibit all discriminatory treatment, rather it chose its language carefully, and the courts must look to the plain language and meaning of the statute to determine what conduct is covered by the statute.

Back Taxes: Offer in Compromise - abuse of discretion

Edward F. Murphy, Petitioner, Appellant v . Commissioner of Internal Revenue, Respondent, Appellee.U.S. Court of Appeals, 1st Circuit; 06-1109, November 20, 2006, 469 F3d 27.Affirming the Tax Court, 125 TC 301.




[

[

In 1998, Congress established the CDP hearing process to temper "any harshness caused by allowing the IRS to levy on property without any provision for advance hearing." Olsen v. United States [

2005-1 USTC ¶50,395], 411 F.3d 621, 624 (6th Cir. 2005). During the hearing, a taxpayer may raise "any relevant issue relating to the unpaid tax or the proposed levy, including ... offers of collection alternatives, which may include an offer-in-compromise." 26 U.S.C. §6330(d)(1) (as amended by Pub. L. No. 109-281, §855(a)).2
A. Extra-Record EvidenceDuring the evidentiary hearing before the Tax Court, Murphy testified about the circumstances that made him unable to offer a larger settlement payment, and the appeals officer testified concerning the process that she employed to evaluate Murphy's offer-in-compromise. The IRS objected to the introduction of this testimony on the basis that the Tax Court should not consider evidence that was not part of the administrative record of the CDP hearing. The court rejected this argument but still excluded the evidence as irrelevant. The IRS urges us to affirm this ruling on an alternative ground: Tax Court review should be limited to the administrative record.We recently considered this issue in the context of a taxpayer appeal to the district court from the denial of an offer-in-compromise made during a CDP hearing. See Olsen [2005-2 USTC ¶50,637], 414 F.3d at 155. The reasons supporting application of the administrative record rule in district court CDP hearing appeals have equal force where the appeal takes place in the Tax Court. The Tax Court, like the district court, is charged with determining whether the IRS's rulings during a CDP hearing were within its discretion. Thus, judicial review normally should be limited to the information that was before the IRS when making the challenged rulings. See Robinette [

B. Conduct of the HearingMurphy contends that the IRS abused its discretion in the conduct of his CDP hearing. He argues that the appeals officer acted "with a clear predisposition toward an inflexible and expeditious determination of ... the matter" by declining to grant him additional extensions to file more information.The relevant regulations do not provide a time period within which a CDP hearing must be concluded. Rather, they instruct the IRS to complete the hearing "as expeditiously as possible under the circumstances." 26 C.F.R. §301.6330-1(e)(3). Thus, there is no requirement that an appeals officer "wait a certain amount of time before rendering [a] determination as to a proposed levy." Clawson v. Comm'r [

See, e.g., Carlson v. United States [

In exercising this discretion, the IRS must consider all the facts and circumstances of the taxpayer's case, including whether they warrant acceptance of an amount that might not otherwise be acceptable under the IRS's policies and procedures. Id. There is no dispute that Murphy established a doubt as to collectability and therefore was eligible to compromise his debt. The only question is whether the IRS abused its discretion in declining to accept Murphy's proposed compromise.

Murphy argues that the IRS's determination that the reasonable collection value of his case exceeded $10,000 was unreasonable.Based on information provided by Murphy, the appeals officer calculated that, after expenses, Murphy had a monthly surplus of $1,128. The officer multiplied this figure by 60 months (a reasonable period until Murphy could expect to retire) for a total of $67,680 in available income.

The officer then added realizable equity to conclude that Murphy could offer to pay $82,164 to settle his tax liability.Murphy has never mounted a serious challenge to these calculations. After complaining to the appeals officer that her proposed compromise figure was too high, Murphy never offered an explanation for why the officer's calculations were unreasonable. Even now, Murphy offers only a conclusory allegation that the appeals officer's calculation was "preposterous."

On this record, the IRS did not abuse its discretion in rejecting Murphy's offer-in-compromise.

3 Affirmed.* Of the District of Rhode Island, sitting by designation.1 The court did admit testimony from the appeals officer explaining the meaning of certain notes and symbols that appeared in the record.2 Prior to the enactment of Pub. L. No. 109-281, appeals from CDP hearings were heard in federal district court if the Tax Court did not have jurisdiction over the underlying tax liability. See 26 U.S.C. 3 Murphy has not presented a developed argument that the IRS abused its discretion by declining to accept his offer-in-compromise because of special circumstances. See United States v. Zannino, 895 F.2d 1, 17 (1st Cir. 1990).

Tax Help: Self employment tax - IRC 1402


Nancy L. and Gerald L. Harper v. Commissioner.Docket No. 17561-05S . Filed July 30, 2007.[1402] Self-employment tax. --

A married couple failed to report the wife's commission income from her sales of insurance policies as an independent insurance agent; the couple was liable for self-employment tax but was entitled to a deduction for one half of the self-employment tax. The commissions were taxable despite the taxpayers' contention that they did not receive a check corresponding to the amount reported on Form 1099-MISC.

Tax Attorney IRS Identifies Frivolous Argument


Notice 2007-30, I.R.B. 2007-14, March 15, 2007.

[Code Secs. 6159, 6320, 6330, 6702, 7122 and 7811]

Penalties, civil: Frivolous returns: Frivolous submissions: Frivolous positions: Installment agreements: Collection Due Process hearings: Offer in compromise: Taxpayer assistance orders. --The IRS has identified 40 frivolous positions that have been deemed frivolous by courts or have no basis for validity in existing law. These positions are determined to be frivolous for purposes of the Code Sec. 6702(a) penalty for filing frivolous tax returns, and the Code Sec. 6702(b) penalty for filing specified frivolous submissions, which include requests for collection due process (CDP) hearings, and applications for installment agreements, offers in compromise, and taxpayer assistance orders. The identified frivolous positions include most of the common tax-protester-type arguments, such as false claims that wages are not taxable income; filing returns and paying taxes is voluntary; the IRS must provide the taxpayer with a Form 23C, Assessment Certificate - Summary Record of Assessments, before collecting overdue taxes; and the taxpayer's income is not taxable because the taxpayer is a citizen of an individual state or is not a "person" as defined by the Internal Revenue Code. Back references: ¶37,181.20, ¶38,134.023, ¶38,134.20, ¶38,184.023, ¶38.184.108, ¶40,043.01, ¶40,043.50, ¶41,130.025, ¶41,130.45 and ¶43,312.10.



PURPOSE

Positions that are the same as or similar to the positions listed in this Notice are identified as frivolous for purposes of the penalty for a "frivolous tax return" under section 6702(a) of the Internal Revenue Code and the penalty for a "specified frivolous submission" under section 6702(b). Persons who file a purported return of tax, including an original or amended return, based on one or more of these positions are subject to a penalty of $5,000 if the purported return of tax does not contain information on which the substantial correctness of the self-assessed determination of tax may be judged or contains information that on its face indicates the self-assessed determination of tax is substantially incorrect. Likewise, persons who submit a "specified submission" (namely, a request for a collection due process hearing or an application for an installment agreement, offer-in-compromise, or Taxpayer Assistance Order) based on one or more of the positions listed in this Notice are subject to a penalty of $5,000. The penalty may also be applied if the purported return or any portion of the specified submission is not based on a position set forth in this Notice, yet reflects a desire to delay or impede the administration of Federal tax laws for purposes of section 6702(a)(2)(B) or 6702(b)(2)(A)(ii).



BACKGROUND

Section 407 of Tax Relief and Health Care Act of 2006, Pub. L. No. 109-432, 120 Stat. 2922 (2006), amended section 6702 to increase the amount of the penalty for frivolous tax returns from $500 to $5,000 and to impose a penalty of $5,000 on any person who submits a "specified frivolous submission." A submission is a "specified frivolous submission" if it is a "specified submission" (defined in section 6702(b)(2)(B) as a request for a hearing under section 6320 or 6330 or an application under section 6159, 7122 or 7811) and any portion of the submission (i) is based on a position identified by the Secretary as frivolous or (ii) reflects a desire to delay or impede administration of the Federal tax laws. Section 6702 was further amended to add a new subsection (c) requiring the Secretary to prescribe a list of positions identified as frivolous. This Notice contains the prescribed list.



DISCUSSION

Frivolous Positions. Positions that are the same as or similar to the following are frivolous.


(1) Compliance with the internal revenue laws is voluntary or optional and not required by law, including arguments that:



a. Filing a Federal tax or information return or paying tax is purely voluntary under the law, or similar arguments described as frivolous in Rev. Rul. 2007-20, 2007-14 I.R.B. ___



b. Nothing in the Internal Revenue Code imposes a requirement to file a return or pay tax, or that a person is not required to file a tax return or pay a tax unless the Internal Revenue Service responds to the person's questions, correspondence, or a request to identify a provision in the Code requiring the filing of a return or the payment of tax.



c. There is no legal requirement to file a Federal income tax return because the instructions to Forms 1040, 1040A, or 1040EZ or the Treasury regulations associated with the filing of the forms do not display an OMB control number as required by the Paperwork Reduction Act of 1980, 44 U.S.C. §3501 et seq., or similar arguments described as frivolous in Rev. Rul. 2006-21, 2006-15 I.R.B. 745.



d. Because filing a tax return is not required by law, the Service must prepare a return for a taxpayer who does not file one in order to assess and collect tax.



e. A taxpayer has an option under the law to file a document or set of documents in lieu of a return or elect to file a tax return reporting zero taxable income and zero tax liability even if the taxpayer received taxable income during the taxable period for which the return is filed, or similar arguments described as frivolous in Rev. Rul. 2004-34, 2004-1. C.B. 619.



f. An employer is not legally obligated to withhold income or employment taxes on employees' wages.



g. A taxpayer may "untax" himself or herself at any time or revoke the consent to be taxed and thereafter not be subject to internal revenue taxes.



h. Only persons who have contracted with the government by applying for a governmental privilege or benefit, such as holding a Social Security number, are subject to tax, and those who have contracted with the government may choose to revoke the contract at will.



i. A taxpayer may lawfully decline to pay taxes if the taxpayer disagrees with the government's use of tax revenues, or similar arguments described as frivolous in Rev. Rul. 2005-20, 2005-1 C.B. 821.



j. An administrative summons issued by the Service is per se invalid and compliance with a summons is not legally required.



(2) The Internal Revenue Code is not law (or "positive law") or its provisions are ineffective or inoperative, including the sections imposing an income tax or requiring the filing of tax returns, because the provisions have not been implemented by regulations even though the provisions in question either (a) do not expressly require the Secretary to issue implementing regulations to become effective or (b) expressly require implementing regulations which have been issued.



(3) A taxpayer's income is excluded from taxation when the taxpayer rejects or renounces United States citizenship because the taxpayer is a citizen exclusively of a State (sometimes characterized as a "natural-born citizen" of a "sovereign state"), that is claimed to be a separate country or otherwise not subject to the laws of the United States. This position includes the argument that the United States does not include all or a part of the physical territory of the 50 States and instead consists of only places such as the District of Columbia, Commonwealths and Territories (e.g., Puerto Rico), and Federal enclaves (e.g., Native American reservations and military installations), or similar arguments described as frivolous in Rev. Rul. 2004-28, 2004-1 C.B. 624, or Rev. Rul. 2007-22, 2007-14 I.R.B. ___.



(4) Wages, tips, and other compensation received for the performance of personal services are not taxable income or are offset by an equivalent deduction for the personal services rendered, including an argument that a taxpayer has a "claim of right" to exclude the cost or value of the taxpayer's labor from income or that taxpayers have a basis in their labor equal to the fair market value of the wages they receive, or similar arguments described as frivolous in Rev. Rul. 2004-29, 2004-1 C.B. 627, or Rev. Rul. 2007-19, 2007-14 I.R.B. ___ .



(5) United States citizens and residents are not subject to tax on their wages or other income derived from sources within the United States, as only foreign-based income or income received by nonresident aliens and foreign corporations from sources within the United States is taxable, and similar arguments described as frivolous in Rev. Rul. 2004-30, 2004-1 C.B. 622.



(6) A taxpayer has been removed or redeemed from the Federal tax system though the taxpayer remains a United States citizen or resident, or similar arguments described as frivolous in Rev. Rul. 2004-31, 2004-1 C.B. 617.



(7) Only certain types of taxpayers are subject to income and employment taxes, such as employees of the Federal government, corporations, nonresident aliens, or residents of the District of Columbia or the Federal territories, or similar arguments described as frivolous in Rev. Rul. 2006-18, 2006-15 I.R.B. 743.



(8) Only certain types of income are taxable, for example, income that results from the sale of alcohol, tobacco, or firearms or from transactions or activities that take place in interstate commerce.



(9) Federal income taxes are unconstitutional or a taxpayer has a constitutional right not to comply with the Federal tax laws for one of the following reasons:



a. The First Amendment permits a taxpayer to refuse to pay taxes based on religious or moral beliefs.



b. A taxpayer may withhold payment of taxes or the filing of a tax return until the Service or other government entity responds to a First Amendment petition for redress of grievances.



c. Mandatory compliance with, or enforcement of, the tax laws invades a taxpayer's right to privacy under the Fourth Amendment.



d. The requirement to file a tax return is an unreasonable search and seizure contrary to the Fourth Amendment.



e. Income taxation, tax withholding, or the assessment or collection of tax is a "taking" of property without due process of law or just compensation in violation of the Fifth Amendment.



f. The Fifth Amendment privilege against self-incrimination grants taxpayers the right not to file returns or the right to withhold all financial information from the Service.



g. Mandatory or compelled compliance with the internal revenue laws is a form of involuntary servitude prohibited by the Thirteenth Amendment.



h. Individuals may not be taxed unless they are "citizens" within the meaning of the Fourteenth Amendment.



i. The Sixteenth Amendment was not ratified, has no effect, contradicts the Constitution as originally ratified, lacks an enabling clause, or does not authorize a non-apportioned, direct income tax.



j. Taxation of income attributed to a trust, which is a form of contract, violates the constitutional prohibition against impairment of contracts.



k. Similar constitutional arguments described as frivolous in Rev. Rul. 2005-19, 2005-1 C.B. 819.



(10) A taxpayer is not a "person" within the meaning of section 7701(a)(14) or other provisions of the Internal Revenue Code, or similar arguments described as frivolous in Rev. Rul. 2007-22, 2007-14 I.R.B. ___.



(11) Federal Reserve Notes are not taxable income when paid to a taxpayer because they are not gold or silver and may not be redeemed for gold or silver.



(12) In a transaction using gold and silver coins, the value of the coins is excluded from income or the amount realized in the transaction is the face value of the coins and not their fair market value for purposes of determining taxable income.



(13) A taxpayer with a home-based business may deduct as business expenses the costs of maintaining the taxpayer's household along with personal expenses, or similar arguments described as frivolous by Rev. Rul. 2004-32, 2004-1 C.B. 621.



(14) A "reparations" tax credit exists, including arguments that African-American taxpayers may claim a tax credit on their Federal income tax returns as reparations for slavery or other historical mistreatment, that Native Americans are entitled to an analogous credit (or are exempt from Federal income tax on the basis of a treaty), or similar arguments described as frivolous in Rev. Rul. 2004-33, 2004-1 C.B. 628, or Rev. Rul. 2006-20, 2006-15 I.R.B. 746.



(15) A Native American or other taxpayer who is not an employer engaged in a trade or business may nevertheless claim (for example, in an amount exceeding all reported income) the Indian Employment Credit under section 45A, which explicitly requires, among other criteria, that the taxpayer be an employer engaged in a trade or business to claim the credit.



(16) A taxpayer's wages are excluded from Social Security taxes if the taxpayer waives the right to receive Social Security benefits, or a taxpayer is entitled to a refund of, or may claim a charitable-contribution deduction for, the Social Security taxes that the taxpayer has paid, or similar arguments described as frivolous in Rev. Rul. 2005-17, 2005-1 C.B. 823.



(17) Taxpayers may reduce or eliminate their Federal tax liability by altering a tax return, including striking out the penalty-of-perjury declaration, or attaching documents to the return, such as a disclaimer of liability, or similar arguments described as frivolous in Rev. Rul. 2005-18, 2005-1 C.B. 817.



(18) A taxpayer is not obligated to pay income tax because the government has created an entity separate and distinct from the taxpayer --a "straw man" --that is distinguishable from the taxpayer by some variation of the taxpayer's name, and any tax obligations are exclusively those of the "straw man," or similar arguments described as frivolous in Rev. Rul. 2005-21, 2005-1 C.B. 822.



(19) Inserting the phrase "nunc pro tunc" on a return or other document filed with or submitted to the Service has a legal effect, such as reducing a taxpayer's tax liability, or similar arguments described as frivolous in Rev. Rul. 2006-17, 2006-15 I.R.B. 748.



(20) A taxpayer may avoid tax on income by attributing the income to a trust, including the argument that a taxpayer can put all of the taxpayer's assets into a trust to avoid income tax while still retaining substantial powers of ownership and control over those assets or that a taxpayer may claim an expense deduction for the income attributed to a trust, or similar arguments described as frivolous in Rev. Rul. 2006-19, 2006-15 I.R.B. 749.



(21) A taxpayer may lawfully avoid income tax by sending income offshore, including depositing income into a foreign bank account.



(22) By purchasing equipment and services for an inflated price (which may or may not have been actually paid), a taxpayer can use the section 44 Disabled Access Credit to reduce tax or generate a refund irrespective of whether the taxpayer is a small business that purchased the equipment or services to comply with the requirements of the Americans with Disabilities Act.



(23)A taxpayer is allowed to buy or sell the right to claim a child as a qualifying child for purposes of the Earned Income Tax Credit.



(24) An IRS Form 23C, Assessment Certificate - Summary Record of Assessment, is an invalid record of assessment for purposes of section 6203 and Treas. Reg. §301.6203-1, the Form 23C must be personally signed by the Secretary of the Treasury for an assessment to be valid, the Service must provide a copy of the Form 23C to a taxpayer if requested before taking collection action, or similar arguments described as frivolous in Rev. Rul. 2007-21, 2007-14 I.R.B. ___.



(25) A tax assessment is invalid because the assessment was made from a section 6020(b) substitute for return, which is not a valid return.



(26) A statutory notice of deficiency is invalid because the taxpayer to whom the notice was sent did not file an income tax return reporting the deficiency or because the statutory notice of deficiency was unsigned or not signed by the Secretary of the Treasury or by someone with delegated authority.



(27) A Notice of Federal Tax Lien is invalid because it is not signed by a particular official (such as by the Secretary of the Treasury), or because it was filed by someone without delegated authority.



(28) The form or content of a Notice of Federal Tax Lien is controlled by or subject to a state or local law, and a Notice of Federal Tax Lien that does not comply in form or content with a state or local law is invalid.



(29) A collection due process notice under section 6320 or 6330 is invalid if it is not signed by the Secretary of the Treasury or other particular official, or if no certificate of assessment is attached.



(30) Verification under section 6330 that the requirements of any applicable law or administrative procedure have been met may only be based on one or more particular forms or documents (which must be in a certain format), such as a summary record of assessment, or that the particular forms or documents or the ones on which verification was actually determined must be provided to a taxpayer at a collection due process hearing.



(31) A Notice and Demand is invalid because it was not signed, was not on the correct form (e.g., a Form 17), or was not accompanied by a certificate of assessment when mailed.



(32) The United States Tax Court is an illegitimate court or does not, for any purported constitutional or other reason, have the authority to hear and decide matters within its jurisdiction.



(33) Federal courts may not enforce the internal revenue laws because their jurisdiction is limited to admiralty or maritime cases or issues.



(34) Revenue Officers are not authorized to issue levies or Notices of Federal Tax Lien or to seize property in satisfaction of unpaid taxes.



(35) A Service employee lacks the authority to carry out the employee's duties because the employee does not possess a certain type of identification or credential, for example, a pocket commission or a badge, or it is not in the correct form or on the right medium.



(36) A person may represent a taxpayer before the Service or in court proceedings even if the person does not have a power of attorney from the taxpayer, has not been enrolled to practice before the Service, or has not been admitted to practice before the court.



(37) A civil action to collect unpaid taxes or penalties must be personally authorized by the Secretary of the Treasury and the Attorney General.



(38) A taxpayer's income is not taxable if the taxpayer assigns or attributes the income to a religious organization (a "corporation sole" or ministerial trust) claimed to be tax-exempt under section 501(c)(3), or similar arguments described as frivolous in Rev. Rul. 2004-27, 2004-1 C.B. 625.



(39) The Service is not an agency of the United States government but rather a private-sector corporation or an agency of a State or Territory without authority to administer the internal revenue laws.



(40) Any position described as frivolous in any revenue ruling or other published guidance in existence when the return adopting the position is filed with or the specified submission adopting the position is submitted to the Service.


Returns or submissions that contain positions not listed above, which on their face have no basis for validity in existing law, or which have been deemed frivolous in a published opinion of the United States Tax Court or other court of competent jurisdiction, may be determined to reflect a desire to delay or impede the administration of Federal tax laws and thereby subject to the $5,000 penalty.

The list of frivolous positions above will be periodically revised as required by section 6702(c).



DRAFTING INFORMATION

The principal author of this notice is the Office of Associate Chief Counsel (Procedure & Administration). For further information regarding this notice contact the Office of Associate Chief Counsel (Procedure & Administration), Administrative Provisions & Judicial Practice Division, Branch 2, at (202) 622-4940 (not a toll-free call).

For questions on what is frivolous argument, contact

Alvin S. Brown, Esq.
Tax attorney
www.irstaxattorney.com
703.425.1400


Contact www.irsforum.org if you wish to offer an opinion about any of your IRS experiences.

Back Taxes: Section 83 - Substantially vested stock

The IRS addressed the tax consequences under Code Sec. 83 when restrictions were imposed on substantially vested stock, causing that stock to become substantially nonvested. Analyzing three fact patterns, the IRS ruled that if the imposition of restrictions on substantially vested stock causes that stock to become substantially nonvested, but there was no exchange of stock, the substantially nonvested stock is not subject to Code Sec. 83. However, if substantially vested stock is exchanged for substantially nonvested stock, the nonvested stock is subject to Code Sec. 83.


Rev. Rul. 2007-49 , I.R.B. 2007-31, July 6, 2007.


ISSUES

1) Is there a transfer of substantially nonvested stock subject to §83 of the Internal Revenue Code where restrictions imposed on substantially vested stock cause the substantially vested stock to become substantially nonvested?

2) Is there a transfer of substantially nonvested stock subject to §83 where a service provider exchanges substantially vested stock for substantially nonvested stock in a reorganization described in §368(a)?

3) Is there a transfer of substantially nonvested stock subject to §83 where a service provider exchanges substantially vested stock for substantially nonvested stock in a taxable stock acquisition?



FACTS

Investors form Corporation´in 2004, by contributing $1,000 each to Corporation X in exchange for 100 shares of Corporation´stock. In exchange for Individual A's agreement to perform services for Corporation X, Corporation´issues 100 shares of its stock to A. The fair market value of the Corporation´stock on that date is $10 per share. The shares of Corporation´stock transferred to A are "substantially vested" within the meaning of §1.83-3(b) of the Income Tax Regulations.

For the 2004 taxable year, the amount included in A's income under §83(a) is $1,000 (the fair market value of the stock ($10´100 shares) less the amount paid ($0)). A's basis in the stock is $1,000.

Situation 1. In connection with its plan to start a new business venture, Corporation´seeks financing from Investor M on July 9, 2007. Investor M agrees to invest funds in Corporation´in exchange for a specified number of shares and the further requirement that A agree to subject A's shares to a restriction that will cause the stock to be "substantially nonvested" within the meaning of §1.83-3(b). Under this restriction, if the employment of A with Corporation X terminates before July 9, 2009, A must sell the shares to Corporation´in exchange for the lesser of $150 per share (the fair market value of Corporation´stock on July 9, 2007) or the fair market value at the time of forfeiture. In addition, the shares are nontransferable before that date. A remains employed with Corporation X, and on July 9, 2009, the fair market value of Corporation´stock is $250 per share.

Situation 2. Corporation Y, a corporation unrelated to Corporation X, agrees to acquire all of the stock of Corporation X. Accordingly, on August 9, 2010, Corporation Y causes Corporation Z (a newly formed wholly-owned subsidiary of Corporation Y) to merge into Corporation´in a transaction that qualifies as a reorganization described in §368(a). In the merger, the shareholders of Corporation´receive solely Corporation Y voting stock in exchange for their Corporation´stock. The fair market value of the Corporation´stock on August 9, 2010, is $310 per share.

In the merger, A's 100 shares of substantially vested Corporation X stock are exchanged for 100 shares of Corporation Y stock subject to a restriction that will cause the stock to be "substantially nonvested" within the meaning of §1.83-3(b). Under this restriction, if A's employment with Corporation´is terminated for any reason before August 9, 2013, A must sell the substantially nonvested Corporation Y shares to Corporation Y in exchange for the lesser of $310 per share (the fair market value of the shares on August 9, 2010) or the fair market value at the time of forfeiture. In addition, the shares are nontransferable before that date. No other shareholder of Corporation´receives Corporation Y stock subject to a restriction.

A timely files an election under §83(b) with respect to the substantially nonvested Corporation Y stock A receives in the merger.

A continues to be employed by Corporation´until August 9, 2013 at which time the fair market value of the stock is $500. A sells the stock on October 31, 2014 when the fair market value of the stock is $550 per share.

Situation 3. Assume the same facts as in Situation 2 except that in the merger half of the Corporation´stock is exchanged for cash and half is exchanged for Corporation Y stock, the transaction is fully taxable, and all of A's Corporation´stock is exchanged for Corporation Y stock.



LAW

Section 83, provides that if, in connection with the performance of services, property is transferred to any person other than the service recipient, the excess of the fair market value of the property (determined without regard to any restriction other than a restriction which by its terms will never lapse), on the first day that the rights to the property are either transferable or not subject to a substantial risk of forfeiture, over the amount paid for the property is included in the service provider's gross income for the first taxable year in which the rights to the property are either transferable or not subject to a substantial risk of forfeiture.

Section 1.83-3(f) provides that property transferred to an employee or independent contractor (or beneficiary thereof) in recognition of the performance of, or the refraining from performance of, services is considered transferred in connection with the performance of services within the meaning of §83. However, the existence of other persons entitled to buy stock on the same terms and conditions as an employee, whether pursuant to a public or private offering, may indicate that in such circumstances a transfer to the employee is not in recognition of the performance of, or the refraining from performance of, services.

Subjecting stock to a restriction that will cause it to be "substantially nonvested" (within the meaning of §1.83-3(b)) indicates that the property is transferred in connection with the performance of services even if the employee pays fair value for the stock. See Alves v. Commissioner [ 84-2 USTC ¶9546], 734 F.2d 478 (9th Cir. 1984), aff'g [ CCH Dec. 39,501] 79 T.C. 864 (1982).

Section 1.83-1(a)(1) provides that property transferred in connection with the performance of services is not taxable under §83(a) until it has been transferred (as defined in §1.83-3(a)) to an employee or independent contractor and becomes substantially vested (as defined in §1.83-3(b)) in such person. Until such property becomes substantially vested, the transferor is regarded as the owner of the property, and any income from such property received by the employee or independent contractor (or beneficiary thereof) or the right to the use of such property by the employee or independent contractor constitutes additional compensation and must be included in the gross income of such employee or independent contractor for the taxable year in which such income is received or such use is made available.

Section 83(b) provides that any person who has performed services in connection with which property is transferred to any person may elect to include in gross income, for the taxable year in which such property is transferred, the excess of the fair market value of such property at the time of transfer (determined without regard to any restriction other than a restriction which by its terms will never lapse) over the amount paid for such property.

Section 1.83-2(a) provides, in part, that the fact that the transferee has paid full value for the property transferred, realizing no bargain element in the transaction, does not preclude the use of the election under §83(b). If this election is made, the substantial vesting rules of §83(a) and the regulations thereunder do not apply with respect to such property. Thus, with respect to such property, the excess (if any) of the fair market value of the property at the time of transfer (determined without regard to any restriction other than a restriction which by its terms will never lapse) over the amount (if any) paid for such property is includible in gross income as compensation at the time of transfer, and no compensation will be includible in gross income when such property becomes substantially vested. An employee who makes an election under §83(b) is considered to be the owner of the property. See Rev. Rul. 83-22, 1983-1 C.B. 17.

Section 1001(a) provides that the gain from the sale or other disposition of property is the excess of the amount realized over the adjusted basis provided in §1011 for determining gain, and the loss is the excess of the adjusted basis provided in such section for determining loss over the amount realized.

Section 1001(b) provides that the amount realized from the sale or other disposition of the property is the sum of any money received plus the fair market value of the property (other than money) received.

Section 1001(c), provides, except as otherwise provided in Subtitle A, the entire amount of the gain or loss, determined under section 1001, on the sale or exchange of the property shall be recognized.

Section 1.83-3(g) provides that for purposes of §83 and its regulations, the term "amount paid" refers to the value of any money or property paid for the transfer of property to which §83 applies.



ANALYSIS - Situation 1

In Situation 1, in connection with the new investment, the substantially vested shares of Corporation´stock owned by A are subjected to a restriction causing them to be "substantially nonvested". Because the substantially vested shares of Corporation´stock are already owned by A for purposes of §83, there is no "transfer" under §83. Thus, the imposition of new restrictions on the substantially vested shares has no effect for purposes of §83.

When the substantially nonvested Corporation´stock becomes substantially vested on July 9, 2009, A does not recognize compensation income under §83(a). A's basis in the stock continues to be $1,000.



ANALYSIS - Situation 2

In Situation 2, A receives 100 shares of Corporation Y stock with an exchanged basis of $1,000 in the tax-free reorganization. Because the substantially vested Corporation´stock is exchanged for stock that is subjected to a restriction causing the shares to be "substantially nonvested," the substantially nonvested shares are treated as having been transferred in connection with the performance of services, and thus, are subject to §83. As a result of the §83(b) election, A becomes the owner of those shares.

The "amount paid" for the stock under §83 on the transfer of the substantially nonvested shares is the fair market value of the substantially vested Corporation´stock exchanged for the substantially nonvested Corporation Y stock ($31,000) on the exchange date, August 9, 2010. On A's election under §83(b), $31,000 is treated as the amount paid for the Corporation Y stock for purposes of applying §83. On A's return for the 2010 taxable year, A does not report any taxable income from the transfer of the Corporation Y stock under the §83(b) election because the fair market value of the stock less the amount paid is $0. A does not include any amount in compensation income in the 2013 taxable year when the stock becomes substantially vested because of the prior §83(b) election. A's basis in the Corporation Y stock continues to be $1,000. Upon the sale of the shares in 2014, A recognizes capital gain of $54,000, the amount by which $55,000 ($550, the fair market value of the stock,´100 shares) exceeds A's $1,000 basis in the shares.



ANALYSIS - Situation 3

In Situation 3, A holds substantially vested Corporation´stock with a basis of $1,000 at the time of the merger. A exchanges that substantially vested Corporation´stock for substantially nonvested Corporation Y stock with a fair market value of $310 per share in a taxable transaction. Because A disposed of the substantially vested Corporation´stock in exchange for substantially nonvested Corporation Y stock in an exchange to which §1001 applies, A recognizes capital gain on the disposition of the Corporation´stock in the amount of $30,000 ($31,000 fair market value of substantially nonvested Corporation Y stock ($310 per share´100 shares) less $1,000 basis in the Corporation´stock). A's basis in the Corporation Y stock is $31,000.

Because the substantially vested Corporation´stock is exchanged for Corporation Y stock that is subjected to a restriction causing the shares to be "substantially nonvested," the substantially nonvested shares are treated as having been transferred in connection with the performance of services, and thus, are subject to §83.

As in Situation 2, the "amount paid" for the stock under §83 is $31,000. When A makes an election under §83(b) with respect to the Corporation Y stock, A does not report any additional amount of income for the 2010 taxable year as a result of such election because the fair market value of the stock less the amount paid for the stock is $0. A does not include any amount in compensation income in the 2013 taxable year when the stock becomes substantially vested because of the prior §83(b) election. A's basis in the Corporation Y stock continues to be $31,000. On the sale of the 100 shares in 2014, A will recognize capital gain of $24,000, the amount by which $55,000 ($550, the sale price,´100 shares) exceeds A's $31,000 basis in the shares.

If A had not made an election under §83(b) with respect to the Corporation Y stock, when the stock becomes substantially vested on August 9, 2013, A would include $19,000 in gross income as compensation under §83(a). This is the amount by which the fair market value of 100 Corporation Y shares ($50,000 or $500 per share) exceeds the amount paid for those shares ($31,000). Consequently, A's basis in the Corporation Y stock would be increased by $19,000 to $50,000. See §1.83-4(b). On the sale of the 100 shares, A would recognize capital gain of $5,000, the amount by which $55,000 ($550, the sale price,´100 shares) exceeds A's basis of $50,000 in the shares.



HOLDINGS

1) There is not a transfer of substantially nonvested stock subject to §83 where restrictions imposed on substantially vested stock cause the substantially vested stock to become substantially nonvested.

2) There is a transfer of substantially nonvested stock subject to §83 where a service provider exchanges substantially vested stock for substantially nonvested stock in a reorganization described in §368(a).

3) There is a transfer of substantially nonvested stock subject to §83 where a service provider exchanges substantially vested stock for substantially nonvested stock in a taxable stock acquisition.



DRAFTING INFORMATION

The principal author of this revenue ruling is Jean Casey of the Office of Division Counsel/Associate Chief Counsel (Tax Exempt & Government Entities). However, other personnel from the IRS and Treasury Department participated in its development. For further information regarding this revenue ruling, contact Ms. Casey at (202) 622-6030 (not a toll-free call). For further information regarding issues with respect to subchapter C, contact Ms. Jean Brenner at (202) 622-7790 (not a toll-free number).


Alvin S. Brown, Esq.
Tax attorney
www.irstaxattorney.com

You can upload any of your IRS experiences to www.irsforum.com, a nonprofit corporation

Tax Help: "Hardship" will not eliminat 10% early withdrawal penalty

Unfortunately, the courts stricly construe the statutory limitations for avoiding the 10% penalty for from a retirment plans.

Jeffrey Lee Golian v. Commissioner.Docket No. 6603-06S . Filed July 26, 2007.[

Petitioner contributed 3 percent of his salary to the

On line 15a of his return, petitioner reported an IRA distribution of $86,333.33, and on line 15b he reported the entire distribution as the taxable amount, which he included in gross income.

Discussion
In general, the Commissioner's determinations in a notice of deficiency are presumed correct, and the taxpayer bears the burden of showing that those determinations are erroneous. Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); Welch v. Helvering, 290 U.S. 111, 115 (1933). Pursuant to

section 7491(a) applies in this case.4

section 401(k) plan and an IRA. See 408(a), 5

iv), (F).The 10-percent additional tax does not apply to certain distributions, including distributions: (1) To an employee age 59-1/2 or older; (2) on account of the employee's disability; (3) as part of a series of substantially equal periodic payments made for the employee's life (or life expectancy); or (4) to an individual from an IRA which are qualified first-time home buyer distributions.6 7

Petitioner also does not contend that he satisfies any of the specific exceptions set forth in section 72(t). E.g., Arnold v. Commissioner, 111 T.C. 250, 255 (1998); Milner v. Commissioner, T.C. Memo. 2004-111; Gallagher v. Commissioner, T.C. Memo. 2001-34.

We recognize that petitioner received his IRA distribution at a time when he was both a single parent and temporarily unemployed and that he used the distribution for a laudable purpose. Unfortunately for petitioner, we are bound by the list of statutory exceptions set forth in

Finally, the fact that respondent only determined the 10-percent additional tax sometime after making a mechanical adjustment to petitioner's return upon its initial processing is of no moment.8 The fact of the matter is that respondent sent petitioner the notice of deficiency within the applicable statute of limitations. See sec. 6404(e), (h); Rule 280(b); see generally tit. XXVII, Tax Court Rules of Practice and Procedure, regulating actions for review of failure to abate interest; see also Bax v. Commissioner, 13 F.3d 54, 56-57 (2d Cir. 1993) (Tax Court ordinarily lacks jurisdiction to consider interest on a deficiency in the context of an action for redetermination of deficiency); Pen Coal Corp. v. Commissioner, 107 T.C. 249, 255 (1996) (same).

To reflect our disposition of the disputed issue, as well as the parties' concessions, see supra note 2,
Decision will be entered for respondent as to the deficiency in income tax and for petitioner as to the accuracy-related penalty under 1 All subsequent section references are to the Internal Revenue Code in effect for 2003, the taxable year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.2 Petitioner concedes that he received taxable nonemployee compensation of $1,106 from Translink, Inc., that was not reported on his 2003 return. Respondent concedes that petitioner is not liable for the accuracy-related penalty under 3 The distribution did not exhaust petitioner's account balance; however, the distribution was not part of a series of substantially equal periodic payments made for petitioner's life (or life expectancy).4 Pursuant to sec. 72(t) is an "additional amount" for which respondent bears the burden of production, respondent has met such burden by demonstrating that petitioner was 46 years old in 2003 when he received the distribution in issue. See Milner v. Commissioner, T.C. Memo. 2004-111 n. 2.5 At trial, petitioner accurately described his IRA as an account "for my retirement." This is precisely why a preretirement distribution is generally subject to the 10-percent additional tax and why there are relatively few exceptions. "The legislative purpose underlying the 6 For purposes of Sec. 72(t)(5).7 Generally, a distribution from an IRA is includable in the distributee's gross income in the year of distribution under the provisions of sec. 408(d)(1); see also 8 See sec. 6213(b)(1), permitting summary assessments arising out of mathematical or clerical errors.

Alvin S. Brown, Esq.

703.425.1400

www.irstaxattorney.com

Submit any of your IRS experiences to www.irsforum.org

Tax Attorney: Interest Abatement not abuse of discretion



Ralph Howell v. Commissioner, Dkt. No. 13117-05 , TC Memo. 2007-204, July 25, 2007.



[Code Sec. 6404]



The IRS's denial of a taxpayer's interest abatement request was not an abuse of discretion because none of the errors or delays he complained of were ministerial acts under Code Sec. 6404. The taxpayer had requested an abatement of interest that had accrued while the IRS conducted a criminal investigation of several tax-shelter partnerships in which he had invested. Although the IRS included erroneous information regarding the status of the investigation in a letter to the taxpayer, that did not contribute to the accrual of interest. Moreover, the IRS was not collaterally estopped by the case of another investor (Beall v. U.S., 2006-2 USTC ¶50,615) from denying it lost some of the records it had confiscated, and that others were returned in disarray, because that issue was not litigated in Beall. --CCH.




MEMORANDUM OPINION


VASQUEZ, Judge: Petitioner submitted to the Internal Revenue Service (IRS) a request for abatement of interest relating to his 1984, 1985, and 1986 income tax liabilities. Respondent denied the request. The issue for our determination is whether respondent abused his discretion under section 6404 by failing to abate assessments of interest relating to petitioner's 1984, 1985, and 1986 taxable years.1



Background







OPINION




I. Section 6404(e)

Pursuant to section 6404(e)(1) as it applies in this case, the Commissioner may abate the assessment of interest in two situations: (1) When a deficiency is attributable to an error or delay by an officer or employee of the IRS in performing a ministerial act, or (2) when interest is assessed on any payment of certain taxes (including income tax) to the extent that an error or delay in such payment is attributable to an officer or employee of the IRS being erroneous or dilatory in performing a ministerial act.5 An error or delay by an officer or employee of the IRS shall be taken into account only if no significant aspect of such error or delay can be attributed to the taxpayer involved, and after the IRS has contacted the taxpayer in writing with respect to such deficiency or payment. Id.

A "ministerial act" is a procedural or mechanical act that does not involve the exercise of judgment or discretion and that occurs during the processing of a taxpayer's case after all prerequisites to the act, such as conferences and review by supervisors, have taken place. Sec. 301.6404-2T(b)(1), Temporary Proced. & Admin. Regs., 52 Fed. Reg. 30163 (Aug. 13, 1987).6 A decision concerning the proper application of Federal tax law (or other Federal or state law) is not a ministerial act. Id.

Even where errors or delays are present, the Commissioner's decision to abate interest remains discretionary. See sec. 6404(e)(1); Mekulsia v. Commissioner, T.C. Memo. 2003-138, affd. 389 F.3d 601 (6th Cir. 2004). When Congress enacted section 6404(e), it did not intend the provision to be used routinely to avoid payment of interest. Rather, Congress intended abatement of interest to be used only where failure to do so "would be widely perceived as grossly unfair." H. Rept. 99-426, at 844 (1985), 1986-3 C.B. (Vol. 2) 1, 844; S. Rept. 99-313, at 208 (1986), 1986-3 C.B. (Vol. 3) 1, 208.



II. Standard of Review and Burden of Proof

When reviewing the Commissioner's determination not to abate interest, we apply an abuse of discretion standard. See sec. 6404; Camerato v. Commissioner, T.C. Memo. 2002-28. The taxpayer bears the burden of proof with respect to establishing an abuse of discretion. See Rule 142(a). In order to prevail, the taxpayer must establish that in not abating interest the Commissioner exercised his discretion arbitrarily, capriciously, or without sound basis in fact or law. Lee v. Commissioner, 113 T.C. 145, 149 (1999); Woodral v. Commissioner, 112 T.C. 19, 23 (1999).



III. Analysis

Petitioner alleges that respondent engaged in several forms of ministerial error or delay.

Petitioner first alleges that during respondent's criminal investigation of AMCOR respondent "was in full possession of the records necessary to issue a tax deficiency, but failed to do so."

Regardless of whether respondent possessed the records required to determine petitioner's deficiencies during respondent's criminal investigation of AMCOR, the long and winding procedural history of the AMCOR audit and litigation prevented respondent from making that determination for several years. Pursuant to section 6221, the proper tax treatment of petitioner's AMCOR-related items was required to be determined at the partnership level. Pursuant to section 6225(a), respondent was prohibited from assessing or collecting petitioner's deficiencies until the decisions in the AMCOR partnership cases in this Court became final. As noted supra, that did not occur until October 17, 2001, long after respondent returned the AMCOR records in 1993. Petitioner has therefore failed to establish that respondent's delay in assessing petitioner's deficiencies until the close of AMCOR-related partnership litigation constitutes error or delay in performing a ministerial act.7

Petitioner also alleges that the imposition of interest is grossly unfair because the amounts of interest assessed now greatly exceed the amounts of the deficiencies. As we have noted on several occasions, the mere passage of time does not establish error or delay in performing a ministerial act. Lee v. Commissioner, supra at 151; Mekulsia v. Commissioner, supra; Hawksley v. Commissioner, T.C. Memo. 2000-354; Cosgriff v. Commissioner, T.C. Memo. 2000-241.

Petitioner further alleges that the information regarding the examination status of Agri-Venture Fund contained in respondent's letter of January 20, 1997, was erroneous and its inclusion constituted ministerial error.8


In order to qualify for relief pursuant to section 6404(e), a taxpayer must demonstrate a direct link between the error or delay and a specific period during which interest accrued. Guerrero v. Commissioner, T.C. Memo. 2006-201; Braun v. Commissioner, T.C. Memo. 2005-221. Respondent's error has not been shown to have caused the accrual of any interest. Although the case of Agri-Venture Fund may not have been "in Appeals" when respondent issued the letter of January 20, 1997, the case was before this Court when the letter was issued. As the letter correctly noted, the period of limitations on assessment of deficiencies in petitioner's taxes was consequently suspended. See sec. 6229(d)(1). Petitioner has not shown that respondent's letter of January 20, 1997, caused any accrual of interest that is attributable to error or delay in performing a ministerial act.

Petitioner further contends that the error contained in respondent's letter of January 20, 1997, provides an independent basis for the abatement of interest pursuant to section 6404(f). Generally speaking, section 6404(f) allows for the abatement of penalties and additions to tax, and not of assessments of interest.9 See sec. 301.6404-3(c)(2), Proced. & Admin. Regs. Petitioner's argument regarding section 6404(f) is therefore unfounded.

Finally, petitioner argues that respondent lost some of the documents that respondent seized in March of 1989 from AMCOR's office and that respondent returned other documents in a state of disarray. Petitioner appears to argue that respondent is collaterally estopped from denying such facts pursuant to statements in the U.S. Court of Appeals for the Fifth Circuit's opinion in the case of another AMCOR investor, Beall v. United States, 467 F.3d 864 (5th Cir. 2006) affg. 335 F. Supp. 2d 743, (E.D. Tex. 2004).10 The relevant portion of the Court of Appeals' opinion reads as follows: "The IRS did not return the partnerships' books and records until 1993, and when the IRS did return them, some had been lost and the remainder were in disarray." Id. at 866.

The doctrine of issue preclusion, or collateral estoppel, provides that once an issue of fact or law is "'actually and necessarily determined by a court of competent jurisdiction, that determination is conclusive in subsequent suits based on a different cause of action involving a party to the prior litigation.'" Monahan v. Commissioner, 109 T.C. 235, 240 (1997) (quoting Montana v. United States, 440 U.S. 147, 153 (1979)). The following five conditions must be satisfied before application of issue preclusion in the context of a factual dispute: (1) The issue in the second suit must be identical in all respects with the one decided in the first suit; (2) there must be a final judgment rendered by a court of competent jurisdiction; (3) collateral estoppel may be invoked against parties and their privies to the prior judgment; (4) the parties must actually have litigated the issues and the resolution of these issues must have been essential to the prior decision; and (5) the controlling facts and applicable legal rules must remain unchanged from those in the prior litigation. Peck v. Commissioner, 90 T.C. 162, 166-167 (1988), affd. 904 F.2d 525 (9th Cir. 1990).

The statement in the Court of Appeals' opinion in Beall does not establish that respondent failed to return documents or that respondent returned other documents in disarray. First, petitioner was not a party to the dispute in Beall . Second, as respondent correctly notes, the Court of Appeals' opinion in Beall related to the review of a District Court's decision to grant a motion of respondent's that was treated as a motion to dismiss for failure to state a claim upon which relief could be granted pursuant to rule 12(b)(6) of the Federal Rules of Civil Procedure. Pursuant to that rule:

"a claim may be dismissed when a plaintiff fails to allege any set of facts in support of his claim which would entitle him to relief," and "the court accepts as true the well-pled factual allegations in the complaint, and construes them in the light most favorable to the plaintiff."

Beall v. United States, 335 F. Supp. 2d at 747 (quoting Taylor v. Books A Million, Inc., 296 F.3d 376, 378 (5th Cir. 2002)) (internal citations removed). Applying this standard, both the District Court and the Court of Appeals were required to accept the plaintiffs' factual allegations as true regardless of their veracity. Consequently, the question of whether respondent's agents or employees lost some documents and returned others in disarray was not actually litigated in Beall, and collateral estoppel does not apply to the factual assumptions in Beall. The parties have not stipulated the relevant factual assumptions in Beall. Petitioner has therefore not established that respondent lost some AMCOR records and returned others in disarray in pursuit of respondent's criminal investigation of AMCOR.

We conclude that respondent's denial of petitioner's request for interest abatement was not arbitrary, capricious, or without sound basis in fact or law. In reaching all of our holdings herein, we have considered all arguments made by the parties, and to the extent not mentioned above, we find them to be irrelevant or without merit.

To reflect the foregoing,

Decision will be entered for respondent.

1 All section references are to the Internal Revenue Code in effect for the years in issue unless otherwise indicated, and all Rule references are to the Tax Court Rules of Practice and Procedure.

2 After receiving an extension of time to file, petitioner timely filed his 1984 return. Petitioner filed his 1985 and 1986 returns a few days after the end of extension periods respondent granted.

3 For some of the history of AMCOR and the investigation into its operations, see, for example, Crop Associates-1986 v. Commissioner, T.C. Memo. 2000-216.

4 The parties did not submit a copy of respondent's Jan. 17, 2003, letter disallowing petitioner's request for interest abatement with regard to his 1986 deficiency, but the parties stipulated that the contents of that letter were identical in all respects to the letters disallowing petitioner's requests for interest abatement with regard to his 1984 and 1985 deficiencies.

5 In 1996, sec. 6404(e) was amended by the Taxpayer Bill of Rights 2, Pub. L. 104-168, sec. 301(a)(1) and (2), 110 Stat. 1457, to permit the Commissioner to abate the assessment of interest attributable to IRS errors or delays in performing both managerial and ministerial acts. The amendment applies to interest accruing with respect to deficiencies for taxable years beginning after July 30, 1996, and therefore does not apply to the matter before us.

6 Final regulations under sec. 6404 were issued on Dec. 18, 1998, and contain the same definition of a ministerial act as do the temporary regulations. See sec. 301.6404-2(b)(2), Proced. & Admin. Regs. The final regulations generally apply to interest accruing on deficiencies or payments of tax described in sec. 6212(a) for taxable years beginning after July 30, 1996, and do not apply to the years at issue in this case. See sec. 301.6404-2(d)(1), Proced. & Admin. Regs.

7 In Crop Associates-1986 v. Commissioner, supra, in answer to the TMP's allegations that respondent had delayed the litigation of AMCOR partnership cases, we concluded that "Blame (if any) for the time it took to proceed to the present posture cannot be laid only at the feet of respondent." Indeed, it appears that the litigation was protracted by, among other things, sundry claims advanced on behalf of the AMCOR partnerships, none of which was deemed persuasive. See Crop Associates-1986 v. Commissioner, 113 T.C. 198 (1999); Agri-Cal Venture Associates v. Commissioner, T.C. Memo. 2000-271; Crop Associates-1986 v. Commissioner, T.C. Memo. 2000-216.

8 In his second amended petition, petitioner alleges that an additional letter from respondent dated June 27, 2000, contained similar erroneous information. Petitioner attached a copy of that letter to his second amended petition, but no copy of the letter was entered into evidence. Documentary material attached to a petition is not evidence. Greengard v. Commissioner, 29 F.2d 502 (7th Cir. 1928), affg. 8 B.T.A. 734 (1927); Pallottini v. Commissioner, T.C. Memo. 1986-530. Moreover, in a fully stipulated case such as the matter before us, we consider those matters not contained in the stipulations to be without support in the record. Miyamoto v. Commissioner, T.C. Memo. 1986-313. We therefore do not consider the contents of the letter attached to petitioner's second amended petition. We note, however, that consideration of the letter would not alter our conclusions in the matter before us.

9 Sec. 6404(f) does allow for abatement of interest imposed with respect to any penalty or addition to tax. See sec. 301.6404-3(c)(2), Proced. & Admin. Regs. Such interest is not at issue in the matter before us.

10 Petitioner does not appear to request that the Court take judicial notice of the "facts" in Beall v. United States, 467 F.3d 864 (5th Cir. 2006). We note, however, that taking judicial notice would be inappropriate in this matter. See Abelein v. Commissioner, T.C. Memo. 2007-24.

Alvin S. Brown, Esq.
Tax Attorney
703.45.1400
www.irstaxattorney.com

for IRS abuses, see www.IRSForum.org

Back Taxes: "Reasonable cause" for IRC 6651(a) - reliance on an attorney


Estate of Gertrude Zlotowski, Deceased, Gunther Grewe, Ancillary Administrator, C.T.A. v. Commissioner.Dkt. No. 22150-04 , TC Memo. 2007-203, July 24, 2007.

An estate was liable for penalties under section 6018 imposes on the executor the obligation to make the necessary return of tax. The term "executor" is defined in section 2203, and the parties agree that (1) Messrs. Roisen and Helman were executors within the meaning of those sections, and (2) they, and only they, were responsible for filing the estate tax return when it became due.

Section 6651(a)(1) provides for an addition to tax in the event a taxpayer fails to file a timely return (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. The amount of the addition is equal to 5 percent of the amount required to be shown as tax on the delinquent return for each month or fraction thereof during which the return remains delinquent, up to a maximum addition of 25 percent for returns more than 4 months delinquent.II.

Dispute
The parties do not dispute the computation of the 1

The term "willful neglect" denotes "a conscious, intentional failure or reckless indifference." United States v. Boyle, 469 U.S. 241, 245 (1985). Reasonable cause is established where, despite the exercise of ordinary business care and prudence, a taxpayer is unable to file timely. Id. at 246 & n.4; sec. 301.6651-1(c)(1), Proced. & Admin. Regs.; see also McMahan v. Commissioner, 114 F.3d 366, 369 (2d Cir. 1997) (considering elements constituting reasonable cause for late filings under

Nevertheless, describing the executor's duty to file the return as an "unambiguous, precisely defined duty", the Court cautioned that the executor's expectation that the attorney, as his agent, would attend to the matter "does not relieve the principal of his duty to comply with the statute." Id. The Court described as among those very narrow circumstances in which an executor may be excused from discharging his duty to ascertain and meet the filing deadline the circumstance in which an executor has relied on the erroneous advice of counsel concerning a question of law; e.g., "when a taxpayer shows that he reasonably relied on the advice of an accountant or attorney that it was unnecessary to file a return, even when such advice turned out to have been mistaken." Id.
B. Analysis
We start our analysis with two unassailable facts: Messrs. Roisen and Helman were obligated to file the estate tax return no later than December 10, 2000, and they failed in that obligation. Petitioner may escape an addition to tax on account of that failure if he can show that they had reasonable cause for the failure because they reasonably relied on the advice of Mr. Ledley that they had no such obligation. Petitioner, however, has failed to make that showing. Indeed, petitioner has failed to show that, on December 10, 2000, Messrs. Roisen and Helman were aware that the last day for filing the estate tax return was passing without the return being filed, much less that they let it pass without filing the return in reliance on Mr. Ledley's advice.
Mr. Helman is deceased, and petitioner has provided no evidence of Mr. Helman's state of mind. Mr. Roisen testified about his administration of the estate, and, from that testimony, we draw the conclusion that he was almost completely disengaged from estate administration, relying on Mr. Ledley to do virtually all that was required of him and Mr. Helman. Specifically, we make the following findings, based on Mr. Roisen's testimony: He agreed to serve as an executor to accommodate his old business acquaintance, decedent's husband. He relied on decedent's attorney for the selection of Mr. Ledley as executors' counsel. He knew nothing about the estate and relied fully on Mr. Ledley, who, from his perspective, was in charge of the estate. Apart from signing the Form 706, he did not participate in filing it, which job, he believed, was in Mr. Ledley's hands. He never discussed with Mr. Ledley penalties for a late-filed return. He only discussed with Mr. Ledley whether the return was going to be filed on time after it already was late.
Mr. Roisen's almost complete disengagement from return preparation is captured by his final exchange with one of respondent's counsel:
Q: So, essentially your testimony is that they [i.e., Mr. Ledley] took care of everything relative to the filing of the return?
A: Absolutely. That is a hundred percent correct.
Q: And you had no participation in the filing of the return?
A: No, except that they required my signature, because being the executor of the will, I had to sign it, and which I did. I had full confidence in them.
Mr. Roisen signed the estate tax return, on August 28, 2001, after it was more than 8 months overdue.
While we have before us Mr. Ledley's testimony that, in late September or early October of 2000, he advised Messrs. Roisen and Helman to suspend their administration of the estate and he also advised them not to file an estate tax return, we have no testimony from Mr. Roisen that either he or Mr. Helman ever received (or, if received, understood) that advice. At trial, Mr. Roisen was called as a witness by petitioner. He was examined by one of petitioner's counsel with respect to advice received from Mr. Ledley. He readily agreed with counsel that he had received advice from Mr. Ledley and had followed that advice. Counsel's questions, however, were with respect to advice generally; she did not ask Mr. Roisen whether he received and followed any advice with respect to not making a timely return of tax (i.e., filing the estate tax return on or before December 10, 2000). We infer from that failure of inquiry that Mr. Roisen's answer to that question would not have been favorable to petitioner's case. See Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158, 1165 (1946) ("the failure of a party to introduce evidence within his possession and which, if true, would be favorable to him, gives rise to the presumption that if produced it would be unfavorable"), affd. 162 F.2d 513 (10th Cir. 1947). We are not dissuaded by Mr. Ledley's testimony from our conclusion, expressed above, that petitioner has not shown that Messrs. Roisen and Helman's failure to file timely the return was due to their reliance on advice received from Mr. Ledley.
Finally, even considering Mr. Ledley's advice, it was not advice that, as a matter of law, Messrs. Roisen and Helman had no obligation to file an estate tax return by December 10, 2000. It was simply advice that there was some risk (unspecified) with continuing their administration of the estate (including filing the estate tax return). Indeed, Mr. Ledley returned to preparation of the estate tax return in late January or early February 2001 since, he testified, it was taking a long time for the heirs under the German will to take over the New York proceeding.

2
C. Conclusion
Petitioner has failed to show that, on account of reasonable cause and not due to willful neglect, petitioner is excepted from liability for the section 6651(a)(1) for failure to file timely the Form 706.
Decision will be entered under Rule 155.1 The delinquency having been established, respondent has met the burden of production placed on him by 2 Until Messrs. Roisen and Helman were relieved of their duties as executors, there is no question but that it was their obligation to file the Form 706. See sec. 20.6018-2, Estate Tax Regs. Although they may not have had complete information about the German assets, they could have satisfied that obligation by filing a timely tax return based on the best information available and later filing an amended return. See Estate of Vriniotis v. Commissioner, 79 T.C. 298, 311 (1982).

Tax Help: $25,000 maximum penalty for frivolous argument

Taxpayer was found to have appealed to the Tax Court with the only purpose to delay the IRS. The individual failed to file returns for several consecutive years and at his Collection Due Process hearing, and in subsequent communications, made only frivolous and groundless arguments. At trial, the individual offered no evidence as to his deficiency or the IRS determination and continued to make only frivolous arguments. The maximum penalty of $25,000 under Code Sec. 6673 was imposed for instituting and maintaining proceedings simply for delay. The individual also made several disrespectful statements to the court and acted belligerently, and the court warned him that, if he returned to the court and proceeded to act belligerently or disrespectfully, it would consider additional criminal and civil sanctions under Code Sec. 7456.

I have no problem with this decision, but it does make the point that failure to file tax returns in most cases is not treated as a criminal act under IRC 7203. For this reason, I find the IRS inconsistent in dealing with taxpayers who have not filed tax returns.


Kevin M. Moore v. Commissioner, Dkt. No. 17901-06L , TC Memo. 2007-200, July 23, 2007.

Kevin M. Moore, pro se; Monica J. Miller and Laura A. Price, for respondent.


MEMORANDUM FINDINGS OF FACT AND OPINION

VASQUEZ, Judge: Pursuant to section 6330(d),1 petitioner seeks review of respondent's determination to proceed with collection of his 1997, 1998, 1999, 2000, 2001, and 2002 income tax liabilities.

Confronted with petitioner's refusal to work toward a stipulation of facts, on March 7, 2007, respondent filed a motion to show cause why proposed facts in evidence should not be accepted as established pursuant to Rule 91(f). Respondent attached to his motion a proposed stipulation of facts and exhibits.

On March 9, 2007, the Court issued an order to show cause under Rule 91(f), requiring petitioner to file a response on or before March 29, 2007, as to why matters set forth in respondent's motion should not be deemed admitted. Additionally, the Court ordered that if petitioner's response was evasive or not fairly directed to the proposed stipulation or portion thereof, that matter or portion thereof would be deemed stipulated for purposes of the pending case, and an order would be entered accordingly, pursuant to Rule 91(f).

On April 2, 2007, petitioner filed a response to the Court's order to show cause.

On April 4, 2007, the Court made absolute its order to show cause under Rule 91(f), and ordered that the facts and evidence set forth in respondent's proposed stipulation of facts were deemed established.


FINDINGS OF FACT

Accordingly, pursuant to Rule 91(f), the facts set forth in the Rule 91(f) motion are deemed stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference. At the time he filed the petition, petitioner resided in Tampa, Florida.

Petitioner failed to timely file Federal income tax returns for 1997, 1998, 1999, 2000, 2001, and 2002. On October 17, 2003, respondent sent petitioner statutory notices of deficiency for 1997, 1999, and 2000. On February 4, 2004, respondent sent petitioner a statutory notice of deficiency for 2001. Respondent determined deficiencies in and additions to petitioner's Federal income tax as follows:2



Additions to Tax

__________________________________________
Year Deficiency Sec. 6651(a)(1) Sec. 6654(a)




1997 $52,911 $11,905 $2,851

1999 28,242 5,454 1,294

2000 53,465 12,030 2,876

2001 51,134 15,852 2,024


Petitioner received the notices of deficiency and chose not to petition this Court.

On March 29, 2006, respondent sent petitioner a Final Notice --Notice of Intent to Levy and Notice of Your Right to a Hearing with respect to petitioner's 1997, 1998, 1999, 2000, 2001, and 2002 taxable years (levy notice). The levy notice listed petitioner's total outstanding liabilities as of that date as $79,614, $37,697, $18,099, $67,404, $64,011, and $55,670, for 1997, 1998, 1999, 2000, 2001, and 2002, respectively (a total of $322,495).

On April 20, 2006, petitioner sent respondent a Form 12153, Request for a Collection Due Process Hearing, regarding his 1997, 1998, 1999, 2000, 2001, and 2002 tax years. The only reason petitioner provided on the Form 12153 for respondent not to proceed with collection was "Does not make sufficient money to help support myself."

On June 29, 2006, petitioner had a face-to-face section 6330 hearing with Settlement Officer James Feist. Among other things, petitioner requested that Settlement Officer Feist "provide evidence verifying the U.S. Individual Income Tax/Forms 1040 and Form 433-A in question are in compliance with the specifications of the PAPERWORK REDUCTION ACT (PRA) and have been issued current and valid control numbers from the Office of Management and Budget." The only nonfrivolous issue petitioner raised at the hearing was financial hardship.

On or about July 12, 2006, petitioner mailed Settlement Officer Feist a copy of Rev. Rul. 2006-21, 2006-1 C.B. 745, regarding frivolous tax returns. This revenue ruling states that arguments regarding the Paperwork Reduction Act --including that the Paperwork Reduction Act allegedly relieves taxpayers of the duty to file income tax returns --have no merit and are frivolous. The revenue ruling, under the heading "CIVIL AND CRIMINAL PENALTIES", notes that in addition to several other potential penalties, taxpayers may be liable for "a penalty of up to $25,000 under section 6673 if the taxpayer makes frivolous arguments in the United States Tax Court." Id., 2006-1 C.B. at 746. On the face of the revenue ruling petitioner wrote that he had read the revenue ruling. Petitioner attached a document containing frivolous and groundless arguments to the revenue ruling.

On August 3, 2006, respondent issued a Notice of Determination Concerning Collection Action(s) Under Section 6320 and/or 6330 (notice of determination) to petitioner regarding his 1997, 1998, 1999, 2000, 2001, and 2002 tax years. In the notice of determination, respondent determined that the proposed collection action was appropriate, petitioner failed to submit a viable collection alternative, and collection should proceed. In an attachment to the notice of determination, respondent referred petitioner to "The Truth About Frivolous Tax Arguments" and provided an Internet address to access the document.

On May 16, 2007, the Court held a trial in this matter. That same day, the Court filed respondent's and petitioner's pretrial memoranda. In his pretrial memorandum, petitioner stated that he did not intend to call any witnesses. Petitioner's pretrial memorandum contained frivolous and groundless arguments. Respondent's pretrial memorandum again warned petitioner about the section 6673 penalty for making frivolous arguments to the Court.

On May 18, 2007, petitioner filed a statement containing frivolous and groundless arguments. Petitioner's statement also contained disparaging and disrespectful statements directed to the Court. That same day, petitioner filed a voluminous document entitled "Petitioner's Motions" which was replete with frivolous and groundless tax-protester arguments.

On May 30, 2007, the Court denied "Petitioner's Motions".


OPINION




I. Determination To Proceed With Collection
Section 6330(a) provides that the Secretary shall furnish taxpayers with written notice of their right to a hearing before any property is levied upon. Section 6330 further provides that the taxpayer may request administrative review of the matter (in the form of a hearing) within a 30-day period. Sec. 6330(a) and (b).

Pursuant to section 6330(c)(2)(A), a taxpayer may raise at the section 6330 hearing any relevant issue with regard to the Commissioner's collection activities, including spousal defenses, challenges to the appropriateness of the Commissioner's intended collection action, and alternative means of collection. Sego v. Commissioner, 114 T.C. 604, 609 (2000); Goza v. Commissioner, 114 T.C. 176, 180 (2000). If a taxpayer received a statutory notice of deficiency for the years in issue or otherwise had the opportunity to dispute the underlying tax liability, the taxpayer is precluded from challenging the existence or amount of the underlying tax liability. Sec. 6330(c)(2)(B); Sego v. Commissioner, supra at 610-611; Goza v. Commissioner, supra at 182-183.

Petitioner received notices of deficiency for 1997, 1999, 2000, and 2001. Accordingly, he cannot challenge his underlying liabilities for those years. See sec. 6330(c)(2)(B); Sego v. Commissioner, supra at 610-611; Goza v. Commissioner, supra at 182-183.

At trial, the Court gave petitioner several opportunities to present evidence regarding his underlying liabilities for 1998 and 2002. The Court asked petitioner several times whether he wanted to address his deficiencies or underlying liabilities. When asked by the Court whether he had anything to say about his deficiencies or underlying liabilities, petitioner answered "No." Accordingly, we review respondent's determination for 1997, 1998, 1999, 2000, 2001, and 2002 for an abuse of discretion. See Sego v. Commissioner, supra at 610.

Settlement Officer Feist conducted a thorough review of the financial information that petitioner provided to him. Upon the basis of: (1) Petitioner's financial information, (2) petitioner's having taken no significant voluntary action (as suggested) towards resolving his tax situation, and (3) petitioner's having paid only $111 (via withholding) and $4,000 (via a 1999 estimated tax payment) towards assessed taxes of $184,733 for 1997 through 2003, respondent determined that petitioner did not submit a viable collection alternative.

At trial, the Court asked petitioner several times whether he wanted to put on any evidence or had any evidence to submit regarding respondent's determination. Petitioner did not take advantage of any of the repeated opportunities the Court presented to him.

Petitioner has failed to raise a spousal defense, make a valid challenge to the appropriateness of respondent's intended collection action, or offer a viable alternative means of collection. These issues are now deemed conceded. See Rule 331(b)(4). Accordingly, we conclude that respondent did not abuse his discretion, and we sustain respondent's determination to proceed with collection.



II. Section 6673(a)
Section 6673(a)(1) authorizes this Court to require a taxpayer to pay to the United States a penalty not to exceed $25,000 if the taxpayer took frivolous positions in the proceedings or instituted the proceedings primarily for delay. A position maintained by the taxpayer is "frivolous" where it is "contrary to established law and unsupported by a reasoned, colorable argument for change in the law." Coleman v. Commissioner, 791 F.2d 68, 71 (7th Cir. 1986).

At trial, the Court repeatedly advised petitioner to address the issues in, and present evidence regarding, his case. Instead of presenting evidence or addressing the merits of his case, petitioner belligerently shouted, yelled, and screamed irrelevant questions repeatedly at the Court. Petitioner repeatedly interrupted the Court and directed disrespectful statements to the Court. Additionally, rather than directing his attention to his case or the Court, petitioner shouted and called out to approximately a dozen persons in the gallery disrespectful and irrelevant remarks impugning the integrity of the Court.

In Pierson v. Commissioner, 115 T.C. 576, 581 (2000), we issued an unequivocal warning to taxpayers concerning the imposition of penalties pursuant to section 6673(a) on those taxpayers who abuse the protections afforded by sections 6320 and 6330 by instituting or maintaining actions under those sections primarily for delay or by taking frivolous or groundless positions in such actions. Petitioner filed multiple frivolous documents with the Court. Petitioner's position, based on stale and meritless contentions, is manifestly frivolous and groundless, and he has wasted the time and resources of this Court. We are convinced that petitioner instituted and maintained these proceedings primarily for delay. Although the amount is scarcely sufficient,3 we shall impose a penalty of $25,000 pursuant to section 6673.



III. Additional Sanctions
As we stated in Williams v. Commissioner, 119 T.C. 276, 281-282 (2002) (citations omitted):

all courts are vested with the inherent "power to impose silence, respect, and decorum, in their presence, and submission to their lawful mandates". It is established that this Court has

inherent power and authority to regulate and supervise proceedings before it so as to insure the integrity of its processes. The Court's inherent power extends to regulate both conduct before it and conduct beyond its confines. The Court has recognized its authority to maintain the integrity of its proceedings and its ability to provide relief for a party's misconduct.

In addition to our inherent power, section 7456(c), as pertinent to this case, provides that

The Tax Court and each division thereof shall have power to punish by fine or imprisonment, at its discretion, such contempt of its authority, and none other, as --

(1) misbehavior of any person in its presence or so near thereto as to obstruct the administration of justice; * * *

In Williams, as is the case herein, a $25,000 penalty under section 6673 was imposed because of the taxpayer's obvious pattern of delay and extensive waste of the resources of the court system and the Government. Id. at 282. In Williams, we considered whether it would be appropriate to impose a sanction on the taxpayer in addition to the $25,000 section 6673 penalty for his institution or maintenance of the proceeding for purposes of delay. Id.

We stated: "contempt of court may be civil or criminal, depending upon the purpose being served. '[C]ivil contempt is coercive and remedial in character whereas criminal contempt is punitive to vindicate the authority of the Court.'" Id. at 282-283 (citations omitted). Because of the possibility of a monetary fine being imposed as a criminal sanction, the taxpayer was provided with an opportunity to show cause why such a fine should not be imposed. Id. at 283.

Although petitioner's actions herein were contemptuous, we shall not reward petitioner by delaying this matter any further. Perhaps petitioner will see the error of his ways. Should he return to the Court, however, and proceed similarly (e.g., by engaging in belligerent or disrespectful misbehavior in the presence of the Court to obstruct the administration of justice), petitioner is on notice that the Court will consider imposing appropriate sanctions pursuant to section 7456(c), in addition to the penalty provided by section 6673, to impress upon him that such misbehavior will not be tolerated by this Court. To reflect the foregoing,

An appropriate decision will be entered.

1 Unless otherwise indicated, all section references are to the Internal Revenue Code, and all Rule references are to the Tax Court Rules of Practice and Procedure.

2 Amounts are rounded to the nearest dollar.

3 We note that the original version of the sec. 6673 penalty dates back to 1926; however, Congress has not raised the amount of the sec. 6673 penalty since 1989. See Omnibus Budget Reconciliation Act of 1989, Pub. L. 101-239, sec. 7731(a), 103 Stat. 2400. For a discussion of the history of sec. 6673, see Wilkinson v. Commissioner, 71 T.C. 633

Alvin S. Brown
Tax attorney
703.425.1400
www.irstaxattorney.com

Tax Attorney: Unlawful IRC 6103 disclosure by IRS.

I was personally very pleased to see the decision in Snider v. US where the 8th Cir. stated that the IRS should not announce to 3rds parties that they are conducting a "criminal examination."
The public does not understand the burden of proof and that an allegation is merely an allegation. There is serious personal and business damage where the IRS informs other that a person is under "criminal ivestigation."

Snider v. United States; Turley v. United States,1 468 F.3d 500 (8th Cir. 2006),petition for reh'g en banc denied,U.S. Court of Appeals, 8th Circuit; 05-3636, 05-3639, 05-3835, 05-3836, 05-4203, November 8, 2006.Affirming in part and reversing in part DC Mo. 2005-2 USTC ¶50,610.[ Code Sec. 6103], IRS Non-acq.


Taxpayer Leonard Snider operated a business called National Sales and Service, LLC ("NSS"). Taxpayer Theresa Turley operated a business called Labor Resources. These businesses supplied workers to hotels and businesses near the Lake of the Ozarks, Missouri. In July of 2001, the IRS opened a criminal administrative investigation against Snider and Turley after receiving a tip that they were not paying income and employment taxes, employing illegal aliens, submitting false documents regarding those illegal aliens, and engaging in money laundering.Special Agent Robert Jackson with the IRS Criminal Investigation Division in Kansas City, Missouri, performed the investigation. In the course of his investigation, Jackson disclosed certain "return information" regarding the Taxpayers without legal authorization, in violation of §6103. Essentially, Jackson told many third parties that the Taxpayers were being investigated for criminal tax violations and accused the Taxpayers of several crimes. Jackson also warned some of the Taxpayers' business customers that they might be liable for the Taxpayers' unpaid taxes.In one instance, Jackson interviewed Ineke Kirby, who performed accounting services for Turley in 2000 and 2001. During the interview, Jackson made the following affirmative statements, all of which constituted return information: (1) Turley had a large increase in income from 1999 to 2000 that was questionable; (2) Turley employed illegal immigrants; (3) Turley was avoiding paying employer taxes; (4) Turley and Snider were involved in money laundering; and (5) Turley's workers used fake social security numbers. Jackson also disclosed return information when he showed Turley's 1999 tax return to Kirby, which was the first time she had seen it. From this encounter, the district court found one unauthorized disclosure as to Snider and six unauthorized disclosures as to Turley.In the course of his investigation, Jackson approached various employees, business associates, and customers for interviews. During the interviews, Jackson stated to the interviewees that he was conducting a criminal investigation of Taxpayers. He represented to the interviewees that Taxpayers did not pay employment taxes, employed and harbored illegal immigrants, and were "involved in a scam" and a "grand conspiracy." In addition, Jackson repeatedly referred to Snider and Turley as criminals and stated that Snider had been criminally investigated previously. Jackson also told customers that they might be liable to the United States for Snider and Turley's "thousands and thousands of dollars" of unpaid taxes. Jackson showed numerous people various tax documents that the Taxpayers had filed. Lastly, after the administrative investigation ended and a grand jury investigation began, Jackson told interviewees that he was conducting a grand jury investigation of Taxpayers.After noting the extensive training and written instructions that Jackson had received, the district court concluded that "Jackson repeatedly and intentionally engaged in conduct outside the standard of conduct for IRS special agents" and "further f[ound] that Jackson's Section 6103 disclosures were made knowingly, willfully, and intentionally and were the result of gross negligence as defined by [26 U.S.C. §] 7431(c)(1)(B)(ii)."In total, the district court found Jackson made 79 3 unauthorized disclosures of return information to approximately 20 people. As demonstrated by the Kirby interview, the district court counted each piece of return information as an unauthorized disclosure. Thus, although Jackson only interviewed Kirby once, the six pieces of Turley's return information disclosed counted as six violations of §6103. Similarly, the district court counted one unauthorized statement that was overheard by two people as two violations. For example, when Jackson interviewed Jennifer Fry, her husband, Greg Fry, was present and heard the entire conversation. Therefore, the district court considered each statement of unauthorized return information as two violations of §6103 because two people received the disclosure. Counted in this fashion, the district court determined that Snider suffered 44 unauthorized disclosures, NSS suffered 6 unauthorized disclosures, and Turley suffered 29 unauthorized disclosures. The court declined to find that Jackson's March 10, 2002 Sworn Declaration filed with the court contained improper disclosures under §6103.The court found that Taxpayers substantially prevailed within the meaning of 26 U.S.C. §7430(c)(4), entitling them to reasonable litigation costs and attorney's fees. The court also found that the government's position was not substantially justified as defined by §7430(c)(4)(B). Finding that the actual damages sustained by Snider and Turley were less than $1,000 for each disclosure, the court awarded them statutory damages of $44,000 and $29,000, respectively. The court found that four of the disclosures as to NSS resulted in actual damages less than $1,000 and that the disclosure to two of NSS's clients resulted in actual damages totaling $9,794.63. Therefore, the court awarded NSS $4,000 in statutory damages and $9,794.63 in actual damages.After finding that punitive damages were "warranted and necessary to punish the willful behavior and gross negligence of Jackson and to deter such behavior by others," the court awarded punitive damages using a ratio of two-to-one. Consequently, Snider, NSS, and Turley received punitive damages of $88,000, $27,589.26, and $58,000, respectively. The court also awarded Taxpayers expert witness fees of $4,050, costs of $4,400, and attorney's fees of $463,777.50.The government asks this court to reverse the district court in essentially every respect, including the merits of the action, the calculation of damages, and the award of attorney's fees. Taxpayers, in their cross-appeal, ask this court to hold that Jackson's disclosures before the district court were unauthorized and to increase the damages award.

II. Discussion

The Internal Revenue Code (IRC) provides that "Returns and return information shall be confidential" and strictly prohibits government employees from disclosing "any return or return information." 26 U.S.C. §6103(a). The IRC broadly defines "return information" as
a taxpayer's identity, the nature, source, or amount of his income, payments, receipts, deductions, exemptions, credits, assets, liabilities, net worth, tax liability, tax withheld, deficiencies, overassessments, or tax payments, whether the taxpayer's return was, is being, or will be examined or subject to other investigation or processing, or any other data, received by, recorded by, prepared by, furnished to, or collected by the Secretary with respect to a return or with respect to the determination of the existence, or possible existence, of liability (or the amount thereof) of any person under this title for any tax, penalty, interest, fine, forfeiture, or other imposition, or offense....26 U.S.C. §6103(b)(2)(A). A revenue officer may properly disclose return information "in connection with his official duties relating to any...civil or criminal investigation...to the extent that such disclosure is necessary in obtaining information, which is not otherwise reasonably available, with respect to" the investigation. §6103(k)(6). The statute further requires that "[s]uch disclosures shall be made only in such situations and under such conditions as the Secretary may prescribe by regulation." Id.

A. Authorization

The government argues that the disclosures made by Jackson were authorized. Specifically, the government contends that §6103 permits the investigator to identify himself, state that he is performing a criminal investigation, and name the taxpayer under investigation. We disagree. Section 6103 clearly defines both "a taxpayer's identity" and "whether the taxpayer's return was, is being, or will be examined or subject to other investigation" as "return information." Therefore, the disclosures made by Jackson were clearly prohibited by statute. In addition, in a section entitled "Return Information," the Internal Revenue Manual recognizes that "The statutory definition of `return information' is very broad." IRM §9.3.1.2.2. It goes on to state that an example of "return information" is "the fact that a person is under investigation." Id.The government's argument that agents should be able to show their badges and identify themselves as criminal investigators as a necessary part of their investigation misses the mark. Such conduct is not prohibited by statute and does not constitute a disclosure of return information. An agent violates the statute, as well as the Internal Revenue Manual, when he or she identifies the subject of his or her investigation.The government has neither shown that the disclosure of the Taxpayers' identity was necessary nor does the record reveal any necessity for the disclosures. First, Snider's attorney offered to supply the information that the IRS sought. However, Officer Jackson never attempted to obtain the documents from Snider. Second, Officer Jackson maintained throughout the litigation that he never made the disclosures during his investigation. The district court logically concluded the disclosures could not be both necessary and yet unmade during Jackson's investigation. We agree with the district court's analysis.

B. Good Faith

The government next asserts that it should not be liable because the disclosures were made in good faith. Even if an unauthorized disclosure is made, the Internal Revenue Code excludes liability "with respect to any disclosure which results from a good faith, but erroneous, interpretation of section 6103." 26 U.S.C. §7431(b)(1). Under the good-faith defense, a government official may avoid liability for violating a constitutional or statutory right where that right is not clearly established such that a reasonable person would have known that his or her conduct violated the right. See Jones v. United States [ 96-2 USTC ¶50,537], 97 F.3d 1121, 1124 (8th Cir. 1996) (citing Harlow v. Fitzgerald, 457 U.S. 800, 818 (1982)). The government bears the burden of proving the good-faith defense. Jones [ 96-2 USTC ¶50,537], 97 F.3d at 1124.We hold that the district court did not err in finding that the government failed to establish the good-faith defense. As mentioned above, the plain language of the statute prohibits the disclosure of both "a taxpayer's identity" and "whether the taxpayer's return was, is being, or will be examined or subject to other investigation," as both forms of information constitute "return information." Therefore, it cannot be said that a reasonable officer would have failed to understand that such a disclosure would violate a clearly established right of the taxpayer.

C. Grand Jury Investigation

The government next contends that disclosing the fact that Taxpayers were under grand jury investigation is not a disclosure of return information. However, the statute plainly provides that the fact that a taxpayer is under grand jury investigation constitutes "return information" because the statute defines "return information" to include "whether the taxpayer[]...is being, or will be...subject to other investigation ...." §6103(b)(2) (emphasis added). While the government is correct that an agent can disclose that he or she is making an official inquiry, this does not mean that the agent can disclose the target of the investigation. The same reasons mentioned above that apply to disclosing the identity of the taxpayer under criminal investigation apply to disclosing the identity of a taxpayer under grand jury investigation. Therefore, the disclosure that the taxpayers were under investigation by a grand jury was not authorized and was not made in good faith. 4
D. Counting Disclosures

Next, the government challenges the district court's method of counting. The government urges that we hold that (1) a disclosure to more than one person at a time amounts to one act of disclosure; and (2) a disclosure of more than one piece of return information in a single interview constitutes a single act of disclosure. We disagree. Increased culpability warrants increased punishment. Direct disclosures to multiple persons multiplies the harm to the taxpayer. Our sister circuit has held that one disclosure to two people counts as two separate disclosures. Mallas v. United States [ 93-1 USTC ¶50,302], 993 F.2d 1111, 1125 (4th Cir. 1993). As Mallas recognized, §7431(c)(1)(A) imposes statutory damages for "each act of unauthorized disclosure of...return information," and §6103(b)(8) defines "disclosure" as "making known to any person in any manner whatever a return or return information." Id. Accepting the government's position would nullify the language "in any manner whatever." Id. If a government official directly discloses a taxpayer's return information to two listeners at the same time, the official has informed both listeners and caused as much harm as telling them separately. Id. We see no reason why the government should benefit from a wider audience, especially where a wider audience means an increased injury to the taxpayer's privacy. The same reasoning applies to the quantity of information disclosed.At the same time, we recognize the concerns addressed in Miller v. United States [ 95-2 USTC ¶50,516], 66 F.3d 220 (9th Cir. 1995). In Miller, the Ninth Circuit held that the IRS's disclosure of return information to a Los Angeles Times reporter, who subsequently published 184,000 newspapers containing the information, represented a single act of disclosure rather than 184,000 acts of disclosure. Id. at 223-24. The court reasoned that §7431 "punishes `disclosure,' not subsequent disseminations" and declined to extend Mallas to such a situation. Id. at 224. We agree that the proper limitation of liability is the initial act of disclosure, not secondary disclosures made by others such as the media. Because §7431 represents a waiver of sovereign immunity, it must be "strictly construed, in terms of its scope, in favor of the sovereign." Lane v. Pena, 518 U.S. 187, 192 (1996).However, we do not agree with the Ninth Circuit's holding in Siddiqui v. United States [ 2004-1 USTC ¶50,193], 359 F.3d 1200, 1202-03 (9th Cir. 2004), which extended Miller and declined to impose liability for an agent's unauthorized disclosure of return information in a speech to a party of 100 people. As discussed above, we believe that liability should track culpability and injury. A disclosure to 100 people is certainly more egregious than a disclosure to one person, and we believe that Congress drafted the statute to scale damages to injury and culpability with respect to the agent's own acts of disclosure. The method of counting performed by the district court is affirmed.
E. Actual Damages

The government also challenges the district court's award of actual damages to NSS, contending that they are not supported in the record. "`In reviewing a district court's order entering judgment after a bench trial, we review the court's factual findings for clear error and its legal conclusions de novo.' " Robinson v. GEICO Gen. Ins. Co., 447 F.3d 1096, 1101 (8th Cir. 2006) (quoting Tadlock v. Powell, 291 F.3d 541, 546 (8th Cir.2002) (citing Fed. R. Civ.P. 52(a))). A factual finding is clearly erroneous when "although there is evidence to support a finding, on the entire evidence we are left with the definite and firm conviction that a mistake has been committed." Hoefelman v. Conservation Comm'n of Mo. Dept. of Conservation, 718 F.2d 281, 285 (8th Cir. 1983). "A factual finding supported by substantial evidence on the record is not clearly erroneous. A district court's choice between two permissible views of evidence cannot be clearly erroneous." Robinson, 447 F.3d at 1101 (citation and internal quotations omitted).Here, the actual damages award is composed of two sets of damages --one from the Holiday Inn SunSpree's refusal to pay $3,638 under its contract with NSS and the other from The Knolls Condominiums' refusal to pay $6,156 under its contract with NSS. As for Holiday Inn, the district court committed no clear error. The court specifically found that Jackson made an unauthorized disclosure of NSS return information to Mark Bowman, the general manager of Holiday Inn SunSpree. Furthermore, the district court specifically found that "[t]he evidence at trial demonstrates that the Holiday Inn terminated its contract with NSS after Jackson advised the general manager of the potential civil liability for payroll taxes due on accounts of the workers NSS supplied to the hotel....Holiday Inn Sun Spree [sic] and The Knolls Condominiums both refused to pay outstanding invoices due and owing to NSS after meeting with Jackson."With regard to The Knolls, the district court did not make specific mention of any unauthorized disclosure of NSS return information to any representative of the Knolls. However, Taxpayers point out that the district court heard evidence that on October 4, 2001, Jackson interviewed Dick Musial, the general manager of The Knolls, and Marjorie Forbis, the housekeeping supervisor at The Knolls, and that while Jackson was still on the premises, The Knolls "immediately terminated all workers supplied by [NSS] even though they were good workers." 5 The court also heard testimony from two witnesses that The Knolls considered NSS to have breached its contract. On this record, we are not left with a firm conviction that a mistake was made and affirm.
F. Punitive Damages

The government alleges that punitive damages are not available to the Taxpayers under §7431(c)(1). The government is correct. Section 7431(c)(1) allows either (A) statutory damages; or (B) actual damages plus punitive damages, when available. Therefore, a plaintiff receiving statutory damages for an unauthorized disclosure cannot also recover punitive damages. Mallas [ 93-1 USTC ¶50,302], 993 F.2d at 1125-26. Other than the disclosures made to Holiday Inn SunSpree and The Knolls, the district court found that "the actual damages sustained by [Tapayers] as a result of the unauthorized disclosures of return information are less than $1,000 for each disclosure." However, the court awarded punitive damages to Snider in the amount of $88,000, to NSS in the amount of $27,589.26, and to Turley in the amount of $58,000.To the extent that the punitive damages overlap with statutory damages, the district court erred. We thus vacate the award of punitive damages to Snider and Turley. However, with respect to the punitive damages awarded to NSS, part of this award was based on actual damages. Because the district court followed a two-to-one ratio in assessing punitive damages, we amend the court's award to NSS to $19,589.26 in punitive damages based upon the $9,794.63 in actual damages. The remaining $8,000 in punitive damages awarded to NSS were based on the $4,000 in statutory damages awarded, and we vacate this portion of the punitive damages awarded to NSS.
G. Attorney's Fees
The government argues that the Taxpayers were not entitled to attorney's fees because "they did not substantially prevail as to the amount in controversy, and because the position of the United States was substantially justified." The government does not challenge the amount of the award. The Taxpayers respond that (1) they are entitled to fees even if the government's position was substantially justified; (2) they substantially prevailed with respect to the amount in controversy and the most significant issue (that Jackson made numerous disclosures of return information); and (3) the government's position was not substantially justified.Section 7431(c)(2)(3) allows a plaintiff to recover reasonable attorney's fees against the United States but only if the plaintiff is a "prevailing party" within the meaning of 26 U.S.C. §7430(c)(4). Section 7430(c)(4) defines "prevailing party" as a party who either "has substantially prevailed with respect to the amount in controversy" or "has substantially prevailed with respect to the most significant issue or set of issues presented." However, "[a] party shall not be treated as a prevailing party...if the United States establishes that the position of the United States in the proceeding was substantially justified." §7430(c)(4)(B). We review the district court's award of attorney's fees for an abuse of discretion. Kaffenberger v. United States [ 2003-1 USTC ¶50,164], 314 F.3d 944, 960 (8th Cir. 2003).Given the plain language of the statutes, Taxpayers fail in their argument that they are entitled to attorney's fees notwithstanding whether or not the government's position was substantially justified. The issues, then, are whether Taxpayers substantially prevailed and whether the government has shown that its position was substantially justified. We hold that the Taxpayers substantially prevailed and that the government's position was not substantially justified. Thus, the award of attorney's fees stands.The Taxpayers substantially prevailed because they established that Jackson made numerous disclosures of return information. The conduct of Jackson certainly was "the most significant issue...presented" because the entire case turned upon his conduct, i.e., whether he made unauthorized disclosures of return information. By prevailing on this point, the Taxpayers substantially prevailed within the meaning of §7430(c)(4)(A). 6 We hold that the government's position was not substantially justified. The government contends that its position was substantially justified, arguing primarily that the decisive issue was one of witness credibility. The government cites Jones v. United States [ 2000-1 USTC ¶50,312], 207 F.3d 508, 512-13 (8th Cir. 2000), which held that the district court correctly found that the government was substantially justified in its position because the IRS agent asserted that he never told the informant about the search warrant and the government was warranted in aggressively resisting the taxpayers' excessive damages claims. The government argues that under Jones, if the issue is witness credibility, then the government's position is always substantially justified.We do not read Jones so broadly. Jones is distinguishable from the case at bar due to the number of disclosures involved and, more importantly, the number of witnesses to those disclosures. Jones involved the disclosure of a search warrant to one person --an informant. Here, Jackson made numerous unauthorized disclosures of return information to approximately twenty people. After deposing several of the Taxpayers' witnesses before trial, the government should have realized that Jackson lied when he maintained that he never made the alleged disclosures and thus that the government's position was not substantially justified. To that end, the district court made the following pointed observation: "At trial, [Taxpayers] produced 20 disclosure fact witnesses. Their collective testimonies were remarkably consistent in describing repeated, virtually identical, unnecessary disclosures, and provide compelling evidence of a pattern of improper disclosures by Jackson." Accordingly, we affirm the district court's award of attorney's fees.
H. Expert Witness Fees
The district court awarded Taxpayers $4,050 in expert witness fees. The government posits that expert witness fees are not recoverable, and Taxpayers concede as much. We therefore vacate the award of expert witness fees.
I. Disclosures During Instant Litigation
In their cross appeal, Taxpayers allege that Jackson made additional unauthorized disclosures to the Department of Justice in his March 5, 2002 Sworn Declaration and that these disclosures were then disclosed to the court. Specifically, Taxpayers argue that (1) the disclosures were "unnecessary to defend a civil damage claim and are contrary to the scope and purpose of §6103;" and (2) the government failed to "obtain the requisite request to disclose return information" in the proceedings below.The government's most persuasive response is that the Taxpayers raise these arguments for the first time on appeal. We agree. Taxpayers argued before the district court that the disclosures were unauthorized because the civil proceedings below were "not `tax administration' proceedings as defined in 26 U.S.C. §6103(b)(4)." We agree with the government that this is not the same argument advanced on appeal.As a general rule, we will not consider issues raised for the first time on appeal. Norwest Bank of N.D., N.A. v. Doth, 159 F.3d 328, 334 (8th Cir. 1998). "We may, however, consider an issue for the first time on appeal `when the argument involves a purely legal issue in which no additional evidence or argument would affect the outcome of the case,' or where manifest injustice might otherwise result." Id. (citation omitted). With respect to Taxpayers' argument regarding obtaining the requisite request for disclosure, the issue is not properly before us. Although Taxpayers aver that they raise "only issues of law," their opening brief belies this contention by pointing to the government's failed attempt to establish authorization pursuant to §6103(h)(3). Taxpayers' argument regarding the necessity of the disclosure is closer to a purely legal issue; however, we decline to broadly review issues not raised and ruled upon by the district court.
III. Conclusion
We affirm in part and reverse in part. Jackson's numerous disclosures of return information, including the fact that Taxpayers were under grand jury investigation, were unauthorized and were not made in good faith. Additionally, the district court properly counted the number of violations because the Taxpayers suffered increased injury to their statutorily protected privacy by the increased volume of information disclosed and the widened audience to whom the disclosures were made. We hold that the actual damages awarded are allowed by law and supported by the record. With regard to the punitive damages, we reverse the award with respect to the disclosures for which the district court assessed statutory damages, reducing the punitive damages to $19,589.26. Because the Taxpayers substantially prevailed and the government's position was not substantially justified, we affirm the award of attorney's fees. We vacate the district court's award of expert witness fees. As for Taxpayers' cross appeal, we decline to reach the merits because the issues were not presented to the district court.
[Concurring and dissenting Opinion]
GRUENDER, Circuit Judge, concurring in part and dissenting in part.I respectfully dissent from parts II.A, B, D and G of the Court's opinion. I agree with the Court that §6103(a) does not forbid an agent from showing his badge and identifying himself as a criminal investigator. 7 I also agree that Special Agent Jackson violated the statute when he disclosed return information beyond the identities of the Taxpayers under investigation. However, I would hold that Jackson's disclosures that the Taxpayers were under investigation do not constitute violations of §6103(a) because they were necessary under §6103(k)(6). In addition to being necessary, these disclosures were made consistent with the IRS's good faith interpretation of §6103(k)(6) and the corresponding regulation at 26 C.F.R. §301.6103(k)(6)-1 and Jackson's good faith interpretation of the IRS policy memorandum. See §7431(b)(1). I also would hold that the number of disclosures for statutory damages purposes should be calculated based on each specific act of Jackson's disclosure, regardless of the number of individuals who heard each improper disclosure or the number of pieces of information disclosed in any single act of disclosure. Finally, I would hold that the Taxpayers are not entitled to attorney's fees because the Government's position was substantially justified.Turning first to the question of Jackson's disclosures that the Taxpayers were under investigation, I would hold that these disclosures were not violations of §6103(a). I agree with the Court that Jackson disclosed return information as defined in §6103(b)(2)(A), but these disclosures were necessary under §6103(k)(6). Furthermore, these disclosures were based on the IRS's good faith interpretation of §6103(k)(6) and the corresponding regulation as well as Jackson's good faith interpretation of the IRS policy memorandum. See §7431(b)(1).It frequently will be necessary for a special agent to disclose that a taxpayer is under investigation when he questions a third-party witness during an investigation. The term "necessary" in §6103(k) is undefined by that statute. Two possible interpretations are "strictly essential" or "appropriate or helpful." Payne v. United States [ 2002-1 USTC ¶50,431], 289 F.3d 377, 389 (5th Cir. 2002) (Garza, J., dissenting in part). The "strictly essential" meaning, which the district court appeared to adopt, would require absolute proof that there was no other possible means for obtaining information. Id. at 389-90. This rigid definition is not commonly used in legal contexts. Id. (citing Comm'r v. Heininger [ 44-1 USTC ¶9106], 320 U.S. 467, 471 (1943)). Instead, the "appropriate or helpful" meaning of "necessary" is the only practical interpretation in this context. Id. In fact, just prior to some of the final interviews at issue in this case, the IRS expressly adopted the "appropriate or helpful" definition pursuant to Congress's authorization for the IRS to identify the situations where a disclosure is necessary. §6103(k)(6). The temporary regulation defined "necessary" as "appropriate and helpful in obtaining the information sought." 26 C.F.R. §301.6103(k)(6)-1T(c)(1) (effective July 10, 2003). The current regulation continues to employ this definition of "necessary." 26 C.F.R. §301.6103(k)(6)-1(c)(1) (2006). Therefore, I would adopt the "appropriate or helpful" meaning of "necessary."A special agent's disclosure of the taxpayer who is under investigation is almost always appropriate or helpful during an interview because third-party witnesses expect an agent to disclose the reason for the interview. See Payne [ 2002-1 USTC ¶50,431], 289 F.3d at 390 (Garza, J., dissenting in part); Gandy v. United States [ 2001-1 USTC ¶50,115], 234 F.3d 281, 286 (5th Cir. 2000). This disclosure is helpful because of the spontaneous and personal nature of an interview and the witness's apprehension naturally occasioned by the presence of a criminal investigator. Absent this degree of introductory detail, a third-party witness typically will fear that he or she is a target of the investigation and, as a result, be less than candid or exercise his or her right to refuse to answer questions. Setting the witness's mind at ease on this point will often be necessary to encourage the witness to speak freely in response to an agent's questions. 8 See Fostvedt v. United States [ 93-1 USTC ¶50,299], 824 F.Supp. 978, 983 (D. Colo. 1993) (finding the disclosure of "such minimal, `nonsensitive' facts as the taxpayer's name" during an investigation was necessary), aff'd 16 F.3d 416 (10th Cir. 1994) (unpublished); Rhodes v. United States [ 95-2 USTC ¶50,622], 903 F.Supp. 819, 824 (M.D. Pa. 1995) (holding that minimal disclosures such as the name of the investigated taxpayer fall within the §6103 exception).Jackson's disclosures that the Taxpayers were under investigation were necessary despite the Taxpayers' witnesses' post hoc testimony at trial that they would have been cooperative without these disclosures by Jackson. The district court incorrectly determined that these disclosures were unnecessary based on a "strictly essential" definition of "necessary." However, under the "appropriate or helpful" meaning of "necessary," Jackson's disclosures were "helpful" in establishing the needed trust of the witnesses at the outset of the interviews. If Jackson had missed an introductory opportunity to gain this trust, the interview may not have been salvageable. While there might have been another way to gain this trust, evidence showing "some [other] possible way" to obtain information cannot render an oral disclosure unnecessary under the "appropriate or helpful" definition. Payne [ 2002-1 USTC ¶50,431], 289 F.3d at 390 (Garza, J., dissenting in part). Therefore, Jackson's disclosures of the identities of the Taxpayers under investigation were necessary.The Court and the district court incorrectly dismiss Jackson's necessity defense based on the assertion that Jackson denied making these disclosures. This reasoning is flawed in its premise because Jackson, in fact, did testify at trial that he began his interviews by disclosing the names of the taxpayers being investigated. 9 Trial Transcript at 783-84, 824. Because Jackson did, in fact, acknowledge disclosing that the Taxpayers were under investigation, his necessity defense cannot be denied on that basis.Even if I were to find that the disclosures were not necessary, I would find that Jackson's disclosures that the Taxpayers were under investigation also resulted from the IRS's and Jackson's good faith interpretations that such disclosures were necessary under §6103(k)(6). When an agent discloses return information that is not necessary under §6103(k)(6), the IRS and its agent will not be liable if the disclosure "results from a good faith, but erroneous, interpretation of §6103." §7431(b)(1). We have expressed two different viewpoints regarding this good faith exception. Under one view, the good faith exception only applies when the IRS, not the special agent, interprets the statute in good faith. Diamond [ 91-2 USTC ¶50,466], 944 F.3d at 435. Under the second view, the good faith exception also applies when the special agent interprets the IRS guidelines in good faith. Jones v. United States [ 96-2 USTC ¶50,537], 97 F.3d 1121, 1125 (8th Cir. 1996). Under either viewpoint, Jackson's disclosures that the Taxpayers were under investigation resulted from a good faith interpretation of §6103(k)(6) and the corresponding regulation.At the time of Jackson's disclosures, the courts had not provided clear guidance concerning the necessity of orally disclosing the identity of the taxpayer under investigation. See Diamond [ 91-2 USTC ¶50,466], 944 F.2d at 437; Gandy [ 2001-1 USTC ¶50,115], 234 F.3d at 285. The Fifth Circuit in Gandy avoided the question and simply stated that the necessity of disclosing the identity of the taxpayer under criminal investigation during an interview with a witness was a "difficult legal question." Id. Rather than addressing that difficult question, the Fifth Circuit instead affirmed the oral disclosures based on the agent's good faith in making the disclosures. Gandy [ 2001-1 USTC ¶50,115], 234 F.3d at 285.In the absence of controlling authority, the IRS interpreted §6103(k)(6) and the corresponding regulation in good faith and determined that it was necessary for its special agents to disclose the identity of the taxpayer under investigation during thirdparty interviews. The IRS released a memorandum based on this good faith interpretation of §6103(k)(6) that provided direction to special agents as to the appropriate method of introducing themselves at a third-party witness interview. The memorandum directed special agents to identify themselves as follows:

Mr. or Ms. XXXXXX my name is John Doe, I am a special agent with Internal Revenue Service, Criminal Investigation (display credentials for examination and introduce any other officials present). I am conducting an investigation of Mr. or Ms. XXXXX and I would like to ask you some questions regarding this matter.

Memorandum for CI Special Agents in Charge, Internal Revenue Service, Criminal Investigation, Feb. 2, 2001 (Def. Exhibit 51). The memorandum, along with the lack of clear guidance by the courts, suggests that the IRS interpreted the necessary exception of §6103(k)(6) in good faith. In Diamond, we applied this good faith exception to the IRS in a similar manner. Although we held that the use of "Criminal Investigation Division" in circular letters was not necessary, we still found that the IRS interpreted §6103(k)(6) in good faith. Diamond [ 91-2 USTC ¶50,466], 944 F.2d at 435-36. The IRS made a similar good faith interpretation in this case.Jackson also acted in good faith by adhering to this IRS policy. Jackson testified that he generally followed the IRS's recommended method of introducing himself to witnesses, including the disclosure of the identity of the taxpayer under investigation. Jackson gave the following description of his method of introducing himself to witnesses: "I would introduce myself as Rob Jackson. I'm a special agent with IRS Criminal Investigation and I'm conducting an interview [sic] of Mr. Snider and Ms. Turley and I would show them my credentials." Trial Transcript at 782. This testimony demonstrates that Jackson's disclosure that the Taxpayers were under investigation was consistent with the IRS's policy. Therefore, because both the IRS's interpretation of §6103 and Jackson's interpretation of the IRS's policy were in good faith, I would find no liability for Jackson's disclosures that the Taxpayers were under investigation. 10 Next, I would find that §7431(c)(1)(A) limits the statutory damages for disclosures to the number of specific acts of disclosure. When there are no actual damages, the number of violations for purposes of determining statutory damages is based on "each act of unauthorized inspection or disclosure of a return or return information with respect to which such defendant is found liable." 26 U.S.C. §7431(c)(1)(A) (emphasis added). A statement by a special agent is a single "act," regardless of the number of people who hear the statement or the number of separate items of return information included in the statement. Even if one oral disclosure is heard by numerous people, it is still one "act" of disclosure. Siddiqui v. United States [ 2004-1 USTC ¶50,193], 359 F.3d 1200, 1202-03 (9th Cir. 2004) (holding that an oral disclosure to 100 people did not equal 100 disclosures). I agree with the Ninth Circuit's reasoning in Siddiqui that this interpretation of §7431(c)(1)(A) is based on the "plain meaning of the language used by Congress in §6103." Id. at 1202. Additionally, if one oral disclosure includes numerous items of return information, it is still one "act" of disclosure. See Rorex v. Traynor [ 85-2 USTC ¶9636], 771 F.2d 383 (8th Cir. 1985).Under the Court's expansive reading of the statute, the statutory damages for a single act of disclosure could result in an unimaginable windfall to a taxpayer for a disclosure disseminated to a large number of recipients over the internet, television or radio. For instance, a single disclosure of a taxpayer's return information to one million people on national television would result in $1,000,000,000 in statutory damages. This surely was not the result Congress intended when it provided for statutory damages of $1,000 per act of improper disclosure in the absence of actual damages. The Court's concern that counting only the agent's "act" would "nullify the language `in any manner whatever' " and not adequately "track culpability and injury" is unfounded. Ante at 10-11.

The statute provides for actual damages where dissemination to multiple listeners or of multiple items of return information results in more substantial injury. Because a taxpayer can use evidence of widespread dissemination to prove actual damages, there is no disproportionality to culpability or injury. The taxpayer is free to prove that the disclosure resulted in actual damages to the extent that actual damages exceed the statutory damage amount of $1,000 for the act of improper disclosure. In the instant case, applying the plain language of the statute would reduce significantly the number of disclosures found by the district court for which statutory damages are appropriate. For example, the district court found seven unauthorized disclosures of Leonard Snider's return information from Jackson's interview with Mark Bowman when it should have only found one unauthorized "act" of disclosure.Finally, I would hold that the Taxpayers are not entitled to attorney's fees because the Government's position was substantially justified under §7430(c)(4)(B). 11 The Government's position is substantially justified "if a reasonable person could think it correct, that is, if it has a reasonable basis in law and fact." Pierce v. Underwood, 487 U.S. 552, 556 n.2 (1988). Where the Government relies on its witness's credibility, its position is substantially justified. See, e.g., Jones v. United States [ 2000-1 USTC ¶50,312], 207 F.3d 508, 512-13 (8th Cir. 2000). The Government correctly argued that Jackson's credibility was a key issue in the case. While Jackson admitted to disclosing both his position with the IRS and the Taxpayers' identities in interviews, he denied any further disclosure of the Taxpayers' return information. As the district court stated, this was a case of witness credibility, and a reasonable person could agree with the Government's position. Consequently, the Government's position was substantially justified.The Court incorrectly holds that the Government's position was not substantially justified because the Taxpayers' witnesses consistently refuted Jackson's testimony. However, the Government reasonably could believe that the district court would find these witnesses unreliable because of their biases and relationships with the Taxpayers. Additionally, the Government could also reasonably believe that the district court would find the special agent's testimony credible. Because a reasonable person could believe the Government's position, it was substantially justified. Therefore, the taxpayers should not be entitled to $463,777.50 in attorney's fees.For these reasons, I respectfully dissent in part and would remand for a determination of the correct number of violations and damages consistent with this opinion.1 The case was submitted for oral argument to Judges Heaney, Smith and Gruender on June 12, 2006. Judge Heaney retired on August 31, 2006. Judge Wollman joined the panel on October 27, 2006 for consideration of the matter. See 8th Cir. R. 47E.2 26 U.S.C. §74313 On page 14 of the district court's opinion, the court stated that Jackson made 78 disclosures of return information. The court stated in the paragraphs that immediately followed that Snider, NSS, and Turley suffered 44, 5, and 29 disclosures respectively. By our assessment of the record, this is a typographical error, as the district court in fact found 79 total disclosures. The reason for the discrepancy is that NSS actually suffered 6 disclosures of return information. On page 25 of the district court's opinion, the district court, discussing the damages to be awarded to each party, awarded NSS actual damages for the improper disclosures to Holiday Inn SunSpree and The Knolls Condominiums. The court then stated, "Having found 4 additional unlawful disclosures with respect to NSS, other than those made to the Holiday Inn Sun Spree [sic] and The Knolls Condominiums, the Court awards plaintiff NSS an additional $4,000 in statutory damages."In the district court's recitation of the facts at the beginning of its opinion, it fails to mention the basis for the disclosure of NSS return information that caused NSS actual damages under its contract with The Knolls Condominiums. As discussed infra in Part II.B, the district court heard substantial evidence that NSS did in fact suffer such a disclosure, causing actual damages.Considering the district court's opinion in its entirety, as well as the briefing of the parties with respect to the disclosures made to The Knolls, we believe that the actual number of disclosures found by the district court is 79, six of which were made as to NSS.4 Although the government says that only one district court opinion from another circuit supports the decision below, this argument misses the point, which is that the plain text of the statute prohibits Officer Jackson's actions. Therefore, the law was clearly established, albeit not by a court decision but by legislative pronouncement. Furthermore, the government fails to point to any case that actually adopted the rule that the government proposes. As mentioned, the government bears the burden of proving good faith.5 Although Jackson made unauthorized disclosures to Marjorie Forbis, the housekeeping supervisor at The Knolls, the district court found that these disclosures pertained to Turley and Snider --not to NSS.6 The government attempts to make a legislative history argument that the amount in controversy is "determinative." However, the plain language of the statute says that a "prevailing party" is one that has substantially prevailed "with respect to the amount in controversy" or "with respect to the most significant issue." 26 U.S.C. §7430(c)(4)(A). Because the statute is clear and unambiguous, we need not resort to legislative history.Similarly, the government's attempt to distinguish legal issues from factual issues is unpersuasive. The statute says "issues" and does not distinguish between factual and legal issues.7 While we have held that an agent's use of "Criminal Investigative Division" in circular letters to describe his or her position is not necessary, see Diamond v. United States [ 91-2 USTC ¶50,466], 944 F.2d 431, 436 (8th Cir. 1991), I agree with the Court that this disclosure is necessary during a personal interview because an interview is different than a circular letter. See Payne v. United States [ 2002-1 USTC ¶50,431], 289 F.3d 377, 390-91 (5th Cir. 2002) (Garza, J., dissenting in part) (stating that witnesses have "social expectations about police identifying themselves" during an interview).8 It is true that a special agent could inform the witness that he or she is not being investigated without identifying the taxpayer who is being investigated. However, such evasiveness by the special agent about the true target of the criminal investigation would likely leave some doubt in the witness's mind about his or her status as a potential target and create an untrustworthy environment for the ensuing interview. Instead, an agent's specific disclosure of the actual taxpayer being investigated is more likely to reassure the witness and result in a successful and candid interview.9 Jackson did deny disclosing other facts to the third-party witnesses, such as the facts that one Taxpayer employed illegal immigrants and that two Taxpayers did not pay taxes on workers. Trial Transcript at 861-62, 865-66. However, these facts are not at issue.10 The IRS memorandum suggests that agents should disclose that the taxpayers are under investigation, but not under criminal investigation. The district court found that Jackson disclosed that one or more of the Taxpayers were "under criminal investigation" in some interviews and that one or more of the Taxpayers were "under investigation" in other interviews. I find no reason to distinguish between the two situations because Jackson, in both situations, interpreted the IRS memorandum in good faith. Jackson could reasonably believe that it was appropriate to disclose that the Taxpayers were under criminal investigation when he was also authorized to state (1) he was a special agent in the Criminal Investigation Division and (2) he was investigating the Taxpayers. Any reasonable person would deduce that a special agent working in the Criminal Investigation Division was conducting a criminal investigation. Thus, in light of the conclusion that §6103(a) allows Jackson to identify himself as an agent in the Criminal Investigation Division, the distinction between a criminal investigation and an investigation is insignificant.11 In addition, if the district court applied my analysis on remand, Taxpayers may not have substantially prevailed in this case. See §§7431(c)(3), 7430(c)(4).

Alvin S. Brown
Tax Attorney
703 425-1400
www.irstaxattorney.com

Back Taxes: Deducting "Other" Business Expenses


If you own a trade or business, you can deduct a number of expenses under the broad category of “other.”


In general, taxpayers may deduct ordinary and necessary expenses incurred in the conducting of a trade or business. An ordinary expense is common and accepted in the taxpayer’s trade or business. A necessary expense is appropriate for the business.


Although many common expenses are deducted on designated lines of the tax schedule, some expenses may not fit into a particular category. Taxpayers can deduct these as “other” expenses. A breakdown of “other” expenses must be listed on line 48 of Form 1040 Schedule C. The total is then entered on line 27.
Examples of “other” expenses include:


• Amortization of certain costs, such as pollution-control facilities, research and experimentation, 74and intangibles including goodwill.


• Bad debts. Business bad debts must be directly related to sales or services provided by the business, must have been previously included in income and must be worthless (non-recoverable). If a taxpayer deducts a bad debt expense and later recovers it, the amount must be included in income in the year collected.


• Business start-up costs. These are costs related to creating an active trade or business, or investigating the creation or acquisition of an active trade or business. Generally these costs are amortized. However, taxpayers who started a business in 2006 may elect to deduct up to $5,000 of certain start up costs, subject to limitations. Refer to chapter 7 of Publication 535, Business Expenses, for more information.


• Gulf Opportunity (GO) Zone clean-up costs. Fifty percent of qualified clean-up costs for the removal of debris from, or the demolition of structures on, real property located in the GO Zone which are paid or incurred in 2006 are deductible as “other” expenses. The property must be held for use in a trade or business, for the production of income, or as inventory.
Personal, living and family expenses, do not qualify as deductible “other” business expenses.
Further information is available in IRS Publication 535, Business Expenses available at IRS.gov or ordered by calling 800-TAX-FORM (800-829-3676)

See IRS Publication 535, Business Expenses


Alvin S. Brown
Tax Attorney
703 425-1400
www.irstaxattorney.com

www.irsforum.org

Tax Help: NTA Offer in Compromise Comment

The National Taxpayer Advocate is appropriately objecting to the "20% depoisit" rules for Offers in Compromise. Low income taxpayers are having difficlulty coming up with the 20% deposit, and that deposit is not refundable if the OIC is rejected.

IRS News Release IR-2007-131 , July 18, 2007.[

National Taxpayer Advocate Nina E. Olson today delivered a report to Congress that identifies the priority issues the Office of the Taxpayer Advocate will address in the coming fiscal year. Among the key areas of focus will be improving taxpayer services, ensuring that taxpayer rights are protected in the IRS's private debt collection initiative, and making the IRS's offer-in-compromise program more accessible for taxpayers who are unable to pay their tax debts in full.The report also addresses the challenges the IRS is facing because of pressure to close the tax gap quickly. The tax gap represents the difference between the amount of tax owed and the amount of tax collected. "For fiscal year 2008, both the IRS and the Taxpayer Advocate Service (TAS) face similar challenges," Olson wrote. "The IRS is under scrutiny for its efforts to close the tax gap, while TAS is struggling to address taxpayer difficulties that arise as a result of these very efforts."In prior reports to Congress, Olson has identified the tax gap as one of the most serious challenges in tax administration, and she has advanced numerous proposals to help address it. At the same time, she has expressed concern that the IRS may ramp up enforcement excessively and begin to "cut corners" in its treatment of taxpayers if it is pressured to do too much too quickly.She emphasized that Congress can play an important role in helping to achieve an appropriate balance. "IRS oversight should not just be limited to urging the IRS to collect more tax revenue," Olson wrote. "Even as Congress directs the IRS to address specific areas of noncompliance, Congress should require the IRS to adopt a long-term research strategy that focuses not only on "closing the tax gap" but also on understanding what it takes to encourage taxpayers to be voluntarily compliant and how to change taxpayer behavior."The Advocate's report, which is required by law, sets out the objectives of the Office of the Taxpayer Advocate for the upcoming fiscal year and provides substantive analysis of issues as well as statistical information.

The report identifies three areas for particular emphasis in FY 2008:

1. Improve Taxpayer Services. In April 2007, the IRS published a strategic plan detailing its taxpayer service priorities for the next five years. The report, known as the Taxpayer Assistance Blueprint or "TAB," was developed in response to an Appropriations directive. OIson was a participant in the development of the TAB, and she generally praised the product. She notes, however, that the TAB is only a "first step" because the IRS still faces challenges in implementing the plan. She urges the IRS to conduct further research on taxpayer needs and preferences and to maintain a commitment to providing face-to-face service for taxpayers who need it. Working with the IRS to implement the TAB will be a top TAS priority in FY 2008.

2. Ensure that Taxpayer Rights Are Protected in the IRS's Private Debt Collection Initiative. In 2006, the IRS began to use private debt collection agencies to collect certain tax debts. Olson has previously stated her opposition to the initiative, citing risks to taxpayer privacy and confidence in the federal tax system. However, her office has worked closely with the IRS to ensure that taxpayer rights are protected to the maximum extent possible. Her office will continue to work closely with the IRS toward this end in the coming year.

3. Make the IRS's Offer In Compromise Program Accessible for Appropriate Taxpayers. A taxpayer who is unable to pay his or her tax liability in full may seek to compromise the debt by submitting an "offer in compromise." The offer program is a good deal for both the government and the taxpayer. The government benefits because it frequently collects more than it would in the absence of the program and the taxpayer is induced to pay taxes on time and in full in the future; a taxpayer whose offer is accepted must remain fully compliant for five years or face reinstatement of the compromised tax debt. The taxpayer benefits because he or she is able to make a fresh start. Legislation enacted in 2006 requires taxpayers who submit "lump sum" offers to make a down payment of 20 percent of the amount of the offer with the submission. To determine the impact of this requirement on bona fide offers, TAS reviewed a sample of 414 offers that the IRS accepted prior to the enactment of the down-payment requirement. In about 70 percent of those cases, the taxpayer did not have access to sufficient liquid funds to make the required down payment. The National Taxpayer Advocate will work with the IRS and the Treasury Department to try to improve the accessibility of the offer program.The report includes an update on a review the Office of the Taxpayer Advocate conducted on IRS compliance with Freedom of Information Act (FOIA) and related transparency guidelines. The results of the review were published in the National's Taxpayer Advocate's 2006 year-end report to Congress. In the current report, the National Taxpayer Advocate states that the IRS has made major strides toward improving the transparency of its procedures.The report also describes the challenges TAS itself is facing due to rapidly growing case inventories and staffing declines. By statute, TAS is required to maintain at least one office in every state, and it currently maintains 75 offices. TAS assists taxpayers who either are experiencing significant economic harm or are having difficulty resolving their problems through normal IRS processes. From FY 2004 through FY 2006, TAS's case receipts have grown by 43 percent, while the number of case advocates available to work those cases has declined by 8 percent. The report states that TAS has been making process changes to achieve efficiencies but faces significant challenges in the next few years to continue to deliver high quality taxpayer service to help taxpayers resolve their tax problems.

* * * * * * *The National Taxpayer Advocate is required by statute to submit two annual reports to the House Committee on Ways and Means and the Senate Committee on Finance. The statute requires these reports to be submitted directly to the Committees without any prior review or comment from the Commissioner of Internal Revenue, the Secretary of the Treasury, the IRS Oversight Board, any other officer or employee of the Department of the Treasury, or the Office of Management and Budget. The first report is submitted mid-year and must identify the objectives of the Office of the Taxpayer Advocate for the fiscal year beginning in that calendar year. The second report, due on December 31 of each year, must identify at least 20 of the most serious problems encountered by taxpayers, discuss the 10 tax issues most frequently litigated in the courts during the prior year, and make administrative and legislative recommendations to resolve taxpayer problems.About the Taxpayer Advocate ServiceThe Taxpayer Advocate Service is an independent organization within the IRS that assists taxpayers who are experiencing economic harm, who are seeking help in resolving tax problems that have not been resolved through normal channels, or who believe that an IRS system or procedure is not working as it should. Taxpayers may be eligible for assistance if:

Ÿ They are experiencing economic harm or significant cost (including fees for professional representation); Ÿ They have experienced a delay of more than 30 days to resolve a tax issue; or
Ÿ They have not received a response or resolution to their problem by the date promised by the IRS.The service is free, confidential, tailored to meet taxpayers' needs, and available for businesses as well as individuals. There is at least one local taxpayer advocate in each state, the District of Columbia and Puerto Rico.Taxpayers can contact the Taxpayer Advocate Service by calling its toll-free case intake line at 1-877-777-4778 or TTY/TTD 1-800-829-4059 to determine whether they are eligible for assistance. They can also call or write to their local taxpayer advocate, whose phone number and address are listed in the local telephone directory and in Publication 1546, The Taxpayer Advocate Service of the IRS - How to Get Help With Unresolved Tax Problems, which is available on the IRS website at IRS.gov.Links:
Ÿ National Taxpayer Advocate's 2008 Objectives Report to Congress --http://www.irs-tas.com.
Ÿ Taxpayer Advocate Service --http://www.irs.gov/advocate/index.html

Alvin S. Brown
Tax Attorney
703 425-1400
www.irstaxattorney.com
www.irsforum.org

Tax Attorney: Backdated Stock Options

IRS Large and Mid-Size Business Division (LMSB) Industry Directive on Backdated Stock OptionsJuly 13, 2007Backdated stock options: Internal Revenue Service: Large and Mid-Size Business Division.Industry Director Directive

DEPARTMENT OF THE TREASURY INTERNAL REVENUE SERVICE WASHINGTON, D. C. 20224 Large and Mid-Size DivisionLMSB Control No. 04-0407-036Impacted IRM 4.51.5June 15, 2007MEMORANDUM FOR INDUSTRY DIRECTORS
DIRECTOR, PREFILING AND TECHNICAL GUIDANCE
DIRECTOR, INTERNATONAL COMPLIANCE STRATEGY AND POLICYFROM: Walter Harris /s/ Walter L. Harris

Director, Field SpecialistsSUBJECT: Tier I Issue -

Backdated Stock Options Directive # 1

The Backdated Stock Options Issue has been designated as an LMSB Tier I issue. Laura M. Prendergast, Deputy Director, Field Specialist has been named as Issue Owner Executive for this Tier I issue and will be responsible for ensuring that the issue is identified, developed and resolved in a consistent manner.Background/Strategic Importance: This issue was identified from media reports of a practice among some publicly traded companies to backdate stock option exercise prices to a date that provides a lower cost to acquire the underlying stock. This issue also exists for stock options described as discounted, mis-priced, mis-dated, or in-the-money, and may arise from clerical or other errors in addition to deliberate backdating. Over one hundred companies have confirmed backdating stock options in SEC filings and press releases. Many are the subject of investigations by the Securities and Exchange Commission (SEC) and/or the Department of Justice (DOJ).Stock options provide the right to purchase company stock on a future date at a set price (the exercise or strike price), and this right is normally exercised when the per share stock value is above the exercise price. Typically, when options are granted, the exercise price is set at the per share value on the grant date so that the option holder will profit from the option only if the stock price increases after the grant date. A backdated option provides the holder with a "built-in" profit on the option at the time of grant, which may result in the company having to accrue a charge against its earnings for financial accounting purposes.The practice of granting options with a discounted exercise price can have adverse tax consequences for the corporation issuing the option. Generally, Regulations section 1.162-27(e)(2)(vi) provides a "qualified performance based compensation" exception to the $1 million deduction limit for compensation attributable to option exercises if the option exercise price equals or exceeds the per share value on the grant date and certain other requirements are met. A failure to satisfy this requirement may cause compensation attributable to the option exercise to be subject to the $1 million deduction limit. Treasury IRC section 422. As a result, if a discounted option was intended to be an incentive stock option, the issuing corporation may have an obligation to withhold and pay income and employment taxes when the option is exercised and the individual taxpayer may owe additional taxes at the time of exercise. Second, options granted with a discounted exercise price may be subject to Section 409A generally does not apply to options granted before January 1, 2005, but it does apply to discounted options that were not earned and vested as of December 31, 2004, and to discounted options that were materially modified after October 3, 2004. Under the transition rules, taxpayers generally may amend options until December 31, 2007 to avoid problems under Notice 2005-1, 2005-2 I.R.B. 274, Q&A 4(d); Preamble to Proposed Regulations §1.409A, 70 Fed. Reg. 57956 (October 4, 2005); Notice 2006-100, 2006-51, IRB 1109; section 409A, the taxpayer would be required to include the deferred income under the option in taxable income, pay an additional 20% tax, and an additional tax calculated by reference to interest on the taxes the executive saved by not reporting the deferred income in earlier years.Issue Tracking: To better identify and analyze patterns, trends and the compliance impact of the Backdated Stock Options Issue, the following issue tracking procedures are now required on all open examinations in which this issue has been identified.

1. On ERCS, Tracking Code 0537 and/or Project Code 0537 is required to be manually input on all Backdated Stock Option issues at the examination level.

2. On IMS, examiners need to accurately identify the proper UIL code.
Ÿ UIL Codes used to track issue on IMS for cases input after April 1, 2007:
o 162.40-00 - Compensation Limitation due to the backdating or discounting of Stock options for covered employees (162(m))
o 422.06-00 - Conversion of incentive stock options to nonstatutory options due to backdating or discounting of the option
o 409A.01-00 - Conversion of incentive stock options to nonstatutory options due to backdating or discounting of exercised stock options.Planning and Examination Guidance: The determination as to the existence of any Backdated Stock Option Issues should be addressed at the beginning of each examination to ensure proper statute control procedures are in place to address this issue at the individual level.When addressing backdated stock options issues, examiners must follow the issued guidance including this Industry Directive. If assistance is needed, examiners should contact one of the Executive Compensation Technical Advisors. An information document request (IDR) should be issued early in the examination.Planning and Examination Risk Analysis: This is a Tier I Compliance Issue and therefore is a mandatory examination item for taxpayers with backdated stock option grant and/or exercise prices. The field should address issues including section 422, Section 162(m) Audit Technique GuideSection 409A -

Alvin S. Brown
Tax Attorney
703 425-1400
www.irstaxattorney.com

Back Taxes: Innocent Spouse victory. IRS had the buden of proof

Carlos R. Menendez and Maria L. Menendez v. Commissioner.Dkt. No. 3975-06 , TC Memo. 2007-193, July 18, 2007. Withdrawn funds had been deposited into a checking account, over which the husband had sole control, and were not reported to the IRS. The former husband claimed that his ex-spouse had knowledge of the item giving rise to the assessed deficiency because she had signed an asset inventory list indicating that the IRA funds had been withdrawn. However, although the former wife had signed the inventory list, it could not be proven that, at the time of signing, she knew that the funds had been withdrawn during the tax year at issue. --

Carlos R. Menendez and Maria L. Menendez, pro sese; Thomas Fenner, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION

FOLEY, Judge: The issue for decision is whether petitioner Maria Menendez is entitled to innocent spouse relief pursuant to 1

FINDINGS OF FACT

In January 1963, petitioners were married in Cuba. In October 2003, petitioner Carlos Menendez closed his individual retirement account (IRA) and received $35,407. Mr. Menendez was the only person authorized to request distributions from the IRA, and the funds were deposited into a checking account over which he had sole control.

On February 16, 2004, in preparation for petitioners' divorce, petitioner Maria Menendez signed an asset inventory list (the inventory list) prepared by their financial adviser that listed all the assets of Mr. and Ms. Menendez. The inventory list delineated eight retirement accounts, including Mr. Menendez's IRA showing a balance of "None". The inventory list signed by Ms. Menendez was based on their financial adviser's records as of January 8, 2004.

On March 19, 2004, petitioners' marriage was dissolved. On October 12, 2004, petitioners jointly filed their Form 1040, U.S. Individual Income Tax Return, relating to 2003. In preparation for their joint 2003 return, petitioners individually provided tax information in their possession to their accountant. The proceeds from the IRA were not reported on the 2003 return.

By notice of deficiency, dated December 19, 2005, respondent determined that petitioners were liable for a deficiency of $10,161 and a Sec. 6013(a). Each spouse filing a joint return is jointly and severally liable for the accuracy of the return and the entire tax due. section 6015(c), a requesting spouse may seek relief from joint liability and elect to allocate a deficiency to a nonrequesting spouse if the following conditions are met: a joint return was filed; at the time of the election, the requesting spouse is separated or divorced from the nonrequesting spouse; the requesting spouse seeks relief within 2 years of the first collection activity relating to the liability; and the requesting spouse did not have actual knowledge, at the time of signing the joint return, of the item giving rise to the deficiency. section 6015(c) and respondent agrees. Mr. Menendez, however, contends that relief is not available because Ms. Menendez signed the inventory list indicating the IRA funds had been withdrawn, and, therefore, she had actual knowledge of the item giving rise to the deficiency.

Although she signed the inventory list that noted a withdrawal of the IRA funds, the list was based on information as of January 8, 2004. Pursuant to the inventory list, Mr. Menendez could have withdrawn his IRA funds at any time between October 1, 2003 and January 7, 2004. Moreover, there is no other evidence in the record to establish that Ms. Menendez had actual knowledge of the withdrawal in 2003. Cf. Cheshire v. Commissioner, 115 T.C. 183, 194 (2000) (taxpayer had actual knowledge when she knew of the amount, the source, and the date of receipt of the retirement distribution), affd. 282 F.3d 326 (5th Cir. 2002). Thus, she is entitled to relief pursuant to 1 Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year in issue.

Tax Help: Keeping Necessary Tax Records

Well–organized records are necessary to help you prepare your tax return. They also help you answer questions if your return is selected for examination or prepare a response if you are billed for additional tax.

Fortunately, you don’t have to keep all tax records around forever. There are laws known as statutes of limitations that impact how long you must keep receipts, canceled checks, and other documents that support an item of income or a deduction on your return. I recommend that records be kept for 6 years.

Generally, for questioning the amount of tax you reported or making an assessment of additional tax, the IRS has 3 years from the date you filed the return. However, if the IRS audits you for negligence or tax fraud, the statute of limitations is extended to 6 years. The stutue of limitations will not run unless tax returns are filed.

For filing a claim for credit or refund, you generally have 3 years from the date the original return was filed, or 2 years from the date the tax was paid, whichever is later. For either purpose, returns filed before the due date are treated as filed on the due date. There is no statute of limitations when a return is fraudulent or when no return is filed.

You should keep some records indefinitely, such as property records. You may need them to prove the amount of gain or loss if the property is sold.

Generally, income tax returns should be kept for 6 years from the date the return was filed. They could help you prepare future tax returns or amend a return. For more information on recordkeeping requirements for individuals, order Publication 552, Recordkeeping for Individuals.

If you are an employer, you must keep all your employment tax records for at least 4 years after the tax becomes due or is paid, whichever is later. I recommed 6 years.

If you are in business, there is no particular method of bookkeeping you must use. However, you must clearly and accurately show your gross income and expenses. The records should substantiate both your income and expenses.

Publication 583, Starting a Business and Keeping Records, and Publication 463, Travel, Entertainment, Gift, and Car Expenses, provide additional information on required documentation for taxpayers with business expenses. The publications are available at IRS.gov or by calling 800-TAX-FORM (800-829-3676).

IRS Publication 552 – Recordkeeping for Individuals http://www.irs.gov/pub/irs-pdf/p552.pdf
IRS Publication 583 – Business Records http://www.irs.gov/pub/irs-pdf/p583.pdf

IRS Publication 483 – Travel, Entertainment Records http://www.irs.gov/pub/irs-pdf/p463.pdf


Alvin S. Brown, Esq.
Tax Attorney
703 425-1400

http://www.irstaxattorney.com/

Tax Attorney: Supreme Court - Is IRS Required To File Substitute Returns?
The Supremee Court Will Consider The Selgas Case On That Issue.

Thomas Drennan Selgas, Petitioner-Appellant v. Commissioner of Internal Revenue, Respondent-Appellee. U.S. Court of Appeals, 5th Circuit; m 06-60311, January 16, 2007.Unpublished opinion affirming an unreported (TC) decision.

An individual's argument that a notice of deficiency was invalid because the IRS failed to prepare a proper substitute tax return was meritless. There is no requirement that the IRS prepare a substitute return. The two unsigned tax returns that the individual claimed were in the IRS's possession had no legal effect. Although he claimed that he had filed them before the IRS sent him the deficiency notice, the IRS had no record of ever receiving these returns. Further, the Tax Court properly ignored the corrected amended return that the individual filed just before trial because he failed to demonstrate how the deductions and other items on the return entitled him to a substantial refund. His claim that he provided power of attorney to the IRS employee who received the return was meritless because the employee was not required to exercise such power and sign the return. That duty was the taxpayer's and he failed to fulfill it. .

Before: Smith, Wiener and Owen, Circuit Judges.¬ Caution: The court has designated this opinion as NOT FOR PUBLICATION. Consult the Rules of the Court before citing this case.®S MITH, Circuit Judge: Thomas Selgas received a notice of deficiency from the Internal Revenue Service ("IRS") and petitioned for redetermination of his tax liability. The United States Tax Court entered judgment against Selgas, and he appeals. We affirm.

I.
On July 19, 2004, the Commissioner of Internal Revenue ("the Commissioner") sent Selgas a letter stating that the IRS had not received a tax return from him for 2002. The Commissioner attached a form providing a proposed computation of Selgas's liability based on third-party payer information reflecting wages of $104,278, interest income of $50, and dividend income of $11. The form stated that Selgas was entitled to a standard deduction of $4,700 and a personal exemption of $3,000. The form included a computation showing that Selgas's tax deficiency was $23,303, against which he was entitled to prepayment withholding credits of $21,329, leaving a net tax liability of $1,974. The form noted that in addition, Selgas owed $592.20 pursuant to 26 U.S.C. §6651(a)(1) and (2) because he was late in filing his return and in paying the full amount due.The Commissioner's letter informed Selgas that he could agree to the IRS's proposed examination changes and paythe amount due, respond within thirty days by filing a return, or explain why he had not filed a return and would like the IRS to reconsider. Attached to the letter was yet another form, which informed Selgas, "Your best course of action is to file your own tax return now to claim your credits and deductions as allowed by law."Selgas made no response. 1 On September 14, 2004, the Commissioner sent him a "Notice of Deficiency" pursuant to 26 U.S.C. §6212 reflecting a 2002 federal income tax deficiency of $23,303 and a delinquency penalty of $592.20. Attached to the notice were several forms reflecting the same computation and explanation as had appeared in the Commissioner's initial letter as well as a certification by an IRS Operations Manager that the documents attached to the notice of deficiency constituted the return prepared for Selgas by the Commissioner pursuant to 26 U.S.C. §6020(b). The certification further stated that the return was to be treated as filed by the taxpayer for the purpose of determining the amount of the delinquency penalty. See 26 U.S.C. §6651(a)(2)-(3), (g)(2).Selgas timely filed a petition in the Tax Court attacking the Commissioner's calculations of the existence and amount of his deficiency on numerous grounds, all of which were rejected by the Tax Court. He timely filed a motion to vacate the judgment, which the Tax Court likewise rejected. Selgas asserts three arguments on appeal: (1) that the Tax Court lacked jurisdiction because the notice of deficiency was not promulgated pursuant to a valid delegation of authority; (2) that the decision should be vacated because Selgas was prejudiced by the clerk's failure to transcribe certain routine scheduling conferences involving the parties and the court; and (3) that the Commissioner's calculation was incorrect because Selgas filed documents illustrating that he was entitled to a refund.

II.
Whether the Tax Court had jurisdiction pursuant to a validly issued notice of deficiency is a matter of law that we review de novo. See Portillo v. Comm'r [ 91-2 USTC ¶50,304], 932 F.2d 1128, 1131-32 (5th Cir. 1991). The notice of deficiency sent to Selgas was valid, and the Tax Court appropriately exercised jurisdiction. The Tax Court acquires jurisdiction when a taxpayer files a timely petition contesting a notice of deficiency issued by the Commissioner. See 26 U.S.C. §6213; Portillo [ 91-2 USTC ¶50,304], 932 F.2d at 1132.Selgas claims that the court lacked jurisdiction because the notice sent to him was invalid for two reasons: (1) The employee who signed the deficiencynotice lacked authorityto do so; and (2) the IRS improperly failed to prepare a substitute tax return for Selgas before issuing the notice of deficiency. Selgas's arguments in this vein are irrelevant to the outcome. Citing a delegation order issued as part of the IRS's internal operating procedures, Selgas contends that the Supervisory Program Analyst who signed his deficiency notice lacked authority to act on behalf of the Secretary of the Treasury by issuing the deficiency. The Commissioner states that "Supervisory ProgramAnalyst" is equivalent to Campus Department Manager, an official who plainly enjoys delegated authority to issue deficiency notices.As a general matter, IRS internal operating procedures confer no rights on individual taxpayers, 2 but we need not consider this dispute at great length because, in any event, no signature is required to render a deficiency notice valid. 3 A taxpayer is entitled to notice of a deficiency, but the relevant statute does not mandate any particular form of notice or specify any content it must include. See 26 U.S.C. §6212. Like our sister circuits, we conclude that a notice of deficiency is valid as long as it informs a taxpayer that the IRS has determined that a deficiency exists and specifies the amount of the deficiency. 4 The existence of a signature or the identity of any IRS official who provides one, is superfluous.Likewise, Selgas's argument that the notice of deficiency was invalid because the IRS failed to prepare a proper substitute tax return is meritless. We need not consider whether the substitute return was properly calculated and presented on the appropriate forms because, for the purpose of determining a deficiency, there is no need for the Commissioner to prepare a substitute tax return. 5 "Where there has been no tax return filed the deficiency is the amount of tax due." 6 Nothing about the notice of deficiency sent to Selgas operated to defeat the Tax Court's jurisdiction.

III.
Selgas was not prejudiced by the clerk's failure to record two off-the-record status conferences. Selgas was afforded a fair trial on the merits of the issues he claims were discussed at the status conferences. He was not prejudiced by the clerk's failure to record the Tax Court's "admission," during a status conference, that the IRS possessed two unsigned tax returns entitling Selgas to relief, even assuming that the Tax Court ever made such a statement. In any event, for reasons explained below, the fact that the tax returns were unsigned strips them of any legal effect and renders irrelevant the question whether the IRS ever had them.

IV.
Selgas's claim that the notice of deficiency is inaccurate because he filed two unsigned tax returns illustrating that he was entitled to a refund in 2002 is neither credible nor relevant. Selgas first produced these returns at the calendar call for trial of his case in the Tax Court, claiming that he had filed them before the IRS sent him the deficiency notice. The IRS had no record of ever receiving these returns. The trial judge specifically found Selgas's testimony to be incredible on this point and determined that the returns had never been filed. Selgas provides no reason for us to upset that plausible factual determination. Likewise, the Tax Court properly ignored the "corrected amended" return that Selgas filed just before trial, because he supplied no evidence substantiating the deductions and other items on the return that purported to show that he was entitled to a substantial refund.Even if the returns were filed, the fact that they were unsigned deprives them of legal effect. 7 Selgas claims that he provided power of attorney to the IRS employee who received the return, but, again assuming that this is true, there is no reason to believe that the employee was required to, or even should have, exercised such power and signed the return. That duty lay upon Selgas and, at best, he failed to fulfill it.

V.
Selgas's arguments are utterly lacking in merit and, as an aside, his conduct in this litigation appears to have been inconsistent with that of a litigant endeavoring to aid in the truthful and efficient resolution of contested issues of fact and law. We have no sympathy for Selgas's behavior or his arguments in defense of what appears to have been a brazen attempt to avoid a few thousand dollars in legitimate tax liability. The judgment of the Tax Court is AFFIRMED.1 Selgas later claimed that he had filed two unsigned tax returns during this period. The IRS did not receive them, and the Tax Court did not find Selgas's testimony on this matter credible. For reasons explained below, even if these returns were filed, they were invalid because they lacked the taxpayer's signature.2 See Smith v. United States [ 73-1 USTC ¶9402], 478 F.2d 398, 400 (5th Cir. 1973); see also Tavano v. Comm'r [ 93-1 USTC ¶50,205], 986 F.2d 1389, 1390 (11th Cir. 1993).3 See Brafman v. United States [ 67-2 USTC ¶12,494], 384 F.2d 863, 865 n.4 (5th Cir. 1967). See also Tavano, 986 F.2d at 1390; Urban v. Comm'r [ 92-1 USTC ¶50,264], 964 F.2d 888, 889 (1992).4 See Bokum v. Comm'r [ 93-1 USTC ¶50,342], 992 F.2d 1136, 1139 (11th Cir. 1993); Estate of Yaeger v. Comm'r [ 89-2 USTC ¶9633], 889 F.2d 29, 35 (2d Cir. 1990).5 See 26 U.S.C. §§6020(b), 6211(a); United States v. Stafford [ 93-1 USTC ¶50,235], 983 F.2d 25, 27 (5th Cir. 1993) ( "[A]lthough [ §6020(b)] authorizes the Secretary to file for a taxpayer, the statute does not require such a filing.").6 Laing v. United States [ 76-1 USTC ¶9164], 423 U.S. 161, 174 (1976). See also 26 C.F.R. §301.6211-1(a).7 See 26 U.S.C. §§6012, 6061(a), 6065; 26 C.F.R. §1.6061-1(a); Brafman [ 67-2 USTC ¶12,494], 384 F.2d at 868; Reaves v. Comm'r [ 61-2 USTC ¶9703], 295 F.2d 336, 338 (5th Cir. 1961).

http://www.irstaxattorney.com/ 703-425-1400

Back Taxes: New IRS e-file PIN Requirement

IRS News Release IR-2007-130 , July 16, 2007.Electronic filing of tax returns: IRS e-file program: Electronic PIN signature: Practitioner PIN: Electronic Return Originator (ERO). --
The IRS has announced a new electronic PIN signature requirement for electronically filed returns beginning in 2008. Taxpayers can select a five-digit PIN and Electronic Return Originators (EROs) can use a practitioner PIN when filing electronically. Practitioners will no longer send Form 8453, U.S. Individual Income Tax Declaration, for an e-filed return. Instead, EROs will use new Form 8879, IRS e-file Signature Authorization, which they are required to retain in their files.

WASHINGTON --The Internal Revenue Service will simplify the signature process for electronically filed individual income tax returns submitted by tax practitioners. The simplification eliminates the need for a paper signature document to be sent to the IRS in support of electronically filed tax returns.Beginning with the 2008 filing season, tax practitioners can e-file individual income tax returns only if the returns are signed electronically using one of two methods: either a Self-Select Personal Identification Number (PIN) or a Practitioner PIN. A Self-Select PIN allows taxpayers to electronically sign their e-filed return by selecting a five-digit PIN. A Practitioner PIN is used when a taxpayer authorizes an Electronic Return Originator (ERO) to input an electronic signature on behalf of the taxpayer. Practitioner PINs require the use of Form 8879, IRS e-file Signature Authorization, which is retained by the ERO."Nearly 90 percent of tax professionals already use electronic signatures to sign returns," Acting IRS Commissioner Kevin M. Brown said. "It's the right time to take the next step toward truly paperless filing."Out of some 55 million e-filed returns that have come from tax professionals this year, more than 49 million used the Self-Select PIN or the Practitioner PIN. Overall, more than 77 million individual tax returns have been e-filed so far this year.The change will simplify tracking, verification and follow-up on the paper signature documents, which were required for tax returns that did not use an electronic signature.Tax practitioners will no longer submit a paper signature for e-filed returns by using Form 8453, U.S. Individual Income Tax Declaration for an IRS e-file Return. Instead, a newly designed Form 8453 will be used to transmit supporting paper documents that are required to be submitted to the IRS with e-filed returns. The new Form 8453 will be released later for use during the 2008 filing season.

www.irstaxattorney.com

Tax Help: IRS Declares Tax Avoidance in Notice 2007-57 , I.R.B. 2007-29, June 21, 2007.

The IRS, effective June 20, 2007, has identified loss importation transactions as listed transactions for purposes of Code Secs. 6111 and §1.6011-4(b)(2) of the Income Tax Regulations and 6112 of the Internal Revenue Code. This notice also alerts persons involved with these transactions to certain responsibilities that may arise from their involvement with these transactions.FACTSIn one variation of the loss importation transaction, a U.S. taxpayer (Taxpayer) is a shareholder of an S corporation (S Corporation). S Corporation acquires control of a foreign entity (Foreign Entity) by purchasing from a foreign shareholder stock of Foreign Entity meeting the requirements of §957(a).Foreign Entity enters into substantially offsetting positions in foreign currency. Next, Foreign Entity disposes of or closes out some positions in the foreign currency for a gain while retaining the offsetting loss positions. Foreign Entity is not itself subject to U.S. taxation on the gains from the offsetting options. Foreign Entity may use the proceeds from these dispositions or closings out to enter into new positions in foreign currency. By entering into the new positions in foreign currency, Foreign Entity can effectively preserve the retained loss positions in the foreign currency and virtually eliminate further economic risk.After realizing gains from disposing of or closing out some of the offsetting positions, Foreign Entity elects to be disregarded as an entity separate from its owner for U.S. tax purposes. Based on the effective date of this election, Foreign Entity is not a CFC for an uninterrupted period of 30 days during Foreign Entity's taxable year, and S Corporation is not required to include any of Foreign Entity's subpart F income in its gross income. See §§881 and §351 applies. Variations also exist in how the offsetting positions may be used in the transaction described above. For example, taxpayers may use positions with respect to property other than foreign currency.DISCUSSIONThe transactions described in this notice are designed so that taxpayers may claim losses without taking into account the corresponding gains attributable to the offsetting positions in foreign currency or other property. In the loss importation transaction described above, taxpayers are attempting to exploit the entity classification rules and §§165, 482, and §§1.6011-4(b)(2) and 6112 effective June 20, 2007, the date this notice was released to the public. Independent of their classification as listed transactions, transactions that are the same as, or substantially similar to, the transactions described in this notice may already be subject to the requirements of §6111, §1.6011-4 who fail to do so may be subject to the penalty under §1.6011-4 who fail to do so may be subject to an extended period of limitations under §6111 who fail to do so may be subject to the penalty under §6112 who fail to do so (or who fail to provide such lists when requested by the Service) may be subject to the penalty under §6662 or

Tax Attorney: Tax Benefit - Summer Day Camp For Kids

Parents Can Get Credit for Sending Kids to Day Camp

Here’s a tax break for the busy summer. Many working parents must arrange for care of their children under 13 years of age during the school vacation period. A popular solution — with a tax benefit — is a day camp program.

The cost of day camp can count as an expense towards the child and dependent care credit. Expenses for overnight camps do not qualify. If your childcare provider is a sitter at your home, you'll get some tax benefit if you qualify for the credit.

The credit is generally 20% to 35% of non-reimbursed expenses; up to $3000 in expenses for one child and up to $6000 for two or more children. The actual credit is also based on your income.

You figure the credit on up to $3,000 of expenses for one child, $6,000 for two or more children. The credit rate ranges from 20% to 35% of expenses, depending on your income. The 35% rate applies if your income is under $15,000; the 20% rate, if your income is over $43,000.
For more information, check out IRS Publication 503, Child and Dependent Care Expenses available on the IRS Web site, IRS.gov or by calling 800-TAX-FORM (800-829-3676).

Back Taxes: Tax Benefit - Day Camp for KitsParents

Parents Can Get Credit for Sending Kids to Day Camp

Here’s a tax break for the busy summer. Many working parents must arrange for care of their children under 13 years of age during the school vacation period. A popular solution — with a tax benefit — is a day camp program.

The cost of day camp can count as an expense towards the child and dependent care credit. Expenses for overnight camps do not qualify. If your childcare provider is a sitter at your home, you'll get some tax benefit if you qualify for the credit.
The credit is generally 20% to 35% of non-reimbursed expenses; up to $3000 in expenses for one child and up to $6000 for two or more children. The actual credit is also based on your income.

You figure the credit on up to $3,000 of expenses for one child, $6,000 for two or more children. The credit rate ranges from 20% to 35% of expenses, depending on your income. The 35% rate applies if your income is under $15,000; the 20% rate, if your income is over $43,000.

For more information, check out IRS Publication 503, Child and Dependent Care Expenses available on the IRS Web site, IRS.gov or by calling 800-TAX-FORM (800-829-3676).
Link:
• IRS Publication 503, Child and Dependent Care

Tax Help: Good Faith Defense For Fraud
United States v. Ward Franklin Dean, U.S. Court of Appeals, 11th Circuit; 06-13946, May 25, 2007.

Code Sec. 7212




In 1996, Ward Dean, a medical doctor, published author, and retired naval flight surgeon, became a tax protester.





B. The Jury Instruction Regarding the Defendant's "Good Faith" Defense

As a general rule, ignorance of the law or a mistake of law is no defense to criminal prosecution in the United States. Cheek v. United States, 498 U.S. 192, 199 (1991). However, the Supreme Court has noted that there is a "good faith" exception under the federal criminal tax statutes. Id. at 199-202. According to this exception, if someone simply fails to understand that he has a duty to pay income taxes under the Internal Revenue Code, he cannot be guilty of "willfully" evading those taxes. Id. at 201-02. The term "willfulness" presupposes the existence of a legal duty and knowledge of that duty. Id. at 201. If, however, someone recognizes that he has a duty to pay taxes, but simply refuses to pay or to declare his income because he believes that the Code is unconstitutional, he is not acting in "good faith." Id. at 204-07.

A person who is charged with tax evasion is entitled to have the jury hear an instruction on this "good faith" defense. Id. at 202. And, the district court provided one that was used in a Seventh Circuit case, United States v. Hilgeford, 7 F.3d 1340, 1343 n.1 (7th Cir. 1993). Dean argues that the instruction misled the jury because it implied that they could reject his good faith defense if they found it to be objectively unreasonable. Dean contends that the Supreme Court rejected this sort of instruction in Cheek.

We find that the district court's instruction conforms quite well to the Supreme Court's holding in Cheek. The district court instructed Dean's jury that:


A defendant does not act willfully if he believes in good faith that he is acting within the law or that his actions comply with the law. This is so even if the defendant's belief was not objectively reasonable as long as he held the belief in food faith. Nevertheless, you may consider whether the defendant's belief about the tax statutes was actually reasonable as a factor in deciding whether he held that belief in good faith.


The court did not insert a caveat that a defendant's belief must be objectively reasonable to be in good faith. It simply reiterated a point that the Supreme Court made in Cheek:


In this case, if Cheek asserted that he truly believed that the Internal Revenue Code did not purport to treat wages as income, and the jury believed him, the Government would not have carried its burden to prove willfulness, however unreasonable a court might deem such a belief. ...



Of course, the more unreasonable the asserted beliefs or misunderstandings are, the more likely the jury will consider them to be nothing more than simple disagreement with known legal duties imposed by the tax laws and will find that the Government has carried its burden of proving knowledge.


Id. at 202-04. Accordingly, we find that the district court's good faith instruction accurately stated the law on this issue. If we are satisfied that the district court's instruction has not misstated the law or misled the jury, we give the district court "wide discretion as to the style and wording employed in the instructions." United States v. Bender, 290 F.3d 1279, 1284 (11th Cir. 2002). The district court did not abuse that discretion in this case.

Dean also argues that the district court erred in adding a willful blindness instruction at the end of its good faith instruction. There is no merit to this argument. A willfull blindness instruction is entirely appropriate where the evidence supports a finding that a defendant intentionally insulated himself from knowledge of his tax obligations. The record showed that Dean, much like the defendant in Cheek, had paid his taxes faithfully for a number of years before he became convinced that income taxes were unconstitutional. The record also showed that he, like the defendant in Cheek, had previously challenged the validity of the income tax requirement in court, and knew, as a result of the court's ruling that his arguments were frivolous. Yet, Dean failed to file a 2002 return although a court ruled against him on October 24, 2002 when he challenged a penalty that the IRS imposed on him for filing a frivolous return in 1997.

As the Supreme Court indicated in Cheek, albeit, not in so many words, the law would not countenance such blindness:


We do not believe that Congress contemplated that such a taxpayer, without risking criminal prosecution, could ignore the duties imposed upon him by the Internal Revenue Code and refuse to utilize the mechanisms provided by Congress to present his claims of invalidity to the courts and to abide by their decisions. There is no doubt that Cheek, from year to year, was free to pay the tax that the law purported to require, file for a refund and, if denied, present his claims of invalidity, constitutional or otherwise, to the courts. See 26 U. S. C. § 7422. Also, without paying the tax, he could have challenged claims of tax deficiencies in the Tax Court, § 6213, with the right to appeal to a higher court if unsuccessful. § 7482(a)(1). Cheek took neither course in some years, and when he did was unwilling to accept the outcome.


Cheek, 498 U.S. at 206. Thus, we conclude the district court did not err in adding a willfull blindness instruction.



C. The Jury Instruction on Income Tax Evasion and Attempted Obstruction

The district court used the Eleventh Circuit's Pattern Jury Instruction on income tax evasion, Criminal Offense Instruction 93.1, and attempting to interfere with the administration of internal revenue laws, Criminal Offense Instruction 97. Dean stated at trial that he did not object to the use of either of these instructions, so we review the court's decision to employ them under a plain error standard. See Puche, 350 F.3d at 1148.

Granted, district courts do not have to use our pattern jury instructions for they "are not precedent and cannot solely foreclose the construction of the necessary elements of a crime as stated in the statute." United States v. Ettinger, 344 F.3d 1149, 1158 (11th Cir. 2003). Nevertheless, our pattern jury instructions clearly state the elements of proof required for conviction under both 26 U.S.C. § 7201, See Sansone v. United States, 380 U.S. 343, 350-51 (1965); United States v. Stone, 702 F.2d 1333, 1338-39 (11th Cir. 1983), and under 26 U.S.C. 7212(a). See United States v. Popkin, 943 F.2d 1535, 1539-40 (11th Cir. 1991). Accordingly, the district court did not err, much less commit plain error, in using our pattern jury instruction on these offenses.

In a related vein, Dean also argues that the district court erred when it instructed the jury on the charges under count VII of the indictment, which deals with attempted interference in internal revenue actions. Dean contends that the district court should not have summarized the individual obstruction charges. This argument has no merit. Dean sent essentially the same letter to each of the entities that received summonses from IRS; namely, Dean's employer, the DFAS, and his banks. The individual letters stated the same falsehood --that the entities did not have to comply with the summons to produce Dean's financial records for an IRS investigation. Thus, the court could summarize the offensive conduct quite properly as "informing entities that they were under no obligation to comply with lawful summons documents from the IRS."

This Court will not reverse a conviction on the basis of a jury charge unless we find, after examining the entire charge, that "the issues of law were presented inaccurately, the charge included crimes not contained in the indictment, or the charge improperly guided the jury in such a substantial way as to violate due process." United States v. Arias, 984 F.2d 1139, 1143 (11th Cir. 1993) (citing United States v. Turner, 871 F.2d 1574, 1578 (11th Cir.), cert. denied, 493 U.S. 997 (1989)).We find no evidence that any of these errors occurred here.



D. Denial of Defendant's Proffered Jury Instructions, Numbers 41 and 42

Dean proffered jury instructions on the requirements of 26 U.S.C. §§ 6001 and 6011. These statutes mandate that anyone who is liable for income tax must keep records, submit returns and comply with the rules prescribed by the Secretary of the Treasury. Dean argues that these statutes could be read to apply only to persons who are "liable" for tax, rather than all persons, and suggests that this reading bolsters his "good faith" belief defense. Accordingly, he argues, the district court abused its discretion when it refused to read these additional instructions to the jury.

We do not agree. The Government charged Dean with two offenses --income tax evasion and attempted interference in the administration of internal revenue laws. The district court instructed the jury on these two offenses and on "good faith," which provides a defense to the charge of income tax evasion. See Cheek, 498 U.S. at 202-07. Dean has not shown how the court's failure to include these additional instructions impaired his ability to mount a defense. See United States v. Martinelli, 454 F.3d 1300, 1318 (11th Cir. 2006). Dean was free to, and did, introduce documents into evidence at trial that quoted from sections 6601 and 6011 of the Internal Revenue Code. He had every opportunity to explain his reading of those sections when he testified. Thus, the court did not abuse its discretion in refusing to instruct the jury on these other, not clearly relevant, sections of the Code.



E. The Sufficiency of the Evidence on the Attempted Obstruction Charge

The Government presented ample evidence that Dean attempted to interfere with the administration of the summonses issued by IRS Agent Wayne Jackson on January 10, 2004. The statute that criminalizes such interference specifically proscribes the use of corrupt or forceful methods of intimidation. 26 U.S.C. § 7212(a). Our Pattern Jury Instruction on this offense advises that a defendant acts "corruptly" if he acts "knowingly and dishonestly with the specific intent to secure an unlawful benefit either for himself or another." Eleventh Circuit Pattern Jury Instructions, Criminal P 97 (2003).

Evidence presented at trial showed that Dean sent strongly-worded letters to his employer, the DFAS, and his banks, after he learned they had received IRS summonses to produce copies of his financial records. The letters stated in no uncertain terms that these summonses were not court orders and they had no obligation to comply with them. The letters further stated that the summonses were "phony" and "fraudulent," and that the IRS Agent had no legal authority to issue summonses. The letters closed by threatening legal action against anyone who complied with them.

Although Dean may have wanted to challenge the constitutionality of the statutes that gave IRS agents the authority to issue summons, he knew that the summonses were not phony. The IRS sent him copies of each of the summonses it issued, and he knew from his prior court challenge that IRS had clear legal authority to investigate his earnings. Nevertheless, he alleged that the summonses were phony and fraudulent in an attempt to dissuade his employer, the DFAS, and his banks from complying with the IRS and disclosing his earnings. Accordingly, we find that a rational trier of fact could have concluded that Dean was guilty beyond reasonable doubt of violating 26 U.S.C. § 7212(a) because he acted corruptly when he made these false allegations.



F. Defendant's Challenge to His Sentencing

Dean argues that the district court erred when it based his sentence upon facts that were not conceded at trial nor proved to a jury beyond a reasonable doubt, citing Apprendi v. New Jersey, 530 U.S. 466, 490 (2000). This is not the first time that he raised this objection; he asserted it at his sentencing hearing as well. Dean's Pre-Sentencing Investigation Report ("PSI") calculated his base offense level at 18 because the tax loss to the Government was $290,997.44. Dean argues that the Government did not charge the amount of tax loss in its indictment, nor prove it to the jury beyond reasonable doubt, and that he certainly did not concede this amount of loss at trial. Therefore, Dean contends it was error for the court to use this figure in calculating his Guidelines range, and that his base level should have been calculated at 6 since the amount of loss was indeterminable.

Moreover, the court compounded this error, Dean argues, when it sentenced him in keeping with the so-called remedial portion or second majority opinion in United States v. Booker, 543 U.S. 220, 259-260 (2005). Booker held that the section of the Sentencing Reform Act which made the Guidelines mandatory was unconstitutional. Id. Rather than invalidate the entire Act, the Court excised that section, making the Guidelines effectively advisory. 3 Id. Under the mandatory sentencing scheme that prevailed at the time Dean committed his offenses, 1997- 2003, Dean's maximum sentence would have been capped by the upper end of the Guidelines range.

After Booker, however, district courts were free to increase sentences beyond the Guidelines range. 4 This is what the district court did in Dean's case. He argues that the court violated the due process and ex post facto clauses of the Fifth Amendment because the offenses for which he was being sentenced occurred before Booker.

We have repeatedly rejected the argument that the application of the remedial portion of Booker to conduct that occurred prior to Booker violates ex post facto principles or due process. United States v. Thomas, 446 F.3d 1348, 1353-55 (11th Cir. 2006); United States v. Duncan, 400 F.3d 1297, 1306-08 (11th Cir.), cert. denied, 126 S. Ct. 432 (2005); United States v. Hunt, 459 F.3d 1180, 1181 n.1 (11th Cir. 2006).

We have also held that a district court may make additional factual findings under a preponderance of the evidence standard, that go beyond the facts found by the jury, so long as the court recognizes the Guidelines are advisory. United States v. Pope, 461 F.3d 1331, 1335 (11th Cir. 2006). And, we have held that a district court may enhance a sentence based upon judicial fact-finding provided that its findings do not increase the sentence beyond the statutory maximum authorized by facts determined in a guilty plea or jury verdict. Hunt, 459 F.3d at 1182. We have also stated that the maximum sentence is the sentence prescribed under United States Code. See Duncan, 400 F.3d at 1308 (citing United States v. Sanchez, 269 F.3d 1250, 1268 (11th Cir. 2001)).

The district court applied the Guidelines as advisory. It sentenced Dean to a total of 84 months: three concurrent jail terms of 60 months on Counts I - III and three concurrent jail terms of 24 months on Counts IV - VII. The sentences for Counts I -III and Counts IV - VII were to run consecutively. Under the United States Code, the statutory maximum for tax evasion (Counts I - VI) is 60 months and the maximum for attempting to interfere with the administration of internal revenue laws (Count VII) is 36 months. See 26 U.S.C. § 7201 and 26 U.S.C. § 7212(a). The district court did not increase Dean's sentence beyond this statutory maximum. Additionally, we find that the amount of tax loss stated in Dean's PSI conforms to the evidence on record from the IRS. Accordingly, the district court's factual finding on the amount of loss was not clearly erroneous.




IV. CONCLUSION


The district court properly denied Dean's motion to stay proceedings because of a substantial failure to comply with the Jury Selection and Service Act. Dean's motion was untimely and it did not contain a sworn affidavit stating facts in support of his allegation. Thus, we find that his motion is barred on procedural grounds.

We also find that there was sufficient evidence to convict Dean of attempting to interfere with the administration of internal revenue laws under 26 U.S.C. § 7212(a). The record showed that Dean wrote his employer, the DFAS, and various financial institutions to notify them that the IRS had issued "phony" and "fraudulent" summonses for information from his financial records, and to advise them that he would take legal action if they released his records to the IRS. The statute criminalizes corrupt or forceful attempts to impede the administration of internal revenue laws, including the use of "threatening letters."

We also find that the district court's jury instructions were proper. The district court did not err when it used our pattern jury instructions to inform the jury on what the charges of tax evasion and attempting to interfere with the administration of internal revenue laws entailed. Nor did it err when it instructed the jury on the "good faith" belief defense that applies to charges of income tax evasion. The district court's instruction on "good faith" conformed to the standards that the Supreme Court recognized for this defense in Cheek.

We also find that the district court did not abuse its discretion when it refused to give the jury the additional instructions proffered by Dean. The proffered instructions concerned sections of the Internal Revenue Code that were not specifically relevant to the sections cited in the Government's charges against Dean. And, Dean did not show that the failure to give these additional instructions impacted his ability to assert a good faith defense.

Finally, we find that the district court's determination on the amount of tax loss was supported by the record and not clearly erroneous. Thus, the district court properly relied upon this finding in calculating the Guidelines range for Dean's sentence. The district court treated the Guidelines as advisory and chose to increase Dean's sentence beyond the advisory Guidelines range. This decision did not violate Booker, nor did it offend due process or subject him to ex post facto punishment.

AFFIRMED.

* Honorable Richard D. Cudahy, United States Circuit Judge for the Seventh Circuit, sitting by designation.

1 In Bonner v. City of Prichard, 661 F.2d 1206, 1209 (11th Cir. 1981) (en banc), this Court adopted as binding precedent all of the decisions that the former Fifth Circuit issued prior to October 1, 1981.

2 The district court denied Dean's motion to stay proceedings for both of the procedural reasons cited above, but it also denied Dean's motion on the merits. See Transcript of Motions Hearing, December 5, 2005, at 14. The motion identified three potentially troublesome concerns with respect to jury qualification questionnaires: (1) some prospective jurors did not state where they were born, while others clearly stated they were born outside the country; (2) some prospective jurors did not state how long they had resided within the northern district of Florida, and lastly, (3) none of the questionnaires asked prospective jurors whether they had English language skills.

The fact that a juror indicated he or she was foreign born did not prove that the juror lacked U.S. citizenship, the court noted. Moreover, the defendant's counsel acknowledged at the motion hearing that he had not studied the District Jury Plan to know whether the court did any follow-up questioning when jurors reported for grand jury selection. Indeed, the court always asked these questions before it seated jurors reporting for grand jury duty, the court noted. Accordingly, the court concluded, the defendant had failed to meet his burden as a moving party and demonstrate that there was a "substantial failure to comply" with the Jury Selection and Service Act. Additionally, we note that Dean failed to ask any questions on these issues during voir dire, even though his counsel conceded during motion hearing that he could probably resolve the doubts about juror citizenship, residency or English language proficiency during voir dire.

3 The Supreme Court actually excised two sections: 18 U.S.C. § 3553(b)(1), which mandated that courts impose sentences within the Guidelines range, and a related section, 18 U.S.C. § 3742(e), which addressed the standards of review that would govern appeals. United States v. Booker, 543 U.S. 220 (2005).

4 A district court must consult the Guidelines range and consider 18 U.S.C. § 3553 sentencing factors, but once it has done so, it "may impose a more sever or lenient sentence as long as it is reasonable." United States v. Pope, 461 F.3d 1331, 1335 (11th Cir. 2006). Dean is not challenging the ultimate reasonableness of his sentence, however.


Alvin S. Brown
Tax Attorney
703 425-1400
www.irstaxattorney.com
www.irsforum.org

Tax Attorney: Sham LLC treated as a partnership
RJT Investments X,v Commissioner CA-8, 2007-2 USTC ¶50,535, July 2, 2007.


Partners and partnerships: Partnership item determinations: Sham transactions. --
The Tax Court correctly treated as a partnership item its determination that an LLC was a sham and lacked economic substance. Although the definition of partnership item in Code Sec. 6231(a)(3) includes items required to be taken into account under subtitle A, the statutory language provides room for partnership items that, even in the absence of an explicit subtitle A reference, are necessary for income tax calculation purposes. Further, other courts have applied a similarly broad reading of the partnership item definition in concluding that the TEFRA statute of limitations is a partnership item, even through the statute of limitations is not governed by subtitle A. The taxpayer did not present a compelling reason to distinguish the partnership's status as a sham from the treatment of the statute of limitations. Moreover, the treatment of sham status as a partnership item was consistent with Congress's intent in enacting TEFRA. The determination of sham status was also more appropriately determined at the partnership level. Under Reg. §301.6231(a)(3)-1(b), the determination of partnership items includes underlying legal and factual determinations including the partnership's method of accounting, its inventory method, and whether partnership activities have been engaged in with the intent to make a profit for purposes of Code Sec. 183. The status of a partnership as a sham is an underlying legal determination that falls within the definition of partnership item.

The taxpayer's argument that the LLC's sham status cannot constitute a partnership item was rejected. Although the definition of partnership item in Code Sec. 6231(a)(3) includes items required to be taken into account under subtitle A, the statutory language provides room for partnership items that, even in the absence of an explicit subtitle A reference, are necessary for income tax calculation purposes. Further, other courts have applied a similarly broad reading of the partnership item definition in concluding that the TEFRA statute of limitations is a partnership item, even through the statute of limitations is not governed by subtitle A. The taxpayer did not present a compelling reason to distinguish the partnership's status as a sham from the treatment of the statute of limitations. Moreover, the treatment of sham status as a partnership item was consistent with Congress's intent in enacting TEFRA.

The determination of sham status was also more appropriately determined at the partnership level. Under Reg. §301.6231(a)(3)-1(b), the determination of partnership items includes underlying legal and factual determinations including the partnership's method of accounting, its inventory method, and whether partnership activities have been engaged in with the intent to make a profit for purposes of Code Sec. 183. The status of a partnership as a sham is an underlying legal determination that falls within the definition of partnership item.



II.


The Internal Revenue Code defines "partnership item" as "[(A)] any item required to be taken into account for the partnership's taxable year under any provision of subtitle A[, (B)] to the extent regulations prescribed by the Secretary provide that...such item is more appropriately determined at the partnership level than at the partner level." 26 U.S.C. §6231(a)(3). 5


A. "Required to be taken into account under...subtitle A"


RJT and Thompson first contend that the "sham, etc." status cannot constitute a partnership item because no provision of subtitle A explicitly requires that a partnership make such a determination for purposes of deriving individual income tax. They assert, as a result, that the Tax Court improperly broadened the partnership item definition by effectively substituting "regarding any provision of subtitle A" for the "required to be taken into account...under any provision of subtitle A" language. We find Thompson's argument unavailing and contrary to TEFRA's language and intent.

To begin, we disagree with RJT and Thompson's premise that the legal validity of a partnership is not something "required to be taken into account" for income tax calculation purposes. When filling out individual tax returns, the very process of calculating an outside basis, reporting a sales price, and claiming a capital loss following a partnership liquidation presupposes that the partnership was valid. Even if the partnership's validity is, in some instances, assumed, the proper resolution of a partner's income tax is no less dependant on the correctness of that assumption.

Additionally RJT and Thompson misread the statutory language when they argue that the "sham, etc." status cannot be a partnership item because subtitle A does not reference it. Their interpretation effectively and improperly replaces the actual language "required... under any provision" with "required... by any provision." The word "under" is typically used to broadly describe relevance or relatedness to the overarching concept. "By," on the other hand, connotes a distinct and explicit link connecting one thing to another. 6 Accordingly, the statutory language itself provides room for partnership items that, even in the absence of an explicit subtitle A reference, are nevertheless necessary for income tax calculation purposes. Cf. Weiner v. United States, 389 F.3d 152, 155-58 (5th Cir. 2005) (finding a broad definition by relying, in part, on regulatory language).

This interpretation is supported by case law as well. 7 For example, the majority of courts faced with the question have considered the running of TEFRA's statute of limitations to be a partnership item. See, e.g., Weiner, 389 F.3d at 157 (collecting cases); Slovacek v. United States, 36 Fed. Cl. 250, 255 (Fed. Cl. 1996); see also Chimblo v. Comm'r, 177 F.3d 119, 125 (2nd Cir. 1999). This result could not be reached by what we understand to be RJT and Thompson's narrow reading of the "required to be taken into account under subtitle A" language. The statute of limitations under TEFRA is governed by subtitle F, not subtitle A. When addressing an identical argument to that presented by RJT and Thompson as it pertained to the statute of limitations, the court in Weiner observed that the absence of the statute of limitations from subtitle A does not alone defeat the conclusion that the statute of limitations is a partnership item because the partnership item definition "is broad enough to include in its parameters legal and factual determinations not specifically found in subtitle A." Weiner, 389 F.3d at 157 n.3.

RJT and Thompson have not presented a compelling reason to distinguish the partnership's status as a "sham ,etc." from our treatment of the statute of limitations. There are reasons to treat it similarly, however. Status as a "sham, etc." directly affects various components relevant for income tax reporting. It not only may render a "thumbs-up or thumbs-down" verdict on other relevant partnership item entries, see Weiner, 389 F.3d at 152 (noting how the statute of limitations affects the tax reporting process), but also, in the event of a legally incognizable partnership, it dictates whether certain income tax concepts are even applicable. The IRS notes, for example, that for individual tax reporting purposes, one cannot take into account startup investment costs for an illegitimate, legally unrecognizable partnership.

Furthermore, RJT and Thompson's interpretation runs counter to congressional intent. TEFRA was intended, in relevant part, to prevent inconsistent and inequitable income tax treatment between various partners of the same partnership resulting from conflicting determinations of partnership level items in individual partner proceedings. Randell v. United States, 64 F.3d 101, 103-04 (3rd Cir. 1995) (describing the goals of TEFRA and the problems TEFRA was intended to address); see also H.R. CONF. REP. NO. 97-760, at 599-600 (1982), reprinted in 1982 U.S.C.C.A.N. 1190, 1371-72. With that intention in mind, we can think of few examples more emblematic of a congressionally envisioned partnership item than the one before us here. The resulting tax treatment of two partners in the same partnership could vary substantially if the court in one partner's deficiency proceeding recognized the legitimate existence of the partnership and the court in the other proceeding decided to disregard the partnership as a matter of law. Accordingly, even were there some ambiguity in the act's language, we would choose the interpretation consistent with Congress's clear intention when enacting TEFRA. "Sham, etc." status, then, meets the first of TEFRA's two threshold requirements for consideration as a partnership item.


B. More appropriately determined at the partnership level


As previously stated, however, the Secretary of the Treasury must also consider a partnership item to be something more appropriately determined at the partnership level. Although RJT and Thompson do not challenge the validity of the Treasury regulation at issue, they contend that no fair reading of it allows for the conclusion that the Secretary made such an assessment with respect to "sham, etc." status. We disagree.

The Treasury regulation includes within the "partnership item" classification "the legal and factual determinations that underlie the determination of the amount, timing, and characterization of items of income, credit, gain, loss, deduction, etc." 26 C.F.R. §301.6231(a)(3)-1(b) (emphasis added). Examples of such legal and factual determinations falling within the partnership item ambit include, among other things, the partnership's method of accounting, its inventory method, and even "whether partnership activities have been engaged in with the intent to make a profit for purposes of §183." Id. As an underlying legal determination with direct bearing on the items mentioned, the status of the partnership as a "sham, etc." falls squarely within this definition. The regulation does not limit its applicability to line items and technical accounting issues as RJT and Thompson suggest. Finally, just as Thompson and RJT have failed to justify treating "sham, etc." differently from our treatment of the statute of limitations with respect to the statutory language, they have also failed to present us with any reason to distinguish our treatment of "sham, etc." from the statute of limitations under the language of the regulation. In fact, RJT and Thompson even acknowledge that the statute of limitations is a valid partnership item under the regulation. Accordingly, the Tax Court correctly treated as a partnership item its determination that RJT is a "sham, etc." 8

The judgment is affirmed. 9

Back Taxes: IRS Appeals Chief Offers Taxpayers a "Fresh Look"

IRS Appeals Chief Sarah Ingram reported on July 10, 2007 how taxpayers may take advantage of the IRS Appeals process after their interaction with the IRS Examinations or Collections Divisions has come to an end. Ingram reported how the Appeals Division strenuously maintains its impartial resolution of taxpayer concerns.



After taxpayers receive their determination letter from the IRS Examinations or Collection Divisions, they may take their case to the Appeals Division to get what Ingram termed "a fresh look." She reported that Appeals attempts to be unbiased, remain fair, make impartial decisions regarding both the taxpayer and the IRS and, therefore, maintain public confidence in the federal tax system. Ingram even pointed out that, while the appeals process is unavailable to taxpayers in federal district court, those who have received their statutory notice of deficiency and even filed a claim in the U.S. Tax Court may still take the case to the IRS Appeals Division.


Settlement Guidelines


Acting proactively, Ingram reported that the Division will deem tax shelters and cutting edge issues to be "coordinated issues" and publish settlement guidelines, stating the Division's opinion with regard to them. To create these guidelines Appeals seeks input from practitioners, affected taxpayers, and the affected taxpayer community at large to help officials understand the issue in more detail. The guidelines are then published on the IRS's website at http://www.irs.gov/individuals/article/0,,id=108652,00.html. With this move, the Appeals Division seeks to promote horizontal equity among taxpayers, efficiency and transparency in the tax administrative process. Ingram offered the advice to tax practitioners that "it's a good idea to have the discussion at the beginning of your case as to whether there are coordinated issues."


Ex parte Rights
Ingram also reported that the Appeals Division continues to strongly enforce a taxpayer's right to be aware of, and participate in, discussions between Appeals and other branches of the IRS during the appeals process. If taxpayers suspect that this prohibited communication has occurred, Ingram advises them to report it immediately to the Appeals officer in charge of their case.



If the prohibited communication indeed occurred, the IRS will share the communication with the taxpayer and offer them the opportunity to present their side of the issue to Appeals --what Ingram called "bringing sunshine" to the issue. If the U.S. Tax Court finds that such communication has occurred, Ingram pointed out that the court may reassign the case to a different Appeals officer in order to preserve the "fresh look."



"This is something which is very important to our organization," she added.

Tax Help: Updated Exempt Organizations procedures are republished, regarding the request, issuance and appeal of determination letters and rulings on the exempt status of organizations under Code Secs. 501 and 521. The updated procedures provide guidance on requesting determination letters, the steps taken in issuing determination letters, appealing determination letters, revoking determination letters and when an organization will have sufficiently exhausted administrative remedies allowing for a declaratory judgment proceeding under Code Sec. 7428. Included in the guidance is the new central address for the processing of exempt status applications, replacing the former system of district offices. Rev. Proc. 90-27, 1990-1 CB 514, is superseded and. Proc. 76-34, 1976-2 CB 656, is supplemented. See Rev. Proc. 2007-52 , I.R.B. 2007-30,Rev July 9, 2007.



Exempt organizations: Exempt status: Application for exempt status: Procedures. --

TABLE OF CONTENTS



SECTION 1. WHAT IS THE PURPOSE OF THIS REVENUE PROCEDURE?

.01 Description of terms used in this revenue procedure

.02 Updated annually




SECTION 2. NATURE OF CHANGES AND RELATED REVENUE PROCEDURES

.01 Rev. Proc. 90-27 is superseded and the processing of applications is
now centralized

.02 Related revenue procedures




SECTION 3. WHAT ARE THE PROCEDURES FOR REQUESTING RECOGNITION OF EXEMPT STATUS?

.01 In general

.02 User fee

.03 Form 1023 application

.04 Form 1024 application

.05 Letter application

.06 Form 1028 application

.07 Form 8871 notice for political organizations

.08 Requirements for a substantially completed application

.09 Terrorist organizations not eligible to apply for recognition of
exemption




SECTION 4. WHAT ARE THE STANDARDS FOR ISSUING A DETERMINATION LETTER OR RULING ON
EXEMPT STATUS?

.01 Exempt status must be established in application and supporting
documents

.02 Determination letter or ruling based solely on administrative record

.03 Exempt status may be recognized in advance of actual operations

.04 No letter if exempt status issue in litigation or under consideration
within the Service

.05 Incomplete application

.06 Even if application is complete, additional information may be required

.07 Expedited handling




SECTION 5. WHAT OFFICES ISSUE AN EXEMPT STATUS DETERMINATION LETTER OR RULING?

.01 EO Determinations issues a determination letter in most cases

.02 Certain applications referred to EO Technical

.03 Technical advice may be requested in certain cases

.04 Technical advice must be requested in certain cases




SECTION 6. WITHDRAWAL OF AN APPLICATION

.01 Application may be withdrawn prior to issuance of a determination
letter or ruling

.02 § 7428 implications of withdrawal of application under § 501(c)(3)




SECTION 7. WHAT ARE THE PROCEDURES WHEN EXEMPT STATUS IS DENIED?

.01 Proposed adverse determination letter or ruling

.02 Appeal of a proposed adverse determination letter issued by EO
Determinations

.03 Protest of a proposed adverse ruling issued by EO Technical

.04 Final adverse determination letter or ruling where no appeal or protest
is submitted

.05 How EO Determinations handles an appeal of a proposed adverse
determination letter

.06 Consideration by the Appeals Office

.07 If a protest of a proposed adverse ruling is submitted to EO Technical

.08 An appeal or protest may be withdrawn

.09 Appeal or protest and conference rights not applicable in certain
situations




SECTION 8. DISCLOSURE OF APPLICATIONS AND DETERMINATION LETTERS AND RULINGS

.01 Disclosure of applications, supporting documents, and favorable
determination letters and rulings

.02 Disclosure of adverse determination letters or rulings

.03 Disclosure to State officials when the Service refuses to recognize
exemption under § 501(c)(3)

.04 Disclosure to State officials of information about § 501(c)(3)
applicants




SECTION 9. REVIEW OF DETERMINATION LETTERS BY EO TECHNICAL

.01 Determination letters may be reviewed by EO Technical to assure
uniformity

.02 Procedures for cases where EO Technical takes exception to a
determination letter




SECTION 10. DECLARATORY JUDGMENT PROVISIONS OF § 7428

.01 Actual controversy involving certain issues

.02 Exhaustion of administrative remedies

.03 Not earlier than 270 days after seeking determination

.04 Service must have reasonable time to act on an appeal or protest

.05 Final determination to which § 7428 applies




SECTION 11. EFFECT OF DETERMINATION LETTER OR RULING RECOGNIZING EXEMPTION

.01 Effective date of exemption

.02 Reliance on determination letter or ruling




SECTION 12. REVOCATION OR MODIFICATION OF DETERMINATION LETTER OR RULING
RECOGNIZING EXEMPTION

.01 Revocation or modification of a determination letter or ruling may be
retroactive

.02 Appeal and conference procedures in the case of revocation or
modification of exempt status letter




SECTION 13. EFFECT ON OTHER REVENUE PROCEDURES




SECTION 14. EFFECTIVE DATE




SECTION 15. PAPERWORK REDUCTION ACT





DRAFTING INFORMATION



SECTION 1. WHAT IS THE PURPOSE OF THIS REVENUE PROCEDURE?

This revenue procedure sets forth procedures for issuing determination letters and rulings on the exempt status of organizations under §§ 501 and 521 of the Internal Revenue Code other than those subject to Rev. Proc. 2007-6, 2007-1 I.R.B. 189 (relating to pension, profit-sharing, stock bonus, annuity, and employee stock ownership plans). Generally, the Service issues these determination letters and rulings in response to applications for recognition of exemption from Federal income tax. These procedures also apply to revocation or modification of determination letters or rulings This revenue procedure also provides guidance on the exhaustion of administrative remedies for purposes of declaratory judgment under § 7428 of the Code.



Description of terms used in this revenue procedure

.01 For purposes of this revenue procedure -

(1) the term "Service" means the Internal Revenue Service.

(2) the term "application" means the appropriate form or letter that an organization must file or submit to the Service for recognition of exemption from Federal income tax under the applicable section of the Internal Revenue Code. See section 3 for information on specific forms.

(3) the term "EO Determinations" means the office of the Service that is primarily responsible for processing initial applications for tax-exempt status. It includes the main EO Determinations office located in Cincinnati, Ohio, and other field offices that are under the direction and control of the Manager, EO Determinations.

(4) the term "EO Technical" means the office of the Service that is primarily responsible for issuing letter rulings to taxpayers on exempt organization matters, and for providing technical advice or technical assistance to other offices of the Service on exempt organization matters. The EO Technical office is located in Washington, DC.

(5) the term "Appeals Office" means any office under the direction and control of the Chief, Appeals. The purpose of the Appeals Office is to resolve tax controversies, without litigation, on a fair and impartial basis. The Appeals Office is independent of EO Determinations and EO Technical.

(6) the term "determination letter" means a written statement issued by EO Determinations or an Appeals Office in response to an application for recognition of exemption from Federal income tax under §§ 501 and 521. This includes a written statement issued by EO Determinations or an Appeals Office on the basis of advice secured from EO Technical pursuant to the procedures prescribed herein and in Rev. Proc. 2007-5, 2007-1 I.R.B. 161.

(7) the term "ruling" means a written statement issued by EO Technical in response to an application for recognition of exemption from Federal income tax under §§ 501 and 521.



Updated annually

.02 This revenue procedure is updated annually, but may be modified or amplified during the year.



SECTION 2. NATURE OF CHANGES AND RELATED REVENUE PROCEDURES



Rev. Proc. 90-27 is superseded and the processing of applications is now centralized

.01 This revenue procedure updates Rev. Proc. 90-27, 1990-1 C.B. 514, which is hereby superseded.

(1) The responsibility for processing applications is now centralized in the EO Determinations office in Cincinnati, Ohio. Key district offices no longer exist.

(2) Although applications are generally processed in the Cincinnati office, some applications may be processed in other EO Determinations offices or referred to EO Technical.



Related revenue procedures

.02 This revenue procedure supplements Rev. Proc. 76-34, 1976-2 C.B. 656, with respect to the effects of § 7428 of the Code on the classification of organizations under §§ 509(a) and 4942(j)(3). Rev. Proc. 80-27, 1980-1 C.B. 677, sets forth procedures under which exemption may be recognized on a group basis for subordinate organizations affiliated with and under the general supervision and control of a central organization. Rev. Proc. 72-5, 1972-1 C.B. 709, provides information for religious and apostolic organizations seeking recognition of exemption under § 501(d). General procedures for requests for a determination letter or ruling are provided in Rev. Proc. 2007-4, 2007-1 I.R.B. 118. User fees for requests for a determination letter or ruling are set forth in Rev. Proc. 2007-8, 2007-1 I.R.B. 230.



SECTION 3. WHAT ARE THE PROCEDURES FOR REQUESTING RECOGNITION OF EXEMPT STATUS?



In general

.01 An organization seeking recognition of exempt status under § 501 or § 521 is required to submit the appropriate application. In the case of a numbered application form, the current version of the form must be submitted. A central organization that has previously received recognition of its own exemption can request a group exemption letter by submitting a letter application with Form 8718, User Fee for Exempt Organization Determination Letter Request. See Rev. Proc. 80-27.



User fee

.02 An application must be submitted with the correct user fee, as set forth in Rev. Proc. 2007-8.



Form 1023 application

.03 An organization seeking recognition of exemption under § 501(c)(3) and §§ 501(e), (f), (k), (n) or (q) must submit a completed Form 1023. In the case of an organization that provides credit counseling services, see section 501(q) of the Code.



Form 1024 application

.04 An organization seeking recognition of exemption under §§ 501(c)(2), (4), (5), (6), (7), (8), (9), (10), (12), (13), (15), (17), (19) or (25) must submit a completed Form 1024 with Form 8718. In the case of an organization that provides credit counseling services and seeks recognition of exemption under section 501(c)(4), see section 501(q) of the Code.



Letter application

.05 An organization seeking recognition of exemption under §§ 501(c)(11), (14), (16), (18), (21), (22), (23), (26), (27) or (28) or under § 501(d) must submit a letter application with Form 8718 .



Form 1028 application

.06 An organization seeking recognition of exemption under § 521 must submit a completed Form 1028 with Form 8718 .



Form 8871 notice for political organizations

.07 A political party, a campaign committee for a candidate for federal, state or local office, and a political action committee are all political organizations subject to tax under § 527. To be tax-exempt, a political organization may be required to notify the Service that it is to be treated as a § 527 organization by electronically filing Form 8871, Political Organization Notice of Section 527 Status. For details, go to the IRS website at www.irs.gov/polorgs.



Requirements for a substantially completed application

.08 A substantially completed application, including a letter application, is one that:

(1) is signed by an authorized individual.

(2) includes an Employer Identification Number (EIN).

(3) includes a statement of receipts and expenditures and a balance sheet for the current year and the three preceding years (or the years the organization was in existence, if less than four years). If the organization has not yet commenced operations, or has not completed one accounting period, a substantially completed application generally includes a proposed budget for two full accounting periods and a current statement of assets and liabilities.

(4) includes a detailed narrative statement of proposed activities, including each of the fundraising activities of a § 501(c)(3) organization, and a narrative description of anticipated receipts and contemplated expenditures.

(5) includes a copy of the organizing or enabling document that is signed by a principal officer or is accompanied by a written declaration signed by an authorized individual certifying that the document is a complete and accurate copy of the original or otherwise meets the requirements of a "conformed copy" as outlined in Rev. Proc. 68-14, 1968-1 C.B. 768.

(6) if the organizing or enabling document is in the form of articles of incorporation, includes evidence that it was filed with and approved by an appropriate state official (e.g., stamped "Filed" and dated by the Secretary of State). Alternatively, a copy of the articles of incorporation may be submitted if accompanied by a written declaration signed by an authorized individual that the copy is a complete and accurate copy of the original copy that was filed with and approved by the state. If a copy is submitted, the written declaration must include the date the articles were filed with the state.

(7) if the organization has adopted by-laws, includes a current copy. The by-laws need not be signed if submitted as an attachment to the application for recognition of exemption. Otherwise, the by-laws must be verified as current by an authorized individual.

(8) is accompanied by the correct user fee and Form 8718, when applicable.



Terrorist organizations not eligible to apply for recognition of exemption

.09 An organization that is identified or designated as a terrorist organization within the meaning of section 501(p)(2) of the Code is not eligible to apply for recognition of exemption.



SECTION 4. WHAT ARE THE STANDARDS FOR ISSUING A DETERMINATION LETTER OR RULING ON EXEMPT STATUS?



Exempt status must be established in application and supporting documents

.01 A favorable determination letter or ruling will be issued to an organization only if its application and supporting documents establish that it meets the particular requirements of the section under which exemption from Federal income tax is claimed.



Determination letter or ruling based solely on administrative record

.02 A determination letter or ruling on exempt status is issued based solely upon the facts and representations contained in the administrative record.

(1) The applicant is responsible for the accuracy of any factual representations contained in the application.

(2) Any oral representation of additional facts or modification of facts as represented or alleged in the application must be reduced to writing over the signature of an authorized individual.

(3) The failure to disclose a material fact or misrepresentation of a material fact on the application may adversely affect the reliance that would otherwise be obtained through issuance by the Service of a favorable determination letter or ruling.



Exempt status may be recognized in advance of actual operations

.03 Exempt status may be recognized in advance of the organization's operations if the proposed activities are described in sufficient detail to permit a conclusion that the organization will clearly meet the particular requirements for exemption pursuant to the section of the Internal Revenue Code under which exemption is claimed.

(1) A mere restatement of exempt purposes or a statement that proposed activities will be in furtherance of such purposes will not satisfy this requirement.

(2) The organization must fully describe all of the activities in which it expects to engage, including the standards, criteria, procedures or other means adopted or planned for carrying out the activities, the anticipated sources of receipts, and the nature of contemplated expenditures.

(3) Where the organization cannot demonstrate to the satisfaction of the Service that it qualifies for exemption pursuant to the section of the Internal Revenue Code under which exemption is claimed, the Service will generally issue a proposed adverse determination letter or ruling. See also section 7.



No letter if exempt status issue in litigation or under consideration within the Service

.04 A determination letter or ruling on exempt status will not ordinarily be issued if an issue involving the organization's exempt status under § 501 or § 521 is pending in litigation, is under consideration within the Service, or if issuance of a determination letter or ruling is not in the interest of sound tax administration. If the Service declines to issue a determination or ruling to an organization seeking exempt status under § 501(c)(3), the organization may pursue a declaratory judgment under § 7428 provided that it has exhausted its administrative remedies.



Incomplete application

.05 If an application does not contain all of the items set out in section 3.08, the Service may return it to the applicant for completion.

(1) In lieu of returning an incomplete application, the Service may retain the application and request additional information needed for a substantially completed application.

(2) In the case of an application or a group exemption request under § 501(c)(3) that is returned incomplete, the 270-day period referred to in § 7428(b)(2) will not be considered as starting until the date a substantially completed Form 1023 or group exemption request is refiled with or remailed to the Service. If the application or group exemption request is mailed to the Service and a postmark is not evident, the 270-day period will start to run on the date the Service actually receives the substantially completed Form 1023 or group exemption request. The same rules apply for purposes of the notice requirement of § 508.

(3) Generally, the user fee will not be refunded if an incomplete application is filed. See Rev. Proc. 2007-8, section 10.



Even if application is complete, additional information may be required

.06 Even though an application is substantially complete, the Service may request additional information before issuing a determination letter or ruling.

(1) If the application involves an issue where contrary authorities exist, an applicant's failure to disclose and distinguish contrary authorities may result in requests for additional information, which could delay final action on the application.

(2) In the case of an application under § 501(c)(3), the period of time beginning on the date the Service requests additional information until the date the information is submitted to the Service will not be counted for purposes of the 270-day period referred to in § 7428(b)(2).



Expedited handling

.07 Applications are normally processed in the order of receipt by the Service. However, expedited handling of an application may be approved where a request is made in writing and contains a compelling reason for processing the application ahead of others. Upon approval of a request for expedited handling an application will be considered out of its normal order. This does not mean the application will be immediately approved or denied. Circumstances generally warranting expedited processing include:

(1) A grant to the applicant is pending and the failure to secure the grant may have an adverse impact on the organization's ability to continue to operate.

(2) The purpose of the newly created organization is to provide disaster relief to victims of emergencies such as flood and hurricane.

(3) There have been undue delays in issuing a determination letter or ruling caused by a Service error.



SECTION 5. WHAT OFFICES ISSUE AN EXEMPT STATUS DETERMINATION LETTER OR RULING?



EO Determinations issues a determination letter in most cases

.01 Under the general procedures outlined in Rev. Proc. 2007-4, EO Determinations is authorized to issue determination letters on applications for exempt status under §§ 501 and 521.



Certain applications referred to EO Technical

.02 EO Determinations will refer to EO Technical those applications that present issues which are not specifically covered by statute or regulations, or by a ruling, opinion, or court decision published in the Internal Revenue Bulletin. In addition, EO Determinations will refer those applications that have been specifically reserved by revenue procedure or by other official Service instructions for handling by EO Technical for purposes of establishing uniformity or centralized control of designated categories of cases. EO Technical will notify the applicant organization upon receipt of a referred application, and will consider each such application and issue a ruling directly to the organization.



Technical advice may be requested in certain cases

.03 If at any time during the course of consideration of an exemption application by EO Determinations the organization believes that its case involves an issue on which there is no published precedent, or there has been non-uniformity in the Service's handling of similar cases, the organization may request that EO Determinations either refer the application to EO Technical or seek technical advice from EO Technical. See Rev. Proc. 2007-5, section 4.04.



Technical advice must be requested in certain cases

.04 If EO Determinations proposes to recognize the exemption of an organization to which EO Technical had issued a previous contrary ruling or technical advice, EO Determinations must seek technical advice from EO Technical before issuing a determination letter. This does not apply where EO Technical issued an adverse ruling and the organization subsequently made changes to its purposes, activities, or operations to remove the basis for which exempt status was denied.



SECTION 6. WITHDRAWAL OF AN APPLICATION



Application may be withdrawn prior to issuance of a determination letter or ruling

.01 An application may be withdrawn upon the written request of an authorized individual at any time prior to the issuance of a determination letter or ruling. Therefore, an application may not be withdrawn after the issuance of a proposed adverse determination letter or ruling.

(1) When an application is withdrawn, the Service will retain the application and all supporting documents. The Service may consider the information submitted in connection with the withdrawn request in a subsequent examination of the organization.

(2) Generally, the user fee will not be refunded if an application is withdrawn. See Rev. Proc. 2007-8, section 10.



§ 7428 implications of withdrawal of application under § 501(c)(3)

.02 The Service will not consider the withdrawal of an application under § 501(c)(3) as either a failure to make a determination within the meaning of § 7428(a)(2) or as an exhaustion of administrative remedies within the meaning of § 7428(b)(2).



SECTION 7. WHAT ARE THE PROCEDURES WHEN EXEMPT STATUS IS DENIED?



Proposed adverse determination letter or ruling

.01 If EO Determinations or EO Technical reaches the conclusion that the organization does not satisfy the requirements for exempt status pursuant to the section of the Internal Revenue Code under which exemption is claimed, the Service will generally issue a proposed adverse determination letter or ruling, which will:

(1) Include a detailed discussion of the Service's rationale for the denial of tax-exempt status.

(2) Advise the organization of its opportunity to appeal or protest the decision and request a conference.



Appeal of a proposed adverse determination letter issued by EO Determinations

.02 A proposed adverse determination letter issued by EO Determinations will advise the organization of its opportunity to appeal the determination by requesting Appeals Office consideration. To do this, the organization must submit a statement of the facts, law and arguments in support of its position within 30 days from the date of the adverse determination letter. The organization must also state whether it wishes an Appeals Office conference. Any determination letter issued on the basis of technical advice from EO Technical may not be appealed to the Appeals Office on issues that were the subject of the technical advice.



Protest of a proposed adverse ruling issued by EO Technical

.03 A proposed adverse ruling issued by EO Technical will advise the organization of its opportunity to file a protest statement within 30 days and to request a conference. If a conference is requested, the conference procedures outlined in Rev. Proc. 2007-4, section 12, are applicable.



Final adverse determination letter or ruling where no appeal or protest is submitted

.04 If an organization does not submit a timely appeal of a proposed adverse determination letter issued by EO Determinations, or a timely protest of a proposed adverse ruling issued by EO Technical, a final adverse determination letter or ruling will be issued to the organization. The final adverse letter or ruling will provide information about the filing of tax returns and the disclosure of the proposed and final adverse letters or rulings.



How EO Determinations handles an appeal of a proposed adverse determination letter

.05 If an organization submits an appeal of the proposed adverse determination letter, EO Determinations will first review the appeal, and if it determines that the organization qualifies for tax-exempt status issue a favorable exempt status determination letter. If EO Determinations maintains its adverse position after reviewing the appeal, it will forward the appeal and the exemption application case file to the Appeals Office.



Consideration by the Appeals Office

.06 The Appeals Office will consider the organization's appeal. If the Appeals Office agrees with the proposed adverse determination, it will either issue a final adverse determination or, if a conference was requested, contact the organization to schedule a conference. At the end of the conference process, which may involve the submission of additional information, the Appeals Office will either issue a final adverse determination letter or a favorable determination letter. If the Appeals Office believes that an exemption or private foundation status issue is not covered by published precedent or that there is non-uniformity, the Appeals Office must request technical advice from EO Technical in accordance with Rev. Proc. 2007-5, section 4.04.



If a protest of a proposed adverse ruling is submitted to EO Technical

.07 If an organization submits a protest of a proposed adverse exempt status ruling, EO Technical will review the protest statement. If the protest convinces EO Technical that the organization qualifies for tax-exempt status, a favorable ruling will be issued. If EO Technical maintains its adverse position after reviewing the protest, it will either issue a final adverse ruling or, if a conference was requested, contact the organization to schedule a conference. At the end of the conference process, which may involve the submission of additional information, EO Technical will either issue a final adverse ruling or a favorable exempt status ruling.



An appeal or protest may be withdrawn

.08 An organization may withdraw its appeal or protest before the Service issues a final adverse determination letter or ruling. Upon receipt of the withdrawal request, the Service will complete the processing of the case in the same manner as if no appeal or protest was received.



Appeal or protest and conference rights not applicable in certain situations

.09 The opportunity to appeal or protest a proposed adverse determination letter or ruling and the conference rights described above are not applicable to matters where delay would be prejudicial to the interests of the Service (such as in cases involving fraud, jeopardy, the imminence of the expiration of the statute of limitations, or where immediate action is necessary to protect the interests of the Government).



SECTION 8. DISCLOSURE OF APPLICATIONS AND DETERMINATION LETTERS AND RULINGS

§§ 6104 and 6110 of the Code provide rules for the disclosure of applications, including supporting documents, and determination letters and rulings.



Disclosure of applications, supporting documents, and favorable determination letters or rulings

.01 The applications, any supporting documents, and the favorable determination letter or ruling issued are available for public inspection under § 6104(a)(1) of the Code. However, there are certain limited disclosure exceptions for a trade secret, patent, process, style of work, or apparatus if the Service determines that the disclosure of the information would adversely affect the organization.

(1) The Service is required to make the applications, supporting documents, and favorable determination letters or rulings available upon request. The public can request this information by submitting Form 4506-A, Request for Public Inspection or Copy of Exempt or Political Organization IRS Form.

(2) The exempt organization is required to make its exemption application, supporting documents, and determination letter or ruling available for public inspection without charge. For more information about the exempt organization's disclosure obligations, see Publication 557, Tax-Exempt Status for Your Organization.



Disclosure of adverse determination letters or rulings

.02 The Service is required to make adverse determination letters and rulings available for public inspection under § 6110 of the Code. Upon issuance of the final adverse determination letter or ruling to an organization, both the proposed adverse determination letter or ruling and the final adverse determination letter or ruling will be released under § 6110.

(1) These documents are made available to the public after the deletion of names, addresses, and any other information that might identify the taxpayer. See § 6110(c) for other specific disclosure exemptions.

(2) The final adverse determination letter or ruling will enclose Notice 437, Notice of Intention to Disclose, and redacted copies of the final and proposed adverse determination letters or rulings. Notice 437 provides instructions if the organization disagrees with the deletions proposed by the Service.



Disclosure to State officials when the Service refuses to recognize exemption under § 501(c)(3)

.03 The Service may notify the appropriate State officials of a refusal to recognize an organization as tax-exempt under § 501(c)(3). See § 6104(c) of the Code. The notice to the State officials may include a copy of a proposed or final adverse determination letter or ruling the Service issued to the organization. In addition, upon request by the appropriate State official, the Service may make available for inspection and copying the exemption application and other information relating to the Service's determination on exempt status.



Disclosure to State officials of information about § 501(c)(3) applicants

.04 The Service may disclose to State officials the name, address, and identification number of any organization that has applied for recognition of exemption under § 501(c)(3).



SECTION 9. REVIEW OF DETERMINATION LETTERS BY EO TECHNICAL



Determination letters may be reviewed by EO Technical to assure uniformity

.01 Determination letters issued by EO Determinations may be reviewed by EO Technical, or the Office of the Associate Chief Counsel (Passthroughs and Special Industries) (for cases under § 521), to assure uniform application of the statutes or regulations, or rulings, court opinions, or decisions published in the Internal Revenue Bulletin.



Procedures for cases where EO Technical takes exception to a determination letter

.02 If EO Technical takes exception to a determination letter issued by EO Determinations, the manager of EO Determinations will be advised. If EO Determinations notifies the organization of the exception taken, and the organization disagrees with the exception, the file will be returned to EO Technical. The referral to EO Technical will be treated as a request for technical advice and the procedures in Rev. Proc. 2007-5 will be followed.



SECTION 10. DECLARATORY JUDGMENT PROVISIONS OF § 7428



Actual controversy involving certain issues

.01 Generally, a declaratory judgment proceeding under § 7428 of the Code can be filed in the United States Tax Court, the United States Court of Federal Claims, or the district court of the United States for the District of Columbia with respect to an actual controversy involving a determination by the Service or a failure of the Service to make a determination with respect to the initial or continuing qualification or classification of an organization under § 501(c)(3) (charitable, educational, etc.); § 170(c)(2) (deductibility of contributions); § 509(a) (private foundation status); or § 4942(j)(3) (operating foundation status).



Exhaustion of administrative remedies

.02 Before filing a declaratory judgment action, an organization must exhaust its administrative remedies by taking, in a timely manner, all reasonable steps to secure a determination from the Service. These include:

(1) the filing of a substantially completed application Form 1023 or group exemption request under § 501(c)(3) pursuant to section 3.08 of this Revenue Procedure or the request for a determination of foundation status pursuant to Rev. Proc. 76-34;

(2) in appropriate cases, requesting relief pursuant to § 301.9100-1 of the Procedure and Administration Regulations regarding the extension of time for making an election or application for relief from tax ( see Rev. Proc. 92-85, 1992-2 C.B. 490);

(3) the timely submission of all additional information requested by the Service to perfect an exemption application or request for determination of private foundation status; and

(4) exhaustion of all administrative appeals available within the Service pursuant to section 7.



Not earlier than 270 days after seeking determination

.03 An organization will in no event be deemed to have exhausted its administrative remedies prior to the earlier of:

(1) the completion of the steps in section 10.02, and the sending by the Service by certified or registered mail of a final determination letter or ruling; or

(2) the expiration of the 270-day period described in § 7428(b)(2) in a case where the Service has not issued a final determination letter or ruling and the organization has taken, in a timely manner, all reasonable steps to secure a determination letter or ruling.



Service must have reasonable time to act on an appeal or protest

.04 The steps described in section 10.02 will not be considered completed until the Service has had a reasonable time to act upon an appeal or protest as the case may be.



Final determination to which § 7428 applies

.05 A final determination to which § 7428 of the Code applies is a determination letter or ruling, sent by certified or registered mail, which holds that the organization is not described in § 501(c)(3) or § 170(c)(2), is a public charity described in a part of § 509 or § 170(b)(1)(A) other than the part under which the organization requested classification, is not a private foundation as defined in § 4942(j)(3), or is a private foundation and not a public charity described in a part of § 509 or § 170(b)(1)(A).



SECTION 11. EFFECT OF DETERMINATION LETTER OR RULING RECOGNIZING EXEMPTION



Effective date of exemption

.01 A determination letter or ruling recognizing exemption is usually effective as of the date of formation of an organization if its purposes and activities prior to the date of the determination letter or ruling were consistent with the requirements for exemption. However, special rules under § 508(a) of the Code may apply to an organization applying for exemption under § 501(c)(3), and special rules under § 505(c) may apply to an organization applying for exemption under §§ 501(c)(9), (17), or (20).

(1) If the Service requires the organization to alter its activities or make substantive amendments to its enabling instrument, the exemption will be effective as of the date specified in a determination letter or ruling.

(2) If the Service requires the organization to make a nonsubstantive amendment, exemption will ordinarily be recognized as of the date of formation. Examples of nonsubstantive amendments include correction of a clerical error in the enabling instrument or the addition of a dissolution clause where the activities of the organization prior to the determination letter or ruling are consistent with the requirements for exemption.



Reliance on determination letter or ruling

.02 A determination letter or ruling recognizing exemption may not be relied upon if there is a material change, inconsistent with exemption, in the character, the purpose, or the method of operation of the organization. Also, a determination letter or ruling may not be relied upon if it was based on any inaccurate material factual representations. See section 12.01.



SECTION 12. REVOCATION OR MODIFICATION OF DETERMINATION LETTER OR RULING RECOGNIZING EXEMPTION

A determination letter or ruling recognizing exemption may be revoked or modified by (1) a notice to the taxpayer to whom the determination letter or ruling was issued, (2) enactment of legislation or ratification of a tax treaty, (3) a decision of the United States Supreme Court, (4) the issuance of temporary or final regulations, or (5) the issuance of a revenue ruling, revenue procedure, or other statement published in the Internal Revenue Bulletin.



Revocation or modification of a determination letter or ruling may be retroactive

.01 The revocation or modification of a determination letter or ruling recognizing exemption may be retroactive if the organization omitted or misstated a material fact, operated in a manner materially different from that originally represented, or, in the case of organizations to which § 503 of the Code applies, engaged in a prohibited transaction with the purpose of diverting corpus or income of the organization from its exempt purpose and such transaction involved a substantial part of the corpus or income of such organization. In certain cases an organization may seek relief from retroactive revocation or modification of a determination letter or ruling under § 7805(b). Requests for § 7805(b) relief are subject to the procedures set forth in Rev. Proc. 2007-5.

(1) Where there is a material change, inconsistent with exemption, in the character, the purpose, or the method of operation of an organization, revocation or modification will ordinarily take effect as of the date of such material change.

(2) In the case where a determination letter or ruling is issued in error or is no longer in accord with the Service's position and § 7805(b) relief is granted ( see sections 13 and 14 of Rev. Proc. 2007-4), ordinarily, the revocation or modification will be effective not earlier than the date when the Service modifies or revokes the original determination letter or ruling.



Appeal and conference procedures in the case of revocation or modification of exempt status letter

.02 In the case of a revocation or modification of a determination letter or ruling, the appeal and conference procedures are generally the same as set out in section 7 of these procedures, including the right of the organization to request that EO Determinations or the Appeals Office seek technical advice from EO Technical. However, appeal and conference rights are not applicable to matters where delay would be prejudicial to the interests of the Service (such as in cases involving fraud, jeopardy, the imminence of the expiration of the statute of limitations, or where immediate action is necessary to protect the interests of the Government).

(1) If the case involves an exempt status issue on which EO Technical had issued a previous contrary ruling or technical advice, EO Determinations generally must seek technical advice from EO Technical.

(2) EO Determinations does not have to seek technical advice if the prior ruling or technical advice has been revoked by subsequent contrary published precedent or if the proposed revocation involves a subordinate unit of an organization that holds a group exemption letter issued by EO Technical, the EO Technical ruling or technical advice was issued under the Internal Revenue Code of 1939 or prior revenue acts, or if the ruling was issued in response to Form 4653, Notification Concerning Foundation Status.



SECTION 13. EFFECT ON OTHER REVENUE PROCEDURES

Rev. Proc. 90-27 is superseded.



SECTION 14. EFECTIVE DATE

This revenue procedure is effective July 23, 2007.



SECTION 15. PAPERWORK REDUCTION ACT

The collection of information for a letter application under section 3.05 of this revenue procedure has been reviewed and approved by the Office of Management and Budget (OMB) in accordance with the Paperwork Reduction Act (44 U.S.C. § 3507) under control number 1545-2080. All other collections of information under this revenue procedure have been approved under separate OMB control numbers.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid OMB control number.

The collection of this information is required if an organization wants to be recognized as tax-exempt by the Service. We need the information to determine whether the organization meets the legal requirements for tax-exempt status. In addition, this information will be used to help the Service delete certain information from the text of an adverse determination letter or ruling before it is made available for public inspection, as required by § 6110.

The time needed to complete and file a letter application will vary depending on individual circumstances. The estimated average time is 10 hours.

Books and records relating to the collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. The rules governing the confidentiality of letter applications are covered in § 6104.



DRAFTING INFORMATION

The principal author of this revenue procedure is Wayne Hardesty of the Exempt Organizations, Tax Exempt and Government Entities Division. For further information regarding this revenue procedure, please contact the TE/GE Customer Service office at (877) 829-5500 (a toll-free call).

Tax Attorney: New Tax Shelter Regulations under Sec. 4965

The IRS has issued final, temporary and proposed regulations relating to returns accompanying payment of excise taxes under Code Sec. 4965, as well as addressing filing and disclosure requirements related to these excise taxes under Code Secs. 6011, 6033 and 6071.

T.D. 9334
Code Sec. 4965, which was added by the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) (P.L. 109-222), imposed two new excise taxes that affect a broad array of tax-exempt entities. An entity-level tax is now imposed on nonplan entities that are parties to prohibited tax shelter transactions; this tax applies to each tax year during which the nonplan entity is a party to such a transaction and has net income or proceeds attributable to the transaction that are properly allocable to that tax year. The other excise tax, a manager-level tax, is imposed on entity managers who approve the tax-exempt entity as a party to a prohibited tax shelter transaction and know or have reason to know that the transaction is a prohibited tax shelter transaction.

T.D. 9334 provides that nonplan entities liable for Code Sec. 4965 excise taxes and entity managers of nonplan entities liable for those taxes are required to file a return on Form 4720, Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code, on or before the date the entity's annual return is due. If the entity is not required to file such a return, the entity return is due on or before the 15th day of the fifth month after the end of the nonplan entity's accounting period for which the liability under Code Sec. 4965 was incurred. Entity managers of plan entities who are liable for Code Sec. 4965 taxes are required to file a return on Form 5330, Return of Excise Taxes Related to Employee Benefit Plans, on or before the 15th day of the fifth month following the close of the manager's tax year during which the entity entered into a prohibited tax shelter transaction.

These regulations are generally effective/applicable on July 6, 2007, and will cease to apply on July 6, 2010. However, a transition rule states that returns of Code Sec. 4965 taxes that are or were due on or before October 4, 2007, will be deemed timely if the return is filed and the tax is paid before that date.

T.D. 9335
The IRS also issued temporary regulations under Code Sec. 6033(a)(2) that provide rules regarding the form, manner and timing of disclosure requirements with respect to prohibited tax shelter transactions to which tax-exempt entities are parties. These regulations require that every tax-exempt entity to which Code Sec. 4965 applies that is a party to a prohibited tax shelter transaction must disclose to the IRS that the entity is a party to a prohibited tax shelter transaction and the identity of any other party to the transaction known to the tax-exempt entity.

The temporary regulations issued in T.D. 9335 define a tax-exempt party to a prohibited tax shelter transaction, and provide guidance with respect to the frequency of disclosure, who is to make the disclosure and the time and place for making the disclosure on Form 8886-T, Disclosure by Tax-Exempt Entity Regarding Prohibited Tax Shelter Transaction. A transition rule is provided for tax-exempt entities that entered into a prohibited tax shelter transaction after May 17, 2006, and before January 1, 2007. Disclosure is not required for any prohibited tax shelter transaction entered into by a tax-exempt entity on or before May 17, 2006.

Proposed Regulations
The texts of the temporary regulations in T.D. 9334 and T.D. 9335 also serve as the texts of proposed regulations. Temporary regulations providing guidance under Code Sec. 4965 have also been released.

Background. Notice 2006-65, I.R.B. 2006-31, 102, and Notice 2007-18, I.R.B. 2007-9, 608 (TAXDAY, 2007/02/08, I.1) provided guidance regarding prohibited tax shelter transactions under Code Sec. 4965, and requested comments regarding these provisions and the guidance. After consideration of the comments received, the IRS has issued proposed regulations.

Proposed Regulations. The proposed regulations define the terms "tax-exempt entity," "prohibited tax shelter transactions," "net income" and "reportable transactions," and clarify that a tax-exempt entity does not become a party to a prohibited tax shelter transaction solely because it invests in an entity that becomes involved in such a transaction. Furthermore, the regulations address the definition of the term "entity manager," and provide guidance regarding persons who could be deemed entity managers pursuant to a delegation of authority. The regulations also define the term "approve or otherwise cause," limiting the definition to affirmative actions of persons who have the authority to commit the entity to a transaction.

The level of tax imposed under Code Sec. 4965 depends on whether the entity knew or had reason to know that it was becoming a party to a prohibited tax shelter transaction. Under the proposed regulations, receipt by an entity manager of a disclosure statement in advance of a transaction is a relevant factor but does not necessarily demonstrate that the entity or any of its managers knew or had reason to know that the transaction was a prohibited tax shelter transaction. The regulations also clarify that entity manager liability for these excise taxes is not joint and several.

Notice 2007-18 provided that allocation of net income and proceeds is determined according to normal tax accounting rules. This rule is included in the proposed regulations.

Effective Dates. When finalized the regulations under Code Sec. 4965are proposed to be applicable for tax years ending after July 6, 2007. Taxpayers may rely on these proposed regulations for periods ending on or before such date.

Comments Requested The IRS requests comments on these regulations, specifically regarding the clarity of the proposed rule and how it may be made easier to understand. A public hearing is not scheduled, but may be scheduled if requested in writing by a person who timely submits written comments. Comments and requests for a public hearing must be received by October 4, 2007. Submissions should be sent to CC:PA:LPD:PR (REG-142039-06; REG-139268-06), Room 5203, IRS, P.O. Box 7604, Ben Franklin Station, Washington, D.C., 20044. Submissions may also be hand-delivered between 8:00 a.m. and 4:00 p.m. to CC:PA:LPD:PR (REG-142039-06; REG-139268-06), Courier's Desk, IRS, 1111 Constitution Avenue, NW., Washington, D.C., or submitted electronically via the Federal eRulemaking Portal at http://www.regulations.gov (IRS-REG-142039-06; REG-139268-06).

T.D. 9334 , filed with the Federal Register on July 5, 2007.

Returns: Information returns: Excise taxes: Time for filing. --
Reg. §53.6071-1T and amendments of Reg. §§53.6011-1, 53.6071-1, 54.6011-1 and 54.6011-1T, relating to the requirement of a return to accompany payment of excise taxes under Code Sec. 4965 and the time for filing that return, are adopted.
AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

SUMMARY: This document contains final and temporary regulations providing guidance relating to the requirement of a return to accompany payment of excise taxes under section 4965 of the Internal Revenue Code (Code) and the time for filing that return. These regulations affect a broad array of tax-exempt entities, including charities, state and local government entities, Indian tribal governments and employee benefit plans, as well as entity managers of these entities. This action is necessary to implement section 516 of the Tax Increase Prevention and Reconciliation Act of 2005. The text of the temporary regulations also serves as the text of the proposed regulations set forth in the Proposed Rules section in this issue of the Federal Register.

DATES: Effective date. These regulations are effective on July 6, 2007.

Applicability date. For dates of applicability, see §§53.6071-1T(g) and 54.6011-1T(c) of these regulations.

FOR FURTHER INFORMATION CONTACT: Galina Kolomietz, (202) 622-6070, Michael Blumenfeld, (202) 622-1124, or Dana Barry, (202) 622-6060 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:



Background

The Tax Increase Prevention and Reconciliation Act of 2005, Public Law 109-222 (120 Stat. 345) (TIPRA), enacted on May 17, 2006, added section 4965 to the Code. Section 4965 affects a broad array of tax-exempt entities as defined in section 4965(c). Tax-exempt entities described in section 4965(c)(1), (2), or (3) (referred to herein as "non-plan entities") include entities described in section 501(c), religious or apostolic associations or corporations described in section 501(d), entities described in section 170(c), including states, possessions of the United States, the District of Columbia, political subdivisions of states and political subdivisions of possessions of the United States (but not including the United States), and Indian tribal governments within the meaning of section 7701(a)(40). Tax-exempt entities described in section 4965(c)(4), (c)(5), (c)(6), or (c)(7) (referred to herein as "plan entities") include tax-favored retirement plans, individual retirement arrangements, and savings arrangements described in section 401(a), 403(a), 403(b), 529, 457(b), 408(a), 220(d), 408(b), 530 or 223(d).

Section 4965 imposes two new excise taxes, one on the tax-exempt entity (the entity-level tax) and the other on certain of the tax-exempt entity's managers (the manager-level tax). The entity-level tax is imposed on non-plan entities that are parties to prohibited tax shelter transactions. The entity-level tax does not apply to plan entities. Prohibited tax shelter transactions are transactions that are identified by the IRS as "listed transactions" (within the meaning of section 6707A(c)(2)) and reportable transactions that are confidential transactions or transactions with contractual protection (as defined in section 6707A(c)(1) and §1.6011-4(b) of this chapter).

The entity-level tax applies to each taxable year during which the non-plan entity is a party to a prohibited tax shelter transaction and has net income or proceeds attributable to the transaction which are properly allocable to that taxable year. The amount of the entity-level tax depends on whether the non-plan entity knew or had reason to know that the transaction was a prohibited tax shelter transaction at the time the entity became a party to the transaction. If the non-plan entity did not know (and did not have reason to know) that the transaction was a prohibited tax shelter transaction at the time the entity became a party to the transaction, the tax is the highest rate of tax under section 11 (currently 35 percent) multiplied by the greater of: (i) The entity's net income with respect to the prohibited tax shelter transaction (after taking into account any tax imposed by Subtitle D, other than by this section, with respect to such transaction) for the taxable year or (ii) 75 percent of the proceeds received by the entity for the taxable year that are attributable to such transaction. If the non-plan entity knew or had reason to know that the transaction was a prohibited tax shelter transaction at the time the entity became a party to the transaction, the tax is the greater of (i) 100 percent of the entity's net income with respect to the transaction (after taking into account any tax imposed by Subtitle D, other than by this section, with respect to such transaction) for the taxable year or (ii) 75 percent of the proceeds received by the entity for the taxable year that are attributable to such transaction. In the case of a transaction that becomes a prohibited tax shelter transaction by reason of becoming a listed transaction after the non-plan entity has become a party to such transaction (subsequently listed transactions), the amount of tax is based on the net income or proceeds attributable to such transaction that are properly allocable to the period beginning on the date the transaction became listed or the first day of the entity's taxable year, whichever is later. No entity-level tax applies to any income or proceeds that are properly allocable to a period ending on or before August 15, 2006.

The manager-level tax is imposed on entity managers (as defined in section 4965(d)) of all tax-exempt entities described in section 4965(c) who approve the entity as a party (or otherwise cause the entity to be a party) to a prohibited tax shelter transaction and know or have reason to know that the transaction is a prohibited tax shelter transaction. In the case of non-plan entities, the term entity manager means the person with authority or responsibility similar to that exercised by an officer, director or trustee, and, with respect to any act, the person having authority or responsibility with respect to such act. In the case of plan entities, the term entity manager means the person who approves or otherwise causes the entity to be a party to the prohibited tax shelter transaction. An individual beneficiary (including a plan participant) or owner of the tax-favored retirement plans, individual retirement arrangements, and savings arrangements described in section 401(a), 403(a), 403(b), 529, 457(b), 408(a), 220(d), 408(b), 530 or 223(d), may be liable as an entity manager if the individual beneficiary or owner has broad investment authority under the arrangement. The amount of the manager-level tax is $20,000 for each approval or other act causing the entity to be a party to a prohibited tax shelter transaction. The manager-level tax applies separately to each entity manager.

These final and temporary regulations are being issued concurrently with proposed regulations under sections 4965, 6033(a)(2) and 6011(g) published elsewhere in the Federal Register.



Explanation of Provisions

The regulations provide that non-plan entities (including exempt organizations and governments) that are liable for section 4965 excise taxes and entity managers of non-plan entities who are liable for section 4965 excise taxes as entity managers are required to file a return on Form 4720, "Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code." The entity return is due on or before the date the non-plan entity's annual return under section 6033(a)(1) (for example, Form 990, "Return of Organization Exempt From Income Tax") is due, if the non-plan entity is required to file such a return. In all other cases, the entity return is due on or before the 15th day of the fifth month after the end of the non-plan entity's accounting period for which the liability under section 4965 was incurred. In the case of a non-plan entity manager, the entity manager return is due on or before the 15th day of the fifth month following the close of the manager's taxable year during which the entity entered into a prohibited tax shelter transaction.

The regulations also provide that entity managers of plan entities who are liable for section 4965 taxes as entity managers are required to file a return on Form 5330, "Return of Excise Taxes Related to Employee Benefit Plans." For section 4965 taxes, the Form 5330 is due on or before the 15th day of the fifth month following the close of the manager's taxable year during which the entity entered into a prohibited tax shelter transaction.

The regulations provide a transition rule that returns of section 4965 taxes that are or were due on or before October 4, 2007 will be deemed timely if the return is filed and the tax is paid before that date.



Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. For the applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6), refer to the Special Analyses section of the preamble to the cross-referencing notice of proposed rulemaking published in the Proposed Rules section in this issue of the Federal Register. Pursuant to section 7805(f) of the Code, these regulations have been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on business.



Drafting Information

The principal authors of these regulations are Galina Kolomietz and Dana Barry, Office of Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). However, other personnel from the IRS and the Treasury Department participated in their development.



List of Subjects

26 CFR Part 53

Excise taxes, Foundations, Investments, Lobbying, Reporting and recordkeeping requirements.

26 CFR Part 54

Excise Taxes, Pensions, Reporting and recordkeeping requirements.



Amendments to the Regulations

Accordingly, 26 CFR parts 53 and 54 are amended as follows:



PART 53 --FOUNDATION AND SIMILAR EXCISE TAXES

Paragraph 1. The authority citation for part 53 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *



§53.6011-1 [Amended]

Par. 2. In §53.6011-1, paragraph (b) is amended by:

1. Removing from the first sentence, the language "or 4958(a)," and adding "4958(a), or 4965(a)," in its place.

2. Removing from the last sentence, the language "or 4958(a)," and adding "4958(a), or 4965(a)," in its place.

Par. 3. Section 53.6071-1 is amended by adding and reserving paragraph (g) and adding paragraph (h) to read as follows:



§53.6071-1 Time for filing returns.

* * * * *

(g) [Reserved]. For further guidance, see §53.6071-1T(g).

(h) Effective/applicability date. For the applicability date of paragraph (g) of this section, see §53.6071-1T(h).

Par. 4. Section 53.6071-1T is added to read as follows:



§53.6071-1T Time for filing returns (temporary).

(a) through (f) [Reserved]. For further guidance, see §53.6071-1(a) through (f).

(g) Taxes imposed with respect to prohibited tax shelter transactions to which tax-exempt entities are parties --(1) Returns by certain tax-exempt entities. A Form 4720, "Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code," required by §53.6011-1(b) for a tax-exempt entity described in section 4965(c)(1), (c)(2) or (c)(3) that is a party to a prohibited tax shelter transaction and is liable for tax imposed by section 4965(a)(1) shall be filed on or before the due date (not including extensions) for filing the tax-exempt entity's annual information return under section 6033(a)(1). If the tax-exempt entity is not required to file an annual information return under section 6033(a)(1), the Form 4720 shall be filed on or before the 15th day of the fifth month after the end of the tax-exempt entity's taxable year or, if the entity has not established a taxable year for Federal income tax purposes, the entity's annual accounting period.

(2) Returns by entity managers of tax-exempt entities described in section 4965(c)(1), (c)(2) or (c)(3). A Form 4720, required by §53.6011-1(b) for an entity manager of a tax-exempt entity described in section 4965(c)(1), (c)(2) or (c)(3) who is liable for tax imposed by section 4965(a)(2) shall be filed on or before the 15th day of the fifth month following the close of the entity manager's taxable year during which the entity entered into the prohibited tax shelter transaction.

(3) Transition rule. A Form 4720, for a section 4965 tax that is or was due on or before October 4, 2007 will be deemed to have been filed on the due date if it is filed by October 4, 2007 and if all section 4965 taxes required to be reported on that Form 4720 are paid by October 4, 2007.

(h) Effective/applicability date --(1) In general. Paragraph (g) of this section is applicable on July 6, 2007.

(2) Expiration date. Paragraph (g) of this section will cease to apply on July 6, 2010.



PART 54 --PENSION EXCISE TAXES

Par. 5. The authority citation for part 54 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 6. Section 54.6011-1 is amended by adding and reserving paragraph (c) and adding paragraph (d) to read as follows:



§54.6011-1 General requirement of return, statement, or list.

* * * * *

(c) [Reserved]. For further guidance, see §54.6011-1T(c).

(d) Effective/applicability date. For the applicability date of paragraph (c) of this section, see §54.6011-1T(d).

Par. 7. Section 54.6011-1T is amended as follows:

1. The undesignated text is designated as paragraph (a) and a paragraph heading is added.

2. Paragraph (b) is added and reserved.

3. Paragraphs (c) and (d) are added.



§54.6011-1T General requirement of return, statement or list (temporary).

(a) Tax on reversions of qualified plan assets to employer. * * *

(b) [Reserved].

(c) Entity manager tax on prohibited tax shelter transactions --(1) In general. Any entity manager of a tax-exempt entity described in section 4965(c)(4), (c)(5), (c)(6), or (c)(7) who is liable for tax under section 4965(a)(2) shall file a return on Form 5330, "Return of Excise Taxes Related to Employee Benefit Plans," on or before the 15th day of the fifth month following the close of such entity manager's taxable year during which the entity entered into the prohibited tax shelter transaction, and shall include therein the information required by such form and the instructions issued with respect thereto.

(2) Transition rule. A Form 5330, "Return of Excise Taxes Related to Employee Benefit Plans," for an excise tax under section 4965 that is or was due on or before October 4, 2007 will be deemed to have been filed on the due date if it is filed by October 4, 2007 and if the section 4965 tax that was required to be reported on that Form 5330 is paid by October 4, 2007.

(d) Effective/applicability date --(1) In general. Paragraph (c) of this section is applicable on July 6, 2007.

(2) Expiration date. Paragraph (c) of this section will expire on July 5, 2010.

Kevin M. Brown,

Deputy Commissioner for Services and Enforcement.

Approved: June 21, 2007.

Eric Solomon,

Assistant Secretary of the Treasury (Tax Policy)



T.D. 9335 , filed with the Federal Register on July 5, 2007.

Returns: Information returns: Exempt organizations: Prohibited tax shelter transaction. --
Reg. §§1.6033-5T and 301.6033-5T, providing rules regarding the form, manner and timing of disclosure obligations with respect to prohibited tax shelter transactions to which tax-exempt entities are parties, are adopted.



AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

SUMMARY: This document contains temporary regulations under section 6033(a)(2) of the Internal Revenue Code (Code) that provide rules regarding the form, manner and timing of disclosure obligations with respect to prohibited tax shelter transactions to which tax-exempt entities are parties. These temporary regulations affect a broad array of tax-exempt entities, including charities, state and local government entities, Indian Tribal governments and employee benefit plans, as well as entity managers of these entities. This action is necessary to implement section 516 of the Tax Increase Prevention and Reconciliation Act of 2005. The text of the temporary regulations also serves as the text of the proposed regulations set forth in the Proposed Rules section in this issue of the Federal Register.

DATES: Effective Date: These regulations are effective on July 6, 2007.

Applicability Date: For dates of applicability, see §1.6033-5T(g).

FOR FURTHER INFORMATION CONTACT: Galina Kolomietz, (202) 622-6070, or Michael Blumenfeld, (202) 622-1124 (not toll-free numbers). For questions specifically relating to qualified pension plans, individual retirement accounts, and similar tax-favored savings arrangements, contact Dana Barry, (202) 622-6060 (not a toll-free number).

SUPPLEMENTARY INFORMATION:



Background

The Tax Increase Prevention and Reconciliation Act of 2005, Public Law 109-222 (120 Stat. 345) (TIPRA), enacted on May 17, 2006, defines certain transactions as prohibited tax shelter transactions and imposes excise taxes and disclosure requirements with respect to prohibited tax shelter transactions to which a tax-exempt entity is a party. TIPRA creates new section 4965 and amends sections 6033(a)(2) and 6011(g) of the Code. The amended section 6033(a)(2) requires every tax-exempt entity to which section 4965 applies that is a party to a prohibited tax shelter transaction to disclose to the IRS (in such form and manner and at such time as determined by the Secretary) the following information: (a) That such entity is a party to the prohibited tax shelter transaction; and (b) the identity of any other party to the transaction which is known to the tax-exempt entity. The amended section 6011(g) requires any taxable party to a prohibited tax shelter transaction to disclose by statement to any tax-exempt entity to which section 4965 applies that is a party to such transaction that such transaction is a prohibited tax shelter transaction.

On July 11, 2006, the IRS released Notice 2006-65 (2006-31 IRB 102), which alerted taxpayers to the new provisions. On February 7, 2007, the IRS released Notice 2007-18 (2007-9 IRB 608), which provided interim guidance regarding the circumstances under which a tax-exempt entity will be treated as a party to a prohibited tax shelter transaction for purposes of sections 4965, 6033(a)(2) and 6011(g) and regarding the allocation to various periods of net income and proceeds attributable to a prohibited tax shelter transaction, including amounts received prior to the effective date of the section 4965 tax. See §601.601(d)(2)(ii)(b).

These temporary regulations are being issued concurrently with proposed regulations under sections 4965, 6033(a)(2) and 6011(g) published elsewhere in the Federal Register.



Explanation of Provisions

These temporary regulations contain rules concerning disclosure requirements imposed by section 6033(a)(2) on tax-exempt entities that are parties to prohibited tax shelter transactions. Proposed regulations providing rules concerning disclosure requirements under section 6033(a)(2) are being issued concurrently with these temporary regulations.



Effective Date

These temporary regulations are applicable with respect to transactions entered into by a tax-exempt entity after May 17, 2006.



Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. For the applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6), refer to the Special Analyses section of the preamble to the cross-referencing notice of proposed rulemaking published in the Proposed Rules section in this issue of the Federal Register. Pursuant to section 7805(f) of the Code, these regulations have been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business.



Drafting Information

The principal authors of these regulations are Galina Kolomietz and Dana Barry, Office of Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). However, other personnel from the IRS and the Treasury Department participated in their development.



List of Subjects

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 301

Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income taxes, Penalties, Reporting and recordkeeping requirements.



Adoption of Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 301 are amended as follows:



PART 1 --INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.6033-5T is added to read as follows:

§1.6033-5T Disclosure by tax-exempt entities that are parties to certain reportable transactions (temporary).

(a) In general. Every tax-exempt entity (as defined in section 4965(c)) shall file with the IRS on Form 8886-T, "Disclosure by Tax-Exempt Entity Regarding Prohibited Tax Shelter Transaction" (or a successor form), in accordance with this section and the instructions to the form, a disclosure of --

(1) Such entity's being a party (as defined in paragraph (b) of this section) to a prohibited tax shelter transaction (as defined in section 4965(e)); and

(2) The identity of any other party (whether taxable or tax-exempt) to such transaction that is known to the tax-exempt entity.

(b) Definition of tax-exempt party to a prohibited tax shelter transaction --(1) In general. For purposes of section 6033(a)(2), a tax-exempt entity is a party to a prohibited tax shelter transaction if the entity --

(i) Facilitates a prohibited tax shelter transaction by reason of its tax-exempt, tax indifferent or tax-favored status;

(ii) Enters into a listed transaction and the tax-exempt entity's tax return (whether an original or an amended return) reflects a reduction or elimination of its liability for applicable Federal employment, excise or unrelated business income taxes that is derived directly or indirectly from tax consequences or tax strategy described in the published guidance that lists the transaction; or

(iii) Is identified in published guidance, by type, class or role, as a party to a prohibited tax shelter transaction.

(2) Published guidance may identify which tax-exempt entities, by type, class or role, will not be treated as a party to a prohibited tax shelter transaction for purposes of section 6033(a)(2).

(c) Frequency of disclosure. A single disclosure is required for each prohibited tax shelter transaction.

(d) By whom disclosure is made --(1) Tax-exempt entities referred to in section 4965(c)(1), (2) or (3). In the case of tax-exempt entities referred to in section 4965(c)(1), (2) or (3), the disclosure required by this section must be made by the entity.

(2) Tax-exempt entities referred to in section 4965(c)(4), (5), (6) or (7). In the case of tax-exempt entities referred to in section 4965(c)(4), (5), (6) or (7), including a fully self-directed qualified plan, IRA, or other savings arrangement, the disclosure required by this section must be made by the entity manager (as defined in section 4965(d)(2)) of the entity.

(e) Time and place for filing --(1) Tax-exempt entities described in paragraph (b)(1)(i) of this section --(i) In general. The disclosure required by this section shall be filed on or before May 15 of the calendar year following the close of the calendar year during which the tax-exempt entered into the prohibited tax shelter transaction.

(ii) Subsequently listed transactions. In the case of subsequently listed transactions (as defined in section 4965(e)(2)), the disclosure required by this section shall be filed on or before May 15 of the calendar year following the close of the calendar year during which the transaction was identified by the Secretary as a listed transaction.

(2) Tax-exempt entities described in paragraph (b)(1)(ii) of this section. The disclosure required by this section shall be filed on or before the date on which the first tax return (whether an original or an amended return) is filed which reflects a reduction or elimination of the tax-exempt entity's liability for applicable Federal employment, excise or unrelated business income taxes that is derived directly or indirectly from tax consequences or tax strategy described in the published guidance that lists the transaction.

(3) Transition rule. If a tax-exempt entity entered into a prohibited tax shelter transaction after May 17, 2006 and before January 1, 2007, the disclosure required by this section shall be filed --

(i) In the case of tax-exempt entities described in paragraph (b)(1)(i) of this section, on or before November 5, 2007;

(ii) In the case of tax-exempt entities described in paragraph (b)(1)(ii) of this section, on or before the later of --

(A) November 5, 2007; or

(B) The date on which the first tax return (whether an original or an amended return) is filed which reflects a reduction or elimination of the tax-exempt entity's liability for applicable Federal employment, excise or unrelated business income taxes that is derived directly or indirectly from tax consequences or tax strategy described in the published guidance that lists the transaction.

(4) Disclosure is not required with respect to any prohibited tax shelter transaction entered into by a tax-exempt entity on or before May 17, 2006.

(f) Penalty for failure to provide disclosure statement. See section 6652(c)(3) for penalties applicable to failure to disclose a prohibited tax shelter transaction in accordance with this section.

(g) Effective date --(1) Applicability date. This section applies with respect to transactions entered into by a tax-exempt entity after May 17, 2006.

(2) Expiration date. This section will expire on July 6, 2010.



PART 301 --PROCEDURE AND ADMINISTRATION

Par. 3. The authority citation for part 301 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 4. Section 301.6033-5T is added to read as follows:

§301.6033-5T Disclosure by tax-exempt entities that are parties to certain reportable transactions (temporary).

(a) In general. For provisions relating to the requirement of the disclosure by a tax-exempt entity that it is a party to certain reportable transactions, see §1.6033-5T of this chapter (Income Tax Regulations).

(b) Effective date --(1) Applicability date. This section applies with respect to transactions entered into by a tax-exempt entity after May 17, 2006.

(2) Expiration date. This section will expire on July 5, 2010.

Kevin M. Brown,

Deputy Commissioner for Services and Enforcement.

Approved: June 21, 2007.

Eric Solomon,

Assistant Secretary of the Treasury (Tax Policy).

Proposed Regulations (REG-142039-06, REG-139268-06) , published in the Federal Register on July 6, 2007.


Excise taxes: Tax-exempt entities: Tax shelter transactions: Returns: Filing requirements. --
Reg. §§53.4965-1 --53.4965-9, 301.6011(g)-1, 1.6033-5 and 301.6033-5 and amendments of Reg. §§53.6071-1 and 54.6011-1, providing guidance under Code Sec. 4965 relating to entity-level and manager-level excise taxes with respect to prohibited tax shelter transactions to which tax-exempt entities are parties, are proposed.



AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking by reference to temporary regulations and notice of proposed rulemaking.

SUMMARY: This document contains proposed regulations that provide guidance under section 4965 of the Internal Revenue Code (Code), relating to entity-level and manager-level excise taxes with respect to prohibited tax shelter transactions to which tax-exempt entities are parties; sections 6033(a)(2) and 6011(g), relating to certain disclosure obligations with respect to such transactions; and sections 6011 and 6071, relating to the requirement of a return and time for filing with respect to section 4965 taxes. In the Rules and Regulations section of this issue of the Federal Register, the IRS is issuing cross-referencing temporary regulations that provide guidance under section 6033(a)(2), relating to certain disclosure obligations with respect to prohibited tax shelter transactions; and sections 6011 and 6071, relating to the requirement of a return and time for filing with respect to section 4965 taxes. This action is necessary to implement section 516 of the Tax Increase Prevention Reconciliation Act of 2005. These proposed regulations affect a broad array of tax-exempt entities, including charities, state and local government entities, Indian tribal governments and employee benefit plans, as well as entity managers of these entities.

DATES: Written or electronic comments and requests for a public hearing must be received by October 4, 2007.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-142039-06; REG-139268-06), room 5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-142039-06, REG-139268-06), Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue, NW., Washington, DC. Alternatively, taxpayers may submit comments electronically via the Federal eRulemaking Portal at http://www.regulations.gov (IRS-REG-142039-06; REG-139268-06).

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Galina Kolomietz, (202) 622-6070 or Michael Blumenfeld, (202) 622-1124; concerning submission of comments and requests for a public hearing, Richard Hurst, Richard.A.Hurst@irscounsel.treas.gov (not toll-free numbers). For questions specifically relating to qualified pension plans, individual retirement accounts, and similar tax-favored savings arrangements, contact Dana Barry, (202) 622-6060 (not a toll-free number).



SUPPLEMENTARY INFORMATION:



Paperwork Reduction Act

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number assigned by the Office of Management and Budget.

The collection of information in this proposed regulation is in §301.6011(g)-1. The collection of information in §301.6011(g)-1 flows from section 6011(g) which requires a taxable party to a prohibited tax shelter transaction to disclose to any tax-exempt entity that is a party to the transaction that the transaction is a prohibited tax shelter transaction. The likely recordkeepers are taxable entities or individuals that participate in prohibited tax shelter transactions. Estimated number of recordkeepers: 1250 to 6500. The information that is required to be collected for purposes of §301.6011(g)-1 is a subset of information that is required to be collected in order to complete and file Form 8886, "Reportable Transaction Disclosure Statement." The estimated paperwork burden for taxpayers filling out Form 8886 is approved under OMB number 1545-1800 and is as follows:


Recordkeeping ...................................................6 hr., 13 min.

Learning about the law
or the form ......................................................4 hr. 28 min.

Preparing, copying, assembling,
and sending the form to the IRS
..................................................................4 hr. 46 min.



Based on the numbers in the preceding paragraph, the total estimated burden per recordkeeper complying with the disclosure requirement in §301.6011(g)-1 will not exceed 15 hr., 27 min. This burden has been submitted to the Office of Management and Budget for review.

Books and records relating to the collection of information must be retained as long as their contents may become material in the administration of any internal revenue law.



Background

The Tax Increase Prevention and Reconciliation Act of 2005, Public Law 109-222 (120 Stat. 345) (TIPRA), enacted on May 17, 2006, defines certain transactions as prohibited tax shelter transactions and imposes excise taxes and disclosure requirements with respect to prohibited tax shelter transactions to which a tax-exempt entity is a party. Section 516 of TIPRA creates new section 4965 and amends sections 6033(a)(2) and 6011(g) of the Code.

On July 11, 2006, the IRS released Notice 2006-65 (2006-31 IRB 102), which alerted taxpayers to the new provisions and solicited comments regarding these provisions. One hundred written comments and numerous phone calls were received in response to the request for comments contained in Notice 2006-65. On February 7, 2007, the IRS released Notice 2007-18 (2007-9 IRB 608), which provided interim guidance regarding the circumstances under which a tax-exempt entity will be treated as a party to a prohibited tax shelter transaction and regarding the allocation to various periods of net income and proceeds attributable to a prohibited tax shelter transaction, including amounts received prior to the effective date of the section 4965 tax. Notice 2007-18 also solicited comments from the public regarding these and other issues raised by section 4965. Eight written comments and numerous phone calls were received in response to the request for comments contained in Notice 2007-18. See §601.601(d)(2)(ii)(b).

The comments received in response to Notice 2006-65 and Notice 2007-18 addressed all aspects of the new excise taxes and disclosure requirements. While some comments discussed the implications of a broad application of the new excise taxes and disclosure requirements, commentators generally responded favorably to Congress' effort to restrict tax-exempt entities from being involved in Federal tax avoidance schemes. Commentators noted the lack of meaningful penalties prior to TIPRA for tax-exempt entities involved in tax shelter transactions and the need for disclosure in the case where a tax-exempt entity is improperly using its tax-exempt status to facilitate a tax shelter transaction. After consideration of all comments received, the IRS and the Treasury Department are issuing the following proposed regulations and soliciting comments thereon. The major areas of comments and the IRS and Treasury Department's responses thereto are discussed in the following sections.



Explanation of Provisions



Covered Tax-Exempt Entities

Section 4965(c) defines the term "tax-exempt entity" for section 4965 purposes by reference to sections 501(c), 501(d), 170(c), 7701(a)(40), 4979(e) (paragraphs (1), (2) and (3)), 529, 457(b), and 4973(a). The proposed regulations describe the types of entities captured by the statutory cross-references in section 4965(c).



Definition of Prohibited Tax Shelter Transactions

Section 4965(e) defines the term "prohibited tax shelter transaction" by reference to section 6707A(c)(1) and (c)(2). In accordance with the statutory definition, the proposed regulations define the term "prohibited tax shelter transaction" by reference to the definition of the term "reportable transaction" in section 6707A(c)(1) and (c)(2) and the regulations under section 6011. The proposed regulations define a subsequently listed transaction as a transaction (other than a reportable transaction within the meaning of section 6707A(c)(1)) to which a tax-exempt entity becomes a party before the transaction becomes a listed transaction within the meaning of section 6707A(c)(2).

Several commentators expressed concern over the severe penalties imposed on tax-exempt entities and entity managers for participating in many common and legitimate transactions which have no tax avoidance purpose, yet may fall within the definition of prohibited tax shelter transaction. The commentators suggested that the IRS and the Treasury Department carve out certain types of transactions from the definition of "prohibited tax shelter transaction" or revise current listing procedures to give taxpayers an opportunity to object to the identification of a specific transaction as a tax avoidance transaction. Some commentators recommended that any future published guidance which designates a transaction as a listed or reportable transaction be issued with a prospective effective date and state that it will not apply retroactively. Several commentators requested that the proposed regulations identify listed, subsequently listed, confidential and contractual protection transactions that would not be treated as prohibited tax shelter transactions for purposes of section 4965. The above recommendations are not adopted in these proposed regulations because section 4965 defines the term "prohibited tax shelter transaction" by reference to the existing reportable transaction regime. Any additions to, or exclusions from, the definition of reportable transactions, or any changes to the current listing procedures, must be made within the framework of section 6011 rather than section 4965.

One commentator suggested that the term "reportable transaction" should be narrowly interpreted for purposes of section 4965. However, this term already has been defined under section 6011, and consequently, these proposed regulations interpret it consistently for section 4965 and section 6011 purposes.



Definition of Tax-Exempt Party to a Prohibited Tax Shelter Transaction

Excise taxes under section 4965 apply only if a tax-exempt entity is a party to a prohibited tax shelter transaction. A number of commentators requested guidance in determining when a tax-exempt entity is a party to a prohibited tax shelter transaction. Notice 2007-18 defined the term party as a tax-exempt entity that facilitates a prohibited tax shelter transaction by reason of its tax-exempt, tax indifferent or tax-favored status. The proposed regulations incorporate this definition of the term party. Notice 2007-18 also notified the public that the IRS and the Treasury Department would provide a broader definition of the term party in future guidance in accordance with section 4965. Consistent with Notice 2007-18, the proposed regulations define the term "party" for purposes of sections 4965 and 6033(a)(2) to include a tax-exempt entity that enters into a listed transaction and reflects on its tax return a reduction or elimination of its liability for applicable Federal employment, excise or unrelated business income taxes that is derived directly or indirectly from tax consequences or tax strategy described in the published guidance that lists the transaction.

Several commentators specifically requested that the proposed regulations address under what circumstances, if any, a tax-exempt entity may be treated as a party to a prohibited tax shelter transaction if the tax-exempt entity is an investor in a partnership, hedge fund or other conduit. Invoking the language in the legislative history to section 4965, commentators recommended that the IRS and Treasury Department establish a rule or a safe harbor that would treat an investor in an indirect investment activity as being a party for section 4965 purposes only in limited circumstances.

As illustrated by an example in the proposed regulations, a tax-exempt entity does not become a party to a prohibited tax shelter transaction solely because it invests in an entity that in turn becomes involved in a prohibited tax shelter transaction. To be considered a "party" under the proposed regulations, the tax-exempt entity must either facilitate the prohibited tax shelter transaction by reason of its tax-exempt, tax indifferent or tax-favored status, or must treat the prohibited tax shelter transaction on its tax return as reducing or eliminating its own Federal tax liability. The IRS and the Treasury Department request comments on any further clarifications that may be helpful in reflecting the intended application of the statute as expressed in the legislative history.



Entity Managers and Related Definitions

The proposed regulations clarify the definition of the term "entity manager" in section 4965(d) and provide guidance on persons who could be entity managers pursuant to a delegation of authority from other entity managers.

The proposed regulations also define the term "approve or otherwise cause." Under section 4965(a)(2), an entity manager may be liable for the manager-level excise tax only if the manager "approves such entity as (or otherwise causes such entity to be) a party" to a prohibited tax shelter transaction and knows or has reason to know the transaction is a prohibited tax shelter transaction. The proposed regulations generally limit the definition of "approving or otherwise causing" to affirmative actions of persons who, individually or as members of a collective body, have the authority to commit the entity to the transaction.

One commentator requested guidance on whether entity managers may be liable for section 4965 taxes in successor-in-interest situations. Several commentators requested guidance on the consequences under section 4965 of the exercise or nonexercise of certain options pursuant to the terms of the transaction. In response to these comments, the proposed regulations provide rules for successor-in-interest situations and the consequences of the exercise or nonexercise of certain options.



Meaning of "Knows or Has Reason to Know"

The level of tax imposed on the tax-exempt entity under section 4965(b)(1) depends upon whether the entity knows or has reason to know, at the time it enters into the transaction, that it is becoming a party to a prohibited tax shelter transaction. The liability of the entity manager for the tax under section 4965(b)(2) depends on whether the entity manager knows or has reason to know that the transaction is a prohibited tax shelter transaction at the time of approving or otherwise causing the entity to be a party to the transaction. The proposed regulations treat the entity as knowing or having reason to know if its manager(s) knew or had to reason to know and provide rules for determining whether entity managers knew or had reason to know. The "reason-to-know" rules in these proposed regulations are consistent with the "reason-to-know" and "should have known" standards under other provisions of the Code.

Commentators recommended that the IRS and the Treasury Department not treat receipt of a disclosure statement regarding a transaction by the tax-exempt entity as conclusive evidence that the tax-exempt entity knew or had reason to know that the transaction was a prohibited tax shelter transaction. The proposed regulations adopt this recommendation and provide that receipt by an entity manager of a disclosure statement in advance of a transaction is a relevant factor but, by itself, does not necessarily demonstrate that the tax-exempt entity or any of its managers knew or had reason to know that the transaction was a prohibited tax shelter transaction.



Taxes on Prohibited Tax Shelter Transactions

Section 4965(b)(1) provides the rules for computing the entity-level excise tax with respect to prohibited tax shelter transactions. Section 4965(b)(2) imposes a flat $20,000 excise tax on any entity manager that approved or otherwise caused the entity to become a party to a prohibited tax shelter transaction. The proposed regulations follow the computational rules in the statute, define the term "taxable year" for purposes of determining the entity-level tax under section 4965, and clarify the timing of the entity manager taxes under section 4965. The proposed regulations provide that entity manager liability for section 4965 taxes is not joint and several.



Definition of Net Income and Proceeds and Their Allocation to Various Periods

The proposed regulations define the terms "net income" and "proceeds" for section 4965 purposes and provide rules regarding the allocation of net income or proceeds attributable to a prohibited tax shelter transaction to various periods, including the appropriate treatment of net income or proceeds received prior to the effective date of the section 4965(a) tax.

Commentators recommended that net income for purposes of section 4965 be determined in a manner consistent with the determination of net income for other purposes of the Code. The proposed regulations adopt this recommendation.

Numerous commentators requested guidance in determining what amounts constitute proceeds for section 4965 purposes and urged the IRS and the Treasury Department to limit the definition of proceeds to the tax-exempt entity's economic return from the transaction. One commentator recommended that return of basis and return of capital be excluded from the definition of proceeds as these amounts are arguably not "attributable to" a prohibited tax shelter transaction. Several commentators recommended that the IRS and the Treasury Department adopt a rule that would exclude from proceeds earnings on certain set-aside amounts that are used to defease the tax-exempt entity's obligations under so-called sale-in, lease-out (SILO) and lease-in, lease-out (LILO) transactions. See Notice 2000-15 (2000-1 CB 826), and Notice 2005-13 (2005-9 IRB 630). Several commentators suggested that nonexercise of options to repurchase in the SILO / LILO context should not be treated as giving rise to net income or proceeds. See §601.601(d)(2)(ii)(b).

The proposed regulations define the term proceeds separately for tax-exempt entities that are involved in prohibited tax shelter transactions to facilitate the tax avoidance of others and tax-exempt entities that are involved in listed transactions for their own tax benefit. In the case of tax-exempt entities that are involved in prohibited tax shelter transactions to facilitate the tax avoidance of others, the proposed regulations define proceeds as the gross amount of the tax-exempt entity's consideration for facilitating the transaction, not reduced by any costs or expenses attributable to the transaction. This definition subjects the tax-exempt party's economic return from the transaction to the entity-level excise tax. In the case of tax-exempt entities that are involved in listed transactions to reduce or eliminate their own tax liability, the proposed regulations define the term proceeds as tax savings purportedly generated by the transaction and claimed by the tax-exempt entity in the tax year.

In Notice 2007-18, the IRS and Treasury Department provided that the allocation of net income and proceeds is determined according to normal tax accounting rules. The proposed regulations incorporate this rule both for purposes of allocating amounts to pre- and post-effective date periods, and allocating amounts to pre- and post-listing periods where a subsequently listed transaction is involved. Under the proposed regulations, tax-exempt entities that have not adopted a method of accounting are required to use the cash method. Several commentators recommended that the IRS adopt a position that net income or proceeds from pre-enactment transactions would not be properly allocable to any periods after the effective date of the section 4965(a) tax. The IRS and the Treasury Department decline to adopt this blanket rule because such rule would be inconsistent with established principles of tax accounting and would conflict with the plain language of the effective date provisions in section 516 of TIPRA.



Effective Dates of the Taxes

In accordance with section 516(d) of TIPRA, the proposed regulations provide that the taxes under section 4965 are effective for taxable years ending after May 17, 2006, with respect to transactions entered into before, on or after such date, except that no tax under section 4965(a) applies with respect to income or proceeds that are properly allocable to any period ending on or before August 15, 2006. The proposed regulations also provide that the 100 percent entity-level tax under section 4965(b)(1)(B) with respect to knowing transactions does not apply to prohibited tax shelter transactions entered into by a tax-exempt entity on or before May 17, 2006 and that the IRS will not assert an entity manager tax under section 4965(b)(2) with respect to any prohibited tax shelter transaction entered into by a tax-exempt entity on or before May 17, 2006. In addition, the proposed regulations provide that the 100 percent entity-level tax under section 4965(b)(1)(B) and the entity manager tax under section 4965(b)(2) do not apply with respect to any subsequently listed transaction.

Numerous commentators questioned whether it would be appropriate to apply the new excise taxes to pre-enactment transactions that already have closed and advocated a narrow application of the new excise taxes to pre-enactment transactions. The commentators argued that it would be unfair to apply the new excise taxes to pre-enactment transactions that have already closed and subject tax-exempt entities to unforeseen, harsh penalties. The commentators recommended that all transactions closed prior to May 17, 2006, be "delisted" for purposes of section 4965. The proposed regulations do not adopt these recommendations as they are inconsistent with the statutory effective date of section 4965 and the statutory definition of prohibited tax shelter transaction.

When finalized, the regulations under section 4965 are proposed to be applicable for taxable years ending after July 6, 2007. Taxpayers may rely on these proposed regulations for periods ending on or before such date.



Disclosure by Tax-exempt Entities that Are Parties to Certain Reportable Transactions

Section 6033(a)(2), as amended by TIPRA, requires every tax-exempt entity that is a party to a prohibited tax shelter transaction to disclose to the IRS, in such form and manner and at such time as determined by the Secretary, such entity's being a party to such transaction and the identity of any other party to the transaction which is known to the tax-exempt entity. The statute gives the IRS discretion with respect to the form, manner and timing of this disclosure. The proposed regulations provide rules regarding the form, manner and timing of this disclosure. With respect to the due date for the disclosure, the proposed regulations provide that, in the case of tax-exempt entities that are involved in prohibited tax shelter transactions to facilitate the tax avoidance of others, the disclosure must be filed by May 15 of the calendar year following the close of the calendar year during which the tax-exempt entity entered into the prohibited tax shelter transaction (or, in the case of subsequently listed transactions, by May 15 of the calendar year following the close of the calendar year during which the transaction was identified by the Secretary as a listed transaction). In the case of tax-exempt entities that are involved in listed transactions to reduce or eliminate their own tax liability, the proposed regulations provide that the disclosure must be filed on or before the date on which the first tax return (whether an original or an amended return) is filed on which the tax-exempt entity reflects a reduction or elimination of its liability for applicable Federal employment, excise or unrelated business income taxes that is derived directly or indirectly from tax consequences or tax strategy described in the published guidance that lists the transaction.

Temporary regulations providing the same rules are being issued concurrently with these proposed regulations.

The temporary regulations under section 6033(a)(2) apply to disclosures with respect to transactions entered into by a tax-exempt entity after May 17, 2006. Transition relief is provided with respect to transactions entered into during a transition period beginning on May 18, 2006 and ending on December 31, 2006. The due date for the disclosure with respect to the transactions entered into during the transition period is November 5, 2007 or, in the case of tax-exempt entities that are involved in listed transactions to reduce or eliminate their own tax liability, the later of: the date on which the first tax return (whether an original or an amended return) is filed on which the tax-exempt entity reflects a reduction or elimination of its liability for applicable Federal employment, excise or unrelated business income taxes that is derived directly or indirectly from tax consequences or tax strategy described in the published guidance that lists the transaction; or November 5, 2007.



Disclosure by Taxable Party to the Tax-exempt Entity

Section 6011(g), as amended by TIPRA, requires any taxable party to a prohibited tax shelter transaction to notify any tax-exempt entity which is a party to such transaction that the transaction is a prohibited tax shelter transaction. The statute is silent as to how and when the section 6011(g) disclosure needs to be made. The proposed regulations provide rules regarding the form, timing and frequency of the section 6011(g) disclosure. The proposed regulations also explain to whom the section 6011(g) disclosure must be made. With respect to the due date for the disclosure, the proposed regulations provide that the disclosure to each tax-exempt entity that is a party to the transaction must be made within 60 days after the last to occur of: (1) The date the taxable person becomes a taxable party to the transaction; or (2) the date the taxable party knows or has reason to know that the tax-exempt entity is a party to the transaction. No disclosure is required if the taxable party does not know or have reason to know that the tax-exempt entity is a party to the transaction on or before the first date on which the transaction is required to be disclosed by the taxable party under §§1.6011-4, 20.6011-4, 25.6011-4, 31.6011-4, 53.6011-4, 54.6011-4, or 56.6011-4.

One commentator recommended that the IRS provide an exception to the disclosure requirements for any transactions for which there would be no income or proceeds subject to the taxes imposed by section 4965. The proposed regulations do not adopt this recommendation because one of the purposes of section 6011(g) disclosure is to notify the tax-exempt entity that it may have a disclosure obligation under section 6033(a)(2) with respect to the transaction.

When finalized, the proposed regulations under section 6011(g) will apply to disclosures with respect to transactions entered into by a tax-exempt entity after May 17, 2006.



Payment of Section 4965 Taxes

The proposed regulations amend the existing regulations under sections 6011 and 6071 to specify the forms that must be used to pay section 4965 taxes and to provide the due dates for filing these forms. With respect to the due dates, the proposed regulations provide that a return of the entity-level excise tax under section 4965 must be made on or before the due date (not including extensions) for filing the tax-exempt entity's annual information return under section 6033(a)(1). If the tax-exempt entity is not required to file an annual information return, the return of section 4965 taxes must be made on or before the 15th day of the fifth month after the end of the tax-exempt entity's annual accounting period. A return of manager-level excise tax under section 4965 must be made on or before the 15th day of the fifth month following the close of the entity manager's taxable year during which the entity entered into the prohibited tax shelter transaction.

Temporary regulations providing the same rules are being issued concurrently with these proposed regulations.

A commentator recommended that the IRS and the Treasury Department not make the section 4965 excise taxes effective prior to the issuance of final regulations in cases where application of the new law or provisions of the new law is unclear. The proposed regulations do not adopt this recommendation because the effective date for the section 4965 taxes is statutory.

One commentator recommended that the IRS waive the excise taxes under section 4965 in appropriate circumstances. The proposed regulations do not adopt this recommendation as the obligation to pay section 4965 taxes flows directly from the statute, which does not authorize the IRS to waive the entity-level or manager-level taxes.

The amendments and additions to the regulations under sections 6011 and 6071 will be effective on July 6, 2007. Transition relief is provided with respect to returns of section 4965 taxes due on or before October 4, 2007. These returns will be deemed timely if the return is filed and the tax paid before October 4, 2007.



Special Analyses

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to this notice of proposed rulemaking. It is hereby certified that the collection of information in §301.6011(g)-1 will not have a significant economic impact on a substantial number of small entities. Accordingly, a regulatory flexibility analysis under the Regulatory Flexibility Act (5 U.S.C. 601) (RFA) is not required.

The effect of these proposed regulations on small entities flows directly from the statutes these regulations implement. Section 6011(g), as amended by TIPRA, requires any taxable party to a prohibited tax shelter transaction to notify any tax-exempt entity which is a party to such transaction that the transaction is a prohibited tax shelter transaction. In implementing this statute, §301.6011(g)-1 of the proposed regulations requires every taxable party to a prohibited tax shelter transaction (or a single taxable party acting by designation on behalf of other taxable parties) to provide to every tax-exempt entity that the taxable party knows or has reason to know is a party to the transaction a single statement disclosing that the transaction is a prohibited tax shelter transaction within 60 days after the last to occur: (1) The date the taxable person becomes a taxable party to the transaction; or (2) the date the taxable party knows or has reason to know that the tax-exempt entity is a party to the transaction. Moreover, it is unlikely that a significant number of small businesses will engage in transactions that are subject to disclosure under 301.6011(g). The IRS and the Treasury Department request comments concerning the likelihood that small businesses are engaging in transactions subject to disclosure under this provision.

Pursuant to section 7805(f) of the Code, this regulation as been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.



Comments and Requests for a Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any comments (a signed original and eight (8) copies) that are submitted timely to the IRS at the address listed in the Addresses section of this document. The IRS and the Treasury Department specifically request comments on the clarity of the proposed rule and how it may be made easier to understand. All comments will be available for public inspection and copying.

A public hearing may be scheduled if requested in writing by a person who timely submits written comments. If a public hearing is scheduled, notice of the date, time, and place will be published in the Federal Register.



Drafting Information

The principal authors of these regulations are Galina Kolomietz and Dana Barry, Office of Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). However, other personnel from the IRS and the Treasury Department participated in their development.



List of Subjects

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 53

Excise taxes, Foundations, Investments, Lobbying, Reporting and recordkeeping requirements.

26 CFR Part 54

Excise Taxes, Pensions, Reporting and recordkeeping requirements.

26 CFR Part 301

Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income taxes, Penalties, Reporting and recordkeeping requirements.



Proposed Amendments to the Regulations

Accordingly, 26 CFR parts 1, 53, 54, and 301 are proposed to be amended as follows:



PART 1 --INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read, in part, as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.6033-5 is added to read as follows:



§1.6033-5 Disclosure by tax-exempt entities that are parties to certain reportable transactions.

[The text of this section is the same as the text of §1.6033-5T published elsewhere in this issue of the Federal Register].



PART 53 --FOUNDATION AND SIMILAR EXCISE TAXES

Par. 3. The authority citation for part 53 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 4. Sections 53.4965-1 through 53.4965-9 are added to read as follows:



§53.4965-1 Overview.

(a) Entity-level excise tax. Section 4965 imposes two excise taxes with respect to certain tax shelter transactions to which tax-exempt entities are parties. Section 4965(a)(1) imposes an entity-level excise tax on certain tax-exempt entities that are parties to "prohibited tax shelter transactions," as defined in section 4965(e). See §53.4965-2 for the discussion of covered tax-exempt entities. See §53.4965-3 for the definition of prohibited tax shelter transactions. See §53.4965-4 for the definition of tax-exempt party to a prohibited tax shelter transaction. The entity-level excise tax under section 4965(a)(1) is imposed on a specified percentage of the entity's net income or proceeds that are attributable to the transaction for the relevant tax year (or a period within that tax year). The rate of tax depends on whether the entity knew or had reason to know that the transaction was a prohibited tax shelter transaction at the time the entity became a party to the transaction. See §53.4965-7(a) for the discussion of the entity-level excise tax under section 4965(a)(1). See §53.4965-6 for the discussion of "knowing or having reason to know." See §53.4965-8 for the definition of net income and proceeds and the standard for allocating net income and proceeds that are attributable to a prohibited tax shelter transaction to various periods.

(b) Manager-level excise tax. Section 4965(a)(2) imposes a manager-level excise tax on "entity managers," as defined in section 4965(d), of tax-exempt entities who approve the entity as a party (or otherwise cause the entity to be a party) to a prohibited tax shelter transaction and know or have reason to know, at the time the tax-exempt entity enters into the transaction, that the transaction is a prohibited tax shelter transaction. See §53.4965-5 for the definition of entity manager and the meaning of "approving or otherwise causing," and §53.4965-6 for the discussion of "knowing or having reason to know." See §53.4965-7(b) for the discussion of the manager-level excise tax under section 4965(a)(2).

(c) Effective/applicability dates. See §53.4965-9 for the discussion of the relevant effective dates.



§53.4965-2 Covered tax-exempt entities

(a) In general. Under section 4965(c), the term "tax-exempt entity" refers to entities that are described in sections 501(c), 501(d), or 170(c) (other than the United States), Indian tribal governments (within the meaning of section 7701(a)(40)), and tax-qualified pension plans, individual retirement arrangements and similar tax-favored savings arrangements that are described in sections 4979(e)(1), (2) or (3), 529, 457(b), or 4973(a). The tax-exempt entities referred to in section 4965(c) are divided into two broad categories, non-plan entities and plan entities.

(b) Non-plan entities. Non-plan entities are --

(1) Entities described in section 501(c);

(2) Religious or apostolic associations or corporations described in section 501(d);

(3) Entities described in section 170(c), including states, possessions of the United States, the District of Columbia, political subdivisions of states and political subdivisions of possessions of the United States (but not including the United States); and

(4) Indian tribal governments within the meaning of section 7701(a)(40).

(c) Plan entities. Plan entities are --

(1) Entities described in section 4979(e)(1) (qualified plans under section 401(a), including qualified cash or deferred arrangements under section 401(k) (including a section 401(k) plan that allows designated Roth contributions));

(2) Entities described in section 4979(e)(2) (annuity plans described in section 403(a));

(3) Entities described in section 4979(e)(3) (annuity contracts described in section 403(b), including a section 403(b) arrangement that allows Roth contributions);

(4) Qualified tuition programs described in section 529;

(5) Eligible deferred compensation plans under section 457(b) that are maintained by a governmental employer as defined in section 457(e)(1)(A);

(6) Arrangements described in section 4973(a) which include --

(i) Individual retirement plans defined in sections 408(a) and (b), including --

(A) Simplified employee pensions (SEPs) under section 408(k);

(B) Simple individual retirement accounts (SIMPLEs) under section 408(p);

(C) Deemed individual retirement accounts or annuities (IRAs) qualified under a qualified plan (deemed IRAs) under section 408(q)); and

(D) Roth IRAs under section 408A.

(ii) Arrangements described in section 220(d) (Archer Medical Savings Accounts (MSAs));

(iii) Arrangements described in section 403(b)(7) (custodial accounts treated as annuity contracts);

(iv) Arrangements described in section 530 (Coverdell education savings accounts); and

(v) Arrangements described in section 223(d) (health savings accounts (HSAs)).



§53.4965-3 Prohibited tax shelter transactions.

(a) In general. Under section 4965(e), the term prohibited tax shelter transaction means --

(1) Listed transactions within the meaning of section 6707A(c)(2), including subsequently listed transactions described in paragraph (b) of this section; and

(2) Prohibited reportable transactions, which consist of the following reportable transactions within the meaning of section 6707A(c)(1) --

(i) Confidential transactions, as described in §1.6011-4(b)(3) of this chapter; or

(ii) Transactions with contractual protection, as described in §1.6011-4(b)(4) of this chapter.

(b) Subsequently listed transactions. A subsequently listed transaction for purposes of section 4965 is a transaction that is identified by the Secretary as a listed transaction after the tax-exempt entity has entered into the transaction and that was not a prohibited reportable transaction (within the meaning of section 4965(e)(1)(C) and paragraph (a)(2) of this section) at the time the entity entered into the transaction.

(c) Cross-reference. The determination of whether a transaction is a listed transaction or a prohibited reportable transaction for section 4965 purposes shall be made under the law applicable to section 6707A(c)(1) and (c)(2).



§53.4965-4 Definition of tax-exempt party to a prohibited tax shelter transaction.

(a) In general. For purposes of sections 4965 and 6033(a)(2), a tax-exempt entity is a party to a prohibited tax shelter transaction if the entity --

(1) Facilitates a prohibited tax shelter transaction by reason of its tax-exempt, tax indifferent or tax-favored status;

(2) Enters into a listed transaction and the tax-exempt entity's tax return (whether an original or an amended return) reflects a reduction or elimination of its liability for applicable Federal employment, excise or unrelated business income taxes that is derived directly or indirectly from tax consequences or tax strategy described in the published guidance that lists the transaction; or

(3) Is identified in published guidance, by type, class or role, as a party to a prohibited tax shelter transaction.

(b) Published guidance may identify which tax-exempt entities, by type, class or role, will not be treated as a party to a prohibited tax shelter transaction for purposes of sections 4965 and 6033(a)(2).

(c) Examples. The following examples illustrate the principles of this section:

Example 1. A tax-exempt entity enters into a transaction (Transaction A) with an S corporation. Transaction A is the same as or substantially similar to the transaction identified by the Secretary as a listed transaction in Notice 2004-30 (2004-1 CB 828). The tax-exempt entity's role in Transaction A is similar to the role of the tax-exempt party, as described in Notice 2004-30. Under the terms of the transaction, as described in Notice 2004-30, the tax-exempt entity receives the S corporation stock and, due to the tax-exempt entity's tax-exempt status, aids the S corporation and its shareholders in avoiding taxable income. The tax-exempt entity facilitates Transaction A by reason of its tax-exempt, tax indifferent or tax-favored status. Accordingly, the tax-exempt entity is a party to Transaction A for purposes of sections 4965 and 6033(a)(2). See §601.601(d)(2)(ii)(b) of this chapter.

Example 2. A tax-exempt entity is a partner in a partnership. The partnership has a number of other taxable and tax-exempt partners. The tax-exempt entity does not control the partnership. The partnership enters into a number of transactions, including a transaction (Transaction B) which is the same as or substantially similar to the transaction identified by the Secretary as a listed transaction in Notice 2002-35 (2002-1 CB 992) (as clarified and modified by Notice 2006-16 (2006-9 IRB 538). The partnership's role in Transaction B is similar to the role of T, as described in Notice 2002-35, that is, the role of the taxpayer claiming the tax benefits from the transaction. The tax-exempt entity's tax returns do not reflect a reduction or elimination of its liability for applicable Federal taxes as a result of Transaction B. The tax and economic consequences from Transaction B to the other partners are not dependent on the tax-exempt entity's tax-exempt, tax indifferent or tax-favored status. Accordingly, the tax-exempt entity does not facilitate Transaction B by reason of its tax-exempt, tax indifferent or tax-favored status. Because the tax-exempt entity's tax returns do not reflect a reduction or elimination of its liability for applicable Federal taxes that is derived directly or indirectly from tax consequences or tax strategy described in the published guidance that lists the transaction, the tax-exempt entity is not a party to Transaction B by reason of paragraph (a)(2) of this section. The tax-exempt entity also has not been identified, by type, class or role, as a party to a prohibited tax shelter transaction in published guidance. Therefore, the tax-exempt entity is not a party to Transaction B for purposes of sections 4965 and 6033(a)(2). See §601.601(d)(2)(ii)(b) of this chapter.

(d) Effective/applicability dates. See §53.4965-9 for the discussion of the relevant applicability dates.



§53.4965-5 Entity managers and related definitions.

(a) Entity manager of a non-plan entity --(1) In general. Under section 4965(d)(1), an entity manager of a non-plan entity is --

(i) A person with the authority or responsibility similar to that exercised by an officer, director, or trustee of an organization (that is, the non-plan entity); and

(ii) With respect to any act, the person who has final authority or responsibility (either individually or as a member of a collective body) with respect to such act.

(2) Definition of officer. For purposes of paragraph (a)(1)(i) of this section, a person is considered to be an officer of the non-plan entity (or to have similar authority or responsibility) if the person --

(i) Is specifically designated as such under the certificate of incorporation, by-laws, or other constitutive documents of the non-plan entity; or

(ii) Regularly exercises general authority to make administrative or policy decisions on behalf of the non-plan entity.

(3) Exception for acts requiring approval by a superior. With respect to any act, any person is not described in paragraph (a)(2)(ii) of this section if the person has authority merely to recommend particular administrative or policy decisions, but not to implement them without approval of a superior.

(4) Delegation of authority. A person is an entity manager of a non-plan entity within the meaning of paragraph (a)(1)(ii) of this section if, with respect to any prohibited tax shelter transaction, such person has been delegated final authority or responsibility with respect to such transaction (including by transaction type or dollar amount) by a person described in paragraph (a)(1)(i) of this section or the governing board of the entity. For example, an investment manager is an entity manager with respect to a prohibited tax shelter transaction if the non-plan entity's governing body delegated to the investment manager the final authority to make certain investment decisions and, in the exercise of that authority, the manager committed the entity to the transaction. To be considered an entity manager of a non-plan entity within the meaning of paragraph (a)(1)(ii) of this section, a person need not be an employee of the entity. A person is not described in paragraph (a)(1)(ii) of this section if the person is merely implementing a decision made by a superior.

(b) Entity manager of a plan entity --(1) In general. Under section 4965(d)(2), an entity manager of a plan entity is the person who approves or otherwise causes the entity to be a party to the prohibited tax shelter transaction.

(2) Special rule for plan participants and beneficiaries who have investment elections --(i) Fully self-directed plans or arrangements. In the case of a fully self-directed qualified plan, IRA, or other savings arrangement (including the case where a plan participant or beneficiary is given a list of prohibited investments, such as collectibles), if the plan participant or beneficiary selected a certain investment and, therefore, approved the plan entity to become a party to a prohibited tax shelter transaction, the plan participant or the beneficiary is an entity manager.

(ii) Plans or arrangements with limited investment options. In the case of a qualified plan, IRA, or other savings arrangement where a plan participant or beneficiary is offered a limited number of investment options from which to choose, the person responsible for determining the pre-selected investment options is an entity manager and the plan participant or the beneficiary generally is not an entity manager.

(c) Meaning of "approves or otherwise causes" --(1) In general. A person is treated as approving or otherwise causing a tax-exempt entity to become a party to a prohibited tax shelter transaction if the person has the authority to commit the entity to the transaction, either individually or as a member of a collective body, and the person exercises that authority.

(2) Collective bodies. If a person shares the authority described in paragraph (c)(1) of this section as a member of a collective body (for example, board of trustees or committee), the person will be considered to have exercised such authority if the person voted in favor of the entity becoming a party to the transaction. However, a member of the collective body will not be treated as having exercised the authority described in paragraph (c)(1) of this section if he or she voted against a resolution that constituted approval or an act that caused the tax-exempt entity to be a party to a prohibited tax shelter transaction, abstained from voting for such approval, or otherwise failed to vote in favor of such approval.

(3) Exceptions --(i) Successor in interest. If a tax-exempt entity that is a party to a prohibited tax shelter transaction is dissolved, liquidated, or merged into a successor entity, an entity manager of the successor entity will not, solely by reason of the reorganization, be treated as approving or otherwise causing the successor entity to become a party to a prohibited tax shelter transaction, provided that the reorganization of the tax-exempt entity does not result in a material change to the terms of the transaction. For purposes of this paragraph a material change includes an extension or renewal of the agreement (other than an extension or renewal that results from another party to the transaction unilaterally exercising an option granted by the agreement) or a more than incidental change to any payment under the agreement. A change for the sole purpose of substituting the successor entity for the original tax-exempt party is not a material change.

(ii) Exercise or nonexercise of options. Nonexercise of an option pursuant to a transaction involving the tax-exempt entity generally will not constitute an act of approving or causing the entity to be a party to the transaction. If, pursuant to a transaction involving the tax-exempt entity, the entity manager exercises an option (such as a repurchase option), the entity manager will not be subject to the entity manager-level tax if the exercise of the option does not result in the tax-exempt entity becoming a party to a second transaction that is a prohibited tax shelter transaction.

(4) Example. The following example illustrates the principles of paragraph (c)(3)(ii) of this section:

Example. In a sale-in, lease-out (SILO) transaction described in Notice 2005-13 (2005-9 IRB 630), X, which is a non-plan entity, has purported to sell property to Y, a taxable entity and lease it back for a term of years. At the end of the basic lease term, X has the option of "repurchasing" the property from Y for a predetermined purchase price, with funds that have been set aside at the inception of the transaction for that purpose. The entity manager, by deciding to exercise or not exercise the "repurchase" option is not approving or otherwise causing the non-plan entity to become a party to a second prohibited tax shelter transaction. See §601.601(d)(2)(ii)(b) of this chapter.

(5) Coordination with the reason-to-know standard. The determination that an entity manager approved or caused a tax-exempt entity to be a party to a prohibited tax shelter transaction, by itself, does not establish liability for the section 4965(a)(2) tax. For rules on determining whether an entity manager knew or had reason to know that the transaction was a prohibited tax shelter transaction, see §53.4965-6(b).

(d) Effective/applicability dates. See §53.4965-9 for the discussion of the relevant applicability dates.



§53.4965-6 Meaning of "knows or has reason to know".

(a) Attribution to the entity. An entity will be treated as knowing or having reason to know for section 4965 purposes if one or more of its entity managers knew or had reason to know that the transaction was a prohibited tax shelter transaction at the time the entity manager(s) approved the entity as (or otherwise caused the entity to be) a party to the transaction. The entity shall be attributed the knowledge or reason to know of any entity manager described in §53.4965-5(a)(1)(i) even if that entity manager does not approve the entity as (or otherwise cause the entity to be) a party to the transaction.

(b) Determining whether an entity manager knew or had reason to know --(1) In general. Whether an entity manager knew or had reason to know that a transaction is a prohibited tax shelter transaction is based on all facts and circumstances. In order for an entity manager to know or have reason to know that a transaction is a prohibited tax shelter transaction, the entity manager must have knowledge of sufficient facts that would lead a reasonable person to conclude that the transaction is a prohibited tax shelter transaction. An entity manager will be considered to have "reason to know" if a reasonable person in the entity manager's circumstances would conclude that the transaction was a prohibited tax shelter transaction based on all the facts reasonably available to the manager at the time of approving the entity as (or otherwise causing the entity to be) a party to the transaction. Factors that will be considered in determining whether a reasonable person in the entity manager's circumstances would conclude that the transaction was a prohibited tax shelter transaction include, but are not limited to --

(i) The presence of tax shelter indicia (see paragraph (b)(2) of this section);

(ii) Whether the entity manager received a disclosure statement prior to the consummation of the transaction indicating that the transaction may be a prohibited tax shelter transaction (see paragraph (b)(3) of this section); and

(iii) Whether the entity manager made appropriate inquiries into the transaction (see paragraph (b)(4) of this section).

(2) Tax-shelter indicia. The presence of indicia that a transaction is a tax shelter will be treated as an indication that the entity manager knew or had reason to know that the transaction was a prohibited tax shelter transaction. Tax shelter indicia include but are not limited to --

(i) The transaction is extraordinary for the entity considering prior investment activity;

(ii) The transaction promises an economic return for the organization that is exceptional considering the amount invested by, the participation of, or the absence of risk to the organization; or

(iii) The transaction is of significant size relative to the receipts of the entity.

(3) Effect of disclosure statements. Receipt by an entity manager of a statement, including a statement described in section 6011(g), in advance of a transaction that the transaction may be a prohibited tax shelter transaction (or a statement that a partnership, hedge fund or other investment conduit may engage in a prohibited tax shelter transaction in the future) is a factor relevant in the determination of whether the entity manager knew or had reason to know that the transaction is a prohibited transaction. However, an entity manager will not be treated as knowing or having reason to know that the transaction was a prohibited tax shelter transaction solely because the entity manager receives such a disclosure.

(4) Appropriate inquiries. What inquiries are appropriate will be determined from the facts and circumstances of each case. For example, if one or more tax shelter indicia are present or if an entity manager receives a disclosure statement described in paragraph (b)(3) of this section, an entity manager has a responsibility to inquire further whether the transaction is a prohibited tax shelter transaction.

(c) Reliance on professional advice --(1) In general. An entity manager is not required to obtain the advice of a professional tax advisor to establish that the entity manager made appropriate inquiries. Moreover, not seeking professional advice, by itself, shall not give rise to an inference that the entity manager had reason to know that a transaction is a prohibited tax shelter transaction.

(2) Reliance on written opinion of professional tax advisor. An entity manager may establish that he or she did not have a reason to know that a transaction was a prohibited tax shelter transaction at the time the tax-exempt entity entered into the transaction if the entity manager reasonably, and in good faith, relied on the written opinion of a professional tax advisor. Reliance on the written opinion of a professional tax advisor establishes that the entity manager did not have reason to know if, taking into account all the facts and circumstances, the reliance was reasonable and the entity manager acted in good faith. For example, the entity manager's education, sophistication, and business experience will be relevant in determining whether the reliance was reasonable and made in good faith. In no event will an entity manager be considered to have reasonably relied in good faith on an opinion unless the requirements of this paragraph (c)(2) are satisfied. The fact that these requirements are satisfied, however, will not necessarily establish that the entity manager reasonably relied on the opinion in good faith. For example, reliance may not be reasonable or in good faith if the entity manager knew, or reasonably should have known, that the advisor lacked knowledge in the relevant aspects of Federal tax law.

(i) All facts and circumstances considered. The advice must be based upon all pertinent facts and circumstances and the law as it relates to those facts and circumstances. The requirements of this paragraph (c)(2) are not satisfied if the entity manager fails to disclose a fact that it knows, or reasonably should know, is relevant to determining whether the transaction is a prohibited tax shelter transaction.

(ii) No unreasonable assumptions. The advice must not be based on unreasonable factual or legal assumptions (including assumptions as to future events) and must not unreasonably rely on the representations, statements, findings, or agreements of the entity manager or any other person (including another party to the transaction or a material advisor within the meaning of sections 6111 and 6112).

(iii) "More likely than not" opinion. The written opinion of the professional tax advisor must apply the appropriate law to the facts and, based on this analysis, must conclude that the transaction was not a prohibited tax shelter transaction at a "more likely than not" level of certainty at the time the entity manager approved the entity (or otherwise caused the entity) to be a party to the transaction.

(3) Special rule. An entity manager's reliance on a written opinion of a professional tax advisor will not be considered reasonable if the advisor is, or is related to a person who is, a material advisor with respect to the transaction within the meaning of sections 6111 and 6112.

(d) Subsequently listed transactions. An entity manager will not be treated as knowing or having reason to know that a transaction (other than a prohibited reportable transaction as defined in section 4965(e)(1)(C) and §53.4965-3(a)(2)) is a prohibited tax shelter transaction if the entity enters into the transaction before the date on which the transaction is identified by the Secretary as a listed transaction.

(e) Effective/applicability dates. See §53.4965-9 for the discussion of the relevant applicability dates.



§53.4965-7 Taxes on prohibited tax shelter transactions.

(a) Entity-level taxes --(1) In general. Entity-level excise taxes apply to non-plan entities (as defined in §53.4965-2(b)) that are parties to prohibited tax shelter transactions.

(i) Prohibited tax shelter transactions other than subsequently listed transactions --(A) Amount of tax if the entity did not know and did not have reason to know. If the tax-exempt entity did not know and did not have reason to know that the transaction was a prohibited tax shelter transaction at the time the entity entered into the transaction, the tax is the highest rate of tax under section 11 multiplied by the greater of --

(1) The entity's net income with respect to the prohibited tax shelter transaction (after taking into account any tax imposed by Subtitle D, other than by this section, with respect to such transaction) for the taxable year; or

(2) 75 percent of the proceeds received by the entity for the taxable year that are attributable to such transaction.

(B) Amount of tax if the entity knew or had reason to know. If the tax-exempt entity knew or had reason to know that the transaction was a prohibited tax shelter transaction at the time the entity entered into the transaction, the tax is the greater of --

(1) 100 percent of the entity's net income with respect to the transaction (after taking into account any tax imposed by Subtitle D, other than by this section, with respect to such transaction) for the taxable year; or

(2) 75 percent of the proceeds received by the entity for the taxable year that are attributable to such transaction.

(ii) Subsequently listed transactions --(A) In general. In the case of a subsequently listed transaction (as defined in section 4965(e)(2) and §53.4965-3(b)), the tax-exempt entity's income and proceeds attributable to the transaction are allocated between the period before the transaction became listed and the period beginning on the date the transaction became listed. See §53.4965-8 for the standard for allocating net income or proceeds to various periods. The tax for each taxable year is the highest rate of tax under section 11 multiplied by the greater of --

(1) The entity's net income with respect to the subsequently listed transaction (after taking into account any tax imposed by Subtitle D, other than by this section, with respect to such transaction) for the taxable year that is allocable to the period beginning on the later of the date such transaction is identified by the Secretary as a listed transaction or the first day of the taxable year; or

(2) 75 percent of the proceeds received by the entity for the taxable year that are attributable to such transaction and allocable to the period beginning on the later of the date such transaction is identified by the Secretary as a listed transaction or the first day of the taxable year.

(B) No increase in tax. The 100 percent tax under section 4965(b)(1)(B) and §53.4965-7(a)(1)(i)(B) does not apply to any subsequently listed transaction (as defined in section 4965(e)(2) and §53.4965-3(b)) entered into by a tax-exempt entity before the date on which the transaction is identified by the Secretary as a listed transaction.

(2) Taxable year. The excise tax imposed under section 4965(a)(1) applies for the taxable year in which the entity becomes a party to the prohibited tax shelter transaction and any subsequent taxable year for which the entity has net income or proceeds attributable to the transaction. A taxable year for tax-exempt entities is the calendar year or fiscal year, as applicable, depending on the basis on which the tax-exempt entity keeps its books for Federal income tax purposes. If a tax-exempt entity has not established a taxable year for Federal income tax purposes, the entity's taxable year for the purpose of determining the amount and timing of net income and proceeds attributable to a prohibited tax shelter transaction will be deemed to be the annual period the entity uses in keeping its books and records.

(b) Manager-level taxes --(1) Amount of tax. If any entity manager approved or otherwise caused the tax-exempt entity to become a party to a prohibited tax shelter transaction and knew or had reason to know that the transaction was a prohibited tax shelter transaction, such entity manager is liable for the $20,000 tax. See §53.4965-5(d) for the meaning of approved or otherwise caused. See §53.4965-6 for the meaning of knew or had reason to know.

(2) Timing of the entity manager tax. If a tax-exempt entity enters into a prohibited tax shelter transaction during a taxable year of an entity manager, then the entity manager that approved or otherwise caused the tax-exempt entity to become a party to the transaction is liable for the entity manager tax for that taxable year if the entity manager knew or had reason to know that the transaction was a prohibited tax shelter transaction.

(3) Example. The application of paragraph (b)(2) of this section is illustrated by the following example:

Example. The entity manager's taxable year is the calendar year. On December 1, 2006, the entity manager approved or otherwise caused the tax-exempt entity to become a party to a transaction that the entity manager knew or had reason to know was a prohibited tax shelter transaction. The tax-exempt entity entered into the transaction on January 31, 2007. The entity manager is liable for the entity manager level tax for the entity manager's 2007 taxable year, during which the tax-exempt entity entered into the prohibited tax shelter transaction.

(4) Separate liability. If more than one entity manager approved or caused a tax-exempt entity to become a party to a prohibited tax shelter transaction while knowing (or having reason to know) that the transaction was a prohibited tax shelter transaction, then each such entity manager is separately (that is, not jointly and severally) liable for the entity manager-level tax with respect to the transaction.

(c) Effective dates. See §53.4965-9 for the discussion of the relevant effective dates.



§53.4965-8 Definition of net income and proceeds and standard for allocating net income or proceeds to various periods.

(a) In general. For purposes of section 4965(a), the amount and the timing of the net income and proceeds attributable to the prohibited tax shelter transaction will be computed in a manner consistent with the substance of the transaction. In determining the substance of listed transactions, the IRS will look to, among other items, the listing guidance and any subsequent guidance published in the Internal Revenue Bulletin relating to the transaction.

(b) Definition of net income and proceeds --(1) Net income. A tax-exempt entity's net income attributable to a prohibited tax shelter transaction is its gross income derived from the transaction reduced by those deductions that are attributable to the transaction and that would be allowed by chapter 1 of the Internal Revenue Code if the tax-exempt entity were treated as a taxable entity for this purpose, and further reduced by taxes imposed by Subtitle D, other than by this section, with respect to the transaction.

(2) Proceeds --(i) Tax-exempt entities that facilitate the transaction by reason of their tax-exempt, tax indifferent or tax-favored status. Solely for purposes of section 4965, in the case of a tax-exempt entity that is a party to the transaction by reason of §53.4965-4(a)(1) of this chapter, the term proceeds means the gross amount of the tax-exempt entity's consideration for facilitating the transaction, not reduced for any costs or expenses attributable to the transaction. Published guidance with respect to a particular prohibited tax shelter transaction may designate additional amounts as proceeds from the transaction for section 4965 purposes.

(ii) Tax-exempt entities that enter into transactions to reduce or eliminate their liability for applicable Federal taxes. For purposes of section 4965, in the case of a tax-exempt entity that is a party to the transaction by reason of §53.4965-4(a)(2) of this chapter, the term proceeds means tax savings purportedly generated by the transaction and claimed by the tax-exempt entity on its tax return with respect to the tax year. Published guidance with respect to a particular prohibited tax shelter transaction may designate additional amounts as proceeds from the transaction for section 4965 purposes.

(iii) Treatment of gifts and contributions. To the extent not otherwise included in the definition of proceeds in paragraphs (b)(2)(i) and (ii) of this section, any amount that is a gift or a contribution to a tax-exempt entity and is attributable to a prohibited tax shelter transaction will be treated as proceeds for section 4965 purposes, unreduced by any associated expenses.

(c) Allocation of net income and proceeds --(1) In general. For purposes of section 4965(a), the net income and proceeds attributable to a prohibited tax shelter transaction must be allocated in a manner consistent with the tax-exempt entity's established method of accounting for Federal income tax purposes. If the tax-exempt entity has not established a method of accounting for Federal income tax purposes, solely for purposes of section 4965(a) the tax-exempt entity must use the cash receipts and disbursements method of accounting (cash method) provided for in section 446 of the Internal Revenue Code to determine the amount and timing of net income and proceeds attributable to a prohibited tax shelter transaction.

(2) Special rule. If a tax-exempt entity has established a method of accounting other than the cash method, the tax-exempt entity may nevertheless use the cash method of accounting to determine the amount of the net income and proceeds --

(i) Attributable to a prohibited tax shelter transaction entered into prior to the effective date of section 4965(a) tax and allocable to pre- and post-effective date periods; or

(ii) Attributable to a subsequently listed transaction and allocable to pre- and post-listing periods.

(d) Transition year rules. In the case of the taxable year that includes August 16, 2006 (the transition year), the IRS will treat the period beginning on the first day of the transition year and ending on August 15, 2006, and the period beginning on August 16, 2006, and ending on the last day of the transition year as short taxable years. This treatment is solely for purposes of allocating net income or proceeds under section 4965. The tax-exempt entity continues to file tax returns for the full taxable year, does not file tax returns with respect to these deemed short taxable years and does not otherwise take the short taxable years into account for Federal tax purposes. Accordingly, the net income or proceeds that are properly allocated to the transition year in accordance with this section will be treated as allocable to the period --

(1) Ending on or before August 15, 2006 (and accordingly not subject to tax under section 4965(a)) to the extent such net income or proceeds would have been properly taken into account in accordance with this section by the tax-exempt entity in the deemed short year ending on August 15, 2006; and

(2) Beginning after August 15, 2006 (and accordingly subject to tax under section 4965(a)) to the extent such income or proceeds would have been properly taken into account in accordance with this section by the tax-exempt entity in the short year beginning August 16, 2006.

(e) Allocation to pre- and post-listing periods. If a transaction (other than a prohibited reportable transaction (as defined in section 4965(e)(1)(C) and §53.4965-3(a)(2)) to which the tax-exempt entity is a party is subsequently identified in published guidance as a listed transaction during a taxable year of the entity (the listing year) in which it has net income or proceeds attributable to the transaction, the net income or proceeds are allocated between the pre- and post-listing periods. The IRS will treat the period beginning on the first day of the listing year and ending on the day immediately preceding the date of the listing, and the period beginning on the date of the listing and ending on the last day of the listing year as short taxable years. This treatment is solely for purposes of allocating net income or proceeds under section 4965. The tax-exempt entity continues to file tax returns for the full taxable year, does not file tax returns with respect to these deemed short taxable years and does not otherwise take the short taxable years into account for Federal tax purposes. Accordingly, the net income or proceeds that are properly allocated to the listing year in accordance with this section will be treated as allocable to the period --

(1) Ending before the date of the listing (and accordingly not subject to tax under section 4965(a)) to the extent such net income or proceeds would have been properly taken into account in accordance with this section by the tax-exempt entity in the deemed short year ending on the day immediately preceding the date of the listing; and

(2) Beginning on the date of the listing (and accordingly subject to tax under section 4965(a)) to the extent such income or proceeds would have been properly taken into account in accordance with this section by the tax-exempt entity in the short year beginning on the date of the listing.

(f) Examples. The following examples illustrate the allocation rules of this section:

Example 1. (i) In 1999, X, a calendar year non-plan entity using the cash method of accounting, entered into a lease-in/lease-out transaction (LILO) substantially similar to the transaction described in Notice 2000-15 (2000-1 CB 826) (describing Rev. Rul. 99-14 (1999-1 CB 835), superseded by Rev. Rul. 2002-69 (2002-2 CB 760)). In 1999, X purported to lease property to Y pursuant to a "head lease," and Y purported to lease the property back to X pursuant to a "sublease" of a shorter term. In form, X received $268M as an advance payment of head lease rent. Of this amount, $200M had been, in form, financed by a nonrecourse loan obtained by Y. X deposited the $200M with a "debt payment undertaker." This served to defease both a portion of X's rent obligation under its sublease and Y's repayment obligation under the nonrecourse loan. Of the remainder of the $268M advance head lease rent payment, X deposited $54M with an "equity payment undertaker." This served to defease the remainder of X's rent obligation under the sublease as well as the exercise price of X's end-of-sublease term purchase option. This amount inures to the benefit of Y and enables Y to recover its investment in the transaction and a return on that investment. In substance, the $54M is a loan from Y to X. X retained the remaining $14M of the advance head lease rent payment. In substance, this represents a fee for X's participation in the transaction. See §601.601(d)(2)(ii)(b) of this chapter.

(ii) According to the substance of the transaction, the head lease, sublease and nonrecourse debt will be ignored for Federal income tax purposes. Therefore, any net income or proceeds resulting from these elements of the transaction will not be considered net income or proceeds attributable to the LILO transaction for purposes of section 4965(a). The $54M deemed loan from Y to X and the $14M fee are not ignored for Federal income tax purposes.

(iii) Under X's established cash basis method of accounting, any net income received in 1999 and attributable to the LILO transaction is allocated to X's December 31, 1999, tax year for purposes of section 4965. The $14M fee received in 1999, and which constitutes proceeds of the transaction, is likewise allocated to that tax year. Because the 1999 tax year is before the effective date of the section 4965 tax, X will not be subject to any excise tax under section 4965 for the amounts received in 1999.

(iv) Any earnings on the amount deposited with the equity payment undertaker that constitute gross income to X will be reduced by X's original issue discount deductions with respect to the deemed loan from Y, in determining X's net income from the transaction.

Example 2. B, a non-plan entity using the cash method of accounting, has an annual accounting period that ends on December 31, 2006. B entered into a prohibited tax shelter transaction on March 15, 2006. On that date, B received a payment of $600,000 as a fee for its involvement in the transaction. B received no other proceeds or income attributable to this transaction in 2006. Under B's method of accounting, the payment received by B on March 15, 2006, is taken into account in the deemed short year ending on August 15, 2006. Accordingly, solely for purposes of section 4965, the payment is treated as allocable solely to the period ending on or before August 15, 2006, and is not subject to the excise tax imposed by section 4965(a).

Example 3. The facts are the same as in Example 2, except that B received an additional payment of $400,000 on September 30, 2006. Under B's method of accounting, the payment received by B on September 30, 2006, is taken into account in the deemed short year beginning on August 16, 2006. Accordingly, solely for purposes of section 4965, the $400,000 payment is treated as allocable to the period beginning after August 15, 2006, and is subject to the excise tax imposed by section 4965(a).

Example 4. C, a non-plan entity using the cash method of accounting, has an annual accounting period that ends on December 31. C entered into a prohibited tax shelter transaction on May 1, 2005. On March 15, 2007, C received a payment of $580,000 attributable to the transaction. On June 1, 2007, the transaction is identified by the IRS in published guidance as a listed transaction. On June 15, 2007, C received an additional payment of $400,000 attributable to the transaction. Under C's method of accounting, the payments received on March 15, 2007, and June 15, 2007, are taken into account in 2007. The IRS will treat the period beginning on January 1, 2007, and ending on May 31, 2007, and the period beginning on June 1, 2007, and ending on December 31, 2007, as short taxable years. The payment received by C on March 15, 2007, is taken into account in the deemed short year ending on May 31, 2007. Accordingly, solely for purposes of section 4965, the payment is treated as allocable solely to the pre-listing period, and is not subject to the excise tax imposed by section 4965(a). The payment received by C on June 15, 2007, is taken into account in the deemed short year beginning on June 1, 2007. Accordingly, solely for purposes of section 4965, the payment is treated as allocable to the post-listing period, and is subject to the excise tax imposed by section 4965(a).

(g) Effective/applicability dates. See §53.4965-9 for the discussion of the relevant applicability dates.



§53.4965-9 Effective/applicability dates.

(a) In general. The taxes under section 4965(a) and §53.4965-7 are effective for taxable years ending after May 17, 2006, with respect to transactions entered into before, on or after that date, except that no tax under section 4965(a) applies with respect to income or proceeds that are properly allocable to any period ending on or before August 15, 2006.

(b) Applicability of the regulations. Except as provided in paragraph (c) of this section, upon publication of final regulations, §§53.4965-1 through 53.4965-8 of this chapter will apply to taxable years ending after July 6, 2007. A tax-exempt entity may rely on the provisions of §§53.4965-1 through 53.4965-8 for taxable years ending on or before July 6, 2007.

(c) Effective date with respect to certain knowing transactions --(1) Entity-level tax. The 100 percent tax under section 4965(b)(1)(B) and §53.4965-7(a)(1)(i)(B) does not apply to prohibited tax shelter transactions entered into by a tax-exempt entity on or before May 17, 2006.

(2) Manager-level tax. The IRS will not assert that an entity manager who approved or caused a tax-exempt entity to become a party to a prohibited tax shelter transaction is liable for the entity manager tax under section 4965(b)(2) and §53.4965-7(b)(1) with respect to the transaction if the tax-exempt entity entered into such transaction prior to May 17, 2006.

Par. 5. In §53.6071-1, paragraphs (g) and (h) are added to read as follows:



§53.6071-1 Time for filing returns.

* * * * *

(g) [The text of the proposed amendment to §53.6071-1(g) is the same as the text of §53.6071-1T(g) published elsewhere in this issue of the Federal Register].

(h) [The text of the proposed amendment to §53.6071-1(h) is the same as the text of §53.6071-1T(h) published elsewhere in this issue of the Federal Register].



PART 54 --EXCISE TAXES, PENSIONS, REPORTING AND RECORDKEEPING REQUIREMENTS

Par. 6. The authority citation for part 54 continues to read, in part, as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 7. In §54.6011-1, paragraphs (c) and (d) are added to read as follows:



§54.6011-1 General requirement of return, statement or list.

* * * * *

(c) [The text of the proposed amendment to §54.6011-1(c) is the same as the text of §54.6011-1T(c) published elsewhere in this issue of the Federal Register].

(d) [The text of the proposed amendment to §54.6011-1(d) is the same as the text of §54.6011-1T(d) published elsewhere in this issue of the Federal Register].



PART 301 --PROCEDURE AND ADMINISTRATION

Par. 8. The authority citation for part 301 continues to read, part, as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 9. Section 301.6011(g)-1 is added to read as follows:



§301.6011(g)-1 Disclosure by taxable party to the tax-exempt entity.

(a) Requirement of disclosure --(1) In general. Except as provided in paragraph (d)(2) of this section, any taxable party (as defined in paragraph (c) of this section) to a prohibited tax shelter transaction (as defined in section 4965(e) and §53.4965-3 of this chapter) must disclose by statement to each tax-exempt entity (as defined in section 4965(c) and §53.4965-2 of this chapter) that the taxable party knows or has reason to know is a party to such transaction (as defined in paragraph (b) of this section) that the transaction is a prohibited tax shelter transaction.

(2) Determining whether a taxable party knows or has reason to know. Whether a taxable party knows or has reason to know that a tax-exempt entity is a party to a prohibited tax shelter transaction is based on all the facts and circumstances. If the taxable party knows or has reason to know that a prohibited tax shelter transaction involves a tax-exempt, tax indifferent or tax-favored entity, relevant factors for determining whether the taxable party knows or has reason to know that a specific tax-exempt entity is a party to the transaction include --

(i) The extent of the efforts made to determine whether a tax-exempt entity is facilitating the transaction by reason of its tax-exempt, tax-indifferent or tax-favored status (or is identified in published guidance, by type, class or role, as a party to the transaction); and

(ii) If a tax-exempt entity is facilitating the transaction by reason of its tax-exempt, tax-indifferent or tax-favored status (or is identified in published guidance, by type, class or role, as a party to the transaction), the extent of the efforts made to determine the identity of the tax-exempt entity.

(b) Definition of tax-exempt party to a prohibited tax shelter transaction --(1) In general. For purposes of section 6011(g), a tax-exempt entity is a party to a prohibited tax shelter transaction if the entity --

(i) Facilitates a prohibited tax shelter transaction by reason of its tax-exempt, tax indifferent or tax-favored status; or

(ii) Is identified in published guidance, by type, class or role, as a party to a prohibited tax shelter transaction.

(2) Published guidance may identify which tax-exempt entities, by type, class or role, will not be treated as a party to a prohibited tax shelter transaction for purposes of section 6011(g).

(c) Definition of taxable party --(1) In general. For purposes of this section, the term taxable party means --

(i) A person who has entered into and participates or expects to participate in the transaction under §§1.6011-4(c)(3)(i)(A), (B), or (C), 20.6011-4, 25.6011-4, 31.6011-4, 53.6011-4, 54.6011-4, or 56.6011-4 of this chapter; or

(ii) A person who is designated as a taxable party by the Secretary in published guidance.

(2) Special rules --(i) Certain listed transactions. If a transaction that was otherwise not a prohibited tax shelter transaction becomes a listed transaction after the filing of a person's tax return (including an amended return) reflecting either tax consequences or a tax strategy described in the published guidance listing the transaction (or a tax benefit derived from tax consequences or a tax strategy described in the published guidance listing the transaction), the person is a taxable party beginning on the date the transaction is described as a listed transaction in published guidance.

(ii) Persons designated as non-parties. Published guidance may identify which persons, by type, class or role, will not be treated as a party to a prohibited tax shelter transaction for purposes of section 6011(g).

(d) Time for providing disclosure statement --(1) In general. A taxable party to a prohibited tax shelter transaction must make the disclosure required by this section to each tax-exempt entity that the taxable party knows or has reason to know is a party to the transaction within 60 days after the last to occur of --

(i) The date the person becomes a taxable party to the transaction within the meaning of paragraph (c) of this section; or

(ii) The date the taxable party knows or has reason to know that the tax-exempt entity is a party to the transaction within the meaning of paragraph (b) of this section.

(2) Termination of a disclosure obligation. A person shall not be required to provide the disclosure otherwise required by this section if the person does not know or have reason to know that the tax-exempt entity is a party to the transaction within the meaning of paragraph (b) of this section on or before the first date on which the transaction is required to be disclosed by the person under §§1.6011-4, 20.6011-4, 25.6011-4, 31.6011-4, 53.6011-4, 54.6011-4, or 56.6011-4 of this chapter.

(3) Disclosure is not required with respect to any prohibited tax shelter transaction entered into by a tax-exempt entity on or before May 17, 2006.

(e) Frequency of disclosure. One disclosure statement is required per tax-exempt entity per transaction. See paragraph (h) of this section for rules relating to designation agreements.

(f) Form and content of disclosure statement. The statement disclosing to the tax-exempt entity that the transaction is a prohibited tax shelter transaction must be a written statement that --

(1) Identifies the type of prohibited tax shelter transaction (including the published guidance citation for a listed transaction); and

(2) States that the tax-exempt entity's involvement in the transaction may subject either it or its entity manager(s) or both to excise taxes under section 4965 and to disclosure obligations under section 6033(a) of the Internal Revenue Code.

(g) To whom disclosure is made. The disclosure statement must be provided --

(1) In the case of a non-plan entity as defined in §53.4965-2(b) of this chapter, to --

(i) Any entity manager of the tax-exempt entity with authority or responsibility similar to that exercised by an officer, director or trustee of an organization; or

(ii) If a person described in paragraph (g)(1)(i) of this section is not known, to the primary contact on the transaction.

(2) In the case of a plan entity as defined in §53.4965-2(c) of this chapter, including a fully self-directed qualified plan, IRA, or other savings arrangement, to any entity manager of the plan entity who approved or otherwise caused the entity to become a party to the prohibited tax shelter transaction.

(h) Designation agreements. If more than one taxable party is required to disclose a prohibited tax shelter transaction under this section, the taxable parties may designate by written agreement a single taxable party to disclose the transaction. The transaction must then be disclosed in accordance with this section. The designation of one taxable party to disclose the transaction does not relieve the other taxable parties of their obligation to disclose the transaction to a tax-exempt entity that is a party to the transaction in accordance with this section, if the designated taxable party fails to disclose the transaction to the tax-exempt entity in a timely manner.

(i) Penalty for failure to provide disclosure statement. See section 6707A for penalties applicable to failure to disclose a prohibited tax shelter transaction in accordance with this section.

(j) Effective/applicability date. This section will apply with respect to transactions entered into by a tax-exempt entity after May 17, 2006.

Par. 11. Section 301.6033-5 is added to read as follows:



§301.6033-5 Disclosure by tax-exempt entities that are parties to certain reportable transactions.

[The text of this section is the same as the text of §301.6033-5T published elsewhere in this issue of the Federal Register].

Kevin M. Brown,

Deputy Commissioner for Services and Enforcement.

Back Taxes: New Tax Shelter Regulations under Sec. 4965

The IRS has issued final, temporary and proposed regulations relating to returns accompanying payment of excise taxes under Code Sec. 4965, as well as addressing filing and disclosure requirements related to these excise taxes under Code Secs. 6011, 6033 and 6071.

T.D. 9334
Code Sec. 4965, which was added by the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) (P.L. 109-222), imposed two new excise taxes that affect a broad array of tax-exempt entities. An entity-level tax is now imposed on nonplan entities that are parties to prohibited tax shelter transactions; this tax applies to each tax year during which the nonplan entity is a party to such a transaction and has net income or proceeds attributable to the transaction that are properly allocable to that tax year. The other excise tax, a manager-level tax, is imposed on entity managers who approve the tax-exempt entity as a party to a prohibited tax shelter transaction and know or have reason to know that the transaction is a prohibited tax shelter transaction.

T.D. 9334 provides that nonplan entities liable for Code Sec. 4965 excise taxes and entity managers of nonplan entities liable for those taxes are required to file a return on Form 4720, Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code, on or before the date the entity's annual return is due. If the entity is not required to file such a return, the entity return is due on or before the 15th day of the fifth month after the end of the nonplan entity's accounting period for which the liability under Code Sec. 4965 was incurred. Entity managers of plan entities who are liable for Code Sec. 4965 taxes are required to file a return on Form 5330, Return of Excise Taxes Related to Employee Benefit Plans, on or before the 15th day of the fifth month following the close of the manager's tax year during which the entity entered into a prohibited tax shelter transaction.

These regulations are generally effective/applicable on July 6, 2007, and will cease to apply on July 6, 2010. However, a transition rule states that returns of Code Sec. 4965 taxes that are or were due on or before October 4, 2007, will be deemed timely if the return is filed and the tax is paid before that date.

T.D. 9335
The IRS also issued temporary regulations under Code Sec. 6033(a)(2) that provide rules regarding the form, manner and timing of disclosure requirements with respect to prohibited tax shelter transactions to which tax-exempt entities are parties. These regulations require that every tax-exempt entity to which Code Sec. 4965 applies that is a party to a prohibited tax shelter transaction must disclose to the IRS that the entity is a party to a prohibited tax shelter transaction and the identity of any other party to the transaction known to the tax-exempt entity.

The temporary regulations issued in T.D. 9335 define a tax-exempt party to a prohibited tax shelter transaction, and provide guidance with respect to the frequency of disclosure, who is to make the disclosure and the time and place for making the disclosure on Form 8886-T, Disclosure by Tax-Exempt Entity Regarding Prohibited Tax Shelter Transaction. A transition rule is provided for tax-exempt entities that entered into a prohibited tax shelter transaction after May 17, 2006, and before January 1, 2007. Disclosure is not required for any prohibited tax shelter transaction entered into by a tax-exempt entity on or before May 17, 2006.

Proposed Regulations
The texts of the temporary regulations in T.D. 9334 and T.D. 9335 also serve as the texts of proposed regulations. Temporary regulations providing guidance under Code Sec. 4965 have also been released.

Background. Notice 2006-65, I.R.B. 2006-31, 102, and Notice 2007-18, I.R.B. 2007-9, 608 (TAXDAY, 2007/02/08, I.1) provided guidance regarding prohibited tax shelter transactions under Code Sec. 4965, and requested comments regarding these provisions and the guidance. After consideration of the comments received, the IRS has issued proposed regulations.

Proposed Regulations. The proposed regulations define the terms "tax-exempt entity," "prohibited tax shelter transactions," "net income" and "reportable transactions," and clarify that a tax-exempt entity does not become a party to a prohibited tax shelter transaction solely because it invests in an entity that becomes involved in such a transaction. Furthermore, the regulations address the definition of the term "entity manager," and provide guidance regarding persons who could be deemed entity managers pursuant to a delegation of authority. The regulations also define the term "approve or otherwise cause," limiting the definition to affirmative actions of persons who have the authority to commit the entity to a transaction.

The level of tax imposed under Code Sec. 4965 depends on whether the entity knew or had reason to know that it was becoming a party to a prohibited tax shelter transaction. Under the proposed regulations, receipt by an entity manager of a disclosure statement in advance of a transaction is a relevant factor but does not necessarily demonstrate that the entity or any of its managers knew or had reason to know that the transaction was a prohibited tax shelter transaction. The regulations also clarify that entity manager liability for these excise taxes is not joint and several.

Notice 2007-18 provided that allocation of net income and proceeds is determined according to normal tax accounting rules. This rule is included in the proposed regulations.

Effective Dates. When finalized the regulations under Code Sec. 4965are proposed to be applicable for tax years ending after July 6, 2007. Taxpayers may rely on these proposed regulations for periods ending on or before such date.

Comments Requested The IRS requests comments on these regulations, specifically regarding the clarity of the proposed rule and how it may be made easier to understand. A public hearing is not scheduled, but may be scheduled if requested in writing by a person who timely submits written comments. Comments and requests for a public hearing must be received by October 4, 2007. Submissions should be sent to CC:PA:LPD:PR (REG-142039-06; REG-139268-06), Room 5203, IRS, P.O. Box 7604, Ben Franklin Station, Washington, D.C., 20044. Submissions may also be hand-delivered between 8:00 a.m. and 4:00 p.m. to CC:PA:LPD:PR (REG-142039-06; REG-139268-06), Courier's Desk, IRS, 1111 Constitution Avenue, NW., Washington, D.C., or submitted electronically via the Federal eRulemaking Portal at http://www.regulations.gov (IRS-REG-142039-06; REG-139268-06).

T.D. 9334 , filed with the Federal Register on July 5, 2007.

Returns: Information returns: Excise taxes: Time for filing. --
Reg. §53.6071-1T and amendments of Reg. §§53.6011-1, 53.6071-1, 54.6011-1 and 54.6011-1T, relating to the requirement of a return to accompany payment of excise taxes under Code Sec. 4965 and the time for filing that return, are adopted.
AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

SUMMARY: This document contains final and temporary regulations providing guidance relating to the requirement of a return to accompany payment of excise taxes under section 4965 of the Internal Revenue Code (Code) and the time for filing that return. These regulations affect a broad array of tax-exempt entities, including charities, state and local government entities, Indian tribal governments and employee benefit plans, as well as entity managers of these entities. This action is necessary to implement section 516 of the Tax Increase Prevention and Reconciliation Act of 2005. The text of the temporary regulations also serves as the text of the proposed regulations set forth in the Proposed Rules section in this issue of the Federal Register.

DATES: Effective date. These regulations are effective on July 6, 2007.

Applicability date. For dates of applicability, see §§53.6071-1T(g) and 54.6011-1T(c) of these regulations.

FOR FURTHER INFORMATION CONTACT: Galina Kolomietz, (202) 622-6070, Michael Blumenfeld, (202) 622-1124, or Dana Barry, (202) 622-6060 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:



Background

The Tax Increase Prevention and Reconciliation Act of 2005, Public Law 109-222 (120 Stat. 345) (TIPRA), enacted on May 17, 2006, added section 4965 to the Code. Section 4965 affects a broad array of tax-exempt entities as defined in section 4965(c). Tax-exempt entities described in section 4965(c)(1), (2), or (3) (referred to herein as "non-plan entities") include entities described in section 501(c), religious or apostolic associations or corporations described in section 501(d), entities described in section 170(c), including states, possessions of the United States, the District of Columbia, political subdivisions of states and political subdivisions of possessions of the United States (but not including the United States), and Indian tribal governments within the meaning of section 7701(a)(40). Tax-exempt entities described in section 4965(c)(4), (c)(5), (c)(6), or (c)(7) (referred to herein as "plan entities") include tax-favored retirement plans, individual retirement arrangements, and savings arrangements described in section 401(a), 403(a), 403(b), 529, 457(b), 408(a), 220(d), 408(b), 530 or 223(d).

Section 4965 imposes two new excise taxes, one on the tax-exempt entity (the entity-level tax) and the other on certain of the tax-exempt entity's managers (the manager-level tax). The entity-level tax is imposed on non-plan entities that are parties to prohibited tax shelter transactions. The entity-level tax does not apply to plan entities. Prohibited tax shelter transactions are transactions that are identified by the IRS as "listed transactions" (within the meaning of section 6707A(c)(2)) and reportable transactions that are confidential transactions or transactions with contractual protection (as defined in section 6707A(c)(1) and §1.6011-4(b) of this chapter).

The entity-level tax applies to each taxable year during which the non-plan entity is a party to a prohibited tax shelter transaction and has net income or proceeds attributable to the transaction which are properly allocable to that taxable year. The amount of the entity-level tax depends on whether the non-plan entity knew or had reason to know that the transaction was a prohibited tax shelter transaction at the time the entity became a party to the transaction. If the non-plan entity did not know (and did not have reason to know) that the transaction was a prohibited tax shelter transaction at the time the entity became a party to the transaction, the tax is the highest rate of tax under section 11 (currently 35 percent) multiplied by the greater of: (i) The entity's net income with respect to the prohibited tax shelter transaction (after taking into account any tax imposed by Subtitle D, other than by this section, with respect to such transaction) for the taxable year or (ii) 75 percent of the proceeds received by the entity for the taxable year that are attributable to such transaction. If the non-plan entity knew or had reason to know that the transaction was a prohibited tax shelter transaction at the time the entity became a party to the transaction, the tax is the greater of (i) 100 percent of the entity's net income with respect to the transaction (after taking into account any tax imposed by Subtitle D, other than by this section, with respect to such transaction) for the taxable year or (ii) 75 percent of the proceeds received by the entity for the taxable year that are attributable to such transaction. In the case of a transaction that becomes a prohibited tax shelter transaction by reason of becoming a listed transaction after the non-plan entity has become a party to such transaction (subsequently listed transactions), the amount of tax is based on the net income or proceeds attributable to such transaction that are properly allocable to the period beginning on the date the transaction became listed or the first day of the entity's taxable year, whichever is later. No entity-level tax applies to any income or proceeds that are properly allocable to a period ending on or before August 15, 2006.

The manager-level tax is imposed on entity managers (as defined in section 4965(d)) of all tax-exempt entities described in section 4965(c) who approve the entity as a party (or otherwise cause the entity to be a party) to a prohibited tax shelter transaction and know or have reason to know that the transaction is a prohibited tax shelter transaction. In the case of non-plan entities, the term entity manager means the person with authority or responsibility similar to that exercised by an officer, director or trustee, and, with respect to any act, the person having authority or responsibility with respect to such act. In the case of plan entities, the term entity manager means the person who approves or otherwise causes the entity to be a party to the prohibited tax shelter transaction. An individual beneficiary (including a plan participant) or owner of the tax-favored retirement plans, individual retirement arrangements, and savings arrangements described in section 401(a), 403(a), 403(b), 529, 457(b), 408(a), 220(d), 408(b), 530 or 223(d), may be liable as an entity manager if the individual beneficiary or owner has broad investment authority under the arrangement. The amount of the manager-level tax is $20,000 for each approval or other act causing the entity to be a party to a prohibited tax shelter transaction. The manager-level tax applies separately to each entity manager.

These final and temporary regulations are being issued concurrently with proposed regulations under sections 4965, 6033(a)(2) and 6011(g) published elsewhere in the Federal Register.



Explanation of Provisions

The regulations provide that non-plan entities (including exempt organizations and governments) that are liable for section 4965 excise taxes and entity managers of non-plan entities who are liable for section 4965 excise taxes as entity managers are required to file a return on Form 4720, "Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code." The entity return is due on or before the date the non-plan entity's annual return under section 6033(a)(1) (for example, Form 990, "Return of Organization Exempt From Income Tax") is due, if the non-plan entity is required to file such a return. In all other cases, the entity return is due on or before the 15th day of the fifth month after the end of the non-plan entity's accounting period for which the liability under section 4965 was incurred. In the case of a non-plan entity manager, the entity manager return is due on or before the 15th day of the fifth month following the close of the manager's taxable year during which the entity entered into a prohibited tax shelter transaction.

The regulations also provide that entity managers of plan entities who are liable for section 4965 taxes as entity managers are required to file a return on Form 5330, "Return of Excise Taxes Related to Employee Benefit Plans." For section 4965 taxes, the Form 5330 is due on or before the 15th day of the fifth month following the close of the manager's taxable year during which the entity entered into a prohibited tax shelter transaction.

The regulations provide a transition rule that returns of section 4965 taxes that are or were due on or before October 4, 2007 will be deemed timely if the return is filed and the tax is paid before that date.



Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. For the applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6), refer to the Special Analyses section of the preamble to the cross-referencing notice of proposed rulemaking published in the Proposed Rules section in this issue of the Federal Register. Pursuant to section 7805(f) of the Code, these regulations have been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on business.



Drafting Information

The principal authors of these regulations are Galina Kolomietz and Dana Barry, Office of Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). However, other personnel from the IRS and the Treasury Department participated in their development.



List of Subjects

26 CFR Part 53

Excise taxes, Foundations, Investments, Lobbying, Reporting and recordkeeping requirements.

26 CFR Part 54

Excise Taxes, Pensions, Reporting and recordkeeping requirements.



Amendments to the Regulations

Accordingly, 26 CFR parts 53 and 54 are amended as follows:



PART 53 --FOUNDATION AND SIMILAR EXCISE TAXES

Paragraph 1. The authority citation for part 53 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *



§53.6011-1 [Amended]

Par. 2. In §53.6011-1, paragraph (b) is amended by:

1. Removing from the first sentence, the language "or 4958(a)," and adding "4958(a), or 4965(a)," in its place.

2. Removing from the last sentence, the language "or 4958(a)," and adding "4958(a), or 4965(a)," in its place.

Par. 3. Section 53.6071-1 is amended by adding and reserving paragraph (g) and adding paragraph (h) to read as follows:



§53.6071-1 Time for filing returns.

* * * * *

(g) [Reserved]. For further guidance, see §53.6071-1T(g).

(h) Effective/applicability date. For the applicability date of paragraph (g) of this section, see §53.6071-1T(h).

Par. 4. Section 53.6071-1T is added to read as follows:



§53.6071-1T Time for filing returns (temporary).

(a) through (f) [Reserved]. For further guidance, see §53.6071-1(a) through (f).

(g) Taxes imposed with respect to prohibited tax shelter transactions to which tax-exempt entities are parties --(1) Returns by certain tax-exempt entities. A Form 4720, "Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code," required by §53.6011-1(b) for a tax-exempt entity described in section 4965(c)(1), (c)(2) or (c)(3) that is a party to a prohibited tax shelter transaction and is liable for tax imposed by section 4965(a)(1) shall be filed on or before the due date (not including extensions) for filing the tax-exempt entity's annual information return under section 6033(a)(1). If the tax-exempt entity is not required to file an annual information return under section 6033(a)(1), the Form 4720 shall be filed on or before the 15th day of the fifth month after the end of the tax-exempt entity's taxable year or, if the entity has not established a taxable year for Federal income tax purposes, the entity's annual accounting period.

(2) Returns by entity managers of tax-exempt entities described in section 4965(c)(1), (c)(2) or (c)(3). A Form 4720, required by §53.6011-1(b) for an entity manager of a tax-exempt entity described in section 4965(c)(1), (c)(2) or (c)(3) who is liable for tax imposed by section 4965(a)(2) shall be filed on or before the 15th day of the fifth month following the close of the entity manager's taxable year during which the entity entered into the prohibited tax shelter transaction.

(3) Transition rule. A Form 4720, for a section 4965 tax that is or was due on or before October 4, 2007 will be deemed to have been filed on the due date if it is filed by October 4, 2007 and if all section 4965 taxes required to be reported on that Form 4720 are paid by October 4, 2007.

(h) Effective/applicability date --(1) In general. Paragraph (g) of this section is applicable on July 6, 2007.

(2) Expiration date. Paragraph (g) of this section will cease to apply on July 6, 2010.



PART 54 --PENSION EXCISE TAXES

Par. 5. The authority citation for part 54 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 6. Section 54.6011-1 is amended by adding and reserving paragraph (c) and adding paragraph (d) to read as follows:



§54.6011-1 General requirement of return, statement, or list.

* * * * *

(c) [Reserved]. For further guidance, see §54.6011-1T(c).

(d) Effective/applicability date. For the applicability date of paragraph (c) of this section, see §54.6011-1T(d).

Par. 7. Section 54.6011-1T is amended as follows:

1. The undesignated text is designated as paragraph (a) and a paragraph heading is added.

2. Paragraph (b) is added and reserved.

3. Paragraphs (c) and (d) are added.



§54.6011-1T General requirement of return, statement or list (temporary).

(a) Tax on reversions of qualified plan assets to employer. * * *

(b) [Reserved].

(c) Entity manager tax on prohibited tax shelter transactions --(1) In general. Any entity manager of a tax-exempt entity described in section 4965(c)(4), (c)(5), (c)(6), or (c)(7) who is liable for tax under section 4965(a)(2) shall file a return on Form 5330, "Return of Excise Taxes Related to Employee Benefit Plans," on or before the 15th day of the fifth month following the close of such entity manager's taxable year during which the entity entered into the prohibited tax shelter transaction, and shall include therein the information required by such form and the instructions issued with respect thereto.

(2) Transition rule. A Form 5330, "Return of Excise Taxes Related to Employee Benefit Plans," for an excise tax under section 4965 that is or was due on or before October 4, 2007 will be deemed to have been filed on the due date if it is filed by October 4, 2007 and if the section 4965 tax that was required to be reported on that Form 5330 is paid by October 4, 2007.

(d) Effective/applicability date --(1) In general. Paragraph (c) of this section is applicable on July 6, 2007.

(2) Expiration date. Paragraph (c) of this section will expire on July 5, 2010.

Kevin M. Brown,

Deputy Commissioner for Services and Enforcement.

Approved: June 21, 2007.

Eric Solomon,

Assistant Secretary of the Treasury (Tax Policy)



T.D. 9335 , filed with the Federal Register on July 5, 2007.

Returns: Information returns: Exempt organizations: Prohibited tax shelter transaction. --
Reg. §§1.6033-5T and 301.6033-5T, providing rules regarding the form, manner and timing of disclosure obligations with respect to prohibited tax shelter transactions to which tax-exempt entities are parties, are adopted.



AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

SUMMARY: This document contains temporary regulations under section 6033(a)(2) of the Internal Revenue Code (Code) that provide rules regarding the form, manner and timing of disclosure obligations with respect to prohibited tax shelter transactions to which tax-exempt entities are parties. These temporary regulations affect a broad array of tax-exempt entities, including charities, state and local government entities, Indian Tribal governments and employee benefit plans, as well as entity managers of these entities. This action is necessary to implement section 516 of the Tax Increase Prevention and Reconciliation Act of 2005. The text of the temporary regulations also serves as the text of the proposed regulations set forth in the Proposed Rules section in this issue of the Federal Register.

DATES: Effective Date: These regulations are effective on July 6, 2007.

Applicability Date: For dates of applicability, see §1.6033-5T(g).

FOR FURTHER INFORMATION CONTACT: Galina Kolomietz, (202) 622-6070, or Michael Blumenfeld, (202) 622-1124 (not toll-free numbers). For questions specifically relating to qualified pension plans, individual retirement accounts, and similar tax-favored savings arrangements, contact Dana Barry, (202) 622-6060 (not a toll-free number).

SUPPLEMENTARY INFORMATION:



Background

The Tax Increase Prevention and Reconciliation Act of 2005, Public Law 109-222 (120 Stat. 345) (TIPRA), enacted on May 17, 2006, defines certain transactions as prohibited tax shelter transactions and imposes excise taxes and disclosure requirements with respect to prohibited tax shelter transactions to which a tax-exempt entity is a party. TIPRA creates new section 4965 and amends sections 6033(a)(2) and 6011(g) of the Code. The amended section 6033(a)(2) requires every tax-exempt entity to which section 4965 applies that is a party to a prohibited tax shelter transaction to disclose to the IRS (in such form and manner and at such time as determined by the Secretary) the following information: (a) That such entity is a party to the prohibited tax shelter transaction; and (b) the identity of any other party to the transaction which is known to the tax-exempt entity. The amended section 6011(g) requires any taxable party to a prohibited tax shelter transaction to disclose by statement to any tax-exempt entity to which section 4965 applies that is a party to such transaction that such transaction is a prohibited tax shelter transaction.

On July 11, 2006, the IRS released Notice 2006-65 (2006-31 IRB 102), which alerted taxpayers to the new provisions. On February 7, 2007, the IRS released Notice 2007-18 (2007-9 IRB 608), which provided interim guidance regarding the circumstances under which a tax-exempt entity will be treated as a party to a prohibited tax shelter transaction for purposes of sections 4965, 6033(a)(2) and 6011(g) and regarding the allocation to various periods of net income and proceeds attributable to a prohibited tax shelter transaction, including amounts received prior to the effective date of the section 4965 tax. See §601.601(d)(2)(ii)(b).

These temporary regulations are being issued concurrently with proposed regulations under sections 4965, 6033(a)(2) and 6011(g) published elsewhere in the Federal Register.



Explanation of Provisions

These temporary regulations contain rules concerning disclosure requirements imposed by section 6033(a)(2) on tax-exempt entities that are parties to prohibited tax shelter transactions. Proposed regulations providing rules concerning disclosure requirements under section 6033(a)(2) are being issued concurrently with these temporary regulations.



Effective Date

These temporary regulations are applicable with respect to transactions entered into by a tax-exempt entity after May 17, 2006.



Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. For the applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6), refer to the Special Analyses section of the preamble to the cross-referencing notice of proposed rulemaking published in the Proposed Rules section in this issue of the Federal Register. Pursuant to section 7805(f) of the Code, these regulations have been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business.



Drafting Information

The principal authors of these regulations are Galina Kolomietz and Dana Barry, Office of Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). However, other personnel from the IRS and the Treasury Department participated in their development.



List of Subjects

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 301

Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income taxes, Penalties, Reporting and recordkeeping requirements.



Adoption of Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 301 are amended as follows:



PART 1 --INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.6033-5T is added to read as follows:

§1.6033-5T Disclosure by tax-exempt entities that are parties to certain reportable transactions (temporary).

(a) In general. Every tax-exempt entity (as defined in section 4965(c)) shall file with the IRS on Form 8886-T, "Disclosure by Tax-Exempt Entity Regarding Prohibited Tax Shelter Transaction" (or a successor form), in accordance with this section and the instructions to the form, a disclosure of --

(1) Such entity's being a party (as defined in paragraph (b) of this section) to a prohibited tax shelter transaction (as defined in section 4965(e)); and

(2) The identity of any other party (whether taxable or tax-exempt) to such transaction that is known to the tax-exempt entity.

(b) Definition of tax-exempt party to a prohibited tax shelter transaction --(1) In general. For purposes of section 6033(a)(2), a tax-exempt entity is a party to a prohibited tax shelter transaction if the entity --

(i) Facilitates a prohibited tax shelter transaction by reason of its tax-exempt, tax indifferent or tax-favored status;

(ii) Enters into a listed transaction and the tax-exempt entity's tax return (whether an original or an amended return) reflects a reduction or elimination of its liability for applicable Federal employment, excise or unrelated business income taxes that is derived directly or indirectly from tax consequences or tax strategy described in the published guidance that lists the transaction; or

(iii) Is identified in published guidance, by type, class or role, as a party to a prohibited tax shelter transaction.

(2) Published guidance may identify which tax-exempt entities, by type, class or role, will not be treated as a party to a prohibited tax shelter transaction for purposes of section 6033(a)(2).

(c) Frequency of disclosure. A single disclosure is required for each prohibited tax shelter transaction.

(d) By whom disclosure is made --(1) Tax-exempt entities referred to in section 4965(c)(1), (2) or (3). In the case of tax-exempt entities referred to in section 4965(c)(1), (2) or (3), the disclosure required by this section must be made by the entity.

(2) Tax-exempt entities referred to in section 4965(c)(4), (5), (6) or (7). In the case of tax-exempt entities referred to in section 4965(c)(4), (5), (6) or (7), including a fully self-directed qualified plan, IRA, or other savings arrangement, the disclosure required by this section must be made by the entity manager (as defined in section 4965(d)(2)) of the entity.

(e) Time and place for filing --(1) Tax-exempt entities described in paragraph (b)(1)(i) of this section --(i) In general. The disclosure required by this section shall be filed on or before May 15 of the calendar year following the close of the calendar year during which the tax-exempt entered into the prohibited tax shelter transaction.

(ii) Subsequently listed transactions. In the case of subsequently listed transactions (as defined in section 4965(e)(2)), the disclosure required by this section shall be filed on or before May 15 of the calendar year following the close of the calendar year during which the transaction was identified by the Secretary as a listed transaction.

(2) Tax-exempt entities described in paragraph (b)(1)(ii) of this section. The disclosure required by this section shall be filed on or before the date on which the first tax return (whether an original or an amended return) is filed which reflects a reduction or elimination of the tax-exempt entity's liability for applicable Federal employment, excise or unrelated business income taxes that is derived directly or indirectly from tax consequences or tax strategy described in the published guidance that lists the transaction.

(3) Transition rule. If a tax-exempt entity entered into a prohibited tax shelter transaction after May 17, 2006 and before January 1, 2007, the disclosure required by this section shall be filed --

(i) In the case of tax-exempt entities described in paragraph (b)(1)(i) of this section, on or before November 5, 2007;

(ii) In the case of tax-exempt entities described in paragraph (b)(1)(ii) of this section, on or before the later of --

(A) November 5, 2007; or

(B) The date on which the first tax return (whether an original or an amended return) is filed which reflects a reduction or elimination of the tax-exempt entity's liability for applicable Federal employment, excise or unrelated business income taxes that is derived directly or indirectly from tax consequences or tax strategy described in the published guidance that lists the transaction.

(4) Disclosure is not required with respect to any prohibited tax shelter transaction entered into by a tax-exempt entity on or before May 17, 2006.

(f) Penalty for failure to provide disclosure statement. See section 6652(c)(3) for penalties applicable to failure to disclose a prohibited tax shelter transaction in accordance with this section.

(g) Effective date --(1) Applicability date. This section applies with respect to transactions entered into by a tax-exempt entity after May 17, 2006.

(2) Expiration date. This section will expire on July 6, 2010.



PART 301 --PROCEDURE AND ADMINISTRATION

Par. 3. The authority citation for part 301 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 4. Section 301.6033-5T is added to read as follows:

§301.6033-5T Disclosure by tax-exempt entities that are parties to certain reportable transactions (temporary).

(a) In general. For provisions relating to the requirement of the disclosure by a tax-exempt entity that it is a party to certain reportable transactions, see §1.6033-5T of this chapter (Income Tax Regulations).

(b) Effective date --(1) Applicability date. This section applies with respect to transactions entered into by a tax-exempt entity after May 17, 2006.

(2) Expiration date. This section will expire on July 5, 2010.

Kevin M. Brown,

Deputy Commissioner for Services and Enforcement.

Approved: June 21, 2007.

Eric Solomon,

Assistant Secretary of the Treasury (Tax Policy).

Proposed Regulations (REG-142039-06, REG-139268-06) , published in the Federal Register on July 6, 2007.


Excise taxes: Tax-exempt entities: Tax shelter transactions: Returns: Filing requirements. --
Reg. §§53.4965-1 --53.4965-9, 301.6011(g)-1, 1.6033-5 and 301.6033-5 and amendments of Reg. §§53.6071-1 and 54.6011-1, providing guidance under Code Sec. 4965 relating to entity-level and manager-level excise taxes with respect to prohibited tax shelter transactions to which tax-exempt entities are parties, are proposed.



AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking by reference to temporary regulations and notice of proposed rulemaking.

SUMMARY: This document contains proposed regulations that provide guidance under section 4965 of the Internal Revenue Code (Code), relating to entity-level and manager-level excise taxes with respect to prohibited tax shelter transactions to which tax-exempt entities are parties; sections 6033(a)(2) and 6011(g), relating to certain disclosure obligations with respect to such transactions; and sections 6011 and 6071, relating to the requirement of a return and time for filing with respect to section 4965 taxes. In the Rules and Regulations section of this issue of the Federal Register, the IRS is issuing cross-referencing temporary regulations that provide guidance under section 6033(a)(2), relating to certain disclosure obligations with respect to prohibited tax shelter transactions; and sections 6011 and 6071, relating to the requirement of a return and time for filing with respect to section 4965 taxes. This action is necessary to implement section 516 of the Tax Increase Prevention Reconciliation Act of 2005. These proposed regulations affect a broad array of tax-exempt entities, including charities, state and local government entities, Indian tribal governments and employee benefit plans, as well as entity managers of these entities.

DATES: Written or electronic comments and requests for a public hearing must be received by October 4, 2007.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-142039-06; REG-139268-06), room 5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-142039-06, REG-139268-06), Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue, NW., Washington, DC. Alternatively, taxpayers may submit comments electronically via the Federal eRulemaking Portal at http://www.regulations.gov (IRS-REG-142039-06; REG-139268-06).

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Galina Kolomietz, (202) 622-6070 or Michael Blumenfeld, (202) 622-1124; concerning submission of comments and requests for a public hearing, Richard Hurst, Richard.A.Hurst@irscounsel.treas.gov (not toll-free numbers). For questions specifically relating to qualified pension plans, individual retirement accounts, and similar tax-favored savings arrangements, contact Dana Barry, (202) 622-6060 (not a toll-free number).



SUPPLEMENTARY INFORMATION:



Paperwork Reduction Act

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number assigned by the Office of Management and Budget.

The collection of information in this proposed regulation is in §301.6011(g)-1. The collection of information in §301.6011(g)-1 flows from section 6011(g) which requires a taxable party to a prohibited tax shelter transaction to disclose to any tax-exempt entity that is a party to the transaction that the transaction is a prohibited tax shelter transaction. The likely recordkeepers are taxable entities or individuals that participate in prohibited tax shelter transactions. Estimated number of recordkeepers: 1250 to 6500. The information that is required to be collected for purposes of §301.6011(g)-1 is a subset of information that is required to be collected in order to complete and file Form 8886, "Reportable Transaction Disclosure Statement." The estimated paperwork burden for taxpayers filling out Form 8886 is approved under OMB number 1545-1800 and is as follows:


Recordkeeping ...................................................6 hr., 13 min.

Learning about the law
or the form ......................................................4 hr. 28 min.

Preparing, copying, assembling,
and sending the form to the IRS
..................................................................4 hr. 46 min.



Based on the numbers in the preceding paragraph, the total estimated burden per recordkeeper complying with the disclosure requirement in §301.6011(g)-1 will not exceed 15 hr., 27 min. This burden has been submitted to the Office of Management and Budget for review.

Books and records relating to the collection of information must be retained as long as their contents may become material in the administration of any internal revenue law.



Background

The Tax Increase Prevention and Reconciliation Act of 2005, Public Law 109-222 (120 Stat. 345) (TIPRA), enacted on May 17, 2006, defines certain transactions as prohibited tax shelter transactions and imposes excise taxes and disclosure requirements with respect to prohibited tax shelter transactions to which a tax-exempt entity is a party. Section 516 of TIPRA creates new section 4965 and amends sections 6033(a)(2) and 6011(g) of the Code.

On July 11, 2006, the IRS released Notice 2006-65 (2006-31 IRB 102), which alerted taxpayers to the new provisions and solicited comments regarding these provisions. One hundred written comments and numerous phone calls were received in response to the request for comments contained in Notice 2006-65. On February 7, 2007, the IRS released Notice 2007-18 (2007-9 IRB 608), which provided interim guidance regarding the circumstances under which a tax-exempt entity will be treated as a party to a prohibited tax shelter transaction and regarding the allocation to various periods of net income and proceeds attributable to a prohibited tax shelter transaction, including amounts received prior to the effective date of the section 4965 tax. Notice 2007-18 also solicited comments from the public regarding these and other issues raised by section 4965. Eight written comments and numerous phone calls were received in response to the request for comments contained in Notice 2007-18. See §601.601(d)(2)(ii)(b).

The comments received in response to Notice 2006-65 and Notice 2007-18 addressed all aspects of the new excise taxes and disclosure requirements. While some comments discussed the implications of a broad application of the new excise taxes and disclosure requirements, commentators generally responded favorably to Congress' effort to restrict tax-exempt entities from being involved in Federal tax avoidance schemes. Commentators noted the lack of meaningful penalties prior to TIPRA for tax-exempt entities involved in tax shelter transactions and the need for disclosure in the case where a tax-exempt entity is improperly using its tax-exempt status to facilitate a tax shelter transaction. After consideration of all comments received, the IRS and the Treasury Department are issuing the following proposed regulations and soliciting comments thereon. The major areas of comments and the IRS and Treasury Department's responses thereto are discussed in the following sections.



Explanation of Provisions



Covered Tax-Exempt Entities

Section 4965(c) defines the term "tax-exempt entity" for section 4965 purposes by reference to sections 501(c), 501(d), 170(c), 7701(a)(40), 4979(e) (paragraphs (1), (2) and (3)), 529, 457(b), and 4973(a). The proposed regulations describe the types of entities captured by the statutory cross-references in section 4965(c).



Definition of Prohibited Tax Shelter Transactions

Section 4965(e) defines the term "prohibited tax shelter transaction" by reference to section 6707A(c)(1) and (c)(2). In accordance with the statutory definition, the proposed regulations define the term "prohibited tax shelter transaction" by reference to the definition of the term "reportable transaction" in section 6707A(c)(1) and (c)(2) and the regulations under section 6011. The proposed regulations define a subsequently listed transaction as a transaction (other than a reportable transaction within the meaning of section 6707A(c)(1)) to which a tax-exempt entity becomes a party before the transaction becomes a listed transaction within the meaning of section 6707A(c)(2).

Several commentators expressed concern over the severe penalties imposed on tax-exempt entities and entity managers for participating in many common and legitimate transactions which have no tax avoidance purpose, yet may fall within the definition of prohibited tax shelter transaction. The commentators suggested that the IRS and the Treasury Department carve out certain types of transactions from the definition of "prohibited tax shelter transaction" or revise current listing procedures to give taxpayers an opportunity to object to the identification of a specific transaction as a tax avoidance transaction. Some commentators recommended that any future published guidance which designates a transaction as a listed or reportable transaction be issued with a prospective effective date and state that it will not apply retroactively. Several commentators requested that the proposed regulations identify listed, subsequently listed, confidential and contractual protection transactions that would not be treated as prohibited tax shelter transactions for purposes of section 4965. The above recommendations are not adopted in these proposed regulations because section 4965 defines the term "prohibited tax shelter transaction" by reference to the existing reportable transaction regime. Any additions to, or exclusions from, the definition of reportable transactions, or any changes to the current listing procedures, must be made within the framework of section 6011 rather than section 4965.

One commentator suggested that the term "reportable transaction" should be narrowly interpreted for purposes of section 4965. However, this term already has been defined under section 6011, and consequently, these proposed regulations interpret it consistently for section 4965 and section 6011 purposes.



Definition of Tax-Exempt Party to a Prohibited Tax Shelter Transaction

Excise taxes under section 4965 apply only if a tax-exempt entity is a party to a prohibited tax shelter transaction. A number of commentators requested guidance in determining when a tax-exempt entity is a party to a prohibited tax shelter transaction. Notice 2007-18 defined the term party as a tax-exempt entity that facilitates a prohibited tax shelter transaction by reason of its tax-exempt, tax indifferent or tax-favored status. The proposed regulations incorporate this definition of the term party. Notice 2007-18 also notified the public that the IRS and the Treasury Department would provide a broader definition of the term party in future guidance in accordance with section 4965. Consistent with Notice 2007-18, the proposed regulations define the term "party" for purposes of sections 4965 and 6033(a)(2) to include a tax-exempt entity that enters into a listed transaction and reflects on its tax return a reduction or elimination of its liability for applicable Federal employment, excise or unrelated business income taxes that is derived directly or indirectly from tax consequences or tax strategy described in the published guidance that lists the transaction.

Several commentators specifically requested that the proposed regulations address under what circumstances, if any, a tax-exempt entity may be treated as a party to a prohibited tax shelter transaction if the tax-exempt entity is an investor in a partnership, hedge fund or other conduit. Invoking the language in the legislative history to section 4965, commentators recommended that the IRS and Treasury Department establish a rule or a safe harbor that would treat an investor in an indirect investment activity as being a party for section 4965 purposes only in limited circumstances.

As illustrated by an example in the proposed regulations, a tax-exempt entity does not become a party to a prohibited tax shelter transaction solely because it invests in an entity that in turn becomes involved in a prohibited tax shelter transaction. To be considered a "party" under the proposed regulations, the tax-exempt entity must either facilitate the prohibited tax shelter transaction by reason of its tax-exempt, tax indifferent or tax-favored status, or must treat the prohibited tax shelter transaction on its tax return as reducing or eliminating its own Federal tax liability. The IRS and the Treasury Department request comments on any further clarifications that may be helpful in reflecting the intended application of the statute as expressed in the legislative history.



Entity Managers and Related Definitions

The proposed regulations clarify the definition of the term "entity manager" in section 4965(d) and provide guidance on persons who could be entity managers pursuant to a delegation of authority from other entity managers.

The proposed regulations also define the term "approve or otherwise cause." Under section 4965(a)(2), an entity manager may be liable for the manager-level excise tax only if the manager "approves such entity as (or otherwise causes such entity to be) a party" to a prohibited tax shelter transaction and knows or has reason to know the transaction is a prohibited tax shelter transaction. The proposed regulations generally limit the definition of "approving or otherwise causing" to affirmative actions of persons who, individually or as members of a collective body, have the authority to commit the entity to the transaction.

One commentator requested guidance on whether entity managers may be liable for section 4965 taxes in successor-in-interest situations. Several commentators requested guidance on the consequences under section 4965 of the exercise or nonexercise of certain options pursuant to the terms of the transaction. In response to these comments, the proposed regulations provide rules for successor-in-interest situations and the consequences of the exercise or nonexercise of certain options.



Meaning of "Knows or Has Reason to Know"

The level of tax imposed on the tax-exempt entity under section 4965(b)(1) depends upon whether the entity knows or has reason to know, at the time it enters into the transaction, that it is becoming a party to a prohibited tax shelter transaction. The liability of the entity manager for the tax under section 4965(b)(2) depends on whether the entity manager knows or has reason to know that the transaction is a prohibited tax shelter transaction at the time of approving or otherwise causing the entity to be a party to the transaction. The proposed regulations treat the entity as knowing or having reason to know if its manager(s) knew or had to reason to know and provide rules for determining whether entity managers knew or had reason to know. The "reason-to-know" rules in these proposed regulations are consistent with the "reason-to-know" and "should have known" standards under other provisions of the Code.

Commentators recommended that the IRS and the Treasury Department not treat receipt of a disclosure statement regarding a transaction by the tax-exempt entity as conclusive evidence that the tax-exempt entity knew or had reason to know that the transaction was a prohibited tax shelter transaction. The proposed regulations adopt this recommendation and provide that receipt by an entity manager of a disclosure statement in advance of a transaction is a relevant factor but, by itself, does not necessarily demonstrate that the tax-exempt entity or any of its managers knew or had reason to know that the transaction was a prohibited tax shelter transaction.



Taxes on Prohibited Tax Shelter Transactions

Section 4965(b)(1) provides the rules for computing the entity-level excise tax with respect to prohibited tax shelter transactions. Section 4965(b)(2) imposes a flat $20,000 excise tax on any entity manager that approved or otherwise caused the entity to become a party to a prohibited tax shelter transaction. The proposed regulations follow the computational rules in the statute, define the term "taxable year" for purposes of determining the entity-level tax under section 4965, and clarify the timing of the entity manager taxes under section 4965. The proposed regulations provide that entity manager liability for section 4965 taxes is not joint and several.



Definition of Net Income and Proceeds and Their Allocation to Various Periods

The proposed regulations define the terms "net income" and "proceeds" for section 4965 purposes and provide rules regarding the allocation of net income or proceeds attributable to a prohibited tax shelter transaction to various periods, including the appropriate treatment of net income or proceeds received prior to the effective date of the section 4965(a) tax.

Commentators recommended that net income for purposes of section 4965 be determined in a manner consistent with the determination of net income for other purposes of the Code. The proposed regulations adopt this recommendation.

Numerous commentators requested guidance in determining what amounts constitute proceeds for section 4965 purposes and urged the IRS and the Treasury Department to limit the definition of proceeds to the tax-exempt entity's economic return from the transaction. One commentator recommended that return of basis and return of capital be excluded from the definition of proceeds as these amounts are arguably not "attributable to" a prohibited tax shelter transaction. Several commentators recommended that the IRS and the Treasury Department adopt a rule that would exclude from proceeds earnings on certain set-aside amounts that are used to defease the tax-exempt entity's obligations under so-called sale-in, lease-out (SILO) and lease-in, lease-out (LILO) transactions. See Notice 2000-15 (2000-1 CB 826), and Notice 2005-13 (2005-9 IRB 630). Several commentators suggested that nonexercise of options to repurchase in the SILO / LILO context should not be treated as giving rise to net income or proceeds. See §601.601(d)(2)(ii)(b).

The proposed regulations define the term proceeds separately for tax-exempt entities that are involved in prohibited tax shelter transactions to facilitate the tax avoidance of others and tax-exempt entities that are involved in listed transactions for their own tax benefit. In the case of tax-exempt entities that are involved in prohibited tax shelter transactions to facilitate the tax avoidance of others, the proposed regulations define proceeds as the gross amount of the tax-exempt entity's consideration for facilitating the transaction, not reduced by any costs or expenses attributable to the transaction. This definition subjects the tax-exempt party's economic return from the transaction to the entity-level excise tax. In the case of tax-exempt entities that are involved in listed transactions to reduce or eliminate their own tax liability, the proposed regulations define the term proceeds as tax savings purportedly generated by the transaction and claimed by the tax-exempt entity in the tax year.

In Notice 2007-18, the IRS and Treasury Department provided that the allocation of net income and proceeds is determined according to normal tax accounting rules. The proposed regulations incorporate this rule both for purposes of allocating amounts to pre- and post-effective date periods, and allocating amounts to pre- and post-listing periods where a subsequently listed transaction is involved. Under the proposed regulations, tax-exempt entities that have not adopted a method of accounting are required to use the cash method. Several commentators recommended that the IRS adopt a position that net income or proceeds from pre-enactment transactions would not be properly allocable to any periods after the effective date of the section 4965(a) tax. The IRS and the Treasury Department decline to adopt this blanket rule because such rule would be inconsistent with established principles of tax accounting and would conflict with the plain language of the effective date provisions in section 516 of TIPRA.



Effective Dates of the Taxes

In accordance with section 516(d) of TIPRA, the proposed regulations provide that the taxes under section 4965 are effective for taxable years ending after May 17, 2006, with respect to transactions entered into before, on or after such date, except that no tax under section 4965(a) applies with respect to income or proceeds that are properly allocable to any period ending on or before August 15, 2006. The proposed regulations also provide that the 100 percent entity-level tax under section 4965(b)(1)(B) with respect to knowing transactions does not apply to prohibited tax shelter transactions entered into by a tax-exempt entity on or before May 17, 2006 and that the IRS will not assert an entity manager tax under section 4965(b)(2) with respect to any prohibited tax shelter transaction entered into by a tax-exempt entity on or before May 17, 2006. In addition, the proposed regulations provide that the 100 percent entity-level tax under section 4965(b)(1)(B) and the entity manager tax under section 4965(b)(2) do not apply with respect to any subsequently listed transaction.

Numerous commentators questioned whether it would be appropriate to apply the new excise taxes to pre-enactment transactions that already have closed and advocated a narrow application of the new excise taxes to pre-enactment transactions. The commentators argued that it would be unfair to apply the new excise taxes to pre-enactment transactions that have already closed and subject tax-exempt entities to unforeseen, harsh penalties. The commentators recommended that all transactions closed prior to May 17, 2006, be "delisted" for purposes of section 4965. The proposed regulations do not adopt these recommendations as they are inconsistent with the statutory effective date of section 4965 and the statutory definition of prohibited tax shelter transaction.

When finalized, the regulations under section 4965 are proposed to be applicable for taxable years ending after July 6, 2007. Taxpayers may rely on these proposed regulations for periods ending on or before such date.



Disclosure by Tax-exempt Entities that Are Parties to Certain Reportable Transactions

Section 6033(a)(2), as amended by TIPRA, requires every tax-exempt entity that is a party to a prohibited tax shelter transaction to disclose to the IRS, in such form and manner and at such time as determined by the Secretary, such entity's being a party to such transaction and the identity of any other party to the transaction which is known to the tax-exempt entity. The statute gives the IRS discretion with respect to the form, manner and timing of this disclosure. The proposed regulations provide rules regarding the form, manner and timing of this disclosure. With respect to the due date for the disclosure, the proposed regulations provide that, in the case of tax-exempt entities that are involved in prohibited tax shelter transactions to facilitate the tax avoidance of others, the disclosure must be filed by May 15 of the calendar year following the close of the calendar year during which the tax-exempt entity entered into the prohibited tax shelter transaction (or, in the case of subsequently listed transactions, by May 15 of the calendar year following the close of the calendar year during which the transaction was identified by the Secretary as a listed transaction). In the case of tax-exempt entities that are involved in listed transactions to reduce or eliminate their own tax liability, the proposed regulations provide that the disclosure must be filed on or before the date on which the first tax return (whether an original or an amended return) is filed on which the tax-exempt entity reflects a reduction or elimination of its liability for applicable Federal employment, excise or unrelated business income taxes that is derived directly or indirectly from tax consequences or tax strategy described in the published guidance that lists the transaction.

Temporary regulations providing the same rules are being issued concurrently with these proposed regulations.

The temporary regulations under section 6033(a)(2) apply to disclosures with respect to transactions entered into by a tax-exempt entity after May 17, 2006. Transition relief is provided with respect to transactions entered into during a transition period beginning on May 18, 2006 and ending on December 31, 2006. The due date for the disclosure with respect to the transactions entered into during the transition period is November 5, 2007 or, in the case of tax-exempt entities that are involved in listed transactions to reduce or eliminate their own tax liability, the later of: the date on which the first tax return (whether an original or an amended return) is filed on which the tax-exempt entity reflects a reduction or elimination of its liability for applicable Federal employment, excise or unrelated business income taxes that is derived directly or indirectly from tax consequences or tax strategy described in the published guidance that lists the transaction; or November 5, 2007.



Disclosure by Taxable Party to the Tax-exempt Entity

Section 6011(g), as amended by TIPRA, requires any taxable party to a prohibited tax shelter transaction to notify any tax-exempt entity which is a party to such transaction that the transaction is a prohibited tax shelter transaction. The statute is silent as to how and when the section 6011(g) disclosure needs to be made. The proposed regulations provide rules regarding the form, timing and frequency of the section 6011(g) disclosure. The proposed regulations also explain to whom the section 6011(g) disclosure must be made. With respect to the due date for the disclosure, the proposed regulations provide that the disclosure to each tax-exempt entity that is a party to the transaction must be made within 60 days after the last to occur of: (1) The date the taxable person becomes a taxable party to the transaction; or (2) the date the taxable party knows or has reason to know that the tax-exempt entity is a party to the transaction. No disclosure is required if the taxable party does not know or have reason to know that the tax-exempt entity is a party to the transaction on or before the first date on which the transaction is required to be disclosed by the taxable party under §§1.6011-4, 20.6011-4, 25.6011-4, 31.6011-4, 53.6011-4, 54.6011-4, or 56.6011-4.

One commentator recommended that the IRS provide an exception to the disclosure requirements for any transactions for which there would be no income or proceeds subject to the taxes imposed by section 4965. The proposed regulations do not adopt this recommendation because one of the purposes of section 6011(g) disclosure is to notify the tax-exempt entity that it may have a disclosure obligation under section 6033(a)(2) with respect to the transaction.

When finalized, the proposed regulations under section 6011(g) will apply to disclosures with respect to transactions entered into by a tax-exempt entity after May 17, 2006.



Payment of Section 4965 Taxes

The proposed regulations amend the existing regulations under sections 6011 and 6071 to specify the forms that must be used to pay section 4965 taxes and to provide the due dates for filing these forms. With respect to the due dates, the proposed regulations provide that a return of the entity-level excise tax under section 4965 must be made on or before the due date (not including extensions) for filing the tax-exempt entity's annual information return under section 6033(a)(1). If the tax-exempt entity is not required to file an annual information return, the return of section 4965 taxes must be made on or before the 15th day of the fifth month after the end of the tax-exempt entity's annual accounting period. A return of manager-level excise tax under section 4965 must be made on or before the 15th day of the fifth month following the close of the entity manager's taxable year during which the entity entered into the prohibited tax shelter transaction.

Temporary regulations providing the same rules are being issued concurrently with these proposed regulations.

A commentator recommended that the IRS and the Treasury Department not make the section 4965 excise taxes effective prior to the issuance of final regulations in cases where application of the new law or provisions of the new law is unclear. The proposed regulations do not adopt this recommendation because the effective date for the section 4965 taxes is statutory.

One commentator recommended that the IRS waive the excise taxes under section 4965 in appropriate circumstances. The proposed regulations do not adopt this recommendation as the obligation to pay section 4965 taxes flows directly from the statute, which does not authorize the IRS to waive the entity-level or manager-level taxes.

The amendments and additions to the regulations under sections 6011 and 6071 will be effective on July 6, 2007. Transition relief is provided with respect to returns of section 4965 taxes due on or before October 4, 2007. These returns will be deemed timely if the return is filed and the tax paid before October 4, 2007.



Special Analyses

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to this notice of proposed rulemaking. It is hereby certified that the collection of information in §301.6011(g)-1 will not have a significant economic impact on a substantial number of small entities. Accordingly, a regulatory flexibility analysis under the Regulatory Flexibility Act (5 U.S.C. 601) (RFA) is not required.

The effect of these proposed regulations on small entities flows directly from the statutes these regulations implement. Section 6011(g), as amended by TIPRA, requires any taxable party to a prohibited tax shelter transaction to notify any tax-exempt entity which is a party to such transaction that the transaction is a prohibited tax shelter transaction. In implementing this statute, §301.6011(g)-1 of the proposed regulations requires every taxable party to a prohibited tax shelter transaction (or a single taxable party acting by designation on behalf of other taxable parties) to provide to every tax-exempt entity that the taxable party knows or has reason to know is a party to the transaction a single statement disclosing that the transaction is a prohibited tax shelter transaction within 60 days after the last to occur: (1) The date the taxable person becomes a taxable party to the transaction; or (2) the date the taxable party knows or has reason to know that the tax-exempt entity is a party to the transaction. Moreover, it is unlikely that a significant number of small businesses will engage in transactions that are subject to disclosure under 301.6011(g). The IRS and the Treasury Department request comments concerning the likelihood that small businesses are engaging in transactions subject to disclosure under this provision.

Pursuant to section 7805(f) of the Code, this regulation as been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.



Comments and Requests for a Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any comments (a signed original and eight (8) copies) that are submitted timely to the IRS at the address listed in the Addresses section of this document. The IRS and the Treasury Department specifically request comments on the clarity of the proposed rule and how it may be made easier to understand. All comments will be available for public inspection and copying.

A public hearing may be scheduled if requested in writing by a person who timely submits written comments. If a public hearing is scheduled, notice of the date, time, and place will be published in the Federal Register.



Drafting Information

The principal authors of these regulations are Galina Kolomietz and Dana Barry, Office of Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). However, other personnel from the IRS and the Treasury Department participated in their development.



List of Subjects

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 53

Excise taxes, Foundations, Investments, Lobbying, Reporting and recordkeeping requirements.

26 CFR Part 54

Excise Taxes, Pensions, Reporting and recordkeeping requirements.

26 CFR Part 301

Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income taxes, Penalties, Reporting and recordkeeping requirements.



Proposed Amendments to the Regulations

Accordingly, 26 CFR parts 1, 53, 54, and 301 are proposed to be amended as follows:



PART 1 --INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read, in part, as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.6033-5 is added to read as follows:



§1.6033-5 Disclosure by tax-exempt entities that are parties to certain reportable transactions.

[The text of this section is the same as the text of §1.6033-5T published elsewhere in this issue of the Federal Register].



PART 53 --FOUNDATION AND SIMILAR EXCISE TAXES

Par. 3. The authority citation for part 53 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 4. Sections 53.4965-1 through 53.4965-9 are added to read as follows:



§53.4965-1 Overview.

(a) Entity-level excise tax. Section 4965 imposes two excise taxes with respect to certain tax shelter transactions to which tax-exempt entities are parties. Section 4965(a)(1) imposes an entity-level excise tax on certain tax-exempt entities that are parties to "prohibited tax shelter transactions," as defined in section 4965(e). See §53.4965-2 for the discussion of covered tax-exempt entities. See §53.4965-3 for the definition of prohibited tax shelter transactions. See §53.4965-4 for the definition of tax-exempt party to a prohibited tax shelter transaction. The entity-level excise tax under section 4965(a)(1) is imposed on a specified percentage of the entity's net income or proceeds that are attributable to the transaction for the relevant tax year (or a period within that tax year). The rate of tax depends on whether the entity knew or had reason to know that the transaction was a prohibited tax shelter transaction at the time the entity became a party to the transaction. See §53.4965-7(a) for the discussion of the entity-level excise tax under section 4965(a)(1). See §53.4965-6 for the discussion of "knowing or having reason to know." See §53.4965-8 for the definition of net income and proceeds and the standard for allocating net income and proceeds that are attributable to a prohibited tax shelter transaction to various periods.

(b) Manager-level excise tax. Section 4965(a)(2) imposes a manager-level excise tax on "entity managers," as defined in section 4965(d), of tax-exempt entities who approve the entity as a party (or otherwise cause the entity to be a party) to a prohibited tax shelter transaction and know or have reason to know, at the time the tax-exempt entity enters into the transaction, that the transaction is a prohibited tax shelter transaction. See §53.4965-5 for the definition of entity manager and the meaning of "approving or otherwise causing," and §53.4965-6 for the discussion of "knowing or having reason to know." See §53.4965-7(b) for the discussion of the manager-level excise tax under section 4965(a)(2).

(c) Effective/applicability dates. See §53.4965-9 for the discussion of the relevant effective dates.



§53.4965-2 Covered tax-exempt entities

(a) In general. Under section 4965(c), the term "tax-exempt entity" refers to entities that are described in sections 501(c), 501(d), or 170(c) (other than the United States), Indian tribal governments (within the meaning of section 7701(a)(40)), and tax-qualified pension plans, individual retirement arrangements and similar tax-favored savings arrangements that are described in sections 4979(e)(1), (2) or (3), 529, 457(b), or 4973(a). The tax-exempt entities referred to in section 4965(c) are divided into two broad categories, non-plan entities and plan entities.

(b) Non-plan entities. Non-plan entities are --

(1) Entities described in section 501(c);

(2) Religious or apostolic associations or corporations described in section 501(d);

(3) Entities described in section 170(c), including states, possessions of the United States, the District of Columbia, political subdivisions of states and political subdivisions of possessions of the United States (but not including the United States); and

(4) Indian tribal governments within the meaning of section 7701(a)(40).

(c) Plan entities. Plan entities are --

(1) Entities described in section 4979(e)(1) (qualified plans under section 401(a), including qualified cash or deferred arrangements under section 401(k) (including a section 401(k) plan that allows designated Roth contributions));

(2) Entities described in section 4979(e)(2) (annuity plans described in section 403(a));

(3) Entities described in section 4979(e)(3) (annuity contracts described in section 403(b), including a section 403(b) arrangement that allows Roth contributions);

(4) Qualified tuition programs described in section 529;

(5) Eligible deferred compensation plans under section 457(b) that are maintained by a governmental employer as defined in section 457(e)(1)(A);

(6) Arrangements described in section 4973(a) which include --

(i) Individual retirement plans defined in sections 408(a) and (b), including --

(A) Simplified employee pensions (SEPs) under section 408(k);

(B) Simple individual retirement accounts (SIMPLEs) under section 408(p);

(C) Deemed individual retirement accounts or annuities (IRAs) qualified under a qualified plan (deemed IRAs) under section 408(q)); and

(D) Roth IRAs under section 408A.

(ii) Arrangements described in section 220(d) (Archer Medical Savings Accounts (MSAs));

(iii) Arrangements described in section 403(b)(7) (custodial accounts treated as annuity contracts);

(iv) Arrangements described in section 530 (Coverdell education savings accounts); and

(v) Arrangements described in section 223(d) (health savings accounts (HSAs)).



§53.4965-3 Prohibited tax shelter transactions.

(a) In general. Under section 4965(e), the term prohibited tax shelter transaction means --

(1) Listed transactions within the meaning of section 6707A(c)(2), including subsequently listed transactions described in paragraph (b) of this section; and

(2) Prohibited reportable transactions, which consist of the following reportable transactions within the meaning of section 6707A(c)(1) --

(i) Confidential transactions, as described in §1.6011-4(b)(3) of this chapter; or

(ii) Transactions with contractual protection, as described in §1.6011-4(b)(4) of this chapter.

(b) Subsequently listed transactions. A subsequently listed transaction for purposes of section 4965 is a transaction that is identified by the Secretary as a listed transaction after the tax-exempt entity has entered into the transaction and that was not a prohibited reportable transaction (within the meaning of section 4965(e)(1)(C) and paragraph (a)(2) of this section) at the time the entity entered into the transaction.

(c) Cross-reference. The determination of whether a transaction is a listed transaction or a prohibited reportable transaction for section 4965 purposes shall be made under the law applicable to section 6707A(c)(1) and (c)(2).



§53.4965-4 Definition of tax-exempt party to a prohibited tax shelter transaction.

(a) In general. For purposes of sections 4965 and 6033(a)(2), a tax-exempt entity is a party to a prohibited tax shelter transaction if the entity --

(1) Facilitates a prohibited tax shelter transaction by reason of its tax-exempt, tax indifferent or tax-favored status;

(2) Enters into a listed transaction and the tax-exempt entity's tax return (whether an original or an amended return) reflects a reduction or elimination of its liability for applicable Federal employment, excise or unrelated business income taxes that is derived directly or indirectly from tax consequences or tax strategy described in the published guidance that lists the transaction; or

(3) Is identified in published guidance, by type, class or role, as a party to a prohibited tax shelter transaction.

(b) Published guidance may identify which tax-exempt entities, by type, class or role, will not be treated as a party to a prohibited tax shelter transaction for purposes of sections 4965 and 6033(a)(2).

(c) Examples. The following examples illustrate the principles of this section:

Example 1. A tax-exempt entity enters into a transaction (Transaction A) with an S corporation. Transaction A is the same as or substantially similar to the transaction identified by the Secretary as a listed transaction in Notice 2004-30 (2004-1 CB 828). The tax-exempt entity's role in Transaction A is similar to the role of the tax-exempt party, as described in Notice 2004-30. Under the terms of the transaction, as described in Notice 2004-30, the tax-exempt entity receives the S corporation stock and, due to the tax-exempt entity's tax-exempt status, aids the S corporation and its shareholders in avoiding taxable income. The tax-exempt entity facilitates Transaction A by reason of its tax-exempt, tax indifferent or tax-favored status. Accordingly, the tax-exempt entity is a party to Transaction A for purposes of sections 4965 and 6033(a)(2). See §601.601(d)(2)(ii)(b) of this chapter.

Example 2. A tax-exempt entity is a partner in a partnership. The partnership has a number of other taxable and tax-exempt partners. The tax-exempt entity does not control the partnership. The partnership enters into a number of transactions, including a transaction (Transaction B) which is the same as or substantially similar to the transaction identified by the Secretary as a listed transaction in Notice 2002-35 (2002-1 CB 992) (as clarified and modified by Notice 2006-16 (2006-9 IRB 538). The partnership's role in Transaction B is similar to the role of T, as described in Notice 2002-35, that is, the role of the taxpayer claiming the tax benefits from the transaction. The tax-exempt entity's tax returns do not reflect a reduction or elimination of its liability for applicable Federal taxes as a result of Transaction B. The tax and economic consequences from Transaction B to the other partners are not dependent on the tax-exempt entity's tax-exempt, tax indifferent or tax-favored status. Accordingly, the tax-exempt entity does not facilitate Transaction B by reason of its tax-exempt, tax indifferent or tax-favored status. Because the tax-exempt entity's tax returns do not reflect a reduction or elimination of its liability for applicable Federal taxes that is derived directly or indirectly from tax consequences or tax strategy described in the published guidance that lists the transaction, the tax-exempt entity is not a party to Transaction B by reason of paragraph (a)(2) of this section. The tax-exempt entity also has not been identified, by type, class or role, as a party to a prohibited tax shelter transaction in published guidance. Therefore, the tax-exempt entity is not a party to Transaction B for purposes of sections 4965 and 6033(a)(2). See §601.601(d)(2)(ii)(b) of this chapter.

(d) Effective/applicability dates. See §53.4965-9 for the discussion of the relevant applicability dates.



§53.4965-5 Entity managers and related definitions.

(a) Entity manager of a non-plan entity --(1) In general. Under section 4965(d)(1), an entity manager of a non-plan entity is --

(i) A person with the authority or responsibility similar to that exercised by an officer, director, or trustee of an organization (that is, the non-plan entity); and

(ii) With respect to any act, the person who has final authority or responsibility (either individually or as a member of a collective body) with respect to such act.

(2) Definition of officer. For purposes of paragraph (a)(1)(i) of this section, a person is considered to be an officer of the non-plan entity (or to have similar authority or responsibility) if the person --

(i) Is specifically designated as such under the certificate of incorporation, by-laws, or other constitutive documents of the non-plan entity; or

(ii) Regularly exercises general authority to make administrative or policy decisions on behalf of the non-plan entity.

(3) Exception for acts requiring approval by a superior. With respect to any act, any person is not described in paragraph (a)(2)(ii) of this section if the person has authority merely to recommend particular administrative or policy decisions, but not to implement them without approval of a superior.

(4) Delegation of authority. A person is an entity manager of a non-plan entity within the meaning of paragraph (a)(1)(ii) of this section if, with respect to any prohibited tax shelter transaction, such person has been delegated final authority or responsibility with respect to such transaction (including by transaction type or dollar amount) by a person described in paragraph (a)(1)(i) of this section or the governing board of the entity. For example, an investment manager is an entity manager with respect to a prohibited tax shelter transaction if the non-plan entity's governing body delegated to the investment manager the final authority to make certain investment decisions and, in the exercise of that authority, the manager committed the entity to the transaction. To be considered an entity manager of a non-plan entity within the meaning of paragraph (a)(1)(ii) of this section, a person need not be an employee of the entity. A person is not described in paragraph (a)(1)(ii) of this section if the person is merely implementing a decision made by a superior.

(b) Entity manager of a plan entity --(1) In general. Under section 4965(d)(2), an entity manager of a plan entity is the person who approves or otherwise causes the entity to be a party to the prohibited tax shelter transaction.

(2) Special rule for plan participants and beneficiaries who have investment elections --(i) Fully self-directed plans or arrangements. In the case of a fully self-directed qualified plan, IRA, or other savings arrangement (including the case where a plan participant or beneficiary is given a list of prohibited investments, such as collectibles), if the plan participant or beneficiary selected a certain investment and, therefore, approved the plan entity to become a party to a prohibited tax shelter transaction, the plan participant or the beneficiary is an entity manager.

(ii) Plans or arrangements with limited investment options. In the case of a qualified plan, IRA, or other savings arrangement where a plan participant or beneficiary is offered a limited number of investment options from which to choose, the person responsible for determining the pre-selected investment options is an entity manager and the plan participant or the beneficiary generally is not an entity manager.

(c) Meaning of "approves or otherwise causes" --(1) In general. A person is treated as approving or otherwise causing a tax-exempt entity to become a party to a prohibited tax shelter transaction if the person has the authority to commit the entity to the transaction, either individually or as a member of a collective body, and the person exercises that authority.

(2) Collective bodies. If a person shares the authority described in paragraph (c)(1) of this section as a member of a collective body (for example, board of trustees or committee), the person will be considered to have exercised such authority if the person voted in favor of the entity becoming a party to the transaction. However, a member of the collective body will not be treated as having exercised the authority described in paragraph (c)(1) of this section if he or she voted against a resolution that constituted approval or an act that caused the tax-exempt entity to be a party to a prohibited tax shelter transaction, abstained from voting for such approval, or otherwise failed to vote in favor of such approval.

(3) Exceptions --(i) Successor in interest. If a tax-exempt entity that is a party to a prohibited tax shelter transaction is dissolved, liquidated, or merged into a successor entity, an entity manager of the successor entity will not, solely by reason of the reorganization, be treated as approving or otherwise causing the successor entity to become a party to a prohibited tax shelter transaction, provided that the reorganization of the tax-exempt entity does not result in a material change to the terms of the transaction. For purposes of this paragraph a material change includes an extension or renewal of the agreement (other than an extension or renewal that results from another party to the transaction unilaterally exercising an option granted by the agreement) or a more than incidental change to any payment under the agreement. A change for the sole purpose of substituting the successor entity for the original tax-exempt party is not a material change.

(ii) Exercise or nonexercise of options. Nonexercise of an option pursuant to a transaction involving the tax-exempt entity generally will not constitute an act of approving or causing the entity to be a party to the transaction. If, pursuant to a transaction involving the tax-exempt entity, the entity manager exercises an option (such as a repurchase option), the entity manager will not be subject to the entity manager-level tax if the exercise of the option does not result in the tax-exempt entity becoming a party to a second transaction that is a prohibited tax shelter transaction.

(4) Example. The following example illustrates the principles of paragraph (c)(3)(ii) of this section:

Example. In a sale-in, lease-out (SILO) transaction described in Notice 2005-13 (2005-9 IRB 630), X, which is a non-plan entity, has purported to sell property to Y, a taxable entity and lease it back for a term of years. At the end of the basic lease term, X has the option of "repurchasing" the property from Y for a predetermined purchase price, with funds that have been set aside at the inception of the transaction for that purpose. The entity manager, by deciding to exercise or not exercise the "repurchase" option is not approving or otherwise causing the non-plan entity to become a party to a second prohibited tax shelter transaction. See §601.601(d)(2)(ii)(b) of this chapter.

(5) Coordination with the reason-to-know standard. The determination that an entity manager approved or caused a tax-exempt entity to be a party to a prohibited tax shelter transaction, by itself, does not establish liability for the section 4965(a)(2) tax. For rules on determining whether an entity manager knew or had reason to know that the transaction was a prohibited tax shelter transaction, see §53.4965-6(b).

(d) Effective/applicability dates. See §53.4965-9 for the discussion of the relevant applicability dates.



§53.4965-6 Meaning of "knows or has reason to know".

(a) Attribution to the entity. An entity will be treated as knowing or having reason to know for section 4965 purposes if one or more of its entity managers knew or had reason to know that the transaction was a prohibited tax shelter transaction at the time the entity manager(s) approved the entity as (or otherwise caused the entity to be) a party to the transaction. The entity shall be attributed the knowledge or reason to know of any entity manager described in §53.4965-5(a)(1)(i) even if that entity manager does not approve the entity as (or otherwise cause the entity to be) a party to the transaction.

(b) Determining whether an entity manager knew or had reason to know --(1) In general. Whether an entity manager knew or had reason to know that a transaction is a prohibited tax shelter transaction is based on all facts and circumstances. In order for an entity manager to know or have reason to know that a transaction is a prohibited tax shelter transaction, the entity manager must have knowledge of sufficient facts that would lead a reasonable person to conclude that the transaction is a prohibited tax shelter transaction. An entity manager will be considered to have "reason to know" if a reasonable person in the entity manager's circumstances would conclude that the transaction was a prohibited tax shelter transaction based on all the facts reasonably available to the manager at the time of approving the entity as (or otherwise causing the entity to be) a party to the transaction. Factors that will be considered in determining whether a reasonable person in the entity manager's circumstances would conclude that the transaction was a prohibited tax shelter transaction include, but are not limited to --

(i) The presence of tax shelter indicia (see paragraph (b)(2) of this section);

(ii) Whether the entity manager received a disclosure statement prior to the consummation of the transaction indicating that the transaction may be a prohibited tax shelter transaction (see paragraph (b)(3) of this section); and

(iii) Whether the entity manager made appropriate inquiries into the transaction (see paragraph (b)(4) of this section).

(2) Tax-shelter indicia. The presence of indicia that a transaction is a tax shelter will be treated as an indication that the entity manager knew or had reason to know that the transaction was a prohibited tax shelter transaction. Tax shelter indicia include but are not limited to --

(i) The transaction is extraordinary for the entity considering prior investment activity;

(ii) The transaction promises an economic return for the organization that is exceptional considering the amount invested by, the participation of, or the absence of risk to the organization; or

(iii) The transaction is of significant size relative to the receipts of the entity.

(3) Effect of disclosure statements. Receipt by an entity manager of a statement, including a statement described in section 6011(g), in advance of a transaction that the transaction may be a prohibited tax shelter transaction (or a statement that a partnership, hedge fund or other investment conduit may engage in a prohibited tax shelter transaction in the future) is a factor relevant in the determination of whether the entity manager knew or had reason to know that the transaction is a prohibited transaction. However, an entity manager will not be treated as knowing or having reason to know that the transaction was a prohibited tax shelter transaction solely because the entity manager receives such a disclosure.

(4) Appropriate inquiries. What inquiries are appropriate will be determined from the facts and circumstances of each case. For example, if one or more tax shelter indicia are present or if an entity manager receives a disclosure statement described in paragraph (b)(3) of this section, an entity manager has a responsibility to inquire further whether the transaction is a prohibited tax shelter transaction.

(c) Reliance on professional advice --(1) In general. An entity manager is not required to obtain the advice of a professional tax advisor to establish that the entity manager made appropriate inquiries. Moreover, not seeking professional advice, by itself, shall not give rise to an inference that the entity manager had reason to know that a transaction is a prohibited tax shelter transaction.

(2) Reliance on written opinion of professional tax advisor. An entity manager may establish that he or she did not have a reason to know that a transaction was a prohibited tax shelter transaction at the time the tax-exempt entity entered into the transaction if the entity manager reasonably, and in good faith, relied on the written opinion of a professional tax advisor. Reliance on the written opinion of a professional tax advisor establishes that the entity manager did not have reason to know if, taking into account all the facts and circumstances, the reliance was reasonable and the entity manager acted in good faith. For example, the entity manager's education, sophistication, and business experience will be relevant in determining whether the reliance was reasonable and made in good faith. In no event will an entity manager be considered to have reasonably relied in good faith on an opinion unless the requirements of this paragraph (c)(2) are satisfied. The fact that these requirements are satisfied, however, will not necessarily establish that the entity manager reasonably relied on the opinion in good faith. For example, reliance may not be reasonable or in good faith if the entity manager knew, or reasonably should have known, that the advisor lacked knowledge in the relevant aspects of Federal tax law.

(i) All facts and circumstances considered. The advice must be based upon all pertinent facts and circumstances and the law as it relates to those facts and circumstances. The requirements of this paragraph (c)(2) are not satisfied if the entity manager fails to disclose a fact that it knows, or reasonably should know, is relevant to determining whether the transaction is a prohibited tax shelter transaction.

(ii) No unreasonable assumptions. The advice must not be based on unreasonable factual or legal assumptions (including assumptions as to future events) and must not unreasonably rely on the representations, statements, findings, or agreements of the entity manager or any other person (including another party to the transaction or a material advisor within the meaning of sections 6111 and 6112).

(iii) "More likely than not" opinion. The written opinion of the professional tax advisor must apply the appropriate law to the facts and, based on this analysis, must conclude that the transaction was not a prohibited tax shelter transaction at a "more likely than not" level of certainty at the time the entity manager approved the entity (or otherwise caused the entity) to be a party to the transaction.

(3) Special rule. An entity manager's reliance on a written opinion of a professional tax advisor will not be considered reasonable if the advisor is, or is related to a person who is, a material advisor with respect to the transaction within the meaning of sections 6111 and 6112.

(d) Subsequently listed transactions. An entity manager will not be treated as knowing or having reason to know that a transaction (other than a prohibited reportable transaction as defined in section 4965(e)(1)(C) and §53.4965-3(a)(2)) is a prohibited tax shelter transaction if the entity enters into the transaction before the date on which the transaction is identified by the Secretary as a listed transaction.

(e) Effective/applicability dates. See §53.4965-9 for the discussion of the relevant applicability dates.



§53.4965-7 Taxes on prohibited tax shelter transactions.

(a) Entity-level taxes --(1) In general. Entity-level excise taxes apply to non-plan entities (as defined in §53.4965-2(b)) that are parties to prohibited tax shelter transactions.

(i) Prohibited tax shelter transactions other than subsequently listed transactions --(A) Amount of tax if the entity did not know and did not have reason to know. If the tax-exempt entity did not know and did not have reason to know that the transaction was a prohibited tax shelter transaction at the time the entity entered into the transaction, the tax is the highest rate of tax under section 11 multiplied by the greater of --

(1) The entity's net income with respect to the prohibited tax shelter transaction (after taking into account any tax imposed by Subtitle D, other than by this section, with respect to such transaction) for the taxable year; or

(2) 75 percent of the proceeds received by the entity for the taxable year that are attributable to such transaction.

(B) Amount of tax if the entity knew or had reason to know. If the tax-exempt entity knew or had reason to know that the transaction was a prohibited tax shelter transaction at the time the entity entered into the transaction, the tax is the greater of --

(1) 100 percent of the entity's net income with respect to the transaction (after taking into account any tax imposed by Subtitle D, other than by this section, with respect to such transaction) for the taxable year; or

(2) 75 percent of the proceeds received by the entity for the taxable year that are attributable to such transaction.

(ii) Subsequently listed transactions --(A) In general. In the case of a subsequently listed transaction (as defined in section 4965(e)(2) and §53.4965-3(b)), the tax-exempt entity's income and proceeds attributable to the transaction are allocated between the period before the transaction became listed and the period beginning on the date the transaction became listed. See §53.4965-8 for the standard for allocating net income or proceeds to various periods. The tax for each taxable year is the highest rate of tax under section 11 multiplied by the greater of --

(1) The entity's net income with respect to the subsequently listed transaction (after taking into account any tax imposed by Subtitle D, other than by this section, with respect to such transaction) for the taxable year that is allocable to the period beginning on the later of the date such transaction is identified by the Secretary as a listed transaction or the first day of the taxable year; or

(2) 75 percent of the proceeds received by the entity for the taxable year that are attributable to such transaction and allocable to the period beginning on the later of the date such transaction is identified by the Secretary as a listed transaction or the first day of the taxable year.

(B) No increase in tax. The 100 percent tax under section 4965(b)(1)(B) and §53.4965-7(a)(1)(i)(B) does not apply to any subsequently listed transaction (as defined in section 4965(e)(2) and §53.4965-3(b)) entered into by a tax-exempt entity before the date on which the transaction is identified by the Secretary as a listed transaction.

(2) Taxable year. The excise tax imposed under section 4965(a)(1) applies for the taxable year in which the entity becomes a party to the prohibited tax shelter transaction and any subsequent taxable year for which the entity has net income or proceeds attributable to the transaction. A taxable year for tax-exempt entities is the calendar year or fiscal year, as applicable, depending on the basis on which the tax-exempt entity keeps its books for Federal income tax purposes. If a tax-exempt entity has not established a taxable year for Federal income tax purposes, the entity's taxable year for the purpose of determining the amount and timing of net income and proceeds attributable to a prohibited tax shelter transaction will be deemed to be the annual period the entity uses in keeping its books and records.

(b) Manager-level taxes --(1) Amount of tax. If any entity manager approved or otherwise caused the tax-exempt entity to become a party to a prohibited tax shelter transaction and knew or had reason to know that the transaction was a prohibited tax shelter transaction, such entity manager is liable for the $20,000 tax. See §53.4965-5(d) for the meaning of approved or otherwise caused. See §53.4965-6 for the meaning of knew or had reason to know.

(2) Timing of the entity manager tax. If a tax-exempt entity enters into a prohibited tax shelter transaction during a taxable year of an entity manager, then the entity manager that approved or otherwise caused the tax-exempt entity to become a party to the transaction is liable for the entity manager tax for that taxable year if the entity manager knew or had reason to know that the transaction was a prohibited tax shelter transaction.

(3) Example. The application of paragraph (b)(2) of this section is illustrated by the following example:

Example. The entity manager's taxable year is the calendar year. On December 1, 2006, the entity manager approved or otherwise caused the tax-exempt entity to become a party to a transaction that the entity manager knew or had reason to know was a prohibited tax shelter transaction. The tax-exempt entity entered into the transaction on January 31, 2007. The entity manager is liable for the entity manager level tax for the entity manager's 2007 taxable year, during which the tax-exempt entity entered into the prohibited tax shelter transaction.

(4) Separate liability. If more than one entity manager approved or caused a tax-exempt entity to become a party to a prohibited tax shelter transaction while knowing (or having reason to know) that the transaction was a prohibited tax shelter transaction, then each such entity manager is separately (that is, not jointly and severally) liable for the entity manager-level tax with respect to the transaction.

(c) Effective dates. See §53.4965-9 for the discussion of the relevant effective dates.



§53.4965-8 Definition of net income and proceeds and standard for allocating net income or proceeds to various periods.

(a) In general. For purposes of section 4965(a), the amount and the timing of the net income and proceeds attributable to the prohibited tax shelter transaction will be computed in a manner consistent with the substance of the transaction. In determining the substance of listed transactions, the IRS will look to, among other items, the listing guidance and any subsequent guidance published in the Internal Revenue Bulletin relating to the transaction.

(b) Definition of net income and proceeds --(1) Net income. A tax-exempt entity's net income attributable to a prohibited tax shelter transaction is its gross income derived from the transaction reduced by those deductions that are attributable to the transaction and that would be allowed by chapter 1 of the Internal Revenue Code if the tax-exempt entity were treated as a taxable entity for this purpose, and further reduced by taxes imposed by Subtitle D, other than by this section, with respect to the transaction.

(2) Proceeds --(i) Tax-exempt entities that facilitate the transaction by reason of their tax-exempt, tax indifferent or tax-favored status. Solely for purposes of section 4965, in the case of a tax-exempt entity that is a party to the transaction by reason of §53.4965-4(a)(1) of this chapter, the term proceeds means the gross amount of the tax-exempt entity's consideration for facilitating the transaction, not reduced for any costs or expenses attributable to the transaction. Published guidance with respect to a particular prohibited tax shelter transaction may designate additional amounts as proceeds from the transaction for section 4965 purposes.

(ii) Tax-exempt entities that enter into transactions to reduce or eliminate their liability for applicable Federal taxes. For purposes of section 4965, in the case of a tax-exempt entity that is a party to the transaction by reason of §53.4965-4(a)(2) of this chapter, the term proceeds means tax savings purportedly generated by the transaction and claimed by the tax-exempt entity on its tax return with respect to the tax year. Published guidance with respect to a particular prohibited tax shelter transaction may designate additional amounts as proceeds from the transaction for section 4965 purposes.

(iii) Treatment of gifts and contributions. To the extent not otherwise included in the definition of proceeds in paragraphs (b)(2)(i) and (ii) of this section, any amount that is a gift or a contribution to a tax-exempt entity and is attributable to a prohibited tax shelter transaction will be treated as proceeds for section 4965 purposes, unreduced by any associated expenses.

(c) Allocation of net income and proceeds --(1) In general. For purposes of section 4965(a), the net income and proceeds attributable to a prohibited tax shelter transaction must be allocated in a manner consistent with the tax-exempt entity's established method of accounting for Federal income tax purposes. If the tax-exempt entity has not established a method of accounting for Federal income tax purposes, solely for purposes of section 4965(a) the tax-exempt entity must use the cash receipts and disbursements method of accounting (cash method) provided for in section 446 of the Internal Revenue Code to determine the amount and timing of net income and proceeds attributable to a prohibited tax shelter transaction.

(2) Special rule. If a tax-exempt entity has established a method of accounting other than the cash method, the tax-exempt entity may nevertheless use the cash method of accounting to determine the amount of the net income and proceeds --

(i) Attributable to a prohibited tax shelter transaction entered into prior to the effective date of section 4965(a) tax and allocable to pre- and post-effective date periods; or

(ii) Attributable to a subsequently listed transaction and allocable to pre- and post-listing periods.

(d) Transition year rules. In the case of the taxable year that includes August 16, 2006 (the transition year), the IRS will treat the period beginning on the first day of the transition year and ending on August 15, 2006, and the period beginning on August 16, 2006, and ending on the last day of the transition year as short taxable years. This treatment is solely for purposes of allocating net income or proceeds under section 4965. The tax-exempt entity continues to file tax returns for the full taxable year, does not file tax returns with respect to these deemed short taxable years and does not otherwise take the short taxable years into account for Federal tax purposes. Accordingly, the net income or proceeds that are properly allocated to the transition year in accordance with this section will be treated as allocable to the period --

(1) Ending on or before August 15, 2006 (and accordingly not subject to tax under section 4965(a)) to the extent such net income or proceeds would have been properly taken into account in accordance with this section by the tax-exempt entity in the deemed short year ending on August 15, 2006; and

(2) Beginning after August 15, 2006 (and accordingly subject to tax under section 4965(a)) to the extent such income or proceeds would have been properly taken into account in accordance with this section by the tax-exempt entity in the short year beginning August 16, 2006.

(e) Allocation to pre- and post-listing periods. If a transaction (other than a prohibited reportable transaction (as defined in section 4965(e)(1)(C) and §53.4965-3(a)(2)) to which the tax-exempt entity is a party is subsequently identified in published guidance as a listed transaction during a taxable year of the entity (the listing year) in which it has net income or proceeds attributable to the transaction, the net income or proceeds are allocated between the pre- and post-listing periods. The IRS will treat the period beginning on the first day of the listing year and ending on the day immediately preceding the date of the listing, and the period beginning on the date of the listing and ending on the last day of the listing year as short taxable years. This treatment is solely for purposes of allocating net income or proceeds under section 4965. The tax-exempt entity continues to file tax returns for the full taxable year, does not file tax returns with respect to these deemed short taxable years and does not otherwise take the short taxable years into account for Federal tax purposes. Accordingly, the net income or proceeds that are properly allocated to the listing year in accordance with this section will be treated as allocable to the period --

(1) Ending before the date of the listing (and accordingly not subject to tax under section 4965(a)) to the extent such net income or proceeds would have been properly taken into account in accordance with this section by the tax-exempt entity in the deemed short year ending on the day immediately preceding the date of the listing; and

(2) Beginning on the date of the listing (and accordingly subject to tax under section 4965(a)) to the extent such income or proceeds would have been properly taken into account in accordance with this section by the tax-exempt entity in the short year beginning on the date of the listing.

(f) Examples. The following examples illustrate the allocation rules of this section:

Example 1. (i) In 1999, X, a calendar year non-plan entity using the cash method of accounting, entered into a lease-in/lease-out transaction (LILO) substantially similar to the transaction described in Notice 2000-15 (2000-1 CB 826) (describing Rev. Rul. 99-14 (1999-1 CB 835), superseded by Rev. Rul. 2002-69 (2002-2 CB 760)). In 1999, X purported to lease property to Y pursuant to a "head lease," and Y purported to lease the property back to X pursuant to a "sublease" of a shorter term. In form, X received $268M as an advance payment of head lease rent. Of this amount, $200M had been, in form, financed by a nonrecourse loan obtained by Y. X deposited the $200M with a "debt payment undertaker." This served to defease both a portion of X's rent obligation under its sublease and Y's repayment obligation under the nonrecourse loan. Of the remainder of the $268M advance head lease rent payment, X deposited $54M with an "equity payment undertaker." This served to defease the remainder of X's rent obligation under the sublease as well as the exercise price of X's end-of-sublease term purchase option. This amount inures to the benefit of Y and enables Y to recover its investment in the transaction and a return on that investment. In substance, the $54M is a loan from Y to X. X retained the remaining $14M of the advance head lease rent payment. In substance, this represents a fee for X's participation in the transaction. See §601.601(d)(2)(ii)(b) of this chapter.

(ii) According to the substance of the transaction, the head lease, sublease and nonrecourse debt will be ignored for Federal income tax purposes. Therefore, any net income or proceeds resulting from these elements of the transaction will not be considered net income or proceeds attributable to the LILO transaction for purposes of section 4965(a). The $54M deemed loan from Y to X and the $14M fee are not ignored for Federal income tax purposes.

(iii) Under X's established cash basis method of accounting, any net income received in 1999 and attributable to the LILO transaction is allocated to X's December 31, 1999, tax year for purposes of section 4965. The $14M fee received in 1999, and which constitutes proceeds of the transaction, is likewise allocated to that tax year. Because the 1999 tax year is before the effective date of the section 4965 tax, X will not be subject to any excise tax under section 4965 for the amounts received in 1999.

(iv) Any earnings on the amount deposited with the equity payment undertaker that constitute gross income to X will be reduced by X's original issue discount deductions with respect to the deemed loan from Y, in determining X's net income from the transaction.

Example 2. B, a non-plan entity using the cash method of accounting, has an annual accounting period that ends on December 31, 2006. B entered into a prohibited tax shelter transaction on March 15, 2006. On that date, B received a payment of $600,000 as a fee for its involvement in the transaction. B received no other proceeds or income attributable to this transaction in 2006. Under B's method of accounting, the payment received by B on March 15, 2006, is taken into account in the deemed short year ending on August 15, 2006. Accordingly, solely for purposes of section 4965, the payment is treated as allocable solely to the period ending on or before August 15, 2006, and is not subject to the excise tax imposed by section 4965(a).

Example 3. The facts are the same as in Example 2, except that B received an additional payment of $400,000 on September 30, 2006. Under B's method of accounting, the payment received by B on September 30, 2006, is taken into account in the deemed short year beginning on August 16, 2006. Accordingly, solely for purposes of section 4965, the $400,000 payment is treated as allocable to the period beginning after August 15, 2006, and is subject to the excise tax imposed by section 4965(a).

Example 4. C, a non-plan entity using the cash method of accounting, has an annual accounting period that ends on December 31. C entered into a prohibited tax shelter transaction on May 1, 2005. On March 15, 2007, C received a payment of $580,000 attributable to the transaction. On June 1, 2007, the transaction is identified by the IRS in published guidance as a listed transaction. On June 15, 2007, C received an additional payment of $400,000 attributable to the transaction. Under C's method of accounting, the payments received on March 15, 2007, and June 15, 2007, are taken into account in 2007. The IRS will treat the period beginning on January 1, 2007, and ending on May 31, 2007, and the period beginning on June 1, 2007, and ending on December 31, 2007, as short taxable years. The payment received by C on March 15, 2007, is taken into account in the deemed short year ending on May 31, 2007. Accordingly, solely for purposes of section 4965, the payment is treated as allocable solely to the pre-listing period, and is not subject to the excise tax imposed by section 4965(a). The payment received by C on June 15, 2007, is taken into account in the deemed short year beginning on June 1, 2007. Accordingly, solely for purposes of section 4965, the payment is treated as allocable to the post-listing period, and is subject to the excise tax imposed by section 4965(a).

(g) Effective/applicability dates. See §53.4965-9 for the discussion of the relevant applicability dates.



§53.4965-9 Effective/applicability dates.

(a) In general. The taxes under section 4965(a) and §53.4965-7 are effective for taxable years ending after May 17, 2006, with respect to transactions entered into before, on or after that date, except that no tax under section 4965(a) applies with respect to income or proceeds that are properly allocable to any period ending on or before August 15, 2006.

(b) Applicability of the regulations. Except as provided in paragraph (c) of this section, upon publication of final regulations, §§53.4965-1 through 53.4965-8 of this chapter will apply to taxable years ending after July 6, 2007. A tax-exempt entity may rely on the provisions of §§53.4965-1 through 53.4965-8 for taxable years ending on or before July 6, 2007.

(c) Effective date with respect to certain knowing transactions --(1) Entity-level tax. The 100 percent tax under section 4965(b)(1)(B) and §53.4965-7(a)(1)(i)(B) does not apply to prohibited tax shelter transactions entered into by a tax-exempt entity on or before May 17, 2006.

(2) Manager-level tax. The IRS will not assert that an entity manager who approved or caused a tax-exempt entity to become a party to a prohibited tax shelter transaction is liable for the entity manager tax under section 4965(b)(2) and §53.4965-7(b)(1) with respect to the transaction if the tax-exempt entity entered into such transaction prior to May 17, 2006.

Par. 5. In §53.6071-1, paragraphs (g) and (h) are added to read as follows:



§53.6071-1 Time for filing returns.

* * * * *

(g) [The text of the proposed amendment to §53.6071-1(g) is the same as the text of §53.6071-1T(g) published elsewhere in this issue of the Federal Register].

(h) [The text of the proposed amendment to §53.6071-1(h) is the same as the text of §53.6071-1T(h) published elsewhere in this issue of the Federal Register].



PART 54 --EXCISE TAXES, PENSIONS, REPORTING AND RECORDKEEPING REQUIREMENTS

Par. 6. The authority citation for part 54 continues to read, in part, as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 7. In §54.6011-1, paragraphs (c) and (d) are added to read as follows:



§54.6011-1 General requirement of return, statement or list.

* * * * *

(c) [The text of the proposed amendment to §54.6011-1(c) is the same as the text of §54.6011-1T(c) published elsewhere in this issue of the Federal Register].

(d) [The text of the proposed amendment to §54.6011-1(d) is the same as the text of §54.6011-1T(d) published elsewhere in this issue of the Federal Register].



PART 301 --PROCEDURE AND ADMINISTRATION

Par. 8. The authority citation for part 301 continues to read, part, as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 9. Section 301.6011(g)-1 is added to read as follows:



§301.6011(g)-1 Disclosure by taxable party to the tax-exempt entity.

(a) Requirement of disclosure --(1) In general. Except as provided in paragraph (d)(2) of this section, any taxable party (as defined in paragraph (c) of this section) to a prohibited tax shelter transaction (as defined in section 4965(e) and §53.4965-3 of this chapter) must disclose by statement to each tax-exempt entity (as defined in section 4965(c) and §53.4965-2 of this chapter) that the taxable party knows or has reason to know is a party to such transaction (as defined in paragraph (b) of this section) that the transaction is a prohibited tax shelter transaction.

(2) Determining whether a taxable party knows or has reason to know. Whether a taxable party knows or has reason to know that a tax-exempt entity is a party to a prohibited tax shelter transaction is based on all the facts and circumstances. If the taxable party knows or has reason to know that a prohibited tax shelter transaction involves a tax-exempt, tax indifferent or tax-favored entity, relevant factors for determining whether the taxable party knows or has reason to know that a specific tax-exempt entity is a party to the transaction include --

(i) The extent of the efforts made to determine whether a tax-exempt entity is facilitating the transaction by reason of its tax-exempt, tax-indifferent or tax-favored status (or is identified in published guidance, by type, class or role, as a party to the transaction); and

(ii) If a tax-exempt entity is facilitating the transaction by reason of its tax-exempt, tax-indifferent or tax-favored status (or is identified in published guidance, by type, class or role, as a party to the transaction), the extent of the efforts made to determine the identity of the tax-exempt entity.

(b) Definition of tax-exempt party to a prohibited tax shelter transaction --(1) In general. For purposes of section 6011(g), a tax-exempt entity is a party to a prohibited tax shelter transaction if the entity --

(i) Facilitates a prohibited tax shelter transaction by reason of its tax-exempt, tax indifferent or tax-favored status; or

(ii) Is identified in published guidance, by type, class or role, as a party to a prohibited tax shelter transaction.

(2) Published guidance may identify which tax-exempt entities, by type, class or role, will not be treated as a party to a prohibited tax shelter transaction for purposes of section 6011(g).

(c) Definition of taxable party --(1) In general. For purposes of this section, the term taxable party means --

(i) A person who has entered into and participates or expects to participate in the transaction under §§1.6011-4(c)(3)(i)(A), (B), or (C), 20.6011-4, 25.6011-4, 31.6011-4, 53.6011-4, 54.6011-4, or 56.6011-4 of this chapter; or

(ii) A person who is designated as a taxable party by the Secretary in published guidance.

(2) Special rules --(i) Certain listed transactions. If a transaction that was otherwise not a prohibited tax shelter transaction becomes a listed transaction after the filing of a person's tax return (including an amended return) reflecting either tax consequences or a tax strategy described in the published guidance listing the transaction (or a tax benefit derived from tax consequences or a tax strategy described in the published guidance listing the transaction), the person is a taxable party beginning on the date the transaction is described as a listed transaction in published guidance.

(ii) Persons designated as non-parties. Published guidance may identify which persons, by type, class or role, will not be treated as a party to a prohibited tax shelter transaction for purposes of section 6011(g).

(d) Time for providing disclosure statement --(1) In general. A taxable party to a prohibited tax shelter transaction must make the disclosure required by this section to each tax-exempt entity that the taxable party knows or has reason to know is a party to the transaction within 60 days after the last to occur of --

(i) The date the person becomes a taxable party to the transaction within the meaning of paragraph (c) of this section; or

(ii) The date the taxable party knows or has reason to know that the tax-exempt entity is a party to the transaction within the meaning of paragraph (b) of this section.

(2) Termination of a disclosure obligation. A person shall not be required to provide the disclosure otherwise required by this section if the person does not know or have reason to know that the tax-exempt entity is a party to the transaction within the meaning of paragraph (b) of this section on or before the first date on which the transaction is required to be disclosed by the person under §§1.6011-4, 20.6011-4, 25.6011-4, 31.6011-4, 53.6011-4, 54.6011-4, or 56.6011-4 of this chapter.

(3) Disclosure is not required with respect to any prohibited tax shelter transaction entered into by a tax-exempt entity on or before May 17, 2006.

(e) Frequency of disclosure. One disclosure statement is required per tax-exempt entity per transaction. See paragraph (h) of this section for rules relating to designation agreements.

(f) Form and content of disclosure statement. The statement disclosing to the tax-exempt entity that the transaction is a prohibited tax shelter transaction must be a written statement that --

(1) Identifies the type of prohibited tax shelter transaction (including the published guidance citation for a listed transaction); and

(2) States that the tax-exempt entity's involvement in the transaction may subject either it or its entity manager(s) or both to excise taxes under section 4965 and to disclosure obligations under section 6033(a) of the Internal Revenue Code.

(g) To whom disclosure is made. The disclosure statement must be provided --

(1) In the case of a non-plan entity as defined in §53.4965-2(b) of this chapter, to --

(i) Any entity manager of the tax-exempt entity with authority or responsibility similar to that exercised by an officer, director or trustee of an organization; or

(ii) If a person described in paragraph (g)(1)(i) of this section is not known, to the primary contact on the transaction.

(2) In the case of a plan entity as defined in §53.4965-2(c) of this chapter, including a fully self-directed qualified plan, IRA, or other savings arrangement, to any entity manager of the plan entity who approved or otherwise caused the entity to become a party to the prohibited tax shelter transaction.

(h) Designation agreements. If more than one taxable party is required to disclose a prohibited tax shelter transaction under this section, the taxable parties may designate by written agreement a single taxable party to disclose the transaction. The transaction must then be disclosed in accordance with this section. The designation of one taxable party to disclose the transaction does not relieve the other taxable parties of their obligation to disclose the transaction to a tax-exempt entity that is a party to the transaction in accordance with this section, if the designated taxable party fails to disclose the transaction to the tax-exempt entity in a timely manner.

(i) Penalty for failure to provide disclosure statement. See section 6707A for penalties applicable to failure to disclose a prohibited tax shelter transaction in accordance with this section.

(j) Effective/applicability date. This section will apply with respect to transactions entered into by a tax-exempt entity after May 17, 2006.

Par. 11. Section 301.6033-5 is added to read as follows:



§301.6033-5 Disclosure by tax-exempt entities that are parties to certain reportable transactions.

[The text of this section is the same as the text of §301.6033-5T published elsewhere in this issue of the Federal Register].

Kevin M. Brown,

Deputy Commissioner for Services and Enforcement.

Tax Help: Innocent Spouse New Form 8857 - IRSNews Release IR 2007-125 , July 6, 2007.

The IRS has released a revised Form 8857, Request for Innocent Spouse Relief. The new form will ask for more information early in the process, eliminating the need for follow-up letters requesting further information. The revisions will result in faster determinations and lower government costs. The new form will also be easier to understand and will educate taxpayers about the innocent spouse relief process. The revisions were based on suggestions from a team lead by the Office of Taxpayer Burden Reduction.

WASHINGTON --The Internal Revenue Service today announced a redesigned Form 8857, Request for Innocent Spouse Relief, that will help reduce follow up questions and reduce the burden on taxpayers.

The form will ask more questions initially, but collecting critical information early in the process will mean faster processing of the request. The new design will eliminate an estimated 30,000 follow-up letters annually. The result will be a reduced burden and quicker answer for taxpayers and less cost for the government.

The form was revised based on suggestions from an IRS process improvement team led by the Office of Taxpayer Burden Reduction. The new Form 8857 is available on the IRS.gov Web site.

When a taxpayer files a joint return, both spouses are jointly and individually responsible for the tax. Innocent Spouse relief provides an opportunity for a spouse to be relieved from the joint debt under certain circumstances. If one taxpayer believes that only his or her spouse or former spouse who should be responsible for the tax, the taxpayer can request relief from the tax liability.

The redesigned form also will be easier to understand and to complete and will help educate taxpayers about the process. Previously, the questionnaire was separate from the form. A line-by-line analysis also resulted in a reduction in the number of questions asked of taxpayers.
For married taxpayers, joint and several liability is the obligation that accompanies the privilege of filing a joint return. Thus, one spouse may be subject to joint liability for the omissions from income or erroneous deductions of the other spouse. In some cases, one spouse intentionally has not reported income or has claimed false deductions and concealed the return errors from the other spouse. The question then becomes whether the innocent spouse, who merely signed a joint return, should be held liable for errors on the return attributable to the actions of the other spouse. The answer is especially critical if the couple has divorced and the innocent spouse is the only source of collection for the unpaid tax. However, once a joint liability has been reduced to a closing agreement with the IRS, executed by both spouses, innocent spouse relief is unavailable (Reg. §1.6015-1(c)).

Code Sec. 6015 offers conditional relief to an innocent spouse. Enacted by the IRS Restructuring and Reform Act of 1998 (P.L. 105-206), it replaced Code Sec. 6013(e), which was enacted in 1971 (P.L. 91-679) in response to judicial pleas for statutory language enabling relief from liability in situations where the result of joint and several liability was particularly harsh and inequitable. The rules for granting relief were amended by the Tax Reform Act of 1984 (P.L. 98-369), but the crucial elements necessary to obtain relief under current law are similar in many respects to those contained in the original rule. For that reason, pre-1998 case law cannot be disregarded in attempting to interpret the scope of the present language of Code Sec. 6015.

A spouse may qualify for relief from joint and several liability under Code Sec. 6015 if:
(1) a joint return has been made for the tax year;

(2) on the return there is an understatement of tax attributable to erroneous items of one of the individuals filing the joint return;

(3) the innocent spouse establishes that in signing the return he or she did not know or have reason to know of the understatement;

(4) under all the facts and circumstances, it would be inequitable to hold the innocent spouse liable for the deficiency in tax resulting from the substantial understatement; and

(5) the other individual properly elects this relief within two years after the date the IRS has begun collection activities with respect to the individual making the election (see Code Sec. 6015(b) and Reg. §1.6015-2(a)).

Failing to establish any one of these requirements generally prevents a spouse from qualifying for relief. If a spouse qualifies, relief extends to the tax (including interest, penalties and other amounts) attributable to the understatement.

However, even if these requirements cannot be satisfied, a spouse has two other avenues of relief:
Elect separation of liability (Code Sec. 6015(c) or

Request equitable relief (Code Sec. 6015(f).

While a requesting spouse may qualify for relief under Code Sec. 6015(b) (innocent spouse relief), Code Sec. 6015(c) (separation of liability), or Code Sec. 6015(f) (equitable relief), relief under (b) and (c) must be specifically elected by the requesting spouse. If the requesting spouse only seeks equitable relief under Code Sec. 6015(f), the IRS cannot grant relief under either (b) or (c). However, if it is determined that the requesting spouse would be eligible for innocent spouse relief or separation of liability, then the IRS will contact the requesting spouse to see if he or she wishes to amend the claim for relief to affirmatively seek relief under Code Sec. 6015(b) or Code Sec. 6015(c). For purposes of determining timeliness of the claim, the amended claim will relate back to the time of the filing of the original claim (Reg. §1.6015-1(a)(2)).

Although Code Sec. 6015 continues many rules contained in former Code Sec. 6013(e), it also contains significant provisions designed to protect married taxpayers from the tax misdeeds of their spouses.

Innocent spouse relief is available on an apportioned basis.

The IRS has initiated a series of steps to protect victims of domestic violence who apply for innocent spouse relief. Taxpayers who are victims of domestic violence and fear that filing a claim for innocent spouse relief would result in retaliation should write the term "Potential Domestic Abuse Case" on the top of their Form 8857, Request for Innocent Spouse Relief. Taxpayers should also explain their concerns in a statement attached to the form, in addition to explaining why they should qualify for innocent spouse relief. These steps will alert the IRS as to the sensitivity of the taxpayer's situation and the information provided. IRS employees working innocent spouse cases will receive special training on how to properly handle abuse cases (Internal Revenue News Release IR-2001-23, February 20, 2001).

The IRS is authorized to provide equitable innocent spouse relief to spouses in community property states who do not file joint returns.

Divorced or widowed taxpayers, and married taxpayers who are legally separated or who have been living apart for at least one year are permitted to elect separate tax liability despite having filed a joint return.

The Tax Court is given jurisdiction to review denials of innocent spouse relief and separate liability elections and restrains IRS collection efforts while a Tax Court procedure is pending (see ¶35,192.028).

In order to make married taxpayers more aware of the legal consequences of filing a joint return, the IRS is required to notify joint filers of their joint and several liability and send any notice relating to a joint return separately to each individual on the return.

Effective date. The provisions in Code Sec. 6015 apply to any tax liability arising after July 22, 1998 and any tax liability arising on or before July 22, 1998 remaining unpaid as of that date (Act Sec. 3201(g)(1) of the IRS Restructuring and Reform Act of 1998 (P.L. 105-206)).

Election of innocent spouse treatment under the 1998 Act is available for any tax liabilities remaining unpaid as of July 22, 1998, even liabilities arising from a court decision. The Second Circuit vacated a Tax Court decision that had denied innocent spouse relief for a capital loss carryover deduction because the deduction was not grossly erroneous as required by former Code Sec. 6013(e)(2) (P. Friedman, CA-2, 98-2 USTC ¶50,717, at ¶35,192.67). The IRS conceded that the wife could elect "innocent spouse" treatment under Code Sec. 6015, because the liabilities remained unpaid.

The two-year period for electing innocent spouse relief or separate liability will not expire before the date which is two years after the date of the first collection activity after the date of enactment (Act Sec. 3201(g)(2) of P.L. 105-206).

A Taxpayer Advocate Directive addresses the abatement of any penalty accrued or assessed to taxpayers who had made claims for relief from liability under Code Secs. 6015 or Code Sec. 6013(e) prior to December 7, 1998, and whose cases were placed on suspension until procedures were provided for relief. The penalties that should be abated (1) are attributable to unpaid tax liability for which the taxpayers made a claim for relief and (2) apply to the period beginning the later of the date such claim for relief was made or July 22, 1998, and ending on March 31, 1999 (Taxpayer Advocate Directive 1998-1, March 19, 1999).

Tax Attorney: Unrelated business income for a Business League
ULTR 200717029, April 27, 2007.

ISSUES



Whether funds derived by T, a state-chartered credit union described in section 501(c)(14) of the Internal Revenue Code, from the following activities should be treated as unrelated business taxable income under section 511 of the Internal Revenue Code:



A. Sale of accidental death and dismemberment (AD&D) insurance



B. Sale of credit life and credit disability insurance



FACTS



Established in 1973, T is a state-chartered credit union, which is recognized as exempt from federal income tax under section 501(a) of the Internal Revenue Code ("Code") as an organization described in section 501(c)(14)(A).



T's board of directors, supervisory committee and loan committee are comprised entirely of elected members of the credit union who serve on a voluntary basis without compensation.



T's purposes as stated in its articles of incorporation are to promote thrift and provide low cost credit for its members.



T's activities include accepting deposits from and maintaining the accounts and savings of its members. These deposit accounts include savings or share accounts on which members earn periodic dividends credited to the accounts and share draft accounts, which are transaction accounts similar to bank checking accounts. T represents that its day-to-day business operations differ from conventional banking institutions in several ways. T states that it conducts its business to reflect its non-profit mutual structure. T makes loans to its members and states that many borrowers have low incomes and might not otherwise qualify for credit from conventional for-profit banks. T also represents that it regularly issues loans for very small amounts, such as loans for auto repairs, which are typically not made by for-profit banks. T indicates that it serves smaller communities than those served by for-profit banks. T also indicates that because of its mutual, non-profit operation, all members, not just those maintaining high minimum balances, are able to earn competitive rates on their deposits and pay low banking fees.



T represents that in order to maintain its financial viability and continue to satisfy its stated purposes of promoting thrift and providing a source of low cost credit, it has endeavored to become a full service financial institution. Consequently, T offers more than just demand deposits and loans. Currently, T makes AD&D insurance and credit life and credit disability insurance available to members. The different types of insurance are described in more detail below.



All of these insurance products are underwritten or otherwise provided by third-party insurance companies or other third-party vendors. In each case, T makes its members aware of the purpose and availability of these products, answers members' questions about the products or refers the member to the vendor for additional information, and with respect to some of the products, obtains and submits applications for coverage, premium payments and claims.



During the year at issue, T made the following types of loans: personal, mortgage, vehicle, and other secured and unsecured loans. The majority of the loans were personal, mortgage and vehicle. In 2000, a total of 100 loans were made and 26% of these loans were collateralized.



The default rate on these loans as a percentage of total loans for the year at issue was 1.21%.



T filed Form 990-T, Unrelated Business Income Tax Return for the year at issue. However, the amounts derived from the sale of the products discussed herein were not included as income derived from unrelated trade or business.



A. Sale of AD&D insurance



T offers AD&D insurance to its members. T states that providing this insurance is an activity that is beyond the scope of services directly associated with members' monetary deposits and loans made to members. Rather, the provision of AD&D insurance is a financial security activity that is offered to members. Under the terms of the AD&D policy, if the member has an accident that triggers a claim meeting the terms of the policy, then the member or the member's beneficiary receive specified insurance payments under the policy. In the case of accidental death, the member's beneficiary would receive payments; in the case of dismemberment, the member would receive payments.



T markets and sells AD&D insurance to its members under a policy issued by an independent insurance company. T makes its members aware of the purpose and availability of AD&D insurance, answers members' questions about the product, refers the member to the independent insurance company for additional information if it is needed, and obtains and submits applications for coverage, premium payment and claims. T receives an administrative allowance for AD&D insurance based on services provided by T. The reimbursement is 30% of gross premiums collected less the cost of basic insurance which was $0.18 per $2,000 of coverage per quarter.



No information was provided regarding number of policies sold during the year at issue, or the percentage of members that elected AD&D insurance coverage.



B. Sale of credit life and credit disability insurance



T offers its member/borrowers the opportunity to purchase credit life and credit disability insurance on certain loans. T is a party to, and beneficiary under, standard group credit life and credit disability policies with a third party insurance company. Under these policies, a member-borrower who obtains a loan (mortgages and other loans secured by real estate are often excluded) may, if he or she chooses, obtain credit life and credit disability insurance which pays the loan installments during the period of physical disability which impacts the borrower's employment. A loan officer informs each member-borrower of the availability of credit life and credit disability insurance coverage, and if the member-borrower elects to obtain the coverage, the premium charge is added to the borrower's loan balance. Obtaining the credit life and credit disability insurance coverage is never a condition of the member's receiving the loan.



As reflected in the group credit insurance policy and letter agreements, the credit disability coverage is standard coverage that provides that the insurer will repay the balance of a member's loan up to the policy limit. The maximum loan duration covered was not provided, however, only credit union members are eligible. T does not offer credit disability insurance in connection with overdraft protection, home equity loans, and real estate loans.



Under the terms of the policy, T is also reimbursed for its administrative expenses in connection with its performance of the prescribed duties as the policyholder. T's employees perform the following duties with respect to the credit disability insurance program:



--During the loan process, and as part of the loan transaction itself, explain the insurance program to member-borrowers;



--Process insurance applications;



--Collect and forward the premiums to the insurance company;



--Receive and forward claims (claims can be filed directly by the member-borrower) to the insurance company; and



--Answer member-borrowers' questions.



T's staff may recommend that the member opt to obtain coverage in situations where coverage appears beneficial based on the level of personal and family resources available for loan repayment in the event of disability.



The credit disability insurance coverage requires monthly premium payments. The charges are calculated by T and added to the member's loan balance. T remits the premiums it has collected, less its expenses as noted above, to the insurance company.



T receives a commission for its role in coverage issuance and policy administration that is based on a percentage of the premiums written for credit life and credit disability insurance. This percentage is based on an agreement between T and the insurance company at the time the insurance was purchased.



No information was provided regarding loans covered by credit life and credit disability insurance during the year at issue. Additionally, no information was provided regarding what percentage of these loans to total loans made by T during that year.



LAW



Section 501(a) of the Internal Revenue Code ("Code") provides, in part, that organizations described in section 501(c) are exempt from federal income tax.



Section 501(c)(14)(A) of the Code specifically exempts from federal income tax credit unions without capital stock organized and operated for mutual purposes and without profit.



Section 1.501(c)(14)-1 of the Income Tax Regulations ("regulations") provides, in part, that credit unions (other than Federal credit unions described in section 501(c)(1) of the Code) without capital stock, organized and operated for mutual purposes and without profit, are exempt from tax under section 501(a).



State-chartered credit unions were first acknowledged as exempt from federal income tax in a 1917 Opinion of the Attorney General. The Attorney General considered credit unions organized under the laws of the Commonwealth of ***** The Attorney General's opinion described the purposes of credit unions existing at that time:



[I]t is apparent that the purpose of these financial associations is to help people save and to assist those in need of financial help whose credit may not be established at the larger banks. In reality, they are fundamentally similar and supplemental to the existing agencies for promoting thrift, namely, the savings banks and cooperative banks, except on a much smaller scale.



The Attorney General's opinion also described some of the operations of credit unions --making loans in appropriate amounts to members, "on which a low rate of interest is charged," and that "[p]rompt payment of obligations is a fundamental requirement..." The opinion described in detail the procedures by which members' savings were held by the credit union, and how the members earned interest on their deposits. The opinion also pointed to the democratic character of the governance of these early credit unions by their members: "At the annual meeting of the association each member (shareholder and depositor) has but one vote..."



After review of the features and operations of these early credit unions, the Attorney General's opinion held that state-chartered credit unions would be exempt from federal income tax. See 31 U.S. Op. Atty. Gen. 176 (1917).



The legal analysis of the Attorney General's 1917 opinion was adopted in Treasury regulations issued in 1918, and this remained the official basis for the tax exempt status of state-chartered credit unions until the Revenue Act of 1951 granted express statutory tax-exempt status to state-chartered credit unions. However, the Revenue Act of 1951 removed tax exemption from savings and loan associations, cooperative banks, and mutual savings banks. The legislative history of the act suggests that the reason these entities lost their exemption was because of their increasing similarity to commercial banks and the resulting loss of their original characteristic of mutuality. Specifically referring to the early days of these institutions, the legislative history states:



"The fact that the members were both the borrowers and the lenders was the essence of the "mutuality" of these organizations." See generally S. Rep. No. 781 (Sept. 18, 1951), reprinted in U.S. CODE CONG. & AD. SVC. 1969, 1991-97.



Present-day section 501(c)(14)(A) - as enacted in 1951 - incorporates the requirements of mutuality and non-profit operation which formed the basis for the Attorney General's recognition of credit unions' tax-exempt status in 1917. Accordingly, the basic purposes of the credit union tax exemption remain essentially the same today as they were in 1917. Based on the Attorney General's opinion, the basis for exemption is the provision of savings accounts and loans to members who may not be served by banks in a non-profit and mutual manner.



Section 511 of the Code imposes a tax on the unrelated business taxable income of organizations otherwise exempt from federal income tax under section 501(c).



Section 512(a)(1) of the Code provides that the term "unrelated business taxable income" means, with certain modifications, the gross income derived by an organization from any unrelated trade or business regularly carried on by it, less allowable deductions.



Section 513(a) of the Code defines the term "unrelated trade or business" in the case of any organization subject to tax imposed by section 511, as any trade or business the conduct of which is not substantially related (aside from the need of such organization for the income or funds or the use it makes of the profits derived) to the exercise or performance by such organization of its exempt function.



Section 1.513-1(a) of the regulations provides that gross income of an exempt organization subject to the tax imposed by section 511 of the Code is, with certain exceptions, includable in the computation of unrelated business taxable income if (1) it is income from trade or business, (2) such trade or business is regularly carried on by the organization, and (3) the conduct of such trade or business is not substantially related (other than through the production of funds) to the organization's performance of its exempt functions.



Section 1.513-1(b) of the regulations provides that the term "trade or business" has the same meaning it has in section 162 of the Code, and generally includes any activity carried on for the production of income from the sale of goods or the performance of services.



Section 1.513-1(c)(1) of the regulations states that in determining whether a trade or business is "regularly carried on" within the meaning of section 512 of the Code, regard must be had to the frequency and continuity with which the activities are conducted and the manner in which they are pursued. Hence, for example, specific business activities will ordinarily be deemed "regularly carried on" if they manifest a frequency and continuity, and are pursued in a manner generally similar to comparable commercial activities of nonexempt organizations.



Section 1.513-1(d)(1) of the regulations provides that gross income is derived from "unrelated trade or business" within the meaning of section 513(a) of the Code, if the conduct of the trade or business which produces the income is not substantially related (other than through the production of funds) to the purposes for which exemption is granted. The presence of this requirement necessitates an examination of the relationship between the business activities that generate the particular income in question - the activities, that is, of producing or distributing the goods or performing the services involved - and the accomplishment of the organization's exempt purposes.



Section 1.513-1(d)(2) of the regulations provides that a trade or business is "related" to exempt purposes, in the relevant sense, only where the conduct of the business activities has a causal relationship to the achievement of exempt purposes (other than through the production of income), and it is "substantially related," for purposes of section 513, only if the causal relationship is a strong one. Thus, for the conduct of a trade or business from which a particular amount of gross income is derived to be substantially related to purposes for which exemption is granted, the production or distribution of the goods or the performance of the services from which the gross income is derived must contribute importantly to the accomplishment of those exempt purposes. Whether activities contribute importantly to an organization's exempt purposes depends in each case upon the facts and circumstances involved.



In Louisiana Credit Union League, 693 F.2d 525 (5th Cir. 1982), a business league described in section 501(c)(6) of the Code engaged in several activities including the endorsement of insurance to its members. The court analyzed whether these activities were substantially related to the business league's exempt purpose under section 501(c)(6) of advancing the credit union movement, in order to determine whether income generated from those activities resulted in unrelated business income to the business league. In its analysis, the court stated that the "'substantial relationship' determination is necessarily a fact-based inquiry." Id. at 535. The court also noted that the regulations under section 513 require a case-by-case identification of the exempt purpose, an analysis of how the activity contributes to that purpose and an examination of the scale on which the activity is conducted. The League promoted the purchase of insurance policies from a particular carrier, providing the carrier with convenient services in the marketing and administration of its programs. The court stated that the League's endorsement of group insurance plans was principally motivated by a desire to raise revenue. The court also discussed at length the distinction between group and individual benefit. The court said the distinction between inherently group benefits and individual benefits is analogous to the aggregate/entity concept familiar in partnership taxation.



Just as a member of a partnership may enjoy benefits in his separate capacities as partner and non-partner, so may a member of the ..[League may]... enjoy benefits both as a League member and as an individual credit union. Only those activities that benefit the credit unions in their capacities as League members can be considered substantially related to the League's exempt function. This group benefit standard also accords with the requirement that a business league seek to improve the conditions of an entire line of business rather than perform discrete services for individuals. See Treas. Reg. Section 1.501(c)(6)-1. When the activities of a business league are directed toward the achievement of the common business interest of its members, the benefits that accrue to its members are inherently group benefits.


Id. at 536. The court continued its analysis by stating that insurance endorsement and administration is not the sort of unique activity that satisfies the substantial relationship test, nor are its benefits group-related. Id. at 536. Rather than merely advising members of the availability and desirability of insurance coverage to credit unions generally, the league promoted the purchase of polices from a particular carrier. The court affirmed the district court's rationale that the league's insurance activities did little more than generate revenue. Because the league's endorsement was basically a fundraising activity, it was by definition unrelated business activity under section 513(a). Id. at 537. Therefore, the court concluded that the League's insurance activities were not substantially related to its tax-exempt purpose of advancing the credit union movement. Rather, the connection between the furtherance of the credit union movement and the selling of insurance was at best tangential.


In Professional Insurance Agents of Michigan v. Comm'r., 78 T.C. 246 (1982) [CCH Dec. 38,797], aff'd 726 F.2d 1097 (6th Cir. 1984), the court held that promotional and administrative fees and an experience rating reserve refund received by a business league described in section 501(c)(6) of the Code for promoting group insurance programs for its members constituted unrelated business taxable income under section 512(a)(1). In holding that the business league's activities were not substantially related, the court considered whether the league's insurance activities contributed importantly to the league's exempt purpose of advancing the common business interests of independent insurance agents. The court stated the burden is on the taxpayer to show that the challenged activities contribute directly and importantly to the improvement of conditions in a particular line of business. The court noted that the petitioner's insurance activities did little more than generate revenue for the association and provided members with a convenient and economical service in the operation of their agencies. As such, they stood in sharp contrast to petitioner's educational and legislative activities, which served the broader purpose of improving the general business environment in which insurance agents operated. Thus, the court found petitioner's activity of promoting insurance was not substantially related to its exempt purpose.



In La Caisse Populaire Ste. Marie (St. Mary's Bank) v. U.S., 563 F.2d 505 (1st Cir. 1977)[77-2 USTC ¶9698], the Government unsuccessfully challenged the exempt status under section 501(c)(14)(A) of the Code of an organization chartered as a credit union by the State of New Hampshire. The Government maintained that the organization was not exempt because it offered a wide variety of services typically offered by nonexempt full service banks, and was therefore not organized or operated as a credit union. Among these services were checking accounts, mortgage loans, banking by mail, safe deposit boxes and a night depository. This case focused solely on the taxpayer's exemption under section 501(c)(14) and did not address the provisions of sections 511 through 513.



In Alabama Central Credit Union v. U.S., 646 F. Supp. 1199 (N.D. Ala. 1986) [86-2 USTC ¶9658], a credit union described in section 501(c) (14) of the Code offered cancer and group life insurance to its individual members. The issue was whether commissions the credit union received from servicing these particular types of insurance policies constituted unrelated business income under section 512. The court did not reach the issue for jurisdictional reasons; however, it stated in a footnote that the petitioner would have lost on the merits of this issue because the policies benefited the insured without any reference to the member's loans or accounts with the credit union. That court stated in dicta that cancer and group life insurance offered by a credit union to its members would result in unrelated business table income for the following reasons:



1. Petitioner earned commissions for servicing cancer and group life insurance policies;



2. These policies were for the express benefit of the insured without any reference to the member's loans or accounts with the credit union;



3. Petitioner derived no benefit from the policies other than commission on the sale of said policies earned from the insurance companies which issued the policies;



4. The sale of the cancer and group life insurance policies referred to had no substantial, causal relationship to petitioner's exempt purposes; and



5. The sale of the policies bore no relationship to petitioner's function as a credit union.


Id. at 1208, n. 14.


Rev. Rul. 69-282, 1969-1 C.B. 155, provides that an organization must be formed and operated under the state law governing the formation of credit unions to qualify for exemption under section 501(c)(14) of the Code as a state-chartered credit union.



Rev. Rul. 72-37, 1972-1 C.B. 152, provides that to qualify as a credit union exempt from income tax under section 501(c) (14) (A) of the Code an organization must, in addition to being formed and operated under a state credit union law, operate without profit and for the mutual benefit of its members. The revenue ruling clarified Rev. Rul. 69-282, stating that a state charter is a threshold requirement for exemption but not the sole requirement.



Rev. Rul. 60-228, 1960-1 C.B. 200, interprets the substantially related requirement of section 513. An organization exempt from federal income tax as an agricultural organization described in section 501(c)(5) of the Code promoted wider insurance coverage among its members and other local farmers, including life, casualty, and fire insurance. The insurance programs are provided by several insurance companies, but the organization's administrative and secretarial staff is assigned to the work. The organization receives an overall fee from the insurance company for office and other services rendered them in connection with the insurance programs. The revenue ruling provides that a trade or business is substantially related to an organization's exempt activities if the principal purpose of the trade or business furthers these exempt purposes. However, in this case, such activities are not usually associated with the functions of an agricultural organization and normally would not be carried on by such an organization in furtherance of its exempt purposes. Therefore, these activities are not substantially related to the organization's exempt purposes. Thus, the income resulting from these activities is subject to tax under section 511.



ANALYSIS



In determining whether an income-producing activity is an unrelated trade or business, it is necessary to show that (1) there is a trade or business, (2) the trade or business is regularly carried on, and (3) the conduct of the trade or business is not substantially related to the organization's exempt purpose or function. See section 1.513-1 (a) of the regulations.



T has agreed that the activities at issue are trades or businesses that are regularly carried on. Therefore, the sole issue is whether each activity is substantially related to the organization's achievement of its exempt purposes.



Gross income is derived from an unrelated trade or business if the conduct of the trade or business is not substantially related (other than through production of funds) to the purposes for which exemption is granted. Section 1.513-1(d)(1) of the regulations. Determination of the substantial relationship issue requires an examination of the relationship between the business activities which generate the particular income in question, and the accomplishment of the organization's exempt purposes. Id. The regulations further state that for the conduct of trade or business from which a particular amount of gross income is derived to be substantially related to purposes for which exemption is granted, the production or distribution of the goods or the performance of services from which the gross income is derived must contribute importantly to the accomplishment of those purposes. Section 1.513-1(d)(2) of the regulations. See also Prof'l Ins. Agents of Michigan, supra, (insurance activity was not substantially related because activity did little more than generate revenue and provide members with a service and did not further taxpayer's exempt purpose of improving business conditions); and Louisiana Credit Union League, supra, (League's endorsement of group insurance plans was principally motivated by a desire to raise revenue, and at best was only tangentially related to the furtherance of the League's exempt purpose of improving business conditions of one or more lines of business. The court found the requisite substantial relationship lacking.)



For T's activities to escape taxation as unrelated business income, the activities must contribute directly and importantly to the accomplishment of one or more of T's exempt purposes --promotion of thrift and providing low cost credit for its members through mutual and nonprofit operation. Section 1.513-1(d)(2) of the regulations. See also Prof'l Ins. Agents of Michigan, supra. We address each of the activities below.



AD&D insurance



T argues that making AD&D insurance available to members is substantially related to the credit union's exempt purpose of promoting thrift by providing basic financial protection to members on a mutual basis. T also argues that AD&D insurance facilitates prompt repayment of loans on a mutual basis by protecting the individual member's financial security.



The facts do not show how T's sales of AD&D insurance contribute directly and importantly to T's exempt purposes. T has not demonstrated that sales of AD&D insurance encourage savings by members who purchase it. T has also not provided information showing that the sale of AD&D insurance aids a member in obtaining credit or reduces the cost of providing credit to members. The facts do not demonstrate that the sale of AD&D insurance to individual members advances T's mutual operation. AD&D insurance provides a financial protection to an individual. The individual's purchase of the AD&D insurance does not provide a benefit to the members as a whole. The legislative history of section 501(c)(14)(A) of the Code indicates that mutuality is tied to the same members being the borrowers and lenders in loan transactions rather than the general principles that T espouses. S. Rep. No. 781 (Sept. 18, 1951).



T has not stated how the sale of AD&D insurance to an individual provides a mutual benefit to T members. The facts also do not show how sale of AD&D insurance benefits the members of the credit union as a whole. A member may purchase AD&D insurance without obtaining credit or a loan from T. If a member of T receives accidental dismemberment insurance payments, the member may use the insurance payments as he or she wishes rather than saving them or paying off an obligation to T. In the case of accidental death, the member's beneficiary may or may not be a member of T and also may use the payments as he or she desires.



In Alabama Central Credit Union, supra, the court stated in dicta several factors cited above relevant to the "substantially related" inquiry. In this case, T (1) earns commissions for servicing AD&D insurance policies; (2) sells policies for the express benefit of the insured without any reference to the member's loans or accounts with the credit union; (3) derives no benefit from the policies other than commission on the sale of the policies earned from the insurance companies which issued the policies; (4) the sale of the insurance policies referred to has no substantial, causal relationship to T's exempt purposes; and (5) the sale of the policies bears no relationship to T's function as a credit union.



Based on all of the facts and circumstances, T's activities with respect to the sale of AD&D insurance do not contribute importantly to accomplishing T's exempt purposes. The AD&D insurance sold benefits an individual and T receives no benefit other than the production of income. Therefore, the sale of AD&D insurance is not substantially related to T's exempt purposes and amounts received therefrom are subject to unrelated business income tax (UBIT).



Credit life and credit disability



T argues that the sale of credit disability insurance is directly related to the credit union's specific exempt purposes of fostering thrift among the members (including both the extension of credit to members on reasonable terms, and encouraging savings among the members), and providing services to members on a mutual basis. T further maintains that credit insurance, which is an integral part of a member loan transaction, is a mechanism for assuring the prompt repayment of debts in situations where the financial resources of the borrower, and the borrower's family, become strained as a result of disability.



The facts do not show how sales of credit life and credit disability insurance contribute directly and importantly to accomplishing T's exempt purposes. Credit life and credit disability insurance is not required for the approval of a loan. In fact, credit life and credit disability insurance is not available to members on certain types of loans, such as mortgage and other real estate loans. The member decides whether to purchase credit life and credit disability insurance based on his or her own assessment of whether the insurance will provide a benefit to that individual member. The individual member benefits in that the member need not worry about paying a loan to T in the event of death or disability. While there is also a benefit to the credit union as the beneficiary, the facts do not show how the sale of credit life and credit disability insurance otherwise contributes importantly and directly to accomplishing T's exempt purposes, other than through the production of income. Availability of credit life and credit disability insurance does not encourage savings or assist T in offering low cost credit.



T does not take into consideration the need for this insurance by members. T performs no studies to determine which members may need credit life and credit disability insurance, and there is no required corresponding counseling to members who may have more need than others. Although T's staff may recommend insurance based on the level of personal and family resources, these recommendations are not mandatory in specific cases and coverage is not required in these cases.



Additionally, T receives a commission based on a percentage of premiums paid for credit life and credit disability. Because the insurance is voluntary and has no bearing on the approval of a loan, the individual benefit --to the selling employee --is the primary benefit of offering the insurance.



Applying the factors of Alabama Central Credit Union, supra, T (1) earns commissions for providing credit life and credit disability insurance; (2) sells policies for the express benefit of the insured albeit with reference to a member's loan with the credit union; (3) derives some benefit from the credit life and credit disability insurance but the primary benefit is production of income, through the commission on the sale of the insurance earned; (4) the insurance referred to has no substantial, causal relationship to T's exempt purposes; and (5) the insurance bears no relationship to T's function as a credit union.



Looking at the facts with respect to credit life and credit disability insurance, the sale of credit insurance is not substantially related to T's exempt purposes. The available information indicates that the sale of insurance is primarily: 1) for the purpose of generating income to T and some of its employees; and 2) for the benefit of the insured rather than for the benefit of T's membership. Based on all of the facts and circumstances, T's activities with respect to the sale of credit life and credit disability insurance do not contribute importantly to accomplishing T's exempt purposes. Therefore, the sale of credit life and credit disability insurance is not substantially related to T's exempt purposes and amounts received therefrom are subject to UBIT.



CONCLUSION



For reasons set forth above, we conclude that the income received by a section 501(c)(14) credit union from the activities listed below are not substantially related to the furtherance of T's exempt purposes and therefore are subject to UBIT.



A. Sale of AD&D insurance



B. Sale of credit life and credit disability insurance



A copy of this technical advice memorandum is to be given to the taxpayer. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

Back Taxes: What is alimony? Payments made by an ex-husband to his ex-wife pursuant to a settlement agreement were not alimony payments under Code Sec. 71(b) because the payments would not terminate on the death of the ex-wife; thus, the payments were not deductible under Code Sec. 215(a). The ex-husband's obligation was for a lump sum payable in monthly installments, which, under state (Georgia) law, was a lump-sum alimony that does not terminate upon the death of either the payee or the payor. Further, under state law, the obligation to pay lump-sum alimony does not terminate upon the death of either party because lump-sum alimony is in the nature of property settlement, regardless of whether it was designated as alimony. See Thomas Lettieri v. Commissioner<, T.C. Summary Opinion 2007-114, Docket No. 13055-06S . Filed July 3, 2007.


Section 215(a) provides a deduction to an individual equal to the alimony or separate maintenance payments paid during that individual's taxable year. Section 215(b) defines alimony as any payment that is includable in the gross income of the payee under section 71. Section 71(a) provides for the inclusion in income of any alimony or separate maintenance payments received during the taxable year. Section 71(b)(1) defines "alimony or separate maintenance payment" as any payment in cash if --

(A) such payment is received by (or on behalf of) a spouse under a divorce or separation instrument,

(B) the divorce or separation instrument does not designate such payment as a payment which is not includible in gross income under this section and not allowable as a deduction under section 215,

(C) in the case of an individual legally separated from his spouse under a decree of divorce or of separate maintenance, the payee spouse and the payor spouse are not members of the same household at the time such payment is made, and

(D) there is no liability to make any such payment for any period after the death of the payee spouse and there is no liability to make any payment (in cash or property) as a substitute for such payments after the death of the payee spouse.

Under section 71(b)(1)(D), if the payor is liable for any qualifying payment after the recipient's death, none of the related payments required will be deductible as alimony by the payor. See Kean v. Commissioner, 407 F.3d 186, 191 (3d Cir. 2005), affg. T.C. Memo. 2003-163. Whether a postdeath obligation exists may be determined by the terms of the divorce or separation instrument or, if the instrument is silent on the matter, by State law. Morgan v. Commissioner, 309 U.S. 78, 80-81 (1940); see also Kean v. Commissioner, supra. The parties dispute whether the payments at issue meet the requirement of section 71(b)(1)(D). The parties are in agreement that the divorce decree does not provide any conditions for the termination of these payments. Respondent maintains that the payments made by petitioner to Von Bergen are not deductible from petitioner's income as alimony under section 215(a) because the obligation to make the payments does not terminate at the death of either party under Georgia law. Petitioner contends that the payments are deductible because he intended the payments to be alimony and because the settlement agreement did not specifically state that the payments do not terminate at the death of petitioner or Von Bergen.

Although section 71(b)(1)(D), as it was enacted in 1984, originally required that a divorce or separation instrument affirmatively state that liability for payments terminate upon the death of the payee spouse in order to be considered alimony, the statute was retroactively amended in 1986 so that such payments now qualify as alimony as long as termination of such liability would occur upon the death of the payee spouse by operation of State law. Hoover v. Commissioner, 102 F.3d 842, 845-846 (6th Cir. 1996), affg. T.C. Memo. 1995-183.

Under Georgia law, the obligation to pay periodic alimony terminates at the death of either party, while the obligation to pay lump sum alimony in installments over a period of time does not. Winokur v. Winokur, 365 S.E.2d 94, 95 (Ga. 1988). The Georgia Supreme Court has held that the obligation to pay lump sum alimony does not terminate upon the death of either party because lump sum alimony is in the nature of a property settlement, regardless of whether it is designated as alimony. Id. The Georgia Supreme Court has also established the following test to be used in determining whether particular payments are lump sum alimony payable in installments, as opposed to periodic alimony: "If the words of the documents creating the obligation state the exact amount of each payment and the exact number of payments to be made without other limitations, conditions or statements of intent, the obligation is one for lump sum alimony payable in installments." Id. at 96.

The settlement agreement between petitioner and Von Bergen requires petitioner to pay "the sum of $66,000" to Von Bergen in monthly payments of at least $1,000. Although the exact number of payments would have varied if petitioner had paid more than the minimum $1,000 in any installment, petitioner was not legally obligated to pay to Von Bergen any more than "the sum of $66,000"; if petitioner did not have the option in the settlement agreement of paying more than the required $1,000 each month, he would have been required by the settlement agreement to pay Von Bergen exactly 66 payments of $1,000 each. Petitioner's obligation to Von Bergen is for an exact sum payable in monthly installments, which obligation is lump sum alimony under Georgia law and does not terminate upon the death of either the payee or the payor. Thus, we hold that the $12,000 paid to Von Bergen in 2004 pursuant to the settlement agreement between petitioner and Von Bergen does not qualify to be deducted as alimony paid by petitioner under section 215. Sec. 71(b)(1)(D); see Mukherjee v. Commissioner, T.C. Memo. 2004-98.

Tax Help: IRS determined that a horse-breeding activity is a business not a hobby in Michael J. Rozzano, Jr. and Rose Marie Rozzano v. Commissioner.Dkt. No. 12344-03 , TC Memo. 2007-177, July 3, 2007. Taxpayers conducted their horse-boarding activity as a bona fide business activity within the meaning of Code Sec. 183. Although the couple never reached a financial break-even point with respect to the activity, the manner in which the taxpayers conducted the activity indicated that it was engaged in for profit. The couple maintained accurate records, followed and modified business plans and, upon realizing that they could not earn a profit under the circumstances, minimized expenses until they were able to sell the business. The taxpayers had the expertise to run the business and expended effort to do so, and any pleasure the taxpayers may have experienced through their ownership and running of the business did not trump the finding the activity was operated for profit. Horse breeding cases are normally examined and the IRS is normally adverse on any business activity that does not make a profit.

Section 183(a) disallows deductions attributable to an activity not engaged in for profit. Section 183(b) provides two exceptions to this general rule. The first, provided by section 183(b)(1), permits deductions that otherwise would be allowable without regard to whether the activity is engaged in for profit; the second, provided by section 183(b)(2), permits deductions that would be allowable only if the activity were engaged in for profit to the extent that the gross income from the activity exceeds the deductions allowable pursuant to section 183(b)(1). Section 183(c) defines an "activity not engaged in for profit" as "any activity other than one with respect to which deductions are allowable for the taxable year under section 162 or under paragraph (1) or (2) of section 212." In general, the Commissioner's determination set forth in the notice of deficiency is presumed correct. Rule 142(a)(1); Welch v. Helvering , 290 U.S. 111, 115 (1933). In certain circumstances the burden of proof shifts to respondent. Sec. 7491(a)(1); Rule 142(a). Because the issue in this case is a legal one, we reach our decision without regard to the burden of proof. However, petitioners contend that section 7491(a) and Rule 142(a) are applicable with respect to the increases in the deficiencies pleaded in respondent's answer. They are correct on this point.

In deciding whether petitioners' horse-boarding activity was engaged in for profit during the taxable years at issue, we must inquire whether petitioners had an actual and honest objective of making a profit from the activity. Dreicer v. Commissioner, 78 T.C. 642, 645 (1982), affd. without opinion 702 F.2d 1205 (D.C. Cir. 1983). The taxpayers' expectation need not be a reasonable one. Id. at 644-645; Golanty v. Commissioner, 72 T.C. 411, 425 (1979), affd. without published opinion 647 F.2d 170 (9th Cir. 1981); sec. 1.183-2(a), Income Tax Regs. Whether there is present an actual and honest objective of making a profit is a question of fact that is to be resolved upon a consideration of all relevant circumstances, with the greatest weight being given to the objective factors rather than the taxpayers' expression of their intent. Dreicer v. Commissioner, supra at 645; Golanty v. Commissioner, supra at 426; sec. 1.183-2(a) and (b), Income Tax Regs.

Section 1.183-2(b), Income Tax Regs., lists these relevant factors that we now consider: (1) The manner in which the taxpayers carry on the activity; (2) the expertise of the taxpayers or their advisers; (3) the time and effort expended by the taxpayers in carrying on the activity; (4) the expectation that the assets used in the activity may appreciate in value; (5) the success of the taxpayers in carrying on similar or dissimilar activities; (6) the taxpayers' history of income or loss with respect to the activity; (7) the amount of occasional profits; (8) the financial status of the taxpayers; and (9) whether elements of pleasure or recreation are involved. Golanty v. Commissioner, supra at 426; sec. 1.183-2(b), Income Tax Regs.

Based on our consideration of these factors and in the light of the detailed record in this case, we conclude that petitioners' horse-boarding activity was carried on as a business within the meaning of sections 162 and 183 during the taxable years at issue. In reaching this conclusion, we view the following facts and circumstances as most persuasive:
Manner in Which Taxpayers Carried On the Activity

Respondent contends that the manner in which petitioners conducted their horse-boarding activity does not indicate that the activity was engaged in for profit during the years in issue. The relevant inquiries before us include whether petitioners conducted their business in a manner similar to other comparable businesses, whether petitioners maintained complete and accurate books and records, and whether changes were attempted to improve profitability. See Engdahl v. Commissioner, 72 T.C. 659, 667-668 (1979); sec. 1.183-2(b)(1), Income Tax Regs.

As to their manner of conduct, during the taxable years in issue, petitioners, for the most part, rented more than one-half of the available stalls in their barn. Petitioners provided detailed monthly boarding records for 1999 and 2000, which list each horse and the expenses incurred. From the inception of their activities in 1992, through the years in issue, petitioners also maintained extensive and separate accountings for all of their horse-boarding income and expenses using a software program tailored to small farm operators. Based on these facts, we are satisfied that petitioners' maintenance of complete and accurate records in this case supports a profit objective. See Elliott v. Commissioner, 90 T.C. 960, 971-972 (1988), affd. without published opinion 899 F.2d 18 (9th Cir. 1990); sec. 1.183-2(b), Income Tax Regs.

As to petitioners' other business practices, although petitioners made no great effort to advertise their boarding service to the general public, we do not find their lack of advertising indicative of an absence of profit motive, as their word-of-mouth approach in attracting clientele was clearly successful, as they had, at one point during the years in issue, 80 percent of their stalls rented.

Notably, however, despite the significant stall rental statistics and petitioners' thorough accounting methods, we cannot overlook Mr. Rozzano's refreshingly candid testimony at trial that he came to realize sometime in 1999 that petitioners would neither earn a profit nor reach a break-even point if they held to their existing boarding fees, nor could they raise boarding fees or hire additional help in order to become profitable. Mr. Rozzano reached this conclusion after he analyzed all factors necessary to attempt to make the business more profitable.

In fact, after his analysis, he calculated that these measures (i.e., raising boarding fees and hiring additional help) would likely increase his operating costs taking into account the scope of the services provided to the boarders. Moreover, it was likely that the terms of the contracts then existing with the boarders meant that any modification to the monthly rental agreements would have placed petitioners in breach of contract. Mr. Rozzzano then did what any prudent business person would do, attempt to lessen expenses until the business including the property could be sold.

Petitioners' rental fees remained unchanged after Mr. Rozzano decided to sell Sugar Tree (a decision made sometime in 2000). Notably, petitioners still kept meticulous business records and used word-of-mouth to advertise their boarding services during the years in which they were continuing the boarding activities while, at the same time, preparing the property for sale.

Mr. Rozzano also testified that it was primarily the cost associated with hay feed that caused their business to experience ongoing losses. We note that for 1999 and 2000, hay and feed expenses accounted for 34 percent and 32 percent, respectively, of all cash expenses before depreciation. To this end, petitioners devised a strategy to ensure that their hay supply costs could be mitigated so as to reduce losses and accord with their budget projections. Petitioners took steps to ensure that the hay would remain dry and free from infestation and that their helper would not waste it unnecessarily. Petitioners also took steps in 1999 and 2000 to reduce other operating expenses, such as travel, meals, and utilities. These costs did, in fact, decrease from 1999 to 2000. Although petitioners did make efforts to reduce their hay expenses by protecting their supply, an increase in the number of boarders in 2000, coupled with an increase in the wholesale price of the feed, resulted in an increase in hay costs. While we recognize that efforts to improve profitability can be indicative of whether petitioners intended to realize a profit, we do not find their refusal to raise stall rental prices or hire additional help, especially in the light of their existing contracts, of their decision to sell Sugar Tree, and of their efforts to reduce hay and other costs, dispositive on the issue of their profit motive. It is beyond this Court's purview to second-guess petitioners' business judgment or the manner of operations of their business. We decline to do so.

In this case, we are presented with taxpayers who admit that during 1999, they became aware that they could not make a profit but yet still continued business operations while taking steps to mitigate their expenses until the business and property could be sold. Accordingly, we now address whether petitioners' admission at trial should trump the other facts and circumstances of this case.

While we cannot disregard Mr. Rozzano's admission that at some point in 1999 he realized that his hopes of turning the boarding activities into a profitable business were unattainable we do not find that as of that moment, petitioners' activities ceased to be a bona fide business within the meaning of section 183. Moreover, our decision comports with this Court's holding in Dreicer , where greater weight must be afforded to the consideration of all of the facts and circumstances. In this case, the facts and circumstances surrounding petitioners' actions between the time of their realization with respect to profitability in 1999 and the ultimate disposal of the property in 2003 show that they continued to conduct their horse-boarding activities in a businesslike manner.

Even after petitioners' realization with respect to the profitability of their horse-boarding activities, their actions illustrate steps taken to mitigate costs and to try to achieve at least a break-even point until the business could be sold. First, petitioners held contracts for stall rentals which they did not change, nor could they change, for fear of being in breach. Second, petitioners made active attempts to reduce hay and feed costs. Third, petitioners continued to rent stalls, maintain their ongoing operations, and even moved back to the property on a full-time basis in 2000. Finally, and perhaps most significantly, the amount of operating costs borne by petitioners comprised a large share of their wage income in the years at issue. Petitioners had wages of $221,968 in 1999, and $159,018 in 2000, and reported net out-of-pocket expenses in those years from Sugar Tree of $76,687 and $73,722,4 respectfully. These net out-of-pocket expenditures were 34 percent and 46 percent of petitioners' wages in 1999 and 2000, respectfully. We cannot conclude, based on the entirety of the foregoing, that their activities turned from business into hobby overnight in 1999 based upon Mr. Rozzano's admission at trial.

Expertise of and Effort Expended by the Taxpayers

Respondent does not challenge either petitioners' expertise or the time and effort expended on the activity at issue. We believe that petitioners have established, through credible testimony, that they not only were well possessed of the knowledge necessary to operate a horse-boarding business, but that Mr. Rozzano contributed vast amounts of time to the operations at Sugar Tree. First, petitioners were well aware from their experience as horse owners of the requirements for boarding horses before they commenced activity at Sugar Tree. Second, horse-boarding, unlike other horse-related endeavors, such as breeding and training, while it entails risk, to be sure, is rather simple in its day-to-day execution; horses are taken out to pasture ("turned out"), fed, returned to stables to rest, taken out again, fed again, and retired to their stables. There is nothing in the record that suggests that petitioners were not well versed and extremely competent in these practices.

Finally, although we suspect that Mr. Rozzano's testimony that he spent every weekend and holiday for 10 years performing upkeep at Sugar Tree may be an overstatement, we find him a credible and forthright witness overall and moreover, we believe that he performed most, if not all, of the major upkeep projects on Sugar Tree himself. Therefore, we believe that the expertise of and time and effort expended by petitioners support a finding that the activity was engaged in for profit.

Expectation That Assets Would Appreciate

Petitioners argue that the increase in the value of Sugar Tree and the efforts they expended and expenses they incurred in upkeep of the property support a conclusion that the horse-boarding activity was engaged in for profit. We disagree. On the issue of whether appreciation of land supports petitioners' profit intent, the relevant inquiry is whether the holding of the land for appreciation and the conducting of the horse-boarding constitute a single activity or separate activities. Sec. 1.183-1(d)(1), Income Tax Regs. Determining whether the two undertakings are a single activity requires the examination of all of the facts of the case; the most significant facts being those that show the degree of organizational and economic interrelationship of the undertakings. Id.

In this case, petitioners primarily purchased the land for personal enjoyment and not to engage in a business. Therefore, they had no bona fide intention, at the time of purchase, to realize a profit that could offset later operating losses as they had not yet contemplated any business using the property. Only subsequent to the purchase did petitioners use the property in their horse-boarding activities.

Moreover, we note that the variable costs of petitioners' horse-boarding activities, including fees, veterinarian care, etc., exceeded the gross income produced by the activities, with the result that the horse-boarding activities do not meet the test imposed under the regulation pertaining whether such activities will be integrated. See sec. 1.183-1(d)(1), Income Tax Regs. Accordingly, we believe, in this case, that their holding the property for appreciation and horse-boarding are separate activities. See sec. 1.183-2(b)(4), Income Tax Regs.; Engdahl v. Commissioner, 72 T.C. 659 (1979); Allen v. Commissioner, 72 T.C. 28 (1979). Irrespective of this conclusion, however, we do not believe that petitioners' inability to argue the appreciation of their land is ultimately determinate on the issue of whether the horse-boarding activity was engaged in for profit.

Financial Status of the Taxpayers

The fact that petitioners have substantial income from sources other than the activity at issue may indicate that the activity was not engaged in for profit. Cf. Engdahl v. Commissioner, 659, 670. Respondent argues that Mr. Rozzano's income from his job in executive management was sufficient to absorb the expenses in operating Sugar Tree, indicating that it was not operated for profit. We disagree. As previously stated, these out-of-pocket expenditures were 34 percent and 46 percent of petitioners' wages in 1999 and 2000, respectively. We are not persuaded that petitioners were able to absorb easily the losses attributable to the activity at Sugar Tree during these years. As previously stated, the income reported by petitioners on their tax returns for the years in controversy does not, in our opinion, demonstrate that the losses incurred by petitioners were offset either by petitioners' income in those years or excessive depreciation deductions claimed by them.

Moreover, whatever income petitioners may have had during the years in issue is secondary to the primary inquiry as to whether or not petitioners engaged in the activity with a genuine intent to profit from it. We note that petitioners had no other income in the years at issue apart from Mr. Rozzano's work and a 3-week, holiday job taken by Mrs. Rozzano at The Gap, Inc. By 1999, both of petitioners' adult children had left the familial home, and so, the physical work and personal efforts expended by petitioners were not being done for the immediate benefit of their children. We believe it unlikely, given the distance petitioners regularly traveled to and from Sugar Tree, the liability risk inherent to their activity, and the nature and extent of the physical labor which they performed while at Sugar Tree, that petitioners would maintain a hobby costing thousands of dollars and entailing much physical labor.

Elements of Pleasure/Recreation

Respondent argues that not only are Mr. Rozzano's claims regarding his involvement with the work done at Sugar Tree improbable, but that regardless of the amount of effort petitioners put into the activity, elements of pleasure should trump any consideration that the activity was a business. We disagree. Until sometime in 2000, petitioners resided at least 5 hours away from Sugar Tree. This distance required petitioners to travel between their home and Sugar Tree on weekends and holidays. We believe, based on their credible testimony at trial, that once at Sugar Tree, petitioners did perform a significant amount, if not all, of the major upkeep on the property. Furthermore, petitioners did not ride either of their horses for pleasure after 1990. We do not find that the pleasure that petitioners may have experienced through their ownership of Sugar Tree should trump a finding that the horse-boarding activity was operated for profit. See Jackson v. Commissioner, 59 T.C. 312, 317 (1972).

Possibly the only elements of pleasure taken by petitioners were either when watching their own horses frolic in the pasture or in the mere fact that they could attest to "owning a horse farm near Lexington, Kentucky."

Therefore, on the basis of all of the evidence in the record of this case, the circumstances of which are unique, we conclude and hold that petitioners conducted their horse-boarding activity in the years in issue as a bona fide business within the meaning of section 183.

Tax Attorney: Taxpayers contended that the IRS abused its discretion in sustaining the second notice of Federal tax lien because they were negotiating an offer-in-compromise when the lien was filed. The notice was filed after the IRS assessed the taxpayers' liabilities, gave notice and made demand for payment, and after it returned their proposed offer because they failed to provide supporting documentation. Oliver W. and Harriet S. Williams v. Commissioner. Dkt. No. 3000-06L , TC Memo. 2007-162, June 21, 2007. This case is interesting because it implies that the IRS cannot file a notice of lien when an offer in compromise is being actively considered by the IRS. The Tax Court noted:

The Federal Government obtains a lien against "all property and rights to property, whether real or personal" of any person liable for Federal taxes upon demand for payment and failure to pay. Sec. 6321; Iannone v. Commissioner, 122 T.C. 287, 293 (2004). The lien arises automatically on the date of assessment and continues until the tax liability is satisfied or the statute of limitations bars enforcement. Sec. 6322; Iannone v. Commissioner, supra at 293. The notice of Federal tax lien is filed with the appropriate State office or other government office in order to validate the lien against any purchaser, holder of a security interest, mechanic's lienor, or judgment lien creditor. See sec. 6323(a); Lindsay v. Commissioner, T.C. Memo. 2001-285, affd. [2003-1 USTC ¶50,307] 56 Fed. Appx. 800 (9th Cir. 2003).

The Commissioner "may" withdraw a Federal tax lien pursuant to section 6323(j)(1), but respondent's failure to do so in this case is not an abuse of discretion. See Crisan v. Commissioner, T.C. Memo. 2007-67; Ramirez v. Commissioner [Dec. 56,102(M)], T.C. Memo. 2005-179; Stein v. Commissioner , T.C. Memo. 2004-124.

Back Taxes: The Tax Court determined that the IRS made excessive interrogatories and motions in Richard L. Clark v. Commissioner, TC Memo. 2007-172, July 2, 2007.

IRS interrogatories contained eight pages of "definitions" and "instructions" and were, in effect, directions to require petitioner to lay out his case in writing rather than simple questions such as those anticipated by Rule 71. See Pleier v. Commissioner, 92 T.C. 499 (1989). Such interrogatories are particularly inappropriate against a pro se petitioner and were unnecessary in this case because petitioner's compliance with other Rules and the standing pretrial order would have supplied the information that respondent needed. Moreover, the interrogatories apparently motivated petitioner to give evasive answers to respondent's poorly phrased requests for admissions and to refuse to admit to the items of income identified in the statutory notice and in the requests for admissions. Thus, respondent's motions to compel answers to interrogatories and to review the sufficiency of the responses to the requests for admissions were denied.

Tax Help: The Tax Court considered “substance over form” standards in determining whether a tax shelter was “tax motivated” in River City Ranches , Jeffry Bergamyer, Tax Matters Partner, et al., v. Commissioner, TC Memo. 2007-171, July 2, 2007. The Tax Court also determined that there was fraud for purposes of applying the 6-year statute of limitations

The Tax Court noted:

Section 6621(c) provides for an increased rate of interest with respect to any substantial underpayment of tax in any taxable year attributable to a tax-motivated transaction. Section 6621(c)(3)(A) generally lists the types of transactions which are considered "tax-motivated transactions". A tax-motivated transaction includes any valuation overstatement within the meaning of section 6659(c), and such a valuation overstatement exists, among other situations, if the adjusted basis of property claimed on any return exceeds 150 percent of the correct amount of basis. Secs. 6621(c)(3)(A)(i), 6659(c). A tax-motivated transaction further includes "any sham or fraudulent transaction." Sec. 6621(c)(3)(A)(v).

It is well established that the tax consequences of transactions are governed by substance rather than form. Frank Lyon Co. v. United States, 435 U.S. 561, 573 (1978). When taxpayers resort to the expedient of drafting documents to characterize transactions in a manner which is contrary to objective economic realities and which has no significance beyond expected tax benefits, the particular forms they employ are disregarded for tax purposes. Id. at 572-573; Helvering v. F. & R. Lazarus & Co., 308 U.S. 252, 255 (1939). If a transaction is devoid of economic substance, it is not recognized for Federal taxation purposes. Gregory v. Helvering, 293 U.S. 465 (1935).

Determining the economic substance of a transaction requires an analysis of several objective factors: (1) Whether the stated price for the property was within reasonable range of its value; (2) whether there was any intent that the purchase price would be paid; (3) the extent of the taxpayer's control over the property; (4) whether the taxpayer would receive any benefit from the disposition of the property; (5) whether the benefits and burdens of ownership passed; (6) the presence or absence of arm's-length negotiations; (7) the structure of the financing; (8) the degree of adherence to contractual terms; and (9) the reasonableness of the income and residual value projections. Levy v. Commissioner, 91 T.C. 838, 854 (1988); Rose v. Commissioner, 88 T.C. 386, 410 (1987), affd. 868 F.2d 851 (6th Cir. 1989).

Our findings reflect the consideration of these objective factors. The partnerships had no business purpose beyond generating tax benefits. The facts show that the partnerships themselves were shams and lacked economic substance. They were merely a facade used by Hoyt to provide the tax benefits he promised in his promotional materials. They had no independent economic substance beyond the purported sheep breeding transactions which were also illusory and had no economic effect.


It is also significant in these cases that for section 6621(c) penalty-interest purposes the partnerships overvalued their assets and overstated their bases therein. The parties have stipulated facts that support findings of partnership asset overvaluations and basis overstatements. For example, they stipulated that: (1) The purchase prices exceeded the value of each partnership's flock because many of the sheep purportedly sold did not exist; (2) sheep sold to the partnerships for average prices ranging from $1,135 to $2,126 were nowhere near the quality of breeding sheep Barnes Ranches sold for $400 or more; (3) the partnerships never acquired the benefits and burdens of ownership; and (4) the promissory notes used to purchase the sheep did not represent valid indebtedness. Because we have determined that the partnership transactions lacked economic substance and are shams and that the partnerships never acquired the benefits and burdens of ownership, it follows that the adjusted bases in the sheep are zero. Clayden v. Commissioner, 90 T.C. 656, 677-678 (1988); Rose v. Commissioner, supra at 426; Zirker v. Commissioner, 87 T.C. 970, 978-979 (1986).

We conclude that the partnerships' activities are tax-motivated transactions within the meaning of section 6621(c).

Issue 2. Whether the Period of Limitations on Assessment Had Expired When the FPAAs Were Issued

The period for making assessments of tax attributable to a partnership item or affected item is set forth in section 6229. Section 6229 provides in pertinent part:

SEC. 6229. PERIOD OF LIMITATIONS FOR MAKING ASSESSMENTS.

(a) General Rule. --Except as otherwise provided in this section, the period for assessing any tax imposed by subtitle A with respect to any person which is attributable to any partnership item (or affected item) for a partnership taxable year shall not expire before the date which is 3 years after the later of --

(1) the date on which the partnership return for such taxable year was filed, or

(2) the last day for filing such return for such year (determined without regard to extensions).

(b) Extension by Agreement. --

(1) In general. --The period described in subsection (a) (including an extension period under this subsection) may be extended --

*******

(B) with respect to all partners, by an agreement entered into by the Secretary and the tax matters partner (or any other person authorized by the partnership in writing to enter into such an agreement),

before the expiration of such period.

*******

(c) Special Rule in Case of Fraud, Etc. --

(1) False return. --If any partner has, with the intent to evade tax, signed or participated directly or indirectly in the preparation of a partnership return which includes a false or fraudulent item --

(A) in the case of partners so signing or participating in the preparation of the return, any tax imposed by subtitle A which is attributable to any partnership item (or affected item) for the partnership taxable year to which the return relates may be assessed at any time, and

(B) in the case of all other partners, subsection (a) shall be applied with respect to such return by substituting "6 years" for "3 years."

Respondent issued the FPAAs at issue after the normal 3-year periods for assessment had expired. With regard to these FPAAs, however, Hoyt, as TMP, had executed consents extending the limitations periods. The partnerships argue that the extensions are invalid because Hoyt executed them while disabled by conflicts between his own interests and those of his partners. Respondent argues that the consents were valid and, alternatively, if the waivers are invalid, the 6-year limitations period under section 6229(c)(1) applies.

The 6-year limitations period applies if four requirements are met: (1) The entity is a partnership; (2) the partnership return includes a false or fraudulent item; (3) a partner signed or participated directly or indirectly in the preparation of the return; and (4) the partner signed or participated with the intent to evade tax. Sec. 6229(c)(1); Transpac Drilling Venture, 1983-2 v. United States, 83 F.3d 1410, 1414 (Fed. Cir. 1996), affg. 32 Fed. Cl. 810 (1995); cf. Allen v. Commissioner, 128 T.C. 37 (2007). There is no requirement that the signer of the partnership return intend to evade his own taxes. The 6-year statute is applicable to each partner if, in signing a false or fraudulent partnership return, the signer intended to evade the taxes of the other partners. Transpac Drilling Venture, 1983-2 v. United States, supra at 1414-1415. There is also no requirement that the other partners have knowledge of the false or fraudulent deductions claimed on a partnership return. The intent of the signer of the partnership return to evade the taxes of the other partners satisfies the intent element of the 6-year statute of limitations for making additional assessments under section 6229(c)(1), which applies when the partnership return containing false or fraudulent items is signed with intent to evade tax.Id. It is the fraudulent nature of the return that extends the limitations period. Allen v. Commissioner, supra at 42.

Through participation in the Hoyt partnerships, the partners received the benefits of the false and fraudulent partnership deductions. A partnership is required to file an annual information tax return even though it is not a taxable entity for Federal income tax purposes. Secs. 701, 6031; sec. 1.701-1, Income Tax Regs. Each partner is liable for income tax in his or her individual capacity with respect to his or her share of partnership items of income, loss, deduction, and credit. Sec. 701; sec. 1.702-1, Income Tax Regs. Thus, through such participation in the Hoyt partnerships, each partner received flowthrough partnership deductions that were false and fraudulent and which reduced or eliminated the partner's tax liability.

Tax Attorney: Fraudulent intent may be inferred from various kinds of circumstantial evidence, or "badges of fraud", including the consistent understatement of income, inadequate records, implausible or inconsistent explanations of behavior, concealing assets, and failure to cooperate with tax authorities. Dealing in cash is also considered a "badge of fraud" by the courts because it is indicative of a taxpayer's attempt to avoid scrutiny of his finances. Whether a taxpayer has consistently underreported income over an extended period of time is also a relevant factor in analyzing whether the taxpayer had a fraudulent intent in understating his tax liability. Kosinski v. Commissioner, TC Memo. 2007-173, July 2, 2007. The Tax Court noted:

Fraud Penalty

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 the taxpayer's fraud. Helvering v. Mitchell, 303 U.S. 391, 401 (1938); Sadler v. Commissioner, 113 T.C. 99, 102 (1999). Respondent has the burden of proving, by clear and convincing evidence, an underpayment for the year in issue and that some part of the underpayment for that year is due to fraud. Sec. 7454(a); Rule 142(b). If respondent establishes that any portion of the underpayment is attributable to fraud, the entire underpayment is treated as attributable to fraud and subjected to a 75-percent penalty, unless the taxpayer establishes that some part of the underpayment is not attributable to fraud. Sec. 6663(b). Respondent must show that the taxpayer intended to conceal, mislead, or otherwise prevent the collection of taxes. Katz v. Commissioner, 90 T.C. 1130, 1143 (1988).

The existence of fraud is a question of fact to be resolved upon consideration of the entire record. King's Court Mobile Home Park, Inc. v. Commissioner, 98 T.C. 511, 516 (1992). Fraud will never be presumed. Id.; Beaver v. Commissioner, 55 T.C. 85, 92 (1970). Fraud may, however, be proved by circumstantial evidence and inferences drawn from the facts because direct proof of a taxpayer's intent is rarely available. Niedringhaus v. Commissioner, 99 T.C. 202, 210 (1992). The taxpayer's entire course of conduct may establish the requisite fraudulent intent. Stone v. Commissioner, 56 T.C. 213, 223-224 (1971). Fraudulent intent may be inferred from various kinds of circumstantial evidence, or "badges of fraud", including the consistent understatement of income, inadequate records, implausible or inconsistent explanations of behavior, concealing assets, and failure to cooperate with tax authorities. Bradford v. Commissioner, 796 F.2d 303, 307 (9th Cir. 1986), affg. T.C. Memo. 1984-601. Dealing in cash is also considered a "badge of fraud" by the courts because it is indicative of a taxpayer's attempt to avoid scrutiny of his finances. See id. at 308. Whether a taxpayer has consistently underreported income over an extended period of time is also a relevant factor in analyzing whether the taxpayer had a fraudulent intent in understating his tax liability. Solomon v. Commissioner, 732 F.2d 1459, 1461 (6th Cir. 1984), affg. T.C. Memo. 1982-603.
Although petitioner's conviction for subscribing false Federal tax returns does not collaterally estop him from denying that he fraudulently understated petitioners' income tax liability, his conviction is evidence of fraudulent intent. See Wright v. Commissioner, 84 T.C. 636, 643-644 (1985).
A taxpayer is not entitled to shift responsibility for inaccurate returns onto his return preparer where the preparer is not provided with complete and accurate information regarding the taxpayer's income and expenses. See Korecky v. Commissioner, 781 F.2d 1566, 1569 (11th Cir. 1986), affg. per curiam T.C. Memo. 1985-63; Merritt v. Commissioner, 301 F.2d 484, 487 (5th Cir. 1962), affg. T.C. Memo. 1959-172. The responsibility of filing accurate returns remains principally with the taxpayer, especially where the taxpayer has taken an active and controlling role regarding the information that is used for the preparation of the returns. See Medlin v. Commissioner, T.C. Memo. 2003-224, affd. 138 Fed. Appx. 298 (11th Cir. 2005). Petitioners cannot blame their return preparers for the substantial errors in reporting their tax liability for 1997 when petitioner, who alone possessed the information that would have indicated potential discrepancies between petitioners' actual tax liabilities and the amounts reported on their returns, provided the accountants with misleading information and documentation regarding the nature of disbursements out of T.J. Construction. See Bacon v. Commissioner, T.C. Memo. 2000-257, affd. without published opinion 275 F.3d 33 (3d Cir. 2001). Furthermore, petitioner's failure to inform the accountants, despite regular meetings with them, of the existence of the cash advances from petitioner to Phillips or that Phillips was endorsing checks received from T.J. Construction back to petitioner, who was then depositing those funds in petitioners' personal bank account, is indicative of fraud. See Medlin v. Commissioner, supra; Ishler v. Commissioner, T.C. Memo. 2002-79.
Petitioners cite McGowan v. Commissioner, T.C. Memo. 2004-146, affd. 187 Fed. Appx. 915 (11th Cir. 2006), in support of their contention that the errors on petitioner's tax returns are due to confusion between petitioner and his accountants, and not fraudulent intent. We have found, for the reasons stated above, that the errors were deliberately designed by petitioner and were coupled with several other indications of fraudulent intent.
As outlined above, the evidence indicates the fraudulent intent of both petitioner and Mrs. Kosinski with regard to the overstatement of cost of goods sold and understatement of their taxable income for 1997. Petitioners have not proven that any part of the underpayments was not attributable to fraud. See sec. 6663(b). On consideration of the entire record, we conclude that petitioners are liable for the fraud penalty determined under section 6663(a).
.

Back Taxes: The Internal Revenue Service is always looking for ways to improve taxpayer compliance with current tax laws. Two ways the IRS enforces compliance include examinations and collections. Here is some helpful information for you about IRS examination and collection activities:

When selecting taxpayer returns for examination, the IRS pays special attention to taxpayer categories that have, in the past, demonstrated a high degree of noncompliance. This means that small businesses like yours, as well as self-employed individuals, are always under scrutiny. Make sure you report your income and expenses correctly and file all of your returns on time to help stay in compliance with current tax laws.

In matters of examination and collection, the earlier you address ant tax issue, the better. The only thing waiting will accomplish is to increase any interest and penalties that you may owe.

If you have not filed federal tax returns for up to six years, and if you have not received any notices from the IRS, then you can opt to use the voluntary disclosure program. You will still owe taxes – and possibly interest and penalties, as well – but voluntary disclosure will allow you to avoid criminal prosecution.

set up an online payment agreement with the IRS if you owe $25,000, or less, and if all of your returns have been filed. You can check out the rest of the terms for an online payment agreement on the IRS Web site: www.irs.gov.
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Tax Help: IRS guidance has been announced for the return preparer penalty provisions of Code Sec. 6694, as amended by the Small Business and Work Opportunity Act of 2007 (P.L. 110-28) (the Small Business Tax Act). The Small Business Tax Act expanded the income tax return preparer penalties to apply to all tax return preparers, including preparers of estate, gift, and generation-skipping transfer (GST) tax returns. The amendments also altered the standards of conduct that a return preparer must meet to avoid imposition of the penalty. The "realistic possibility" standard for undisclosed positions was replaced by an "unreasonable position" standard.

In addition, the Small Business Tax Act of 2007 increased the amount of the return preparer penalty for the understatement of a tax liability from $250 to the greater of $1,000 or 50 percent of the income derived (or to be derived) by the preparer with respect to the return or refund claim. The return preparer penalty for an understatement of tax liability due to willful or reckless conduct was increased under the new law from $1,000 to the greater of $5,000 or 50 percent of the income derived (or to be derived) by the preparer with respect to the return or refund claim. The IRS is considering the type of guidance necessary to address the changes made by the Small Business Tax Act. In the interim, for estate, gift, and GST tax returns, the reasonable basis standard provided in the regulations issued under Code Sec. 6662, without regard to the disclosure requirements contained therein, will be applied in determining whether the IRS will impose a penalty under Code Sec. 6694(a). The transitional relief is effective as of May 25, 2007. See IRS Notice 2007-54, to be published in I.R.B. 2007-27, July 2, 2007. Notice 2007-54 states:


This notice provides guidance and transitional relief for the return preparer penalty provisions under section 6694 of the Internal Revenue Code, as amended by the Small Business and Work Opportunity Act of 2007.



SCOPE

The transitional relief provided by this notice will apply to all returns, amended returns, and refund claims due on or before December 31, 2007 (determined with regard to any extension of time for filing); to 2007 estimated tax returns due on or before January 15, 2008; and to 2007 employment and excise tax returns due on or before January 31, 2008.



BACKGROUND

The Small Business and Work Opportunity Act of 2007, Pub. L. No. 110-28, 121 Stat. ___, (the Act) was enacted into law on May 25, 2007. Section 8246 of the Act amends several provisions of the Code to extend the application of the income tax return preparer penalties to all tax return preparers, alter the standards of conduct that must be met to avoid imposition of the penalties for preparing a return which reflects an understatement of liability, and increase applicable penalties. The amendments are effective for tax returns prepared after the date of the enactment, May 25, 2007.

The amendments made by the Act raise questions regarding activities representing preparation of a tax return, who is a return preparer within the meaning of section 7701(a)(36) (as amended), and how the statute applies to signing and non-signing preparers. In order to address these questions, the Internal Revenue Service and the Treasury Department are considering whether regulations or other published guidance are needed, including but not limited to, amendments to Treas. Reg. sections 301.7701-15 and 1.6694-0 through 1.6694-4. Because the Act extends the types of returns subject to the new provisions, changes are also required to the relevant forms and publications. The Service must also alter existing procedures in order to process disclosures with certain forms and in electronic formats. Because the amendments to section 6694 are effective immediately for returns prepared after May 25, 2007, the Service and the Treasury Department believe that effective tax administration requires transitional relief with respect to the new standards of conduct under section 6694(a).



PENALTY UNDER SECTION 6694

Prior to amendment by the Act, the penalty under section 6694(a) applied if:

(1) any part of an understatement of liability with respect to any return or claim for refund is due to a position for which there was not a realistic possibility of being sustained on its merits,

(2) any person who is an the income tax return preparer with respect to such return or claim knew (or reasonably should have known) of such position, and,

(3) such position was not disclosed as provided in section 6662(d)(2)(B)(ii) or was frivolous.

Prior to amendment by the Act, the penalty under section 6694(b) applied if any part of an understatement was due to:
(1) a willful attempt in any manner by an income tax return preparer to understate the liability for tax; or

(2) to any reckless or intentional disregard of rules or regulations by an income tax return preparer.

Section 8246 of the Act amended several provisions of the Code to extend the scope of the income tax return preparer penalties to preparers of all tax returns, amended returns and claims for refund, including estate and gift tax returns, generation-skipping transfer tax returns, employment tax returns, and excise tax returns. The Act amended section 6694(a) to provide that the penalty would apply if:

(A) the tax return preparer knew (or reasonably should have known) of the position,

(B) there was not a reasonable belief that the position would more likely than not be sustained on its merits, and

(C)(i) the position was not disclosed as provided in section 6662(d)(2)(B)(ii), or

(ii) there was no reasonable basis for the position.

Although the Act did not alter the standard of conduct under section 6694(b), it increased the amount of the penalty and made the penalty applicable to all tax return preparers.

Section 8246 of the Act amends the standards of conduct under section 6694(a) in two ways. First, for undisclosed positions, the Act replaces the realistic possibility standard with a requirement that there be a reasonable belief that the tax treatment of the position would more likely than not be sustained on its merits. Second, for disclosed positions, the Act replaces the not-frivolous standard with the requirement that there be a reasonable basis for the tax treatment of the position.

The Act also increased the first-tier section 6694(a) penalty for understatements from $250 to the greater of $1000 or 50% of the income derived (or to be derived) by the tax return preparer from the preparation of a return or claim with respect to which the penalty was imposed. The Act increased the second-tier section 6694(b) penalty for willful or reckless conduct from $1000 to the greater of $5,000 or 50% of the income derived (or to be derived) by the tax return preparer.

Under both the prior and current law, disclosure under section 6694(a) is adequate if made on a Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement, attached to the return, amended return, or refund claim, or pursuant to the annual revenue procedure authorized in Treasury Regulation sections 1.6694-2(c)(3) and 1.6662-4(f)(2). In addition, under both the prior and current law, the penalty under section 6694(a) would not be imposed if it is shown that there is reasonable cause for the understatement and the tax return preparer acted in good faith.



TRANSITIONAL RELIEF

In order to provide sufficient time to address issues pertaining to the implementation of the Act, the Service is providing the following transitional relief: For income tax returns, amended returns, and refund claims, the standards set forth under the previous law and current regulations under section 6694 will be applied in determining whether the Service will impose a penalty under section 6694(a). Generally, in applying transitional relief for income tax returns, amended returns or refund claims, disclosure would be adequate if made on a Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement, attached to the return, amended return, or refund claim, or pursuant to the annual revenue procedure authorized in Treasury Regulation sections 1.6694-2(c)(3) and 1.6662-4(f)(2).

For all other returns, amended returns, and claims for refund, including estate, gift, and generation-skipping transfer tax returns, employment tax returns, and excise tax returns, the reasonable basis standard set forth in the regulations issued under section 6662, without regard to the disclosure requirements contained therein, will be applied in determining whether the Service will impose a penalty under section 6694(a).

This transitional relief will apply to all returns, amended returns, and refund claims due on or before December 31, 2007 (determined with regard to any extension of time for filing); to 2007 estimated tax returns due on or before January 15, 2008; and to 2007 employment and excise tax returns due on or before January 31, 2008.

No transitional relief is available under section 6694(b) as transitional relief is not appropriate for return preparers who exhibit willful or reckless conduct, regardless of the type of return prepared.



EFFECTIVE DATE

This Notice is effective as of May 25, 2007.