Tax Attorney: Trading stocks can be a "business"

Even though the investor in this case did not qualify as having been engaged in a business, the Court outlined the standards it uses in determining whether the person's stock activities is a business activity.

Stanley C. Cameron v. Commissioner.Dkt. No. 21726-05 , TC Memo. 2007-260, August 30, 2007.[Appealable, barring stipulation to the contrary, to CA-10. --

Investors and traders. --
A taxpayer's stock, option and futures trading activities did not rise to the level of a trade or business; therefore, the expenses he incurred were not business expenses. The taxpayer also failed to establish that his expenses were incurred for the production of income. During the two years at issue, there were only two months during which the taxpayer conducted trading activity on more than ten days. The taxpayer's trading activities were not frequent, regular or continuous enough to cause the taxpayer to be in the trade or business of being a trader; instead, he was an investor. Moreover, during one of the years, the taxpayer collected unemployment insurance, which further demonstrated that he was not in a trade or business. The taxpayer's deduction of "continuing education" expenses for supplies, books, software, online services, and costs of travelling to and attending classes and seminars was denied because he did not demonstrate that these expense were incurred for the production of income. The seminar and class expenses were also disallowed under FINDINGS OF FACT
Some facts have been stipulated and are so found. The stipulated facts and the exhibits submitted therewith are incorporated herein by this reference. Petitioner resided in Colorado Springs, Colorado, when his petition was filed.
Petitioner holds a bachelor's degree in accounting and began investing in the stock market in 2001. In 2002, he developed software as an employee of Analysts International and was paid wages of $28,543. In January 2002, he suffered severe injuries from a car accident which left him unable to work for 4 months. In August 2002, he received a settlement of $71,553 (after the payment of legal fees and other expenses) as to the accident. Afterwards, he ceased his employment and began trading in the market to a greater extent. He purchased software and opened brokerage accounts to enable him execute trades quickly.
Petitioner's 2002 trading activity was conducted through Datek, a brokerage subsequently acquired by Ameritrade. In 2002, petitioner made 46 purchases totaling $26,108 and 14 sales totaling $17,004. At the close of 2002, his brokerage account was worth $11,774. On a Schedule D, Capital Gains and Losses, attached to his 2002 Federal income tax return, petitioner reported that he had realized a $2,127 capital gain from 11 sales. As reported, six transactions had a holding period of less than 61 days, and three of the transactions had a holding period of less than 31 days. The holding periods of the remaining 2 of the 11 transactions were not available. The proceeds received on each of the transactions ranged from a high of $5,739 to a low of $529.
Petitioner also included with his 2002 tax return a Schedule C, Profit or Loss from Business, reporting that he had a sole proprietorship named "Cameron Enterprises", the principal business of which was "Cameron Trading". The 2002 Schedule C reported that the business had received gross income of ($18), after taking into account $59 for cost of goods sold reported as a withdrawal for petitioner's personal use.1 The Schedule C reported that the business paid $200 for "office expenses", $28 for "supplies", and $12,211 for "continuing education". Petitioner's 2002 tax return reported that petitioner was entitled to deduct the $12,457 business loss (negative $18 of gross income less the sum of $200, $28, and $12,211) to arrive at his gross income.
In 2003, all of petitioner's trading activity was conducted through Datek/Ameritrade, OptionsXpress, and Trade Station Securities, Inc. In 2003, petitioner made 109 purchases totaling $79,409 and 103 sales totaling $89,204. His brokerage account at the end of 2003 was worth $10,287, and his futures account was worth $2,541. On his 2003 Schedule D, he reported 65 sales totaling $88,799. He also reported on Form 6781, Gains and Losses from section 12562 contracts marked to market. Petitioner held 30 futures contracts for 1 to 30 days. He held 21 futures contracts for 31 to 60 days. He held seven futures contracts for 60 to 90 days. He held seven futures contracts for 91 to 180 days. Petitioner's 2003 Schedule C for Cameron Enterprises reported that its "principal business or profession" was "SERVICE MARKET TRADI". The Schedule C reported no income from the business and expenses totaling $8,797. The expenses consisted of $959 for travel, $6,043 for continuing education, and $1,795 for "ongoing services". Also in 2003, petitioner reported receiving unemployment compensation of $11,971.
During the years at issue, petitioner did not conduct trades 5 days a week. Of the years at issue, there were only 2 months in which petitioner conducted trading activity on more than 10 days. On the days he was not conducting trades, petitioner was maintaining a cash position.
Petitioner's continuing education expenses for 2002 and 2003 were attributable to his attending seminars related to his trading activities. These expenses consisted of amounts spent on supplies, books, journals, computer software, online services, classes, seminars, travel, and meals.
Respondent determined in the notice of deficiency that the $200 and $28 expenses deducted for 2002 were deductible under section 162(a). Respondent argues that petitioner did not trade his securities in a trade or business and, to the extent that his expenses are deductible, they are deductible as "below the line" deductions pursuant to 3
In determining whether a taxpayer's trading activities constituted a trade or business, courts have distinguished between "traders" and "investors". Moller v. United States , 721 F.2d 810, 813 (Fed. Cir. 1983); see also Levin v. United States, 220 Ct. Cl. 197, 597 F.2d 760, 765 (1979). Management of securities investments, regardless of the extent and scope of such activity, is seen as the work of a mere investor, "not the trade or business of a trader." Estate of Yaeger v. Commissioner, supra at 34; see also Whipple v. Commissioner, 373 U.S. 193, 202 (1963); Higgins v. Commissioner, supra at 217; Paoli v. Commissioner, supra; Beals v. Commissioner, T.C. Memo. 1987-171. This result is the same notwithstanding the amount of time the individual devotes to the activity. Mayer v. Commissioner, supra. Even "full-time market activity in managing and preserving one's own estate is not embraced within the phrase `carrying on a business,' and * * * salaries and other expenses incident to the operation are not deductible as having been paid or incurred in a trade or business." Commissioner v. Groetzinger , supra at 30. Instead, an investor's expenses may be deductible under 4 As to the first requirement, we find petitioner's trading activity was not substantial. Courts consider the number of executed trades in a year and the amount of money involved in those trades when evaluating whether a taxpayer's trading activities were substantial. See, e.g., Mayer v. Commissioner, supra; Paoli v. Commissioner, supra. In Paoli, the Court held trading activities were substantial when the taxpayers traded stocks or options worth approximately $9 million. In Mayer, the Court considered over 1,100 executed sales and purchases in each of the years at issue there to be substantial trading activity. Trading activity was found to be insubstantial when a taxpayer executed at most 83 purchases and 41 sales in one year and 76 purchases and 30 sales in the second year. Moller v. United States , supra at 813.
In 2002, petitioner's trading activity consisted of 46 purchases and 14 sales. In 2003, he completed 109 purchases and 103 sales. During the years at issue, petitioner did not trade 5 days a week. Of the years at issue, he traded on more than 10 days in a given month only twice. We also note that petitioner's collecting unemployment compensation during 2003 further undermines his argument that he was engaged in a trade or business during that year. We conclude that petitioner was not engaged in a trade or business of trading securities during the years at issue and thus that his expenses related to his trading activities are not deductible under section 274(h)(7), which disallows any deduction under Decision will be entered for respondent.1 With the exception of this $59 withdrawal, the Schedule C reports no item for cost of goods sold.2 Unless otherwise indicated, section references are to the Internal Revenue Code, and Rule references are to the Tax Court Rules of Practice and Procedure.3 Under sec. 7491, and we find that section is inapplicable to this case.4 In contrast to trade or business expenses, a taxpayer's investment-related expenses that are deductible under sec. 67(a) and do not reduce alternative minimum taxable income.

Alvin S. Brown, Esq

Tax attorney

703 425-1400 ex 106

www.irstaxattorney.com

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Back Taxes: Personal travel expenses v. business travel expenses


Travel, lodging and per diem expenses incurred by a pilot and paid by his employer were wages and subject to withholding. The expenses did not qualify as a working condition fringe benefit since the pilot was not entitled to deduct those expenses because they were not incurred while away from home or in the pursuit of a trade or business.

The distinction between personal expenses and business expenses was relevant to the determination of whether the expenses were incurred in the business of the employer under Reg. Sec. 31.3121(a)-1(h).

The expenses were properly considered to be wages because they constituted personal expenses paid for the pilot to commute from his home in Minnesota to work in Alaska. The employer did not require that he live in Minnesota; rather, that was his personal choice.


Marc Jordan, Appellant v. United States of America, Appellee. U.S. Court of Appeals, 8th Circuit; 06-2443, June 21, 2007.Affirming a DC Minn. decision, Code Secs. 132, 3401]Wages: FICA taxes: Personal expenses: Business expenses: Traveling expenses: Away-from-home expenses. --


Before: Wollman and Murphy, Circuit Judges, and Nangle, District Judges.Before WOLLMAN and MURPHY, Circuit Judges, and NANGLE, 1 District Judge.WOLLMAN, Circuit Judge: Marc Jordan appeals from the district court's 2 grant of summary judgment in favor of the United States on his claim for a refund of Federal Insurance Contributions Act (FICA) taxes withheld by his employer, Atlas Air, Inc. (Atlas). We affirm.

I.Jordan is employed as a pilot for Atlas, a company that provides aircraft, crew, maintenance, and insurance services for the transportation of air cargo, as well as charter operations for airlift services to commercial customers and the United States military. Atlas operates out of bases in California, New York, Alaska, and Florida. Pursuant to a collective bargaining agreement (CBA), Atlas has the discretion to reassign its crewmembers to the various bases for a number of reasons, including shifts in manpower, furloughs, or reductions in the number of crewmembers employed by Atlas. Jordan was assigned to work out of the operational base in Anchorage, Alaska, in January 2001 and continued to work there through the period at issue - the quarter ending on June 30, 2003. During this time, Jordan resided in Bemidji, Minnesota. Atlas, in accordance with the terms of the CBA, provided him with transportation from Bemidji to Anchorage at the beginning of each work assignment and then back to his residence in Bemidji at the end of each work assignment. In addition, Atlas provided Jordan with lodging and a per diem for meals and incidental expenses while he was in Alaska. The parties refer to these travel, lodging, and per diem expenses as "gateway expenses."In June 2003, Atlas began withholding income and FICA taxes on the value of the gateway expenses it paid on behalf of its crewmembers. Jordan subsequently filed an administrative claim for a refund of $110.42 -the amount of FICA taxes that were withheld from his paycheck in the second quarter of 2003 based on the value of the gateway expenses he received. After the IRS took no action on his claim, Jordan filed this suit requesting a refund of the specified amount. The government subsequently moved for summary judgment, asserting that Atlas had correctly determined that the gateway expenses were wages and therefore subject to withholding. In response, Jordan moved for summary judgment and also opposed the government's motion, asserting that a genuine issue of material fact existed as to whether the gateway expenses constituted wages. The district court granted summary judgment to the government, concluding that the expense payments were properly considered to be wages and that Jordan was therefore precluded from receiving a refund.

II.On appeal, Jordan contends that summary judgment was improper because the gateway expenses were not wages and therefore not subject to withholding. Jordan alternatively argues that summary judgment was inappropriate because the evidence established a genuine issue of material fact. "We review a grant of summary judgment de novo " and will "affirm when the record, viewed in the light most favorable to the non-moving party, demonstrates that there are no genuine issues of material fact and that the moving party is entitled to judgment as a matter of law." Frosty Treats, Inc. v. Sony Computer Ent. Am., Inc., 426 F.3d 1001, 1003 (8th Cir. 2005).The Internal Revenue Code (IRC) requires individuals to pay FICA taxes on wages received from employment. 26 U.S.C. §3121(a) (2007). This term does not include, however, "any benefit provided to or on behalf of an employee if at the time such benefit is provided it is reasonable to believe that the employee will be able to exclude such benefit from income under section...132." 26 U.S.C. §132(a)(3), the only section 162 or §132(d). §162(a)(2) (2007). Under this framework, then, the gateway expenses should not have been classified as wages for the purposes of FICA tax withholding if Jordan could have deducted these expenses under 3 The gateway expenses at issue here were therefore not incurred "while away from home" and are not deductible under §162 because they were not incurred "in the pursuit of a trade or business." An employee's expenses in commuting from home to work are generally considered to be personal, and not deductible business expenses. Comm'r v. Flowers, 326 U.S. 465, 473-74 (1946); H B & R, Inc. v. United States, 229 F.3d 688, 690 (8th Cir. 2000). "The exigencies of business rather than the personal conveniences and necessities of the traveler must be the motivating factors" for the travel. Flowers, 326 U.S. at 474. As the district court noted, the gateway expenses in this case were incurred as a result of Jordan's personal desire to maintain a home in Bemidji. Atlas did not require him to live in Bemidji and did not gain anything by having him live there. Moreover, Jordan could have lived in Anchorage had he so desired, and he was encouraged to do so. The exigencies of business were therefore not the motivating factors for Jordan's travel to and from Anchorage, and the costs associated with this travel are not deductible under 4 After determining that none of the exclusions to the definition of wages found in §3401(a) (applicable for income tax withholding purposes) were applicable, the court turned to the corresponding Treasury Regulations, 26 C.F.R. §§31.3121(a)-1(h) and 31.3401(a)-1(b) (which are nearly identical). Section 31.3121(a)-1(h), which applies to FICA tax withholding, states:

Amounts paid specifically --either as advances or reimbursements --for traveling or other bona fide ordinary and necessary expenses incurred or reasonably expected to be incurred in the business of the employer are not wages....For amounts that are received by an employee on or after July 1, 1990, with respect to expenses paid or incurred on or after July 1, 1990, see §31.3121(a)-3.Based on these regulations, the court in H B & R concluded that employee traveling expenses are excluded from the term wages "so long as the expense is ordinary and necessary to the business of the employer." H B & R, 229 F.3d at 691. The court went on to conclude further that "viewed from the perspective of H B & R at the time the withholding decision was made, the employee airfare expenses were incurred regularly and necessarily in the business of providing hot oil services to North Slope oil producers" and, as a result, H B & R was not liable for failing to withhold FICA taxes on such expenses. Id. Based on this analysis, Jordan asserts that the district court should have examined whether the gateway expenses paid by Atlas were ordinary and necessary to its business and that such expenses were in fact ordinary and necessary to Atlas's business. We find Jordan's argument unpersuasive.As the government points out, the last sentence of §31.3121(a)-1(h) provides that 26 C.F.R. §31.3121(a)-3 is applicable when travel expenses are paid after July 1, 1990, such as those at issue here. Under the framework established by §31.3121(a)-3, various income tax provisions are incorporated into the determination of whether expenses are excluded from wages. 5 These include 26 C.F.R. §162, which, as recounted in our analysis above, requires that those expenses be incurred "while away from home in the pursuit of a trade or business." In H B & R, we acknowledged that the reference to §31.3121(a)-3 in §31.3121(a)-1(h) might have an effect on our analysis under §31.3121(a)-1(h) by essentially incorporating the income tax distinctions between personal expenses and business expenses when determining whether expenses were ordinary, necessary, and incurred in the business of the employer. H B & R, 229 F.3d at 691 & n.1. We declined to decide the issue, however, because the Commissioner failed to fully argue the point. Id. at 691 n.1. In addition, we were hesitant to incorporate this interpretation and impose a liability on H B & R, Inc. when it did not appear that a withholding obligation had ever been imposed in this type of situation. Id. at 691-92.Now that this point has been fully argued before us, however, and because Atlas is actually withholding FICA taxes, rather than failing to do so, we conclude that the reference to §31.3121(a)-3 in §31.3121(a)-1(h) does in fact have a bearing upon our analysis. The framework set forth in §31.3121(a)-3 incorporates income tax provisions that, among other things, require the expenses to be "incurred by the employee in connection with the performance of services as an employee of the employer," and "while away from home in the pursuit of a trade or business." 26 C.F.R. §162. As recounted earlier in this opinion, commuting expenses have been classified as personal expenses, rather than business-related expenses, in this context. See H B & R, 229 F.3d at 690. As a result, we conclude that for expenses paid after July 1, 1990, the income tax distinctions between personal expenses and business expenses are relevant in determining whether expenses are incurred in the business of the employer under §31.3121(a)-1(h).Based on this framework, then, our earlier analysis under §162, as they constituted personal, rather than business, expenses. Accordingly, the district court did not err in concluding that they were properly considered wages.The judgment is affirmed.1 The Honorable John F. Nangle, United States District Judge for the Eastern District of Missouri, sitting by designation.2 The Honorable Joan N. Ericksen, United States District Judge for the District of Minnesota.3 Jordan contends that his employment in Anchorage, Alaska, should be considered temporary because Atlas had the discretion to reassign its crewmembers to various bases at any time and has done so in the past.4 H B & R, Inc. provided "hot oil" and other services to oil producers on Alaska's North Slope. H B & R, 229 F.3d at 689. Because of the severe climate and security concerns, no one lived near the North Slope oil fields.

Id. Most of H B & R, Inc.'s employees chose to live in the lower 48 states and would travel to and from the North Slope on a three-week-on/three-week-off schedule. Id. H B & R, Inc. would transport its employees from their homes in the lower 48 states to the North Slope by providing round-trip commercial airline tickets from the employees' homes to Alaska. Id.5 As set forth in 26 C.F.R. §31.3121(a)-3(a), travel expenses must meet the requirements set forth in 26 U.S.C. §1.62-2, to be excluded from wages. section 161 and the following), subchapter B, chapter 1of the Code, and...are paid or incurred by the employee in connection with the performance of services as an employee of the employer." 26 C.F.R. §162 allows a taxpayer to deduct traveling expenses incurred "while away from home in the pursuit of a trade or business...."


Alvin S. Brown, Esq.
Tax attorney
703.425.1400

www.irstaxattorney.clm

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Tax Help: An Offer in Compromise is a contract


There was no Offer in Compromise settlement agreement because there was no enforceable contract to settle his outstanding tax liabilities. The IRS agent's written reply to the individual's offer did not constitute a valid offer or counteroffer that could be accepted by the individual to create a binding contract with the IRS. Moreover, the IRS agent was not authorized to enter into any such contract with the individual.


Dennis W. Jordan, Plaintiff v. The United States, Defendant.

U.S. Court of Federal Claims; 06-96C, July 30, 2007.[ Code Sec. 7122]Jurisdiction: Settlement offer: Breach of contract. --

Factual Background 1

Plaintiff Mr. Jordan has outstanding federal tax liabilities for 1999 ($20,946.04) and 2000 ($17,254.83), plus penalties and interest. Complaint, ¶ ¶3, 4. On March 12, 2002, the IRS received a Form 656 "Offer in Compromise" from Mr. Jordan to settle these tax liabilities for $10,000. Defendant's Appendix ("Deft's App.") at 1-4. Mr. Jordan claimed that he was unable to pay the tax liabilities in full. Id. at 3. On May 19, 2003, an IRS Offer Specialist, Ms. Marianna Caldera, responded to Mr. Jordan by stating that "we cannot accept an offer for less than $12,721.00 for a cash offer (payable within 90 days)." Ms. Caldera further stated that "[i]f you do not respond to this letter within 14 days of the date of this letter, your offer cannot be recommended for acceptance, and a Federal Tax Lien will be filed." Id. at 5 (emphasis in original).By letter dated May 30, 2003, Mr. Jordan submitted a revised Form 656 "Offer in Compromise" to the IRS stating that he would pay $12,721.00 to settle his 1999 and 2000 tax liabilities. Complaint, Exh. C. Mr. Jordan also sent a check to the IRS for $12,721.00 on August 18, 2003 representing what he believed was the agreed upon payment. Deft's App. at 18-20. Thereafter, from a review of records provided by Mr. Jordan, Ms. Caldera learned that Mr. Jordan's financial condition would improve as of October 2003 when his obligation to pay his former wife monthly support payments of $3,000.00 expired. Deft's App. at 24-27. By letter dated August 15, 2003, Ms. Caldera informed Mr. Jordan of the IRS's preliminary analysis that Mr. Jordan had "the ability to pay [his] liability in full within the time provided by law." Id. at 14-15. For this reason, the IRS considered but ultimately rejected Mr. Jordan's $12,721.00 offer. IRS Transcript History, Plaintiff's Appendix ("Pltf's App.") at 19-20, 22.On March 2, 2004, an IRS Group Manager, Ms. Donna Seibel, officially rejected Mr. Jordan's $12,721.00 offer, stating that "[b]ased on the financial information you submitted, we have determined you can pay the amount due in full." Deft's App. at 21. On May 6, 2004, the IRS sent a check to Mr. Jordan for $12,721.00 drawn upon the United States Treasury. Complaint ¶18. On May 24, 2004, through his counsel, Mr. Jordan appealed the IRS's rejection of his offer. Id. ¶19. The IRS Office of Appeals sustained the rejection of Mr. Jordan's offer on February 23, 2005. Deft's App. at 28.

Discussion

Whether The Parties Formed An Enforceable Contract
Setting aside the jurisdictional question of whether Mr. Jordan has properly stated a complaint for money damages, the Court will first consider Defendant's Rule 12(b)(6) motion for failure to state a claim upon which relief can be granted. For purposes of this discussion, the Court will assume that Plaintiff has properly alleged a breach of contract within the Court's jurisdiction. See, e.g., Gould, Inc. v. United States, 67 F.3d 925, 929 (Fed. Cir. 1995) ("[T]he court must assume jurisdiction to decide whether the allegations state a cause of action on which the court can grant relief as well as to determine issues of fact arising in the controversy. Jurisdiction, therefore, is not defeated...by the possibility that the averments might fail to state a cause of action on which petitioners could actually recover[.]") (citations omitted). With this assumption, the question to be decided is whether the IRS and Mr. Jordan entered into an enforceable contract settling Mr. Jordan's tax liability for 1999 and 2000.A review of the relevant correspondence reveals that the IRS did not at any time make an offer or counteroffer to Mr. Jordan, and thus Mr. Jordan was not in a position to create a binding contract through his acceptance. Although Mr. Jordan refers to Ms. Marianna Caldera's May 19, 2003 letter as a "counteroffer," and his response as an "acceptance" (Complaint ¶ ¶9, 10), the exchange between the parties does not support Mr. Jordan's contention. Ms. Caldera's letter on behalf of the IRS contains the following statements:
If the payment terms of your amended offer exceed ninety days, a notice of Federal Tax Lien will be filed....You may also provide any other information you believe we should consider in making a final determination as to whether to accept your offer ....Also, if your offer is accepted, your compliance will be monitored for 5 years. In that time, if you do not comply with all filing and paying requirements... your offer will be defaulted....If you do not respond within 14 days of the date of this letter, your offer cannot be recommended for acceptance ....[If] your offer is rejected you will receive information regarding how to appeal....
Complaint, Exh. B; Deft's App. at 5-6 (emphasis added). This letter on its face solicited an amended offer from Mr. Jordan, and did not itself constitute an IRS offer or counteroffer. Indeed, the IRS Form 656 that Mr. Jordan sent back to Ms. Caldera is entitled "Offer in Compromise." Deft's App. at 7. This exchange did not constitute a valid offer and acceptance. The IRS formally rejected Mr. Jordan's amended offer through the March 2, 2004 letter from an IRS Group Manager, Ms. Donna Seibel. Deft's App. at 21-23.Even if the May 19 and 30, 2003 exchanges between Ms. Caldera and Mr. Jordan could be regarded as a contract, the Court must examine whether Ms. Caldera possessed the authority to bind the IRS. In addition to the standard elements of offer, acceptance, and consideration, a valid contract with the Unites States requires authority "on the part of the government representative who entered or ratified the agreement to bind the United States in contract." Total Medical Management, Inc. v. United States, 104 F.3d 1314, 1319 (Fed. Cir. 1997). See also Trauma Serv. Group v. United States, 104 F.3d 1321, 1325 (Fed. Cir. 1997) ("A contract with the United States also requires that the Government representative who entered or ratified the agreement had actual authority to bind the United States.") (emphasis added).As Defendant notes, a government agent's apparent authority "is not sufficient to bind the government...even where the agent in question believed that he held such authority[.]" See Arakaki v. United States, 71 Fed. Cl. 509, 515 (2006) (citing City of El Centro v. United States, 922 F.2d 816, 820 (Fed. Cir. 1990)). When negotiating a contract with the Government, therefore, it is incumbent on a private party to determine whether his public counterpart has the necessary authority to bind the United States. See, e.g., Brooks v. United States, 70 Fed. Cl. 479, 486 (2006) (citing Fed. Crop Ins. Corp. v. Merrill, 332 U.S. 380 (1947)). Moreover, the risk of accurately assessing the scope of a government agent's authority is squarely on the private party. Merrill, 332 U.S. at 384 ("[A]nyone entering into an arrangement with the Government takes the risk of having accurately ascertained that he who purports to act for the Government stays within the bounds of his authority."). The private party retains this risk even where a Government agent displays apparent authority. Trauma Serv. Group, 104 F.3d at 1325) ("this risk remains with the contractor even when the Government agents themselves may have been unaware of the limitations on their authority."). This rule shields the Government from the acts of its own agents. Brooks, 70 Fed. Cl. at 486 (citing Flexfab, LLC v. United States, 424 F.3d 1254, 1263 (Fed. Cir. 2005) ("Surely the assurances from a government agent, having no authority to give them, cannot expose the government to risk of suit for the nonperformance of an obligation that it did not intentionally accept.")). Commensurate with this risk is a plaintiff's burden to prove the scope of the authority asserted. See Arakaki, 71 Fed. Cl. at 516.Here, as the IRS previously explained to Mr. Jordan, Ms. Caldera did not have the authority to enter into a contract with Mr. Jordan. Deft's App. at 28. The IRS Group Manager, Ms. Seibel, possessed the requisite authority, but in her only correspondence with Mr. Jordan, she rejected Mr. Jordan's amended offer. Id. at 21-23, March 2, 2004 letter. Thus, no person with authority to bind the IRS entered into a binding contract with Mr. Jordan.
The Supreme Court has held that "the manifest purpose of §7421(a) is to permit the United States to assess and collect taxes alleged to be due without judicial intervention, and to require that the legal right to the disputed sums be determined in a suit for refund." Enochs v. Williams Packing & Navigation Co., 370 U.S. 1, 7 (1962). Our Court has explained that "[i]n order to bring suit in this Court, the plaintiff must pay the taxes assessed, file a claim for refund with the IRS in accordance with [Internal Revenue Code] §7422(a), and then wait six months[.]" Lyashenko v. United States, 41 Fed. Cl. 626, 630 (1998). Thus, any apparent effort by Mr. Jordan to enjoin the IRS from collecting properly assessed taxes is contrary to law and must be rejected.The claim for relief in Mr. Jordan's Complaint also might be construed as seeking a declaratory judgment that he had a valid contract with the IRS which ought to be enforced, such as through specific performance. However, our Court is not authorized to grant a declaratory judgment or to direct specific performance in the circumstances presented here. Id. (explaining that the Court is generally proscribed from issuing declaratory judgments); Rig Masters, Inc. v. United States, 42 Fed. Cl. 369, 373 (1998) (citing United States v. King, 395 U.S. 1, 3-4 (1969) (Court does not possess jurisdiction over claims for specific performance)). The Anti-Injunction Act, explained above, prevents the Court from entertaining suits for a declaratory judgment or specific performance in tax matters.
Conclusion
Based upon the foregoing, Defendant's motion to dismiss under Rules 12(b)(1) and (b)(6) is GRANTED. For the reasons stated, the Court is treating Defendant's motion for failure to state a claim as a motion for summary judgment under Rule 56, and accordingly, summary judgment is entered for Defendant. The Clerk is directed to enter judgment for Defendant. No costs are awarded to either party.IT IS SO ORDERED.1 The facts in this matter are derived from the documents provided as attachments to Plaintiff's complaint, and in the appendices accompanying Defendant's motion and Plaintiff's response. The Court is satisfied that the facts necessary to decide this matter are not in dispute.





Christopher Cross, Inc., Plaintiff-Appellant v. United States of America, Defendant-Appellee. U.S. Court of Appeals, 5th Circuit; 05-30606, August 21, 2006, 461 F3d 610.Affirming an unreported DC La decision.[ Code Sec. 7122]Offer-in-compromise: Inadequate offer: Nonprocessable offer: Abuse of discretion. --
An IRS Appeals officer did not abuse her discretion when she refused a corporation's offer-in-compromise regarding its unpaid employment taxes. Her rejection of the offer as nonprocessable and inadequate was in accordance with the Internal Revenue Code and Treasury regulations. The corporation was not current on the payment of its estimated tax for the prior two periods. Its failure to timely pay taxes owed was a reasonable basis for the Appeals officer to reject its offer-in-compromise relating to other unpaid taxes. Further, whether or not the Appeals officer properly relied on the Internal Revenue Manual when making her determination, it was grounded in the discretion afforded to her by law.
Before: Jones, Chief Judge, Barksdale and Benavides, Circuit Judges.BENAVIDES, Circuit Judge: This case concerns whether an Internal Revenue Service ("IRS") appeals officer abused her discretion in returning an offer in compromise submitted by Christopher Cross, Inc. ("Taxpayer"). Specifically, Taxpayer challenges the appeals officer's reliance on the Internal Revenue Manual. For the reasons set forth below, we find that the appeals officer acted within her discretion in rejecting Taxpayer's offer in compromise. Therefore, we affirm the district court's dismissal of Taxpayer's claims.
I. BACKGROUND
The facts are undisputed. Taxpayer admittedly owes the IRS unpaid employment taxes for the periods ending March 31, 2002, June 2 30, 2002, September 30, 2002, and December 31, 2002. On December 10, 2002, the IRS issued to Taxpayer a Notice of Intent to Levy with respect to unpaid employment taxes, including penalties and interest, for the first three quarters of 2002. On May 5, 2003, the IRS issued Taxpayer another Notice of Intent to Levy with respect to unpaid employment taxes, including penalties and interest, for the fourth quarter of 2002. Taxpayer's assessed liability totaled $134,078. In response to each Notice of Intent to Levy, Taxpayer requested a Collection Due Process ("CDP") hearing. See I.R.C. §6330. IRS Appeals Officer Brenda Esser (the "Officer") conducted a CDP hearing respecting both Notices.On August 13, 2003, Taxpayer submitted an offer in compromise (the "Offer") with respect to employment taxes due for all four quarters. In the Offer, Taxpayer proposed to pay a total of $85,000 under a deferred-payment schedule. On September 10, 2003, the Officer returned Taxpayer's Offer, stating that, "[Taxpayer] failed to make its federal tax deposits timely for the entire two quarters prior to the quarter [Taxpayer] submitted the offer....Unless and until [Taxpayer] can demonstrate a willingness and ability to meet these circumstances, [Taxpayer] does not qualify for offer-in-compromise consideration."On the same day, the Officer issued a Notice of Determination upholding the proposed levy to collect unpaid employment taxes as set forth in the two Notices of Intent to Levy. Specifically, the Officer stated that (1) the IRS had met all statutory, procedural, and administrative requirements before issuing the Notices of Intent to Levy; (2) Taxpayer had not presented an acceptable payment alternative; and (3) the proposed levy balanced the need for efficient tax collection with Taxpayer's legitimate concern that the collection action be no more intrusive than necessary. Additionally, the Officer stated that Taxpayer's Offer was "nonprocessable" because Taxpayer had not timely made federal tax deposits and because Taxpayer had more than sufficient equity in its current accounts receivable and moveable assets to pay the tax debts at issue.Taxpayer filed suit seeking review of the Notice of Determination. In its complaint, Taxpayer alleged that the IRS had violated its statutory rights under the Internal Revenue Code by failing to consider the Offer. The Government subsequently filed a motion to dismiss, claiming, inter alia, that Taxpayer failed to state a valid claim upon which relief could be granted under Federal Rule of Civil Procedure 12(b)(6).The district court dismissed the case for failure to state a claim. It held that the IRS's procedures for declaring offers to compromise "nonprocessable" violated neither the Taxpayer's due process rights nor the Internal Revenue Code and that the Officer was within her discretion and authority to reject Taxpayer's offer to compromise. Taxpayer filed a motion for reconsideration, which the court denied. Taxpayer appeals.
III. DISCUSSION
A. Statutory Framework
Consideration of an offer in compromise submitted in the context of a CDP hearing is governed by section 7122 of the Internal Revenue Code, which sets out the exclusive method of compromising federal tax liabilities. See Olsen [ 2005-2 USTC ¶50,637], 414 F.3d at 153; I.R.C. §7122. Specifically, section 7122 provides that the "Secretary may compromise any civil or criminal case arising under the internal revenue laws prior to reference to the Department of Justice for prosecution or defense...." I.R.C. §7122(a) (emphasis added). The statute further specifies that the "Secretary shall prescribe guidelines for officers and employees of the [IRS] to determine whether an offer-in-compromise is adequate and should be accepted to resolve a dispute." I.R.C. §7122(c). The Treasury regulations state that "[t]he IRS may...return an offer to compromise a tax liability if it determines that the offer was submitted solely to delay collection or was otherwise nonprocessable." 26 C.F.R. §301.7122-1(d)(2). The Internal Revenue Manual (the "Manual") provides specific circumstances in which an offer is "nonprocessable." One such circumstance is when an in-business taxpayers has failed to timely deposit, file, and pay "all required employment tax returns for the two (2) preceding quarters prior to filing the offer...." I.R.M. §5.8.3.4.1(1)(a).
B. The Officer Did not Clearly Abuse her Discretion in Returning the Offer
Taxpayer argues that the Officer did not have the authority to return the Offer based upon a provision of the Manual, and, therefore, the Officer abused her discretion. We find no abuse of discretion. Even assuming the Manual is not law and assuming that an appeals officer should not rely upon the Manual in making its determination, the Officer in this case acted within her discretion. While the Officer cited the Manual in making her determination, we are not judging the appropriateness of that citation. Instead, we judge whether the Officer abused her discretion in returning the Offer.The Officer's determination was in accordance with the Internal Revenue Code and Treasury regulations. The Internal Revenue Code provides that the Secretary, through its agents, may compromise a civil case. See I.R.C. §7122(a). The statute also orders the Secretary to promulgate guidelines to assist the officers in determining the adequacy of an offer. I.R.C. §7122(c). The Treasury regulations provide those guidelines and state that a "nonprocessable" offer may be returned to the taxpayer. 26 C.F.R. §301.7122-1(d)(2).Here, the Officer acted under the power granted to her by the Internal Revenue Code to settle or not settle this civil case. See I.R.C. §7122(a). She determined that the Offer was inadequate because Taxpayer was not current on the payment of its estimated tax for two periods ending March 31, 2003 and June 30, 2003. See I.R.C. §7122(c). Based on this inadequacy, she returned the Offer as "nonprocessable" under the Treasury regulations. See 26 C.F.R. §301.7122-1(d)(2). The failure to timely pay owed taxes is a perfectly reasonable basis for rejecting an offer in compromise relating to other unpaid taxes. Whether or not she properly relied on the Manual, the Officer made a determination grounded in the discretion afforded to her by law and provided a reasonable basis for finding the Offer inadequate. 1 Therefore, the Officer did not clearly abuse her discretion in returning the Offer.Furthermore, Taxpayer has offered no viable support for its contention that the Officer cannot utilize the guidelines set forth in the Manual when making the discretionary decision to return a submitted offer in compromise. See Living Care [ 2005-1 USTC ¶50,395], 411 F.3d at 631. It therefore has "failed to present sufficient evidence to justify a remand." Id. In sum, the Officer did not clearly abuse her discretion in returning the Offer, and the record evinces no clear taxpayer abuse or unfairness by the IRS. See id.We find additional support for finding no clear abuse of discretion in Living Care. The Sixth Circuit, addressing whether the IRS may reject a plan to present an offer in compromise, unequivocally stated that the "taxpayer must be current on payments for the previous two quarters to be eligible to submit an offer in compromise." Living Care [ 2005-1 USTC ¶50,395], 411 F.3d at 630. Accordingly, it held that the "IRS was well within its discretion to reject [the taxpayer's] plan to present an offer in compromise." Id. at 631. We join the Sixth Circuit in finding no clear abuse of discretion where an appeals officer makes a "fully support[ed]" decision regarding the processability of an offer. 2 Id. at 630.
IV. CONCLUSION
Our review of the Officer's determination is for clear abuse of discretion. Under that standard, the Officer made a reasoned decision under the Internal Revenue Code and Treasury regulations. Moreover, Taxpayer has failed to present authority stating the contrary. Therefore, Taxpayer has not stated a claim upon which relief can be granted. Accordingly, we AFFIRM the dismissal of Taxpayer's claims.1 Additionally, the Officer supported her decision by finding the following: (1) the IRS had met all statutory, procedural, and administrative requirements before issuing the Notices of Intent to Levy; (2) Taxpayer had not presented an acceptable payment alternative; and (3) the proposed levy balanced the need for efficient tax collection with Taxpayer's legitimate concern that the collection action be no more intrusive than necessary.2 The Seventh Circuit similarly has held that an appeals officer's consideration of a taxpayer's failure to remit estimated tax was not an abuse of discretion when that appeals officer denied a second CDP hearing to a taxpayer who had failed to comply with a previous installment plan designed to eliminate tax liabilities. See Orum v. Comm'r [ 2005-2 USTC ¶50,444], 412 F.3d 819, 820-21 (7th Cir. 2005). Although the officer in Orum relied on the failure to remit estimated tax and here the Officer relied on the failure to timely remit, the Seventh Circuit's holding is persuasive in determining that such reliance is a valid reason for an appeals officer's decision and within the officer's discretion.


Living Care Alternatives of Utica, Inc., Plaintiff-Appellant v. United States of America, Internal Revenue Service, Defendant-Appellee. U.S. Court of Appeals, 6th Circuit; 04-3194/3554, June 2, 2005, 411 F3d 621.Affirming DC Ohio, 2004-1 USTC ¶50,167 and 2004-1 USTC ¶50,225.[ Code Sec. 6330]Hearing before levy: Collection Due Process hearing: Standard of review: Adequacy of record: Offer-in-compromise. --
Federal district courts, which reviewed Collection Due Process (CDP) determinations issued by IRS Appeals officers using an abuse of discretion standard, were not required to use a de novo standard because the taxpayer, a nursing home, did not challenge the underlying tax liabilities in the CDP hearings. The nursing home's argument that it was bad public policy to require it to pay taxes when it lacked the financial ability to meet federal regulatory standards governing the care of patients and its request to "remove" the tax liability were not challenges to the validity of the underlying liability. The reports issued by the Appeals officers in connection with their determinations included sufficient information to provide a basis for an abuse of discretion review. Furthermore, the refusal of the IRS to accept the nursing home's offers in compromise was not an abuse of discretion for numerous reasons, including the apparent failure to file the proper forms and financial information, its financial difficulties, and a previous default on an installment payment plan. It was also not necessary for the Appeals officers to consider whether the IRS would receive any revenue from the levy and sale of the nursing home's property due to existing liens of superior creditors, or whether the nursing home would have to close down due to the levy and sale. These considerations are properly made after the determination of the Appeals officer in a CDP hearing when the decision to actually levy upon the property is made. Back references: ¶38,184.11 and ¶38,184.60.
Carla I. Struble, for plaintiff-appellant. Robert J. Branman, Rachel I. Wollitzer, Jonathan S. Cohen, Department of Justice, for defendant-appellee.
Before: Keith, Merritt and Clay, Circuit Judges.
OPINION
MERRITT, Circuit Judge: This opinion addresses separate appeals from two district court cases involving the same parties and almost identical issues. Plaintiff, Living Care Alternatives of Utica, Inc. ("Living Care"), appeals district court decisions affirming the Internal Revenue Service's Appeals Office decisions to allow tax liens and levies on Living Care's property for unpaid employment taxes for various periods between 1995 and 2001. These appeals require an interpretation of the new Internal Revenue Service Restructuring and Reform Act of 1998, Pub. L. No. 105-206, 112 Stat. 685. For the reasons set forth below, we affirm.
SUMMARY OF FACTS
Living Care owns and operates a nursing home facility in Licking County, Ohio, which has approximately thirty-five beds and forty employees and receives ninety percent of its revenue from Medicare and Medicaid billing. This revenue totals approximately $100,000 per month. Since the mid-1990's, Living Care has struggled to comply with its tax obligations. The taxes at issue in the instant cases are payroll taxes withheld from employees' paychecks and held in trust by the employer until payments are made to the government. From 1995 to 2001, Living Care has intermittently failed to forward the required taxes to the IRS. (Living Care I, Case No. 04-3194 involves annual payments for tax year 1999 and quarterly payments in 1999 and 2001; Living Care II, Case No. 04-3554 involves annual payments for tax years 1995, 1998 and 2000 and quarterly taxes for various quarters in 1995, 1996, 1999, 2000 and 2001). 1 Under a previous levy around 1996 or 1997, Living Care entered into an installment agreement with the IRS, but defaulted in 1999. The total current liability (including interest and penalties) is approximately $450,000, although Living Care points out it has paid its newly accrued taxes since July 2002.In May 2001 and May 2002, the government sent Notices of Federal Tax Liens and Notices of Intent to Levy to Living Care, along with a notice of the taxpayer's right to request a hearing before the IRS Appeals Office, which the taxpayer timely invoked. Collection due process hearings were conducted by phone in March 2002 (Living Care II, Case No. 04-3554) and December 2002 (Living Care I, Case No. 04-3194). Notice of Determination letters denying Living Care's claims were mailed June 2002 and March 2003, respectively. Living Care appealed these decisions separately to the District Court for the Southern District of Ohio. In both cases, which were heard by different judges, the courts affirmed the IRS. 2 See Living Care Alternatives of Utica, Inc. v. United States ( Living Care I), No. 02:03-CV-0359, 2003 WL 23311523 (S.D. Ohio Dec. 12, 2003); Living Care Alternatives of Utica, Inc. v. United States (Living Care II) [ 2004-1 USTC ¶50,225], 312 F.Supp.2d 929 (S.D. Ohio 2004). Living Care now appeals these decisions.
ANALYSIS
I. Judicial Review of Collection Due Process Proceedings
Collection due process hearings were created by the Internal Revenue Service Restructuring and Reform Act of 1998, Pub. L. No. 105-206, 112 Stat. 685 ("the Restructuring and Reform Act"). 3 The method or standards for judicial review of these hearings is not yet settled, hence the problems in these cases. Prior to this Act, the IRS had the right to levy on taxpayer property without any prior opportunity for a hearing or procedural due process, so long as post-deprivation procedures were provided. The Supreme Court sustained this approach almost seventy-five years ago. See Phillips v. Commissioner [ 2 USTC ¶743], 283 U.S. 589, 595 (1931). While passage of the Restructuring and Reform Act does indicate Congress's intent to provide taxpayers with additional protection in the form of procedures prior to IRS action, it must be interpreted in this historical context. Tax liens and levies are not typical collection actions; the IRS has much greater latitude and leeway than a normal creditor. See generally Leslie Book, The Collection Due Process Rights: A Misstep or a Step in the Right Direction? 41 Hous. L. Rev. 1145 (2004) (discussing the history of due process in tax collection proceedings).The Tax Code grants taxpayers the right to a hearing both on notice of lien and on notice of levy. See 26 U.S.C. §6320(b); 26 U.S.C. §6330(b). Proceedings are informal and may be conducted via correspondence, over the phone or face to face. See Treas. Reg. §601.106(c) & §301.6330-1, Q&A-D6. No transcript, recording, or other direct documentation of the proceeding is required. See id. §301.6330-1, Q&A-D6. Taxpayers do have a right to an impartial hearing officer "who has had no prior involvement with respect to the unpaid tax ... before the first hearing." 26 U.S.C. §6320(b)(3). A taxpayer may challenge his underlying tax liability at the collection due process hearing, only if he "did not receive any statutory notice of deficiency for such tax liability or did not otherwise have an opportunity to dispute such tax liability." 26 U.S.C. §6330(c)(2)(B). Any other relevant issue relating to the unpaid tax may be raised during the hearing, including spousal defenses, challenges to the appropriateness of collection actions, and alternative collection options (such as posting of a bond, installment agreements, or offers in compromise). 26 U.S.C. §6330(c)(2)(A). By statute, the IRS Appeals Officer must: 1) conduct a verification that the IRS has met all legal requirements and fulfilled its procedural obligations to move forward with the lien or levy, 2) consider defenses and collection alternatives proffered by the taxpayer and, 3) make a determination that the "proposed collection action balances the need for the efficient collection of taxes with the legitimate concern of the person that any collection action be no more intrusive than necessary." 26 U.S.C. §6330(c)(3) (emphasis added). This final balancing factor is novel in American tax law and injects into the calculus an equitable consideration for the taxpayer and his concerns. Not surprisingly, the taxpayer in the instant cases relies quite heavily on this factor in its arguments for relief.On completion of his review, the Appeals Officer sends his final decision to the taxpayer in a Notice of Determination letter. The statutes then allow for judicial review of this determination by whatever federal court has jurisdiction over the underlying tax (either the Tax Court or the District Courts).We review a district court's grant of summary judgment de novo. 4 Both the parties and the district court judges in these cases agreed that it was proper to review the IRS Appeals Office de novo with respect to decisions about the underlying tax liability and for abuse of discretion with respect to all other decisions, see Bartley v. United States, 343 F.Supp.2d. 649, 652 (N.D. Ohio 2004), but the parties disagreed about whether the underlying liability was actually challenged in these cases. See Part II.A., infra. Finally, the district court may only review issues that were originally raised in the collection due process hearing. See Treas. Reg. §301.6330-1(f)(2), Q-F5 & A-F5.Judicial review of collection due process hearings presents a real problem for reviewing courts. Congress overlaid the Restructuring and Reform Act on a previous system that involved very little judicial oversight. The result is a surprisingly scant record, comprised almost exclusively of the parties' appellate briefs and the Notice of Determination letter. No transcript or official record of the hearing is required and, accordingly, one rarely exists. Since normal review of administrative decisions requires the existence of a record, see Citizens to Preserve Overton Park, Inc. v. Volpe, 401 U.S. 402 (1971), overruled on unrelated grounds by Califino v. Sanders, 430 U.S. 99, 105 (1977), Congress must have been contemplating a more deferential review of these tax appeals than of more formal agency decisions. This might explain why, of six collection due process cases reviewed by the Sixth Circuit, five have been disposed of under our Court's Rule 34 and all six have been unpublished. None has overturned the IRS decision or required a remand. See Herip v. United States [ 2005-1 USTC ¶50,354], No. 02-4078, 2004 WL 1987302 (6th Cir. Sept. 2, 2004) (unpublished); Minion v. Commissioner [ 2004-1 USTC ¶50,161], No. 03-1337, 2003 WL 22434751 (6th Cir. Oct. 24, 2003) (unpublished); Wasson v. Commissioner [ 2003-1 USTC ¶50,337], No. 02-2134, 2003 WL 1516288 (6th Cir. Mar. 21, 2003) (unpublished); Hauck v. Commissioner [ 2003-1 USTC ¶50,445], No. 02-2301, 2003 WL 21005238 (6th Cir. May 2, 2003) (unpublished); Brown v. Commissioner [ 2003-1 USTC ¶50,148], No. 02-1630, 2002 WL 31863695 (6th Cir. Dec. 19, 2002) (unpublished); Diefenbaugh v. Weiss [ 2000-2 USTC ¶50,839], No. 00-3344, 2000 WL 1679510 (6th Cir. Nov. 3, 2000) (unpublished).
II. Living Care's Claims
Living Care raises four identical claims in each case. They will therefore be analyzed together.A. District Court Applied an Incorrect Standard of ReviewLiving Care agrees with the government that, in order to receive a de novo review of the Appeals Officers' decisions, it had to have challenged the validity of the underlying tax liability at the collection due process hearings. Otherwise, the Appeals Officers' decisions are reviewed for abuse of discretion. 5 Living Care's evidence that it challenged the validity of the underlying liability is exceptionally weak. One of the Notice of Determination letters does not mention this issue at all and the other states "The underlying tax was not challenged." Living Care therefore argues that the Appeals Officers misconstrued and misunderstood its attempts to challenge the tax.In large part, its argument is based on the premise that "nursing homes are different." Living Care's facility receives almost all of its income from government programs (Medicare and Medicaid) that require strict compliance with comprehensive regulatory regimes. These regimes limit the possibility for profit, control and limit admission of new patients, and mandate high standards in the areas of staffing, food, and medical care. Living Care argues that the regulatory regime became particularly oppressive starting in the mid 1990's.
These government mandated changes resulted in Living Care not being able to pay all its withholding obligations. The government required that Living Care meet the increased mandated care requirements and staffing requirements. Living Care did this and when the decision had to be made between paying for resident care and taxes, Living Care paid for the food, utilities, medications, staffing etc [sic] and delayed the payment of taxes --taxes were not simply refused or neglected.
Living Care Proof Br. (Case No. 04-3554) at 18. Living Care maintains that it relied on the above argument during the collection due process hearings and that this argument was equivalent to challenging the underlying liability itself. 6 Furthermore, it argues that the identical requests in its Complaints to the District Courts that the "tax liability be removed" also constituted a challenge to the validity of the liability.The plain meaning of "challenging validity of the underlying tax liability" requires more than the taxpayer's actions in these cases. Passionately arguing that it is bad public policy to tax a nursing home that was trying in good faith to comply with a comprehensive regulatory scheme is not the same as challenging the validity of the tax. Similarly, requesting that a district court "remove" a tax liability does not constitute a claim at the IRS hearing and is not an assertion that the liability was not valid in the first place; to the contrary, it seems to be admitting it was valid and then requesting that payment be excused. Therefore, all aspects of the Appeals Officers' decisions are reviewed for abuse of discretion.B. Abuse of Discretion in the Balancing AnalysisThe Tax Code requires that an IRS Appeals Officer, in making a final determination after a collection due process hearing, decide "whether any proposed collection action balances the need for the efficient collection of taxes with the legitimate concern of the [taxpayer] that any collection action be no more intrusive than necessary." 26 U.S.C. §6330(c)(3)(C). 7 There is little discussion or guidance about this requirement in legal scholarship or case law. But see, Book, The Collection Due Process Rights, supra, at 1185-93. In most cases, reviewing courts have merely affirmed the Appeals Officer's determination that he conducted the balancing test and that he found the results to be consistent with the decision to proceed with levying the property. See e.g., Jackling v. IRS[ 2005-1 USTC ¶50,159], 352 F.Supp.2d 129 (D. N.H. 2004); Elkins v. United States, No. 4:03-CV-97-1 (CDL), 2004 WL 3187094 (M.D. Ga. Sept. 29, 2004). One notable exception to this pattern is found in Mesa Oil, Inc. v. United States [ 2001-1 USTC ¶50,130], No. Civ.A. 00-B-851, 2000 WL 1745280 (D. Colo. Nov. 21, 2000) (unpublished), where an oil company fell behind in its payroll tax deposits over a six quarter period, totaling about $425,000. There the district court, reviewing an IRS Appeals Officer's collection due process hearing and Notice of Determination, remanded the case to the IRS for development of a more complete record and clarification of the reasoning behind the determination that the balancing test was met. The court was especially concerned that the Notice of Determination included "no statement of facts, no legal analysis, and no explanation of how or why the proposed levy balanced the need for collection with [the taxpayer's] interests" but merely a "blank recitation of the statute." Id. at *4; accord Cox v. United States [ 2004-2 USTC ¶50,404], 345 F.Supp.2d 1218 (W.D. Okla. 2004) (citing positively Mesa Oil's remand for further development of the record and ruling that balancing did not occur because the IRS erroneously believed taxpayer was ineligible for installment agreement). Mesa Oil's remand is an exception to the general practice of reviewing courts showing deference to Appeals Officers' conclusions regarding the balancing analysis.In the instant appeals, Living Care presents three related arguments to support its claim that the balancing test was not met, or more accurately, that the Appeals Officers abused their discretion in conducting the balancing test. First, Living Care claims the Appeals Officers failed to include the existence of senior lienholders in their balancing analyses, in spite of the discussion of this fact during the hearings. 8 Second, the Officers failed to consider that, because of these senior lienholders, the net effect of an IRS levy would be to shut down the business without generating any tax revenue for the government. Since the IRS liens would be junior to existing creditors and the existing debt exceeded the value of the property, the IRS would collect nothing. Finally, in its Reply Brief in the Living Care II case (Case No. 04-3554), Living Care correctly alleges, albeit for the first time, that the IRS has a statutory duty to investigate, prior to executing a levy, the existence of liens on the property and determine "that the equity in such property is sufficient to yield net proceeds from the sale of such property to apply to [taxpayer's] liability." 26 U.S.C. §6331(j)(2)(C).The government first responds that the Appeals Officers were aware of the other lienholders, as evidenced by the statement in the Notice of Determination from Living Care I that "[i]f the business sells, proceeds will be distributed according to priority of claims. (Lien priority)." In Living Care II, the government argues that Living Care's Request for Hearing makes no mention of these senior liens and that there is no evidence they were mentioned during the hearing. The lack of evidence from the hearing is potentially misleading since there is no formal record of the hearing and the government itself prepared the only account of what was discussed. The government's stronger argument, made in the alternative, is that even if the senior liens were raised and ignored, there is no requirement that the government consider in its balancing analysis whether it will receive any revenue from a levy and sale, or whether the business will have to close down due to the levy and sale. It cites several cases for these propositions. See Medlock v. United States, 325 F.Supp.2d 1064 (C.D. Cal. 2003); Cardinal Healthcare, Inc. v. United States [ 2002-2 USTC ¶50,582], No. 01-4300-JLF, 2002 WL 31002880 (S.D. Ill. July 25, 2002); Kitchen Cabinets, Inc. v. United States [ 2001-1 USTC ¶50,287], No. Civ.A.3:00CV0599M, 2001 WL 237384 (N.D. Tex. Mar. 6, 2001). The case law supports the proposition that the government is not required to continue subsidizing failing businesses by foregoing tax collection. Any other conclusion would create a bizarre tax system with perverse incentives for businesses to maintain themselves on the edge of insolvency in order to enjoy immunity from tax enforcement.The government's response to Living Care's statutory argument (which the government first offered at oral argument since Living Care first raised the statute in its Reply Brief) is that the statutory duty has not yet arisen. All that the statute requires is that the IRS investigate the equity in a property prior to levying on it, not prior to the collection due process hearing. The only court that has apparently addressed this issue did so in the context of the collection due process verification requirement and agreed that the statutory investigation was not required prior to a collection due process hearing. In Medlock, 325 F.Supp.2d at 1079, the district court said:
Appeals Officer Rich was not required, during the [Collection Due Process] Appeal process, to determine whether the equity in Medlock's property was sufficient to yield net proceeds ... or investigate the status of Medlock's property .... According to the plain language of the relevant statutory sections, [6331(f) and 6331(j)] these actions must be taken before a taxpayer's property may be levied upon by the IRS but are prematurely raised at this stage of the collection process. Appeals Officer Rich's alleged failure to perform those actions therefore does not constitute a violation of [the collection due process statutes].
We agree with this reasoning and find no statutory violation arising from the IRS's failure to investigate at this time the available equity in the taxpayer's property. This failure cannot, therefore, provide the basis for overturning the Appeals Officers' balancing analyses or final decisions.C. Insufficient Record for ReviewLiving Care includes this issue in its request for a de novo review by this court, "with a hearing that more closely resembles an evidentiary hearing and gives the taxpayer the opportunity to have what he presents actually recorded for future review." Living Care Proof Br. (Case No. 04-3554) at 37. Since it would be inappropriate for this Court to hold an evidentiary hearing under these circumstances, we consider this claim as a request to remand the cases either to the district courts or to the IRS for development of a more thorough record. Not surprisingly, Living Care cites Mesa Oil in support of its request. Only the court in Mesa Oil has gone so far as to remand to the IRS in a collection due process case with an order that the new hearing have a record "made either through audio tape recording, video tape recording, or stenographer." Mesa Oil [ 2001-1 USTC ¶50,130], 2000 WL 1745280 at *7. The court there expressed concern that the Notice of Determination's lack of analysis amounted to no record whatsoever and therefore did not allow for a meaningful review. While this is a conventional remedy in administrative law cases, it was extraordinary in the area of tax collection. As discussed earlier, the notion of due process in tax collection is not the same as in other areas of the law. The IRS has historically had broad discretion and the right to levy on property without any pre-seizure process. The 1998 reform did provide for additional procedural protections, but it still does not require the creation of a formal record and conventional administrative review. Admittedly, this makes application of the abuse of discretion standard quite difficult, but at the very least, in order to overturn the IRS decisions, we must be convinced that the type of taxpayer abuse that Congress sought to remedy has occurred in the case. Neither of these cases presents such egregious facts.In both cases below, the District Courts distinguished the Notices of Determination they were reviewing from the one in Mesa Oil.
Unlike the court in Mesa Oil, this court has before it a report from the collection due process hearing which sets forth the issues raised by Living Care, as well as a discussion of those issues. The [Appeals Officer's] report explains the collection alternatives raised by Plaintiff and why those collection alternatives were impracticable and unreasonable. In the instant case the [Officer] enumerated specific reasons why the IRS's levy action and lien filing balanced the [needs of both parties.]
Living Care I, 2003 WL 23311523 at *3. And similarly, in Living Care II, "the [Appeals Officer's] Determination in this case is clearly more through [sic] and appropriate in its factual review and analysis than was the one which apparently confronted the court in Mesa Oil." Living Care II [ 2004-1 USTC ¶50,225], 312 F.Supp.2d at 935.The Notices of Determination in these cases satisfy due process and provide a sufficient basis for an abuse of discretion review, as that standard is applied in tax levy and lien appeals.D. Abuse of Discretion Not to Allow Offer in CompromiseWhile Living Care raises this claim in both cases, only the Notice of Determination in Living Care I contains problematic language, meaning the Living Care II claim is without merit.One of the three areas that Appeals Officers must consider in making their final Determination is offers of collection alternatives made by the taxpayer. At both hearings, Living Care presented plans to either sell the business as a going concern and use the proceeds to pay its tax liabilities or to present an offer in compromise. Living Care rejected the possibility of an installment agreement, since such an agreement would have to be funded from company profits and Medicare and Medicaid billing generally do not allow for profit. Also, under a previous levy around 1996 or 1997, Living Care had entered into an installment agreement with the IRS, and then defaulted in 1999.The Living Care II Notice of Determination (dated June 21, 2002), see J.A. (Case No. 04-3554) at 12, rejected these plans because the business had currently been on the market for over a year without generating a sale or contract and Living Care was not, at that time, current on its tax payments. The taxpayer must be current on payments for the previous two quarters to be eligible to submit an offer in compromise. These facts, coupled with Living Care's prior default in 1999 on its installment agreement, fully support the decision to reject the alternatives offered.The Living Care I Notice of Determination (dated March 25, 2003), see J.A. (Case No. 04-3194) at 51, however, contains contradictory statements. On page 2, the Notice states, "Tax deposits are being made and the taxpayer appears to be current for both the 3rd and 4th quarters of 2002." Id. at 54. On page 6, in a section discussing the option of an offer in compromise, it states,
The two quarters preceding the current quarter are the 2nd and 3rd. The taxpayer owes tax for the 2nd; consequently, the taxpayer will not be eligible until the 1st quarter of 2003.... Therefore, as of the date of this report, the taxpayer is not eligible for an offer in compromise.Id. at 58 (emphasis added). The hearing date in Living Care I was December 12, 2002. The date on the Notice of Determination was March 25, 2003. Either the Appeals Officer intended to express his eligibility determination in terms of the date of the hearing and simply made a typographical error, or he erroneously determined that Living Care was not eligible as of the date of the report, even though his statements on page 2 express recognition that Living Care had made the last two quarter's payments on time.The government offers several valid responses. First, and most simply, that it was a mere typographical error that does not reach the level of abuse of discretion. This interpretation would have the Court focus on the date of the hearing, since both sides agree that at that time Living Care was not eligible to submit an offer in compromise. In the alternative, the government argues even if the Appeals Officer did misapply the law, Living Care still had an obligation to actually file an offer in compromise, which it failed to do. Therefore, even if it was eligible, its failure to file the proper financial paperwork and IRS forms led to the same result --a rejection of its collection alternatives. Finally, the government presents a litany of additional bases on which the Appeals Officer could have validly rejected Living Care's alternative collection option. These include Living Care's failure to meet the two quarters requirement as of the time of the hearing, its default under the previous installment payment plan in the late 1990's, the escalating amount of unpaid tax liability due to accruing interest and penalties, and the government's need to collect the taxes quickly because of Living Care's financial difficulties.There is no need to rely on any one of these explanations alone. It is clear that the IRS was well within its discretion to reject Living Care's plan to present an offer in compromise. If the Appeals Officer mistakenly felt his hands were tied because of the two quarters requirement, there are administrative remedies available to point out such mistakes and allow the IRS an opportunity to re-examine its earlier decision. Treas. Reg. §301-6330-1(h)(1) ("The Appeals office that makes a determination under section 6330 retains jurisdiction over that determination, including any subsequent administrative hearings that may be requested by the taxpayer regarding levies and any collection action taken or proposed with respect to Appeals' determination."). But for this Court, reviewing the Appeals Officers' decisions for abuse of discretion, Living Care has failed to present sufficient evidence to justify a remand. Otherwise, without a clear abuse of discretion in the sense of clear taxpayer abuse and unfairness by the IRS, as contemplated by Congress, the judiciary will inevitably become involved on a daily basis with tax enforcement details that judges are neither qualified, nor have the time, to administer.For the reasons discussed above, we affirm the decision of the District Courts in these cases.1 Although the administrative hearing for Living Care II was held first, the District Court decided the case second. It will therefore be referred to as Living Care II.2 Other tax periods were the subject of other collection due process hearings and at least three other district court appeals. According to Living Care's Briefs, these cases are awaiting various decisions in the district courts. See Living Care Proof Br. (Case No. 04-3554) at 21 n.7.3 The Commissioner of Internal Revenue shall develop and implement a plan to reorganize the Internal Revenue Service. The plan shall ... eliminate or substantially modify the existing organization of the Internal Revenue Service which is based on a national, regional, and district structure; ... establish organizational units serving particular groups of taxpayers with similar needs; and ... ensure an independent appeals function within the Internal Revenue Service, including the prohibition of ex parte communications between appeals officers and other Internal Revenue Service employees to the extent that such communications appear to compromise the independence of the appeals officers.The Internal Revenue Service Restructuring and Reform Act of 1998, Pub. L. No. 105-206, §1001, 112 Stat. 685, 689 (1998).4 The District Court in Living Care II [ 2004-1 USTC ¶50,225], 312 F.Supp.2d at 933, determined that motions for summary judgment make no sense in the context of judicial review of agency decisions. Therefore, the court treated the motions for summary judgment as cross-motions for judgment on the pleadings. Many courts, including this one, have allowed motions for summary judgment when reviewing collection due process hearings. See e.g., Herip v. United States [ 2005-1 USTC ¶50,354], No. 02-4078, 2004 WL 1987302 (6th Cir. Sept. 2, 2004) (unpublished).5 Since the statute itself is silent as to the appropriate standard, the legislative history of the Restructuring and Reform Act is often cited for establishing this two-tiered approach.Where the validity of the tax liability was properly at issue in the hearing, and where the determination with regard to the tax liability is part of the appeal, no levy may take place during the pendency of the appeal. The amount of the tax liability will in such cases be reviewed by the appropriate court on a de novo basis. Where the validity of the tax liability is not properly part of the appeal, the taxpayer may challenge the determination of the appeals officer for abuse of discretion.Goza v. Commissioner [ CCH Dec. 53,803], 114 T.C. 176, 181 (2000) (quoting with approval H.R. Conf. Rept. No. 105-599, at 266 (1998)).6 In another section of its Brief, Living Care presents the argument this way:Here Living Care submits that the District Court erred in concluding that Living Care did not challenge the underlying tax liability. Living Care may not have talked "tax code" language, but it did talk the normal language of the nursing home business. Living Care explained the Catch 22 of government funding and mndates, [sic] where the government gives on the one hand and takes with the other. Government requirements ruled all aspects of operation and mandated that Living Care do and provide certain things, while at the same time kept out new residents and decreased occupancy, penalized the nursing home for low occupancy and decreased funding. Yet the government required the payment of taxes timely and then the payment of interest and penalties (but which Medicaid will not allowed to be reimbursed [sic]). This challenge was made by Living Care in language that has meaning to a nursing home operator. It may not be how an accountant, attorney or IRS agent would phrase such a challenge. But the taxpayer did challenge it in the Request for Hearing and at the hearing.Living Care Proof Br. (Case No. 04-3554) at 32.7 The other two issues that must be addressed are verification that applicable law and procedures were followed and other relevant issues raised at the hearing (such as defenses and collection alternatives). See 26 U.S.C. §6330(c).8 Living Care also attempts to argue that the Appeals Officers disregarded all additional information provided during the hearing, instead relying only on the information in its Request for Hearing.



Alvin Brown
Tax attorney
703.425.1400 ex 106

www.irstaxattorney.com

To provide "IRS transparency" you should upload your IRS experiences to www.irsforum.org

Tax Attorney: Tile worker held to be an independent contractor

An individual hired to do tiling work in a condominium renovation was an independent contractor, not an employee, and was, therefore, liable for the self-employment tax. The taxpayer was hired to perform tile work on the condominium for a fixed price. The party paying for the renovation supplied only the tile itself, while the taxpayer supplied his own tools and the materials necessary for the work (glue, grout, etc.) and, if the cost of materials exceeded the payment the taxpayer received, he would lose money. After the party renovating the condominium and the taxpayer had a dispute about his work hours, a set work schedule was established. The party performing the renovation indicated that he would not hire the taxpayer for any additional projects, and did not withhold FICA taxes from his payments to the taxpayer and the taxpayer never filled out a Form W-4. The taxpayer's degree of control over his own work, the fact that he provided his own tools and materials, his risk of loss on the project, the fact that he could not be discharged from the job, the lack of permanency in the relationship and the lack of intent to form an employer-employee relationship were consistent with independent contractor status. Only the fact that the taxpayer's work was integral to the renovation of the condominium indicated an employer-employee relationship. -

Uriah Vincent Jones v. Commissioner.

Dkt. No. 18719-05 , TC Memo. 2007-249, August 27, 2007.



[Code Sec. 3401]
Withholding: FICA: Independent contractor. --
H.





Uriah Vincent Jones, pro se; Ladd C. Brown, Jr., for respondent.





MEMORANDUM FINDINGS OF FACT AND OPINION



VASQUEZ, Judge: Respondent determined a deficiency of $2,274 in petitioner's Federal income tax for 2003. After concessions by petitioner, the issue for decision is whether petitioner is liable for self-employment tax. This turns on whether petitioner was an employee or independent contractor of DBMA Corporation (DBMA) during 2003.





FINDINGS OF FACT



Some facts are stipulated and are so found. The stipulated facts and the exhibits submitted therewith are incorporated herein by this reference. At the time he filed the petition, petitioner resided in Palm Beach Gardens, Florida.



From August through December 2003, petitioner, a marble and tile installer, worked on a condominium renovation for DBMA. Barry Shapiro (Mr. Shapiro), president of DBMA, hired petitioner to work on the condominium renovation.



Petitioner submitted a series of proposals to Mr. Shapiro describing the work petitioner was to perform on the condominium renovation. Mr. Shapiro contracted petitioner to perform the tile work on the condominium renovation. In August 2003, petitioner began work by honing the floors and showers of the condominium and taking other preparatory steps in order to complete his work. From August through December 2003, petitioner worked a total of approximately 16 days on the condominium renovation.



DBMA paid petitioner a fixed sum for his work on the condominium renovation. If petitioner needed any additional assistants, petitioner was responsible for hiring, paying, and supervising them.



While working on the condominium renovation, petitioner provided his own work tools. In addition to work tools, petitioner also supplied grout, cork, cork glue, and soundproofing materials. Mr. Shapiro supplied the tile. DBMA did not reimburse petitioner for the supplies he purchased because these amounts were incorporated into petitioner's proposal.



Initially, petitioner set his own hours of work on the condominium renovation. A dispute arose between petitioner and Mr. Shapiro regarding the hours petitioner worked. After this dispute, petitioner agreed to maintain a fixed work schedule of 10:30 a.m. to 4:30 p.m. when working on the condominium renovation.



DBMA paid petitioner $8,360 for his work on the condominium renovation. At no point did petitioner ever sign or submit a Form W-4, Employee's Withholding Allowance Certificate (Form W-4). After petitioner completed work on the condominium renovation, Mr. Shapiro did not engage the services of petitioner on other jobs. In 2003, petitioner worked for three other companies that treated him as an employee, and all three companies issued him Forms W-2, Wage and Tax Statement (Forms W-2), as opposed to Forms 1099-MISC, Miscellaneous Income (Forms 1099-MISC).



Petitioner timely filed a Form 1040EZ, Income Tax Return for Single and Joint Filers With No Dependents, for 2003. Petitioner conceded that he did not report the income he received from DBMA on his 2003 tax return. After filing his 2003 income tax return, petitioner received a Form 1099-MISC, from DBMA. Petitioner did not amend his 2003 tax return after receiving the Form 1099-MISC.



Respondent timely mailed a notice of deficiency to petitioner with respect to taxable year 2003, and petitioner timely petitioned the Court.





OPINION



The burden of proof is on petitioner to show that respondent's determination set forth in the notice of deficiency is incorrect. Rule 142(a)(1);1 Welch v. Helvering, 290 U.S. 111, 115 (1933). Petitioner has neither claimed nor shown that he satisfied the requirements of section 7491(a) to shift the burden of proof to respondent with regard to any factual issue. Accordingly, petitioner bears the burden of proof. Rule 142(a).



The Federal Insurance Contributions Act (FICA), secs. 3101-3125, 68A Stat. 415 (1954), taxes a portion of the wages paid to an employee (FICA tax). The portion of the wages taxed is defined in section 3121(a). Under FICA, the employer and the employee each pay a like amount of tax. See secs. 3101, 3111. The employer withholds the employee's half of the FICA tax and remits it, along with the employer's half, to the Department of the Treasury. See sec. 3102. The FICA tax has two components, the old age, survivors, and disability insurance portion (OASDI) and the hospital insurance portion. For the year in issue, the OASDI rate was 6.2 percent for both the employer and employee, a total of 12.4 percent. The hospital insurance portion was 1.45 percent for both the employer and the employee, a total of 2.9 percent. The combined rate of the FICA tax was 15.3 percent for 2003. DBMA did not withhold any FICA tax because it treated petitioner as an independent contractor.



Independent contractors are not subject to the FICA tax; however, they are subject to a tax under chapter 2 of the Code, the Self-Employment Contributions Act of 1954 (SECA), secs. 1401-1403. See secs. 1401 and 1402. The SECA tax is a different tax from the FICA tax, though the SECA tax contains the same two components as the FICA tax. The SECA rate is equal to the sum of the employer and employee tax rates under FICA.



For the purposes of FICA, an employee is defined as: (1) any officer of a corporation; (2) any common law employee; (3) any individual in a specified occupation group who is not a common law employee; and (4) any individual who performs services that are included under an agreement entered into pursuant to the Social Security Act, 42 U.S.C. sec. 218 (2000). Sec. 3121(d).



A common law employee-employer relationship exists when:



the person for whom the services are performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work but also as to the details and means by which that result is accomplished. That is, an employee is subject to the will and control of the employer not only as to what shall be done but how it shall be done. In this connection, it is not necessary that the employer actually direct or control the manner in which services are performed; it is sufficient if he has the right to do so. The right to discharge is also an important factor indicating that the person possessing that right is an employer. Other factors characteristic of an employer, but not necessarily present in every case, are the furnishing of tools and the furnishing of a place to work, to the individual who performs the services. In general, if an individual is subject to the control or direction of another merely as to the result to be accomplished by the work and not as to the means and methods for accomplishing the result, he is an independent contractor. * * * [Sec. 31.3121(d)-1(c)(2), Employment Tax Regs.]



Petitioner contends that he was a common law employee of DBMA. We consider the following factors to decide whether a worker is a common law employee or an independent contractor: (1) The degree of control exercised by the principal; (2) which party invests in work facilities used by the individual; (3) the opportunity of the individual for profit or loss; (4) whether the principal can discharge the individual; (5) whether the work is part of the principal's regular business; (6) the permanency of the relationship; and (7) the relationship the parties believed they were creating. Weber v. Commissioner, 103 T.C. 378, 387 (1994), affd. per curiam 60 F.3d 1104 (4th Cir. 1995). All the facts and circumstances of each case are considered, and no single factor is dispositive. Id.



1. Degree of Control



The degree of control necessary to find employee status varies with the nature of the services provided by the worker. Id. at 388. To retain the requisite control over the details of an individual's work, the principal need not stand over the individual and direct every move made by the individual; it is sufficient if he has the right to do so. Id. ; see sec. 31.3401(c)-1(b), Employment Tax Regs.



Similarly, the employer need not set the employee's hours or supervise every detail of the work environment to control the employee. Gen. Inv. Corp. v. United States , 823 F.2d 337, 342 (9th Cir. 1987). The fact that workers set their own hours does not necessarily make them independent contractors. Id.



As the project manager, Mr. Shapiro did have some control over petitioner. For instance, after a dispute regarding the hours petitioner kept, Mr. Shapiro and petitioner agreed that petitioner would maintain a fixed work schedule. Despite this, petitioner was free to complete by the means and methods of his choice, the work he was contracted to do. Petitioner advised Mr. Shapiro that the floor in the laundry room needed to be resloped. Additionally, petitioner completed work offsite at his home workshop after advising Mr. Shapiro as to the best means and method to complete the project.



Based on the record before us, petitioner's degree of control over his own work on the condominium renovation is consistent with independent contractor status.



2. Investment in Facilities



The fact that a worker provides his or her own tools generally indicates independent contractor status. Breaux & Daigle, Inc. v. United States , 900 F.2d 49, 53 (5th Cir. 1990).



Petitioner provided his own tools. Furthermore, other than the tile, petitioner supplied most of the supplies he used such as grout, soundproofing materials, cork, and cork glue. Additionally, petitioner was not reimbursed for the materials that he provided. These amounts were included in the proposals that petitioner provided.



Based on the record before us, this factor is consistent with independent contractor status.



3. Opportunity for Profit or Loss



As noted supra, petitioner sent proposals to Mr. Shapiro regarding the work to be done on the condominium renovation. DBMA paid petitioner a fixed sum regardless of the time spent on the job. If petitioner underestimated the cost of the supplies needed or the time it took to complete the job, petitioner bore the risk of losing money, not Mr. Shapiro. Furthermore, if assistants were needed, it was petitioner's sole responsibility to hire and pay them. Additionally, petitioner bore the risk of loss on any loss or damage to his work tools.



Based on the record before us, petitioner's opportunity for profit or loss on his work on the condominium renovation is consistent with independent contractor status.



4. Right To Discharge



Petitioner was never fired by Mr. Shapiro, but Mr. Shapiro chose not to engage petitioner on any future projects. It appears that as long as petitioner's work was quality work that met the job specifications, petitioner could not have been dismissed from his duties on the condominium renovation. Petitioner phoned Mr. Shapiro approximately 3 weeks after petitioner completed work on the condominium renovation. At that time, only after petitioner had finished his duties on the condominium renovation, Mr. Shapiro notified petitioner that he did not wish to work with petitioner on any other projects.



Based on the record before us, the fact that petitioner could not be discharged as long as his work met the specifications is consistent with independent contractor status.



5. Integral Part of Business



As the project manager on the condominium renovation, Mr. Shapiro's responsibilities included making sure that the work was completed. The condominium renovation required tile work. Accordingly petitioner's job was an integral part of DBMA's work.



Based on the record before us, the integral nature of petitioner's work could suggest employee status. This, however, is but one factor that must be weighed among the others.



6. Permanency of the Relationship



A transitory work relationship may point toward independent contractor status. Herman v. Express Sixty-Minutes Delivery Serv ., Inc., 161 F.3d 299, 305 (5th Cir. 1998). If, however, the worker works in the course of the employer's trade or business, the fact that he does not work regularly is not necessarily significant. Avis Rent A Car Sys., Inc. v. United States, 503 F.2d 423, 430 (2d Cir. 1974) (transients may be employees); Kelly v. Commissioner, T.C. Memo. 1999-140 (working for a number of employers during a tax year does not necessitate treatment as an independent contractor). In considering the permanency of the relationship, we must also consider the principal's right to discharge the worker and the worker's right to quit at any time.



DBMA contracted petitioner to work on the condominium renovation and paid petitioner for the job he performed, regardless of the amount of time petitioner spent on the work. Petitioner worked for approximately 16 days, from August through December 2003, on the condominium renovation and received 14 checks from DBMA for his work. Although petitioner stated that DBMA promised him more work, whether or not the relationship continued was within the discretion of Mr. Shapiro. Once DBMA completed the condominium renovation, the relationship between petitioner and DBMA ceased.



Before petitioner began the condominium renovation, he was an employee of Koeckritz Enterprises, Inc. (Koeckritz). Prior to working for Koeckritz, in 2003 petitioner also worked for Celtic Marble & Tile, Inc., and Selective HR Solutions V, Inc. During 2003, petitioner received a total of three Forms W-2 from the three employers. This, however, does not require us to conclude that petitioner worked for DBMA as an employee.



Based on the record before us, petitioner's lack of a permanent relationship with DBMA is consistent with independent contractor status.



7. Relationship the Parties Thought They Created



Petitioner has worked on tile and marble installation for dozens of companies and stated that he always has been treated as an employee by those other companies. Mr. Shapiro stated that DBMA never had any employees and always has treated the individuals who worked for DBMA as independent contractors and issued them Forms 1099-MISC. Although the parties thought they were creating different relationships, we note that petitioner did not submit a Form W-4 to DBMA as he submitted to his three employers. The record does not indicate that petitioner requested or inquired about a Form W-4 from DBMA.



Based on the record before us, the facts are consistent with independent contractor status.



8. Conclusion



In the matter before us, although one factor might indicate an employer-employee relationship, the vast majority suggest that petitioner was an independent contractor of DBMA. Having weighed the evidence and considered the totality of the circumstances, we conclude that petitioner was an independent contractor of DBMA. As a result, he is responsible for self-employment tax for 2003.



In reaching our holding 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 Unless otherwise indicated, all Rule references are to the Tax Court Rules of Practice and Procedure, and all section references are to the Internal Revenue Code in effect for the year in issue.

Alvin S. Brown, Esq.
tax attorney
703.425.1400 ex 106
www.irstaxattorney.com

To provide IRS transparency, upload your IRS experiences to www.irsforum.org

Back Taxes: New controversial return preparer reporting requirements

The new law requires the return preparer to prove that a postion Thas a "realistic possibility" of being successful.



That new standard is rediculous. Most return preparers are untrained, inexperienced and they are not lawyers. In addition there are no standards for "realistic possibility." That standard is very subjective. I agree with the criticism of the new law as discussed below.

My personal advice to all tax return preparers is to always file a disclaimer when they file a tax return. The disclaimer should identify the basis for the information on the tax return. The disclaimer should be a full disclosure of the source of all of the data used in the tax return and what decisions were made in determining any of the data used in the tax return.


Notice 2007-54 , to be published in I.R.B. 2007-27, July 2, 2007.

[ Code Secs. 6662, 6694 and 7701]


Estate, gift, generation-skipping transfer, and income taxes: Returns and procedures: Return preparer penalties: Transitional relief. --

The IRS has provided transitional relief and guidance relating to 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.

.

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.



CONTACT INFORMATION

The principal author of this notice is Michael E. Hara of the Office of Associate Chief Counsel (Procedure and Administration). For further information regarding this notice, contact Mr. Hara at (202) 622-4910 (not a toll-free call).
Controversial Return Preparer Reporting Standards Must Be Corrected, AICPA Tells Congress
The controversial "more likely than not" reporting standards for return preparers in the Small Business and Work Opportunity Tax Act of 2007 (2007 Act) (P.L. 110-28) should apply to tax-avoidance items and not to routine items, the AICPA told leaders of the House and Senate tax-writing committees in a July 10 letter released on July 13. The AICPA also warned that preparers will become advisors, rather than advocates, because of the new law.

"More Likely than Not"
The 2007 Act increases the tax return reporting standards under Code Sec. 6694 on undisclosed, nontax avoidance items from the "realistic possibility of success" to "more likely than not." The AICPA observed, "A preparer must satisfy a higher standard than the standard the taxpayer must satisfy (substantial authority) to avoid the imposition of an understatement penalty." In addition, "it is possible for a preparer to be subject to a penalty with respect to a position taken on a return he or she prepared even though the taxpayer would not be subject to a penalty with respect to that same tax return position."

In addition to the penalty in the statute, practitioners could be in violation of Circular 230 with another penalty and automatic referral to the IRS Office of Professional Responsibility," AICPA Vice President - Taxation Thomas Ochsenschlager, stated.

Preparer's Role
The "more likely than not" approach "results in a fundamental change in the role of a preparer," the AICPA warned. Preparers become advisors rather than advocates.

The AICPA also cautioned that determining the probable correctness of the treatment of routine items would be extremely difficult, if not impossible. "There sometimes is little guidance for the tax treatment of an item at the time the item must be reported on a return and the proper treatment of an item frequently depends on an analysis of unique or unusual circumstances that were not contemplated in published guidance."

Corrective Action
Congress should equalize the return preparer standards with the taxpayer standards, the AICPA stated. For nontax-avoidance items, the "substantial authority" standard should apply. The "more-likely-than-not standard" should apply for tax-avoidance items, such as items attributable to any "listed transaction." The AICPA also recommended an expansion of the authorities that can be relied on in determining if the "substantial authority" is met to include field service advice memoranda, treatises and legal scholarly literature.

Ochsenschlager explained that this "major change in tax policy" was made without any congressional hearings. The AICPA, in its letter to House Ways and Means Committee Chairman Charles B. Rangel, D-N.Y., and ranking member Jim McCrery, and Senate Finance Committee Chairman Max Baucus, D-Mont., and ranking member Charles E. Grassley, R-Iowa, said that the IRS was "blindsided" by the new rule. The IRS issued transitional relief in June (IR-2007-115, Notice 2007-54, I.R.B. 2007-27, 12, TAXDAY, 2007/06/12, I.4). At this time, legislation has not yet been introduced in Congress.

SEC. 6694. UNDERSTATEMENT OF TAXPAYER'S LIABILITY BY TAX RETURN PREPARER.
6694(a) UNDERSTATEMENT DUE TO UNREASONABLE POSITIONS. --

6694(a)(1) IN GENERAL. --Any tax return preparer who prepares any return or claim for refund with respect to which any part of an understatement of liability is due to a position described in paragraph (2) shall pay a penalty with respect to each such return or claim in an amount equal to the greater of --

6694(a)(1)(A) $1,000, or

6694(a)(1)(B) 50 percent of the income derived (or to be derived) by the tax return preparer with respect to the return or claim.

6694(a)(2) UNREASONABLE POSITION. --A position is described in this paragraph if --

6694(a)(2)(A) the tax return preparer knew (or reasonably should have known) of the position,

6694(a)(2)(B) there was not a reasonable belief that the position would more likely than not be sustained on its merits, and

6694(a)(2)(C)(i) the position was not disclosed as provided in section 6662(d)(2)(B)(ii), or

6694(a)(2)(C)(ii) there was no reasonable basis for the position.

6694(a)(3) REASONABLE CAUSE EXCEPTION. --No penalty shall be imposed under this subsection if it is shown that there is reasonable cause for the understatement and the tax return preparer acted in good faith.

6694(b) UNDERSTATEMENT DUE TO WILLFUL OR RECKLESS CONDUCT. --

6694(b)(1) IN GENERAL. --Any tax return preparer who prepares any return or claim for refund with respect to which any part of an understatement of liability is due to a conduct described in paragraph (2) shall pay a penalty with respect to each such return or claim in an amount equal to the greater of --

6694(b)(1)(A) $5,000, or

6694(b)(1)(B) 50 percent of the income derived (or to be derived) by the tax return preparer with respect to the return or claim.

6694(b)(2) WILLFUL OR RECKLESS CONDUCT. --Conduct described in this paragraph is conduct by the tax return preparer which is --

6694(b)(2)(A) a willful attempt in any manner to understate the liability for tax on the return or claim, or

6694(b)(2)(B) a reckless or intentional disregard of rules or regulations.

6694(b)(3) REDUCTION IN PENALTY. --The amount of any penalty payable by any person by reason of this subsection for any return or claim for refund shall be reduced by the amount of the penalty paid by such person by reason of subsection (a).

6694(c) EXTENSION OF PERIOD OF COLLECTION WHERE PREPARER PAYS 15 PERCENT OF PENALTY. --

6694(c)(1) IN GENERAL. --If, within 30 days after the day on which notice and demand of any penalty under subsection (a) or (b) is made against any person who is a tax return preparer, such person pays an amount which is not less than 15 percent of the amount of such penalty and files a claim for refund of the amount so paid, no levy or proceeding in court for the collection of the remainder of such penalty shall be made, begun, or prosecuted until the final resolution of a proceeding begun as provided in paragraph (2). Notwithstanding the provisions of section 7421(a), the beginning of such proceeding or levy during the time such prohibition is in force may be enjoined by a proceeding in the proper court. Nothing in this paragraph shall be construed to prohibit any counterclaim for the remainder of such penalty in a proceeding begun as provided in paragraph (2).

6694(c)(2) PREPARER MUST BRING SUIT IN DISTRICT COURT TO DETERMINE HIS LIABILITY FOR PENALTY. --If, within 30 days after the day on which his claim for refund of any partial payment of any penalty under subsection (a) or (b) is denied (or, if earlier, within 30 days after the expiration of 6 months after the day on which he filed the claim for refund), the tax return preparer fails to begin a proceeding in the appropriate United States district court for the determination of his liability for such penalty, paragraph (1) shall cease to apply with respect to such penalty, effective on the day following the close of the applicable 30-day period referred to in this paragraph.

6694(c)(3) SUSPENSION OF RUNNING OF PERIOD OF LIMITATIONS ON COLLECTION. --The running of the period of limitations provided in section 6502 on the collection by levy or by a proceeding in court in respect of any penalty described in paragraph (1) shall be suspended for the period during which the Secretary is prohibited from collecting by levy or a proceeding in court.

6694(d) ABATEMENT OF PENALTY WHERE TAXPAYER LIABILITY NOT UNDERSTATED. --If at any time there is a final administrative determination or a final judicial decision that there was no understatement of liability in the case of any return or claim for refund with respect to which a penalty under subsection (a) or (b) has been assessed, such assessment shall be abated, and if any portion of such penalty has been paid the amount so paid shall be refunded to the person who made such payment as an overpayment of tax without regard to any period of limitations which, but for this subsection, would apply to the making of such refund.

6694(e) UNDERSTATEMENT OF LIABILITY DEFINED. --For purposes of this section, the term "understatement of liability" means any understatement of the net amount payable with respect to any tax imposed by this title or any overstatement of the net amount creditable or refundable with respect to any such tax. Except as otherwise provided in subsection (d), the determination of whether or not there is an understatement of liability shall be made without regard to any administrative or judicial action involving the taxpayer.

6694(f) CROSS REFERENCE. --

For definition of tax return preparer, see section 7701(a)(36).

National Association of Tax Professionals Comments on Revisions to Section 6694 Made by the Small Business and Work Opportunity Act of 2007

August 27, 2007

National Association of Tax Professionals: Comments: Tax gap.


NATP



National Association of Tax Professionals



Comments on Revisions to Section 6694 Made by the Small Business and Work Opportunity Act of 2007



Tax Return Reporting Standards for Preparers



July 30, 2007




EXECUTIVE SUMMARY -

We understand and support the need and determination on the part of Congress and the Treasury to reduce the "tax gap." Our members are solidly behind reasonable efforts toward this goal. We urge caution, however, as well as support from the public in enacting provisions that impinge upon their rights and relationships in satisfying their compliance with tax law. There was not so much as a hearing on this vital matter nor was there any recommendation from Treasury to create this conflict.

The National Association of Tax Professionals (NATP) was surprised that, on May 25, a tax provision, found in section 8246 of the U.S. Troop Readiness, Veteran's Care, Katrina Recovery, and Iraq Accountability Appropriations Act of 2007 ("the Act"), was enacted without warning and without the characteristic protocol accorded the public to comment. The provision was made under Subtitle B of Title VIII of the Act and is popularly referred to as the "Small Business and Work Opportunity Act of 2007."

Section 6694 of the Internal Revenue Code was thereby amended to revise and raise the standards for tax preparers and those who provide advice, the result of which ends up on a return. The problem arises in that the standards were raised to a point higher or "tougher" than the standards for the taxpayer him or herself. Tax preparers, in order to be protected from a possible imposition of an understatement penalty, must now either hold and be able to demonstrate a reasonable belief that a position taken on a return would "more likely than not" be sustained on its merits, or otherwise insist on a disclosure of the position on the return. Taxpayers, on the other hand, may take a position on a return that has a "substantial authority" for being upheld. Previous to the enactment of this provision, tax return preparers were held to a standard (realistic possibility of success) that was lower than the standard for taxpayers. The Act further extends the penalties for understatement of tax liability to all tax returns including estate and gift tax returns, employment tax returns, and excise tax returns and significantly increases their amounts.

Given the rapid and constant rate at which federal tax law changes, taxpayers increasingly seek the aid of a competent preparer. It is now common to have issues awaiting guidance from Treasury as well as from the IRS in order for professionals, much less taxpayers, to understand the substantively correct position to be taken with regard to an item on a return. It is also now common for technology to challenge guidance previously issued by Treasury and the IRS. One has only to contemplate the continually developing issues affected by the domestic production activities deduction created in the American Jobs Creation Act of 2004 to understand this problem. Preparers and taxpayers are, in these cases, often in the realm of meteorologists in determining the chances of a position being substantively correct. Preparers, however, are subject to penalties for understatement of a tax liability if that reporting standard cannot be satisfied unless they insist on a disclosure of the item. Add to this the fact that the imposition and determination of the appropriateness of the increased penalties are all at the discretion of the IRS and the effect on advocating and representing the taxpayer is indeed chilling.

It appears as though the rights of taxpayers to tax advice and counsel are somewhat less that that of other potential litigants. Imagine standards such as these being imposed in the context of a civil or criminal proceeding. NATP requests a correction to the obvious problems caused by this provision of the Act.

NATP is an eclectic group of tax professionals. Our membership is comprised of attorneys, CPAs, EAs, CFPs, CSAs, BBAs, LLBs, JDs, MBAs, PhDs, as well as Associate degrees, those who have entered the profession as a second career and part-time professionals. Therefore, we have no bias for any one group of tax professionals over another. Our 18,000+ members are employed in offices that assist more than eleven million taxpayers. All of NATP's members are potentially negatively impacted by Section 8246 of the Act, as are all taxpayers. The change in standards resulting from this legislation causes, at a minimum, the following serious problems not only for tax return preparers, but also for taxpayers and the government:

 The change made by the Act raises the tax return reporting standard for preparers above the standard for taxpayers, thereby creating the potential for conflicts of interest between preparers and their clients. As a result, it affects the very nature of the representation of taxpayers and a taxpayer's right to representation. Taxpayers pay for and expect competent service that does not put them at a further disadvantage than the duty to which they are personally held in paying a fair and just tax.

 Applying the tougher "more likely than not" standard to a tax return preparer results in a fundamental change in the role of the preparer, from that of an advocate to that of an advisor or even an auditor.

 It is frequently extremely difficult, if not impossible, to determine the probable correctness of the treatment of some routine items with the degree of certainty required for the higher "more likely than not" standard because: (1) there sometimes is little guidance, if any, for the tax treatment of an item at the time the item must be reported on a return; and (2) the proper treatment of an item frequently depends on an analysis of unique or unusual facts and circumstances that were not contemplated in published guidance.

 A disclosure made under a system with a "more likely than not" standard could be viewed as a concession on the merits.

 The potential penalties on a preparer for failure to satisfy that high standard are so severe that preparers will feel compelled to protect themselves by urging their clients to include disclosures for virtually every item for which there is even the slightest uncertainty regarding the proper treatment. This problem is compounded by the fact that the preparer could be subject to disciplinary action by the IRS Office of Professional Responsibility. These excessive disclosures for routine tax return positions will overburden tax administration, thereby defeating the purpose of the disclosure system and also undermining the electronic filing initiative, which currently is not capable of processing a large number of disclosures in a return.

To avoid this disruption to our tax system and the resultant unfairness to the taxpayer and tax return preparer, NATP recommends that the section 6694 tax return preparer standards be either restored to their standard before the Act (realistic possibility of success) or, at most, raised to a point equal with the taxpayer standards (substantial authority). We would agree that for tax shelter ("tax avoidance") items the "more likely than not" standard should continue to apply. For non-tax shelter ("non-tax avoidance") items, however, the "substantial authority" standard should apply. The rationale for these recommendations is set forth in more detail below.



About NATP

Whereas we could claim here that the National Association of Tax Professionals (NATP) represents the hundreds of thousands of tax return preparers affected by this proposed bill, we believe in stating facts that are not misleading. NATP's 18,000 members are employed in offices that assist more than 11 million taxpayers. Our members include individual preparers (81% of which have undergraduate or graduate degrees), Enrolled Agents, Certified Public Accountants, accountants, attorneys, and Certified Financial Planners. NATP is a nonprofit professional association that is committed to the integrity of the tax administration system and the application of tax laws and regulations by providing education, research, and information to tax professionals. For almost 30 years, we have existed to serve professionals who work in all areas of tax practice. We provide our members with over 200 tax education offerings in over 100 cities throughout the United States, a service unmatched by any other national tax association. In addition, our 35 Chapters and National headquarters serve the public through regular news releases, client brochures and newsletters, and a designated taxpayer website. Our Chapters provide significant member involvement in local and state communities. Our headquarters are located in Appleton, Wisconsin. Our members are served by a staff of 42 employees, 14 of which are CPAs, attorneys, and EAs.



General Comments

The changes brought about by section 8246 of the Act to section 6694 of the Internal Revenue Code surprised tax professionals in every industry association and industry media publication as well as those in government administration. There is a time-honored protocol usually followed by Congress when pursuing legislation that will have a profound effect on the American public at large. There are usually hearings with attendant publicity and subsequent study over such momentous matters. Commentary is sought from respected authorities, academicians, independent policy institutes and the public. Additional debate quite often emanates from Congressional committees and subcommittees. These changes, however, were contained in an appropriations bill introduced on May 8 to help fund the war in Iraq among other things. It passed on May 25. Somehow, in all the fervor, Congress either side-stepped or forgot about this protocol.

We read, in the June 4 edition of Tax Notes Today, that the IRS Chief Counsel commented about the sudden and unexpected change to section 6694, indicating that the IRS had been "blind-sided" by this provision in the Act. It constitutes a major change in tax policy. Although the Treasury Department did ask for and increase in the dollar amount of the section 6694 penalty, it did not recommend a change in the preparer standards. No one, other than Congressional staff, had the chance to view and comment on this legislation. Little time, if any, was given to its study. . .which could easily lead one to conclude that the full consequences of this particular provision were not studied by Congress. Indeed, there is already a proposal to amend a portion of the Act for this very reason.

NATP joins with many others in the industry on behalf of American taxpayers to voice the need and urge Congress to correct the problems and inequities in Section 8246 of the Act. We have held discussions with the AICPA on these matters. We support the positions put forth in their July 10 paper on these issues. We also agree with the AICPA that this matter requires expeditious treatment for the tax profession, taxpayers and the tax administration system. It is in that spirit that the National Association of Tax Professionals hereby submits the detailed commentary below on the nature and consequences of this provision in the hope that it will be studied and that a correction to the problems therein set forth will be expedited. Whereas we have made some original comment, we believe there is no need or time to "reinvent the wheel" by otherwise restating the eloquent positions already set forth by the AICPA. The detailed commentary submitted is largely that of the AICPA, used with their permission.



SPECIFIC COMMENTS



Having Different Reporting Standards for Taxpayers and Preparers is Bad Policy

Section 6694 as revised by the Act, requires that a preparer must satisfy a higher standard ("more likely than not") than the standard the taxpayer must satisfy ("substantial authority") in order to avoid the imposition of an understatement penalty with respect to an undisclosed, non-tax avoidance item reported on the taxpayer's return. Thus, it is possible for a preparer to be subject to a penalty with respect to a position taken on a return he or she prepared, even though the taxpayer would not be subject to a penalty with respect to that same tax return position. That is just plain bad tax policy.

Having a higher standard for the preparer may result in a conflict of interest situation between the preparer and the taxpayer. If the higher preparer standard is not satisfied for a tax return position, the preparer can be protected from the imposition of the section 6694 penalty only if that position is disclosed on the taxpayer's return. Thus, in some situations, even though the taxpayer is not required to disclose a position on a return, the preparer might be forced to encourage the taxpayer to do so, to protect the preparer from a penalty. This is also, clearly, bad policy.

Section 10.29 of Circular 230 specifies generally that "a practitioner shall not represent a client ... before the Internal Revenue Service if the representation involves a conflict of interest." It then defines "conflict of interest" to include a situation where there is "a significant risk that the representation of one or more clients will be materially limited by ... a personal interest of the practitioner." The provision in the Act that raises the preparer standard above that of the taxpayer for penalty purposes creates the potential for conflict of interest situations that could put preparers in violation of Circular 230; thus, it is contrary to a fundamental policy underlying practice before the IRS.

Further, the preparer does not control the taxpayer's tax return and cannot force the taxpayer to disclose a position on a return. If the taxpayer does not agree to disclose the position, the preparer could be placed in a professionally difficult situation of not being able to sign the taxpayer's return, which would be particularly problematic in view of the section 6695 penalty for failure to sign returns that an individual prepares. The very nature of tax representation and a taxpayer's right to representation could be adversely affected if the preparer is required to withdraw from an engagement because the taxpayer will not include a disclosure in the taxpayer's return. It also puts the preparer in an economically disadvantaged position in trying to collect for services rendered.

In addition, a preparer's withdrawal from an engagement because of the taxpayer's refusal to disclose may result in the taxpayer seeking out a preparer who is less knowledgeable about the merits of the position or who feels less constrained by ethical standards and is, therefore, willing to prepare and sign returns that do not comply with the section 6694 reporting standards. Alternatively, the difference in standards between taxpayers and paid preparers may result in the taxpayer deciding to prepare returns in house, in which case the section 6694 standard would not apply.

Accordingly, for the sake of equity in the application of understatement penalties, the ethical operation of the tax compliance system, sound tax policy and the preservation of the nature of taxpayer representation and the taxpayer's right to representation, it is critical that the standards applicable to tax return preparers be, at most, equalized with the standards applicable to taxpayers.



The Recognized Right of the Public to Advocacy and Representation and the Right to Practice

Richard Morgante, Commissioner of the Wage and Investment Division of the IRS, spoke at NATP's National Conference in Las Vegas on July 24, 2007. He stated that ". . .the IRS expects the American public to pay only the amount of tax owed, no more. . .but no less." Sixty percent of taxpayers engage the services of a tax professional in order to accurately determine the amount of tax owed. They pay for the knowledge of the complexity of our tax laws so that their tax liability can be fairly determined. A tax return preparer has long been viewed as having dual roles - as an advocate for the taxpayer-client, and as an advisor with a duty not only to the taxpayer-client, but also to the public and the tax system. The advocacy role of the preparer previously had been recognized and accepted by the government, as evidenced by the "realistic possibility of success" reporting standard in section 6694 prior to the recent revision and in the current section 10.34 of Circular 230. The House Committee Report accompanying the Omnibus Budget Reconciliation Act of 1989 (P.L. 101-239) stated "[t]he committee has adopted this new standard because it generally reflects the professional conduct standards applicable to lawyers and to certified public accountants." The new, "more likely than not," reporting standard substantially and inequitably changes that, turning preparers into supplemental representatives of the IRS through a form of coercion. What's more, in those cases where a return must be filed before adequate guidance is given with respect to a difficult tax issue, the IRS and the Treasury Department have the luxury of playing "Monday morning quarterbacks" in determining the appropriate treatment of a particular tax item or circumstance.

This is a major change in tax policy that should not have been made without hearings and extensive consideration. For this reason, the change to the "more likely than not" reporting standard for non-tax avoidance items should be overridden. As noted above, NATP recommends that the preparer standards should be, at most, equalized with the "realistic possibility of success" standards that apply to taxpayers.



When a "Higher Standard" Ought to Apply to Tax Return Preparers

The United States income tax system has long been recognized as voluntary on the part of taxpayers. They are expected to report their transactions in accordance with the rules prescribed by the income tax laws. Congress has wisely built into the system the flexibility for taxpayers to reasonably interpret the many grey areas of the law without the threat of having penalties imposed. This flexibility is evidenced in the twotiered approach to the standards applicable to taxpayers; one approach for routine, non-tax avoidance items and one for potentially abusive tax avoidance items.

As part of that approach, Congress, Treasury, and the IRS have developed a disclosure regime to provide the IRS with early knowledge of potentially abusive transactions that merit scrutiny. The regime uses various "filters" (i.e., a focus on certain types of transactions) for capturing useful information from taxpayers and "material advisors" while at the same time minimizing the burden imposed on those individuals. This targeted approach to obtaining disclosures also minimizes the number of unnecessary disclosures that must be dealt with by the IRS.



"Substantial Authority" Standard for Non-Tax Avoidance Items

Currently, section 6662 provides that an understatement penalty will not be imposed on a taxpayer with respect a tax return position taken for a non-tax avoidance item if either: (1) the taxpayer has "substantial authority" for the tax treatment of the item on the tax return (i.e., the weight of the authorities supporting the treatment is substantial in relation to the weight of authorities supporting contrary positions, typically understood to be approximately a 40% likelihood of the treatment prevailing on the merits); or (2) the taxpayer made a specific disclosure of the position on the return and there was a "reasonable basis" for the tax treatment of the item on the tax return (i.e., roughly a 20% likelihood of the treatment prevailing on the merits).

Federal tax law is constantly changing; at any given time, there are many issues awaiting guidance from the Treasury Department and the IRS. For example, Treasury's 2006 - 2007 Priority Guidance Plan lists 264 guidance projects that Treasury planned to address between July 2006 and June 2007. As a result, there is sometimes little or no authority or guidance for the tax treatment of an item at the time the item must be reported on a return. Even if there is some authority, in many instances, the proper treatment of an item may not be clear where there are unique facts and circumstances. Thus, given the exceedingly complex and dynamic nature of the tax law, it may be difficult for taxpayers and preparers to know the probable correctness of many return positions. It is not only unrealistic, but in many cases, impossible, to ensure the proper tax treatment of an item with the high degree of accuracy required by the "more likely than not" standard. In some situations, there simply may be no tax treatment that is "more likely than not" the proper treatment.

When Congress created the current section 6662 taxpayer substantial understatement penalty in 1982, it recognized these problems and, as a result, for non-tax avoidance items, decided against imposing a standard requiring certainty, such as the "more likely than not standard" does. The Joint Committee on Taxation Blue Book for Public Law 97-248, section 323 (a) specifically notes that: "Congress did not adopt an absolute standard that a taxpayer may take a position on a return only if, in fact, the position reflects the correct treatment of the item because, in some circumstances, tax advisors may be unable to reach so definitive a conclusion. Rather, Congress adopted a more flexible standard under which the courts may assure that taxpayers who take non-disclosed highly aggressive filing positions are subject to the penalty while those who endeavor in good faith to fairly self-assess are not penalized."

The IRS task force that studied the penalty regime in 1989 likewise pointed out that:

"...a variety of factors limit the ability of taxpayers to report positions disclosing a liability that is probably correct. Perhaps the most significant limitation is the ambiguity inherent in applying a complex and changing set of tax rules to an infinite variety of factual situations, which may themselves be of ambiguous import. These complexities may result in failure to recognize issues, incorrect conclusions as to the probability that a particular position will prevail, and differences of opinion regarding probability that are not resolvable short of the courthouse. The complexity of modern financial affairs, when coupled with the legal requirement to file a return by a statutory deadline and the costs of making the best possible assessment of each individual issue may also provide practical limits on the pursuit of a theoretically perfect return." Witness the myriad questions and factual diversity in the pursuit of the domestic production activity deduction fostered by the American Jobs Creation Act of 2004.

The current taxpayer standard of "substantial authority" for non-tax avoidance items strikes a balance, taking into account the uncertainties that exist when reporting an item on a return and the IRS' need to focus on information that will enable it to prevent abuses to the tax system. In contrast, a standard of "more likely than not" for non-tax avoidance transactions would pose an unworkable burden on the tax system. Accordingly, NATP strongly recommends that both the taxpayer and preparer standard for reporting non-tax avoidance items be, at most, "substantial authority." NATP also recommends an expansion of the authorities that can be relied on in determining if the "substantial authority" standard is met, to include field service advices, treatises, and legal scholarly literature.



"More Likely Than Not" Standard for Tax Avoidance Items

Section 6664(d) provides that an understatement penalty under section 6662A will not be imposed on a taxpayer for tax deficiencies that are assessed with respect to tax avoidance transactions if there was reasonable cause for the understatement and the taxpayer acted in good faith. Further, these requirements will be satisfied only if: (1) the taxpayer made a specific disclosure of the position on the return; (2) there was "substantial authority" for the tax treatment of the item on the return; and (3) the taxpayer reasonably believed that the tax treatment of the item on the return was "more likely than not" the proper treatment (i.e., a greater than 50% likelihood of the treatment prevailing on the merits).

NATP strongly supports well-targeted efforts to eliminate abusive transactions and close the "tax gap." Such transactions undercut the large majority of honest taxpayers and tax return preparers who strive every day to obey the increasingly complex tax laws. NATP believes that the most effective way to combat abusive transactions without interfering with a taxpayer's right to legally minimize taxes is through disclosure and penalties. But, for a disclosure system to be effective in combating abuse, it must be able to focus on the transactions that are the most likely to be abusive. If the "more likely than not" standard is applied to all items, including routine, non-tax avoidance items, the ability of the disclosure system to focus on abusive transactions will be seriously impaired.

Given the complexity of the tax law, the lack of guidance from the Treasury Department and the IRS on many issues, and the factual nature of many issues, the "more likely than not" standard for taxpayers has heretofore wisely been reserved for tax avoidance transactions rather than imposed as a uniform rule for all transactions. NATP recommends that the "more likely than not" standard be applied to taxpayers and preparers only with respect to tax avoidance items. This would be consistent with the approach that Congress and Treasury have taken in recent years to utilize directed disclosures that focus on the potentially problematic transactions without either overburdening the IRS with unnecessary disclosures or inhibiting the electronic filing system.



Does Disclosure Unfairly Concede the Issue?

A disclosure made in a tax system that has "more likely than not" as the reporting standard could be viewed as a concession of the issue disclosed, since the disclosure would only be required if an analysis of the applicable authorities and facts by the taxpayer or preparer resulted in the conclusion that the tax treatment "more likely than not" was not the proper treatment. If the preparer has concluded that the standard has not been satisfied, but the taxpayer wishes to pursue the matter and not disclose, the preparer could be forced to withdraw and the taxpayer's right to tax representation would be affected. So would the tax preparer's right to practice and the preparer's ability to collect for services rendered at that point. To avoid these results, with respect to non-tax avoidance items, NATP recommends that the "more likely than not" standard be applied to taxpayers and preparers only with respect to tax avoidance transactions.



As Ubiquitous as Circular 230 Disclosure Disclaimers

Because of the difficulty of satisfying the "more likely than not" standard, in many routine situations, and the severe penalties for understating tax liabilities, disclosures may be made for numerous tax return positions with respect to which there is any uncertainty regarding the ultimate tax treatment. The resulting increase in the number of disclosures will not create the desired outcome of the disclosure regime, which is the "weeding out" of abuses in the system. This doesn't even take into account the possibilities of multiple professionals covering their bases because they may be deemed "preparers" under this provision of the Act. Consider the recurring circumstance of inherited items and the treatment of their basis on a 1040. Who does the appraisal to determine basis? Will that appraiser be deemed a preparer for these circumstances? Will they want some disclosure of that fact on the taxpayer's return?

Adding to this problem is the fact that, if an understatement penalty is imposed on a preparer who is subject to Circular 230, the preparer may be subject not only to a high section 6694 monetary penalty, but also to an additional fine under Circular 230 and disciplinary action by the IRS Office of Professional Responsibility. Rather than risk such severe penalties, with a "more likely than not" standard, it is likely that preparers will strongly encourage disclosures, even on routine, non-tax avoidance items.

Clearly, this is not a desired outcome. The IRS will be swamped with paper; the ability of the IRS to focus its attention on potentially abusive tax avoidance transactions will be obstructed; the electronic filing system will be undermined, since currently it is not designed to accept a large number of disclosures per return; important disclosures will be overlooked; and a large percent of the voluminous disclosures will be meaningless. If you doubt that the IRS will be swamped with such disclosures, consider the ubiquitous disclaimers under Circular 230 that accompany every and any e-mail or other correspondence from a Circular 230 professional.

The Internal Revenue Service Advisory Council noted in the Briefing Book for its November 15, 2006 public meeting that, even under the current system of targeted disclosures, there is a continuing problem with overdisclosure. The Council gave an example of tens of thousands of unnecessary disclosures received during the year for just one type of transaction. The Council also noted that there is anecdotal evidence that little or nothing was being done with disclosures that had been made. In discussing this problem, the Council cautioned that although it was "fully supportive of the IRS' attack on "abusive tax shelters," it believed that "it is important for the IRS to distinguish between "abusive transactions and transactions that reduce a taxpayer's liability through appropriate tax planning." This situation of excessive disclosures will be drastically worsened if the standard for non-tax avoidance items is "more likely than not."

Given the overwhelming burden that will be imposed on the tax system by excessive disclosures that are made as a result of the high "more likely than not" standard, NATP strongly recommends that the taxpayer and preparer standard for reporting non-tax avoidance items be "substantial authority."



6. Conclusion

NATP recommends that the section 6694 tax return preparer standards be returned to their previous standard of the "realistic possibility of success" or, at most, equalized with the standards currently applicable to taxpayers (substantial authority) for non-tax avoidance items. For tax avoidance items, the "more likely than not" standard should continue to apply. Thank you for the opportunity to share these comments.


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

To provide "IRS transparency" you should upload your IRS experiences to www.irsforum.org.

Tax Help: IRS levied a personal residence - taxpayer made the wrong argument. He should have argued that the levy of his residence would have created an "economic hardship" under IRC 6343. IRS 6343 prevents an IRS levy if it does create an "economic hardship."


Kevin F. Foley and Shula K. Foley v. Commissioner

Dkt. No. 11602-06L , TC Memo. 2007-242, August 23, 2007.



[Code Sec. 6330]
Collection: Collection alternatives: Delay of collection actions: Appeals officer: Abuse of discretion. --

An Appeals officer did not abuse his discretion by sustaining a proposed levy against a married couple's residence. The IRS had levied on the couple's residence because they had no other assets. At their Collection Due Process (CDP) hearing, the couple did not dispute their underlying tax liability but, instead, requested that their outstanding tax liability be designated as currently not collectible. The Appeals officer did not abuse his discretion by determining that the taxes were indeed currently collectible because the couple represented that they planned to sell or refinance the residence in the future and would be able to pay the entire tax liability after the sale. Moreover, the taxpayers did not explain why they could not access the equity from their residence immediately, nor give any reason why collection should be delayed to allow them more time to sell or refinance the house.



Mark A Pridgeon, for petitioners. Trent D. Usitalo, for respondent.



MEMORANDUM OPINION


SWIFT, Judge: This matter is before us under Rule 121 on the parties' cross-motions for summary judgment. The underlying issue in this collection case is whether respondent's Appeals Office abused its discretion in sustaining respondent's proposed levy action against petitioners' residence.

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



Background


At the time of filing the petition, petitioners resided in Afton, Minnesota.

In 1999, petitioners earned $359,378 in short-term capital gains.

On September 7, 2000, petitioners purchased a new residence for $140,000 with a $40,522 cash down payment and a contract for deed for the balance with a balloon payment due on June 1, 2007.

On or about February 21, 2005, petitioners filed late their 1999 joint Federal income tax return showing a tax liability of $99,548. Petitioners included no payment with the return, and in 1999 petitioners paid no withholding taxes and no estimated taxes.

On or about April 4, 2005, respondent assessed the above $99,548 tax liability reported on petitioners' 1999 Federal income tax return, along with interest and penalties and mailed to petitioners a notice and demand for payment.

On or about October 10, 2005, respondent mailed to petitioners a notice of intent to levy relating to petitioners' 1999 Federal income taxes, plus penalties and interest in the total amount of $197,202.22.

On October 28, 2005, respondent filed a Federal tax lien in Washington County, Minnesota, relating to petitioners' 1999 outstanding Federal income taxes.

On or about November 2, 2005, petitioners timely requested an Appeals Office hearing, seeking to avoid or at least to postpone respondent's proposed levy.

In their Appeals Office hearing, petitioners requested that respondent designate their outstanding 1999 Federal income taxes as currently not collectible. Petitioners also represented that because of the balloon payment due on their contract for deed in June of 2007 they intended to sell or refinance their residence and that funds therefrom would be used by petitioners to pay their outstanding 1999 Federal income taxes. Petitioners also represented that they had several business deals that at some point might provide funds to pay their 1999 Federal income taxes.

In the Appeals Office hearing petitioners did not challenge their underlying 1999 Federal income tax liability. Per respondent's request, petitioners filed Form 433-A, indicating that petitioners' monthly living expenses exceeded their monthly earned income and showing their residence as their only significant asset.

On or about April 26, 2006, respondent's Appeals officer advised petitioners' representative that the proposed levy action was sustained and that petitioners should consider either refinancing or selling their residence to pay their 1999 Federal income taxes.

The Appeals officer further determined that it was not appropriate to levy on petitioners' bank accounts because petitioners had no funds in their bank accounts.1

The Appeals officer on his own initiative considered other collection alternatives. In particular, the Appeals officer determined that an installment agreement would not be appropriate because petitioners' monthly necessary living expenses exceeded their monthly income. The Appeals officer further determined that an offer-in-compromise would not be appropriate because of the amount of equity in petitioners' residence.

The Appeals officer determined that it was appropriate to levy on petitioners' residence because there was sufficient equity in the residence to satisfy petitioners' entire outstanding tax liability.

On or about May 11, 2006, respondent's notice of determination was mailed to petitioners, sustaining respondent's proposed levy.

In the notice of determination, the Appeals officer determined, and petitioners do not dispute, that as of May 2006, petitioners had a balance due on the contract for deed relating to their residence of $67,836, and petitioners' residence had a fair market value of approximately $460,000.

On June 19, 2006, petitioners timely filed a petition with this Court.

In their petition, petitioners alleged only the following error:

The Respondent erred in determining that a short-term extension of time to June 2007 for the petitioners to refinance or sell their home pursuant to a balloon payment on their Contract for Deed and thereby raise the funds to pay the liabilities was not an appropriate collection alternative * * *.



Discussion


Summary judgment is appropriate where the pleadings, answers to interrogatories, depositions, admissions, and other material show there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law. Rule 121(b); Beery v. Commissioner, 122 T.C. 184, 187 (2004).

Under section 6330(d)(1), where a taxpayer's underlying tax liability is not at issue, we generally review respondent's Appeals Office notice of determination for an abuse of discretion. Sego v. Commissioner, 114 T.C. 604, 609-610 (2000). In an Appeals Office hearing, generally respondent is required to consider issues raised by a taxpayer including collection alternatives and challenges to the appropriateness of the collection action. Sec. 6330(c).

A taxpayer may request that his Federal income tax liability be designated as currently not collectible. Such status may be available where, based on the taxpayer's assets, equity, income, and expenses, the taxpayer has no apparent ability to make payments on the outstanding tax liability. 2 Administration, Internal Revenue Manual (CCH), sec. 5.16.1.2.9, at 17,810. See also Willis v. Commissioner, T.C. Memo. 2003-302.

In a number of situations, courts have held that it will not be regarded as an abuse of discretion where an Appeals officer refuses to delay a proposed collection action to allow a taxpayer to sell an asset. See Castillo v. Commissioner, T.C. Memo. 2004-238; Clawson v. Commissioner, T.C. Memo. 2004-106; Medlock v. United States , 325 F. Supp. 2d 1064, 1077-1079 (C.D. Cal. 2003).

Herein, the record establishes that respondent's Appeals officer did not abuse his discretion in sustaining the proposed levy. The Appeals officer considered petitioners' request to designate their liability as currently not collectible and correctly determined that it was not merited because of the equity in petitioners' residence. Further, the Appeals officer did not abuse his discretion in rejecting petitioners' request to postpone the levy until after June 2007 to allow petitioners to refinance or sell their residence.

We note that petitioners purchased a new residence with $40,522 in cash at a time when they owed a substantial tax liability. See Steinberg v. Commissioner, T.C. Memo. 2006-217 (no abuse of discretion in rejecting an offer-in-compromise where taxpayers spent $100,000 on a residence down payment).

We are not aware of any reason why petitioners did not attempt to refinance or to sell their residence before June 2007 as recommended by respondent's Appeals officer to pay their outstanding 1999 Federal income tax liability. If respondent's tax lien inhibited petitioners from refinancing or selling their residence, petitioners could have requested respondent to subordinate the tax lien under section 6325(d) to facilitate the refinancing or sale. There is no indication that petitioners made such a request.

For the first time in their summary judgment motion, petitioners allege that respondent's Appeals officer abused his discretion by failing to properly balance the need for efficient collection of taxes with the concern that a collection action be no more intrusive than necessary. Petitioners' argument fails. As stated, petitioners never requested an installment agreement nor did they make an offer-in-compromise, yet the Appeals officer considered these collection alternatives and correctly concluded that a levy on petitioners' residence was the only viable alternative.2

Petitioners contend that the filing of respondent's tax lien alone was sufficient to protect respondent's interest. The lien itself, however, does not collect taxes owed but simply enhances respondent's priority position vis-a-vis other creditors.

Regardless of our opinion, herein, petitioners effectively obtained much of what they wanted --namely --a postponement of respondent's levy until 2007. By requesting an appeal with respondent's Appeals Office and subsequently filing a petition with this Court, respondent was temporarily stayed from levying on petitioners' residence. Sec. 6330(e); Davis v. Commissioner, 115 T.C. 35, 37 (2000).

We hold that respondent's Appeals Office did not abuse its discretion. We will deny petitioners' motion for summary judgment, and we will grant respondent's motion for summary judgment.

To reflect the foregoing,

An appropriate order and decision will be entered for respondent.

1 The record does not explain what disposition petitioners made of the $359,378 in short-term capital gains they realized in 1999.

2 Our opinion here does not necessarily mean that respondent may in fact levy on petitioners' residence. Pursuant to sec. 6334(e), a taxpayer's principal residence is exempt from levy absent the written approval of a Federal district court Judge or Magistrate. We note that, in connection with a proposed levy on a taxpayer's residence, our jurisdiction under sec. 6330(c)(2)(B) to consider whether an Appeals officer properly has balanced the need for efficient collection of taxes with the concern that a collection action be no more intrusive than necessary would appear to be somewhat duplicative of the Federal district courts' jurisdiction under sec. 6334(e) also to review and approve respondent's levy on a taxpayer's residence.



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

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Tax Attorney: Tax fraud mens rea

The taxpayer's was taped by an IRS agent in a seminar tellilng the audience how to evade taxes.This was an easy win for the DOJ in the circumsances.

United States of America, Plaintiff-Appellee, v. Michael E. Diesel, Defendant-Appellant. U.S. Court of Appeals, 10th Circuit; 06-3325, July 31, 2007.Unpublished opinion affirming an unreported DC Kan. decision.

[ ¶41,333.217 and ">ORDER AND JUDGMENT * GORSUCH, Circuit Judge: A federal jury found Michael E . Diesel guilty of willfully underreporting to the IRS over $3 million of his personal income over a three-year period. The United States District Court f o r the District of Kansas thereafter sentenced Mr. Diesel, inter alia, to 42 months of incarceration.

In this appeal, Mr. Diesel a rgues that we should overturn his conviction because (1) he "could not possibly have had the requisite mens rea "; (2) the government unconstitutionally required Mr. Diesel to "create his own tax form"; and (3) the district court violated Apprendi v . New Jersey, 5 30 U.S. 466 (2000) , and its progeny when it sentenced him to a mid-Guidelines term of 42 months of incarceration. Because Mr. Diesel's first two arguments are wholly without merit and Mr. Diesel's third argument is precluded by Supreme Court and our case law, we affirm.

* * *Mr. Diesel founded and, through a series of trusts, effectively owned and operated a telecommunications research company which paid him an annual salary of $103,549 in 1998, $106,754 in 1999, and $108,788 in 2000. Mr . Diesel reported, and presumably paid , income tax on these amounts . In addition to his salary, however, Mr. Diesel's trusts also made over $3 million in distributions from 1998 to 2000, through a series of intermediate trusts , to the Pernour International T rust, an off-shore , Belize-based trust. Mr. Diesel controlled all of the trusts in the chain and ultimately received all of the proceeds from Pernour for his personal use. Mr. Diesel failed to pay income taxes on any of these proceeds.

Mr. Diesel apparently learned how to devise this scheme from the Aegis Company in Chicago, which, following a nationwide investigation, the government successfully prosecuted for tax fraud. In January 1998, an undercover IRS agent at an Aegis seminar in Belize tape recorded Mr . Diesel stating that (1) any income tax above ten percent is "confiscation" and "everybody is trying to cheat" the IRS; (2) the "whole point" of the trusts he employed was that the IRS did not understand them; (3) the trusts are like a "Double K-1 disappearing tax liability trick"; and (4) the trusts were "too good to be true."

Unfortunately for Mr. Diesel, they were not. In January 2005, a federal grand jury returned a three-count indictment against Mr. Diesel, charging him, inter a lia, with three felony violations under 26 U .S.C. 1 , who served as Mr. Diesel's sole witness. Mr. Gross testified that, while he is not a tax attorney 2 , he had advised Mr. Diesel in 2001 that the Aegis trust plan was "appropriate and correct," so long as properly followed. But Mr. Gross also admitted that he knew that the United States Tax Court, as early as 1998, had ruled the Aegis trust plan illegal - and that he communicated this via letter to his clients, including Mr. Diesel.The jury found Mr. Diesel guilty on all three counts, and the district court denied Mr. Diesel's motion for judgment of acquittal. At sentencing, the probation office recommended a Guidelines-based sentence of 37 to 46 months based, in part, on a two-level enhancement under U.S.S.G. §2T1.1(b)(2) for Mr. Diesel's use of "sophisticated means" to conceal his tax evasion offense .

Mr. Diesel objected to this enhancement on factual grounds, arguing that he had concealed nothing. Mr. Diesel also objected that a proper consideration of the factors enumerated under 18 U .S.C. §3553(a) suggested that he deserved a below-Guidelines sentence. See Def. Sent. Mem. at 1-9; see also Sent. Tr. at 809-20.

At the sentencing hearing, the district court indicated that it had considered Mr. Diesel's written sentencing submission in addition to his oral presentation; that it understood the Guidelines to be merely advisory; and that the Guidelines suggested a sentencing range of 37 to 46 months. The district court then announced its judgment that a 42-month sentence would be appropriate in this case , taking into account Section 3553(a) factors. Specifically, the judge noted, among other things, the seriousness and magnitude of Mr. Diesel's tax evasion scheme; the sophistication of Mr. Diesel's efforts to hide his illegal conduct; as well as the possibility that , if not punished sufficiently, Mr . Diesel's conduct might tempt others to follow his example .

* * *On appeal, Mr. Diesel raises three arguments. We address each in turn.1. Mr. Diesel contends that he "could not possibly have had the requisite mens rea " when he signed his tax returns because it was only after signing each of those returns that he took and spent his annual distributions from the Pernour trust. Aplt. Op. Br. at 8; see also id. a t 10 , 12 . Because Mr. Diesel, despite his assertion to the contrary, failed to raise th is issue in the district court, we review for plain error. We hold, however , that Mr. Diesel's argument fails under any standard of review.

The government's case had nothing whatsoever to do with when or how Mr. Diesel caused Pernour to distribute monies to him. Instead, the case focused on whether Mr. Diesel's tax returns failed to account as income to him the money siphoned into the Pernour trust. Thus, the mens rea question for the jury was whether Mr. Diesel, when he signed his tax returns, willfully failed to disclose as income the monies directed to the Pernour trust. See 26 U .S.C. 3 ,
we again review only for plain error. And we again find no error 3 under any standard of review.With respect to Mr. Diesel's Booker argument, the record simply does not support him.

The district court expressly indicated that it treated the Guidelines as "advisory." See Sent. Tr. at 822 (emphasis added) ("I have given particular emphasis, of course, to the presentence investigation report and the United States Sentencing Guidelines, though treating those guidelines as advisory only and not mandatory, in arriving at what I think is a reasonable sentence in this case."). From this starting point, the district court then expanded the scope of its analysis outside of the Guidelines by weighing the Section 3553(a) factors and Mr. Diesel's arguments before ultimately holding that 42 months of incarceration would be "reasonable" in this case. See id. at 822-35. With respect to Mr. Diesel's Cunningham argument, it is foreclosed by Supreme Court and our precedent. District courts may make factual findings and enhance sentences within the statutory range prescribed for the conduct found by the jury. See, e .g., United States v . Holyfield, 4 8 1 F .3d 1260, 1262-6 3 (10th Cir. 2007) (citing Harris v . United States, 536 U.S. 545 (2002)). Quite unlike Cunningham, Mr. Diesel does not allege that his 42 -month sentence fell outside this range. Nor could he , a s 26 U .S.C. * This order and judgment is not binding precedent except under the doctrines of law of the case, resjudicata and collateral estoppel. It may be cited, however, for its persuasive value consistent with Fed. R . App. P . 32.1 and 10th Cir. R. 3 2 .1.1 Mr. Gross is also one of Mr. Diesel's appellate attorneys on this case . The government has not objected to the propriety of this unusual arrangement, and accordingly we do not address it here .2 See, e .g., IV Tr. T ran. at 599 ( "Well, I really didn't have a tax background at the time I went to the seminar. The only tax background I had was one class in law school."); id. at 613 (stating the one course was "just basic federal income tax").3 While Mr. Diesel objected to this two-level enhancement on factual grounds ( e .g., facts demonstrated that Mr. Diesel reported his income in either his personal or trust returns and thus he did not conceal it), he did not object to the two-level enhancement on constitutional or other legal grounds. See Def. Mot. Obj. to PSR a t 1-5; see also Sent . Tr. at 805-09. Mr . Diesel, however, did make a Booker and Section 3553(a) argument that his overall case presented unique circumstances and asked the district court for a sub-Guidelines sentence. See Def. Sent. Mem. at 1-9; see also Sent. Tr. at 809-20.

Back Taxes: New Charity Reporting Requirements - potential of tax abuse

The Treasury Department and IRS have designated the first two "transactions of interest," published under recently released Reg. §1.6011-4(b)(6), concerning reportable transactions. The Treasury and IRS believe these transactions of interest have the potential for abuse, but lack sufficient information to determine whether they should be identified as tax avoidance transactions. Persons involved with such transactions of interest have certain disclosure and other responsibilities, and may be subject to penalties for failing to comply with such obligations. In addition, participants in such transactions may be subject to other penalties, including the accuracy-related penalty under Code Secs. 6662 or 6662A.



IRS News Release IR-2007-143 , August 14, 2007.

[ Code Secs. 6111 and 6112 ]


Remainder interests: Charitable contribution deduction: Reportable transactions: --



The Treasury Department and the Internal Revenue Service issued two notices that identify as transactions of interest certain transactions involving "toggling" grantor trusts and certain transactions involving contributions of a successor member interest in a limited liability company.

Recently released final regulations about the disclosure of reportable transactions include the new transaction of interest category as one of the reportable transactions subject to disclosure.

"These are the first two transactions of interest we have published under the new regulatory scheme," said IRS Chief Counsel Don Korb. "Hopefully, the notices released today will give taxpayers and practitioners a better idea of the types of transactions that we will be identifying as transactions of interest in the future."

"Toggling" grantor trust transactions are utilized by grantors of these trusts in an attempt to avoid recognizing gain or to claim a tax loss greater than any actual economic loss by purportedly terminating and then reestablishing the grantor status of the trust. These grantor trust transactions usually occur within a short period of time (typically within 30 days).

Transactions involving contributions of a successor member interest are utilized by persons to claim charitable contributions that may be excessive. These transactions arise when a taxpayer acquires a successor member interest, directly or indirectly, in real property, transfers the interest to a tax-exempt organization, and claims a charitable contribution deduction that is significantly higher than the amount that the taxpayer paid for the interest.

In designating both transactions as transactions of interest, Treasury and the IRS believe both transactions have the potential for abuse, but lack sufficient information to determine whether the transactions should be identified specifically as tax avoidance transactions. Treasury and the IRS may take one or more future actions, including designating the transactions as listed transactions, or providing a new category of reportable transaction.

The notices also alert persons involved with these transactions of interest to certain responsibilities that may arise from their involvement.

Notice 2007-72 , I.R.B. 2007-36, August 14, 2007.

[ Code Secs. 6111 and 6112]


Remainder interests: Charitable contribution deduction: Reportable transactions: Transactions of interest. --

The Treasury Department and the IRS have designated a "transaction of interest," published under recently released Reg. §1.6011-4(b)(6), concerning reportable transactions. This transaction involves taxpayers who purchase a remainder interest or similar successor member interest directly or indirectly in real property and then transfer such interest to a tax-exempt organization, claiming a charitable contribution deduction significantly higher than the amount paid for the interest. Persons involved with such transactions of interest have certain disclosure and other responsibilities, and may be subject to penalties for failing to comply with such obligations. In addition, participants in such transactions may be subject to other penalties, including the accuracy-related penalty under Code Secs. 6662 or 6662A.



The Internal Revenue Service and the Treasury Department are aware of a type of transaction, described below, in which a taxpayer directly or indirectly acquires certain rights in real property or in an entity that directly or indirectly holds real property, transfers the rights more than one year after the acquisition to an organization described in §170(c) of the Internal Revenue Code, and claims a charitable contribution deduction under §170 that is significantly higher than the amount that the taxpayer paid to acquire the rights. The IRS and the Treasury Department believe this transaction has the potential for tax avoidance or evasion, but lack sufficient information to determine whether the transaction should be identified specifically as a tax avoidance transaction. This notice identifies this transaction, and substantially similar transactions, as transactions of interest for purposes of §1.6011-4(b)(6) of the Income Tax Regulations and §§6111 and 6112. This notice also alerts persons involved with these transactions to certain responsibilities that may arise from their involvement with these transactions.



FACTS

In a typical transaction, Advisor owns all of the membership interests in a limited liability company (LLC) that directly or indirectly owns real property (other than a personal residence as defined in §1.170A-7(b)(3)) that may be subject to a long-term lease. Advisor and Taxpayer enter into an agreement under the terms of which Advisor continues to own the membership interests in LLC for a term of years (the Initial Member Interest), and Taxpayer purchases the successor member interest in LLC (the Successor Member Interest), which entitles Taxpayer to own all of the membership interests in LLC upon the expiration of the term of years. In some variations of this transaction, Taxpayer may hold the Successor Member Interest through another entity, such as a single member limited liability company. Further, the agreement may refer to the Successor Member Interest as a remainder interest.

After holding the Successor Member Interest for more than one year (in order to treat the interest as long-term capital gain property), Taxpayer transfers the Successor Member Interest to an organization described in §170(c) (Charity).

Taxpayer claims the value of the Successor Member Interest to be an amount that is significantly higher than Taxpayer's purchase price (for example, an amount that is a multiple of Taxpayer's purchase price and exceeds normal appreciation). Taxpayer claims a charitable contribution deduction under §170 based on this higher amount. Taxpayer reaches this value by taking into account an appraisal obtained by or on behalf of Advisor or Taxpayer of the fee interest in the underlying real property and the §7520 valuation tables.

The Internal Revenue Service and the Treasury Department are concerned about apparent irregularities in this transaction. Specifically, the IRS and the Treasury Department are concerned with the large discrepancy between (1) the amount Taxpayer paid for the Successor Member Interest, and (2) the amount claimed by Taxpayer as a charitable contribution. The IRS and the Treasury Department also have the following additional concerns, which may be present in some variations of this transaction: (1) any mischaracterization of the ownership interests in LLC; (2) a Charity's agreement not to transfer the Successor Member Interest for a period of time (which may coincide with the expiration of the applicable period in §6050L(a)(1)); and (3) any sale by Charity of the Successor Member Interest to a party selected by or related to Advisor or Taxpayer.



TRANSACTION OF INTEREST



Effective Date

Transactions that are the same as, or substantially similar to, the transactions described in this notice are identified as transactions of interest for purposes of §1.6011-4(b)(6) and §§6111 and 6112 effective August 14, 2007, the date this notice was released to the public. Persons entering into these transactions on or after November 2, 2006, must disclose the transaction as described in §1.6011-4. Material advisors who make a tax statement on or after November 2, 2006, with respect to transactions entered into on or after November 2, 2006, have disclosure and list maintenance obligations under §§6111 and 6112. See §1.6011-4(h) and §§301.6111-3(i) and 301.6112-1(g) of the Procedure and Administration Regulations.

Independent of their classification as transactions of interest, transactions that are the same as, or substantially similar to, the transaction described in this notice already may be subject to the requirements of §6011, 6111, or 6112, or the regulations thereunder. When the IRS and the Treasury Department have gathered enough information to make an informed decision as to whether this transaction is a tax avoidance type of transaction, the IRS and the Treasury Department may take one or more actions, including removing the transaction from the transactions of interest category in published guidance, designating the transaction as a listed transaction, or providing a new category of reportable transaction.



Participation

Under §1.6011-4(c)(3)(i)(E), Advisor, LLC or any entity used in place of LLC, Taxpayer, and any members of Taxpayer if Taxpayer is a flow-through entity, are participants in this transaction for each year in which their respective tax returns reflect tax consequences or the tax strategy described in this notice.

Charity is not a participant if it received the Successor Member Interest described in this notice on or prior to August 14, 2007. For Successor Member Interests received after August 14, 2007, under §1.6011-4(c)(3)(i)(E) Charity is a participant in this transaction for the first year for which Charity's tax return reflects the Successor Member Interest described in this notice. In general, Charity is required to report the receipt of the Successor Member Interest described in this notice on its return for the year in which it is received. See §6033. Therefore, in general, Charity will be a participant for the year in which Charity received the Successor Member Interest.



Time for Disclosure

See §1.6011-4(e) and §301.6111-3(e).



Material Advisor Threshold Amount

The threshold amounts are the same as those for listed transactions. See §301.6111-3(b)(3)(i)(B).



Penalties

Persons required to disclose these transactions under §1.6011-4 who fail to do so may be subject to the penalty under §6707A. Persons required to disclose these transactions under §6111 who fail to do so may be subject to the penalty under §6707(a). Persons required to maintain lists of advisees 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 §6708(a). In addition, the Service may impose other penalties on persons involved in these transactions or substantially similar transactions, including the accuracy-related penalty under §6662 or 6662A.



DRAFTING INFORMATION

The principal authors of this notice are Patricia M. Zweibel of the Office of Associate Chief Counsel (Income Tax and Accounting) and Leslie H. Finlow of the Office of Associate Chief Counsel (Passthroughs and Special Industries). For further information concerning this notice generally, contact Ms. Zweibel at (202) 622-7900 (not a toll-free call). For further information concerning the sections of this notice under the heading TRANSACTIONS OF INTEREST, contact Ms. Finlow at (202) 622-3070 (not a toll-free call).

Notice 2007-73 , I.R.B. 2007-36, August 14, 2007.

[ Code Secs. 6111 and 6112 ]


Grantor trusts: Reportable transactions: Transactions of interest. --
The Treasury Department and the IRS have designated a "transaction of interest," published under recently released Reg. §1.6011-4(b)(6), concerning reportable transactions. This transaction of interest involves a grantor of a trust attempting to avoid recognizing gain, or claiming a tax loss greater than the actual economic loss, by purportedly terminating ( "toggling off") and then reestablishing ( "toggling on") the grantor status of the trust, usually within a brief period of time. Persons involved with such transactions of interest have certain disclosure and other responsibilities, and may be subject to penalties for failing to comply with such obligations. In addition, participants in such transactions may be subject to other penalties, including the accuracy-related penalty under Code Secs. 6662 or 6662A.



The Internal Revenue Service and the Treasury Department are aware of a type of transaction, described below, that uses a grantor trust, and the purported termination and subsequent re-creation of the trust's grantor trust status, for the purpose of allowing the grantor to claim a tax loss greater than any actual economic loss sustained by the taxpayer or to avoid inappropriately the recognition of gain. The IRS and Treasury Department believe this transaction has the potential for tax avoidance or evasion, but lack sufficient information to determine whether the transaction should be identified specifically as a tax avoidance transaction. This notice identifies this transaction, and substantially similar transactions, as transactions of interest for purposes of §1.6011-4(b)(6) of the Income Tax Regulations and §§6111 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.



FACTS

In one variation of the transaction, Grantor purchases four options. The value of each one of the options is expected to move inversely in relation to at least one of the other options over a relevant range of values so that, before expiration of any one of the options, there will be a gain in two options (gain options) and a substantially offsetting loss in the other two options (loss options). Grantor creates Trust and funds Trust with the options and a small amount of cash. Grantor gives a short-term unitrust interest in Trust to Beneficiary and retains a noncontingent remainder interest in Trust. The remainder interest is structured to have a value as determined under §7520 that equals the fair market value of the options. Grantor takes the position that Grantor's remainder interest is a qualified interest under §2702. Because of the retained remainder interest, Grantor treats Trust as a trust owned by Grantor under subpart E ( §671 and following), part I, subchapter J, chapter 1 of the Code (a grantor trust). The trust agreement also provides that Grantor will have the power, exercisable in a nonfiduciary capacity, to reacquire Trust corpus by substituting other property of an equivalent value (the substitution power) and that this substitution power will become effective on a specified date in the future. See §675(4).

After establishing and funding Trust, Grantor sells the remainder interest in Trust to an unrelated person (Buyer) for an amount equal to the fair market value of the remainder interest (which is equal to the fair market value of the options). Grantor claims that the basis in the remainder interest is determined by allocating to the remainder interest a portion of the basis in all of the Trust assets (based on the respective fair market values of the remainder and unitrust interests at the time of the sale). Therefore, Grantor claims there is no gain recognized on the sale of the remainder interest because Grantor's basis in the remainder interest is the same as the amount realized (prearranged to be equivalent to the fair market value of the options). Buyer gives Grantor an installment obligation (Note), cash, or other consideration for the remainder interest. Grantor claims that the sale of the remainder interest has terminated (toggled off) the grantor trust status of Trust so that, during the period after the sale and before the effective date of the substitution power, Trust is no longer a grantor trust under §671.

Grantor claims that, once the substitution power becomes effective, Trust's grantor trust status is restarted (toggled on). The loss options are then closed out. The amount Grantor paid for those options (the original basis of those options) is greater than the amount Trust receives when the loss options are closed out. Grantor claims that Trust's status as a grantor trust causes Grantor to recognize the loss on the two loss options. Grantor calculates the loss based on the difference between the amount realized and the original basis in the loss options, even though Grantor previously used a portion of the basis in the Trust assets (equivalent to the basis in all of the options) to eliminate Grantor's gain on the sale of the remainder interest. Trust's remaining assets then consist of the two gain options, the contributed cash, and amounts received, if any, upon the termination of the loss options.

Buyer then purchases the unitrust interest in Trust from Beneficiary for an amount equal to the actuarial value of that interest (which equals or approximates the amount of cash Grantor contributed to Trust), making Buyer the owner of both the remainder interest and the unitrust interest. Trust then terminates (by operation of law or Buyer's action), and Trust's assets are distributed to Buyer. Buyer claims a basis in the assets (the gain options and the cash) from Trust equal to the amount paid by Buyer for the two separate interests in Trust. Grantor does not treat the termination of Trust as a taxable disposition by Grantor of the assets of Trust.

The gain options are exercised or sold, or otherwise terminate, and Buyer claims to recognize gain on the gain options only to the extent that the amount realized exceeds the basis Buyer allocates to the gain options. The transaction has been structured so that any gain recognized would be minimal. If Buyer purchased the remainder interest from Grantor with a Note, Buyer uses the proceeds from the options to pay the Note. If Grantor borrowed to purchase the options, Grantor repays the loan from the Note proceeds.

In another variation of the transaction, the facts are the same as described above except for the following. Grantor contributes to Trust liquid assets such as cash or marketable securities, rather than options. Grantor's basis in the contributed assets equals or is approximately equal to the fair market value of the assets at the time of contribution. Before the specified date on which Grantor's substitution power becomes effective, Grantor sells the remainder interest in Trust to Buyer for an amount equal to the fair market value of the remainder interest and claims to recognize no gain or a minimal gain or loss for the same reason as described above. As in the prior variation, Grantor claims that the sale terminates (toggles off) Trust's grantor trust status. After the substitution power becomes effective, Grantor substitutes appreciated property for Trust's liquid assets. The fair market value of the substituted property is equivalent to the fair market value of the liquid assets. Grantor claims that, once the substitution power becomes effective (prior to the exchange), Trust's grantor trust status is restarted (toggled on), and, therefore, the substitution will not cause Grantor to recognize gain.

As described above, Buyer purchases the unitrust interest in Trust from Beneficiary, terminates Trust, and receives Trust's assets on distribution. For tax purposes, Grantor does not treat the termination of Trust as a disposition by Grantor of the appreciated assets in Trust. Buyer claims a basis in the assets of Trust (the appreciated property and cash) equal to the amount paid by Buyer for the interests in Trust.

One of the purported tax consequences of the first variation of the transaction is that Grantor sells the remainder interest and receives an amount substantially equal to the fair market value of the (non-cash) assets contributed to Trust but nevertheless claims a tax loss attributable to those assets even though Grantor has not suffered an equivalent economic loss. One of the purported tax consequences of the second variation of the transaction is that Grantor avoids the recognition of gain on the disposition of the appreciated assets substituted for the original assets contributed to Trust.

These transactions usually occur within a short period of time during the taxable year (typically within 30 days), and, in each case, Grantor claims that the termination and subsequent reestablishment of grantor trust status, combined with the series of events regarding Trust's assets, result in tax consequences that could not be achieved without both the toggling off and on of grantor trust status. The transactions in this notice, as described above, do not include the situation where a trust's grantor trust status is terminated, unless there is also a subsequent toggling back to the trust's original status for income tax purposes.



TRANSACTION OF INTEREST



Effective Date

Transactions that are the same as, or substantially similar to, the transactions described in this notice are identified as transactions of interest for purposes of §1.6011-4(b)(6) and §§6111 and 6112 effective August 14, 2007, the date this notice was released to the public. Persons entering into these transactions on or after November 2, 2006, must disclose the transaction as described in §1.6011-4. Material advisors who make a tax statement on or after November 2, 2006, with respect to transactions entered into on or after November 2, 2006, have disclosure and list maintenance obligations under §§6111 and 6112. See §1.6011-4(h) and §§301.6111-3(i) and 301.6112-1(g) of the Procedure and Administration Regulations.

Independent of their classification as transactions of interest, transactions that are the same as, or substantially similar to, the transaction described in this notice may already be subject to the requirements of §§6011, 6111, or 6112, or the regulations thereunder. When the IRS and Treasury Department have gathered enough information to make an informed decision as to whether this transaction is a tax avoidance type of transaction, the IRS and Treasury Department may take one or more actions, including removing the transaction from the transactions of interest category in published guidance, designating the transaction as a listed transaction, or providing a new category of reportable transaction.



Participation

Under §1.6011-4(c)(3)(i)(E), Grantor, Buyer, and Beneficiary are participants in this transaction for each year in which their respective tax returns reflect tax consequences or a tax strategy described in this notice.



Time for Disclosure

See §1.6011-4(e) and §301.6111-3(e).



Material Advisor Threshold Amount

The threshold amounts are the same as those for listed transactions. See §301.6111-3(b)(3)(i)(B).



Penalties

Persons required to disclose these transactions under §1.6011-4 who fail to do so may be subject to the penalty under §6707A. Persons required to disclose these transactions under §6111 who fail to do so may be subject to the penalty under §6707(a). Persons required to maintain lists of advisees 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 §6708(a). In addition, the Service may impose other penalties on parties involved in these transactions or substantially similar transactions, including the accuracy-related penalty under §6662 or §6662A.



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

To provide IRS "transparency" upload your IRS experiences to www.irsforum.org

Tax Help: Suing the IRS for unlawful disclosure

To get damages from the IRS for unlawful disclosure, one must file an Administrative Claim against the IRS and then pursue all IRS administrative remedies

Rebekah H. Miller, Plaintiff v. United States, Defendant. U.S. District Court, D.C.; Civ. 06-1525, July 30, 2007.Related case DC D.C. Code Sec. 7431]

Jurisdiction: Tax return information: Disclosure by IRS: Damages: Exclusive remedy. --

A federal district court lacked subject matter jurisdiction over an individual's Code Sec. 7433 provides the exclusive remedy for unlawful disclosures made in connection with tax-collection activity. Moreover, the taxpayer had previously filed a damages claim under Code Sec. 7431.

MEMORANDUM OPINION
DENYING THE PLAINTIFF'S MOTION FOR LEAVE TO AMEND; GRANTING THE DEFENDANT'S MOTION TO DISMISS

I. INTRODUCTIONURBINA, United States District Judge: This matter comes before the court on the plaintiff's motion for leave to amend her complaint and the defendant's motion to dismiss. The plaintiff brings suit against the federal government alleging violations of

States pursuant to 26 U.S.C.

§7431. Compl. at ¶1. The §7431 actions proceeded in parallel until the former was dismissed for failure to state a claim on July 19, 2007.In her remaining

III. ANALYSIS

A. Standard of Review for Dismissal Under Rule 12(b)(1)Federal courts are courts of limited jurisdiction and the law presumes that "a cause lies outside this limited jurisdiction." Kokkonen v. Guardian Life Ins. Co of Am., 511 U.S. 375, 377 (1994); St. Paul Mercury Indem. Co. v. Red Cab Co., 303 U.S. 283, 288-89 (1938); see also Gen. Motors Corp. v. Envtl. Prot. Agency, 363 F.3d 442, 448 (D.C. Cir. 2004) (noting that "[a]s a court of limited jurisdiction, we begin, and end, with an examination of our jurisdiction").Because "subject-matter jurisdiction is an `Art. III as well as a statutory requirement[,] no action of the parties can confer subject-matter jurisdiction upon a federal court.' " Akinseye v. Dist. of Columbia, 339 F.3d 970, 971 (D.C. Cir. 2003) (quoting Ins. Corp. of Ir., Ltd. v. Compagnie des Bauxites de Guinee, 456 U.S. 694, 702 (1982)). On a motion to dismiss for lack of subject-matter jurisdiction pursuant to Rule 12(b)(1), the plaintiff bears the burden of establishing that the court has subject-matter jurisdiction. Lujan v. Defenders of Wildlife, 504 U.S. 555, 561 (1992). The court may dismiss a complaint for lack of subject-matter jurisdiction only if "it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Empagran S.A. v. F. Hoffman-LaRoche, Ltd., 315 F.3d 338, 343 (D.C. Cir. 2003) (quoting Conley v. Gibson, 355 U.S. 41, 45-46 (1957)).Because subject-matter jurisdiction focuses on the court's power to hear the claim, however, the court must give the plaintiff's factual allegations closer scrutiny when resolving a Rule 12(b)(1) motion than would be required for a Rule 12(b)(6) motion for failure to state a claim. Macharia v. United States, 334 F.3d 61, 64, 69 (D.C. Cir. 2003); Grand Lodge of Fraternal Order of Police v. Ashcroft, 185 F. Supp. 2d 9, 13 (D.D.C. 2001). Moreover, the court is not limited to the allegations contained in the complaint. Hohri v. United State s, 782 F.2d 227, 241 (D.C. Cir. 1986), vacated on other grounds, 482 U.S. 64 (1987). Instead, to determine whether it has jurisdiction over the claim, the court may consider materials outside the pleadings. Herbert v. Nat'l Acad. of Scis., 974 F.2d 192, 197 (D.C. Cir. 1992).

B. The Court Lacks Subject-Matter JurisdictionThe plaintiff brings the instant, surviving suit under 26 U.S.C.

§7431. She seeks damages resulting from "substantial mental and emotional distress," allegedly caused by wrongful disclosures made in bad faith by IRS agents attempting to collect back taxes from the 1999-2000 tax years. Am. Compl. at ¶ ¶3-13.The defendant argues that as the plaintiff has already brought a suit under §7431 because the former is the exclusive remedy for wrongful tax disclosures. Def.'s Mot. at 6. Although the D.C. Circuit has yet to address this question, district courts in this jurisdiction, following the Ninth Circuit, have ruled that "the exclusivity provision [of §7431 claims]." Koerner v. United States, 471 F. Supp. 2d at 127 (Huvelle, J.) ( citing Shwarz v. United States, 234 F.3d 428, 432 (9th Cir. 2000)).The court concurs in this judgment and need not reiterate here the full legal analysis undertaken by the other courts. Briefly, the dispositive factor underlying various courts' parallel conclusions is that section 7432, [ §7433(a) (emphasis added). Because §7433 - and Congress must necessarily have been aware of §7433 - the court presumes that Congress intended to preclude 1

C. The Court Denies the Plaintiff's Motion to AmendThe plaintiff responds to the defendant's motion to dismiss by filing a motion to amend her complaint. "Whether to grant or deny leave to amend rests in the district court's sound discretion," Nwachukwu v. Karl, 222 F.R.D. 208, 210 (D.D.C. 2004) ( citing Foman v. Davis, 371 U.S. 178, 182 (1962)). The court should "determine the propriety of amendment on a case by case basis, using a generous standard." Harris v. Sec'y, Dep't of Veterans Affairs, 126 F.3d 339, 344 (D.C. Cir.1997).In this case, the plaintiff's proposed second amended complaint, like her first amended complaint, comes to the court under 26 U.S.C.

IV. CONCLUSIONFor the foregoing reasons, the court grants the defendant's motion to dismiss and denies the plaintiff's motion to amend. An order consistent with this Memorandum Opinion is separately and contemporaneously issued this 30 th day of July 2007.1 Although the court rests its ruling on the lack of subject-matter jurisdiction, it notes that the plaintiff's failure to file a timely response is itself a sufficient basis for dismissing this action. See Fox v. Am. Airlines, Inc., 389 F.3d 1291, 1294 (D.C. Cir. 2004) (stating that, under Local Rule 7(b), the court has the discretion to treat any motion against which a response is not filed as conceded).

Alvin S. Brown, Esq.

Tax attorney

703.425.1400

www.irstaxattorney.com

To provide IRS transparency, upload your IRS experiences to www.irsforum.org

Back Taxes: Latest Information on Offers in Compromise


An offer in compromise (OIC) is an agreement between a taxpayer and the Internal Revenue Service (IRS) that resolves the taxpayer's tax liability. The IRS has the authority to settle, or compromise, federal tax liabilities by accepting less than full payment under certain circumstances. The IRS may legally compromise for one of the following reasons:
Doubt as to Liability: Doubt exists that the assessed tax is correct.

Doubt as to Collectibility: Doubt exists that the taxpayer could ever pay the full amount of tax owed. The minimum offer amount must generally be equal to (or greater than) the taxpayer's reasonable collection potential (RCP). The RCP is defined as the total of the taxpayer's realizable value in real and personal assets, plus his/her future income.

Note: Unless the taxpayer files an OIC claiming special circumstances, the offered amount must equal or exceed the reasonable collection potential. Realizable value is the asset's quick sale value (amount which could be reasonably expected through the sale of the asset) minus what the taxpayer owes to a secured creditor.

Effective Tax Administration: There is no doubt that the tax is correct and no doubt that the amount owed could be collected in full, but exceptional circumstances exist such that collection of the full amount would create economic hardship or where compelling public policy or equity considerations provide sufficient basis for compromise. The taxpayer bears the burden of proof to show their OIC qualifies for public policy or equity considerations. They must show that their circumstances are compelling enough to justify acceptance of their OIC compared to other taxpayers in similar circumstances.

In order to be considered for an OIC, a taxpayer must meet all of the following requirements:

Use the most current version of Form 656, "Offer in Compromise," and Forms 433-A and 433-B, "Collection Information Statements;

Submit the $150 application fee, or Form 656-A, "Income Certification for Offer in Compromise Application Fee," with the Form 656;

File all required federal tax returns;

File and pay any required employment tax returns on time for the two quarters prior to filing the OIC, and be current with deposits for the quarter in which the offer in compromise is submitted; and

You cannot a debtor in a bankruptcy case.

Taxpayers must comply with all federal tax filing and paying requirements for a period of five years following acceptance of their OIC, or until the OIC is paid in full, whichever is longer. This also includes making required estimated tax payments and federal tax deposits.

Obtain a Form 656, Offer in Compromise package. The package includes information and instructions for completing the form, as well as a worksheet that can be used to calculate an amount to offer. Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, and Form 433-B, Collection Information Statement for Businesses
are included in the Form 656 package and may need to be completed as well depending upon each individual situation.

Taxpayers will need to review and include amounts for items such as housing and utilities from the Collection Financial Standards, and Necessary Expenses, to complete their collection information statement(s).

For corporations and partnerships, Form 433-A may be requested from corporate officers and individual partners.

Collection Information Statement(s) are required for doubt as to collectibility and effective tax administration OICs, and doubt as to liability involving Trust Fund Recovery Penalty assessments.

The forms needed to complete an OIC are available on-line at http://www.irs.gov/. Also, forms may be obtained by calling 1-800-829-3676 or by visiting a local IRS office.

A detailed written narrative must be documented on Form 656, Item 9. The narrative must explain the exceptional circumstances and why payment of the tax liability in full would either create an economic hardship or demonstrate why there is compelling public policy or equity considerations sufficient to support an acceptance recommendation. The taxpayer bears the burden of proof to show their OIC qualifies for public policy or equity considerations. They must show that their circumstances are compelling enough to justify acceptance of their OIC compared to other taxpayers in similar circumstances.

If a taxpayer requests consideration on the basis of effective tax administration, the IRS must first establish that no doubt as to liability and no doubt as to collectibility conditions exist.

Hence, an OIC filed under effective tax administration can only be considered once the IRS determines that the tax liability is correct and collectible in full.Once the IRS begins the process of processing the OIC under the effective tax administration guidelines, it will consider such issues as the taxpayer's overall history of filing and paying taxes, as well as the overall impact on voluntary compliance.

If a tax liability can be paid in a lump sum or through an installment agreement, taxpayers will not be considered for an OIC. If an OIC is received, it will be rejected with appeal rights. The only exception is if a taxpayer can demonstrate special circumstances that would show that full payment of the liability would result in economic hardship or be detrimental to voluntary compliance.

The IRS will keep all payments and credits made, received or applied to the total original tax liability before the OIC was submitted. The IRS may also keep any proceeds from a levy that was served prior to the submission of an OIC, but which were not received at the time the OIC was submitted. Refer to OIC Contractual Terms, Item (f).

Installment agreement payments must be continued while the OIC is being considered. Installment agreement payments will not be applied against the amount you offered.

OICs must include an amount equal to or greater than the total value of all assets, plus future income. That total is generally the reasonable collection potential amount, and not simply an offer of ten cents on the dollar, or a percentage of the debt.

An IRS consumer alert has been issued advising taxpayers to beware of promoters' claims that tax debts can be settled for "pennies on the dollar." The IRS cautions that the OIC program is not designated to be a program for everyone with financial problems, and it should not be viewed as an invitation to avoid paying taxes.

If an OIC is submitted "solely to hinder and/or delay collection actions", the IRS will return the OIC without any further consideration. Taxpayers will not be afforded the right to appeal this decision.

Federal agencies are authorized to establish charges for services provided by the agency, called "user fees." The U.S. Office of Management and Budget encourages agencies to implement these fees to recover the cost of providing special services to some recipients that others do not use. Accordingly, the IRS has established a user fee that will recover part of the cost of processing and reviewing offer in compromise requests. The IRS has chosen to call it an "application fee" because the fee is required when an OIC application is submitted for consideration.

The application fee for submitting an OIC is $150 and will be required on all offers that are postmarked November 1, 2003, and thereafter except in two instances:
The OIC is submitted based solely on "doubt as to liability;" or
The taxpayer's total monthly income falls at or below income levels based on the Department of Health and Human Services (DHSS) poverty guidelines. Payment must be made by check or money order made payable to the United States Treasury.

After the IRS accepts the offer, the IRS will notify the taxpayer to promptly pay any unpaid amounts that become due under the terms of the offer agreement.

Checks that combine application fees for several offers will not be accepted, and the offers will be returned. Each Form 656 must have a separate check attached.

If the IRS receives notification of insufficient funds, the IRS will immediately stop processing the Form 656 and the OIC will be returned to the taxpayer without any further consideration.

The application fee is in addition to the amount listed on Form 656, Item 7. However, when the IRS determines the acceptable amount of an OIC based on doubt as to collectibility, it considers the value of all of the taxpayer's assets. Because some of the taxpayer's assets were used to pay the OIC application fee, payment of the fee will reduce the acceptable amount of the OIC. The taxpayer therefore pays no more for an OIC with the fee than the taxpayer would have paid without the fee.

Because payment of the fee reduces the acceptable OIC amount, most taxpayers will not experience any additional financial hardship as a result of the fee. However, for some taxpayers the $150 fee may exceed their ability to pay. The IRS believes that the exception to the fee for taxpayers whose income is at or below poverty will protect such taxpayers.

The IRS first reviews an OIC to see if it is "processable." Processable is the term the IRS applies to those OICs that have met certain criteria. An OIC is processable if the taxpayer:
Used the most current versions of Form 656, “Offer in Compromise” and Forms 433-A and 433-B, “Collection Information Statements;" Filed all required federal tax returns;
Filed and paid any required employment tax returns on time for the two quarters prior to filing the OIC, and is current with deposits for the quarter in which the offer in compromise was submitted; and Is not a debtor in a bankruptcy case.

The application fee will be returned to the taxpayer if the OIC is determined not to be processable.

The filing of an OIC requires a payment of 20% of the amount offered. That 20% will not be refunded if the OIC is not accepted.

A married couple owing the same joint income tax liability may file only one Form 656 listing the joint liability. One fee of $150 should be attached to Form 656. A married couple opting to file separate offers to compromise the same joint liability may do so, but two $150 fees will be required.

A divorced, separated, or married couple living apart may still file one Form 656 listing their joint liability and pay only one $150 fee, as long as all the taxes owed are joint liabilities. Taxpayers in these situations that opt to file separate offers must pay a $150 application fee for each offer that is submitted for consideration.


Two OICs are needed if the liabilties for a married couple are not the same. One for the joint liability and another one for the individual (non-joint) liability. A check or money order for $150 should accompany each Form 656. In keeping with the “one fee per entity” rule:
The husband should file one offer listing the joint income tax, the individual year he owes before the marriage and his business liability, and attach a $150 application fee to the offer.
The wife should file an offer listing the joint income tax and the individual year that she owes with her prior spouse, and attach a $150 application fee to the offer.
It does not matter that the joint liability will appear on both offers.

In the case of a partnership two Forms 656 will be required. One for the individual liability, and the other for the partnership or corporate liability. A check or money order for $150 must be attached to each offer, for a total of $300. The IRS cannot combine individual tax on an offer application with taxes owed by a partnership or corporation.

Taxpayers are required to submit one fee for each Form 656 taken in for processing. Failure to submit additional Form 656 with the corresponding $150 application fee when requested, will cause the IRS to return the offer without any further consideration. The $150 application fee will be retained.


The taxpayer fails to submit additional financial documents to assist in the IRS review. If the taxpayer fails to respond, and/or submit the requested information, the OIC will be returned without further consideration; or the taxpayer chooses to withdraw the Form 656.

The Form 656 and/or Forms 433 "Collection Information Statements" are necessary to conduct an offer investigation. Failure to submit these documents will cause considerable delay in the process. Taxpayers wanting to pursue the OIC as a way to satisfy their tax liability will have to submit the forms in order to have the OIC reconsidered.

The IRS' procedures require that a taxpayer be contacted in writing and provided a one-time opportunity to correct the error(s), and/or update the financial statement. Failure to correct the error(s) and/or respond results in the OIC being returned to the taxpayer without any further actions on the part of the IRS.

The following are key items that require the IRS to request corrections and delay the processing of OICs:

Incorrect address (don't use P.O. Box, must use street address), Form 656, Item 1.

Taxpayer identification numbers missing or incorrect on Form 656, Item 2.

EIN not included for an offer on a sole proprietor liability, From 656, Item 3.

Tax liability periods/years missing on Form 656, Item 5.

Tax periods included where no tax is due, Form 656, Item 5.

Reason for compromise not checked, Form 656, Item 6.

No "offer to pay" amount or an inappropriate amount shown on Form 656, Item 7.

OIC includes joint liabilities without signatures of both parties, Form 656, Item 11.

OIC includes single liabilities, but has signatures of two parties.

OIC submitted by single taxpayer, but includes joint liabilities.

Allowances for food, clothing and other items, known as the National Standards, apply nationwide, except for Alaska and Hawaii, which have their own tables. Taxpayers are allowed the total National Standards amount for their family size and income level, without questioning amounts actually spent.Maximum allowances for housing and utilities and transportation, known as the Local Standards, vary by location. Unlike the National Standards, the taxpayer is allowed the lesser of the amount actually spent or the standard.

If an OIC is accepted, the following will apply:

The taxpayer must pay the OIC amount as quickly as possible in accordance with the acceptance agreement.

The IRS will keep any tax refund, including interest due, as the result of an overpayment of any tax or other liability for the tax period extending through the calendar year the IRS accepts the OIC. A taxpayer may not designate a refund and/or overpayment to be applied to estimated tax payments for the following year. This condition does not apply if the OIC is based on Doubt as to Liability only.

The taxpayer will waive their right to contest in court or otherwise, the amount of the tax liability.

If a Notice of Federal Tax Lien has been filed against a taxpayer, the IRS will release it when the payment terms of the OIC are satisfied.

The taxpayer must remain in compliance with filing and payment of all tax returns for a period of five years from the date the OIC is accepted or until the OIC is paid in full, whichever is longer. Failure to pay the OIC on time, and/or to remain in compliance during the five-year period or until the OIC is paid in full, whichever is longer, will result in the OIC being declared in default..

If the IRS determines it cannot accept an offer, the taxpayer will be advised of the reasons behind the decision. The taxpayer will be afforded another opportunity to submit any other information that might cause the IRS to reconsider it preliminary decision to reject the offer. The exception to this is when the taxpayer has an ability to satisfy the liability in full and has not pointed to special circumstances.

Interest will not accrue on the taxpayer's accepted OIC amount from the date of acceptance until the OIC is paid. Interest and penalties will continue to accrue on the unpaid tax liability while the OIC is under consideration.

As additional consideration beyond the amount of the taxpayer's offer, the IRS will keep any refund, including interest due, because of an overpayment of any tax or other liability, for tax periods extending through the calendar year the IRS accepts an OIC. Exception: This condition does not apply if the offer is based solely on Doubt as to Liability.

Refunds and overpayments may not be designated as estimated tax payments for the following year. This condition does not apply if the OIC was accepted under doubt as to liability only.

Is a tax lien released when an OIC is accepted?The IRS releases a Notice of Federal Tax Lien when all of the OIC payment terms are satisfied. For an immediate release of a lien, a taxpayer can submit payment using a certified check and include a request letter.

IRS may default the OIC and reinstate the entire tax liability, less all payments and credits received if a taxpayer defaults on the OIC terms. The IRS may take the following actions:

Immediately file suit to collect the entire unpaid balance of the offer

Immediately file suit to collect an amount equal to the original amount of the tax liability as liquidating damages, minus any payment already received under the terms of this offer

Disregard the amount of the offer and apply all amounts already paid under the offer against the original amount of the tax liability

File suit or levy to collect the original amount of the tax liability, without further notice of any kind

An OIC requires future compliance for a period of five (5) years from the date of acceptance of the OIC, or until the offered amount is paid in full, whichever is longer. Compliance is the timely filing and paying of all required returns and taxes.

Under a new federal law, taxpayers submitting new offers in compromise must make a 20 percent nonrefundable, up-front payment in many cases.The recently-enacted Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) made major changes to the offer in compromise (OIC) program, tightening the rules for lump-sum offers and periodic-payment offers. These changes became effective for all offers received by the IRS starting July 16, 2006.

An offer in compromise is an agreement between a taxpayer and the IRS that resolves the taxpayer's tax debt. The IRS has the authority to settle, or "compromise," federal tax liabilities by accepting less than full payment in certain circumstances.Under the new law, taxpayers submitting requests for lump-sum OICs must include a payment equal to 20 percent of the offer amount. The payment is nonrefundable, that is, it will not be returned if the OIC request is later rejected. A lump-sum OIC means any offer of payments made in five or fewer installments.Taxpayers submitting requests for periodic-payment OICs must include the first proposed installment payment with their application. A periodic payment OIC is any offer of payments made in six or more installments. The taxpayer is required to pay additional installments while the offer is being evaluated by the IRS. All installment payments are nonrefundable.

Under the new law, taxpayers qualifying as low-income or filing an offer based solely on doubt as to liability qualify for a waiver of the new partial payment requirements.

If the IRS cannot make a determination on an OIC within two years, then the offer will be deemed accepted.

If a liability included in the offer amount is disputed in any court proceeding, that time period is omitted from calculating the two-year timeframe.OIC requests are submitted using Form 656, Offer in Compromise. Further details on the TIPRA changes can be found in Notice 2006-68, available now on the IRS Web site and scheduled to be published in Internal Revenue Bulletin 2006-31, dated July 31, 2006.


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

To provide IRS transparency, upload all IRS experiences to www.irsforum.org

Tax Help: Disclosure requirements imposed by section 6033(a)(2) on tax-exempt entities that are parties to prohibited tax shelter transactions.

It is very important to understand reporting requirements because the penalties for not reporting are severe. It is my personal experience that the IRS will focus on tax fraud itssues in every tax shelter transaction

TD, 2007FED¶47,042 Returns: Information returns: Exempt organizations: Prohibited tax shelter transaction.,

T.D. 9335 (July 9, 2007) 2007FED ¶47,042 T.D. 9335 July 9, 2007
Code Sec. 6033

Returns: Information returns: Exempt organizations: Prohibited tax shelter transaction.



DEPARTMENT OF THE TREASURY



Internal Revenue Service

26 CFR Parts 1 and 301

[TD 9335]

RIN 1545-BG19

Disclosure Requirements With Respect to Prohibited Tax Shelter Transactions

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).

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

To provide IRS transparency, upload your IRS experience at www.irsforum.org

Tax Attorney: IRS abuse of discrection - Innocent spouse case



The Tax Court used eight factors in considering innocent spouse relief: three weigh toward relief, five are neutral, and only one weighs against relief. tion for denying him relief, we conclude that the Commissioner abused his discretion in denying David relief

David Bruce Billings v. Commissioner.

Dkt. No. 15324-05L , TC Memo. 2007-234, August 16, 2007.

Related decision at Dec. 56,572; 127 TC 7. [Appealable, barring stipulation to the contrary, to CA-10. --CCH.]

[Code Sec. 6015]
Innocent spouse relief: Tax Court jurisdiction: Equitable relief: Deficiency assertion: Knowledge of unpaid tax: Significant benefit from unreported income: Economic hardship. --
The IRS abused its discretion in denying innocent spouse relief based on the factors set forth in Rev. Proc. 2000-15, 2001 CB 447. Under Code Sec. 6015(e), as amended by the Tax Relief and Health Care Act of 2006 (P.L.109-432), a deficiency is not a prerequisite for Tax Court review of liabilities remaining unpaid on December 20, 2006. Thus, the Tax Court had jurisdiction because the parties stipulated that the husband's 1999 tax liability remained unpaid as of that date. The husband had no knowledge of funds that his wife admittedly embezzled from her employer but failed to report when their original 1999 income tax return was filed. The IRS acted arbitrarily by using the taxpayer's knowledge at the time he signed the amended return because its interpretation of the knowledge factor was unexplained, unpersuasive and contrary to the IRS's interest in having taxpayers amend their returns when they discover their spouses' misreporting. The husband did not significantly benefit from the embezzlement income or from not paying the taxes on that income, where the income was not significant to their life, and the husband did not have the unpaid tax money available for his personal use. The fact that the husband lacked economic hardship was not enough to justify denying relief. The parties agreed on the other factors set forth in the revenue procedure. --CCH.





Patrick Wiesner, for petitioner; Vicki L. Miller, for respondent.





MEMORANDUM FINDINGS OF FACT AND OPINION



HOLMES, Judge: David Billings, the petitioner, began this case to be relieved from liability for the tax owed on money that his wife embezzled from her employer without his knowledge. When this case was first before us, we dismissed it for lack of jurisdiction. Billings v. Commissioner, 127 T.C. 7 (2006) ( Billings I). Billings appealed our decision and, while his appeal was pending, Congress amended the Code to give us jurisdiction over cases like his. His case was remanded to us for reconsideration in light of the new law. We examine first whether the new law gives us jurisdiction. Concluding that it does, we then move on to consider the merits of his case.





FINDINGS OF FACT



The parties submitted this case for decision on stipulated facts, which means that the "Background" section of our previous opinion can now be more properly labeled "Findings of Fact." The facts are set out in greater detail in Billings I, 127 T.C. at 8-11, but to recapitulate briefly: David Billings married Rosalee in 1996. He was working at General Motors, and she was a payroll clerk at the local electric company. The Billingses kept two checking accounts, and while both were jointly held, David and Rosalee each kept almost exclusive control over one of them. In 1999, Rosalee transferred money from her employer's payroll account into the checking account that she controlled and into which she had her own pay directly deposited.



Her embezzlement continued into 2000, but Rosalee kept it secret from her husband until the company caught her. She then told her husband what she had done and hired a lawyer. By the time that she was caught, Rosalee and her husband had already filed their joint 1999 tax return, and she had left off the nearly $40,000 that she had stolen that year. Her lawyer advised her to report the embezzlement income on an amended return because, he said, a judge would probably be more lenient in sentencing her if she took responsibility for her actions. But section 1.6013-1(a)(1) of the income tax regulations created a problem.1 It prohibits spouses who have already filed a joint return for a particular year from filing amended returns changing their status to married-filing-separately once the deadline to file returns has passed. The due date for the Billingses' 1999 tax year --April 15, 2000 --was long past, and so David signed the amended return.



That return showed an increase in taxable income, and an increase in tax of over $16,000. When David signed the amended return, he knew that neither he nor his wife expected to be able to pay this increased tax. In 2002, the Billingses filed for bankruptcy and received a discharge, which affected neither Rosalee's obligation to repay the money she'd embezzled nor her own liability for the unpaid 1999 taxes. 11 U.S.C. secs. 523(a)(1), 507(a)(8) (2000). David retired and began collecting a pension --although, as of the date the case was originally submitted, he continued to work two other jobs. He and his wife have filed timely tax returns for later years as they came due.



David asked the IRS for relief from joint liability for the unpaid 1999 tax but, in November 2002, the IRS denied his request based on "all the facts and circumstances," particularly because:



you failed to establish that it was reasonable for you to believe the tax liability was paid or was going to be paid at the time you signed the amended return.



David appealed, and the IRS issued its final determination, again denying him relief because he did not believe when he signed the amended return that the tax would be paid.



David then petitioned our Court to overturn the Commissioner's determination. Such a petition is called a nondeficiency stand-alone petition --"nondeficiency" because the IRS accepted his amended return as filed and asserted no deficiency against him, and "stand-alone" because his claim for innocent-spouse relief was made under section 6015 and not as part of a deficiency action or in response to an IRS decision to begin collecting his tax debt through liens or levies. When this case was first before us, our jurisdiction over such petitions was controversial. We had first held that we did have jurisdiction, Ewing v. Commissioner, 118 T.C. 494 (2002), but then the Ninth Circuit reversed us in Commissioner v. Ewing, 439 F.3d 1009 (9th Cir. 2006), and the Eighth Circuit followed in Bartman v. Commissioner, 446 F.3d 785, 787-788 (8th Cir. 2006), affg. in part, vacating in part T.C. Memo. 2004-93. After these two cases, we revisited the question and in Billings I followed those circuit courts and dismissed David's case for a lack of jurisdiction.



David appealed our decision to the Tenth Circuit (he was a resident of Kansas when he filed his petition). Congress amended section 6015 to give us jurisdiction over nondeficiency stand-alone cases, and the Tenth Circuit remanded the case to us for reconsideration. We then ordered the parties to report whether the Billingses' tax liability remained unpaid, and they recently filed a stipulation agreeing that it did.





OPINION



As we summarized this part of tax law in our earlier opinion, Billings I, 127 T.C. at 11-12, a married couple who file their Federal tax return jointly are both responsible for the return's accuracy and are both jointly and severally liable for the entire tax due. Sec. 6013(d)(3); Butler v. Commissioner, 114 T.C. 276, 282 (2000). Section 6015, however, directs the Commissioner to relieve qualifying innocent spouses from that liability under certain circumstances. Sec. 6015(a). An innocent spouse may seek relief from liability under section 6015(b) if he can show that he was justifiably ignorant of unreported income or inflated deductions. He may have his tax liability allocated between himself and an estranged or former spouse under section 6015(c). Or, like David, he may look to section 6015(f) for relief. Subsection (f) relief is available only to a spouse who is ineligible for relief under subsections (b) and (c) and who shows that "taking into account all the facts and circumstances, it is inequitable to hold [him] liable for any unpaid tax or any deficiency (or any portion of either)."



David and the Commissioner stipulated that he did not qualify for relief under either section 6015(b) or (c) because no deficiency was ever asserted against him and his wife. They were right to do so, because both those subsections require a deficiency as a condition of relief. See, e.g., Block v. Commissioner, 120 T.C. 62, 66 (2003). That left David able to look only for equitable relief under subsection (f), and when the Commissioner denied it to him, left him with the problem of where to seek judicial review. When he first came to us, section 6015's jurisdictional provision read:



SEC. 6015(e). Petition for Review by Tax Court.



(1) In general. --In the case of an individual against whom a deficiency has been asserted and who elects to have subsection (b) or (c) apply --[Emphasis added.]



(A) In general. --In addition to any other remedy provided by law, the individual may petition the Tax Court (and the Tax Court shall have jurisdiction) to determine the appropriate relief available to the individual under this section if such petition is filed --



This was the language we construed in Billings I to require petitioners like David --i.e., those filing stand-alone section 6015(f) petitions --to have had a deficiency asserted against them. But Congress amended section 6015(e) after we released Billings I to insert "or in the case of an individual who requests equitable relief under section 6015(f)" into section 6015(e). The Tax Relief and Health Care Act of 2006 (TRHCA), Pub. L. 109-432, div. C, sec. 408(a), 120 Stat. 2922, 3061. The opening line of section 6015(e) now reads:



SEC. 6015(e). Petition for Review by Tax Court.



(1) In general. --In the case of an individual against whom a deficiency has been asserted and who elects to have subsection (b) or (c) apply, or in the case of an individual who requests equitable relief under subsection (f) --



The amendment is effective for liabilities remaining unpaid on December 20, 2006. TRHCA sec. 408(c), 120 Stat. 3062. No suspense here: The parties' stipulation that David's 1999 tax liability remains unpaid assures us that we do have jurisdiction to review the Commissioner's decision to deny him relief.



We are mindful that our review of that decision is for abuse of discretion. See Butler v. Commissioner, 114 T.C. 276, 287-92 (2000). This standard does not ask us to decide whether in our own opinion we should grant relief, but whether the Commissioner, in refusing to do so, exercised his discretion "arbitrarily, capriciously, or without sound basis in fact." Jonson v. Commissioner, 118 T.C. 106, 125 (2002), affd. 353 F.3d 1181 (10th Cir. 2003). When deciding whether to grant 6015(f) relief, the Commissioner should take "into account all the facts and circumstances," which means that his determination rarely depends on any one factor. See sec. 6015(f); Rev. Proc. 2000-15, sec. 4.03, 2000-1 C.B. at 448. To guide IRS employees in exercising their discretion, the Commissioner has issued revenue procedures that list the factors they should consider.2 We also use the revenue procedure when we determine whether the Commissioner abused his discretion. See, e.g., Washington v. Commissioner, 120 T.C. 137, 147-52 (2003); Jonson v. Commissioner, 118 T.C. at 125-26.



The revenue procedure begins with a list of seven conditions for equitable relief that a taxpayer must meet. Rev. Proc. 2000-15, sec. 4.01, 2000-1 C.B. at 448. Both parties agree that David met all of these threshold conditions. The procedure also has a safe harbor --three conditions that, if met, will ordinarily trigger a grant of relief. Rev. Proc. 2000-15, sec. 4.02, 2000-1 C.B. at 448. David does not qualify for this safe harbor, though, because one of the three conditions is that a requesting spouse be divorced or separated from the nonrequesting spouse, Rev. Proc. 2000-15, sec. 4.02(1)(a), 2000-1 C.B. at 448, and David and Rosalee have remained married throughout her ordeal.



This leaves an eight-factor balancing test to decide whether relief would be "equitable." Id. , sec. 4.03. Those factors, and the circumstances under which they are to weigh for or against relief or be treated as neutral, are easily summarized in a chart. Here we list those factors about which the parties agree in italics.





________________________________________________________________________
Weighs for Relief Neutral Weighs against Relief

________________________________________________________________________
No knowledge of the
underpayment or item
giving rise to the
deficiency ***** Knowledge

________________________________________________________________________
Economic hardship ***** No economic hardship

________________________________________________________________________
No significant
benefit3
Rev. Proc. 2000-15,
sec. 4.03, 2000-1 C.B.
at 448, does not state
that the absence of a
significant benefit
will weigh in a
petitioner's favor, but
only that a significant
benefit will weigh
against relief.
Nonetheless, we decided
in Ewing v.
Commissioner, 122 T.C.
32, 45 (2004), vacated
439 F.2d 1009 (9th Cir.
2006) (and other cases
cited), that the
absence of a
significant benefit
should be a positive
factor for petitioners.

***** Significant benefit

________________________________________________________________________
Later compliance with No later compliance
***** Federal tax laws with Federal tax laws

________________________________________________________________________
Liability Liability
attributable to attributable to
nonrequesting spouse ***** petitioner

________________________________________________________________________






________________________________________________________________________
Weighs for Relief Neutral Weighs against Relief

________________________________________________________________________
Nonrequesting spouse Petitioner
responsible for tax responsible for tax
under divorce decree No divorce decree under divorce decree

________________________________________________________________________
Separated or divorced Still married *****

________________________________________________________________________
Abuse present No abuse present *****

________________________________________________________________________




These are not the only factors that either the Commissioner or we can look at, but they are where we start. Id. In this case, the parties contest only two factors: knowledge and significant benefit.




A. Knowledge


The basic problem in analyzing the Commissioner's decision that David flunks the knowledge factor is that the revenue procedure is quite unclear about when a person's knowledge should be measured. The procedure tells us that the knowledge factor weighs in favor of relief when:



In the case of a liability that was properly reported but not paid, the requesting spouse did not know and had no reason to know that the liability would not be paid. In the case of a liability that arose from a deficiency, the requesting spouse did not know and had no reason to know of the items giving rise to the deficiency.



Rev. Proc. 2000-15, sec. 4.03(1)(d), 2000-1 C.B. at 449. The first sentence in the quoted section would seem to be the one that applies --since there's no deficiency here --and it tells us to look at whether "the requesting spouse did not know and had no reason to know that the liability would not be paid."



But what did David not know and when did he not know it? The parties agree that David was ignorant of his wife's embezzlement when he signed the original return. They also agree that when he signed the amended return he knew about the embezzled income and that the taxes on it would not be paid.



Looking at the procedure's description of when the knowledge factor weighs against relief doesn't help much either. That part of the procedure tells us to ask whether a "requesting spouse knew or had reason to know of the item giving rise to a deficiency or that the reported liability would be unpaid at the time the return was signed." Rev. Proc. 2000-15, sec. 4.03(2)(b), 2000-1 C.B. at 449. Neither section tells us when to measure the knowledge of a requesting spouse who signed both an original and an amended return.



When the Commissioner made his determination, he assumed that the right time to measure the state of David's knowledge was when David signed the amended return, but he didn't explain his assumption. The problem for us on review is that it would have been just as reasonable for the Commissioner to measure David's knowledge when he signed the original return. If he had done so, David's conceded ignorance of the embezzled income when he signed the original return would have caused the Commissioner to find that the knowledge factor weighed in David's favor. We thus need to look elsewhere to decide at which time the Commissioner should have measured David's knowledge.



The first place we look is at a case where a wife who requested relief didn't know about an IRA distribution that her husband failed to report when she signed the original return. She learned about the distribution only after her husband's death, and then filed an amended return that corrected the omission. In that case, the Commissioner also measured her knowledge at the time she signed the amended return. We found his determination to be an abuse of discretion because:



It is unpersuasive to argue, as does respondent, that petitioner's voluntary filing of an amended 1996 return and her attendant payment of the delinquent taxes attributable to the omission of income from the original 1996 return militate against equitable relief simply because she had to have known of the omission before she filed the amended return and made the payment.



Rosenthal v. Commissioner, T.C. Memo. 2004-89.



We acknowledge that in Rosenthal the requesting spouse paid the taxes she owed on the omitted income when she filed her amended return, but we find that this fact does not distinguish David's case --in both cases the innocent spouses were ignorant of the key facts at the time they signed the original return.



A second place we can look to for help is in section 6015(b). That section gives relief when a spouse is reasonably ignorant of an understatement of tax that gives rise to a deficiency. Indeed, the Commissioner argues here that:



Instead of filing an amended return, [Rosalee] could have contacted respondent and informed him of the unreported embezzlement income. Once informed, respondent could have proceeded with examination procedures and [Rosalee] could have agreed to respondent's determination of additional tax.



Resp. Br. at 30. This would have led to the determination of a deficiency and presumably allowed David to file a successful request for relief under section 6015(b). See, e.g., Haltom v. Commissioner, T.C. Memo. 2005-209 (ignorance of embezzlement income).



It would seem a trap for the unwary --and an inefficient requirement from the IRS's perspective --to require spouses to go through an audit whose outcome is preordained in a situation like that faced by the widow Rosenthal or Mr. Billings, rather than fess up by filing an amended return.



Tax law is of course filled with such traps and has never been viewed as a garden of efficiency, but Congress itself has directed the Commissioner --at least in this area --to take a somewhat more open-ended view of the law. Section 6015(f) directs him to consider "all the facts and circumstances." The revenue procedure likewise counsels the Commissioner's employees that, in weighing an application for relief, "No single factor will be determinative of whether equitable relief will or will not be granted in any particular case. Rather, all factors will be considered and weighed appropriately. The list is not intended to be exhaustive." Rev. Proc. 2000-15, sec. 4.03, 2000-1 C.B. at 448.



We conclude from this that, in choosing an interpretation of the knowledge factor that was unexplained, "unpersuasive" (as we called it in Rosenthal), and seemingly contrary to the Commissioner's own interest in having taxpayers amend their returns when they discover their spouses' misreporting, the Commissioner was acting arbitrarily and so abused his discretion. We therefore find that the knowledge factor in this case weighs in favor of relief, not against it.




B. Significant Benefit


The second contested factor is whether David "significantly benefited (beyond normal support) from the unpaid liability or items giving rise to the deficiency." Rev. Proc. 2000-15, sec. 4.03(2)(c), 2000-1 C.B. at 448-49. A spouse's benefit exceeds "normal support" when the money in question was used to pay for a child's education, Jonson , 118 T.C. at 119-20, or special purchases for the couple or their children, Alt v. Commissioner, 119 T.C. 306, 314 (2002), affd. 101 Fed. Appx. 34 (6th Cir. 2004), or for unusually frequent travel, Barranco v. Commissioner, T.C. Memo. 2003-18 (lifestyle as a whole, which included several European vacations, was a significant benefit). We must examine whether David benefited from either the embezzlement income itself or from not paying the taxes on that income. If he did significantly benefit, the factor weighs against relief; otherwise (under our precedents), it weighs in his favor. See supra note 3.



The Commissioner argues that David significantly benefited from his wife's embezzlement because it allowed them to continue their free-spending lifestyle, and still have the means to buy a larger house in 2000, the year the embezzlement ended. He also points out that the spending did not stop after Rosalee's employer discovered the embezzlement, and that the Billingses even bought three new vehicles after she was discovered. David counters that it wasn't Rosalee's embezzlement that supported their lifestyle --it was the two paychecks he earned and the liberal use of his credit cards.



To determine whether the Commissioner erred on this point we can trace the embezzlement income to see where it was spent and by whom. Looking first to see where the money went, in 1999, Rosalee deposited $71,100 into her account and withdrew about $67,500. Of her withdrawals, $7,200 went into a savings account she shared with David, $4,100 went toward her car, and $7,500 went toward her credit cards. While some of the remaining $48,700 paid for their basic living expenses, David received little marginal benefit from his wife's extra cash. She spent most of it on small-money items that benefited only her. She also gave some of the money to her children and her ex-husband. Of the $7,200 she put into their joint savings account in 1999, David withdrew about $1,670. But in their life --a life where they chose to spend nearly all their legitimate 1999 income of $100,000 --this extra income was not "significant".



We also ask whether David significantly benefited from not paying the tax. See Rev. Proc. 2000-15, sec. 4.03(2)(c), 2000-1 C.B. at 448; Mellen v. Commissioner, T.C. Memo. 2002-280. Here, we think it is important that the Billingses filed for bankruptcy under chapter 7 in May 2002. Chapter 7 required them to liquidate all of their nonexempt assets, and turn that money over to a trustee. Rosalee's tax debt was not dischargeable, however, and so she will continue to owe the IRS until that debt (which the parties stipulated was close to $30,000 by the end of 2006) is paid in full. We therefore do not consider David to have this unpaid tax money available for his personal use, and we find that the Commissioner clearly erred when he found that David significantly benefited from the partial nonpayment of the Billingses' 1999 taxes.



Based on our findings, the chart looks like this:





________________________________________________________________________
Weighs for Relief Neutral Weighs against Relief

________________________________________________________________________
No knowledge of the
embezzled funds at the
time the original
return was filed ***** *****

________________________________________________________________________
***** ***** No economic hardship

________________________________________________________________________
No significant
benefit ***** *****

________________________________________________________________________
Later compliance with
***** Federal tax laws *****

________________________________________________________________________
Liability
attributable to
nonrequesting spouse. ***** *****

________________________________________________________________________
***** No divorce decree *****

________________________________________________________________________
***** Still married *****

________________________________________________________________________
***** No abuse present *****

________________________________________________________________________




Thus, of the eight factors described in the revenue procedure, three weigh toward relief, five are neutral, and only one weighs against relief. David's mere lack of economic hardship being too thin a justification for denying him relief, we conclude that the Commissioner abused his discretion in denying David relief, and



Decision will be entered for petitioner.


1 Unless otherwise indicated, all section references are to the Internal Revenue Code and regulations in effect for the year in issue.

2 The procedure in effect when David filed his request for relief was Revenue Procedure 2000-15, 2000-1 C.B. at 447. It has since been replaced by Revenue Procedure 2003-61, 2003-2 C.B. at 296, but the new procedure applies only to requests for relief filed on or after November 1, 2003 or those pending on November 1, 2003, for which no preliminary determination letter has been issued as of November 1, 2003. Rev. Proc. 2003-61, sec. 7, 2003-2 C.B. at 299.


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

To provide IRS "transparency" upload your IRS experiences to www.irsforum.org

Back Taxes: Duty of Consistency applied by Tax Court

The "duty of consistency", sometimes referred to as quasi-estoppel, is an equitable doctrine that Federal courts historically have applied in appropriate cases to prevent unfair tax gamesmanship. Beltzer v. United States [Dec. 50,969 ], 105 T.C. 324 (1995); LeFever v. Commissioner [96-2 USTC ¶60,250 ] 100 F.3d 778 (10th Cir. 1996). The duty of consistency doctrine "is based on the theory that the taxpayer owes the Commissioner the duty to be consistent in the tax treatment of items and will not be permitted to benefit from the taxpayer's own prior error or omission." Cluck v. Commissioner, supra at 331. It prevents a taxpayer from taking one position on one tax return and a contrary position on a subsequent return after the limitations period has run for the earlier year. See id. If the duty of consistency applies, a taxpayer who is gaining Federal tax benefits on the basis of a representation is estopped from taking a contrary return position in order to avoid taxes.

Michael C. Hollen and Joan L. Hollen v. CommissionerDocket No. 5586-97., TC Memo. 2000-99, 79 TCM 1719, Filed March 24, 2000[Appealable, barring stipulation to the contrary, to CA-8.-

[

[6501 ]Partners and partnerships: Gain from sale: Distributive share: Ownership of property: Duty of consistency: Statute of limitations: Estoppel.

--A dentist and his wife could not avoid reporting their distributive share of partnership income arising from the sale of realty that they had treated as partnership property, despite their subsequent claim that the partnership never actually owned the property. The partnership had paid expenses and claimed deductions in connection with a ranch that it operated on the land, which it reported as an asset on its returns. The taxpayers also consistently reported their share of the partnership's distributive losses. Further, the statute of limitations for adjustments to the partnership's returns had expired. Accordingly, the duty of consistency estopped the taxpayers from claiming that the partnership had not owned the property during the year of the sale.

[Code Sec. 6661 , prior to repeal by P.L. 101-239 ]Penalties, civil: Substantial understatement: Substantial authority lacking.--To the extent that the amount of their understatement met the statutory requirements, a dentist and his wife were liable for the substantial understatement penalty in connection with their failure to report partnership income. They did not have substantial authority for their position because they failed to research or analyze their obligations to file a return for the year at issue that was consistent with their previous returns.--

MEMORANDUM FINDINGS OF FACT AND OPINION

MARVEL, Judge:
Respondent determined a deficiency in petitioners' Federal income tax for the taxable year 1988 of $79,308 and additions to tax under 6661(a) of $3,965 and $19,827, respectively. 1 After concessions, 2 the issues for decision are: (1) Whether petitioners were required to report and pay income tax on a one-third distributive share of partnership income from Blue Bird Ranch Partnership (the partnership) in 1988, and (2) whether petitioners are liable for the additions to tax determined by respondent. We resolve both issues in favor of respondent.

FINDINGS OF FACT
Some of the facts have been stipulated. The stipulated facts are incorporated in our findings by this reference.
On the date the petition in this case was filed, petitioners were married and resided in Waterloo, Iowa. Michael C. Hollen (petitioner) is a dentist who, during all relevant periods, operated a professional dental practice through his professional corporation, Michael C. Hollen, D.D.S., Professional Corporation (P.C.).
On March 17, 1982, petitioners and two other married couples purchased a fruit and flower farm in San Diego County, California, from Hugh D. and Bonnie B. Lentz (Mr. and Mrs. Lentz). The property was known as the Blue Bird Ranch (the ranch) and was acquired for $1,138,750. Petitioners and the other purchasers executed a promissory note in the amount of the purchase price and a deed of trust to secure payment of the note. Title to the ranch was conveyed to petitioners and the other purchasers as tenants in common.

On or about April 1, 1982, petitioner and the other two husbands formed the partnership to operate and manage the ranch. The wives did not participate in the partnership. 3
Although the partners did not reduce their partnership agreement to writing, they orally agreed that each couple would contribute its one-third interest in the ranch to the partnership. Petitioner believed that title to the property had been transferred to the partnership until he was advised to the contrary by his attorney in 1998. In fact, title to the property was never formally transferred to the partnership.

From the inception of the partnership in 1982 to the sale of the ranch in 1988, the partnership operated as if it owned the ranch. The partnership paid the expenses of operating the ranch and claimed them as deductions on its Federal partnership tax returns. The partnership listed the ranch and all improvements thereon as assets on its partnership tax returns and depreciated the improvements. Petitioner signed each partnership tax return.

The partnership was not profitable. From 1982 to 1987, petitioners claimed flowthrough losses from the partnership totaling $695,047 on their individual income tax returns. To keep the partnership afloat, petitioner and one of the other partners made several additional capital contributions during this period. Finally, in 1988, the partnership's financial problems came to a head because Mr. and Mrs. Lentz refused to modify the payment obligations under the promissory note and the deed of trust and threatened to foreclose on the ranch.
In October 1988, petitioners and the other two couples entered into a purchase and sale agreement in which they agreed to sell the ranch to Cele and Norma Pou (Mr. and Mrs. Pou). As consideration for the sale, Mr. and Mrs. Pou paid each couple $10,000 4 and assumed the sellers' liability to Mr. and Mrs. Lentz. The sellers executed a grant deed conveying title to Mr. and Mrs. Pou in October 1988, and the partnership dissolved thereafter.

On or about March 15, 1989, the partnership filed its 1988 partnership return in which it recognized gain of $631,507 from the sale of the ranch. The partnership also issued to petitioner, in his individual name, a Schedule K1, Partner's Share of Income, Credits, Deductions, Etc., showing his distributive share of partnership income, which included a one-third share of the gain from the sale of the ranch. The partnership's return was prepared by the partnership's accountant, David Evans, and filed as its final return.

In April 1989, petitioners filed Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return, requesting an extension of time to file their 1988 Federal income tax return. The Form 4868 was prepared by petitioners' accountant, Louis Fettkether. It reported an estimated tax liability for 1988 of $80,000, which petitioners paid with the extension request. Petitioners' estimated tax liability was calculated using the information from petitioner's Schedule K-1.

In July 1989, petitioner filed his P.C.'s Federal income tax return for the fiscal year ended October 31, 1988. This return was also prepared by Mr. Fettkether. It did not include any gain from the sale of the ranch or income from the partnership.

In October 1989, petitioner filed an amended corporate income tax return for the P.C. The amended return was prepared by a different return preparer, John Henss. It contained the following statement:

Reason for Amended Return.
On August 1, 1988 it was the intent of Michael C. Hollen to transfer to Michael C. Hollen, D.D.S., P.C. certain investment assets including an interest in Bluebird Ranch, a partnership. That partnership equity was in a deficit position. It was the intent of the parties that Michael C. Hollen would issue his note payable to Michael C. Hollen, D.D.S., P.C. in an amount equal to the deficit in Bluebird Ranch which was assumed by Michael C. Hollen, D.D.S., P.C. over the value of the other assets assumed by Michael C. Hollen, D.D.S., P.C. Due to a scrivener error the assumption of the Bluebird Ranch deficit was not recorded in the corporate records. Upon detection of said scrivener error the verbal agreement was confirmed and made a matter of record. 5

No gain from the sale of the ranch or income from the partnership was reported on the amended return.

Also in October 1989, petitioners filed their 1988 Federal income tax return. This return was prepared by Mr. Henss. Petitioners did not report any gain from the sale of the ranch or any partnership income on this return and did not make any disclosure with respect to either the sale of the ranch or the Schedule K-1 issued to petitioner. Instead, on Schedule D of their return, petitioners reported a sale of petitioner's partnership interest on August 1, 1988, to the P.C. at a purchase price equal to petitioner's alleged adjusted basis. No gain or loss was realized on the purported sale. Petitioners reported taxable income of $7,013, total tax of $1,054, and an overpayment of $78,946.

In 1992 or 1993, respondent audited the partnership's tax return for 1988. 6 During the audit of the 1988 partnership return, petitioner represented that the ranch was a partnership asset, that petitioner was a partner in the partnership, and that the sale of the ranch had been reported correctly on the partnership return. Relying on petitioner's representations and on the previously filed partnership returns, respondent did not make any adjustments to the partnership's return.

Respondent also audited petitioners' Federal income tax return for 1988. Upon completion of the audit, respondent issued a notice of deficiency in which respondent disregarded the alleged transfer of petitioner's partnership interest to the P.C. and determined that petitioner was a partner when the ranch was sold in 1988, that petitioner was required to report his distributive share of partnership income for 1988, and that petitioners were liable for additions to tax under section 6661 .

OPINION

Petitioners make two arguments in an effort to avoid reporting and paying income tax on petitioner's 1988 distributive share of partnership income. First, petitioners argue that, although the partnership operated the ranch from 1982 to 1988, the partners and their wives, as individuals, owned the ranch. Therefore, petitioners contend that when the ranch was sold in 1988, petitioners and their cotenants were required to report the gain realized on the sale after taking into account their cost basis in the property unreduced by depreciation claimed in prior years by the partnership. 7 Second, petitioners argue that, even if the partnership is deemed to have owned the ranch prior to its sale in 1988, petitioner's interest in the partnership was transferred to the P.C. prior to the sale, and petitioners are not individually liable for income tax on any portion of the gain.

Respondent urges us to reject petitioners' arguments, contending, among other things, that the duty of consistency binds the partnership and petitioners to their original reporting captionposition--that the ranch was partnership property.

The Duty of Consistency

The "duty of consistency", sometimes referred to as quasi-estoppel, is an equitable doctrine that Federal courts historically have applied in appropriate cases to prevent unfair tax gamesmanship. Beltzer v. United States [Dec. 50,969 ], 105 T.C. 324 (1995); LeFever v. Commissioner [96-2 USTC ¶60,250 ] 100 F.3d 778 (10th Cir. 1996). The duty of consistency doctrine "is based on the theory that the taxpayer owes the Commissioner the duty to be consistent in the tax treatment of items and will not be permitted to benefit from the taxpayer's own prior error or omission." Cluck v. Commissioner, supra at 331. It prevents a taxpayer from taking one position on one tax return and a contrary position on a subsequent return after the limitations period has run for the earlier year. See id. If the duty of consistency applies, a taxpayer who is gaining Federal tax benefits on the basis of a representation is estopped from taking a contrary return position in order to avoid taxes.

This case is appealable to the Court of Appeals for the Eighth Circuit. In Beltzer v. United States, supra at 212, the Court of Appeals for the Eighth Circuit held that a taxpayer is placed under a duty of consistency when:
(1) the taxpayer has made a representation or reported an item for tax purposes in one year,
(2) the Commissioner has acquiesced in or relied on that fact for that year, and
(3) the taxpayer desires to change the representation, previously made, in a later year after the statute of limitations on assessments bars adjustments for the initial year.
Id. at 212; see also LeFever v. Commissioner, supra at 543 (quoting Beltzer v. United States, supra). Because the duty of consistency is an affirmative defense, respondent bears the burden of proving that it applies. See Rule 142(a).
Throughout the life of the partnership, petitioner consistently represented to respondent that the ranch was partnership property. Petitioner did so by causing the partnership to file tax returns claiming depreciation deductions with respect to the ranch and by asserting the ranch was partnership property during audits of the partnership's Federal income tax returns. Consistent with the partnership's reporting position, petitioners filed individual Federal income tax returns for each of the taxable years 1982 through 1987 claiming petitioner's distributive loss from the partnership. The loss was calculated, in part, by deducting depreciation on ranch buildings and other improvements. When petitioners filed their Federal income tax return for 1988, however, they changed their representation with respect to the ranch, taking the position instead that the ranch was not partnership property and that the gain from the sale of the ranch was not income to them. Several years later, during the audit of the 1988 partnership return, petitioner failed to inform respondent that title to the ranch was held individually or that he had changed his prior reporting position that the ranch was partnership property.
These facts satisfy the three elements necessary to invoke the duty of consistency under Beltzer v. United States, supra. First, petitioner consistently represented that the ranch was partnership property, from the filing of the first partnership return to the filing of the partnership's final return. That representation carried over to petitioner's Federal income tax returns for 1982 through 1987. Second, respondent acquiesced in and relied upon these representations to respondent's detriment by allowing the period of limitations on assessment to run on petitioners' income tax returns without adjusting their distributive share of partnership income and deductions. See Dec. 36,223 ], 72 T.C. 807, 816 (1979), affd. [8
Petitioners also argue that the duty of consistency does not apply because whether they own a property interest for Federal tax purposes is controlled by State law. 9 We reject this argument. Determining whether the ranch was owned by the partners as individuals or by the partnership is simply not necessary to our decision regarding the duty of consistency. The duty of consistency is an affirmative defense grounded in equity and is designed to prevent taxpayers from changing a tax-significant representation benefiting the taxpayer at a time when the Commissioner is prevented by law from correcting the taxpayer's tax reporting position based on that representation. We need not decide whether the representation in question is true or false in order to decide whether petitioners are bound by the duty of consistency. We need only decide if petitioners are attempting to change a representation for tax purposes after respondent has relied on that representation and the applicable period of limitations has expired. The duty of consistency applies even if the original representation is erroneous, as long as respondent demonstrates that the three elements necessary to invoke the duty of consistency have been satisfied. See Herrington v. Commissioner [Dec. 43,495 ], 87 T.C. 1087 (1986). In this case, once we determine that the duty of consistency applies, we no longer care who actually owned the ranch since, for Federal income tax purposes, the duty of consistency requires petitioners to be bound by their prior representations regarding the ranch's ownership. For this reason, we need not and do not decide who actually owned the ranch or whether State law applies in deciding that issue.
On these facts, we hold that the duty of consistency applies, and, therefore, petitioners are estopped from claiming that the ranch was not partnership property at the time of its sale in 1988.
The Alleged Transfer of the Partnership Interest to the P.C. in 1988
Petitioners' second argument assumes that the ranch was partnership property and focuses on whether petitioner was the owner of his partnership interest for Federal tax purposes when the ranch was sold in October 1988. Petitioner claims that he transferred his partnership interest to his professional corporation in August 1988 and that his professional corporation was required to report the distributive share of income reflected on the Schedule K-1 issued to petitioner for 1988. Petitioners cite Evans v. Commissioner [71-2 USTC ¶9597 ] 447 F.2d 547 (7th Cir. 1971), and Baker v. Commissioner [In Baker, the taxpayer was a partner in a real estate development partnership. After he encountered financial problems, he executed a series of promissory notes to a related corporation as part of an arrangement to sever his business ties with his partner. The issue we resolved was whether the promissory notes provided additional basis in the taxpayer's partnership interest. We held that they did.
Both Evans and Baker are distinguishable from this case. In each of those cases, the taxpayer satisfactorily proved that the transaction in question actually occurred and that it had economic substance. In addition, the taxpayers and related entities did not attempt to avoid a tax liability that otherwise would have been owed by some taxpayer. In the present case, the P.C. failed to report any partnership income on its 1988 return or to list the partnership interest as one of its assets. 10 Other than petitioner's selfserving testimony, there is absolutely no evidence of the alleged transfer in the record. Petitioners did not introduce any contract, assignment, deed, or contemporaneous written documentation to prove that the alleged transfer occurred. We are not required to accept a taxpayer's self-serving, unverified, and undocumented testimony, and we decline to do so here. See Tokarski v. Commissioner [Additions to Tax
In the notice of deficiency, respondent determined that petitioners are liable for additions to tax for negligence under section 6661 .
For 1988, section 6653(a) , negligence is defined as a "lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances." Neely v. Commissioner [67-2 USTC ¶9516 ], 380 F.2d 499, 506 (5th Cir. 1967), affg. in part and remanding in part [section 6653(a) if reasonable reliance in good faith on a competent and experienced return preparer is shown, reliance on professional advice, standing alone, is not an absolute defense to negligence. See United States v. Boyle [Dec. 44,287 ], 89 T.C. 849, 888 (1987), affd. [91-2 USTC ¶50,321 ] 498 U.S. 1066 (1991). Rather, it is a factor to be considered. See Freytag v. Commissioner, supra. In order to claim that he reasonably relied in good faith on a competent and experienced return preparer, a taxpayer must demonstrate that he supplied all necessary information to the preparer, and the incorrect return was a result of the preparer's mistakes. See Weis v. Commissioner [Dec. 31,796 ], 59 T.C. 473, 489 (1972)).
Petitioners have failed to prove that they supplied all necessary information to their return preparer, that the advice they claimed to have received from their return preparer, Mr. Henss, was reasonable, or that they relied on the advice in good faith. The partnership's accountant prepared the partnership tax return for 1988 in a manner consistent with prior years' returns and included on the 1988 partnership return gain from the sale of the ranch. Schedules K-1 consistent with the partnership's return were issued to petitioner and the other partners. Petitioners' regular accountant, Mr. Fettkether, estimated petitioners' Federal income tax liability for 1988 by taking into account the information from the Schedule K-1 and prepared Form 4868, which petitioners signed and filed. Petitioners offered no evidence regarding whether they informed Mr. Henss, when they hired him to prepare their 1988 income tax return, that the partnership and its partners consistently had claimed the ranch as partnership property or whether Mr. Henss did any analysis whatsoever regarding a taxpayer's duty of consistency. Even if petitioner or his adviser had performed any credible analysis of the relevant facts and law, the failure of both petitioner and his P.C. to report the income shown on petitioner's 1988 Schedule K-1 undercuts any argument that petitioner and his adviser acted reasonably under the circumstances.
On this record, we conclude that petitioner was negligent in attempting to avoid paying income tax on petitioner's share of partnership income. Petitioners have failed to prove their position was reasonable under the circumstances or that they had reasonable cause for their failure to report petitioner's distributive share of partnership income.
Petitioners also are liable for the addition to tax for substantial understatement of their tax liability authorized by Section 6661 , in effect for returns due in 1988, provides that, if there is a substantial understatement of income tax for any taxable year, an amount equal to 25 percent of the underpayment attributable to such understatement must be added to the tax. For purposes of sec. 6661(b)(1)(A) .
In cases not involving tax shelters, the addition to tax under section 6661(b)(1) unless, and to the extent that, the taxpayer has substantial authority for the tax treatment of the disputed item or the relevant facts affecting the tax treatment of the disputed item are adequately disclosed within the meaning of sec. 6661(b)(2)(B) .
Although petitioners attempted to show that certain case law supported their positions, petitioners failed to research or analyze their obligation to file consistently with prior returns. In addition, they failed to introduce any evidence showing that they or their return preparer did any investigation of petitioners' tax reporting obligations prior to filing their 1988 income tax return, and they failed to make a disclosure within the meaning of section 6661 . If the recomputed deficiency under Rule 155 attributable to respondent's determinations and the parties' concessions in this case satisfies the definition of substantial understatement under section 6661 .
We have considered carefully all remaining arguments made by petitioners for a result contrary to that expressed herein, including arguments involving documents not in the record, and, to the extent not discussed above, we find them to be irrelevant or without merit.
To reflect the foregoing and the concessions of the parties,
Decision will be entered under Rule 155.
1 Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
2 In the notice of deficiency, respondent determined that petitioners had unreported taxable gain of $280,275, representing 50 percent of the partnership's gain from the sale of the ranch property. Respondent now concedes that only one-third of the gain from the sale of the property in 1988; i.e., $195,425, is allocable to petitioners. Petitioners concede that they received taxable income of $150 from Hawkeye Institute of Technology, $833 from petitioner's professional corporation, and $89 of interest from the Blue Bird Ranch Partnership that was not reported on their Federal income tax return for 1988.
3 Although petitioner testified that the wives were not partners, whether or not the wives contributed capital to the partnership or were partners as a matter of law is not material to the decision we reach in this case. Consequently, we do not make specific findings of fact regarding whether the wives were partners.
4 The check was made payable to petitioners personally and not to the partnership or the P.C. However, the payment was treated as a partnership distribution on the partnership's 1988 return and on the Schedule K-1, Partner's Share of Income, Credits, Deductions, Etc., issued to petitioner.
5 At trial, petitioner testified that he took steps to protect petitioners' personal assets in the event that Mr. and Mrs. Lentz foreclosed on the note and obtained a judgment against petitioners. Specifically, petitioner claimed that, in August 1988, petitioners transferred most of their personal assets to his P.C. in connection with the establishment of an Employee Stock Ownership Plan (ESOP). Although petitioner testified that his interest in the partnership and/or the ranch was included in the transfer, petitioner admitted that neither petitioner's partnership interest nor any ownership interest in the ranch was included on the original list of assets allegedly transferred to the P.C. No documentation regarding the alleged transfer to the P.C. was introduced into evidence at the trial. Petitioner testified that the failure to list his partnership interest or any interest in the ranch was a scrivener's error and that the omission was later corrected. The record is silent as to when this alleged amendment occurred.
6 Respondent also audited the partnership's 1982 tax return several years earlier. Petitioner participated in the audit but did not inform the auditing agent that the ranch was titled in the name of the individuals and not in the partnership's name. Petitioner explained this failure by claiming that he did not know title was held in the names of the individuals until 1998.
7 We question the premise on which petitioner relies in making this argument. Petitioner assumes that if he can convince us that the ranch was not partnership property, he can calculate the gain from the sale of the ranch in 1988 using his cost basis unreduced by depreciation because, in his capacity as the owner of the ranch, he never claimed depreciation on the ranch. sec. 167 are met.
8 In Demirjian v. Commissioner [72-1 USTC ¶9281 ] 457 F.2d 1 (3d Cir. 1972), a case presenting similar facts, we rejected the taxpayers' arguments using a burden of proof analysis. The taxpayers in Demirjian, like the taxpayers in this case, claimed that they held title to certain real property as tenants in common rather than as partners. They had filed partnership tax returns and various correspondence which represented that the partnership owned the real property. Although we did not apply the duty of consistency to resolve the case, we analyzed the applicable burden of proof and concluded that the taxpayers had failed to demonstrate that the property in question was not partnership property. We held that "the record shows that * * * [the taxpayers] intended to and in fact did carry on their prior corporate venture in partnership form, and that they operated the business property conveyed to them as partners. Petitioners have failed to prove otherwise." Id. at 1697-1698. Here, too, the taxpayers "have failed to prove otherwise." Id. at 1698; see also McManus v. Commissioner [Dec. 33,483 ] 65 T.C. 197 (1975); Smith v. Commissioner [9 Petitioners alleged on brief that the partnership is a California partnership and that California law applies.
10 On brief, petitioners, for the first time, claim that the P.C. reported gain from the sale of the ranch on its Federal income tax return for FYE Oct. 31, 1989. Petitioners failed to introduce this return into evidence at trial or to produce any evidence that would corroborate this assertion. We conclude on this record, therefore, that petitioners have failed to prove that the P.C. reported any gain from the sale of the ranch.

Alvin S. Brown, Esq.

Tax Attorney

703.425.1400

www.irstaxattorney.com

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Tax Help: How to reconstruct records

The following IRS Fact Sheet is very helpful to provide secondary evidence in an examination or to prove a disaster loss.


2006FED ¶46,251 FS-2006-7 January 4, 2006

Code Sec. 6001

Internal Revenue Service: Records: Reconstruction.



Internal Revenue Service



IRS Fact Sheet



Media Relations Office



Washington, D.C.



Media Contact: 202.622.4000



Public Contact: 800.829.1040



www.IRS.gov/newsroom




Reconstructing Your Records




FS-2005-7, January 2006

Reconstructing records after a disaster may be essential for tax purposes, getting federal assistance or insurance reimbursement. Records that you need to prove your loss may have been damaged or destroyed in a casualty. While it may not be easy, reconstructing your records may be essential for:


Ÿ Tax purposes - You may need to reconstruct your records to prove you have a casualty loss and the amount of the loss. To compute your casualty loss, you need to determine: 1) the decrease in value of the property as a result of the casualty and 2) the adjusted basis of the property (usually the cost of the property and improvements). You may deduct the smaller of these two amounts, minus insurance or other reimbursement. See Publication 547 for further information on figuring your casualty loss deduction.


If you repair damage caused by the casualty, or spend money for cleaning up, keep the repair bills and any other records of what was done and how much it cost. You cannot deduct these costs, but you can use them as a measure of the decrease in fair market value caused by the casualty if the repairs are actually made, are not excessive, are necessary to bring the property back to its condition before the casualty, take care of the damage only, and do not cause the property to be worth more than before the casualty.


Ÿ Insurance reimbursement.



Ÿ Federal Emergency Management Agency (FEMA) and Small Business Administration aid - The more accurately you estimate your loss, the more loan and grant money there may be available to you.


The following tips may help to reconstruct your records to prove loss of personal-use or business property:



Personal Residence/Real Property

Be sure to take photographs as quickly as possible after the casualty to establish the extent of the damage.


Ÿ Contact the title company, escrow company or bank that handled the purchase to obtain copies of escrow papers. Your real estate broker may also be able to help.



Ÿ Use the current property tax statement for land vs. building ratios, if available; if not available, get copies from the county assessor's office.



Ÿ Check with appraisal companies to locate a library of old multiple listing books. These can be used for "comps" to establish a basis or fair market value. "Comps" are comparable sales within the same neighborhood.



Ÿ Check with your mortgage company for copies of any appraisals or other information they may have about cost or fair market value.



Ÿ Tax records - Immediately after the casualty, file Form 4506, Request for Copy of Tax Return, to request copies of the previous four years of income tax returns. To obtain copies of the previous four years of transcripts you may file a Form 4506-T, Request for Transcripts of a Tax Return. Write the appropriate disaster designation, such as "HURRICANE KATRINA," in red letters across the top of the forms to expedite processing and to waive the normal user fee.



Ÿ Form 4506, Request for Copy of Tax Return



Ÿ Form 4506-T, Request for Transcript of Tax Return



Ÿ Insurance Policy - Most policies list the value of the building to establish a base figure for replacement value insurance.



Ÿ If you are unsure how to reach your insurance company, check with your state insurance department (http://www.naic.org/state_web_map.htm).



Ÿ Improvements - Call the contractor(s) to see if records are available. If possible get statements from the contractors verifying their work and cost.



Ÿ Get written accounts from friends and relatives who saw your house before and after any improvements. See if any of them have photos taken at get-togethers.



Ÿ If a home improvement loan was obtained, obtain paperwork from the institution issuing the loan. The amount of the loan may help establish the cost of the improvements.



Ÿ Inherited Property - Check court records for probate values. If a trust or estate existed, contact the attorney who handled the estate or trust.



Ÿ No other records are available - Check at the county assessor's office for old records about the property. Look for assessed valued and ask for the percentage of assessment to value at the time of purchase. This is a rough guess, but better than no records at all.




Vehicles

Kelley's Blue Book, NADA and Edmunds are available on-line and at most libraries. They are good sources for the current fair market value of most vehicles on the road.


Ÿ Call the dealer and ask for a copy of the contract. If not available, give the dealer all the facts and details and ask for a comparable price figure.



Ÿ Use newspaper ads for the period in which the vehicle was purchased to determine cost basis. Use ads for the period when it was destroyed for fair market value. Be sure to keep copies of the ads.



Ÿ If you're still making payments, check with your lien holder.




Personal Property

The number and types of personal property may make it difficult to reconstruct records. One of the best methods is to draw pictures of each room. Draw a floor plan showing where each piece of furniture was placed. Then show pictures of the room looking toward any shelves or tables. These do not have to be professionally drawn, just functional. Take time to draw shelves with memorabilia on them. Do the same with kitchens and bedrooms. Reconstruct what was there, especially furniture that would have held items --drawers, dressers, shelves. Be sure to include garages, attics and basements.


Ÿ Get old catalogs. These catalogs are a great way to establish cost basis and fair market value.



Ÿ Check the prices on similar items in your local thrift stores to establish fair market value. Walk through the stores and look at comparable items, especially items such as kitchen gadgets. Look for odds and ends you may have had but forgotten because of infrequent use.



Ÿ Use your local "advertiser" as a source for fair market value. Keep copies of the issues handy and copy pages used for specific items to put with your tax records file on the disaster.



Ÿ Check local newspaper want ads for similar items. Again keep a copy of any you use for comparison with the tax file.



Ÿ If you bought items using a credit card, contact your credit card company.



Ÿ Check with your local library for back issues of newspapers. Most libraries keep old issues on microfilm. The sale sections of these back issues may help establish original costs on items such as appliances.



Ÿ Go to a used bookstore with a tape measure and the diagram of the destroyed property. Measure several rows of used books and count the number of books per shelf. Add up the prices of those books and determine an average cost per shelf. Then count the number of shelves you had in your home and multiply by the average cost per shelf. This will help determine the value of your books before the loss.




Business Records


Ÿ Inventories - Get copies of invoices from suppliers. Whenever possible, the invoices should date back at least one calendar year.



Ÿ Income - Get copies of bank statements. The deposits should closely reflect what the sales were for any given time period.



Ÿ Obtain copies of last year's federal, state and local tax returns including sales tax reports, payroll tax returns and business licenses (from city or county). These will reflect gross sales for a given time period.



Ÿ Furniture and fixtures - Sketch an outline of the inside and outside of the business location. Then start to fill in the details of the sketches. (Inside the building --what equipment was where; if a store, where were the products/inventory located. Outside the building --shrubs, parking, signs, awnings, etc.)



Ÿ If you purchased an existing business, go back to the broker for a copy of the purchase agreement. This should detail what was acquired.



Ÿ If the building was constructed for you, contact the contractor for building plans or the county/city planning commissions for copies of any plans.




For assistance and additional information, use these resources:


Ÿ IRS Disaster Assistance Hotline at 1-866-562-5227 (Monday through Friday from 7 a.m. to 10 p.m. local time).



Ÿ IRS Publication 2194, Disaster Losses Kit for Individuals.



Ÿ IRS Publication 2194B, Disaster Losses Kit for Businesses



Ÿ IRS Publication 584, Casualty, Disaster, and Theft Loss Workbook -This can help individuals make a list of stolen or damaged personal-use property and figure the loss. It has a room-by-room listing to help recreate an inventory and figure the loss on the one's home and its contents and one's motor vehicles.



Ÿ IRS Publication 584B, Business Casualty, Disaster, and Theft Loss Workbook -This is available to help businesses list stolen or damaged business or income-producing property and to figure the loss.


Alvin S. Brown, Esq.
Tax attorney
703.425.1400 ex 106
www.irstaxattorney.com

To provide effictive IRS "transparency" you should upload your IRS experiences at www.irsforum.org

Tax Attorney: Insufficient documentation for miscellaneous expenses

An individual taxpayer employed as a systems administrator was not entitled to claim itemized deductions for unsubstantiated miscellaneous expenses. The only records the taxpayer produced were logs of her estimated mileage, cell phone and cleaning expenses, which she created from memory after learning her returns were going to be audited. The Tax Court held that the contradictory nature and general unreliability of the taxpayer's testimony, combined with the unreliable and insufficient logs and the absence of contemporaneous books, records or receipts, failed to meet the ordinary and necessary business requirement under Code Sec. 262. The Tax Court held that while the taxpayer may well have used her cell phone for work, there was no indication that she paid more than she would have had she not used it for work.

Bamidele Arike Kolapo v. Commissioner.Docket No. 8217-06S . Filed August 15, 2007.

[162, 6001]Tax Court: Summary opinion: Miscellaneous itemized deductions: Employee expenses: Substantiation. --


Bamidele Arike Kolapo, pro se. Carrie L. Kleinjan, for respondent.
RUWE, Judge: This case was heard pursuant to the provisions of 1 of the Internal Revenue Code in effect when the petition was filed. Pursuant to 2 we must decide whether petitioner is entitled to claim the remaining miscellaneous deductions in dispute.

Background

Some of the facts have been stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated by this reference. When the petition was filed, petitioner resided in Irvington, New Jersey.

Petitioner was employed as a system administrator for Medco Health, L.L.C. (Medco), in 2003 and 2004. Petitioner worked primarily in Medco's Parsippany, New Jersey, office but sometimes worked in Medco's Franklin Lake, New Jersey, office in 2003 and 2004. She worked in Franklin Lake in April, June, and September of 2003 and July, August, and September of 2004. Petitioner worked in Parsippany during the remaining 9 months of each year.
Petitioner timely filed Federal income tax returns in which she reported adjusted gross income of $24,719 for 2003 and $29,207 for 2004. On March 20, 2006, respondent issued two separate notices of deficiency for 2003 and 2004, respectively. Petitioner timely filed a petition with this Court regarding both 2003 and 2004. The following miscellaneous deductions remain in dispute:3

Miscellaneous Expense 2003 2004

Vehicle expense $9,040 $9,519

Parking fees, tolls,
transportation 98 320

Business expenses 4,800 4,580

Work materials, work clothes,
and cleaning expenses 5,800 5,644

Petitioner provided no receipts or contemporaneous records to substantiate any of her claimed miscellaneous expenses. In January 2005, after the IRS informed petitioner her returns were being audited, and on the recommendation of her accountant, petitioner prepared logs from memory relating to her miscellaneous expenses. Petitioner's logs indicate that she drove her vehicle 420 miles each week for work, paid $40 each week to clean her work clothes and lab coat, and paid $65 each month for a cell phone used in conjunction with her work during 2003 and 2004. Petitioner's logs of her mileage did not distinguish between the days she worked in Parsippany and the days she worked in Franklin Lake, nor did the logs provide the route she took to get to Franklin Lake when she worked there. Parsippany and Franklin Lake are in the same metropolitan area, both less than 35 miles from petitioner's home. Petitioner used her cell phone for personal use as well as to communicate with her employer.

Discussion

As a general rule, the Commissioner's determinations set forth in a notice of deficiency are presumed correct, and the taxpayer bears the burden of proving that these determinations are in error. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).4

Deductions are strictly a matter of legislative grace and the taxpayer bears the burden of proving entitlement to the claimed deduction. Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). Taxpayers are required to maintain records that are sufficient to enable the Commissioner to determine their correct tax liability. See sec. 1.6001-1(a), Income Tax Regs. Additionally, taxpayers bear the burden of substantiating the amount and purpose of each item they claimed as a deduction. See Hradesky v. Commissioner, 65 T.C. 87, 89 (1975), affd. per curiam 540 F.2d 821 (5th Cir. 1976).

section 162 is a question of fact. Commissioner v. Heininger, 320 U.S. 467, 475 (1943).
Respondent argues that petitioner has failed to substantiate the claimed miscellaneous expenses remaining in dispute. The only records petitioner produced at trial were logs of her estimated mileage, cell phone expenses, and cleaning expenses, which she wrote from memory after she found out her returns were going to be audited.

First, we will address petitioner's vehicle expenses. Expenses for transportation between a taxpayer's residence and his or her place of business or employment are generally considered personal expenses, the deduction of which is prohibited by section 162(a). Next, we must address petitioner's cleaning expenses. Petitioner provided no receipts to substantiate her cleaning expenses. As we have already established, petitioner's logs are unreliable and insufficient to substantiate those expenses. Additionally, petitioner failed to show that she was required to wear a uniform to work, thus failing to prove that her cleaning expenses met the ordinary and necessary business requirement under We must next address petitioner's cell phone expenses. As a general rule, section 262 regarding the deductibility of personal expenses takes precedence over the allowance provision of section 262 prohibits petitioner from claiming her cell phone expense deductions.

Finally, with regard to the remaining expense deductions in dispute, petitioner produced no contemporaneous books, records, or receipts to substantiate them.5 Petitioner having failed to substantiate the deductions for those expenses, we find that petitioner is not entitled to them.
We hold that petitioner is not entitled to any of the disallowed miscellaneous deductions in dispute. As a result, we note that the standard deduction for the years in issue might be more advantageous to petitioner than the allowed itemized deductions. Therefore, that determination will be based on the calculations of the parties.

To reflect the foregoing,
Decision will be entered under Rule 155.1 Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.2 Petitioner claimed deductions on Schedules A, Itemized Deductions, for charitable contributions of $1,717 in 2003 and $1,705 in 2004. Respondent disallowed the $245 noncash portions of these claimed charitable contributions for both 2003 and 2004. Petitioner subsequently substantiated greater charitable contributions than she had originally claimed on her returns, and respondent conceded that petitioner was entitled to deductions of $3,380 for 2003 and $3,900 for 2004 unless the standard deduction is more advantageous. Petitioner also provided documentation to substantiate that she paid union dues of $315.20 in 2003 and $391.80 in 2004 and tax preparation fees of $150 in both 2003 and 2004. Respondent concedes that the union dues expenses and the tax preparation fees are deductible, but only to the extent they exceed 2 percent of petitioner's adjusted gross income. See infra note 3.3 4 Pursuant to sec. 7491(a).5 At trial, petitioner submitted a document indicating that total union dues of $728.45 were paid on her behalf in 2004. Petitioner argued at trial that this was the proper amount of union dues she paid in 2004. However, without more evidence that petitioner actually paid this amount, and given the unreliability of petitioner's other testimony and evidence, we find that petitioner is entitled to only the amount stipulated with respondent. See supra note 2.

Back Taxes: GAO Report Addressing Sole Proprietor Noncompliance

The GAO report is reponse to the influence of the pressure from the Senate Finance Committee to reduce the tax gap of about $345 billion. A great deal of that tax gap is the rsult of low tax compliance by sole proprietors.

Government Accountability Office Report: Tax Gap --A Strategy for Reducing the Gap Should Include Options for Addressing Sole Proprietor Noncompliance (GAO-07-1014)August 15, 2007Government Accountability Office report:


Tax gap: Sole proprietor noncompliance.

United States Government Accountability OfficeGAOReport to the Committee on Finance, U.S. SenateJuly 2007TAX GAPA Strategy for Reducing the Gap Should Include Options for Addressing Sole Proprietor NoncomplianceGAOAccountability * Integrity * ReliabilityGAO-07-1014HighlightsHighlights of GAO-07-1014, a report to the Committee on Finance, U.S. SenateWhy GAO Did This StudyThe Internal Revenue Service (IRS) estimates that $68 billion of the annual $345 billion gross tax gap for 2001 was due to sole proprietors, who own unincorporated businesses by themselves, underreporting their net income by 57 percent. A key reason for this underreporting is well known. Unlike wage and some investment income, sole proprietors' income is not subject to withholding and only a portion is subject to information reporting to IRS by third parties.GAO was asked to (1) describe the nature and extent of sole proprietor noncompliance, (2) how IRS's enforcement programs address it, and (3) options for reducing it. GAO analyzed IRS's recent random sample study of reporting compliance by individual taxpayers, including sole proprietors.What GAO RecommendsGAO recommends that the Secretary of the Treasury ensure that the tax gap strategy (1) covers sole proprietor compliance and is coordinated with broader tax gap reduction efforts and (2) includes specific proposals, such as the options in this report. GAO is not making recommendations regarding specific options. IRS and the Department of the Treasury provided technical comments on a draft of this report, which we incorporated as appropriate.www.gao.gov/cgi-bin/getrpt?GAO-07-1014.To view the full product, including the scope and methodology, click on the link above. For more information, contact James R. White at (202) 512-9110 or whitej@gao.gov.July 2007TAX GAPA Strategy for Reducing the Gap Should Include Options for Addressing Sole Proprietor NoncomplianceWhat GAO FoundBased on what IRS examiners could find, most sole proprietors, at least an estimated 61 percent, underreported net business income, but a small proportion of them accounted for the bulk of understated taxes. Both gross income and expenses were misreported. Most of the resulting understated taxes were in relatively small amounts. Half the understatements that IRS examiners could find were less than $903. However, 10 percent of the tax understatements, made by over 1 million sole proprietors, were above $6,200. In this top group, the mean understatement of tax was $18,000.IRS's two main sole proprietor enforcement programs --the Automated Underreporter Program, which computer matches information on a tax return with information submitted to IRS by third parties, and examinations (audits) --have limited reach. The two programs each annually contact less than 3 percent of estimated noncompliant sole proprietors. The limited reach exists for a variety of reasons. In 2001, about 25 percent of sole proprietor gross income was reported on information returns by third parties; expenses generally are not subject to such reporting. Even when required, various barriers make information reporting inconvenient. Examinations of sole proprietors yield less in additional tax assessed and cost more to conduct than examinations for other taxpayers. However, because of the extent of sole proprietor noncompliance, any effect that examinations have on voluntary compliance by other sole proprietors could result in significant revenue.The Treasury Department's recently-released tax gap strategy discusses neither sole proprietor noncompliance specifically nor the many options that could address it. GAO has reported on the need for such a detailed strategy for years. Specific options that address issues including sole proprietor recordkeeping, underreporting of gross income, overreporting of expenses, information reporting, and IRS's enforcement programs are listed in appendix II.
ContentsLetterResults in BriefBackgroundMost Sole Proprietors Underreported Business Income, but a Small Proportion Accounted for the Bulk of Unpaid TaxesEnforcement Programs Have Limited Reach over Sole Proprietors but Still Make Billions of Dollars in Recommended AssessmentsCurrent Treasury Tax Gap Strategy Discusses Neither Sole Proprietor Noncompliance nor the Many Options That Could Address ItConclusionsRecommendation for Executive ActionAgency Comments and Our EvaluationAppendix I Scope and MethodologyAppendix II Options to Address Problems with the Tax Compliance of Sole ProprietorsAppendix III IRS Form 1040 Schedule C, Tax Year 2001Appendix IV Independent Contractors and Section 530 of the Revenue Act of 1978Appendix V Backup Withholding RulesAppendix VI Comments from the Department of the TreasuryAppendix VII GAO Contact and Staff AcknowledgmentsRelated GAO ProductsTablesTable 1: Percentage of Recommended Assessments and Limitations of IRS Enforcement Programs for Detecting Sole Proprietor Reporting NoncomplianceTable 2: Options to Improve Sole Proprietor Tax ComplianceTable 3: Confidence Intervals for Summary of Schedule C Misreporting for Tax Year 2001Table 4: Confidence Intervals for Estimated Understated Tax Amounts by Percentile for Individual Income Tax Returns with Schedule Cs Attached, Tax Year 2001.Table 5: Confidence Intervals for Estimated Cumulative Understated Taxes by Percentile for Individual Income Tax Returns with Schedule Cs Attached, Tax Year 2001FiguresFigure 1: Distribution of Sole Proprietors and Their Gross Receipts by Size of Proprietorship, Tax Year 2003Figure 2: IRS's Nonemployee Compensation Information Returns Matching ProcessFigure 3: Summary of Unadjusted NRP Population Estimates for Schedule C Misreporting, Tax Year 2001Figure 4: Estimated Understated Tax Amounts by Percentile for Form 1040s with Schedule Cs Attached, Tax Year 2001Figure 5: Estimated Cumulative Understated Taxes by Percentile for Form 1040s with Schedule Cs Attached, Tax Year 2001Figure 6: Number of AUR NEC Contacts Made and Total Recommended Assessments, Tax Years 1999-2003Figure 7: Examinations of Returns with Schedule C Attachments and Recommended Tax Assessments, Fiscal Years 2001-2006Figure 8: Recommended Penalties for Sole Proprietors and Non-Sole Proprietors in NRP Examinations with a 100 Percent or Greater Recommended Tax Change by Dollar Value of Tax Change in Tax Year 2001
Abbreviations

AGI adjusted gross income

AUR Automated Underreporter Program

EIN employer identification number

FIRE Filing Information Returns Electronically

IRS Internal Revenue Service

NEC nonemployee compensation

NMA net misreported amount

NRP National Research Program

SOI IRS Statistics of Income Division

TIN taxpayer identification number

This is a work of the U.S. government and is not subject to copyright protection in the United States. It may be reproduced and distributed in its entirety without further permission from GAO. However, because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately.United States Government Accountability OfficeWashington, DC 20548July 13, 2007The Honorable Max BaucusChairmanThe Honorable Charles GrassleyRanking MemberCommittee on FinanceUnited States SenateVoluntary compliance with federal tax laws is a critical component of the federal tax system. Each year, however, a gap arises between tax amounts that were voluntarily reported and paid on time and those that should have been paid. The Internal Revenue Service's (IRS) most recent estimate is that the gross federal tax gap for tax year 2001 was $345 billion.Sole proprietors, who own unincorporated businesses by themselves, have a relatively high rate of tax noncompliance and account for a significant portion of the tax gap. IRS estimates that sole proprietors misreported 57 percent of their business income in 2001 and that $68 billion of the tax gap is attributable to sole proprietors underreporting such income.1 Key reasons for sole proprietors' relatively high tax noncompliance are well known. Sole proprietors are not subject to tax withholding, and only a portion of their net business income is reported to IRS by third parties. By comparison, misreporting rates for wage and interest income, which are subject to withholding or information reporting by financial institutions, are low (about 1 and 4 percent, respectively).Congress has been encouraging IRS to develop an overall tax gap reduction plan or strategy that could include a mix of approaches, like simplifying tax law, increasing enforcement tools, and reconsidering the level of resources devoted to enforcement. On September 26, 2006, the Department of the Treasury (Treasury), Office of Tax Policy, issued "A Comprehensive Strategy for Reducing the Tax Gap." At the time, Treasury officials said that a more detailed strategy would be forthcoming.Because of your concern about the tax gap and the importance of sole proprietor compliance, you asked us to identify steps that might improve that compliance. Our objectives were to (1) describe the nature and extent of the noncompliance associated with sole proprietors, (2) describe the extent to which IRS's enforcement programs address the types of sole proprietor noncompliance found by IRS's most recent research, and (3) identify options to close the tax gap related to sole proprietors that could be included in the tax gap strategy being developed by Treasury. To describe the nature and extent of sole proprietor noncompliance, we analyzed IRS's National Research Program (NRP) results on the reporting compliance of individual taxpayers in tax year 2001, IRS's tax gap estimates, and IRS's Statistics of Income (SOI) data to develop a profile of sole proprietors and related tax compliance issues.2 To determine the extent to which IRS's compliance programs address sole proprietor noncompliance, we reviewed filing guidance and compliance program procedures and analyzed program results. We interviewed IRS staff on the operations and results of the Automated Underreporter Program (AUR), which tests for underreporting by computer matching information returns reporting selected payments made to sole proprietors with income tax returns. We also interviewed staff in IRS's correspondence, office, and field examination (or audit) programs. In addition, we reviewed NRP examination cases to identify examples of barriers when examining sole proprietors.We used several approaches to identify options for closing the sole proprietor tax gap that could fit into the tax gap strategy. We focused on options that could address the types of sole proprietor noncompliance profiled by IRS's research and the limitations of IRS's enforcement programs that address sole proprietors. We also reviewed existing recommendations from the President's Budget, President's Advisory Panel on Federal Tax Reform, our previous recommendations and reports of the Treasury Inspector General for Tax Administration, IRS's Taxpayer Advocate, and IRS advisory groups. We discussed the options with experts on sole proprietor compliance, including persons who have experience with IRS or other federal programs related to sole proprietors or who published related research. We met with officials from various small business organizations, professionals who provide tax advice to small businesses, and tax professional organizations. Further, we reviewed Treasury's tax gap strategy. A more detailed description of our methodology is in appendix I. This report contains estimates which have associated confidence intervals that are conveyed in the body or discussed in the appendix. We conducted our review from July 2006 through June 2007 in accordance with generally accepted government auditing standards.Results in BriefMost sole proprietors underreported net business income for tax year 2001, but a small proportion of them accounted for the bulk of understated taxes. This underreported income was caused by misreporting of both gross income and expenses. Based on what was detected in NRP reviews, at least 61 percent of sole proprietors underreported their net income by $93.6 billion in 2001. IRS recognizes that these are underestimates because detecting underreported income is difficult, especially cash receipts. After upward adjustment, IRS estimated that underreported net income resulted in sole proprietors understating their taxes by $68 billion. Although most sole proprietors had understated taxes, the amounts were skewed. Of all sole proprietors who understated taxes, the lower half understated them by less than an estimated $903. Over 1 million sole proprietors had tax understatements above $6,200, which accounted for the upper 10 percent of understatements. These understatements averaged an estimated $18,000 and accounted for 61 percent of all understated taxes on returns filed by sole proprietors.IRS's main programs to check sole proprietor tax compliance --AUR and the Examination program --have a limited reach. AUR annually contacts about 3 percent of the estimated population of noncompliant sole proprietors while Examination reaches less than 2 percent of them. Information returns that AUR uses to verify sole proprietor income only cover about 25 percent of sole proprietor gross receipts and generally few of their expenses. Barriers to submitting information returns, including complex requirements and lack of convenient electronic filing, also limit AUR's reach. Examinations of sole proprietors' tax returns are more costly and recommend lower additional tax assessments than some other examinations. However, examinations (like other enforcement programs) may have a deterrent effect and increase voluntary compliance by other sole proprietors. Because the rate of noncompliance of sole proprietors is so high, any change in their compliance rate from more enforcement activity could result in significant revenue increases. Even without taking into account any effect on voluntary compliance, IRS's enforcement programs annually make contact with hundreds of thousands of sole proprietors and recommend billions of dollars in additional tax assessments. Finally, IRS did not always apply negligence penalties during NRP for sole proprietors with large tax changes.Since the mid-1990s, we have reported on the need for a strategy to address the overall tax gap as well as the part caused by sole proprietors. That need still exists. Treasury's recently released tax gap strategy discusses neither sole proprietor noncompliance nor the many options that could address it. Although the fiscal year 2008 budget request had legislative proposals on the tax gap, including some related to sole proprietors, these proposals do not make up a long-term, comprehensive strategy. Because no single approach is likely to cost effectively reduce the tax gap by sole proprietors, various options could be considered as part of the overall tax gap strategy and would require IRS, Treasury, or legislative action. These options include enhancing assistance to taxpayers, making information return submission more convenient, requiring more information reporting, and increasing IRS enforcement. Each option has pros and cons. In general, the pros include increasing voluntary compliance, enhancing IRS's ability to detect noncompliance, and reducing the burden of complying. The cons include additional burdens imposed on sole proprietors and third parties as well as costs imposed on IRS. We do not rank the options or recommend particular ones because IRS has other compliance objectives in addition to sole proprietor compliance, some options may be substitutes for each other, and quantitative information about the pros and cons is often lacking. Details on all of our options, including some of the pros and cons, are included in appendix II.We recommend that the Secretary of the Treasury ensure that the tax gap strategy includes (1) a segment on improving sole proprietor compliance that is coordinated with broader tax gap reduction efforts and (2) specific proposals, such as the options we identified, that constitute an integrated package. In commenting on a draft of this report, Treasury said that although not addressed specifically, the seven elements of the department's strategy are intended to apply broadly to all types of businesses and individual taxpayers, including sole proprietorships. Treasury also stated that this report provides valuable insight for applying the strategy to the tax gap. IRS and Treasury also provided technical comments on a draft of this report, which we incorporated as appropriate. IRS did not provide written comments.BackgroundSole proprietors own unincorporated businesses by themselves. As such, they are distinct from corporations and partnerships. In this report, the term sole proprietors refers to both the owners of the businesses and the category of business. In tax year 2003, 20.6 million sole proprietors filed tax returns (the latest year for which detailed IRS data were available). Sole proprietors constitute about 72 percent of all businesses in the United States but are small; they have only 4.8 percent of all business receipts. Sole proprietors include a wide range of businesses, including those that provide services, such as doctors and accountants; produce goods, such as manufacturers; or sell goods at fixed locations, such as car dealers and grocers. These activities may be full time or part time and may be all or part of an individual's income. Figure 1 shows the distribution of sole proprietors and their gross receipts by the size of the proprietorship.
Sole proprietors report their business-related net profit or loss on IRS Form 1040, U.S. Individual Income Tax Return, through their Schedule C Profit or Loss from Business (see app. III). The Schedule C requires sole proprietors to classify their type of business or profession, report gross receipts and income, place expenses in 23 categories, and provide additional data on vehicle expenses. Sole proprietors with expenses up to $5,000 may qualify for simplified tax reporting on Schedule C-EZ, which allows them to report all expenses on one line. Sole proprietors combine their business profits or losses, reported on Schedule C, with income, deductions, and credits from other sources that are reported elsewhere on the Form 1040 to compute their overall individual tax liability.In addition to income tax obligations, sole proprietors have other tax requirements. If they have employees, sole proprietors are responsible for withholding and paying Social Security, Medicare, and federal income tax, and paying federal unemployment tax under an employer identification number (EIN) that is the tax identification number (TIN) for the business. Whether they have employees or not, sole proprietors are required to pay self-employment tax, which is similar to the Social Security and Medicare tax for wage earners.Information ReportingSole proprietors may prepare and receive information returns for payments made to them or made by them for services, known as nonemployee compensation (NEC), on an IRS Form 1099-MISC.3 IRS uses the NEC data in its matching programs, such as AUR, to help verify a sole proprietor's receipts. Generally, a Form 1099-MISC needs to be filed with IRS and the recipient of the payment for
Ÿ payments of $600 or more for services performed for a trade or business, including a sole proprietor, by people who are not employees, such as contractors;4
Ÿ rent payments of $600 or more, other than rents paid to real estate agents;5 and
Ÿ sales of $5,000 or more of consumer goods to persons for resale anywhere other than in a permanent retail establishment.Payments for purchases of goods and service to corporations generally are not required to be reported.6 Based on these rules, organizations (including sole proprietors) that make NEC payments for services provided may be required to submit information returns to IRS and the payee. For example, a store owner (a sole proprietor) who hires a self-employed computer programmer (another sole proprietor) to design the business Web site for $10,000 must submit a Form 1099-MISC information return to report the $10,000 payment made to the computer programmer. However, if the programmer is hired to design a personal, nonbusiness Web site for the store owner, no information return is required.Completing a Form 1099-MISC requires the payer to determine whether the payee is an independent contractor or an employee. To determine independent contractor status, payers are to use 20 common law rules.7 Numerous controversies over interpretation of the common law rules led to the enactment of Section 530 of the Revenue Act of 1978, which stops IRS and Treasury from issuing new interpretations of these rules.8 In 1996, we characterized these rules as confusing and resulting in many misclassifications. If the determination results in an employee-employer relationship, the organization is required to prepare a Form W-2 and withhold tax from each payment to the employee.Similarly, the payer must determine if the payee is a corporation, since such payments generally are not subject to Form 1099-MISC reporting. To determine if the service is provided by a corporation, service providers are asked to declare their corporation status and, if not a corporation, provide a TIN. To ensure that payees provide correct TINs on information returns filed with IRS, NEC payments may be subject to backup withholding. Independent contractors and Section 530 are discussed in appendix IV, and backup withholding rules are discussed in appendix V.IRS Enforcement ProgramsIRS's two main programs for ensuring compliance among sole proprietors are AUR and Examination. AUR matches the NEC income reported on the Schedule C of the sole proprietor's tax return with the NEC income reported on Form 1099-MISC. AUR may send a notice to the sole proprietor if the AUR matching identifies a discrepancy between the NEC reported. The notice proposes adjustments to the tax return filed and requests payment of additional tax, interest, or penalties related to the discrepancy. If the taxpayer disagrees with the notice, the taxpayer is requested to explain the difference and provide any supporting documents. Figure 2 describes the NEC information reporting process.
Examinations may address any type of noncompliance issue and come in three forms. Correspondence examinations are conducted through the mail and usually cover a narrow issue or two. Office examinations are also limited in scope but involve taxpayers going to an IRS office. For field examinations, IRS will send a revenue agent to a taxpayer's home or business to examine the compliance problem that IRS suspects.Compliance Measurement and the Tax GapIRS estimates the gross tax gap --the difference between what taxpayers actually paid and what they should have paid on a timely basis --to be $345 billion for tax year 2001, the most recent estimate made. IRS also estimates that it will collect $55 billion, leaving a net tax gap of $290 billion. IRS estimates that a large portion of the gross tax gap, $197 billion, is caused by the underreporting of income on individual tax returns. Of this, IRS estimates that $68 billion is caused by sole proprietors underreporting their net business income. This estimate does not include other sole proprietor contributions to the tax gap, including not paying because of failing to file a tax return, underpaying the tax due on income that was correctly reported, and underpaying employment taxes. According to IRS, estimates for some parts of the tax gap are more reliable than those for others. For both these reasons, the precise proportion of the overall tax gap caused by sole proprietors is uncertain. What is certain is that the dollar amount of the tax gap associated with sole proprietors is significant.IRS bases its estimates of the tax gap caused by underreporting of individual income on its compliance research program --NRP. The individual reporting compliance study was a detailed review and examination of a representative sample of 46,000 individual tax returns from tax year 2001. IRS generalized from the NRP sample results to compute estimates of underreporting of income and taxes for all individual tax returns. Because even the detailed NRP reviews could not detect all noncompliance, IRS adjusted the NRP estimates to develop final estimates of income misreporting and the resulting tax gap. IRS did not adjust all the NRP population estimates, only those necessary for developing its final tax gap estimates. However, NRP population estimates are a rich source of data about the nature and extent of sole proprietor noncompliance. Consequently, our report sometimes presents NRP population estimates and sometimes final tax gap estimates.Most Sole Proprietors Underreported Business Income, but a Small Proportion Accounted for the Bulk of Unpaid TaxesThe significant amount of sole proprietor noncompliance reported in IRS's tax gap estimates is caused by underreporting of net business income, including the misreporting of both gross business income and expenses. The distribution of the resulting unpaid taxes is uneven. A small proportion of sole proprietors, but still a significant number, has relatively large amounts of unpaid taxes.Most Sole Proprietors Underreported Net Business Income, Misreporting Both Gross Income and ExpensesBased on the unadjusted NRP results, an estimated 70 percent of Schedule C filers in 2001 (about 12.9 million) made an error when reporting net business income (that is, net profit or loss on line 31 of Schedule C). Most of the misreporting was underreporting. These NRP results showed that an estimated 61 percent of Schedule C filers underreported their net income and 9 percent overreported.These reporting errors resulted in $93.6 billion, before adjusting, of misreported net business income as shown in figure 3. This misreporting included an estimated $99 billion of underreported and $5.4 billion of overreported net income.The underreporting of net business income was caused by misreporting of both gross income and expenses, as shown in figure 3. An estimated 39 percent of sole proprietors (6.9 million) made an error on the gross income line of Schedule C and underreported about $53 billion net after subtracting overstatements from understatements. An estimated 73 percent of sole proprietors (10.9 million) made an error on the total expense line of the Schedule C and overreported about $40 billion net after subtracting understatements from overstatements.9 Overstating expenses reduces net business income and thus taxes. However, understating expenses may also contribute to understated tax if it is done to disguise understating higher amounts of gross income.The misreporting of expenses was spread over all the 23 expense categories on the Schedule C. However, 55 percent of expense misreporting was concentrated in four categories: car and truck, depreciation, supplies, and other.
The unadjusted NRP results underestimate the amount of misreporting. The estimates in figure 3 are based on errors detected in the NRP reviews. IRS knows that not all misreporting is detected during its examinations, including NRP reviews. Unreported cash receipts, for example, are difficult to detect. IRS uses various methodologies and other sources of data (on cash transactions, for example) to adjust the aggregate NRP results (but not individual line items) to estimate misreporting. The NRP data limitations are more fully described in appendix I.After these adjustments, IRS estimates that sole proprietors misreported 57 percent of their net business income in 2001 and that the tax gap caused by this misreporting of sole proprietor net business income in 2001 was $68 billion. This is a substantial upward adjustment from the estimated $36.9 billion in understated taxes from all sources on returns with a Schedule C attached based on what NRP detected.10 Taxpayers misreport income and expenses for a variety of reasons. Some misreporting is intentional; some is unintentional. How much misreporting is in each category is not known. IRS refers some misreporting for criminal prosecution, but often it is impossible to tell from a tax return whether errors are intentional. Beyond intentional misreporting, reasons for errors include transcription mistakes, misunderstanding of the relevant tax laws or regulations, and poor recordkeeping. Examples from our review of NRP examination case files illustrate some of these types of reporting errors:
Ÿ The sole proprietor operated a cash-card business and reported about $900,000 in gross receipts on the Schedule C. The business is largely done with cash transactions. The examiner found evidence of more than $1 million in additional sales income, as well as additional expenses from purchases, leading to an adjustment of about $30,000 for Schedule C net income. The adjustment contributed to a total proposed additional tax assessment of about $8,000.
Ÿ The sole proprietor owned a construction business and reported Schedule C losses of over $30,000. The examiner found that that the sole proprietor had poor business skills and shoddy records. Organizing the documentation to support the Schedule C required over 25 hours of examiner time and resulted in net adjustments to receipts and expenses on the Schedule C of over $45,000.
Ÿ The sole proprietor owned a retail business and reported Schedule C gross income of almost $250,000. The examiner proposed adjustments of about $9,000 to Schedule C expenses because the expenses were undocumented or were personal living expenses not associated with the business. In protesting the related assessment to IRS Appeals, the taxpayer's representative said that the taxpayer's records were spread across several store accounts, several accounts for rental properties, and two personal accounts. Eventually, Appeals identified additional records and sent the case back to Examination.
Ÿ The taxpayer was selling craft-related items and admitted to the IRS auditor that the sales were not engaged in for profit. Accordingly, the taxpayer should not have filed a Schedule C, and several thousand dollars of expenses reported by the taxpayer on Schedule C were disallowed.
Ÿ The taxpayer was a minister and filed a schedule C. The examiner explained that although the taxpayer was self-employed in performing ministerial services for Social Security purposes, the taxpayer was considered an employee for income tax purposes. The taxpayer should not have filed a Schedule C.Although a Small Proportion of Sole Proprietors, More Than 1 Million Accounted for the Majority of Understated TaxesUnderstated taxes are spread unevenly among the population of sole proprietors, and slightly more than 1 million sole proprietors accounted for most of the understatements. On one hand, the amount of tax understatement caused by underreported net Schedule C income cannot be calculated precisely. Understated taxes on a return could result from the misreporting of multiple items, and the tax calculations depend on all such misreporting rather than just one item.11 On the other hand, using the best available data on underreporting detected by NRP, we estimate that 72 percent of the underreported adjusted gross income (AGI) on income tax returns filed by sole proprietors was caused by changes in Schedule C income.12 As a result, it is likely that most of the NRP-estimated $36.9 billion (unadjusted) in understated taxes on these returns can be attributed to underreported net business income on Schedule C.Although most sole proprietors had understated taxes, the amounts were skewed. Based on NRP estimates, half of sole proprietors who understated taxes on their individual income tax returns, understated less than an estimated $903 (the 50th percentile amount), as shown in figure 4. Above the 50th percentile, the amount of tax understatement significantly increased to an estimated $2,527 at the 75th percentile, $6,210 at the 90th percentile, and $20,387 at the 98th percentile. About 1.25 million sole proprietors accounted for the largest 10 percent of understatements for which the mean was about $18,000; for the largest 5 percent, the mean understatement was about $27,000. By comparison, as will be discussed further in the next sections, IRS's field examiners assessed on average $27,800 of additional tax for examinations of individual returns without Schedule Cs.
Most of the aggregate $36.9 billion of understated taxes (unadjusted NRP estimate) on returns filed by sole proprietors was concentrated in a small proportion of sole proprietors. As shown in figure 5, the 11.2 million sole proprietors at and below the 90th percentile understated their taxes by a cumulative $14.3 billion. The remaining 10 percent (1.25 million) above the 90th percentile understated a cumulative $22.6 billion in taxes, accounting for 61 percent of the total.
When arrayed by the size of the sole proprietor and based on reported gross receipts, understated taxes are less skewed. Based on Schedule C gross receipts, those sole proprietors at or below the 90th percentile ($127,462) accounted for 65 percent of cumulative understated taxes ($23.9 billion of $36.9 billion).13 Those with the largest 10 percent of gross receipts accounted for the other 35 percent or $12.9 billion of the understated taxes.Enforcement Programs Have Limited Reach over Sole Proprietors but Still Make Billions of Dollars in Recommended AssessmentsIRS's two main programs for addressing sole proprietor reporting compliance14 --AUR and Examination --have limited reach over noncompliant sole proprietors, although they annually contact hundreds of thousands of taxpayers and recommend billions of dollars in assessments. Table 1 shows the types of sole proprietor noncompliance that AUR and Examination investigate, the percentage of the noncompliant sole proprietor population with recommended assessments, and the limitations of the programs.
Table 1: Percentage of Recommended Assessments and Limitations of IRS Enforcement Programs for Detecting Sole Proprietor Reporting Noncompliance

___________________________________________________________________________________
Percentage of
noncompliant
Sole proprietor population with
IRS noncompliance recommended
program addressed assessments Program limitations

___________________________________________________________________________________
AUR Inaccurately 2.7a l Form 1099-MISC is not
reported gross required to be filed on
receipts all gross receipts
(e.g., sales of goods).

l Form 1099-MISC is not
always filed as required
because of various
barriers.

l Does not address sole
proprietor expenses.

l Does not follow up on
all the mismatches
identified.

l Some information
submitted by taxpayers
is not verified.

___________________________________________________________________________________
Examination Receipts and 1.4b l Most examinations are
expense not designed to address
noncompliance sole proprietor tax
issues.

l Examinations can take a
lot of time.

l Recommended assessments
are lower from examining
sole proprietor issues
compared to examining
other types of tax
return issues.

___________________________________________________________________________________
Source: GAO analysis of IRS data.

aTax year 2003, the most recent year for which the appropriate AUR data were
available.

bExaminations conducted in fiscal year 2005 on calendar year 2004 returns, the
most recent year for which the appropriate Schedule C filing data were available.

Assuming that Schedule C filers would misreport net income at the same rate in subsequent years as they did in 2001, AUR recommended that additional tax be assessed on about 2.7 percent of noncompliant sole proprietors for tax year 2003.15 Similarly, Examination recommended that additional tax be assessed on about 1.4 percent of noncompliant sole proprietors for returns from tax year 2004.16 AUR Is Restricted by Limits on Information Reporting and Other Program Constraints but Still Identifies Significant NEC NoncomplianceAUR cannot detect all sole proprietor misreporting because the third-party information returns used for matching do not report all sole proprietor receipts or expenses. One quarter of sole proprietor receipts reported on a Schedule C in 2001 also appeared on a Form 1099-MISC that year. Since not all receipts are reported on a Schedule C, the true percentage would be lower. Exemptions to information reporting requirements prevent greater coverage of sole proprietor receipts. Most merchandise sales, nonbusiness services (such as construction or repairs for homeowners), and payments of less than $600 are exempt from Form 1099-MISC reporting. Additionally, because payments to corporations are generally exempt, sole proprietors that want to avoid information reporting of their receipts could incorporate.Several barriers may inhibit information return filing on NEC payments. First, preparing a Form 1099-MISC to report NEC payments can be a complex process.17 The general instructions for filling out any information return are 21 pages long, and the instructions for Form 1099-MISC are 8 pages long. Payers must figure out whether the businesses they have hired are independent contractors or exempt corporations and whether the payments meet other exemption criteria as well as acquire the payees TINs or EINs.Second, submitting Form 1099-MISC returns is not convenient. In its instructions, IRS requires payers to use forms printed with red, magnetic ink so that IRS scanners can more easily process the forms; payers are instructed not to print Form 1099-MISC off of IRS's Web site. However, we observed plain paper Form 1099-MISC returns being scanned in IRS's Ogden, Utah, processing center. Furthermore, payers must submit Form 1099-MISC returns separately from their tax returns. There is $50 penalty, as the instructions prominently remind payers, for failing to use the correct form. In practice, IRS may not assert the penalty for every violation because of the administrative and collection costs.IRS has an Internet-based system for submitting information returns called Filing Information Returns Electronically (FIRE), but barriers exist to the use of that system. FIRE requires payers to put return information in a particular format that IRS can use, which requires appropriate software that payers must purchase. Payers cannot simply call up a Web site and fill out an online form, and they need to register with IRS before using the system.18 The likelihood that a payer would submit a Form 1099-MISC return electronically decreases as the number of forms that the payer files decreases. For example, IRS data from tax year 2005 show that 93 percent of paper Form 1099-MISC returns were filed by payers with 24 or fewer submissions. One common tax preparation software package allows users to print Form 1099-MISC and submit them to IRS on paper, but the users cannot transmit Form 1099-MISC returns electronically as they can income tax returns. This software vendor said that it had a special arrangement with IRS for its users to print Form 1099-MISC on plain paper.Paper forms are more costly for IRS to process than electronically filed forms. With paper, IRS workers scan forms into a database and visually verify that the information was scanned correctly, a labor-intensive process. A substantial number of Form 1099-MISC returns are filed on paper. For filing year 2005, the Form 1099-MISC constituted 87 percent of all the paper information returns submitted that IRS could scan. Nearly 40 percent of Form 1099-MISC returns (31.5 million) were submitted via paper that year.AUR Is Limited by a Lack of Resources, Expense Matching, and Examination AuthorityBecause of resource constraints, IRS officials said they do not contact taxpayers in all cases where AUR finds a mismatch between what was reported on an information return and what was reported on a tax return. The annual average of NEC-related contacts for tax years 1999 through 2003 is much less than half of the roughly 2 million cases that AUR officials say they annually identify for taxpayer contacts caused by potential NEC underreporting.19 Also, AUR matching generally does not address misreported Schedule C expenses. First, according to IRS, AUR does not match sole proprietors' Schedule C expenses with the information returns they file for their own payments. Second, third-party information generally is not required on sole proprietor expenses.20 AUR reviewers are directed to consider the reasonableness of the taxpayers' responses to notices but generally do not examine the accuracy of the information in the responses because they do not have examination authority.21 IRS officials said that addressing larger issues raised in the returns would take more time and possibly reduce the productivity of AUR overall. Consequently, taxpayers could, after being contacted by AUR about underreported NEC, create fictitious expenses to offset the underreported NEC.AUR does not systematically check for related parties trying to shift income from a tax return in a high-rate bracket to another return with a lower bracket. Related parties may include taxpayers who own multiple businesses, husbands and wives who file separate tax returns, unmarried couples, siblings, or parents and their children. IRS data showed that 3 percent of all Form 1099-MISC returns had the same address for the payer and the payee --one indicator that a related-party transaction might exist. A nonrandom file review of 55 Form 1099-MISC filings at IRS's Ogden, Utah, campus found 8 examples in which the payer and payee had similar addresses or names. We did not determine the appropriateness of the apparent related-party transactions in the IRS Form 1099-MISC data based on the incidence of name and address matches.Two NRP cases are illustrative of apparent related-party transactions involving Form 1099-MISCs. In one case, a couple shared a financial account, and one of them was a sole proprietor. The sole proprietor, who earned more than $450,000 as an executive at a separate company, paid the other individual to run the sole proprietorship and deducted the payment on a Schedule C. The sole proprietorship had over $100,000 in losses and less than $1,000 in revenue. In the case file, an examiner noted that a Form 1099-MISC was filed on the NEC income paid from the executive to the person at the same address. This case file did not note whether the payment inappropriately shifted income to lower the couple's overall tax liability or whether the payment was an allowable business deduction for services actually rendered as an ordinary and necessary expense of carrying out a business, as required by the Internal Revenue Code.22 In another case, however, IRS disallowed deductions for wages that a psychiatrist paid to his children because the taxpayer did not show that the children had rendered services or even that the wages were paid --only that the deductions were taken.Despite Limitations, AUR Annually Recommends Hundreds of Millions of Dollars in Assessments on NEC MisreportingAnnually, AUR receives more than 80 million 1099-MISC forms. From those submissions, AUR contacts hundreds of thousands of taxpayers about potential sole proprietor misreporting on those forms and makes billions of dollars in recommended assessments. From tax years 1999 through 2003,23 AUR annually, on average, sent 371,989 notices on NEC cases and recommended $666 million in tax assessments. Figure 6 shows the trends in NEC contacts and total recommended assessments that AUR made from 1999 through 2003.
Contacts and assessments related to underreported NEC make up a significant portion of the AUR caseload. Of more than 60 categories that AUR uses to sort income data, the two NEC categories combined rank first in the number of contacts with taxpayers and in the dollars of recommended assessments made from tax year 1999 through tax year 2003. NEC cases constituted 17 percent of all AUR contacts and 21 percent of all AUR assessments for tax years 1999 through 2003.Examination Program Is Not Geared toward Schedule C Issues but Still Finds Significant NoncomplianceMost of IRS's examinations do not focus on noncompliance by sole proprietors.24 Correspondence examinations account for the majority of IRS's examinations that IRS did in fiscal year 2006 and generally take the least amount of time to conduct, typically an hour or less, because they deal with simple, limited issues. Schedule C tax issues are generally too complex to make an examination through correspondence practical. For example, in our review of NRP files, we found a case in which an examiner manually sorted through a taxpayer's records and organized them to accurately calculate the taxes owed --a task that could not occur through correspondence. In any case, IRS's correspondence tax examiners, the lowest-graded examiners, do not have the training to examine many Schedule C issues, such as business depreciation or accounting methods.Schedule C tax issues typically must be addressed in field examinations. Field examinations took 20 hours on average to complete in fiscal year 2006. Furthermore, field examinations of returns with Schedule C forms took about 50 percent longer per return (7.2 hours more) to complete than those not categorized as Schedule C returns in that year.Among field examinations, the recommended additional tax assessed for examinations of returns with attached Schedule C forms tended to be smaller than for other types of examinations. For example, the average recommended assessment for revenue agents examining returns with attached Schedule C forms (the employees most likely to do these examinations) was $24,000 in fiscal year 2006. This was $3,800 less than examinations of returns without Schedule C attachments and was less than the average dollars per return for 18 other types of returns without Schedule C attachments, such as tax-shelter program cases.The relatively higher costs and lower yields for Schedule C examinations do not necessarily mean than Schedule C examinations are not cost-effective. The statistics reported above include only the additional taxes expected from the taxpayer who was examined. Examinations may have a deterrent effect on other taxpayers and increase the rate of voluntary compliance.25 Because the rate of noncompliance is so high for sole proprietors, any change in their voluntary compliance from doing more examinations could result in significant revenue increases.IRS has been examining more tax returns with attached Schedule C forms, resulting in billions of dollars in recommended tax assessments. From fiscal years 2001 through 2006, the number of examinations of returns that IRS categorized as Schedule C returns increased by 132 percent, from 128,062 to 297,626, as shown in figure 7.26 In fiscal year 2006, IRS examined about 3 percent of the Schedule C categorized returns. Recommendations of additional tax assessments also increased each year. The large increase in these assessments in 2005 was primarily for returns reporting income greater than $100,000. IRS officials also cited Son of Boss fraud cases from fiscal years 2005 and 2006 and increased examination efficiency as causes for the upward trends.27 Assessments do not reflect amounts actually collected. Amounts ultimately collected are not yet known from the examinations closed in 2005 and 2006.
IRS Did Not Always Apply Negligence Penalties during NRPIRS did not apply negligence penalties in a substantial portion of NRP cases with a tax change. IRS uses negligence penalties28 to encourage compliance and to assure compliant taxpayers that the tax system is fair.Although sole proprietors were more frequently penalized than non-sole proprietors, just 62 percent of the sole proprietors who had a 100 percent or more tax change in their tax liability after the NRP examination and had a tax change of $10,000 or more were penalized. For smaller tax changes, the percentage penalized was lower. Figure 8 summarizes the penalty results from the NRP examinations for tax returns with a 100 percent or more change for sole proprietors and non-sole proprietors.
Our NRP case file review provided some examples in which penalties were not assessed at all or seemed to be assessed inconsistently.
Ÿ A sole proprietor reported AGI of about $10,000 and zero tax liability on the return. An examiner proposed total adjustments of about $3,000, which included unreported Schedule C receipts and overstated expenses resulting in additional tax of about $450. The examiner proposed a negligence penalty of about $90, explaining that the taxpayer did not take reasonable care in preparing the tax return, which was done by a tax preparer.
Ÿ A sole proprietor reported AGI of about $90,000 and a tax liability of about $16,000. An examiner proposed total adjustments of about $35,000, based on unreported Schedule C receipts and overstated expenses, and a tax increase of $15,000. The examination workpapers explained that no negligence penalty was proposed since the tax preparer was responsible for most of the adjustments.The differences in individual cases might be caused in part by IRS procedures that give revenue agents discretion on whether to pursue a penalty, even when the tax change is substantial.29 Recommended penalties must be reviewed by the examiner's manager. Explanations ranging from a lack of knowledge to reliance on a paid preparer can lead some examiners to mitigate a penalty but not others.IRS officials said the application of penalties in NRP cases should be similar to that for operational examinations because NRP examiners were required to follow IRS's standard guidance for penalties. We have started work on a study that will more fully analyze the use of penalties in IRS's operational examinations.Current Treasury Tax Gap Strategy Discusses Neither Sole Proprietor Noncompliance nor the Many Options That Could Address ItThe tax gap strategy issued by Treasury in September 2006 does not discuss sole proprietor noncompliance or specific options to address it. A number of options to improve sole proprietor compliance exist and could be considered as part of the overall tax gap strategy. Each option has both pros (such as improved compliance) and cons (such as burdens on taxpayers or third parties).Tax Gap Strategy Does Not Specifically Discuss Sole Proprietor NoncomplianceTreasury's tax gap strategy does not discuss specific options to address the tax gap overall or sole proprietor noncompliance in particular. As we discussed in February 2007 testimony,30 the strategy generally does not identify specific steps that Treasury and IRS31 will undertake to reduce the tax gap, the related time frames for such steps, or explanations of how much the tax gap would be reduced. Rather, the strategy broadly discusses opportunities for tax evasion and the preventive role of tax research, information technology, compliance activities, taxpayer service, tax law simplification, and working with stakeholders. For example, the portion on improving compliance activities generally discusses initiatives on expanded information reporting, improved document matching, refined detection programs, and increased examinations in selected areas. However, no specifics are provided. Without specifics, the strategy does not include actions that potentially would reduce the tax gap.Since the mid-1990s, we have reported on the need for a strategy to address the federal tax gap as well as sole proprietor noncompliance. In May 1994, we summarized many ideas on reducing the tax gap, including ideas on information reporting, tax withholding, and tax simplification.32 In August 1994, we reported on the lack of a comprehensive linkage between IRS's compliance strategy and compliance efforts for sole proprietors and on the need for better systems to identify the causes of noncompliance and target enforcement resources.33 More recently, in July 2005, we reported that IRS needed a results-oriented approach to reduce the tax gap based on long-term, quantitative voluntary compliance goals and performance measures to determine the success of its strategies and adjust as necessary.34 In April 2006, we testified that IRS had established such compliance goals but lacked a data-based plan for achieving the goals.35 In February 2007, we testified on the need for multiple approaches to reduce the tax gap, including improved taxpayer services, tax code simplification, more information reporting, and an appropriate level of resources for tax enforcement.36 Our products related to the tax gap are listed in the Related GAO Products section at the end of this report.IRS is not without some of the elements of a tax gap strategy. IRS's management continually makes decisions about reallocating resources and has taken steps that demonstrate an understanding of the value of a more strategic approach. One important step is NRP, which gives IRS management more information about the nature of noncompliance and is being used to better target examinations on noncompliant taxpayers. IRS's annual budget requests include specific compliance program proposals. For example, the fiscal year 2008 budget submission had 16 legislative proposals on tax gap reduction. Some of these proposals related to sole proprietors, such as those requiring information reporting on certain government payments made for the procurement of property and services and on merchant card payment reimbursements. Several IRS and Treasury experts, and other knowledgeable individuals also commented that many of these options would be applicable to any small business regardless of its organizational form (such as partnerships, limited liability companies, and corporations). However, these elements do not make up the type of long-term, comprehensive strategy, described above, that provides an overall rationale and specific steps, time frames, and predicted impact on the tax gap.Many Options for Improving Sole Proprietor Compliance Exist and Could Be Considered for the Tax Gap Strategy, But All Have Trade-offsMany options exist that could help reduce sole proprietor noncompliance. These options range from enhancing IRS's assistance to taxpayers to instituting tax withholding on payments made to all or certain types of sole proprietors. Each option has pros and cons.We identified options and their pros and cons by reviewing our reports and the reports of others on sole proprietor compliance as well as through extensive conversations with experts and knowledgeable individuals inside and outside of IRS. Consistent with our previous reports, we tried to identify options that represented a range of approaches, such as improving taxpayer service, more information reporting, and various enforcement actions. Many of the options are directed at the specific sole proprietor compliance problems and IRS program limitations described earlier in this report. We placed the options into broad categories of problems, such as poor recordkeeping, unreported business income, and overstated business expenses. Our list, in table 2, is not exhaustive and not ranked in any order. Appendix II contains a longer description of each option, including pros and cons.
Table 2: Options to Improve Sole Proprietor Tax Compliance

____________________________________________________________________________________
A. Recordkeeping and complexity

____________________________________________________________________________________
1. Work with small business representatives to improve instructions for keeping
records and completing the Schedule C.

____________________________________________________________________________________
2. Provide assistance to first-time Schedule C filers.

a. Target outreach to sole proprietors filing their first Schedule C --IRS
could provide guidance to help them keep records and report accurately on
their Schedule C forms.

b. Notify first time Schedule C filers who did not use a paid tax preparer
and who reported on certain Schedule C lines known to generate more
noncompliance about guidance on IRS's Web site.

____________________________________________________________________________________
3. Separate business and personal records and transactions.

a. Require sole proprietors to include all business transactions in a
financial account or accounts used only for business purposes.

b. Require sole proprietors to obtain TINs for business transactions in
lieu of using their Social Security numbers.

____________________________________________________________________________________
4. Repeal certain limitations in section 530 of the Budget Act of 1978 involving
guidance on rules on classifying workers.

____________________________________________________________________________________
B. Burdens and problems for third parties in filing information returns

____________________________________________________________________________________
5. Clarify Schedule C instructions to indicate that an information return may be
required from sole proprietors who are deducting expenses for wages, fees, and
commissions.

____________________________________________________________________________________
6. Ensure that IRS's Web-based system for filing information returns can
accommodate those filing information returns on payments made to sole proprietors.

____________________________________________________________________________________
7. Create a new Form 1099-NEC to segregate the NEC from the various boxes on the
existing Form 1099-MISC.

____________________________________________________________________________________
C. Unreported sole proprietor income

____________________________________________________________________________________
8. Expand gross receipts reporting on the Schedule C.

____________________________________________________________________________________
9. Close gaps in existing information reporting on payments made to sole
proprietors, for example, by requiring information reporting on annual service
payments that are

a. made to all corporations or to some subset, such as small corporations,
non-publicly held corporations, or noncompliant corporations, or

b. less than $600, which is the current trigger for information reporting.

____________________________________________________________________________________
10. Require new information reporting by organizations on payments to sole
proprietors.

a. Require businesses that process credit (and debit) card payments to
report on the amount of payments made to sole proprietors for a tax year.

b. Require federal, state, and local governments to file information
returns on all nonwage payments made to procure property and services from
businesses.

c. Require financial institutions to file information returns on business
deposits and withdrawals by sole proprietors.

____________________________________________________________________________________
11. Require new information reporting on consumer payments to sole proprietors for
property owners who pay contractors for improvements, if the payments will be used
to adjust the basis of the property.

____________________________________________________________________________________
D. Overstated deductions for sole proprietor expenses

____________________________________________________________________________________
12. Expand expense reporting on the Schedule C.

____________________________________________________________________________________
13. Match information returns filed by sole proprietors with related expenses on
their Schedule C forms.

____________________________________________________________________________________
14. Expand information reporting on the expenses of sole proprietors under two
options.

a. Require businesses that receive certain types of payments from sole
proprietors in large amounts (i.e., thousands of dollars) to file
information returns to report those amounts.

b. Require businesses that process credit (and debit) card payments to
report information on the amount of payments by sole proprietors for each
tax year.

____________________________________________________________________________________
15. Verify additional expenses claimed to offset unreported income.

____________________________________________________________________________________
E. Nonpayment of tax

____________________________________________________________________________________
16. Deny benefits/payments until tax obligations are met, for example, by requiring
that

a. sole proprietors pay their self-employment tax obligations in order to
receive credit for Social Security benefits and

b. federal agencies do a tax compliance check with IRS before providing a
government benefit to a sole proprietor.

____________________________________________________________________________________
17. Withhold tax to encourage compliance through situational or universal means by
requiring those who are to file information returns on payments made to sole
proprietors to

a. withhold a small amount from payments until the sole proprietor's TIN is
certified through an IRS system that is quick and accurate and

b. withhold a very small percentage of the payments made to sole
proprietors in all cases or in limited situations, such as when the sole
proprietor voluntarily consents.

____________________________________________________________________________________
F. IRS management of limited resources

____________________________________________________________________________________
18. Improve IRS's audit selection of sole proprietor tax returns in at least two
ways.

a. Use more advanced automated systems to update the current manual system.

b. Improve the ability of AUR to refer cases for audit.

____________________________________________________________________________________
19. Enhance data sharing with the states.

____________________________________________________________________________________
20. Use informational notices to encourage compliance.

____________________________________________________________________________________
21. Revise the rules for penalties to improve consistency and compliance under two
options.

a. Simplify the process for assessing penalties and develop standards on
using penalties.

b. Increase the penalty for subsequent failures to file required
information returns.

____________________________________________________________________________________
Source: GAO analysis and interviews with tax experts and knowledgeable individuals.

All the options have pros and cons. Because the options are presented as concepts, rather than as detailed plans ready for implementation, the pros and cons could vary with such detail. In most cases, pros and cons are described qualitatively and are not intended to be exhaustive; additional analysis might find others. In general, the pros include helping sole proprietors to comply voluntarily, helping IRS detect and prevent underreporting of income and understatement of taxes, and reducing the burden on taxpayers or third parties for filing tax returns and information returns. The cons include the costs and burdens imposed on sole proprietors, third parties, and IRS.We are not recommending particular options for a number of reasons:
Ÿ Trade-offs. IRS has other compliance objectives in addition to sole proprietor compliance. Devoting more IRS staff and other resources to close the sole proprietor tax gap means that fewer resources are available for combating other types of noncompliance, such as corporate, individual, or tax-exempt entity noncompliance. Forgoing enforcement revenue elsewhere is an opportunity cost of devoting more resources to sole proprietor noncompliance. Also, the resources and management capacity devoted to sole proprietor noncompliance may not be sufficient to implement all the options. Priorities would need to be established.
Ÿ Interaction between options. Some of the options may be substitutes for each other. Others may be complements. Improving assistance to taxpayers might reduce the need for some enforcement actions. Some of the options may reinforce each other --such as expanded inf ormation reporting and more convenient filing options --making it desirable to package them together.
Ÿ Policy judgments. Some of the options involve policy judgments about how the options would affect different groups of people. For example, information reporting invariably imposes some costs on the third parties required to report, but no objective criteria exist for assessing when third-party costs are excessive. In many cases, quantitative information about the effects is not available. Judgments would have to be made based on qualitative information.
For all of these reasons, we are not ranking or otherwise making recommendations on the value of each option, nor are we opining on which options should be packaged together and in what manner. The options could be considered as part of an overall Treasury and IRS tax gap strategy. For most options, Treasury and IRS would need to develop the details on how the options would work both singly and as part of a coordinated strategy. Issues that could be considered in an overall strategy include how much emphasis should be placed on
Ÿ sole proprietor noncompliance versus other types of noncompliance,
Ÿ efforts to help sole proprietors voluntarily comply versus efforts to help IRS detect noncompliance after it occurs,
Ÿ the reporting requirements and added burden placed on sole proprietors versus the reporting requirements and burden placed on third parties, and
Ÿ legislative changes versus administrative changes at IRS.ConclusionsThe tens of billions of dollars in tax revenue lost annually because sole proprietors underreport over half of their aggregate net income contribute to the nation's long-term fiscal challenge. This underreporting is also unfair to compliant taxpayers. Because underreporting is spread among more than 12 million sole proprietors, much of it in small amounts, because the underreporting is for both gross income and expenses, and because IRS's enforcement programs are limited and costly, the sole proprietor tax gap cannot be closed by IRS enforcement alone. As we have said before, improving compliance will require a variety of new approaches.Many options exist for improving sole proprietor compliance; however, they all have individual pros and cons, some may be substitutes for each other and some may reinforce each other. Trade-offs also exist at a broader level. Devoting more IRS resources to sole proprietor compliance must be judged relative to what those resources could accomplish in IRS's other programs. Furthermore, IRS's resources are not the only ones devoted to tax administration. Taxpayers and third parties spend their time and money to make our tax system work. For these reasons, the options are best considered as part of an overall strategy. Such a strategy would provide more assurance that taxpayer, third party, and IRS resources are being used efficiently to promote compliance.Recommendation for Executive ActionWe recommend that the Secretary of the Treasury ensure that the tax gap strategy includes (1) a segment on improving sole proprietor compliance that is coordinated with broader tax gap reduction efforts and (2) specific proposals, such as the options we identified, that constitute an integrated package.Agency Comments and Our EvaluationWe requested written comments from the Secretary of the Treasury and received comments on behalf of the Treasury from its Tax Legislative Counsel (see app. VI). In commenting on a draft of this report, the Treasury said that although not addressed specifically, the seven elements of the department's strategyare intended to apply broadly to all types of businesses and individual taxpayers, including sole proprietorships. Treasury also stated that this report provides valuable insight for applying the strategy to the tax gap. IRS and Treasury also provided technical comments on a draft of this report, which we incorporated as appropriate. IRS did not provide written comments.As agreed with your offices, unless you publicly announce its contents earlier, we plan no further distribution of this report until 30 days after its date. At that time, we will send copies to the Secretary of the Treasury, the Commissioner of Internal Revenue, and other interested parties. This report will also be available at no charge on GAO's Web site at http://www.gao.gov.If you or your staff have any questions about this report, please contact me at (202) 512-9110 or whitej@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. Key contributors to this report are listed in appendix VII.James R. WhiteDirector, Tax IssuesStrategic IssuesAppendix I: Scope and MethodologyTo describe the nature and extent of the noncompliance associated with sole proprietors, we analyzed the Internal Revenue Service's(IRS) National Research Program (NRP) results, tax gap estimates, and Statistics of Income (SOI) data, and interviewed IRS officials. The NRP data are IRS estimates of individual tax reporting compliance based on reviews and examinations of filed tax returns. IRS randomly selected the returns for tax year 2001, which were filed with IRS during calendar year 2002. To compute the percentage of returns with an understatement or overstatement on a Schedule C line and the net misreported amounts, IRS used the following definitions, including related limitations:Percentage of returns with an error: This ratio is the weighted number of taxpayers that have a non-zero net misreported amount divided by the weighted number of returns that should have reported the amount. For some items, taxpayers may have errors that exactly offset each other resulting in no net tax change. For example, a taxpayer may have reported a transaction as an "office expense," but an examiner reclassified the same amount as "repairs and maintenance." NRP did not consider these offsetting changes as errors for those line items.Net misreported amounts (NMA): The NMA is the sum of all amounts underreported minus the sum of all amounts overreported for an item. The NMA does not include adjustments between schedules of the return. For example, the NRP examiner may disallow reported amounts for expense deductions on Schedule C that should have been reported on Schedule A and increase the deductions on Schedule A by the same amounts. Neither adjustment would be in IRS's NMA. However, the adjustments would be included in IRS's definition of the amounts that should have been reported, which are reflected in the denominator of the net misreporting percentage. The NMA does not include adjustments that were made because the taxpayer used the wrong form or line item.Because the percentage of returns with an error and the NMA are derived from samples, table 3 lists the confidence intervals for each amount. IRS did not compute confidence intervals for its estimates. When we calculated confidence intervals, we got slightly different point estimates than IRS. The difference appears to arise from varying definitions of sole proprietors. We are 95 percent confident that the percentages and amounts reported are between the low estimate and the high estimate. In the body of this report, we present IRS's point estimates.
Table 3: Confidence Intervals for Summary of Schedule C Misreporting for Tax Year 2001

____________________________________________________________________________________________________
Dollars in billions

____________________________________________________________________________________________________
Percentage of returns with an error Net misreported amount


________________________________________________________________________________
GAO IRS GAO IRS
Lowcalculated Highpercentage Lowcalculated High reported
Schedule C line estimatepercentage estimate reported estimate amount estimate amount

____________________________________________________________________________________________________
Gross income, line 38 40 42 39 $52.8 $56.8 $60.8 $52.6
7

____________________________________________________________________________________________________
Car and truck 44 46 48 50 6.9 7.5 8.1 7.8
expenses, line 10

____________________________________________________________________________________________________
Depreciation and 36 38 41 42 2.0 2.4 2.8 2.7
section 179 expense
deduction, line 13

____________________________________________________________________________________________________
Supplies, line 22 34 36 38 41 2.4 2.8 3.2 2.9

____________________________________________________________________________________________________
Other expenses, 50 52 54 55 7.2 8.5 9.8 9.0
line 27

____________________________________________________________________________________________________
Total expenses, 67 69 71 73 36.4 38.6 40.8 40.4
line 28

____________________________________________________________________________________________________
Net profit or loss, 68 70 72 70 91.7 95.8 99.9 93.6
line 31

____________________________________________________________________________________________________
Source: GAO analysis of IRS data.

Estimated understated tax amounts, as shown in figure 4, were derived from NRP sample data. Table 4 lists the estimated percentile amount and confidence intervals for each percentile. We are 95 percent confident that the percentages and amounts reported are between the low and high estimates.
Table 4: Confidence Intervals for Estimated Understated Tax Amounts by Percentilefor Individual Income Tax Returns with Schedule Cs Attached, Tax Year 2001.

____________________________________________________________________________________
Percentile lower Percentile upper
confidence interval Estimated percentile confidence interval
Percentile amount amount amount

____________________________________________________________________________________
25th $255 $273 $294

____________________________________________________________________________________
50th 859 903 956

____________________________________________________________________________________
75th 2,422 2,527 2,674

____________________________________________________________________________________
90th 5,976 6,210 6,766

____________________________________________________________________________________
95th 10,635 11,081 12,353

____________________________________________________________________________________
98th 19,631 20,387 64,075

____________________________________________________________________________________
Source: GAO analysis of IRS data.

Estimated cumulative understated tax amounts, as shown in figure 5, were derived from NRP sample data. Table 5 lists the estimated percentile amount and confidence intervals for each percentile. We are 95 percent confident that the percentages and amounts reported are between the low and high estimates.
Table 5: Confidence Intervals for Estimated Cumulative Understated Taxes byPercentile for Individual Income Tax Returns with Schedule Cs Attached, Tax Year2001

____________________________________________________________________________________
Dollars in billions

____________________________________________________________________________________
Percentile lower Percentile upper
confidence interval Estimated percentile confidence interval
Percentile amount amount amount

____________________________________________________________________________________
25th 0.30 0.36 0.44

____________________________________________________________________________________
50th 1.84 2.05 2.35

____________________________________________________________________________________
75th 6.31 6.93 7.65

____________________________________________________________________________________
90th 13.47 14.26 15.64

____________________________________________________________________________________
95th 18.24 19.37 21.08

____________________________________________________________________________________
98th 23.68 24.91 33.06

____________________________________________________________________________________
100th 34.77 36.86 38.95

____________________________________________________________________________________
Source: GAO analysis of IRS data.

According to IRS Research officials, NRP results are not tax gap-related estimates since they do not account for misreporting that the auditors did not detect. Typically, the undetected misreporting of Schedule C net income likely takes the form of understated gross receipts and overstated expenses, for which IRS did not prepare separate tax gap estimates. Overstated expenses tend to be detected since the burden of proof is on the taxpayer to justify them. However, when taxpayers intentionally understate gross receipts, they may also understate expenses to hide the gross-receipt underreporting from IRS. Also, NRP includes estimates of some net business income that is not reported on Schedule C. These amounts are not added to the line-item detail and are not included in the analyses for this report. We could not estimate the amount of tax change that would result from NRP's examinations of Schedule C income because it must be combined with the taxpayer's filing status, exemptions, other types of income, deductions, credits, and other taxes.To analyze the extent to which IRS's enforcement programs address the types of sole proprietor noncompliance found by IRS's most recent research, we used several data sources. We reviewed instructions for tax and information returns and filing guidance as well as program procedures. We analyzed program results data collected from the Automated Underreporter Program (AUR) and Examination officials, and interviewed IRS staff on the operations and results of AUR and the correspondence, office and field examination programs. We reviewed examination plans and Internal Revenue Manual procedures and other instructions to IRS staff describing program procedures. We analyzed data on examination results and numbers of Schedule C forms filed from the IRS Data Book, and data on paper Form 1099-MISC returns published by IRS's Office of Research for 2006. We did not analyze IRS's math error program since all NRP-examined returns were reviewed by this program, which is an integral part of IRS's returns processing function.To calculate the percentage of noncompliant sole proprietors on which AUR and Examination made recommended assessments, we first multiplied the percentage of noncompliant sole proprietors found in NRP data by the number of Schedule C returns for the most recent years that we had available from the IRS Data Book that matched the most recent years for which we had complete AUR and Examination data (tax year 2003 for AUR and tax year 2004 returns for work Examination did in fiscal year 2005). Then we divided the number of recommended assessments made in each program by the number of noncompliant sole proprietors to arrive at the percentage of noncompliant sole proprietors on which the programs made recommended assessments.We reviewed a sample of completed NRP examination case files to understand the types of sole proprietor noncompliance being detected. We selected the sample using the NRP case results database to identify all NRP cases with adjustments to Schedule C items for sole proprietor tax returns. We then selected a nonestimation sample of NRP examination cases with adjustments to gross receipts or sales, total expenses, net profit or loss on the Schedule C, and the business income line on the Form 1040 return, because these lines summarize the sole proprietor's operations. We also randomly selected some Schedule C adjustment cases.We also used NRP data and the NRP case file sample to analyze IRS's use of penalties in NRP examinations. The analysis describes the proportion of NRP cases closed with adjustments and the proportion closed with a penalty recommended by the NRP examination. Because the cases with adjustments and penalties were not drawn from the population of all individual returns, they cannot be used to estimate a penalty assessment rate and other characteristics for all individual taxpayers. Even with these limitations, this analysis provides useful information on the outcome of the NRP sample.To estimate the percentage of reported Schedule C receipts that were on a Form 1099-MISC, we compared amounts reported on the Form 1099-MISC and on Schedule C (line 1 total gross receipts or sales). This analysis used SOI data on individual tax returns for tax year 2001, which included a sample of information returns. We found that three Form 1099-MISC items could be reported on a Schedule C, including nonemployee compensation (NEC), medical payments, and fish sales. According to IRS, these Form 1099-MISC items could also be reported on two other IRS forms --Schedule F, Profit and Loss From Farming, and Form 4835, Farm Rental Income and Expenses --other than the Schedule C. We found that about 4 percent of the amounts reported on the Form 1099-MISC were reported on Schedule F or Form 4835. This difference was not material to our computation. Further, our analysis did not consider several sources of noncompliance that could affect the computation, such as the nonfiling of the required Schedule C or Form 1099-MISC or the underreporting of Schedule C or Form 1099-MISC amounts.To estimate the percentage of Form 1099-MISC returns where the payer and the payee have the same address, we used an SOI data file with tax year 2001 individual income tax return information. We compared the postal codes and the numeric portion of street addresses reported by the payer and payee to identify whether they had the same address. For those who did, we reviewed a sample to verify that the addresses were the same. We also reviewed 55 Form 1099-MISC filings at the Ogden, Utah, campus, which provided 8 examples in which a payer and payee had similar addresses or names. We did not review other IRS records to determine whether these Form 1099-MISC filers were related parties.To assess the likelihood of being assessed a penalty, controlling for other factors, we used logistic regression analysis, an econometric method appropriate for analyzing variables with dichotomous outcomes. We used the deciles of the continuous variables as the independent variables in the model. We did not weight the NRP returns or incorporate the NRP stratification because penalties are a function of the audit and the NRP returns are not representative of audited returns.Controlling for use of a paid preparer, adjusted gross income, Schedule C amount, and total tax as reported by the taxpayer, a logistic regression was used to predict a penalty based on the absolute value of the difference between the total tax reported on the Form 1040 and the total tax after the NRP audit and the percentage of tax change (the difference in total tax divided by the total tax reported on the Form 1040). We found a significant effect of the percentage change in tax owed and the absolute value of the tax change on the likelihood of receiving a penalty. That is, individuals in higher deciles (5th through 10th deciles) of the percentage increase in tax were generally more likely than those in the lowest decile to be recommended for a penalty. Additionally, taxpayers in higher deciles of the absolute value of the tax change (4th through 10th deciles) were more likely than those in the lowest decile to be recommended for a penalty controlling for other factors. We also found that the odds of a penalty decreased with each decile increase in the taxpayer's reported total tax liability.Although we did not test for interactions that could mitigate this effect, we found our results to be robust across a variety of model specifications. We did not control for other potentially relevant variables, such as differences among examiners, and did not test for whether the case was abated.We used several approaches to identify options to close the tax gap related to sole proprietors that could be included in the tax gap strategy being developed by the Department of the Treasury (Treasury). First, we sought ways to address the gaps between the nature of sole proprietor tax noncompliance and existing IRS programs. Second, we reviewed various research publications on sole proprietors and our recommendations, as well as those from the President's Budget, President's Advisory Panel on Federal Tax Reform, Treasury Inspector General for Tax Administration, IRS's Taxpayer Advocate, and IRS advisory group reports. Third, we identified and discussed options and their the pros and cons with experts and knowledgeable individuals on sole proprietor compliance issues, including former Commissioners of Internal Revenue; persons who have experience with IRS or other federal programs related to sole proprietors; representatives for various national organizations representing sole proprietors, tax return preparers, or tax lawyers; tax staff working for Congress; and relevant staff at IRS and Treasury. All of the national organizations representing sole proprietors had large memberships and we contacted each organization's committee which focuses on small business issues. From this work, we consolidated the list of options and pros and cons. We excluded a few options that were raised near the end of our work, lacked details, or generated comments or questions from experts and knowledgeable individuals on how the options would work.The list of options is not exhaustive and has limitations. Since data did not exist for analyzing the effect on the tax gap, taxpayers, or IRS for each option, we could not independently validate or weigh the pros or cons suggested by our experts and knowledgeable individuals. Because the experts and knowledgeable individuals had competing interests on questions of tax policy and administration, we did not seek consensus on the "best" options or on the pros and cons. Experts had limited time to discuss all the options and pros and cons. Thus, we did not discuss each option in detail in each interview, but overall, the interviews provided enough details for the options in our report. As a result of such limitations, we did not try to rank the options. Instead we described the options based on input from the literature and experts. More detailed proposals could raise other pros or cons not listed in our report.We used several approaches to assess data reliability. We assessed whether the examination results and data contained in the NRP database were sufficiently reliable for the purposes of our review. For this assessment, we interviewed IRS officials about the data, collected and reviewed documentation about the data and the system used to capture the data, and completed testing of relevant data fields for obvious errors in accuracy and completeness. We completed analytic testing to ensure that tax return items that should logically be equal were equal. For example, the net profit and loss line on Schedule C should be accurately transferred and equal to the similar line on the individual income tax return. We also compared the information we collected through our case file review to corresponding information in the NRP database to identify inconsistencies. This testing found that the NRP results for Form 1040 returns with Schedule C forms were sufficiently reliable for our review.The tax gap, SOI, AUR, and Examination data are all from sources that we used in previous reports. Based on assessments done for those reports, the fact that the sources are public and widely used, and additional testing we did to ensure that we were properly interpreting individual data elements, the data were sufficiently reliable for our review.We conducted our review at IRS Headquarters in Washington, D.C., and at IRS's Ogden, Utah, campus from July 2006 through June 2007 in accordance with generally accepted government auditing standards.Appendix II: Options to Address Problems with the Tax Compliance of Sole ProprietorsWe have developed a list of options for reducing the tax gap for sole proprietors by reviewing our past reports as well as other related literature and by talking to experts and knowledgeable persons about sole proprietors' tax compliance. As we built the list of options, we discussed the options and the related pros and cons with these experts, including past and current IRS and Treasury staff; former IRS Commissioners; congressional staff; representatives of organizations representing sole proprietors, tax preparers, and tax lawyers; and others who have working knowledge of tax compliance and IRS programs.This list is not exhaustive nor is the list of the pros and cons associated with each option. Many of the options are concepts rather than fully developed proposals with details of how they would be implemented. Additional detail could bring more pros and cons to light. The pros and cons are not weighted, and options should not be judged by the number of pros and cons. We are not making recommendations about the options or ranking their desirability. Rather, we have aligned these options with a series of known problems with sole proprietor tax compliance. Some of the options overlap, covering more than one problem while other options only deal with specific aspects of a problem.A. Recordkeeping and ComplexityFor our system of voluntary compliance to work, taxpayers must keep appropriate records. Our work on sole proprietors has raised issues about incomplete or inaccurate recordkeeping by sole proprietors as well as about the difficulties they face in dealing with complex tax rules. The options in this section look for ways to improve recordkeeping, simplify some of the rules, or provide more guidance and education to sole proprietors to reduce their burden.1. Work with small business representatives on their ideas for improving the instructions for keeping records and meeting their Schedule C filing obligations.More education and better guidance could help sole proprietors comply with the complex tax rules for reporting on the Schedule C. IRS could work with small business and trade representatives to determine whether and how specific changes to IRS's existing education and guidance would help those filing the Schedule C.Pro:
Ÿ Helping educate sole proprietors on their recordkeeping requirements and filing obligations (Schedule C and information returns) could reduce noncompliance.
Ÿ The costs to update the instructions is probably minimal, while the cost for the education would not be.Con:
Ÿ Getting specific ideas that would help sole proprietors might take some time and effort, depending on the extent to which IRS tests these ideas.
Ÿ It may be difficult to target the education and guidance and improve instructions for the sole proprietors who need them the most, that is, those who keep poor records or make errors on the Schedule C. These sole proprietors may not have the time or incentive to pay attention.
Ÿ Changes may not help those who rely on a paid tax return preparer or bookkeeper because of IRS's tendency to forward tax information to the taxpayer but not to the tax return preparer.
Ÿ Some education efforts could be costly to IRS, such as efforts to contact taxpayers individually.2. Provide assistance to first-time Schedule C filers.IRS could consider at least two broad approaches that woulda) specifically target outreach to sole proprietors filing their first Schedule C to inform them about the option to receive regular e-mails on topics of interest, the small business hotline, the resource guide, and other services specifically targeted to help small businesses andb) automatically send computer-generated notices (i.e., soft notices) to first-time Schedule C filers who did not use a paid tax preparers (to reduce the number of notices) and who reported on certain Schedule C lines that involve more complexity or higher noncompliance (e.g., accounting method, depreciation, travel, or home office) about guidance on IRS's Web site on reporting such issues.Pro:
Ÿ This would provide new sole proprietors with the specific information that they need to comply.
Ÿ It would also help new sole proprietors avoid "bad habits" before they become rooted.
Ÿ Using e-mail would reduce IRS's costs.
Ÿ Using automated screening and soft notices would increase IRS's "presence" without the costs of an enforcement contact (e.g., audit).Con:
Ÿ There is no assurance that sole proprietors will read the information and comply.
Ÿ Some sole proprietors may not use e-mail or want to provide an e-mail address to IRS.
Ÿ IRS would incur some costs for the outreach and notices.
Ÿ Soft notices may not boost compliance if they are too vague or if sole proprietors perceive that IRS will not follow up in future tax years on the soft notices.
Ÿ Waiting to act until after the first Schedule C filing may be too late to change the behavior of some sole proprietors.3. Separate business and personal records and transactions.Two requirements could help sole proprietors distinguish their business transactions and records from personal ones. Details would need to be worked out on any exceptions or tolerances; on offering incentives rather than requirements; and on enforcing and penalizing any noncompliance with the requirements, which follow.a) Require sole proprietors to include all business transactions in a business bank account or accounts used only for business purposes. Such transactions would include deposits of business receipts and payments of business expenses. Receipts or expenses generated outside of the business would not be part of these business accounts. Further, financial institutions could provide sole proprietors with an annual summary of inflows and outflows for the business account(s).b) Require each sole proprietor to obtain a taxpayer identification number (TIN) for a business. Currently, sole proprietors generally are required to obtain business TINs, known as employer identification numbers (EIN), when they have wage-earning employees for filing certain types of returns. In this option, sole proprietors could use EINs for their business transactions in lieu of using their Social Security numbers.Pro:
Ÿ Recordkeeping could improve, which would reduce the time and burden of preparing returns and responding to IRS's inquiries.
Ÿ IRS could save money if its computer matching and audits could be done more quickly and with more certainty.
Ÿ Retroactively creating fictitious business expenses after the tax year would be easier to detect.
Ÿ Tax compliance would improve to the extent that sole proprietors would weed out personal expenses from their business expenses.Con:
Ÿ Financial institutions may charge fees for separate business accounts and statements.
Ÿ Taxpayers who want to evade may not deposit all their income in the business accounts or still could run personal expenses through their business accounts.
Ÿ It might be unnecessary or burdensome for Schedule C filers who are not regularly operating a business but have intermittent Schedule C receipts and expenses.
Ÿ IRS may have difficulty enforcing such a requirement.4. Repeal certain limitations in section 530 of the Budget Act of 1978 involving guidance on rules for classifying workers.Lift the limitations on IRS issuing rules and guidance on the criteria to determine whether a worker is to be treated as an employee or an independent contractor for tax purposes as well as on the related safe harbors for employers that classified workers as independent contractors.Pro:
Ÿ Guidance and rules might help clarify confusion in the myriad of employment relationships that have evolved since 1978.
Ÿ Clarification might help ensure that the correct amounts of taxes are being paid.Con:Some types of sole proprietors might prefer
Ÿ legislative clarification rather than trusting IRS to lead the efforts to clarify and
Ÿ living with the current confusion rather than opening the door to changes, particularly if they do not trust IRS to make equitable decisions about the proper classification or the existing safe harbors.B. Burdens and Problems for Third Parties in Filing Information ReturnsInformation reporting offers a way to cover more of the income of sole proprietors who do not report all of their gross receipts. However, information reporting suffers when the information returns are not filed or are filed erroneously and late. Those filing the information returns may face difficulties or burdens in filing information returns on paper or when a sole proprietor does not provide a valid TIN. A number of options exist to better ensure that IRS receives the required information returns on payments made to sole proprietors while minimizing the burden of those filing these information returns.5. Clarify Schedule C instructions to indicate that information returns may be required to be filed by sole proprietors who deduct expenses for wages, fees, and commissions.Pro:
Ÿ To the extent more Forms 1099-MISC are filed, sole proprietors are likely to be more compliant in reporting business income.
Ÿ The instructions would provide another outlet for notifying taxpayers of their Form 1099-MISC reporting obligations at a minimal cost.Con:
Ÿ If those who are to file the required information returns do not read or follow the instructions, the clearer instructions would not boost required filings.
Ÿ If IRS receives more information returns, its costs to process and use them would rise.6. Change the IRS Web-based system for filing information returns to accommodate those filing information returns on payments made to sole proprietors, particularly those filing a smaller number of information returns.Pro:
Ÿ To the extent more Forms 1099-MISC are filed, sole proprietors are likely to be more compliant in reporting business income.
Ÿ Web-based filing could reduce the costs, burdens, and errors for everyone compared to filing/processing paper information returns. IRS may be able to reduce its start-up costs by modifying its Filing Information Returns Electronically system.Con:
Ÿ If those who are to file the required information returns are not comfortable filing information through the Web, do not have access to computers, or do not want to file them at all, more filings of the required returns may not occur.
Ÿ If IRS requires extensive registration steps in order to file on the Web, some filers might find those steps too burdensome.
Ÿ IRS would incur start-up costs to create a new form and a Web-based filing system.
Ÿ IRS would incur additional costs to process and use the information from a significant increase in the number of filed information returns.7. Create a new Form 1099-NEC to segregate NEC from the various boxes on the existing Form 1099-MISC.Although payment of NEC would trigger the requirement to file a Form 1099-NEC, IRS could request other summary information in the expanded space on this separate form about payments to sole proprietors, such as expenses reimbursed, noncash payments, type of services received, or payments for goods.Pro:
Ÿ To the extent more information returns are filed with the new form and filed more clearly,
1. sole proprietors are likely to be more compliant in reporting business income,
2. filing would be less confusing,
3. IRS could refine its computer matching to minimize "false" leads that burden compliant taxpayers, and
4. IRS would have better data to improve its research and case selection for enforcement contacts to the extent that IRS requested other information.Con:
Ÿ IRS has no assurance that a new form would reduce taxpayers' burden enough to lead to more filings of the required information returns.
Ÿ IRS would incur additional costs if it has to process a significant increase in the number of filed information returns and if it has to expand its existing enforcement activities to check compliance in filing these types of required information returns.C. Unreported Income for Sole ProprietorsFor tax year 2001, about 70 percent of the sole proprietors misreported about 57 percent of their net business income. IRS's examinations are limited in number and scope and do not find much of the unreported income. Information reporting offers a way to cover more noncompliant sole proprietors and focus on unreported gross receipts. However, information reporting covered just a quarter of the gross receipts reported on Schedule Cs. One reason for the gap is that current information reporting focuses on payments for services and excludes certain payments, such as those totaling below a certain threshold and those to corporations. These options attempt to address these gaps in information reporting for sole proprietors.8. Expand gross receipts reporting on the Schedule C.Sole proprietors would break out their total gross receipts on the Schedule C to show the amount reported to them on information returns. Other information could be required, such as the number of information returns received and details on large payments.Pro:
Ÿ Sole proprietors could be more sensitized to use the information returns received and thus more accurately report gross receipts.
Ÿ IRS could be more productive in detecting unreported gross receipts by matching the Schedule C and information returns filed or analyzing the ratio of total gross receipts reported on the Schedule C and information returns in audit selection.
Ÿ No additional burden would be placed on third parties.Con:
Ÿ The reporting is unlikely to stop all businesses that wish to hide payments.
Ÿ If their records do not account for whether the income was reported on a Form 1099-MISC, sole proprietors may have an additional burden to report the information.
Ÿ IRS would incur some costs to process and use the additional data.9. Close gaps in existing information reporting on payments made to sole proprietors.Information returns are not required on all payments for services, creating gaps when matching information returns that are filed to determine if all the service payments received have been properly reported. Two options to address these gaps include requiring information reporting on annual service payments that (1) are made to all corporations or to some subset , such as small corporations, non-publicly held corporations, or noncompliant corporations (clear definitions of exclusions would be needed), and (2) total less than $600, which now triggers information reporting.Pro:
Ÿ Sole proprietors who incorporate or receive payments below $600 should be more likely to comply in reporting business income.
Ÿ Sole proprietors would be less likely to structure payment amounts to avoid information reporting.
Ÿ Businesses would not have to distinguish between incorporated and unincorporated businesses in determining whether to file information returns.
Ÿ IRS could improve the productivity of its computer matching for unreported income.Con:
Ÿ Businesses that file more information returns could incur significant costs and burdens, particularly if they have to expand their recordkeeping or make distinctions between small and large corporations.
Ÿ IRS would incur costs to process and match more information returns, and might not be able to use all of the new data if the number filed increases significantly.
Ÿ The information returns would be unlikely to encourage larger corporations that provide services to comply or help IRS find unreported income among larger corporations.
Ÿ Those receiving payments that are less than $600 might not account for much of the unreported income or might not be more noncompliant than other sole proprietors.10. Require new information reporting by organizations on payments to sole proprietors.These options would offer a way to get new information from organizations about payments made to sole proprietors.a) Require businesses that process credit card payments for merchants to report information on the amount of payments made to sole proprietors for a tax year. This reporting could be a summary or include details for payments above some specified amount.b) Require federal, state, and local governments to file information returns on all nonwage payments made (or those above a threshold) for property and services from corporate and noncorporate businesses. Certain payments, such as those related to interest, real property, and tax-exempt entities, would be excluded.c) Require financial institutions to file information returns on business deposits and withdrawals by sole proprietors, which would be facilitated to the extent that business transactions are segregated in business accounts under business TINs.Pro:
Ÿ Sole proprietors covered by any of these options might be more compliant in voluntarily reporting more business income on their Schedule Cs.
Ÿ Each of the options would provide information that IRS could use to select better enforcement cases or to be more productive in its enforcement activities. For example, credit card reporting could allow IRS to develop a ratio of credit card receipts to all receipts reported by sole proprietors by type of industry, and knowing deposit and withdrawal activity could allow IRS to better identify sole proprietors' gross receipts through its bank deposit analysis method. Similarly, the information can be used to avoid selecting a company for audit if the information reports suggest that the taxpayer is compliant.Con:
Ÿ Credit card companies and financial institutions would have some reporting costs.
Ÿ Governments would incur some reporting costs, but they already would have to incur similar costs to meet the tax withholding requirement that Congress approved for these payments starting in 2011, and federal agencies are already required to file some of these data with IRS for federal contracts.1
Ÿ IRS would incur some costs to analyze the information from all the options and to figure out its best uses to identify underreporters.
Ÿ IRS might find it hard to use the increased amount of information returns at all or productively.
Ÿ If some businesses that use credit cards want to underreport income, they might move more transactions to the cash economy.
Ÿ The information would not help identify unreported income among sole proprietors who do not use credit cards, do not have accounts with financial institutions, or do not contract with governments.
Ÿ To the extent that financial institutions are reporting deposits and withdrawals related to nonbusiness activities, or that sole proprietors move funds between multiple business accounts, the information could create false leads for IRS that burden compliant taxpayers.11. Require new information reporting on consumer payments to sole proprietors.This option envisions new information reporting by organizations but also by consumers. It would require property owners to report on payments made to contractors for improvements if the payments will be used to adjust the basis of the property for depreciation or sales purposes. Property owners would be required to report the contractors' TINs. Absent the information return in their records, the property owners could not adjust the basis for tax purposes.Pro:
Ÿ Information reporting on such contracts could cover a substantial dollar value.
Ÿ Sole proprietors may be more likely to report the payments on their tax returns.
Ÿ The payment information could cover a larger portion of the gross receipts than just service payments.
Ÿ Consumers would not have to be burdened with distinguishing the type of business or type of payment in doing the reporting, and overall burden would be limited by how often they contract for improvements.
Ÿ Property owners would have some incentive to report the contractor payments and a defensible foundation for basis adjustments claimed in the future.Con:
Ÿ The incentive for property owners may dissipate if their basis adjustments offer few tax benefits because they do not depreciate or are not expected to have a taxable gain when they are sold, or because property owners do not keep the information returns in their records in order to compute and justify adjustments to basis many years later.
Ÿ Property owners would have some burden to track and report the information and to deal with contractors that do not want to provide their TINs, for which some recourse would be needed.
Ÿ If contractors want to avoid having these payments reported to IRS, they could negotiate with property owners for a lower price in return for property owners not filing the information returns.
Ÿ IRS would have to spend some time and money sorting the information, particularly if the information is reported on paper rather than electronically, and then using the information for research or enforcement.
Ÿ IRS might find it hard to use all of the new information or to use it productively.
Ÿ Some may view disallowing a basis adjustment as a harsh penalty for failing to file an information return.D. Overstated Deductions for Sole Proprietor ExpensesA portion of the $68 billion sole proprietor tax gap arises from overstating deductions for business expenses. Based on what NRP detected, IRS has estimated for 2001 that about 73 percent of the sole proprietors misreported about $40 billion in expense deductions. Although IRS auditors find it easier to check claims for expense deductions than to hunt for unreported income, IRS audits cover few of the noncompliant sole proprietors who overstate business deductions. And the information reporting system does not cover payments made by sole proprietors that could be deductible business expenses. The options in this section look to provide more information about expenses to allow IRS to match or otherwise use to find overstated deductions.12. Expand expense reporting on the Schedule C.Sole proprietors would break out the amount of payments made for services on the relevant expense lines of the Schedule C. Additional information could be required, such as for payments above a specified amount.Pro:
Ÿ Sole proprietors might be more sensitized to the need to accurately claim expense deductions on the Schedule C and the need to also report them on required information returns.
Ÿ Tax preparers would have more incentive to check expense reporting compliance.
Ÿ If adequate, IRS could use the data to detect overstated expenses by matching amounts reported as expenses on the Schedule C lines with the amounts reported on information returns filed by the sole proprietor or by analyzing the ratio of total expenses to amounts reported on an information return's audit selection.
Ÿ No additional burden would be placed on third parties.Con:
Ÿ IRS might have difficulties processing and matching all of the new expense data.
Ÿ IRS would incur difficulties, such as extra costs, to process and use the additional data.
Ÿ If their records are incomplete on their expenses and information returns or their accounting systems do not break out expenses by the services provided, sole proprietors may have an additional burden to report the information.
Ÿ This would not stop all reporting noncompliance.13. Match information returns filed by sole proprietors with related expenses on their Schedule Cs.IRS would match the existing information returns filed by sole proprietors to report their payments made for wages, services, and so forth to the related lines of the Schedule C in order to see whether the expenses claimed are consistent with the amounts reported on the information returns. As with any computer match, IRS would need to develop rules for doing the match and tolerances for contacting the sole proprietors about discrepancies.Pro:
Ÿ Such reverse matching could help identify excess deductions, especially for wages, without incurring the costs of audits.
Ÿ If sole proprietors learn about the reverse matching, they may become more compliant in reporting expenses
Ÿ This matching would not impose any new burdens on third parties and little burden on compliant sole proprietors if the matching criteria are effective.Con:
Ÿ Beyond wages and possibly some types of nonemployee compensation, IRS may find it difficult to effectively match expenses in order to avoid contacting compliant sole proprietors.
Ÿ If sole proprietors want to overstate deductions and know that IRS can use the information returns they file to look for overstated deductions, some of them may file fictitious information returns.14. Expand information reporting on the expenses of sole proprietors.The expanded information reporting to cover expenses claimed on the Schedule C could include two options:a) Businesses receiving certain types of payments from sole proprietors in large amounts (i.e., thousands of dollars) would file information returns to report those amounts by type of expense. Beyond limiting such reporting to large dollar amounts (which would need to be set), the reporting also could be limited to certain types of payments that are easier to report or that tend to be overstated as expenses on the Schedule C (e.g., rents, fees, insurance, and travel).b) Businesses that process credit (and debit) card payments would be required to report information on the amount of payments by sole proprietors for each tax year. This reporting could be a summary total or include more details for payments above some specified amount. IRS would need to decide how it would use this information to check for overstated expenses on the Schedule C.Pro:
Ÿ Having the data might help IRS detect certain overstated expenses without incurring the costs of an audit. Otherwise, IRS would have more information on the expenses of sole proprietors for use in selecting cases for auditing.
Ÿ Sole proprietors might report their expenses more accurately with third-party data.Con:
Ÿ Third-party businesses doing the reporting would have additional costs to file the information returns or burdens to know whether the payments are personal or business related.
Ÿ Some businesses might not want to report to IRS about payments they receive from sole proprietors, particularly if those payments account for most of their gross receipts and they underreport those payments on their tax returns.
Ÿ Sole proprietors wishing to avoid the credit reporting may use more cash purchases.
Ÿ If IRS were to use the information in a matching program, it would incur costs to process and match it in order to avoid contacting compliant sole proprietors and to identify personal expenses mixed in with business expenses.15. Verify additional expenses claimed to offset unreported income.Through some form of review or audit of documentation, IRS could verify additional business expenses in those cases where sole proprietors claim additional expenses after IRS informs them that it has discovered unreported business income.Pro:
Ÿ IRS could improve the effectiveness of its AUR matching to the extent that it stops sole proprietors from claiming unverified expense offsets.Con:
Ÿ If AUR staff do the verification, IRS would incur costs to train them to do the verification and find additional staff to keep up the volume of AUR contacts.
Ÿ If audit staff do the verification, IRS would have to make sure that the return on investment justifies allocating more expensive, better-trained staff to do the verification.
Ÿ If IRS develops some other verification program, it would incur start-up and operational costs.E. Nonpayment of TaxIn addition to misreporting business income and expenses, the noncompliant sole proprietors do not pay their tax liabilities. Even so, they can receive government benefits, such as contract payments and Social Security credits. And they are not subject to a proven tax compliance technique for many individual taxpayers --tax withholding. Th is section lists options that could help induce sole proprietors to meet their tax obligations to receive benefits or avoid tax withholding.16. Deny benefits/payments until tax obligations are met.One way to induce sole proprietors to pay their taxes owed is to deny them government benefits unless they have paid the taxes. Federal agencies that provide the benefits would need to check for tax compliance with IRS, and the prohibitions against disclosing tax data would need to be revised to ensure that the authority exists. Two options for checking tax compliance before providing government benefits are toa) require that sole proprietors pay their self-employment tax obligations in order to receive credit for Social Security benefits orb) require federal agencies to do a tax compliance check with IRS before making a contract payment or otherwise providing a government benefit (certain loans or grants) to a sole proprietor (either all or just contractors). At a minimum, a check would be made to see whether the sole proprietor has unfiled tax returns or unpaid tax liabilities.Pro:
Ÿ Sole proprietors would have an incentive to meet their tax obligations.
Ÿ This would help ensure that compliant sole proprietors' competitors pay their taxes.Con:
Ÿ To the extent that sole proprietors are not motivated by the loss of Social Security credits or government benefits, some of them may continue to not pay their taxes.
Ÿ Sole proprietors could be unjustly denied credits or benefits because of a systemic/human error and thus would need some venue for seeking an administrative remedy.
Ÿ Federal agencies would incur costs to check compliance and might incur some contracting delays if the compliance checks take a lot of time.
Ÿ Denying some types of loans/grants (e.g., for disaster or poverty) may be seen as harsh.17. Withhold tax to encourage tax compliance.Another way to induce sole proprietors to pay their taxes owed is to require situational or universal tax withholding from the payments made to them. Two basic options would require those who are to file information returns (e.g., government and business entities) on payments made to sole proprietors to do tax withholding:a) Withhold a small amount from payments until the sole proprietor's TIN is certified. This up-front withholding would replace "backup withholding" in those cases where, over a year or more later, IRS informs the sole proprietor that the TIN provided is invalid. IRS would need a system for quickly and accurately certifying TINs, which can be either EINs or Social Security numbers. Also, decisions would be needed on how much to withhold and on what to do with the withheld amounts (e.g., paid to the sole proprietor once the TIN is certified or remitted to IRS and reconciled when the tax return is filed).b) Withhold a small percentage of the payments made to sole proprietors for services either in all cases or in limited situations, such as when sole proprietors (1) voluntarily consent or (2) have a recent history of tax noncompliance and IRS has not annually certified that they are now tax compliant.Pro:
Ÿ Sole proprietors would be more motivated to provide TINs that can be certified, file their returns, report their income, and pay their taxes.
Ÿ Those paying sole proprietors would probably have fewer burdens from withholding the taxes up front compared to doing backup withholding over a year later.
Ÿ Using a low rate could get the sole proprietors into the system without necessarily creating an undue burden on their business operations.
Ÿ IRS would have fewer information returns with erroneous TINs that it spends resources trying to correct or that cannot be used in its computer matching programs.Con:
Ÿ Withholding would create an added burden for those doing business with the sole proprietor, especially if they do not have systems for doing withholding or periodically remitting tax amounts to IRS, or if they would not have had to do backup withholding.
Ÿ Business relationships or operations might be disrupted if IRS's system for validating TINs is slow or burdensome, or generates errors, while some businesses may refuse to validate the TINs or to withhold payments if requested to do so by the sole proprietor that they want to use.
Ÿ Even with one low withholding rate, some sole proprietors may be burdened if, for example, they operate on thin profit margins or have limited working capital.
Ÿ If multiple, withholding rates or exceptions for withholding were created by industry, location, years in business, compliance history, and so forth to minimize the negative business impacts on sole proprietors, questions might arise about complexity, equity, and opportunities for "gaming" the system to have a lower or no withholding rate.
Ÿ If withholding were limited to sole proprietors, some could incorporate or claim to be a corporation to avoid withholding.F. IRS Management of Limited ResourcesFollowing up on AUR mismatches and conducting examinations are costly. Furthermore, some of IRS's compliance and enforcement actions mistakenly select compliant, rather than noncompliant, taxpayers. This section discusses options for more effectively using IRS's limited resources by better using data and other tools.18. Improve audit selection of sole proprietor tax returns.IRS could explore opportunities for improving its selection of sole proprietor tax returns and tax issues to be audited in at least two ways.a) IRS would use advanced automated selection systems to update the current manual classification system to better select returns and tax issues for audit.b) IRS would improve the ability of AUR to refer cases for audit, such as when unverified (e.g., oral) claims about income and expenses are made. AUR is limited in pursuing such cases, and IRS Examination already has selected many cases for audit by the time the referrals are made.Pro:
Ÿ IRS could select returns with a higher likelihood of tax changes at a lower cost and with lower burden on compliant sole proprietors.
Ÿ More automation could free a number of experienced audit staff who help select these returns and these tax issues for audit to do more audits.
Ÿ IRS might be able to increase the dollar yield from finding unreported income and denying unjustified claims for offsetting deductions.Con:
Ÿ IRS would incur costs to collect and test enough data to create an effective automated system.
Ÿ IRS is likely to still need some manual intervention to account for location-specific issues that cannot be programmed into the automated system
Ÿ IRS might find that these AUR cases are still less productive than other audit cases.19. Enhance data sharing with the states.IRS would seek to improve data-sharing arrangements with the states. State data could include using business licensing, ownership of real estate or other large assets, sales receipts, and tax compliance data to identify unfiled returns and underreported income.Pro:
Ÿ IRS could cost effectively identify noncompliance, especially nonfilers, that it otherwise would miss.Con:
Ÿ State data may be difficult to match with federal data because states impose different taxes than the federal government, may use a different taxable base, and may report the data in a format that IRS cannot easily use.20. Use informational notices to encourage compliance.IRS would send notices (soft notices) to Schedule C filers when it sees potential compliance issues that it does not have the resources to audit. These notices notify and educate the filers about a potential problem with a tax reporting obligation, and suggest that they either recheck their filed tax returns or change their reporting on future returns.Pro:
Ÿ IRS can expand its presence/education and sensitize sole proprietors about tax obligations without the costs of enforcement contacts.
Ÿ Some sole proprietors may become more compliant voluntarily.Con:
Ÿ Some sole proprietors will ignore the soft notices, particularly if they are received years after a return was filed or if IRS will not take follow-up action regardless of what they do.21. Revise the rules for applying penalties to improve consistency and complianceOne tool to increase compliance is to punish improper behavior with penalties. Two options to remedy the inconsistent application of penalties are to
Ÿ simplify the process for assessing penalties and develop standards to ensure the consistency of their application to sole proprietor errors and misconduct and
Ÿ make information return penalties scalable by increasing the dollar amount of penalties for subsequent failures to file required information returns (e.g., the penalty for the tenth failure to file an information return may be significantly higher than the first).Pro:
Ÿ Sole proprietors who are significantly noncompliant would be penalized, and the equity and consistency of penalty application might improve.
Ÿ Some sole proprietors might become more compliant if they are certain that penalties will be applied.
Ÿ If IRS applies the penalties more consistently, fewer sole proprietors may need to incur the burden of seeking abatements for unnecessary penalties.
Ÿ IRS could receive more required information returns that are accurate and timely.Con:
Ÿ If the process becomes too rigid, some sole proprietors might resent the perceived inequities. Some sole proprietors might have equity concerns if IRS cannot reduce higher penalties caused by a systemic glitch for many information returns (e.g., a computer error that occurred over and over).
Ÿ If revised penalty rules go too far in accounting for inadvertent actions, hardships, and other reasonable causes, the penalty consistency may be hard to achieve.
Ÿ If many sole proprietors are required to file only a few information returns, scaling penalties would have little impact, and if only a small dollar amount of penalties is at stake, IRS procedures are likely to continue authorizing abatement of the penalties.Appendix III: IRS Form 1040 Schedule C, Tax Year 2001
Appendix IV: Independent Contractors and Section 530 of the Revenue Act of 1978With increased IRS enforcement of the employment tax laws beginning in the late 1960s, controversies developed over whether employers had correctly classified certain workers as independent contractors rather than as employees. In some instances when IRS prevailed in reclassifying workers as employees, the employers became liable for portions of employees' Social Security and income tax liabilities (that the employers had failed to withhold and remit), although the employees might have fully paid their liabilities for self-employment and income taxes.In response to this problem, Congress enacted section 530 of the Revenue Act of 1978 (Pub. L. No. 95-600). That provision generally allows an employer who meets certain requirements (such as filing required information returns) to treat a worker as not being an employee for employment tax purposes (but not income tax purposes), regardless of the individual's actual status under the common-law test, unless the taxpayer has no reasonable basis for such treatment. Under section 530, a reasonable basis is considered to exist if the taxpayer reasonably relied on (1) past IRS audit practice with respect to the taxpayer, (2) published rulings or judicial precedent, (3) long-standing recognized practices in the industry of which the taxpayer is a member, or (4) any other reasonable basis for treating a worker as an independent contractor. Section 530 also prohibits the issuance of Treasury regulations and revenue rulings on common-law employment status.1 Congress intended that this moratorium to be temporary until more workable rules were established but the moratorium continues to this day. The provision was extended indefinitely by the Tax Equity and Fiscal Responsibility Act of 1982.2 The rules to classify a worker as an employee or an independent contractor are still complex and often difficult to apply. The determination of whether a worker is an employee or an independent contractor is generally made under a facts and circumstances test that seeks to determine whether the worker is subject to the control of the employer, not only as to the nature of the work performed but the circumstances under which it is performed. In general, the determination of whether an employer-employee relationship exists for federal tax purposes is made under a common-law test.IRS has developed a list of 20 factors that may be examined in determining whether an employer-employee relationship exists. The 20 factors were developed by IRS based on an examination of cases and rulings considering whether a worker is an employee.3 The degree of importance of each factor varies depending on the occupation and the factual context in which the services are performed.4 Misclassification of workers can be either inadvertent or deliberate. Because the determination of classification is factual, reasonable people may differ as to the correct result given a certain set of facts. Thus, even though a taxpayer in good faith determines that a worker is an independent contractor, an IRS agent may reach a different conclusion by, for example, weighing some of the 20 factors differently. The prohibition on issuance of general guidance by IRS may make the likelihood of classification errors greater; IRS is not permitted to publish guidance stating which factors are more relevant than others. In the absence of such guidance, not only may taxpayers and IRS differ, but different IRS agents may also reach different conclusions, resulting in inconsistent enforcement.A significant issue is the potential revenue loss to the federal government when employees are misclassified as independent contractors. An IRS survey of 1984 employment tax returns found that nearly 15 percent of employers misclassified employees as independent contractors. When employers classified workers as employees, more than 99 percent of wage and salary income was reported. When workers were misclassified as independent contractors, 77 percent of income was reported when a Form 1099-MISC was filed and only 29 percent was reported when no Form 1099-MISC was filed.Appendix V: Backup Withholding RulesPersons (payers) making certain types of payments must withhold and pay to IRS a specified percentage of those payments under certain conditions. Related to sole proprietors, for example, both (1) the commissions, fees, or other payments for work as an independent contractor and (2) payments by fishing boat operators, but only the part that is in money and that represents a share of the proceeds of the catch, are reported on Form 1099-MISC. Other payments are not subject to backup withholding, including wages, real estate transactions, foreclosures and abandonments, and canceled debts. Also corporations, governmental entities, and foreign governments generally are exempt from backup withholding.For backup withholding to be initiated on payments to sole proprietors, a payment must be reportable and the payee must fail to furnish a correct TIN.1 If an incorrect TIN is provided, IRS is to notify the payer regarding the missing, incorrect, or not currently issued payee TIN. At that time the payer is required to compare the listing with his or her records and send a notice to the payee, asking for the correct TIN. Under tax rules, if the payee refuses to provide a TIN, the payer is required to immediately begin withholding 28 percent of the amount of the payment and remit that amount to IRS. IRS procedures describe how the payer is to verify the TIN and request that the payee provide a correct TIN. The payer must make up to three solicitations for the TIN (initial, first annual, and second annual) to avoid a penalty for failing to include a TIN on the information return. If the payer files an information return with a missing TIN or with an incorrect name and TIN combination, or does not follow the procedure to correct the TIN, the payer may be subject to a $50 penalty for each incorrect return filed.Appendix VI: Comments from the Department of the Treasury
DEPARTMENT OF THE TREASURYWASHINGTON, D.C. 20220July 10, 2007Mr. James R. WhiteDirector, Tax IssuesStrategic IssuesUnited States Government Accountability OfficeWashington, DC 20548Dear Mr. White:We appreciate the opportunity to review and provide comments on the draft report titled "Tax Gap: A Strategy for Reducing the Gap Should Include Options for Addressing Sole Proprietor Noncompliance (GAO-07-1014)."In addition to specific technical comments that we provided to your staff, we would like to respond to the report's recommendation that "the Secretary of the Treasury ensure that the tax gap strategy includes (1) a segment on improving sole proprietor compliance that is coordinated with broader tax gap reduction efforts and (2) specific proposals such as the options, such we identified, that constitute an integrated package." Although not addressed specifically, the seven elements of the Treasury Department's strategy are intended to apply broadly to all types of business and individual taxpayers, including sole proprietorships. As we continue to consider application of the strategy to the most significant elements of the tax gap, your report will provide valuable insight.Thank you for your analysis and suggestions on this important issue.
Sincerely,
Michael J. Desmond
Tax Legislative CounselAppendix VII: GAO Contact and Staff AcknowledgmentsGAO ContactJames R. White, (202) 512-9110 or whitej@gao.govAcknowledgmentsIn addition to the contact named above, Tom Short, Assistant Director; Evan Gilman; Eric Gorman; Leon Green; George Guttman; Shirley Jones; Donna Miller; Karen O'Conor; Anna Maria Ortiz; and Sam Scrutchins made key contributions to this report.Related GAO ProductsTax Compliance: Multiple Approaches Are Needed to Reduce the Tax Gap. GAO-07-488T. Washington, D.C.: February 16, 2007.Tax Compliance: Multiple Approaches Are Needed to Reduce the Tax Gap. GAO-07-391T. Washington, D.C.: January 23, 2007.Tax Compliance: Opportunities Exist to Reduce the Tax Gap Using a Variety of Approaches. GAO-06-1000T. Washington, D.C.: July 26, 2006.Tax Gap: Making Significant Progress in Improving Tax Compliance Rests on Enhancing Current IRS Techniques and Adopting New Legislative Actions. GAO-06-453T. Washington, D.C.: February 15, 2006.Tax Gap: Multiple Strategies, Better Compliance Data, and Long-Term Goals Are Needed to Improve Taxpayer Compliance. GAO-06-208T. Washington, D.C.: October 26, 2005.Tax Compliance: Better Compliance Data and Long-term Goals Would Support a More Strategic IRS Approach to Reducing the Tax Gap. GAO-05-753. Washington, D.C.: July 18, 2005.Tax Compliance: Reducing the Tax Gap Can Contribute to Fiscal Sustainability but Will Require a Variety of Strategies. GAO-05-527T. Washington, D.C.: April 14, 2005.IRS Audits: Weaknesses in Selecting and Conducting Correspondence Audits. GAO/GGD-99-48. Washington, D.C.: March 31, 1999.Tax Administration: Billions in Self-Employment Tax Are Owed. GAO/GGD-99-18. Washington, D.C.: February 18, 1999.Tax Administration: Issues Involving Worker Classification. GAO/T-GGD-95-224. Washington, D.C.: August 2, 1995.Tax Administration: Estimates of the Tax Gap for Service Providers. GAO/GGD-95-59. Washington, D.C.: December 28, 1994.Tax Administration: IRS Can Better Pursue Noncompliant Sole Proprietors. GAO/GGD-94-175. Washington, D.C.: August 2 1994.Tax Gap: Many Actions Taken, But a Cohesive Compliance Strategy Needed. GAO/GGD-94-123. Washington, D.C.: May 11, 1994.Tax Administration: Approaches for Improving Independent Contractor Compliance. GAO/GGD-92-108. Washington, D.C.: July 23, 1992.GAO's MissionThe Government Accountability Office, the audit, evaluation and investigative arm of Congress, exists to support Congress in meeting its constitutional responsibilities and to help improve the performance and accountability of the federal government for the American people. GAO examines the use of public funds; evaluates federal programs and policies; and provides analyses, recommendations, and other assistance to help Congress make informed oversight, policy, and funding decisions. GAO's commitment to good government is reflected in its core values of accountability, integrity, and reliability.Obtaining Copies of GAO Reports and TestimonyThe fastest and easiest way to obtain copies of GAO documents at no cost is through GAO's Web site (www.gao.gov). Each weekday, GAO posts newly released reports, testimony, and correspondence on its Web site. To have GAO e-mail you a list of newly posted products every afternoon, go to www.gao.gov and select "Subscribe to Updates."Order by Mail or PhoneThe first copy of each printed report is free. Additional copies are $2 each. A check or money order should be made out to the Superintendent of Documents. GAO also accepts VISA and Mastercard. Orders for 100 or more copies mailed to a single address are discounted 25 percent. Orders should be sent to:U.S. Government Accountability Office441 G Street NW, Room LMWashington, D.C. 20548

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To Report Fraud, Waste, and Abuse in Federal ProgramsContact:Web site: www.gao.gov/fraudnet/fraudnet.htmE-mail: fraudnet@gao.govAutomated answering system: (800) 424-5454 or (202) 512-7470Congressional RelationsGloria Jarmon, Managing Director, JarmonG@gao.gov (202) 512-4400 U.S. Government Accountability Office, 441 G Street NW, Room 7125 Washington, D.C. 20548Public AffairsPaul Anderson, Managing Director, AndersonP1@gao.gov (202) 512-4800 U.S. Government Accountability Office, 441 G Street NW, Room 7149 Washington, D.C. 205481 In addition, sole proprietors contributed to an unmeasured extent to the $54 billion in misreported employment taxes, the $34 billion underpayment tax gap, and the $27 billion tax gap created by individuals not filing required tax returns for tax year 2001.2 NRP studied reporting compliance (versus filing or payment compliance) for a random sample of individual tax returns filed for tax year 2001. In most cases, the returns were audited to determine whether income, expenses, and other items were reported accurately by the taxpayers.3 See IRS's Publication 334, Tax Guide for Small Business, and Form 1099-MISC instructions.4 Other reportable items include other income payments, medical and health care payments, crop insurance proceeds, and gross proceeds to an attorney.5 The real estate agent is responsible for reporting payments of rent to the landlord. See Treasury Regulation 1.6041-3(d).6 Payments for merchandise, telegrams, telephone, freight, storage, and similar items are also not reported nor are payments to informers from government agencies about criminal activity.7 See GAO, Tax Administration: Issues in Classifying Workers as Employees or Independent Contractors, GAO/T-GGD-96-130 (Washington, D.C.: June 20, 1996).8 Pub. L. No. 95-600, November 16, 1978.9 IRS NRP and Research officials cited various reasons why a higher percentage and number of sole proprietors misreported expenses compared to overall net income. For example, some taxpayers who misreported expenses were not counted as misreporting net income because of other income or expense adjustments made during the examinations that produced the correct net income amounts.10 The $36.9 billion estimate excludes returns with no understatement and is based on unadjusted NRP results. We are 95 percent confident that the actual estimate is between $34.7 billion and $39.0 billion.11 This tax calculation is difficult to do and requires assumptions to account for how tax changes on one part of the income tax return affect the rest of the tax return (including changes to other types of wage, business, or investment income as well as to itemized deductions, exemptions, and credits), and ultimately flow through to the final tax liability and tax rate to be used.12 We are 95 percent confident that the actual estimate is between 68 percent and 76 percent.13 We are 95 percent confident that the actual 90th percentile amount is between $124,720 and $134,263 and the cumulative amount is between $22.1 billion and $25.8 billion.14 IRS also has programs for addressing nonpayment and nonfiling types of noncompliance, as well as taxpayer service programs for encouraging all types of tax compliance. Because this report focuses on sole proprietor reporting noncompliance, references to "noncompliance" refer to misreporting unless otherwise noted.15 This percentage should not be confused with IRS's "examination coverage rate," which is merely the number of returns examined divided by the number of returns filed.16 For both AUR and Examination, amounts of recommended assessments should not be construed as amounts ultimately collected. For example, recommended assessments could be abated in appeals or the amounts may not be collectible.17 We have started work on a study that will more fully discuss taxpayer burdens in filing 1099-MISC forms.18 Payers filing 250 or more information returns must use FIRE or send IRS special cartridges with the data.19 AUR contacts do not always lead to a tax change. For example, from tax years 1999 through 2003, 26 percent of the NEC contacts did not lead to a tax change.20 We have started work on a study that will more fully discuss Schedule C expense reporting.21 AUR may refer suspicious cases to Examination, but IRS officials have told us that historically, that happens infrequently. IRS started a test in March 2007 on referring such suspicious cases to Examination for questionable NEC income and expenses.22 I.R.C. § 162(a).23 Because IRS officials said data for 2004 were not complete when we requested them, we used only data through 2003. It is possible that contacts and assessments related to NEC are somewhat higher, but IRS does not have the data to separate all contacts that included NEC as well as other types of misreporting. NEC figures used here only refer to those cases where 50 percent or more of the taxpayer's income was NEC or where the tax change was 80 percent or greater than the original tax reported.24 IRS Examination data treat a minority of Schedule C returns it receives as business returns. This section deals only with returns IRS has categorized as Schedule C business returns for Examination purposes and will be referred to as returns with an attached Schedule C.25 GAO, Tax Compliance: Opportunities Exist to Reduce the Tax Gap Using a Variety of Approaches, GAO-06-1000T (Washington, D.C.: July 26, 2006).26 IRS provided us examination data that did not differentiate between examinations of returns that have Schedule C forms attached and those that actually audited Schedule C issues. For example, a real estate agent filing a Schedule C may also own rental real estate and file a Schedule E. IRS may audit the real estate losses reported on the Schedule E, but nothing on the Schedule C. Therefore, IRS's data may overstate the number and amount of time that IRS spends auditing Schedule C returns.27 Son of Boss was an abusive transaction aggressively marketed in the late 1990s and 2000 primarily to wealthy individuals. IRS's settlement initiative regarding Son of Boss required taxpayers to concede 100 percent of the claimed tax losses and pay a penalty of either 10 percent or 20 percent unless they previously disclosed the transactions to IRS. We did not verify whether examinations were more efficient in 2005 and 2006.28 The negligence penalties discussed in this section refer to those in I.R.C. § 6662(b)(1).29 We used a statistical model to assess whether various factors are related to the recommended assessment of penalties. Controlling for other factors, we found that the dollar value of the tax change and the percentage tax change are related to the recommendation to assess a penalty. The relationship raises questions because the guidance about assessing penalties does not provide a basis for considering the percentage error or the dollar amount of the error, above a threshold, when deciding to assess a penalty. App. I describes the model we used, our analysis of the penalty-related data, and results.30 GAO, Tax Compliance: Multiple Approaches Are Needed to Reduce the Tax Gap, GAO-07-488T (Washington, D.C.: Feb. 16, 2007).31 IRS is part Treasury, which is responsible for tax policy analysis and formulation.32 GAO, Tax Gap: Many Actions Taken, But a Cohesive Compliance Strategy Needed, GAO/GGD-94-123 (Washington, D.C.: May 11, 1994).33 GAO, Tax Administration: IRS Can Better Pursue Noncompliant Sole Proprietors, GAO/GGD-94-175 (Washington, D.C.: Aug. 2, 1994).34 GAO, Tax Compliance: Better Compliance Data and Long-term Goals Would Support a More Strategic IRS Approach to Reducing the Tax Gap, GAO-05-753 (Washington, D.C.: July 18, 2005).35 GAO, Internal Revenue Service: Assessment of the Interim Results of the 2006 Filing Season and Fiscal Year 2007 Budget Request, GAO-06-615T (Washington, D.C.: Apr. 6, 2006).36 GAO, Tax Compliance: Multiple Approaches Are Needed to Reduce the Tax Gap, GAO-07-391T (Washington, D.C.: Jan. 23, 2007).1 See section 511 of the Tax Increase Prevention and Reconciliation Act of 2005, Pub. L. No. 109-222, May 17, 2006.1 A taxpayer may, however, request and obtain a written determination from IRS regarding the status of a particular worker as an employee or independent contractor.2 Pub. L. No. 97-248, September 3, 1982.3 IRS has also developed three categories of evidence that may be relevant in determining whether a worker is a contractor or employee under the common-law test. The three categories are behavioral control, financial control, and type of relationship.4 For a list of the 20 factors and a discussion of their application, see GAO, Tax Administration: Approaches for Improving Independent Contractor Compliance, GAO/GGD-92-108 (Washington, D.C.: July 23, 1992).1 Backup withholding also applies when the payee fails to certify, under penalties of perjury, that the TIN provided is correct for interest, dividend, and broker and barter exchange accounts opened or instruments acquired after 1983.

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

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Tax Help: Reasonable cause - reliance on a tax attorny sufficient to abate a negligence penalty


Douglas A. Gibson v. Commissioner.Dkt. No. 13125-05 , TC Memo. 2007-224, August 13, 2007.[Appealable, barring stipulation to the contrary, to CA-9.
Pursuant to the decree, six factors are to be considered in determining the amount of compensation due to unnamed qualified claimants. Those six factors are: (1) The number of citations or threats received; (2) the degree of coercion expressed in the citation or threat or other communication from the county to the claimant; (3) whether the claimant left the dwelling in question because of the citation or threat; (4) the nature and degree of emotional distress suffered, including whether the claimant provided evidence of any physical symptoms of emotional distress, or other special circumstances which increased the emotional distress; (5) whether the claimant provided evidence of any increased costs resulting from the loss of housing, including, but not limited to, increased cost of alternative housing, wages and other income lost during the time spent looking for alternative housing, moving, storage or packing costs, temporary housing costs, any costs of commuting to and from work in excess of those that would have been incurred commuting to and from the denied housing; and (6) whether the claimant provided evidence of any other compensable loss.

Petitioner received $175,000 of the $350,000 awarded to him, his wife's estate, and his children. Petitioner engaged an experienced tax attorney who met with the class action attorneys to obtain all the pertinent facts and circumstances. After reviewing the information, the tax attorney advised petitioner to report $12,500 of the $175,000 as "other income" and to label it "damages" on petitioner's 2002 Form 1040, U.S. Individual Income Tax Return. Petitioner took his tax attorney's advice and reported on his 2002 return $12,500 of the $175,000 in damages he received.

In the notice of deficiency, respondent determined that the entire amount of the settlement was includable in petitioner's gross income. Additionally, respondent determined an accuracy-related penalty of $9,956 related to petitioner's failure to report $162,500 of the settlement proceeds.
OPINIONI. Deficiency
A. Burden of Proof
The Commissioner's determinations generally are presumed correct, and the taxpayer bears the burden of proving that those determinations are erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933); Durando v. United States , 70 F.3d 548, 550 (9th Cir. 1995). The U.S. Court of Appeals for the Ninth Circuit, to which an appeal of this case would lie, has held that in order for the presumption of correctness to attach to the notice of deficiency in unreported income cases,4 the Commissioner must establish "some evidentiary foundation" linking the taxpayer to the income-producing activity, Weimerskirch v. Commissioner, 596 F.2d 358, 361-362 (9th Cir. 1979), revg. 67 T.C. 672 (1977), or "demonstrating that the taxpayer received unreported income", Edwards v. Commissioner, 680 F.2d 1268, 1270 (9th Cir. 1982); see also Rapp v. Commissioner, 774 F.2d 932, 935 (9th Cir. 1985). Once there is evidence of actual receipt of funds by the taxpayer, the taxpayer has the burden of proving that all or part of those funds are not taxable. Tokarski v. Commissioner, 87 T.C. 74 (1986). Accordingly, petitioner bears the burden of proof.5 See Rule 142(a).

B. section 61(a), gross income includes all income from whatever source derived unless otherwise excluded by the Internal Revenue Code. See Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 429-431 (1955). Exclusions from gross income are construed narrowly. Commissioner v. Schleier, 515 U.S. 323, 327-328 (1995).
As relevant here, SEC. 104. COMPENSATION FOR INJURIES OR SICKNESS.
(a) In General. --Except in the case of amounts attributable to (and not in excess of) deductions allowed under 6
"Damages received" mean amounts received "through prosecution of a legal suit or action based upon tort or tort type rights, or through a settlement agreement entered into in lieu of such prosecution." section 104(a)(2), we look to the written terms of the settlement agreement to determine the origin and allocation of the settlement proceeds. See Metzger v. Commissioner, 88 T.C. 834 (1987), affd. without published opinion 845 F.2d 1013 (3d Cir. 1988); Jacobs v. Commissioner, T.C. Memo. 2000-59, affd. sub nom. Connelly v. Commissioner, 22 Fed. Appx. 967 (10th Cir. 2001).
Petitioner settled his claims against the county. The parties entered into a settlement agreement via a consent decree entered by the District Court. In that consent decree, the District Court granted petitioner declaratory, injunctive, and monetary relief. Petitioner received $175,000 of the $350,000 awarded to the Gibsons pursuant to the consent decree. The District Court did not allocate the proceeds among petitioner's claims.
If a settlement agreement lacks express language stating what the settlement amount was paid to settle, we look to the intent of the payor, on the basis of all the facts and circumstances of the case, including the complaint filed and details surrounding the litigation. United States v. Burke, 504 U.S. 229 (1992); Robinson v. Commissioner, 102 T.C. 116, 127 (1994) affd. in part and revd. in part on another issue 70 F.3d 34 (5th. Cir 1995); Knuckles v. Commissioner, T.C. Memo. 1964-33, affd. 349 F.2d 610 (10th Cir. 1965). A key question to ask is "'In lieu of what were the damages awarded?'" Robinson v. Commissioner, supra at 126 (quoting Raytheon Prod. Corp. v. Commissioner, 144 F.2d 110, 113 (1st Cir. 1944), affg. 1 T.C. 952 (1943). Accordingly, the Court must determine the intent of the payor upon the basis of the facts and circumstances including petitioner's complaint in the class action lawsuit.

Petitioner argues that the first amended complaint includes a cause of action and remedy for bodily injury and physical distress. Petitioner testified that he was verbally and physically harassed by other residents of Sun City. According to petitioner, this harassment and the stress of the lawsuit caused him to suffer numerous headaches, stomach aches, and breathing problems. Petitioner testified that he visited a doctor for both stomach aches and breathing problems.

Petitioner failed to show how the county or any of the individuals involved in the class action lawsuit caused his alleged personal physical injury or physical sickness. Additionally, petitioner failed to produce any documentary evidence from his alleged doctor visits. If a party fails to introduce evidence within that party's possession, we may presume in some circumstances that, if produced, the evidence would be unfavorable to that party. Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158, 1165 (1946), affd. 162 F.2d 513 (10th Cir. 1947). This is true where the party that does not produce the evidence has the burden of proof or the other party has established a prima facie case. Id. Furthermore, we have previously held that stomach problems and headaches such as those suffered by petitioner are symptoms of emotional distress. See Hawkins v. Commissioner, T.C. Memo. 2005-149 (explaining that emotional distress includes symptoms such as headaches and stomach disorders). Petitioner produced no receipts, prescriptions, or other evidence to corroborate his testimony of his alleged breathing problems. We are not required to, and do not, accept petitioner's self-serving testimony regarding his alleged personal physical injuries or physical sickness without corroborating evidence. See Geiger v. Commissioner, 440 F.2d 688, 689-690 (9th Cir. 1971), affg. per curiam T.C. Memo. 1969-159; Lerch v. Commissioner, T.C. Memo. 1987-295, affd. 877 F.2d 624 (7th Cir. 1989).
Petitioner argues that because the consent decree entered in the class action lawsuit provided payments for physical injuries and physical sickness, some share of petitioner's settlement proceeds consist of damages received on account of personal physical injury or physical sickness. Petitioner argues that because he was a named member of the certified plaintiff class, his claims are typical of the claims of the plaintiff class. Petitioner argues that since unnamed plaintiffs must satisfy one of the six factors set forth in the consent decree (discussed supra) to qualify for compensation, petitioner must also satisfy at least one of the six factors. Petitioner claims that the only factor he satisfies is "whether claimant provided evidence of any other compensable loss." Petitioner contends that this demonstrates that he sustained physical injury and physical sickness.

We reject this argument. The six factors referred to by petitioner are relevant to determining the amount of compensation due to unnamed claimants. Assuming arguendo that we accept petitioner's self-serving and uncorroborated testimony, it appears that petitioner qualified for at least three of the six factors cited, none of which consists of personal physical injuries or physical sickness.7 Additionally, factor six, for which petitioner claims he qualifies, refers to "any other compensable loss" and does not necessarily include personal physical injury and physical sickness.

Apart from petitioner's self-serving and uncorroborated testimony, the record does not establish that petitioner received a portion of his $175,000 total settlement proceeds on account of personal physical injury or physical sickness. Accordingly, we sustain respondent's determination that the settlement proceeds petitioner received in 2002 are includable in his gross income. See Geiger v. Commissioner, supra; Lerch v. Commissioner, supra.II. Accuracy-Related Penalty

A. section 6662(a) of $9,956. Respondent determined that the entire underpayment of tax for 2002 was attributable to negligence or disregard of rules or regulations, and/or a substantial understatement of income tax.

Pursuant to Sec. 6662(b). The term "understatement" means the excess of the amount of tax required to be shown on a return over the amount of tax imposed which is shown on the return, reduced by any rebate (within the meaning of Sec. 6662(d)(2)(A). Generally, an understatement is a "substantial understatement" when the understatement exceeds the greater of $5,000 or 10 percent of the amount of tax required to be shown on the return. section 6662(b)(1) includes any failure to make a reasonable attempt to comply with the Internal Revenue Code and any failure to keep adequate books and records or to substantiate items properly. Sec. 6662(c).

B. Burden of Production

The Commissioner has the burden of production with respect to the accuracy-related penalty. sec. 1.6664-4(b)(1), Income Tax Regs.

C. Analysis

Respondent met his burden of production pursuant to sec. 6664(c)(1); Higbee v. Commissioner, supra at 446. Relevant factors include the taxpayer's efforts to assess his proper tax liability, including the taxpayer's reasonable and good faith reliance on the advice of a professional.

In reaching all of our holdings herein, we have considered all arguments made by the parties, and, to the extent not mentioned above, we conclude they are irrelevant or without merit.

To reflect the foregoing,
Decision will be entered under Rule 155.

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 Petitioner conceded that the Social Security benefits he received during 2002 are taxable.3 Petitioner's wife died in 2000, and her estate was substituted as a party in the class action lawsuit.4 Although Weimerskirch v. Commissioner, 596 F.2d 358 (9th Cir. 1979), revg. 67 T.C. 672 (1977), was an unreported income case regarding illegal source income, the U.S. Court of Appeals for the Ninth Circuit applies the Weimerskirch rule in all cases involving the receipt of unreported income. See Edwards v. Commissioner, 680 F.2d 1268, 1270-1271 (9th Cir. 1982); Petzoldt v. Commissioner, 92 T.C. 661, 689 (1989).5 For the first time, in the opening brief petitioner raises the issue of respondent's bearing the burden of proof pursuant to 6 7 Petitioner qualified for factor 1 because he received a citation. He qualified for factor 2 because the CCE authorities told the Gibsons they would have to move. Also, the citation threatened fines and imprisonment. Additionally, petitioner was served with a notice to appear in court to face possible criminal charges. He qualified for factor 4 because of the emotional distress he suffered.

Alvin S. Brown, Esq.

Tax attorney

703.425.1400

www.irstaxattorney.com

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Tax Attorney: Employee/subcontractor classification - the issues in the case discussed below are both legal and factual issues

All of the facts and circumstances indicated that the taxpayer's workers were employees and not independent contractors. The taxpayer was also not entitled relief under section 530 of the Revenue Act of 1978 (P.L. 95-600) because it treated all of the workers at issue as employees in the prior tax year. Finally, because the taxpayer continued to argue frivolous and groundless claims it was subject to a penalty under Code Sec. 6673.

Colorado Mufflers Unlimited, Inc. v. Commissioner, Dkt. No. 4083-04 , TC Memo. 2007-222, August 13, 2007.



[Code Secs. 3401 and 6673]


Misclassification of employee as independent contractor: Section 530 relief: Civil Penalties: Frivolous arguments. --

MEMORANDUM FINDINGS OF FACT AND OPINION



MARVEL, Judge: In a Notice of Determination of Worker Classification (notice of determination) under section 7436 respondent determined that nine workers were employees of petitioner during 2000 and 2001 and that petitioner was liable for Federal Insurance Contributions Act (FICA) taxes, income tax withholding, and Federal Unemployment Tax Act (FUTA) taxes, the section 6662 accuracy-related penalty, and the addition to tax under section 6651(a)(1) in the following amounts:





In his pretrial memorandum, respondent conceded that he has mistakenly applied both the section 6651(a)(1) addition to tax and the section 6662 accuracy-related penalty

Issues: whether the workers were employees of petitioner and (2) whether petitioner is entitled to relief under the Revenue Act of 1978, Pub. L. 95-600, sec. 530, 92 Stat. 2885, as amended (act section 530).





FINDINGS OF FACT


The deemed admissions establish the following:



! The nine workers listed in the notice of determination worked at petitioner's business location during the years in issue.



! Petitioner hired, supervised, and paid the workers for their services.



! Petitioner dictated when, where, and how the workers performed their services, and petitioner set their work hours.



! Petitioner controlled the amount of time each worker spent performing services.



! Each worker was employed full time by petitioner and was restricted from working for another employer.



! The workers provided services on petitioner's premises and used petitioner's tools, materials, and equipment.



! The success or continuation of petitioner's business depended upon the performance of the nine workers' services. ! The workers were regularly paid by the hour, week, or month; they were not paid by job or on commission, nor did they realize a profit or loss as a result of their services.



! Both petitioner and the workers had the right to terminate the relationship.



! Petitioner and the workers believed themselves to be entering into an employment relationship. They represented to others that an employment relationship existed.



We issued a notice setting case for trial to petitioner. The notice advised petitioner that a trial would be held during the Denver, Colorado, trial session of this Court beginning on April 17, 2006. Included with the notice was our standing pretrial order, which set forth in considerable detail the requirements imposed on each party for adequate trial preparation. Petitioner did not comply with the standing pretrial order in that petitioner did not cooperate with respondent in pretrial preparation, and petitioner did not exchange trial exhibits with respondent. Moreover, petitioner did not produce information and documents in response to respondent's discovery requests. However, petitioner did file a pretrial memorandum that was filled with arguments that can fairly be characterized as frivolous and groundless.





OPINION




I. Relief From Deemed Admissions


Generally, a fact that is deemed admitted under Rule 90 is conclusively established. Rule 90(f); see also Sarchapone v. Commissioner, T.C. Memo. 1983-446. Rule 90(f) provides, however, that the Court, on motion, may permit an admission to be withdrawn or modified if (1) the withdrawal or modification would subserve the presentation of the merits of the case, and (2) if the party obtaining the admission (respondent in this case) fails to satisfy the Court that the withdrawal or modification will prejudice him in prosecuting his case or defense on the merits. Petitioner did not move for relief from the deemed admissions at any time before or during trial. Petitioner requested relief from the deemed admissions for the first time in its posttrial brief.



Petitioner's agent, Dolores Rudd, who testified for petitioner at trial, attempted to explain petitioner's failure to file a timely response. The explanation was conclusory and unconvincing and did not establish the elements for relief required by Rule 90. Because we find that respondent reasonably relied upon the deemed admissions and that withdrawal of the deemed admissions would not foster presentation of the merits and would unfairly prejudice respondent, we shall deny petitioner's belated request for relief from the deemed admissions. See Dahlstrom v. Commissioner, 85 T.C. 812, 819 (1985); Morrison v. Commissioner, 81 T.C. 644, 649-650 (1983).




II. Classification of Petitioner's Workers


A. Burden of Proof



Ordinarily, the Commissioner's determination is presumed to be correct, and the taxpayer bears the burden of proving that the determination is erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). This principle applies to the Commissioner's determination that a taxpayer's workers are employees. Boles Trucking, Inc. v. United States, 77 F.3d 236, 239-240 (8th Cir. 1996); Allen v. Commissioner, T.C. Memo. 2005-118.



In certain circumstances, special statutory rules may apply to shift the burden of proof to the Commissioner. See, e.g., sec. 7491; act sec. 530(e)(4).11 However, petitioner does not contend that these provisions affect an allocation of the burden of proof in this case, and we conclude that they do not apply.



Petitioner does argue, however, that respondent's determinations are arbitrary and capricious and that, therefore, the burden of proof must shift to respondent.12 See United States v. Janis, 428 U.S. 433, 441-442 & n.8 (1976) (burden of proof shifts to Commissioner where determination lacks rational foundation). However, petitioner has failed to demonstrate that respondent acted arbitrarily in this case. Petitioner's behavior during the audit and the pretrial preparation of this case was characterized by a consistent lack of cooperation and by considerable obfuscation designed to prevent respondent from ascertaining the facts regarding petitioner's business, business payroll, and workers. It appears that petitioner used fictitious names and/or other companies to hide the nature and extent of its business activity from respondent during the years at issue. Respondent's determinations were necessarily based on the best information available, including information obtained from a visit to petitioner's business location, a review of petitioner's Forms W-2, 940, and 941 for prior taxable periods, an analysis of bank records of petitioner and others, and information obtained from at least one of petitioner's suppliers. We conclude, therefore, that respondent's determinations were not arbitrary or capricious, and the burden of proof remains with petitioner.



B. Employment Status



The employment tax sections of the Internal Revenue Code are in subtitle C. Under subtitle C, an employer is obligated to pay certain taxes imposed on employers and must also withhold from employees' wages certain taxes imposed on employees. Sections 3111 and 3301 impose the employer-level taxes under FICA and FUTA, respectively. Section 3101 imposes a FICA tax on employees, which section 3102 requires the employer to collect. Section 3402 requires an employer to withhold from employees' wages the employees' shares of Federal income tax and to deposit the amounts withheld with the Internal Revenue Service. An employer is liable for the amounts required to be withheld if the employer does not withhold as required. Sec. 3403.



For employment tax purposes, the term "employee" includes "any individual who, under the usual common law rules applicable in determining the employer-employee relationship,13 has the status of an employee". Sec. 3121(d)(2); accord sec. 3306(i). In applying the common law rules, uncertainty should be resolved in favor of employment. Breaux & Daigle, Inc. v. United States, 900 F.2d 49, 52 (5th Cir. 1990).



In evaluating whether an employment relationship exists between a business and one of its workers, the courts consider the following factors to decide whether a worker is a common law employee or an independent contractor: (1) The degree of control exercised by the principal; (2) which party invests in the work facilities used by the individual; (3) the opportunity of the individual for profit or loss; (4) whether the principal can discharge the individual; (5) whether the work is part of the principal's regular business; (6) the permanency of the relationship; and (7) the relationship the parties believed they were creating. Ewens & Miller, Inc. v. Commissioner, 117 T.C. 263, 270 (2001); Weber v. Commissioner, 103 T.C. 378, 387 (1994), affd. per curiam 60 F.3d 1104 (4th Cir. 1995). All of the facts and circumstances of each case are considered, and no single factor is dispositive. Ewens & Miller, Inc. v. Commissioner, supra at 270; Weber v. Commissioner, supra at 387. We consider the factors below.



1. Degree of Control



While no single factor is dispositive, the degree of control exercised by the principal over the details of the individual's work is one of the most important factors in determining whether a common law employment relationship exists. See, e.g., Clackamas Gastroenterology Associates, P.C. v. Wells, 538 U.S. 440, 448 (2003); Leavell v. Commissioner, 104 T.C. 140, 149 (1995). The degree of control necessary to find employee status varies with the types of services provided by the worker. Weber v. Commissioner, supra at 388. However, the control factor does not require a supervisor to stand over and direct every move made by the worker; it is sufficient if the supervisor has the right to do so. Id.; see sec. 31.3401(c)-1(b), Employment Tax Regs.



Deemed admissions confirm that petitioner exercised control over each of the nine workers. Petitioner directed when, where, and how each worker was to perform services. Petitioner controlled the manner in which the workers performed. Petitioner set each worker's work hours and controlled the amount of time each person worked.



This factor favors an employment relationship.



2. Investment in Facilities



The fact that a worker provides his or her own tools generally indicates independent contractor status. Breaux & Daigle, Inc. v. United States, supra at 53. Respondent determined that the workers provided services using petitioner's equipment. The deemed admissions establish that petitioner supplied the facility, equipment, and parts the workers used to perform their services.



This factor favors an employment relationship.



3. Opportunity for Profit or Loss



Respondent determined that petitioner paid the workers in cash every week. Although Ms. Rudd summarily disputed respondent's determination, she provided no credible evidence of petitioner's finances and expenditures for 2000 or 2001. In contrast, the deemed admissions establish that petitioner paid the individuals by the hour, week, or month for their services, that petitioner did not pay the workers by the job or on commission, and that the workers did not participate in the profit or loss resulting from their services.



This factor favors an employment relationship.



4. Right To Discharge



The deemed admissions establish that petitioner had the right to hire and fire each of the workers. Petitioner did not introduce any credible evidence to the contrary.



This factor favors an employment relationship.



5. Petitioner's Regular Business



Ms. Rudd testified that the services performed at petitioner's location during 2000 and 2001 were the same kind of services that petitioner offered in 1999. Petitioner's regular business in 1999 was the operation of a muffler shop. Petitioner hired workers to provide services as part of its regular business activity.14



This factor favors an employment relationship.



6. Permanency of the Relationship



The deemed admissions establish that the workers were employed full time during 2000 and 2001. In addition, the record establishes that at least some of the workers had performed services for petitioner and at petitioner's location in prior years.



This factor favors an employment relationship.



7. Relationship the Parties Believed They Were Creating



The deemed admissions establish that petitioner and the workers believed they had created an employment relationship and that petitioner and the workers consistently presented their relationship as an employment relationship.



This factor favors an employment relationship.



8. Conclusion



After reviewing the record and weighing the factors, we conclude that petitioner has failed to prove that respondent's determination treating the workers as petitioner's employees was in error.




III. Act Section 530 Relief


Act section 530 grants relief from the obligation to pay employment taxes to employers who incorrectly treat wage payments to employees as payments to independent contractors if certain requirements are met. Act section 530(a)(1) provides in relevant part:



(1) In general. --If --



(A) for purposes of employment taxes, the taxpayer did not treat an individual as an employee for any period * * *, and



(B) in the case of periods after December 31, 1978, all Federal tax returns (including information returns) required to be filed by the taxpayer with respect to such individual for such period are filed on a basis consistent with the taxpayer's treatment of such individual as not being an employee, then, for purposes of applying such taxes for such period with respect to the taxpayer, the individual shall be deemed not to be an employee unless the taxpayer had no reasonable basis for not treating such individual as an employee.



Act section 530(a)(3) limits the relief available under act section 530(a)(1) by providing that act section 530 relief is not available if the "taxpayer (or a predecessor)" treated any individual holding a "substantially similar position as an employee". An employer must satisfy all of the requirements of act section 530 to qualify for relief under that section. See Ewens & Miller, Inc. v. Commissioner, 117 T.C. 263 (2001).



Petitioner treated all of the workers as employees in 1999, and petitioner filed Forms W-2, 940, and 941 for 1999 consistent with its treatment of the workers as employees. Consequently, petitioner fails to satisfy all of the act section 530 requirements. Petitioner is not entitled to relief under act section 530.15




IV. Section 6673 Penalty


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 it appears that the taxpayer has instituted or maintained a proceeding primarily for delay or that the taxpayer's position is frivolous or groundless. Although respondent has not asked the Court to impose a penalty under section 6673(a)(1), the Court may sua sponte impose such a penalty against a taxpayer. See Pierson v. Commissioner, 115 T.C. 576, 580-581 (2000).



In its opening brief, petitioner argued that Forms 940, 941, and W-2 and Form W-4, Employee's Withholding Allowance Certificate, are invalid because they lack an Office of Management and Budget (OMB) number. Petitioner also listed multiple ways respondent's forms allegedly violated the Paperwork Reduction Act (PRA). Petitioner repeatedly failed to cooperate with respondent because respondent allegedly failed to prove a delegation of authority, and petitioner repeated the delegation of authority argument in its reply brief. Petitioner also argued that even if the workers in question were its employees, they received nontaxable income and not wages. Finally, petitioner questioned the validity of the notice of determination because it "did not contain any statutes telling the Petitioner what statutes created the duty that it must pay someone else's taxes."



The courts have consistently held all of these arguments to be frivolous and without merit. See James v. United States, 970 F.2d 750, 753 n.6 (10th Cir. 1992) (rejecting taxpayer's arguments regarding invalid OMB numbers and violations of PRA); Wilcox v. Commissioner, 848 F.2d 1007, 1008 (9th Cir. 1988) (rejecting taxpayer's arguments that wages are not income), affg. T.C. Memo. 1987-225; Wheeler v. Commissioner, T.C. Memo. 2006-109 (rejecting taxpayer's arguments regarding validity of notice of deficiency); Nunn v. Commissioner, T.C. Memo. 2002-250 (rejecting challenge to Internal Revenue Service jurisdiction over taxpayers and documents). We warned petitioner's agent on at least two occasions that if petitioner continued to raise frivolous arguments, we would impose a penalty under section 6673. After each warning, petitioner continued to assert its frivolous arguments. Accordingly, we award a penalty of $3,000 to the United States.



To reflect the foregoing,



The decision will be entered under Rule 155.


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

2 Petitioner does not directly address respondent's revised adjustments regarding the sec. 6662 accuracy-related penalty or the additions to tax under sec. 6651(a) in its briefs. Therefore, we will deem petitioner to have conceded these adjustments if we conclude that respondent's determination regarding the classification of the workers is sustained. See Rule 151(e)(4) and (5); Petzoldt v. Commissioner, 92 T.C. 661, 683 (1989).

3 During the trial, Ms. Rudd claimed that petitioner had been dissolved but offered no credible evidence to support her claim. In contrast, respondent's revenue agent Beth Nichols testified that petitioner advertised its business in the Yellow Pages during the periods at issue and during the audit and that petitioner was listed, and continues to be listed, in the phone book.

4 Petitioner filed Forms 941 for the periods ended Mar. 31 and June 30, 2000, on which it reported no wages and no tax liability.

5 Petitioner subsequently filed a refund claim for its 1999 employment taxes, which respondent ultimately denied.

6 In 2002, the United States instituted legal proceedings against petitioner for the return of the erroneous refund.

7 Respondent summoned bank records for accounts not in petitioner's name but in the names of entities traceable to petitioner and into which petitioner's receipts were deposited. Respondent traced activity in those accounts to petitioner's business location and attributed the activity to petitioner for tax purposes.

8 Petitioner does not dispute that business activity similar to petitioner's regular business activity in 1999 occurred at petitioner's business location in 2000 and 2001. Ms. Rudd testified that at least some of the same workers who performed services for Colorado Mufflers in 1999 performed similar services at petitioner's business location in 2000 and 2001.

9 Revenue Agent Nichols testified that in her experience, a pattern of periodically cashing large checks written to cash suggested a practice of paying workers in cash.

10 Petitioner mailed a document to this Court entitled "Petitioner's Reply to Respondent's First Requests for Admission", which we received on Apr. 6, 2006. The document had a certificate of service indicating that it had been sent to respondent's counsel more than a month after the deadline established under Rule 90(c). Consequently, the document was not filed.

11 Subsec. (e) was added to act sec. 530 by the Small Business Job Protection Act of 1996, Pub. L. 104-188, sec. 1122(a), 110 Stat. 1766.

12 Sec. 7491, which authorizes a shift in the burden of proof if certain requirements are met, applies only to taxes imposed by subtit. A or B and does not apply to employment taxes imposed by subtit. C.

13 Secs. 31.3121(d)-1(c)(2) and 31.3306(i)-1(b), Employment Tax Regs., define an employer-employee relationship as follows:

Generally such relationship exists when the person for whom services are performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work but also as to the details and means by which that result is accomplished. That is, an employee is subject to the will and control of the employer not only as to what shall be done but how it shall be done. In this connection, it is not necessary that the employer actually direct or control the manner in which the services are performed; it is sufficient if he has the right to do so. The right to discharge is also an important factor indicating that the person possessing that right is an employer. Other factors characteristic of an employer, but not necessarily present in every case, are the furnishing of tools and the furnishing of a place of work, to the individual who performs the services. In general, if an individual is subject to the control or direction of another merely as to the result to be accomplished by the work and not as to the means and methods for accomplishing the result, he is an independent contractor. * * *

See also sec. 31.3401(c)-1(b), Employment Tax Regs. (using virtually identical language).

14 Ms. Rudd admitted that at least some of the workers provided services during 2000 and 2001.

15 Petitioner argues that respondent failed to provide notice of act sec. 530 to it as required by act sec. 530(e)(1). Because in any event petitioner did not satisfy the act sec. 530 requirements before the examination, it was not prejudiced by any lack of notice. See Nu-Look Design, Inc. v. Commissioner, 356 F.3d 290, 295 (3d Cir. 2004), affg. T.C. Memo. 2003-52. Moreover, petitioner was informed of act sec. 530 in the notice of determination of worker classification. See id. (relief under due process clause not warranted where notice of determination of worker classification advised taxpayer of safe harbor provisions of act sec. 530 and procedure for challenging determination



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

To provide IRS "transparency" - upload your IRS experiences at http://www.irsforum.org/


In another case on this topic, the control test was applied to find that the person was an "independent contractor."

Uriah Vincent Jones v. Commissioner.

Dkt. No. 18719-05 , TC Memo. 2007-249, August 27, 2007.



[Code Sec. 3401]
Withholding: FICA: Independent contractor. --
An individual hired to do tiling work in a condominium renovation was an independent contractor, not an employee, and was, therefore, liable for the self-employment tax. The taxpayer was hired to perform tile work on the condominium for a fixed price. The party paying for the renovation supplied only the tile itself, while the taxpayer supplied his own tools and the materials necessary for the work (glue, grout, etc.) and, if the cost of materials exceeded the payment the taxpayer received, he would lose money. After the party renovating the condominium and the taxpayer had a dispute about his work hours, a set work schedule was established. The party performing the renovation indicated that he would not hire the taxpayer for any additional projects, and did not withhold FICA taxes from his payments to the taxpayer and the taxpayer never filled out a Form W-4. The taxpayer's degree of control over his own work, the fact that he provided his own tools and materials, his risk of loss on the project, the fact that he could not be discharged from the job, the lack of permanency in the relationship and the lack of intent to form an employer-employee relationship were consistent with independent contractor status. Only the fact that the taxpayer's work was integral to the renovation of the condominium indicated an employer-employee relationship.





Uriah Vincent Jones, pro se; Ladd C. Brown, Jr., for respondent.





MEMORANDUM FINDINGS OF FACT AND OPINION



VASQUEZ, Judge: Respondent determined a deficiency of $2,274 in petitioner's Federal income tax for 2003. After concessions by petitioner, the issue for decision is whether petitioner is liable for self-employment tax. This turns on whether petitioner was an employee or independent contractor of DBMA Corporation (DBMA) during 2003.





FINDINGS OF FACT



Some facts are stipulated and are so found. The stipulated facts and the exhibits submitted therewith are incorporated herein by this reference. At the time he filed the petition, petitioner resided in Palm Beach Gardens, Florida.



From August through December 2003, petitioner, a marble and tile installer, worked on a condominium renovation for DBMA. Barry Shapiro (Mr. Shapiro), president of DBMA, hired petitioner to work on the condominium renovation.



Petitioner submitted a series of proposals to Mr. Shapiro describing the work petitioner was to perform on the condominium renovation. Mr. Shapiro contracted petitioner to perform the tile work on the condominium renovation. In August 2003, petitioner began work by honing the floors and showers of the condominium and taking other preparatory steps in order to complete his work. From August through December 2003, petitioner worked a total of approximately 16 days on the condominium renovation.



DBMA paid petitioner a fixed sum for his work on the condominium renovation. If petitioner needed any additional assistants, petitioner was responsible for hiring, paying, and supervising them.



While working on the condominium renovation, petitioner provided his own work tools. In addition to work tools, petitioner also supplied grout, cork, cork glue, and soundproofing materials. Mr. Shapiro supplied the tile. DBMA did not reimburse petitioner for the supplies he purchased because these amounts were incorporated into petitioner's proposal.



Initially, petitioner set his own hours of work on the condominium renovation. A dispute arose between petitioner and Mr. Shapiro regarding the hours petitioner worked. After this dispute, petitioner agreed to maintain a fixed work schedule of 10:30 a.m. to 4:30 p.m. when working on the condominium renovation.



DBMA paid petitioner $8,360 for his work on the condominium renovation. At no point did petitioner ever sign or submit a Form W-4, Employee's Withholding Allowance Certificate (Form W-4). After petitioner completed work on the condominium renovation, Mr. Shapiro did not engage the services of petitioner on other jobs. In 2003, petitioner worked for three other companies that treated him as an employee, and all three companies issued him Forms W-2, Wage and Tax Statement (Forms W-2), as opposed to Forms 1099-MISC, Miscellaneous Income (Forms 1099-MISC).



Petitioner timely filed a Form 1040EZ, Income Tax Return for Single and Joint Filers With No Dependents, for 2003. Petitioner conceded that he did not report the income he received from DBMA on his 2003 tax return. After filing his 2003 income tax return, petitioner received a Form 1099-MISC, from DBMA. Petitioner did not amend his 2003 tax return after receiving the Form 1099-MISC.



Respondent timely mailed a notice of deficiency to petitioner with respect to taxable year 2003, and petitioner timely petitioned the Court.





OPINION



The burden of proof is on petitioner to show that respondent's determination set forth in the notice of deficiency is incorrect. Rule 142(a)(1);1 Welch v. Helvering, 290 U.S. 111, 115 (1933). Petitioner has neither claimed nor shown that he satisfied the requirements of section 7491(a) to shift the burden of proof to respondent with regard to any factual issue. Accordingly, petitioner bears the burden of proof. Rule 142(a).



The Federal Insurance Contributions Act (FICA), secs. 3101-3125, 68A Stat. 415 (1954), taxes a portion of the wages paid to an employee (FICA tax). The portion of the wages taxed is defined in section 3121(a). Under FICA, the employer and the employee each pay a like amount of tax. See secs. 3101, 3111. The employer withholds the employee's half of the FICA tax and remits it, along with the employer's half, to the Department of the Treasury. See sec. 3102. The FICA tax has two components, the old age, survivors, and disability insurance portion (OASDI) and the hospital insurance portion. For the year in issue, the OASDI rate was 6.2 percent for both the employer and employee, a total of 12.4 percent. The hospital insurance portion was 1.45 percent for both the employer and the employee, a total of 2.9 percent. The combined rate of the FICA tax was 15.3 percent for 2003. DBMA did not withhold any FICA tax because it treated petitioner as an independent contractor.



Independent contractors are not subject to the FICA tax; however, they are subject to a tax under chapter 2 of the Code, the Self-Employment Contributions Act of 1954 (SECA), secs. 1401-1403. See secs. 1401 and 1402. The SECA tax is a different tax from the FICA tax, though the SECA tax contains the same two components as the FICA tax. The SECA rate is equal to the sum of the employer and employee tax rates under FICA.



For the purposes of FICA, an employee is defined as: (1) any officer of a corporation; (2) any common law employee; (3) any individual in a specified occupation group who is not a common law employee; and (4) any individual who performs services that are included under an agreement entered into pursuant to the Social Security Act, 42 U.S.C. sec. 218 (2000). Sec. 3121(d).



A common law employee-employer relationship exists when:



the person for whom the services are performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work but also as to the details and means by which that result is accomplished. That is, an employee is subject to the will and control of the employer not only as to what shall be done but how it shall be done. In this connection, it is not necessary that the employer actually direct or control the manner in which services are performed; it is sufficient if he has the right to do so. The right to discharge is also an important factor indicating that the person possessing that right is an employer. Other factors characteristic of an employer, but not necessarily present in every case, are the furnishing of tools and the furnishing of a place to work, to the individual who performs the services. In general, if an individual is subject to the control or direction of another merely as to the result to be accomplished by the work and not as to the means and methods for accomplishing the result, he is an independent contractor. * * * [Sec. 31.3121(d)-1(c)(2), Employment Tax Regs.]



Petitioner contends that he was a common law employee of DBMA. We consider the following factors to decide whether a worker is a common law employee or an independent contractor: (1) The degree of control exercised by the principal; (2) which party invests in work facilities used by the individual; (3) the opportunity of the individual for profit or loss; (4) whether the principal can discharge the individual; (5) whether the work is part of the principal's regular business; (6) the permanency of the relationship; and (7) the relationship the parties believed they were creating. Weber v. Commissioner, 103 T.C. 378, 387 (1994), affd. per curiam 60 F.3d 1104 (4th Cir. 1995). All the facts and circumstances of each case are considered, and no single factor is dispositive. Id.



1. Degree of Control



The degree of control necessary to find employee status varies with the nature of the services provided by the worker. Id. at 388. To retain the requisite control over the details of an individual's work, the principal need not stand over the individual and direct every move made by the individual; it is sufficient if he has the right to do so. Id. ; see sec. 31.3401(c)-1(b), Employment Tax Regs.



Similarly, the employer need not set the employee's hours or supervise every detail of the work environment to control the employee. Gen. Inv. Corp. v. United States , 823 F.2d 337, 342 (9th Cir. 1987). The fact that workers set their own hours does not necessarily make them independent contractors. Id.



As the project manager, Mr. Shapiro did have some control over petitioner. For instance, after a dispute regarding the hours petitioner kept, Mr. Shapiro and petitioner agreed that petitioner would maintain a fixed work schedule. Despite this, petitioner was free to complete by the means and methods of his choice, the work he was contracted to do. Petitioner advised Mr. Shapiro that the floor in the laundry room needed to be resloped. Additionally, petitioner completed work offsite at his home workshop after advising Mr. Shapiro as to the best means and method to complete the project.



Based on the record before us, petitioner's degree of control over his own work on the condominium renovation is consistent with independent contractor status.



2. Investment in Facilities



The fact that a worker provides his or her own tools generally indicates independent contractor status. Breaux & Daigle, Inc. v. United States , 900 F.2d 49, 53 (5th Cir. 1990).



Petitioner provided his own tools. Furthermore, other than the tile, petitioner supplied most of the supplies he used such as grout, soundproofing materials, cork, and cork glue. Additionally, petitioner was not reimbursed for the materials that he provided. These amounts were included in the proposals that petitioner provided.



Based on the record before us, this factor is consistent with independent contractor status.



3. Opportunity for Profit or Loss



As noted supra, petitioner sent proposals to Mr. Shapiro regarding the work to be done on the condominium renovation. DBMA paid petitioner a fixed sum regardless of the time spent on the job. If petitioner underestimated the cost of the supplies needed or the time it took to complete the job, petitioner bore the risk of losing money, not Mr. Shapiro. Furthermore, if assistants were needed, it was petitioner's sole responsibility to hire and pay them. Additionally, petitioner bore the risk of loss on any loss or damage to his work tools.



Based on the record before us, petitioner's opportunity for profit or loss on his work on the condominium renovation is consistent with independent contractor status.



4. Right To Discharge



Petitioner was never fired by Mr. Shapiro, but Mr. Shapiro chose not to engage petitioner on any future projects. It appears that as long as petitioner's work was quality work that met the job specifications, petitioner could not have been dismissed from his duties on the condominium renovation. Petitioner phoned Mr. Shapiro approximately 3 weeks after petitioner completed work on the condominium renovation. At that time, only after petitioner had finished his duties on the condominium renovation, Mr. Shapiro notified petitioner that he did not wish to work with petitioner on any other projects.



Based on the record before us, the fact that petitioner could not be discharged as long as his work met the specifications is consistent with independent contractor status.



5. Integral Part of Business



As the project manager on the condominium renovation, Mr. Shapiro's responsibilities included making sure that the work was completed. The condominium renovation required tile work. Accordingly petitioner's job was an integral part of DBMA's work.



Based on the record before us, the integral nature of petitioner's work could suggest employee status. This, however, is but one factor that must be weighed among the others.



6. Permanency of the Relationship



A transitory work relationship may point toward independent contractor status. Herman v. Express Sixty-Minutes Delivery Serv ., Inc., 161 F.3d 299, 305 (5th Cir. 1998). If, however, the worker works in the course of the employer's trade or business, the fact that he does not work regularly is not necessarily significant. Avis Rent A Car Sys., Inc. v. United States, 503 F.2d 423, 430 (2d Cir. 1974) (transients may be employees); Kelly v. Commissioner, T.C. Memo. 1999-140 (working for a number of employers during a tax year does not necessitate treatment as an independent contractor). In considering the permanency of the relationship, we must also consider the principal's right to discharge the worker and the worker's right to quit at any time.



DBMA contracted petitioner to work on the condominium renovation and paid petitioner for the job he performed, regardless of the amount of time petitioner spent on the work. Petitioner worked for approximately 16 days, from August through December 2003, on the condominium renovation and received 14 checks from DBMA for his work. Although petitioner stated that DBMA promised him more work, whether or not the relationship continued was within the discretion of Mr. Shapiro. Once DBMA completed the condominium renovation, the relationship between petitioner and DBMA ceased.



Before petitioner began the condominium renovation, he was an employee of Koeckritz Enterprises, Inc. (Koeckritz). Prior to working for Koeckritz, in 2003 petitioner also worked for Celtic Marble & Tile, Inc., and Selective HR Solutions V, Inc. During 2003, petitioner received a total of three Forms W-2 from the three employers. This, however, does not require us to conclude that petitioner worked for DBMA as an employee.



Based on the record before us, petitioner's lack of a permanent relationship with DBMA is consistent with independent contractor status.



7. Relationship the Parties Thought They Created



Petitioner has worked on tile and marble installation for dozens of companies and stated that he always has been treated as an employee by those other companies. Mr. Shapiro stated that DBMA never had any employees and always has treated the individuals who worked for DBMA as independent contractors and issued them Forms 1099-MISC. Although the parties thought they were creating different relationships, we note that petitioner did not submit a Form W-4 to DBMA as he submitted to his three employers. The record does not indicate that petitioner requested or inquired about a Form W-4 from DBMA.



Based on the record before us, the facts are consistent with independent contractor status.



8. Conclusion



In the matter before us, although one factor might indicate an employer-employee relationship, the vast majority suggest that petitioner was an independent contractor of DBMA. Having weighed the evidence and considered the totality of the circumstances, we conclude that petitioner was an independent contractor of DBMA. As a result, he is responsible for self-employment tax for 2003.



In reaching our holding 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 Unless otherwise indicated, all Rule references are to the Tax Court Rules of Practice and Procedure, and all section references are to the Internal Revenue Code in effect for the year in issue.

Back Taxes: Badges of fraud discussed


The government failed to show by clear and convincing evidence that an individual was not entitled to a refund of interest because the case involved fraud. Evidence offered by the government of the individual's conduct, purported lack of credibility and alleged mischaracterization of transactions regarding his participation in a financial program to save tax was insufficient to prove fraud. The fact that the taxpayer was on notice that the IRS might challenge the tax losses he claimed as a result of his tax-saving financial program did not establish fraud. He had obtained a favorable legal opinion regarding the tax status of the program; therefore, his participation in the program only showed that he was willing to take risks.




Carlos E. Sala, and Tina Zanolini-Sala, Plaintiffs v. United States of America, Defendant.

U.S. District Court, Dist. Colo.; 05-cv-00636-LTB-GJR, May 1, 2007.

[ Code Sec. 6404]

Fraud. --





MEMORANDUM OPINION AND ORDER


BABCOCK, Chief District Judge: Plaintiffs Carlos E. Sala and Tina Zanolini Sala (referred to herein as "Sala," since Tina Sala is a named plaintiff only because the Salas filed a joint tax return) have filed a motion for summary judgment on their entitlement to a refund of a portion of the interest payments on taxes they paid, they believe excessively, on their year 2000 federal tax return, pursuant to 26 U.S.C. �6404(g). The Government asserts that Sala is not entitled to this refund because this is "a case involving fraud" under 26 U.S.C. �6404(g)(2)(B). Based on the discussion below, Sala's motion for summary judgment is GRANTED.



I. BACKGROUND


Sala had income in the year 2000 of over $60 million, but claimed tax losses that essentially nullified his tax burden. This spawned a yearslong dispute with the Internal Revenue Service ("IRS"), culminating in this litigation. Sala ultimately paid more in taxes, but is seeking a refund for both his taxes paid and interest he paid on taxes due. Sala believes the losses he claims are legitimate; the IRS believes they are not.

Sala obtained this reported tax loss through his participation in a financial program known as the Deerhurst transaction. While there is considerable factual dispute as to some of the mechanics of this transaction, according to its promotional materials, the Deerhurst transaction traded foreign currency options in an effort to make profits independent of the equity markets. Under its "diversified" investment strategy, Deerhurst held a fluctuating package of options, including short positions and long positions, some of which are longterm and some of which are shortterm. Andrew Krieger, Deerhurst's principle trader, actively traded the pooled accounts of about 30 individual investors as a single investment entity.

Investors, including Sala, initially entered the program with a comparatively modest investment of about $500,000 for a period of 3045 days. Investors initially invested at a leverage rate of 21, meaning that the account would be traded at twice the value of the cash investment. If they chose to proceed with the program, they would increase their investment and their leverage, thus increasing their risk of loss and potential for profit. Investors who chose to continue made a five year commitment, with penalties for early withdrawal

Investors who chose to stay with the program placed their funds in a limited liability company, to protect them from personal liability for any losses. These individual limited liability companies were then combined into Deerhurst Investors ("DI"), a general partnership, that was the overall entity holding the pooled accounts. At the end of the year, the funds were transferred back to the individual S corporations, the S corporations liquidated their holdings, and the funds were transferred to another Deerhurst general partnership for additional trading in the following calendar year.

The promoters of Deerhurst were explicit about the program's tax advantages. The brochure describing Deerhurst states that "Tax basis will be generated in the long options positions, but the short options should not be treated as 'liabilities'... creating tax basis in the excess of value at the time of the contribution." Moreover, if DI is liquidated, "the investor ordinarily would be expected to realize a tax loss equal to the difference between his tax basis and the fair market value of the portfolio." The brochure also states that an investor who remains with the program for a full five years can expect "A possible tax advantage and the opportunity, based on past trading results, to realize cumulative economic profits far in excess of any tax advantages."

In the late 1990s, Sala was Chief Financial Officer, as well as Secretary and Treasurer, for Abacus Direct, a database marketing firm. When the company was acquired by DoubleClick, Inc., in 1999, Sala received stock options in DoubleClick, which he sold in 2000 for about $60 million. Sala was seeking an appropriate vehicle for managing this substantial year 2000 income, one with both an investment and a tax loss component. Sala first heard about Deerhurst from his friend and former accountant at PriceWaterhouse, John Raby, who introduced him to Deerhurst promoter Michael Schwartz. Sala spent a great deal of time reviewing the underlying finances of Deerhurst. Krieger called Sala's questions about the risk and historic performance of the Deerhurst trading strategy "annoyingly thorough." Sala also consulted several attorneys about various legal aspects of Deerhurst. Ultimately, Sala determined that Deerhurst met his needs.

Sala entered into a test account with Deerhurst in October of 2000, investing $500,000. On November 21, 2000 he increased his investment by $8,425,000. From November 24 through November 28, 2000 a portion of these funds were used to acquire 24 long and short options on various foreign currencies. Sala paid $60,987,866.79 for the long options and received $60,289,568.94 million for the short options, with a net cost to him of $728,298. Krieger sold these options later in the year, for a profit of $91,010, according to the Government's expert, David DeRosa (or $111,599, according to Sala's expert, Robert Kolb.).

Sala initially acquired these options in his personal account, and then moved them into his solelyowned S corporation before transferring them to DI. According to an opinion letter provided to Sala by Michael Ruble, an attorney hired by Sala to evaluate the transaction ("the Ruble letter"), on December 21, 2000 Sala's account was distributed from DI back to his S corporation, in the original foreign currency. At this point, "Deerhurst then liquidated the positions into U.S. dollars to avoid any illiquidity and volatility issues typical of trades over the yearend." On December 29, 2000, the dollars were reinvested into a second Deerhurst fund, Deerhurst Trading Strategies LLC, another pooled investment entity treated as a partnership for U.S. federal income tax purposes. Sala then liquidated the S Corporation.

Sala reported these transactions on his 2000 federal income tax return. Sala contends that even though he made a modest profit on these trades, he legitimately claimed a $60 million tax loss because the long options increased his basis while the short options did not decrease his basis. For reasons neither party makes completely clear, Sala's tax loss is also dependent on the specific steps he took to structure this transaction, particularly his use of the S corporation in relationship to the partnerships and his liquidation of his holdings from the S corporation.

The role of the accounting firm KPMG in Sala's financial transactions is in dispute, and has implications for some of the broader issues at play in this case. KPMG is a defendant in an unrelated criminal case in the Southern District of New York, United States v. Stein, S1 05 CR. 888 (LAK) (S.D. N.Y. 2005). In Stein, the Government has indicted several accountants and lawyers, as well as KPMG, on numerous counts all associated with developing and promoting a series of fraudulent tax shelters. Sala acknowledges that KPMG Accountant Tracie Henderson prepared Sala's year 2000 tax return, and tried to market several investment opportunities to him. He states that he did not use any of these options, and that neither she nor anyone else at KPMG was involved in Deerhurst. The Government believes that Henderson and KPMG may have had a greater involvement in Deerhurst, and has moved separately to stay this case pending the resolution of Stein, to afford it the opportunity to depose Henderson and other Stein witnesses.

Sala filed his original income tax return for the year 2000 prior to April 15, 2001. On or about November 18, 2003 Sala filed an amended federal return, paying additional taxes and paying interest on the additional taxes accruing from the due date of the original return until 18 months from the due date of the return, (October 16, 2002). Although the IRS did not notify Sala prior to the filing of his amended return that he owed additional taxes, the IRS demanded the additional interest paid related to the time period from October 16, 2002 to November 18, 2003, amounting to over $1.5 million. Sala paid this amount.

On April 5, 2005 Sala filed a complaint in federal court for repayment of the taxes he claims he overpaid, and also repayment of the excess interest the IRS demanded. Sala filed this present motion for partial summary judgment on the narrow grounds that 26 U.S.C. �6404(g) limits the IRS to only collect interest on late payments of taxes accruing up to 18 months after the taxes were due, unless the IRS notifies the taxpayer of taxes due prior to the end of the 18 month period. The Government does not dispute that it failed to provide Sala the requisite notification, but contends that Sala's return falls into the exception to this law described in 26 U.S.C. �6404(g)(2)(B) as "a case involving fraud." So the dispute between Sala and the Government regarding the excess interest payment, the subject of this motion, reduces entirely to whether Sala's underlying claim for a tax refund is a case involving fraud.



II. STANDARD OF REVIEW


The purpose of a summary judgment motion is to assess whether trial is necessary. White v. York Int'l Corp., 45 F.3d 357, 360 (10 th Cir. 1995). I shall grant summary judgment if the pleadings, depositions, answers to interrogatories, admissions, or affidavits show there is no genuine issue of material fact and the moving party is entitled to judgment as a matter of law. Fed. R. Civ. P. 56(c). A fact is material if it might affect the outcome of the suit under the governing substantive law. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 255, 106 S. Ct. 2505, 91 L. Ed. 2d 202 (1986).

The nonmoving party has the burden of showing that there are issues of material fact to be determined. Celotex Corp. v. Catrett, 477 U.S. 317, 322, 106 S. Ct. 2548, 91 L. Ed. 2d 265 (1986). If a reasonable juror could not return a verdict for the nonmoving party, summary judgment is proper and there is no need for a trial. Id. at 323. However, I should not enter summary judgment if, viewing the evidence in a light most favorable to the nonmoving party and drawing all reasonable inferences in that party's favor, a reasonable jury could return a verdict for that party. Id. at 252; Mares at 494.

In a motion for summary judgment, I view the evidence "through the prism of the substantive evidentiary burden." Liberty Lobby, 477 U.S. at 254. The inquiry is based on "the quality and quantity of evidence required by the governing law" and "the criteria governing what evidence would enable the jury to find for either the plaintiff or the defendant." Id. Accordingly, in a case where the underlying evidentiary standard is clear and convincing evidence, the nonmoving party must show by clear and convincing evidence that there is no material fact in dispute to defeat a motion for summary judgment. Id. See also North Texas Prod. Credit Ass'n v. McCurtain County Nat'l Bank, 222 F.3d 800, 813 (10 th Cir. 2000).

The dispute underlying this motion is whether Sala's return is a "case involving fraud" under �6404(g). While no court has addressed fraud under this statute, it is well established that the Government must prove fraud in other parts of the tax code by clear and convincing evidence. Upshaw's Estate v. C.I.R [ 69-2 USTC �9637], 416 F.2d 737, 741 (7 th Cir. 1969); Hebrank v. C.I.R [ CCH Dec. 40,488], 81 T.C. 640, 642 (1983); Petzoldt v. C.I.R [ CCH Dec. 45,566], 92 T.C. 661, 699 (1989). I conclude that the Government's burden of proof under 6404(g) is also clear and convincing evidence. To defeat Sala's motion for summary judgment the Government must show that a reasonable jury could find clear and convincing evidence that Sala committed fraud.

Clear and convincing evidence is evidence that "could place in the ultimate factfinder an abiding conviction that the truth of its factual contentions are 'highly probable.'" Colorado v. New Mexico, 467 U.S. 310, 316, 104 S.Ct. 2433, 81 L.Ed.2d 247 (1984) (internal citations omitted.) It is evidence that "instantly tilt(s) the evidentiary scales in the affirmative when weighed against the evidence" offered by the moving party. Id. "Clear and convincing evidence leaves no substantial doubt in your mind. It is proof that establishes in your mind, not only [that] the proposition at issue is probable, but also that it is highly probable." In re Diviney, 211 B.R. 951, 961 (Bkrtcy. N.D. Okl. 1997) ( quoting 4 L. Sand, et al., Modern Federal Jury Instructions �73.01 at 7316 (1997)).



III. DISCUSSION


The Government argues that Sala's 2000 tax return is a case involving fraud in two steps - contending first that the transactions on which he based his claimed loss lack economic substance, and thus are not entitled to preferential tax treatment, and then making the more direct case for fraud. The Government asserts that Sala's transactions lacked substance because there was little risk or opportunity for profit in his investments, because the amount of his tax loss far exceeds the actual money he had at risk, and because the structure of his transactions, involving the S corporation, the Partnership and end of year liquidation - had no economic purpose other than generating a tax loss.

The Government's emphasis on absence of economic substance is curious, since the issue of economic substance goes to whether Sala is entitled to his claimed loss, not to the issue of fraud. The only issue presented in Sala's motion is the interest suspension issue, which in turn relates directly to fraud. It appears that the Government wishes me to make a legal conclusion on economic substance, when this is not before me. Accordingly, even though both parties address the issue of economic substance, I will not discuss it here, except to the extent it is necessary background to the Government's arguments on fraud.



A. Has the Government Presented Clear and Convincing Evidence that Sala's 2000 Tax Return was a Case Involving Fraud?

Finding fraud requires proof that the taxpayer "intended to evade taxes known to be owing by conduct intended to conceal, mislead or otherwise prevent the collection of taxes." Petzoldt [ CCH Dec. 45,566], 92 T.C. at 699 ( citing Stoltzfus v. U.S. [ 68-2 USTC �9499], 398 F.2d 1002, 1004 (3d Cir. 1968)). Fraud is "never imputed or presumed and the courts should not sustain findings of fraud upon circumstances which at the most create only suspicion." Davis v. C.I.R [ 50-2 USTC �9427], 184 F.2d 86, 87 (10 th Cir. 1950). Courts may find as evidence of fraud "any conduct, the likely effect of which would be to mislead or to conceal." Spies v. U.S. [ 43-1 USTC �9243], 317 U.S. 492, 499, 63 S.Ct. 364, 87 L.Ed. 418 (1943). Essential to the intent for fraud is "some element of concealment or deception." Zell v. C.I.R [ 85-2 USTC �9698], 763 F.2d 1139, 1144 (10 th Cir. 1985).

Since direct proof of a taxpayer's intent is rarely available, "fraud may be proved by circumstantial evidence and reasonable inferences drawn from the facts." Petzoldt [ CCH Dec. 45,566], 92 T.C. at 699. "The taxpayer's entire course of conduct may establish the requisite fraudulent intent." Id. Courts have established numerous indicia of fraud. These include: "(1) understatement of income (2) maintenance of inadequate records, (3) failure to file tax returns (4) implausible or inconsistent explanations of behavior, (5) concealment of assets, and (6) failure to cooperate with tax authorities." Id. at 700. Other indicia of fraud include "(1) the taxpayer's engaging in an illegal activity, (2) his attempt to conceal such activity, (3) his dealing in cash, and (4) his failing to make estimated tax payments. Id. "Although no single factor is necessarily sufficient to establish fraud, the combination of a number of factors constitutes persuasive evidence." Jondahl v. C.I.R [ CCH Dec. 55,964(M)], T.C.M. 200555 at *8, 2005 WL 675444 (2005). Additionally, while the Government's "mere refusal to believe" a taxpayer is insufficient to establish fraud, "the lack of credibility of the taxpayer's testimony, the inconsistencies in his testimony and his evasiveness on the stand are heavily weighted factors in considering the fraud issue." Toussaint v. C.I.R [ 84-2 USTC �9839], 743 F.2d 309, 312 (5 th Cir. 1984).

Under this framework, it is not enough to show that Sala's transactions lacked substance; the Government must show that Sala engaged in some act of concealment or misrepresentation. The Government could, for example, show that Sala entered into the Deerhurst transaction knowing it lacked substance, or that Sala filed a tax return he knew did not reflect the realities of his transactions. The Government could also show that Sala concealed information from the IRS or tried to mislead the Government during the course of its investigation.

Here, the Government's case for fraud is hampered by the absence of apparent indicia of concealment or misrepresentation. The Government does not allege that Sala has failed to file returns, that his record keeping is inadequate, that he has tried to conceal the nature of his transactions, that he has misstated information on his returns, or that he has failed to cooperate with the IRS. The Government does not offer any specific or direct evidence that Sala misrepresented or misreported the facts surrounding his economic activity.

Rather, the Government relies on inferences from Sala's conduct, Sala's purported lack of credibility and Sala's alleged mischaracterizations of his transactions as possessing substance. The Government offers as its indicia of fraud Sala's "implausible or inconsistent" explanations for his behavior, his "pattern of conduct" in seeking out Deerhurst and the "lack of credibility" in his statements and testimony. In this instance, the Government's evidence is insufficient to demonstrate concealment or deception and is therefore insufficient to show fraud.

The Government contends that Sala's side agreements with Deerhurst evince Sala's lack of a profit motive in pursuing Deerhurst. Sala negotiated with Deerhurst to increase Deerhurst's share of profits in exchange for lower management fees. Sala also arranged to be able to withdraw from Deerhurst without penalty if he did not receive a favorable tax analysis of the transaction. The facts of these agreements are not in dispute. The Government argues that if Sala were seeking to maximize his profits he would not have negotiated away profits in exchange for reduced fees; and his interest in an exit strategy confirms his principle interest in a tax shelter as opposed to an investment opportunity.

The Government's argument here appears to be not that these actions show that the transaction lacked substance, but that Sala's explanations for his behavior are not credible. Either way this argument is unpersuasive. The Government imputes a motive to these agreements that is little more than speculation. Sala may have wished to further reduce his risk of loss by lowering the fees. And, in fact, Sala had negotiated reduced fee agreements in other investments, not related to this case. Sala's interest in a favorable tax opinion before committing to the program is just as plausibly evidence of his intent to act legally as it is evidence of fraud. This is underscored by the fact that Bruce Nemirow, Sala's tax counsel, advised him to negotiate this kind of agreement. Moreover, neither of these side agreements is itself evidence of concealment or of misrepresentation. Even if the Government's theory is correct that these are indicia that Sala was not seriously interested in profits, this goes only to the substance of the transaction, not to fraud.

The Government also asserts that Sala's behavior during the test period is inconsistent with a legitimate quest for profits, and so casts doubts on his credibility. The Government avers that Sala increased his investment from $500,000 to over $8,000,000, without his customary intense scrutiny. Sala acquired the options in his own name and transferred them to an S corporation, a series of steps, the Government claims, with no economic purpose other than generating a tax loss, since by acquiring the options in his own name he lost any potential liability protection. The Government asserts that the incredibility of Sala's justifications for his actions is indicia of fraud. But the putative gap between Sala's explanation of his behavior and the Government's claim of Sala's actual behavior is marginal. Sala states he sought a tax advantage and an investment opportunity, while the Government asserts he sought only a tax advantage. The Government's expert witness, David DeRosa, acknowledged that there was some profit and profit potential to Sala's trades. DeRosa also testified that Krieger, Deerhurst's trader, always sought profits in his trades. While the degree of substance here may or may not be sufficient to justify Sala's tax claims, the mere fact that Sala sought a taxadvantaged investment program is not evidence of fraud. Also, while the Government has cast some doubt on the credibility of Sala's explanations for using the S corporation, this is not clear and convincing evidence of fraud.

The Government's other evidence of Sala's inconsistencies and implausible explanations is similarly unpersuasive. The Government contends that Sala stated in a deposition earlier in this case that he only received foreign currency back from his S corporation, but that his brokerage statement for his S corporation states that he received the funds in U.S. dollars. But the record is not as clear on this point as the Government suggests. Sala's declaration states that at the end of 2000 the S corporation received foreign currencies from the Deerhurst partnership, which it then converted to dollars and transferred to another Deerhurst pooled investment fund. The brokerage statement the Government cites states only that the S corporation received more than $9 million on December 29, 2000. It is silent on whether this transfer was in dollars, or was in foreign currency then converted to dollars. The DeRosa report documents that the Deerhurst partnership regularly transferred foreign currencies to the S corporation. In sum, the record is too vague to find an inconsistency or contradiction here. Also, it is unclear how this inconsistency, if it exists, is evidence of an effort to conceal or misrepresent a tax liability.

The Government also cites Sala's behavior in seeking out Deerhurst as evidence of intent to mislead, pointing in particular to Sala's actions in regard to IRS Notice 200044, "Tax Avoidance Using Artificially High Basis," I.R.S. Notice 200044, 20002 C.B. 255 (August 13, 2000), ("The Notice"). The Notice describes transactions where a taxpayer acquires long options and transfers them to a partnership, purporting to "create substantial positive basis" in the partnership. The taxpayer is able to claim a tax loss by claiming the positive basis from the long options, but not decreasing the basis through the short options. The Notice states that losses stated through these or similar transactions "are not allowable as deductions for federal income tax purposes." The Notice also states that transactions like these must be listed under IRC �6011(a) and must be registered with the IRS.

The Government argues that Sala entered into Deerhurst knowing it was covered by the Notice, and entered into Deerhurst knowing it would not be registered with the IRS in order to conceal his participation from the IRS. There is no question that Sala was aware of the Notice before participating in Deerhurst. Nemirow expressed concern that the Notice applied to Deerhurst. Sala also testified that Schwartz, Deerhurst's promoter, told Sala that the Notice did not apply to Deerhurst. From this, the Government asserts that "the only reasonable explanation" of Sala's actions is that he sought to conceal his actions from the IRS.

But this conclusion does not follow from these facts. Sala commissioned the Ruble letter, analyzing the Deerhurst transaction, in part to address the issues raised by the Notice. The letter concluded that "there is a greater than 50 percent likelihood that the tax treatment of the Transactions set forth herein will be upheld if challenged by the IRS." While the Ruble letter does not argue specifically that the Notice does not apply to Deerhurst, it does argue that the Notice is not legally binding, that the authorities it relies on when applied to Deerhurst would not compel a finding of a lack of economic substance, and that "it is more likely than not that the authorities cited in Notice 200044 will not provide a basis for denying the deduction of a loss sustained from the transaction."

The law is clear that a taxpayer may reasonably rely on the advice of counsel on issues of tax law. U.S. v. Boyle [ 85-1 USTC �13,602], 469 U.S. 241, 251, 105 S.Ct. 687, 83 L.Ed.2d 622 (1985). Sala commissioned the Ruble letter assessing the tax status of the Deerhurst transaction. Sala reviewed it carefully, and had other lawyers review it. These lawyers, including Nemirow, who initially expressed concerns about the legal status of Deerhurst, concluded that the Ruble letter was reasonable. Sala relied on this opinion, even to the extent of negotiating an exit option on his participation in Deerhurst contingent on receiving this kind of favorable legal letter. Sala also states that he understood the law at the time to allow the tax treatment of contingent liabilities in a partnership in a manner consistent with the way he handled his transactions here, relying on Helmer v. C.I.R [ CCH Dec. 33,225(M)], T.C.M. 1975160, 20002 C.B. 255 (May 27, 1975). If Sala believed in good faith that the tax treatment he claimed on the Deerhurst transaction was legal, the Government cannot show that Sala denied to the Government tax he knew he owed.

I note again that the issue of whether the Notice applies to Deerhurst, and whether the losses claimed by Sala in regard to Deerhurst are legitimate, is not before me. The Government proffers Sala's behavior in relation to the Notice as evidence of his lack of credibility and as evidence of his attempt to conceal his participation in Deerhurst from the IRS. I find this evidence unpersuasive. At most, the Government's evidence shows that Sala was on notice that the IRS might challenge the tax losses offered by Deerhurst but, armed with a favorable legal opinion, he chose to proceed anyway. This may be evidence that Sala was willing to incur some risks, but it does not show fraud.

The Government's attempts to undercut the Ruble letter are unavailing. The Government contends that the Ruble letter is unreliable because Sala did not disclose to Ruble several key facts about his transactions, such as his earlyout option, that participants were told to expect a tax loss in the year 2000, and that the Ruble letter profitability projections differed from Sala's. The Government also finds it significant that the Ruble letter did not address the fact that the structure of the transaction depended on whether participants were seeking capital or ordinary losses. However, the Government does not explain how any of these discrepancies (assuming for the purpose of this motion that they exist) would impact Ruble's conclusions. To be sure, reliance on the Ruble letter and on court decisions does not mean that Sala is entitled to the losses he claims, since technical compliance with the tax law does not render the underlying transactions substantive. See Bohrer v. C.I.R [ 91-2 USTC �50,462], 945 F.2d 344, 347 (10 th Cir. 1991). But it does show that Sala lacked the intent necessary for fraud.

The Government offers other instances of Sala's inconsistent or implausible statements, none of which are consequential or persuasive. For example, the Government contends that it is implausible that Sala did not tell his friend John Raby that he was seeking a tax shelter when Raby referred him to Michael Schwartz, who was at that time recruiting Deerhurst participants; that it is implausible that he was unaware of Deerhurst when he met with Schwartz in New York; that he testified he did not discuss tax shelters with Tracie Henderson of KPMG at their first meeting when Henderson's email states that they did; and that he did not discuss the Notice with Nemirow when Nemirow testified that they did. However, these are all minor inconsistencies that relate to meetings conducted years earlier. Also, these inconsistencies do not themselves evince an effort to conceal; the Government proffers them instead as evidence of Sala's lack of credibility. As such, they are not sufficient to create clear and convincing evidence of fraud.

The Government also refers to a letter from Joseph Barloon, KPMG's attorney, which the Government claims includes an admission that the Deerhurst transaction was fraudulent. Barloon refers to paragraph 20 of a deferred prosecution agreement in Stein (not provided in the record here), and describes it as encompassing "Those SOS transactions that KPMG tax professionals 'marketed and implemented' and those SOS transactions for which KPMG tax professionals 'prepared tax returns incorporating the 'bogus tax losses' of the SOS transactions. The Deerhurst transaction is an SOS transaction that resulted in claimed losses on a tax return prepared by KPMG. Accordingly, the Deerhurst transaction is within the scope of paragraph 20." Barloon never states that Deerhurst is fraudulent, and also states that KPMG has not interviewed the KPMG employees with specific knowledge of Deerhurst, that he has no independent knowledge of the relevant facts, and that KPMG's role in relation to Sala was to prepare his tax return. The information in the record before me is insufficient to conclude that KPMG has admitted that Deerhurst was fraudulent. Moreover any KPMG admission that Deerhurst was fraudulent does not show that Sala was aware that it was fraudulent. I note that the extent to which KPMG's involvement with Sala and Deerhurst implicates other issues in this case is at this time unresolved. I conclude here only that the evidence the Government has provided with this motion is insufficient to enable a reasonable fact finder to find fraud by clear and convincing evidence.

It is so Ordered that Plaintiff's motion for partial summary judgment on the interest suspension issue (Docket #5) is GRANTED.

DONE and ORDERED.


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

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Tax Help: IRS rules on a 1031 exchange


IRS Letter Ruling 200732012

LTR Report Number 1589, August 13, 2007 IRS REF: Symbol: CC:ITA:B04-PLR-152456-06 [Code Sec. 1031]

May 11, 2007

This responds to your request for a private letter ruling dated November 1, 2006. Your request concerns the qualification of a transaction as a like-kind exchange under � 1031(a) of the Internal Revenue Code.



FACTS:


LLC1 is a State A limited liability company, 100 percent owned by LLC2, a State A limited liability company, which itself is 100 percent owned by Taxpayer, a State A limited liability company. Taxpayer has two members and is treated as a partnership for Federal income tax purposes. LLC1 and LLC2 are both disregarded as entities separate from Taxpayer, their owner, under � 301.7701-3(b)(ii) of the Income Tax Regulations. LLC 1 owns an interest in hotel property in State B, which has been held for many years in its trade or business.

On Date 1, LLC1 entered into a contract that provides for the sale of the hotel property to an unrelated party. LLC1 will be entering into an exchange agreement with a qualified intermediary (QI) as defined in � 1.1031(k)-1(g)(4)1 to accomplish an exchange intended to qualify as a like-kind exchange under � 1031 of the Code. Consistent with � 1.1031(k)-1(g)(4)(v), all of LLC1's rights (but not its obligations) in the contract for the sale of the hotel property (Relinquished Property) will be assigned by LLC1 to the QI, with notice being given to the buyer. Thereafter, LLC1 will assign all of its rights, title and interest, as well as all of its obligations in the exchange agreement to LLC2. In turn, LLC2 will assign all of its rights, title and interest as well as all of its obligations in the exchange agreement to Taxpayer.

On or before the 45th day from the transfer of the Relinquished property, Taxpayer will designate like-kind replacement property or properties (Replacement Property), and consistent with � 1.1031(k)-1(g)(4)(v), all of its rights (but not its obligations) in all contracts to acquire Replacement Property will be assigned to the QI, with notice being given to the seller. On or before the 180th day from the transfer of the Relinquished Property, the Replacement Property (or properties) will be acquired by a newly created single member limited liability company (or companies), LLC3, which will be 100 percent owned by Taxpayer and disregarded as an entity separate from Taxpayer under � 301.7701-3(b)(ii).

Under these facts, Taxpayer requests a ruling that the actions of LLC1 and LLC2 are attributable to Taxpayer and that the acquisition of the replacement property by LLC3 is treated as an acquisition by Taxpayer for purposes of � 1031.



LAW AND ANALYSIS:


Section 1031(a)(1) of the Code provides that no gain or loss will be recognized on the exchange of property held for productive use in a trade or business or for investment if the property is exchanged solely for property of a like kind which is to be held either for productive use in a trade or business or for investment. Under � 1.1031(a)-1(b) of the regulations, real property is usually considered to be of like kind to other real property, whether or not any of the real property involved is improved. However, under� 1031(a)(3), any property received by the taxpayer (the "replacement property") will be treated as if it is not of a like kind to the property transferred (the "relinquished property") if the replacement property (a) is not identified within 45 days of the taxpayer's transfer of the relinquished property, or (b) is received after the earlier of (i) 180 days after the taxpayer's transfer, or (ii) the due date of the taxpayer's return for the year in which the taxpayer's transfer occurred.

Section 301.7701-2(c)(2) of the regulations provides that, in general, a business entity that has a single owner and is not a corporation (as defined in 301.7701-2(b)) is disregarded as an entity separate from its owner for federal tax purposes unless the entity elects to treat itself as an association for federal tax purposes. Based on Taxpayer's representations, because LLC1, LLC2 and LLC3 each will be disregarded as an entity separate from its owner for federal tax purposes, the assets of each wholly-owned LLC will be treated as assets of the Taxpayer.



CONCLUSION:


The actions of LLC1 and LLC2 are attributable to Taxpayer and the acquisition of replacement property by LLC3 is treated as an acquisition by Taxpayer for purposes of � 1031.



CAVEATS:


Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter. Specifically, we express no opinion whether the proposed transaction qualifies in all other respects for tax deferral under � 1031 beyond what is expressly stated in the above ruling. A copy of this letter ruling should be attached to the appropriate federal income tax returns for the taxable years in which the transactions described herein are consummated.

This letter ruling is directed only to the taxpayer who requested it. Section 6110(j)(3) of the Code provides that it may not be used or cited as precedent

In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to your authorized representative.

Sincerely, Michael J. Montemurro, Chief, Branch 4 (Income Tax & Accounting).

1 Section 1.1031(k)-1(g) of the regulations sets up four safe harbors, the use of which will prevent actual or constructive receipt of money or other property for purposes of � 1031. Paragraph (g)(4) provides that one of these safe harbors is the qualified intermediary. Paragraph (g)(4)(iii) defines a qualified intermediary as a person who (A) is not the taxpayer or a disqualified person, and (B) enters into a written agreement with the taxpayer (the exchange agreement) and as required by the exchange agreement, acquires the relinquished property from the taxpayer, transfers the relinquished property, acquires the replacement property and transfers the replacement property to the taxpayer.

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

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Tax Attorney: New regulations under IRC 6404 - suspension of penalties and interest



T.D. 9333 June 21, 2007
Code Sec. 6404(g)- reportable transactions

DEPARTMENT OF THE TREASURY



Internal Revenue Service

26 CFR Part 301

[ TD 9333]

RIN 1545-BG64

Application of Section 6404(g) of the Internal Revenue Code Suspension

Provisions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

SUMMARY: This document contains temporary regulations under section 6404(g)(2)(E) of the Internal Revenue Code on the suspension of any interest, penalty, addition to tax, or additional amount with respect to listed transactions or undisclosed reportable transactions. The temporary regulations reflect changes to the law made by the Internal Revenue Service Restructuring and Reform Act of 1998, the American Jobs Creation Act of 2004, the Gulf Opportunity Zone Act of 2005, and the Tax Relief and Health Care Act of 2006. The temporary regulations provide guidance to individual taxpayers who have participated in listed transactions or undisclosed reportable transactions. The text of the temporary regulations also serves as the text of the proposed regulations set forth in the notice of proposed rulemaking on this subject in the Proposed Rules section in this issue of the Federal Register.

DATES: Effective Date: These regulations are effective on June 21, 2007.

Applicability Date: These regulations apply to interest relating to listed transactions and undisclosed reportable transactions accruing before, on, or after October 3, 2004.

FOR FURTHER INFORMATION CONTACT: Stuart Spielman, (202) 622-7950 (not a toll-free call).

SUPPLEMENTARY INFORMATION:



Background

This document amends the Procedure and Administration Regulations (26 CFR part 301) by adding rules under section 6404(g) relating to the suspension of interest, penalties, additions to tax, or additional amounts with respect to listed transactions or undisclosed reportable transactions. Section 3305 of the Internal Revenue Service Restructuring and Reform Act of 1998, Public Law 105-206 (112 Stat. 685, 743) (RRA 98), added section 6404(g) to the Code, effective for taxable years ending after July 22, 1998. Section 6404(g) generally suspends interest and certain penalties if the IRS does not contact a taxpayer regarding possible adjustments to the taxpayer's liability within a specified period of time. Section 903(c) of the American Jobs Creation Act of 2004, Public Law 108-357 (118 Stat. 1418, 1652) (AJCA), excepted from the general interest suspension rules any interest, penalty, addition to tax, or additional amount with respect to a listed transaction or an undisclosed reportable transaction, effective for interest accruing after October 3, 2004. Section 303 of the Gulf Opportunity Zone Act of 2005, Public Law 109-135 (119 Stat. 2577, 2608-09) (GOZA), modified the effective date of the exception from the suspension rules for certain listed and reportable transactions. Section 426(b) of the Tax Relief and Health Care Act of 2006, Public Law 109-432 (120 Stat. 2922, 2975), provided a technical correction regarding the authority to exercise the "reasonably and in good faith" exception to the effective date rules. Section 8242 of the Small Business and Work Opportunity Tax Act of 2007, Public Law 110-28 (121 Stat. 112, 200), extended the current eighteen-month period within which the IRS can, without suspension of interest, contact a taxpayer regarding possible adjustments to the taxpayer's liability to thirty-six months, effective for notices provided after November 25, 2007.



Explanation of Provisions

If an individual taxpayer files a Federal income tax return on or before the due date for that return (including extensions), and if the IRS does not timely provide a notice to that taxpayer specifically stating the taxpayer's liability and the basis for that liability, then the IRS must suspend any interest, penalty, addition to tax, or additional amount with respect to any failure relating to the return that is computed by reference to the period of time the failure continues and that is properly allocable to the suspension period. A notice is timely if provided before the close of the eighteen-month period (thirty-six month period, in the case of notices provided after November 25, 2007) beginning on the later of the date on which the return is filed or the due date of the return without regard to extensions. The suspension period begins on the day after the close of the eighteen-month period (or thirty-six month period) and ends twenty-one days after the IRS provides the notice. This suspension rule applies separately with respect to each item or adjustment. If, on or after December 21, 2005, a taxpayer provides to the IRS an amended return or other signed written document showing an additional tax liability, then the eighteen-month period (or thirty-six month period) does not begin to run with respect to the items that gave rise to the additional tax liability until that return or other signed written document is provided to the IRS.

The general rule for suspension does not apply to any interest, penalty, addition to tax, or additional amount relating to any reportable transaction with respect to which the requirement of section 6664(d)(2)(A) is not met or a listed transaction as defined in section 6707A(c). This exception applies to interest accruing after October 3, 2004. With respect to interest relating to listed transactions or undisclosed reportable transactions accruing on or before October 3, 2004, the general rule for suspension applies only to (1) a participant in a settlement initiative, (2) a taxpayer acting reasonably and in good faith, or (3) a closed transaction. A participant in a settlement initiative is a taxpayer who, as of January 23, 2006, was participating in a settlement initiative described in IRS Announcement 2005-80, 2005-2 CB 967 (see §601.601(d)(2)(ii)(b)); or had entered into a settlement agreement under Announcement 2005-80 or any other prior or contemporaneous settlement initiative either formally published or directly communicated to taxpayers known to have participated in a tax shelter promotion. A taxpayer acting reasonably and in good faith is a taxpayer who the IRS determines has acted reasonably and in good faith, taking into account all the facts and circumstances surrounding a transaction. A transaction is a "closed transaction" if, as of December 14, 2005, the assessment of all federal income taxes for the taxable year in which the tax liability to which the interest relates is prevented by the operation of any law or rule of law. A transaction is also a closed transaction if a closing agreement under section 7121 has been entered into with respect to the tax liability arising in connection with the transaction.



Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. A regulatory assessment is therefore not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 USC chapter 5) does not apply to these regulations. For applicability of the Regulatory Flexibility Act (5 USC chapter 6), please refer to the cross-reference notice of proposed rulemaking published elsewhere in this issue of the Federal Register. Pursuant to section 7805(f) of the Internal Revenue Code, these regulations will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.



Drafting Information

The principal author of these regulations is Stuart Spielman of the Office of Associate Chief Counsel (Procedure and Administration).



List of Subjects in 26 CFR Part 301

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



Amendments to the Regulations

Accordingly, 26 CFR Part 301 is amended as follows:



PART 301 PROCEDURE AND ADMINISTRATION

Paragraph 1. The authority citation for part 301 continues to read in part as follows:

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

Par. 2. Section 301.6404-0T is added to read as follows:



§301.6404-0T Table of contents (temporary).

This section lists the paragraphs contained in §301.6404-4T.

§301.6404-4T Listed transactions and undisclosed reportable transactions (temporary).

(a) [Reserved].

(b)(1) through (b)(4) [Reserved].

(5) Listed transactions and undisclosed reportable transactions.

(i) In general.

(ii) Effective dates.

(iii) Special rule for certain listed or undisclosed reportable transactions.

(A) Participant in a settlement initiative.

(1) Participant in a settlement initiative who as of January 23, 2006, had not reached agreement with the IRS.

(2) Participant in a settlement initiative who, as of January 23, 2006, had reached agreement with the IRS.

(B) Taxpayer acting in good faith.

(1) In general.

(2) Presumption.

(3) Examples.

(C) Closed transactions.

Par. 3. Section 301.6404-4T is added to read as follows:



§301.6404-4T Listed transactions and undisclosed reportable transactions (temporary).

(a) [Reserved].

(b)(1) through (4) [Reserved].

(5) Listed transactions and undisclosed reportable transactions --(i) In general. The general rule of suspension under section 6404(g)(1) does not apply to any interest, penalty, addition to tax, or additional amount with respect to any listed transaction as defined in section 6707A(c) or any undisclosed reportable transaction. For purposes of this section, an undisclosed reportable transaction is a reportable transaction described in the regulations under section 6011 that is not adequately disclosed under those regulations and that is not a listed transaction. Whether a transaction is a listed transaction or an undisclosed reportable transaction is determined as of the date the IRS provides notice to the taxpayer regarding that transaction that specifically states the taxpayer's liability and the basis for that liability.

(ii) Effective/applicability dates. (A) These regulations apply to interest relating to listed transactions and undisclosed reportable transactions accruing before, on, or after October 3, 2004.

(B) The applicability of these regulations expires on or before June 21, 2010.

(iii) Special rule for certain listed or undisclosed reportable transactions. With respect to interest relating to listed transactions and undisclosed reportable transactions accruing on or before October 3, 2004, the exception to the general rule of interest suspension will not apply to a taxpayer who is a participant in a settlement initiative with respect to that transaction, to any transaction in which the taxpayer has acted reasonably and in good faith, or to a closed transaction. For purposes of this special rule, a "participant in a settlement initiative," a "taxpayer acting in good faith," and a "closed transaction" have the following meanings:

(A) Participant in a settlement initiative --(1) Participant in a settlement initiative who, as of January 23, 2006, had not reached agreement with the IRS. A participant in a settlement initiative includes a taxpayer who, as of January 23, 2006, was participating in a settlement initiative described in Internal Revenue Service Announcement 2005-80, 2005-2 CB 967. See §601.601(d)(2)(ii)(b) of this chapter. A taxpayer participates in the initiative by complying with Section 5 of the Announcement. A taxpayer is not a participant in a settlement initiative if, after January 23, 2006, the taxpayer withdraws from or terminates participation in the initiative, or the IRS determines that a settlement agreement will not be reached under the initiative within a reasonable period of time.

(2) Participant in a settlement initiative who, as of January 23, 2006, had reached agreement with the IRS. A participant in a settlement initiative is a taxpayer who, as of January 23, 2006, had entered into a settlement agreement under Announcement 2005-80 or any other prior or contemporaneous settlement initiative either offered through published guidance or, if the initiative was not formally published, direct contact with taxpayers known to have participated in a tax shelter promotion.

(B) Taxpayer acting in good faith --(1) In general. The IRS may suspend interest relating to a listed transaction or an undisclosed reportable transaction accruing on or before October 3, 2004, if the taxpayer has acted reasonably and in good faith. The IRS' determination of whether a taxpayer has acted reasonably and in good faith will take into account all the facts and circumstances surrounding the transaction. The facts and circumstances include, but are not limited to, whether the taxpayer disclosed the transaction and the taxpayer's course of conduct after being identified as participating in the transaction, including the taxpayer's response to opportunities afforded to the taxpayer to settle the transaction, and whether the taxpayer engaged in unreasonable delay at any stage of the matter.

(2) Presumption. If a taxpayer and the IRS promptly enter into a settlement agreement with respect to a transaction on terms proposed by the IRS or, in the event of atypical facts and circumstances, on terms more favorable to the taxpayer, and the taxpayer has complied with the terms of that agreement without unreasonable delay, the taxpayer will be presumed to have acted reasonably and in good faith except in rare and unusual circumstances. Rare and unusual circumstances must involve specific actions involving harm to tax administration. Even if a taxpayer does not qualify for the presumption described in this paragraph (b)(5)(iii)(B)(2), the taxpayer may still be granted interest suspension under the general facts and circumstances test set forth in paragraph (b)(5)(iii)(B)(1) of this section.

(3) Examples. The following examples illustrate the rules the IRS uses in determining whether a taxpayer has acted reasonably and in good faith.

Example 1. The taxpayer participated in a listed transaction. The IRS, in a letter sent directly to the taxpayer in July 2005, proposed a settlement of the transaction. The taxpayer informed the IRS of his interest in the settlement within the prescribed time period. The revenue agent assigned to the taxpayer's case was not able to calculate the taxpayer's liability under the settlement or tender a closing agreement to the taxpayer until March 2006. The taxpayer promptly executed the closing agreement and returned it to the IRS with a proposal for arrangements to pay the agreed-upon liability. The IRS agreed with the proposed arrangements for full payment. For purposes of the application of section 6404(g)(2)(E), the taxpayer has acted reasonably and in good faith. Interest accruing on or before October 3, 2004, relating to the transaction in which the taxpayer participated will be suspended.

Example 2. The facts are the same as in Example 1, except that the letter was sent by the IRS in February 2006, and the closing agreement was tendered to the taxpayer in April 2006. For purposes of the application of section 6404(g)(2)(E), the taxpayer has acted reasonably and in good faith. Interest accruing on or before October 3, 2004, relating to the transaction in which the taxpayer participated will be suspended.

Example 3. The taxpayer participated in a listed transaction. In response to an offer of settlement extended by the IRS in August 2005, the taxpayer informed the IRS of her interest in entering into a closing agreement on the terms proposed by the IRS. The revenue agent assigned to the transaction calculated the taxpayer's liability under the settlement and tendered a closing agreement to the taxpayer in November 2005. The taxpayer executed the closing agreement but failed to make any arrangement for payment of the agreed-upon liability stated in the closing agreement. Taking into account all the facts and circumstances surrounding the transaction, the taxpayer did not act reasonably and in good faith. Interest accruing on or before October 3, 2004, relating to the transaction in which the taxpayer participated will not be suspended.

Example 4. The taxpayer participated in a listed transaction. In a letter sent by the IRS directly to the taxpayer in July 2005, the IRS extended an offer of settlement. The July 2005 letter informed the taxpayer that, absent atypical facts and circumstances, the taxpayer should not expect resolution of the tax issues on more favorable terms than proposed in the letter. The taxpayer declined the proposed settlement terms of the letter and proceeded to Appeals to present what the taxpayer claimed were atypical facts and circumstances. The administrative file did not contain sufficient information bearing on atypical facts and circumstances, and the taxpayer failed to provide additional information when requested by Appeals to explain how the transaction originally proposed to the taxpayer differed in structure or types of tax benefits claimed, from the transaction as implemented by the taxpayer. Appeals determined that the taxpayer's facts and circumstances were not significantly different from those of other taxpayers who participated in that listed transaction and thus, were not atypical. In September 2006, the taxpayer and Appeals entered into a closing agreement on terms consistent with those originally proposed in the July 2005 letter. The taxpayer has complied with the terms of that closing agreement. For purposes of the application of section 6404(g)(2)(E), this taxpayer is not presumed to have acted reasonably and in good faith; instead, the IRS will apply the general rule to determine whether to suspend interest accruing on or before October 3, 2004, relating to the transaction in which the taxpayer participated.

Example 5. The facts are the same as in Example 4, except that Appeals agrees that atypical facts were present that warrant additional concessions by the government. A settlement is reached on terms more favorable to the taxpayer than those proposed in the July 2005 letter. For purposes of the application of section 6404(g)(2)(E), this taxpayer is presumed to have acted reasonably and in good faith, and absent evidence of rare or unusual circumstances harmful to tax administration, is eligible for suspension of interest accruing on or before October 3, 2004, relating to the transaction in which the taxpayer participated.

(C) Closed transactions. A transaction is considered closed for purposes of this clause if, as of December 14, 2005, the assessment of all federal income taxes for the taxable year in which the tax liability to which the interest relates is prevented by the operation of any law or rule of law, or a closing agreement under section 7121 has been entered into with respect to the tax liability arising in connection with the transaction.

(c) [Reserved].

Kevin M. Brown,

Deputy Commissioner for Services and Enforcement.

Approved: June 15, 2007.

Eric Solomon,

Assistant Secretary of the Treasury (Tax Policy).

Back Taxes: Withdrawn IRC 6330 due process request cannot be reinstated

Craig I. Smith v. Commissioner.Dkt. No. 4675-06L , TC Memo. 2007-221, August 9, 2007.

Appealable, barring stipulation to the contrary, to CA-6. -1 entitled petitioners to a section 6330 for both taxable years.2 We hereinafter refer to these March 2004 requests collectively as petitioners' first request for a 3 Thereafter, on April 2, 2004, respondent sent petitioners a letter in response to petitioners' first request for a 4 By signing the form, each petitioner acknowledged:

I've received a resolution with the Internal Revenue Service regarding the tax and tax period that my hearing request concerned and I'm satisfied that I no longer need a hearing with Appeals. Therefore, I withdraw my request for a Collection due Process (CDP) Hearing under * * * IRC Sections 6320 and IRC Section 6320 or 5 In addition, petitioners failed to make estimated tax payments relating to tax years after 2001 and 2002 as required by the terms of the installment agreement. Consequently, respondent terminated the agreement and demanded payment in full of petitioners' uncollected tax liabilities for 2001 and 2002. On December 13, 2004, respondent mailed petitioners a Notice CP 523, Notice of Intent to Levy --You Defaulted On Your Installment Agreement, for 2001. On the same day, respondent mailed a similar notice to petitioners for 2002. We hereinafter refer to these notices collectively as the second notice of levy. Each letter stated:

This is a formal notice of our intent to terminate your installment agreement 30 days from the date of this notice. You defaulted on your agreement because you didn't make your payments as agreed. The agreement states that we may terminate your agreement and collect the entire amount of your tax liability if you don't meet all the conditions. This is your notice, as required by Internal Revenue

Petitioners ignored the December 13, 2004, notices of intent to levy, believing the notices would be followed by other "final" notices of intent to levy before any levies would actually be executed. However, without further notice, in May of 2005 respondent levied on petitioners' bank account. Petitioners thereupon requested, by means of Form 12153,

6 a hearing for each year under section 6330 hearing. Respondent released the levy on petitioners' bank account on May 12, 2005.

Respondent determined that petitioners' second request for a

Discussion

Section 6331(d) provides that the levy authorized in Section 6330 elaborates on Sec. 6330(a)(3)(B) and (b)(1). A request for a collection hearing must be made within the 30-day period commencing on the day after the date of the Sec. 6330(a)(3)(B), (2); sec. 301.6330-1(b)(1), Proced. & Admin. Regs. section 6330 notice only once for the taxable period to which the unpaid tax relates. Once the Secretary issues a notice of intent to levy and notice of right to a section 6330 hearing. Sec. 301.6330-1(b)(2), Q&A-B2, Proced. & Admin. Regs.7

If a Sec. 6330(b)(1), (c)(1). The taxpayer is entitled to one hearing with respect to "the taxable period to which the unpaid tax specified in * * * [the levy notice] relates." Sec. 6330(c)(2)(A).
At the conclusion of the hearing, the Appeals officer must determine whether and how to proceed with collection and take into account: (i) The relevant issues raised by the taxpayer, (ii) challenges to the underlying tax liability by the taxpayer, where permitted, and (iii) whether any proposed collection action balances the need for the efficient collection of taxes with the legitimate concern of the taxpayer that the collection action be no more intrusive than necessary. section 6330(d)(1), within 30 days of the issuance of a notice of determination, the taxpayer may appeal the determination to this Court if we have jurisdiction over the underlying tax liability.

Section 301.6330-1(i)(1), Proced. & Admin. Regs., provides that where a taxpayer does not timely request a section 6330 hearing. Sec. 301.6330-1(i)(1), Proced. & Admin. Regs. The Appeals officer generally follows the same procedures at an equivalent hearing which he or she would have followed had the equivalent hearing been a section 6330 hearing may constitute a "determination" for purposes of Section 6159 authorizes the Secretary to enter into installment agreements and to terminate an installment agreement where the taxpayer fails to timely pay any installment when it is due or to pay any other tax liability when it is due. Sec. 6159(b)(5). The Secretary is required to establish procedures for an independent administrative review of termination of installment agreements for taxpayers who request such review. Sec. 6331(k)(2)(D); sec. 301.6331-4(a)(1), Proced. & Admin. Regs. However, where a taxpayer receives a Letter 1058, but does not timely request a hearing, a second notice of intent to levy sent after termination of an installment agreement does not entitle the taxpayer to a hearing under section 6330 hearing. There is no doubt that petitioners' second request for a 8

Petitioners' claim that this Court has jurisdiction centers on the continuing validity, in their view, of their first request for a section 6330 hearing only because they had obtained an installment agreement with respondent; once respondent had terminated the installment agreement (unjustifiably so, according to petitioners), petitioners' first request for a section 6330 hearing but were instead given an equivalent hearing, respondent's decision letter (issued as a consequence of the equivalent hearing) was a "determination" for purposes of section 6330 hearing), which respondent duly conducted. Thus, respondent asserts, the equivalent hearing gave rise to a decision letter, which is not a "determination" under section 6330 hearing constitutes an exception to the general rule requiring a hearing in response to a timely request. Such a hearing is, in turn, a prerequisite for the Secretary's issuance of a notice of determination. There is no statutory authority for the proposition that a withdrawn request for a section 6330 hearing) that would lead to that outcome. Indeed, in their withdrawal request, petitioners explicitly agreed to give up their right to seek judicial review of the notice of determination that would have been issued by the Appeals Office.9 Even though no section 6330 hearing is designed to accomplish, a payment alternative in the form of an installment agreement.
Because petitioners withdrew their request for a section 6330 hearing in Orum v. Commissioner, supra at 11.

While admitting that their November 2004 payment was not timely and that they failed to make estimated tax payments as required by the installment agreement, petitioners contend that respondent unjustifiably terminated the installment agreement. Petitioners do not allege that the termination of the installment agreement was the result of clerical error, misdirected mail, or the like. They do not dispute that they received the statutory notices to which they were entitled, were afforded an equivalent hearing in response to their second (untimely) request for a section 6330 hearing, and respondent was not required to issue a notice of determination. Respondent's decision letter was not a determination for purposes of 10

To reflect the foregoing,

An appropriate order of dismissal for lack of jurisdiction will be entered.1 Unless otherwise indicated, all section references are to the Internal Revenue Code as amended.2 The request for a sec. 6330 hearing for 2001 was made on Mar. 24, 2004. In the Mar. 24 request, petitioners requested that the hearings for both taxable years be consolidated.3 The installment agreement preceded petitioners' request for a sec. 6330 hearing for 2001 even though they had already entered into an installment agreement for 2001 "to preserve my hearing rights."4 The Apr. 6, 2004, Form 12256 pertained to 2002. Petitioners stipulated that they also executed a Form 12256 for 2001.5 Respondent received and recorded the November payment on Dec. 6, 2004. The record does not disclose any further payments made by petitioners.6 The Commissioner's Form 12153 instructs taxpayers to "Use this form to request a hearing with the IRS Office of Appeals only when you receive a Notice of Federal Tax Lien Filing & Your Right To A Hearing Under IRC 6320, a Final Notice --Notice Of Intent to Levy & Your Notice Of a Right To A Hearing, or a Notice of Jeopardy Levy and Right of Appeal." The parties treated petitioners' May 11, 2005, request for a hearing as a request for a 7 Sec. 301.6330-1(b)(2), Q&A-B2, Proced. & Admin. Regs., provides:Q-B2. Is the taxpayer entitled to a CDP hearing when the IRS, more than 30 days after issuance of a CDP Notice under section 6330, only the first pre-levy or post-levy CDP Notice with respect to the unpaid tax and tax periods entitles the taxpayer to request a CDP hearing. If the taxpayer does not timely request a CDP hearing with Appeals following that first notification, the taxpayer foregoes the right to a CDP hearing with Appeals and judicial review of Appeals' determination with respect to levies relating to that tax and tax period. The IRS generally provides additional notices or reminders (reminder notifications) to the taxpayer of its intent to levy when no collection action has occurred within 180 days of a proposed levy. Under such circumstances, a taxpayer may request an equivalent hearing as described in paragraph (i) of this section.8 Petitioners, expecting to receive yet another, "final", notice before collection by levy, ignored the second notice of intent to levy. They did so at their peril, because no further notice was in fact required for the Secretary to proceed with collection by levy. The Secretary is required to issue a sec. 6330 hearing. See Orum v. Commissioner, 123 T.C. 1, 11 (2004), affd. 412 F.3d 819 (7th Cir. 2005); sec. 301.6330-1(b)(2), Q&A-B4, Proced. & Admin. Regs.9 See Aguirre v. Commissioner, 117 T.C. 324 (2001), where we granted summary judgment against taxpayers who signed Form 4549, Income Tax Examination Changes, in which they waived the right to contest their tax liability in this Court and consented to the immediate assessment and collection of tax.10 In view of our holding that we lack jurisdiction, we need not address the issue of whether, as petitioners argued at trial and on brief, respondent abused his discretion in proceeding with collection by levy. However, for the sake of completeness, we note that we do not find petitioners' position persuasive.

Alvin S. Brown, Esq.

Tax attorney

703.425.1400

www.irstaxattorney.com

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Tax Help: Innocent Spouse Relief Granted

--A wife who filed joint individual income tax returns with her husband was not liable for deficiencies on those returns under the "innocent spouse" provisions of Code Sec. 6015. The wife had satisfied the requirements of Code Sec. 6015(b) and was, therefore, entitled to innocent spouse relief. The tax items giving rise to the deficiency were properly attributable to her husband, the taxpayer did not know or have reason to know of the understatement when she signed the returns for the years of the deficiencies, and it would have been inequitable to hold the taxpayer liable for the tax deficiencies under the facts and circumstances of the case.



Rhonda K. Juell, a.k.a. Rhonda K. Juell-Podlak, Petitioner, and Glenn M. Evans, Intervenor v. Commissioner., Dkt. No. 9631-06 , TC Memo. 2007-219, August 8, 2007.





MEMORANDUM FINDINGS OF FACT AND OPINION




The issue for decision is whether petitioner Rhonda Juell is entitled to relief from joint and several liability under section 6015(b), (c), or (f) with respect to the entire amount of each of the above tax deficiencies determined by respondent. Intervenor Glenn Evans (Glenn) objects to petitioner's right to any relief under section 6015.






OPINION



Generally, taxpayers filing joint Federal income tax returns are jointly and severally liable for all taxes due. Sec. 6013(d)(3). However, relief from joint liability may be available in circumstances described in section 6015(b), (c), and (f).



Petitioner claims that she is entitled to additional relief from joint liability under section 6015(b), (c), and (f), beyond the two-thirds relief already granted by respondent.



A taxpayer spouse who meets certain qualifications may elect relief under section 6015(b). Generally, to qualify for relief under section 6015(b)(1), the electing spouse must establish that:



(A) A joint return was filed;



(B) there is an understatement of tax on the return which is attributable to the erroneous items of the nonelecting spouse;



(C) in signing the return, the electing spouse did not know, and had no reason to know, that there was such an understatement;



(D) taking into account all the facts and circumstances, it is inequitable to hold the electing spouse liable for the deficiency in tax for the taxable year attributable to the understatement; and



(E) a timely election has been made.



Respondent does not dispute that petitioner meets the requirements of subparagraphs (A) and (E) of section 6015(b)(1), but respondent contends that petitioner has not satisfied the requirements of subparagraphs (B), (C), and (D).




Section 6015(b)(1)(B): Attributable to Nonelecting Spouse


When determining whether an erroneous item is attributable to a nonelecting spouse, we look not only to how ownership is nominally held between the spouses but also to each spouse's level of participation in the activity which gave rise to the erroneous item.



Joint ownership, by itself, is not determinative of whether the erroneous item is attributable to one or both spouses. See Rowe v. Commissioner, T.C. Memo. 2001-325; Buchine v. Commissioner, T.C. Memo. 1992-36, affd. 20 F.3d 173 (5th Cir. 1994). A key factor is whether and to what extent the electing spouse voluntarily participated in the investment which gave rise to the erroneous item.



Generally, an electing spouse who voluntarily agrees to enter into an investment and who actively participates in it is precluded from attributing the entire investment to the nonelecting spouse. See Abelein v. Commissioner, T.C. Memo. 2004-274; Capehart v. Commissioner, T.C. Memo. 2004-268, affd. 204 Fed. Appx. 618 (9th Cir. 2006); Bartak v. Commissioner, T.C. Memo. 2004-83, affd. 158 Fed. Appx. 43 (9th Cir. 2005); Ellison v. Commissioner, T.C. Memo. 2004-57; Doyel v. Commissioner, T.C. Memo. 2004-35.



However, if the electing spouse is not an active participant, the electing spouse may qualify for relief even though being named as a shareholder or partner. See McKnight v. Commissioner, T.C. Memo. 2006-155 (in the context of section 6015(c) and (f)); Rowe v. Commissioner, supra; Buchine v. Commissioner, supra.



In Bartak v. Commissioner, supra, Ellison v. Commissioner, supra, and Doyel v. Commissioner, supra, the electing spouses each agreed to invest in the investments which gave rise to the erroneous items and did so jointly with their spouses by using funds from joint bank accounts. Further, the electing spouses considered the investments to be their own, as well as their husbands', and were denied relief because the erroneous items were not entirely attributable to their husbands.



Similarly, in Abelein v. Commissioner, supra, and Capehart v. Commissioner, supra, the electing spouses not only used funds from joint accounts to invest, but also met and toured with persons associated with the business activities, contacted them on occasion, and received and read materials relating to them.



In contrast, in McKnight v. Commissioner, supra, Rowe v. Commissioner, supra, and Buchine v. Commissioner, supra, because they did not participate in the business activity, the electing spouses were granted relief despite being named as shareholders or partners. In Rowe the electing spouse did not make or participate in any decision relating to the activity, did not sign any checks relating to the activity, and was not otherwise involved in the activity. In Buchine , the electing spouse's name appeared as shareholder and partner, but she had no knowledge of being named on the Schedule K-1, and she only attended one promotional meeting.



In McKnight v. Commissioner, supra, erroneous items were attributed entirely to the nonelecting spouse, even though the electing spouse signed organizational documents relating to the investment and was listed as a director. We noted that the spouse signed the documents at her husband's insistence, after assurances from him that he was sole owner of the business and without awareness on her part of the legal significance.



On the facts before us, petitioner more closely resembles the spouses who were granted relief in Rowe v. Commissioner, supra, and Buchine v. Commissioner, supra. Petitioner participated in the Hoyt partnerships in name only. Petitioner repeatedly objected to Glenn's involvement in the Hoyt partnerships. Petitioner never agreed to invest in the Hoyt partnerships, and petitioner signed Hoyt documents solely because of Glenn's representations and insistence and without being aware of the legal significance thereof.



At no time did petitioner invest any of her funds in the Hoyt partnerships. Petitioner did not attend any meetings, make any contact, or read any promotional materials. Glenn made all payments to the Hoyt partnerships from his separate accounts, accounts to which petitioner had no access. Mail relating to the Hoyt partnerships was left unopened for Glenn.



Respondent argues that introductory language in the closing agreement petitioner entered into with respondent constitutes an admission by petitioner that she was a partner in and agreed to the investment in the Hoyt partnerships. To the contrary, that particular language simply associates the Hoyt partnerships with the tax deficiencies and does not constitute an admission as to the level of petitioner's involvement in the Hoyt partnerships. See Zaentz v. Commissioner, 90 T.C. 753, 762 (1988).



Because the understatements are attributable entirely to Glenn, petitioner satisfies section 6015(b)(1)(B).




Section 6015(b)(1)(C): Know or Reason To Know2


A spouse seeking relief from joint liability under section 6015(b) must not have known or had reason to know at the time of signing a joint tax return that there was an understatement of tax on a return. Sec. 6015(b)(1)(C). In deduction cases, the United States Court of Appeals for the Eighth Circuit has adopted the standard set forth in Price v. Commissioner, 887 F.2d 959, 963-965 (9th Cir. 1989). See Erdahl v. Commissioner, 930 F.2d 585, 589 (8th Cir. 1991), revg. T.C. Memo. 1990-101.3



Under the Price standard, the Court inquires as to whether "'a reasonably prudent taxpayer under the circumstances of the spouse at the time of signing the return could be expected to know that the tax liability stated was erroneous or that further investigation was warranted.'" Id. at 590 (quoting Stevens v. Commissioner, 872 F.2d 1499, 1505 (11th Cir. 1989), affg. T.C. Memo. 1988-63).



Even if a spouse is not aware of sufficient facts to give her reason to know of the substantial understatement, she nevertheless may know enough facts to put her on notice that an understatement exists. Price v. Commissioner, supra at 965. The question to ask is whether "a reasonably prudent taxpayer in her position [would] be led to question the legitimacy of the deduction." Guth v. Commissioner, 897 F.2d 441, 445 (9th Cir. 1990) (citing Price v. Commissioner, supra at 975) (emphasis removed), affg. T.C. Memo. 1987-522).



A spouse electing relief may satisfy the duty to inquire by questioning the deductions and receiving assurances as to their legitimacy. Erdahl v. Commissioner, supra at 590 n.7. These assurances may come from the electing spouse's husband. See Price v. Commissioner, supra at 966 (duty of inquiry satisfied where spouse questioned husband about large deductions who assured her that the returns were prepared by a C.P.A.); Foley v. Commissioner, T.C. Memo. 1995-16 (spouse satisfied duty of inquiry by asking husband about tax shelter deductions, hearing that she should not worry because he invested in tax shelters and because return preparer had signed return); Estate of Killian v. Commissioner, T.C. Memo. 1987-365 (spouse took reasonable steps to determine the accuracy of the return by questioning husband about sham losses, who assured her that the losses were due to an investment recommended by a C.P.A. who prepared the return).



The factors established in Price v. Commissioner, supra, as to whether the electing spouse had reason to know or a duty to inquire include the spouse's level of education, the spouse's involvement in family financial affairs, the evasiveness or deceit of the culpable spouse, and any unusual or lavish expenditures inconsistent with the family's ordinary standard of living. Erdahl v. Commissioner, supra at 591 (quoting Guth v. Commissioner, supra at 444).



On the facts before us, we find that petitioner did not know and did not have reason to know of the understatements on the tax returns when she signed them. Petitioner satisfied her duty of inquiry by questioning her husband and receiving strong and repeated assurances from him.



All four factors discussed in Price v. Commissioner, supra, weigh in favor of granting petitioner relief. Petitioner had no experience academically or practically regarding business, taxes, or investments and has worked as an elementary school teacher. Petitioner's involvement in the family financial affairs was limited to paying routine bills out of the joint account. Glenn was deceptive in that he told petitioner she had to file joint Federal income tax returns with him and that the Hoyt partnerships would be his responsibility. Finally, there occurred no unusual or lavish family expenditures that would have notified petitioner of the understatement.



Respondent contends that the size of the deductions on the tax returns was sufficient to instill in petitioner a duty to inquire. Even if such a duty arose, petitioner satisfied the duty of inquiry by confronting Glenn each year and questioning the Hoyt partnership-related items.



Because petitioner did not know or have a reason to know that the deductions were erroneous, and because she satisfied her duty of inquiry, petitioner satisfies section 6015(b)(1)(C).




Section 6015(b)(1)(D): Inequity


Whether it would be inequitable to hold a spouse liable for a tax deficiency is determined by "taking into account all the facts and circumstances." Sec. 6015(b)(1)(D).4 The two most often cited factors to be considered are: (1) Whether there has been a significant benefit to the spouse claiming relief, and (2) whether the failure to report the correct tax liability on the joint return results from concealment, overreaching, or any other wrongdoing on the part of the other spouse. Alt v. Commissioner, 119 T.C. 306, 314 (2002), affd. 101 Fed. Appx. 34 (6th Cir. 2004). We also consider factors utilized in determining "inequity" in the context of section 6015(f).5 Normal support is not considered a significant benefit. Estate of Krock v. Commissioner, 93 T.C. 672, 678 (1989). Where the electing spouse's standard of living remains constant, significant benefit may still be found if the tax savings are "immensely beneficial". Jonson v. Commissioner, 118 T.C. 106, 119-120 (2002), affd. 353 F.3d 1181 (10th Cir. 2003).



Because, as stated previously, petitioner's standard of living remained constant throughout the years in issue and because the claimed tax refunds and savings were not needed or used to support petitioner but were returned to the Hoyt partnerships by Glenn, petitioner received no benefit as a result of the erroneously claimed Hoyt partnership-related tax benefits.



Respondent contends that petitioner could have received a significant benefit from the refunds even though they were reinvested and cites Capehart v. Commissioner, T.C. Memo. 2004-268 (spouse benefited from receiving refund despite reinvestment in Hoyt partnerships).



The determinative fact, however, is not that a refund was received but who benefited from it. In particular, we have held that, where a refund was used to benefit an electing spouse in a manner beyond normal support or where an electing spouse chooses to invest a refund in business activities, a significant benefit was received. See Abelein v. Commissioner, T.C. Memo. 2004-274 (spouse and her husband reinvested portions of refund into a business activity); Pierce v. Commissioner, T.C. Memo. 2003-188 (spouse used refund to contribute capital and lend funds to an investment); French v. Commissioner, T.C. Memo. 1996-38 (spouse used refund to jointly purchase several certificates of deposit in large denominations); Schlosser v. Commissioner, T.C. Memo. 1992-233 (spouse used refund for investments and to pay off debts), affd. without published opinion 2 F.3d 404 (11th Cir. 1993).



If, however, a tax refund is used only by a nonelecting spouse for his or her own investment, the electing spouse would not necessarily have received a significant benefit. See Hillman v. Commissioner, T.C. Memo. 1993-151 (nonelecting spouse used refund to buy himself a Porsche automobile and a Rolex watch and to invest in a motion picture); Estate of Killian v. Commissioner, T.C. Memo. 1987-365 (nonelecting spouse used refund to pay off his personal loans and to invest in a limited partnership).



Petitioner resembles the innocent spouses in Hillman and Killian, in that the funds were not used to benefit her in any way but were funneled into Glenn's investments in the Hoyt partnerships.



Because petitioner received little to no benefit from the erroneously claimed Hoyt partnership-related tax benefits, we find that this factor weighs heavily in favor of granting petitioner relief.



The second prominent factor --namely, concealment or wrongdoing by the nonrequesting spouse, also weighs in petitioner's favor. As stated, Glenn repeatedly told petitioner that they were required to file joint Federal income tax returns, that the Hoyt partnerships were his investments, and that he would be responsible for them. This factor, combined with other factors, demonstrates that it would be inequitable to hold petitioner liable. We note that petitioner is divorced from Glenn, that none of the erroneous deductions is attributable to her, that she did not know and had no reason to know of the substantial understatements, that she satisfied her duty of inquiry, and that she has subsequently made a good faith effort to comply with the tax laws.



The facts that weigh against granting relief, such as petitioner's lack of financial hardship, are insufficient to deny petitioner relief. Petitioner satisfies section 6015(b)(1)(D).




Section 6015(c) and (f)


Because petitioner qualifies under section 6015(b) for relief from joint liability with regard to 100 percent of the tax deficiencies relating to the Hoyt partnership investments, we need not address petitioner's eligibility for relief under subsections (c) and (f) of section 6015.



To reflect the foregoing,



Decision will be entered for petitioner.


1 For a detailed description of the Hoyt partnerships see Bulger v. Commissioner, T.C. Memo. 2005-147.

2 "The requirement in sec. 6015(b)(1)(C) * * * is virtually identical to the same requirement of former sec. 6013(e)(1)(C); therefore, cases interpreting former sec. 6013(e) remain instructive to our analysis." Doyel v. Commissioner, T.C. Memo. 2004-35.

3 Because an appeal in this case would lie in the U.S. Court of Appeals for the Eighth Circuit, we follow Eighth Circuit law. See Golsen v. Commissioner, 54 T.C. 742 (1970), affd. 445 F.2d 985 (10th Cir. 1971).

4 "The requirement in sec. 6015(b)(1)(D) * * * is virtually identical to the same requirement of former sec. 6013(e)(1)(D); therefore cases interpreting former sec. 6013(e) remain instructive to our analysis." Doyel v. Commissioner, T.C. Memo. 2004-35.

5 Rev. Proc. 2000-15, sec. 4.03, 2000-1 C.B. 447, 448-449, lists nonexclusive factors to be considered in determining whether it is inequitable to hold the electing spouse liable for all or part of a deficiency under sec. 6015(f).

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

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Tax Attorney: Charitable Deduction New Rules

You must itemize on IRS Form 1040, Schedule A.

Here are a few tips to ensure your contributions pay off on your tax return:

You cannot deduct contributions made to specific individuals, political organizations and candidates. Nor can you deduct the value of your time or services and the cost of raffles, bingo or other games of chance.


To be deductible, contributions must be made to qualified organizations.


Only contributions actually made during the tax year are deductible.


If your contributions entitle you to merchandise, goods or services, including admission to a charity ball, banquet, theatrical performance or sporting event, you can deduct only the amount that exceeds the fair market value of the benefit received.


Donations of stock or other property are usually valued at the fair market value of the property.


To be deductible, clothing and household items donated after August 17, 2006, generally must be in good used condition or better.


Special rules apply to donations of vehicles.


For a charitable contribution of $250 or more, you can claim a deduction only if you obtain a written acknowledgment from the qualified organization.


If you claim a deduction on your return of more than $500 for all contributed property, you must attach IRS Form 8283, Noncash Charitable Contributions, to your return.


Taxpayers donating an item or a group of similar items valued at more than $5,000 must also complete Section B of Form 8283, which requires an appraisal by a qualified appraiser.

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

Back Taxes: Taxable Social Security disability benefits

An IRS tax auditor and his wife could not exclude Social Security disability benefits from their gross income. Although the wife had been injured at work, her Social Security disability benefits could not be treated as nontaxable workmen's compensation benefits because they were provided under the Social Security Act. The Social Security Act is not considered to be a statute in the nature of workmen's compensation because it provides for disability benefits for an injury regardless of whether the injury occurred in the course of employment. See Code Sec. 165(c)
with respect to an uncollected damage award for personal injuries that the wife sustained outside of her job.

The loss was not incurred in a trade or business or in a transaction entered into for profit. Further, the taxpayers could not claim a casualty loss deduction because they did not establish any tax basis in the judgment. Code Sec. 6662 penalty was sustained against a married couple. The penalty was appropriate in light of the husband's work as an IRS auditor and the relatively straightforward adjustments at issue. --


Theodore Major Green and Jacqueline Green v. Commissioner.Dkt. No. 5216-06 , TC Memo. 2007-217, August 7, 2007.[

MEMORANDUM OPINION

SWIFT, Judge: This matter is before us on respondent's motion for summary judgment under Rule 121.
Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for 2003, and all Rule references are to the Tax Court Rules of Practice and Procedure.
The issues for decision are: (1) Whether taxable Social Security benefits petitioner Jacqueline Green received in 2003 should be treated as nontaxable workmen's compensation benefits; and (2) whether petitioners may deduct from 2003 income $11,068 relating to a $166,013 damage award judgment that Jacqueline Green never received and that has now been discharged in bankruptcy.
Hereinafter, references to petitioner in the singular are to petitioner Jacqueline Green.
Background
At the time the petition was filed, petitioners resided in Moorpark, California. From 1985 to September 19, 2005, Mr. Green worked as a tax auditor for respondent.Petitioner's Social Security Benefits
Prior to November 12, 1989, petitioner worked on a General Motors assembly line.
In November of 1989 petitioner was injured while shopping for groceries. This was unrelated to her employment at General Motors Corporation (General Motors). The injury was caused by a shopping cart under the control of another person. Injuries petitioner sustained therefrom apparently prevented petitioner from further assembly line work at General Motors. Petitioner continued to work for General Motors but as a decal assembler.
On November 7, 1990, petitioner filed a lawsuit for personal injury damages against the person who was pushing the shopping cart.
On or about August 27, 1991, petitioner was involved in another accident, this time while at work at General Motors, as a result of which petitioner sustained additional injuries. Petitioner's injuries required surgery and left her unable to work.
On August 6, 1992, petitioner filed a claim for Social Security disability benefits, and on December 17, 1993, petitioner began receiving Social Security disability benefits.
In addition to her claim for Social Security disability benefits, petitioner filed a claim for California workmen's compensation benefits. The record does not reflect that petitioner ever received any benefits under her workmen's compensation claim.

On November 12, 1996, petitioner obtained a $166,013 default judgment for personal injury damages against the person who was pushing the shopping cart that injured petitioner in 1989.
On or about March 14, 1997, in a bankruptcy proceeding, the person against whom petitioner obtained the default judgment was discharged of liability to pay the $166,013 judgment petitioner had obtained, and petitioner never collected anything on the judgment. Petitioner never included any portion of the $166,013 judgment in taxable income, and the record does not establish that petitioner had any tax basis in the uncollected judgment.

On their 1997 joint Federal income tax return filed with respondent, petitioners reported as taxable $5,789 of the Social Security benefits petitioner received in 1997, and petitioners claimed a $11,068 casualty loss deduction relating to the above $166,013 uncollected judgment. Petitioners also attached to their 1997 tax return a statement that they intended to deduct the balance of the $154,946 uncollected judgment over the course of the next 15 years --$11,068 in each year --as a loss carryforward.

When no material fact remains at issue, we may grant summary judgment as a matter of law. Rule 121(b); Fla. Country Clubs, Inc. v. Commissioner, 122 T.C. 73, 75-76 (2004), affd. on other grounds 404 F.3d 1291 (11th Cir. 2005). Because of the parties' admissions and deemed admissions as to material facts, no material fact remains at issue.Social Security Benefits
Generally, taxpayers who file a joint return and receive Social Security benefits and whose modified adjusted gross income plus half of Social Security benefits received in a year exceeds $32,000 are to include in taxable income a portion of the Social Security benefits received in a year. Sec. 86(d)(1); Joseph v. Commissioner, T.C. Memo. 2003-19.

Benefits received under a workmen's compensation statute or other statute authorizing benefits in the nature of workmen's compensation may not be included in income.

The Social Security Act provides for disability benefits for an injury regardless of whether the injury occurred in the course of employment. See 42 U.S.C. sec. 423(d)(1)(A) (2000).
Petitioner's Social Security disability benefits received in 2003 were provided to petitioner under the Social Security Act. Because the Social Security Act is not a statute in the nature of workmen's compensation, petitioners must include in gross income for 2003 $11,227 of the $13,208 in Social Security disability benefits that petitioner received in 2003, as per the calculation provided under Section 165(c) provides a deduction from income for taxpayers who incur an uncompensated loss relating to a trade or business, to a transaction entered into for profit, or to a casualty resulting in an uncompensated loss of property.

Petitioner's $166,013 uncollected judgment involving the shopping cart was personal in nature and had no connection with petitioner's trade or business or with a transaction entered into for profit.

Petitioner was not premitted a casualty loss deduction under Secs. 165(b), 1016; secs. 1.1011-1, 1-1012-1(a), Income Tax Regs.

The above tax basis limitation set forth in the regulations prevents petitioners herein from obtaining a casualty loss deduction relating to petitioner's uncollected judgment. Petitioner did not include any portion of the $166,013 uncollected judgment in income and did not establish any tax basis therein. Under Sec. 6662(c).



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

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Tax Help: No alimony from oral agreement

An individual improperly deducted amounts paid to his ex-wife as alimony. Although the taxpayer and his ex-wife had an oral agreement, no written agreement or decree was in effect for the tax year at issue. A draft settlement agreement was never signed by either party and the fact that his ex-wife acknowledged receiving the payments did not satisfy the writing requirement.

PURSUANT TO INTERNAL REVENUE CODE SECTION 7463(b),THIS OPINION MAY NOT BE TREATED AS PRECEDENT FOR ANY OTHER CASE.



Randall L. Sindelir, pro se. Tamara L. Kotzker, for respondent.

ARMEN, Special Trial Judge: This case was heard pursuant to the provisions of section 7463 of the Internal Revenue Code in effect when the petition was filed.1 Pursuant to section 7463(b), the decision to be entered is not reviewable by any other court, and this opinion shall not be treated as precedent for any other case.

Respondent determined a deficiency in petitioner's Federal income tax for 2002 of $6,704. The deficiency stemmed from the disallowance of a deduction for alimony payments and the related adjustment of petitioner's itemized deductions. The sole issue for decision is whether petitioner properly deducted $18,000 paid to his ex-wife in 2002 as alimony. For the reasons discussed below, we sustain respondent's determination.



Background


Some of the facts have been stipulated, and they are so found. We incorporate by reference the parties' stipulation of facts and accompanying exhibits.

At the time the petition was filed, Randall L. Sindelir (petitioner) resided in Montana.

Petitioner and his former spouse, Diana Sindelir (ex-wife), were married in February 1978. After separating sometime in late 2001, they filed a joint petition for the dissolution of their marriage in January 2002.2 When the couple separated, they had an oral agreement that petitioner would pay his ex-wife $1,500 per month in temporary maintenance. Petitioner did so.

In August 2002, the couple engaged in court-ordered mediation as part of the divorce proceedings. At the mediation, a written separation agreement was drafted, stating that petitioner was to pay his ex-wife $2,000 per month in maintenance. This separation agreement was never signed or executed by the parties, and petitioner continued to pay his ex-wife $1,500 per month.

The divorce became final in January 2003. In considering maintenance obligations, the District Court for Larimer County refused to enforce the draft separation agreement. Petitioner argued during the course of the final divorce proceeding that the separation agreement was not binding. The court agreed with petitioner and found that although an agreement between petitioner and his ex-wife may have been reduced to writing, it was not enforceable as it was not signed or executed by the parties.

Petitioner claimed an alimony deduction in the amount of $18,000 for the amounts he paid to his ex-wife in 2002.3 Respondent disallowed the deduction, and a deficiency resulted.



Discussion4


Section 71(a) provides the general rule that alimony payments are included in the gross income of the payee spouse; section 215(a) provides the complementary general rule that alimony payments are tax deductible by the payor spouse in "an amount equal to the alimony or separate maintenance payments paid during such individual's taxable year."

The term "alimony" means any alimony as defined in section 71, which provides in relevant part:

SEC. 71(b). Alimony or Separate Maintenance Payments Defined. --For purposes of this section --

(1) In general. --The term "alimony or separate maintenance payment" means 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 * * * 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.

The issue here is solely whether petitioner's payments to his ex-wife in 2002 satisfied the requirement that the payments be made under a divorce or separation instrument. See sec. 71(b)(1)(A).

Section 71(b)(2) provides that a "divorce or separation instrument" means:

(A) decree of divorce or separate maintenance or a written instrument incident to such a decree,

(B) a written separation agreement, or

(C) a decree (not described in subparagraph (A)) requiring a spouse to make payments for the support or maintenance of the other spouse.

Although petitioner and his ex-wife had an oral agreement, no written agreement or decree was in effect for the taxable year at issue.

Courts have leniently interpreted the writing requirement. See, e.g., Leventhal v. Commissioner, T.C. Memo. 2000-92 (finding that letters signed by both the taxpayer's attorney and the ex-wife's attorney clearly setting forth the terms of maintenance payments was a "separation agreement"); Osterbauer v. Commissioner, T.C. Memo. 1982-266 (determining that a letter sent by the wife's representative to the taxpayer memorializing the terms of their oral agreement constituted a written instrument). But courts have also routinely held that there must be some actual writing in effect. See, e.g., Herring v. Commissioner, 66 T.C. 308, 311 (1976) (holding that payments made under an oral agreement were not alimony). The draft settlement agreement was never in effect, and the fact that petitioner's ex-wife acknowledges receiving the payments made by petitioner does not satisfy the writing requirement. See, e.g., Leventhal v. Commissioner, supra.

Although we appreciate the difficult position that petitioner has found himself in, particularly since it seems clear that the intention of the oral agreement in effect between petitioner and his ex-wife had been to have the $1,500 monthly payments serve as "alimony", deductions are a matter of legislative grace and must meet all applicable statutory requirements. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). To be deductible as alimony under section 71, a payment must be made pursuant to some kind of written agreement, and the oral agreement in effect here is insufficient to satisfy that requirement. See sec. 71(b)(1)(A). Accordingly, we hold that petitioner's payments made to his ex-wife in 2002 were not properly deductible as alimony.

To reflect our disposition of the disputed issue,

Decision will be entered for respondent.

1 Unless otherwise indicated, all subsequent section references are to the Internal Revenue Code in effect for 2002.

2 As the couple was living in Colorado at the time, the separation and divorce proceedings were supervised by the District Court for Larimer County.

3 Petitioner wrote checks to his ex-wife totaling $15,440.88 in 2002, testifying at trial that the difference between the amount claimed and the checks written was for expenses paid on her behalf. As we ultimately hold that the entire $18,000 is not deductible as alimony, we need not decide whether petitioner properly substantiated the additional amounts paid.

4 The issue for decision under these facts is essentially legal in nature; therefore, we decide the instant case without regard to the burden of proof.


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

To provide IRS transparency, upload your IRS experiences to www.irsforum.org

Tax Attorney: Business Expense or Hobby?


Fishing, Gardening, Golf, Sewing, Woodworking, Horsemanship, Scrap Booking, Stamp and Coin Collecting, etc. This is a very large audit issue. In the end, the IRS will make a judgement on whether the expense is eigher a business expense or a hobby. Strong advocacy by a competent tax attorney is necessary for these issues. The IRS tends to be adverse in these cases without aggressive advocacy and knowledge of the law.


Your favorite activity may make pofit every year or so, but there be tax implications that surprise you.

What is a hobby? Hobbies, also called not-for-profit activities, are those activities that are not pursued for profit. What is a business? Generally, your activity is considered a business if it is carried on with the reasonable expectation of earning a profit.

If you are not sure whether you are running a business or simply enjoying a hobby, here are some of the factors you should consider:

• Do you run the activity in a businesslike manner?
• Does the time and effort you put into the activity indicate an intention to make a profit?
• Do you depend on income from the activity?
• If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?
• Have you changed methods of operation to improve profitability?
• Do you or your advisors have the knowledge needed to carry on the activity as a successful business?
• Have you made a profit in similar activities in the past?
• Does the activity make a profit in some years?
• Can you expect to make a profit in the future from the appreciation of assets used in the activity?
An activity is usually considered a business if it makes a profit during at least three of the last five tax years, including the current year.
An exception is breeding, showing, training or racing horses. Such activity is presumed to be a business if it makes a profit during at least two of the last seven years.
If you are conducting a trade or business you may deduct your ordinary and necessary expenses. An ordinary expense is an expense that is common and accepted in your trade or business. A necessary expense is one that is appropriate for your business.
Losses from a not-for-profit activity (hobby) may not be used to offset other income. It is possible to claim some deductions for hobby activities as itemized deductions on your Form 1040 income tax return. However, there are special rules and limits to the deductions you can claim, and those deductions may not exceed the gross income from your hobby.

A good resource is IRS ication 535, Business Expenses

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

For those with IRS experiences, you can upload those experiences at http://www.irsforum.org/ in order to provide IRS "transparency."

IRS Tax Gap Proposals

Expect a great deal of legislation to improve tax compliance and collect more tax revenue. Perceived tax loopholes will be closed. There is about a $345 billion tax gap and the Senate will take the lead in enacting tax legislation dealing with topics mentions in the IRS and Treasury Report dated August 3, 2007




IRS Report: Reducing the Federal Tax Gap --A Report on Improving Voluntary Compliance

August 3, 2007

IRS report: Tax gap: Voluntary compliance



Reducing the Federal Tax Gap




A Report on Improving Voluntary Compliance




Internal Revenue Service U.S. Department of the Treasury


August 2, 2007



Table of Contents

EXECUTIVE SUMMARY

UNDERSTANDING THE TAX GAP

VOLUNTARY COMPLIANCE

COMPONENTS

SUMMARY

APPENDIX

Initiative Timeframes

GLOSSARY



EXECUTIVE SUMMARY



INTRODUCTION

In Fiscal Year (FY) 2006, federal receipts totaled over $2.4 trillion. More than 95 percent of the net receipts were collected by the Internal Revenue Service (IRS) through its administration of the income, employment, transfer, and excise tax provisions of the Internal Revenue Code. Virtually all of these receipts were collected through a tax system under which taxpayers voluntarily report and pay their taxes with no direct enforcement and minimal interaction with the government.

The overall compliance rate achieved under the United States revenue system is quite high. For the 2001 tax year, the IRS estimates that, after factoring in late payments and recoveries from IRS enforcement activities, over 86 percent of tax liabilities were collected. Nevertheless, an unacceptably large amount of the tax that should be paid every year is not, such that compliant taxpayers bear a disproportionate share of the revenue burden, and giving rise to the "tax gap." The gross tax gap was estimated to be $345 billion in 2001. After enforcement efforts and late payments, this amount was reduced to a net tax gap of approximately $290 billion.

The Treasury Department and IRS are committed to improving current compliance levels and continuing to address all forms of noncompliance. The IRS Oversight Board has adopted an 86 percent voluntary compliance goal by 2009 and Senate Finance Committee Chairman Max Baucus has asked for a 90 percent voluntary compliance goal by 2017. This report sets forth steps that will be taken to improve compliance and enhance the IRS' ability to measure compliance. Once implemented, these steps will improve the IRS' ability to gauge progress in achieving specific long-term compliance objectives.

This report outline steps that the IRS will take to increase voluntary compliance and reduce the tax gap. It builds on the Comprehensive Strategy for Reducing the Tax Gap (the Treasury Strategy) that was released in September 2006 by the Treasury Department's Office of Tax Policy and provides more detail for that strategy.

The IRS regularly addresses compliance improvement measures in its planning and budgeting processes. The Administration's annual budget request identifies the resources the IRS will need to meet specific performance goals to achieve its strategic priorities. This document combines and addresses current tax gap efforts. In addition, the IRS has long been conducting research in compliance and the tax gap, and resulting data is incorporated throughout this document.

The steps outlined in this report are, in many respects, only initial steps toward improving compliance. As described below, one of the primary challenges that the IRS faces in improving compliance is to get a better understanding of the current sources of noncompliance by improving research in this area. Until that understanding is clarified, efforts to improve compliance may be misdirected and progress may not be measurable. The IRS has taken significant steps in this direction, most importantly through the National Research Program (NRP), which is the source of updated estimates of compliance among individual taxpayers for 2001. The IRS is committed to furthering its work in this area through updated individual taxpayer NRP examinations and a current study focusing on compliance among Subchapter S corporations (S corporations).

In implementing the steps set forth in this document, it is important to have realistic expectations and perspectives. Based on the limited information available, compliance rates appear to have remained relatively stable at around 85 percent for decades. To make a meaningful improvement in this number without a fundamental change in the relationship between taxpayers and the government will require a long-term, focused effort. Implementation of the steps outlined in this document and in the Administration's Fiscal Year (FY) 2008 Budget request for the IRS will be subject to the uncertainties associated with the annual budget process. Moreover, it must be recognized that the causes of noncompliance are numerous and that only a portion of the tax gap results from intentional avoidance or evasion of the law. An equally or perhaps more important part of the problem lies in the growing complexity of the tax laws, which will continue to frustrate efforts to improve compliance.

The Administration is committed to working with Congress and other stakeholders to reduce the tax gap. The Administration's FY 2008 Budget request includes $11.1 billion for the IRS, a 4.7 percent increase over the budget enacted for FY 2007. A total of $410 million is for new enforcement initiatives as part of a strategy to improve compliance by:

Ÿ Increasing front-line enforcement resources;

Ÿ Increasing voluntary compliance through improved taxpayer service options and enhanced research;

Ÿ Investing in technology to reverse infrastructure deterioration, accelerate modernization, and improve the productivity of existing resources; and

Ÿ Implementing legislative and regulatory changes.

Since 2001 (the tax year studied by the NRP), IRS tax collections have increased significantly, audit rates have improved across all taxpayer segments, and measurements of taxpayer service have risen to historic levels. While specific data is not available, there is every reason to believe that these improvements have contributed to a general shift away from aggressive tax planning and an improvement in compliance levels over the past six years. In calling for a significant increase in IRS funding, the Administration's budget recognizes, however, that much work remains to be done. Based on historic experience, the IRS estimates that the overall return on new investments in compliance averages 4:1, with an additional indirect impact resulting from the improved overall compliance that comes from more targeted and effective enforcement of the tax law. However, direct spending on compliance improvements does not lend itself to traditional revenue-estimating analysis, given the difficulty in quantifying the effect that such improvements have on taxpayer behavior.

This report provides detail on how the additional funds requested in the Administration's FY 2008 Budget will build on improvements the IRS has made in recent years to taxpayer service, modernization, and enforcement, all of which are critical elements in the long-term strategy to improve compliance. In particular, this report describes six separate initiatives in the FY 2008 Budget request that are aimed at improving enforcement. The report also details how additional funds requested will be targeted to improving taxpayer service, including implementation of the recommendations made in the recently released Taxpayer Assistance Blueprint (TAB). In addition, the report outlines how additional funds will accelerate implementation of IRS modernization programs, to permit better document matching, faster and more accurate processing of returns, and more timely access to taxpayer account information. A detailed timeline for implementing these various programs is included as an Appendix to this report.

The Treasury Department and IRS will continue to evaluate resource demands for improving taxpayer compliance. In addition, future budget requests will identify ways to utilize resources efficiently and effectively to target enforcement efforts to areas where they will have the greatest direct and indirect impact on compliance. The steps for improving compliance that are detailed in this report will continue to evolve over time as our understanding of the problem improves and as changes in the economy and changes in the tax law present new compliance challenges.



The Treasury Department's Comprehensive Strategy for Reducing the Tax Gap

Four key principles guided the development of the Treasury Strategy and continue to guide IRS efforts to improve compliance:

Ÿ First, both unintentional taxpayer errors and intentional taxpayer evasion should be addressed.

Ÿ Second, sources of noncompliance should be targeted with specificity.

Ÿ Third, enforcement activities should be combined with a commitment to taxpayer service.

Ÿ Fourth, policy positions and compliance proposals should be sensitive to taxpayer rights and maintain an appropriate balance between enforcement activity and imposition of taxpayer burden.

These principles point to the need for a comprehensive, integrated, multi-year strategy to reduce the tax gap. Guided by these key principles, the Treasury Strategy outlines seven components which form the basis for the detailed compliance improvement efforts set forth in this document:

1. Reduce Opportunities for Evasion. The Administration's FY 2008 Budget request contains 16 legislative proposals to reduce evasion opportunities and improve the efficiency of the IRS. Three of these proposals were recently enacted in modified form. The 16 provisions would result in an estimated $29.5 billion of additional revenues over the next ten years. The Treasury Department and the IRS also continue to use the regulatory guidance process to address both procedural and substantive issues to improve compliance and reduce the tax gap.

2. Make a Multi-Year Commitment to Research. Research is essential to identify sources of noncompliance so that IRS resources can be targeted properly. Regularly updating compliance research ensures that the IRS is aware of vulnerabilities as they emerge. New research is needed on the relationship between taxpayer burden and compliance and on the impact of customer service on voluntary compliance. Research also is essential to establish accurate benchmarks and metrics to assess the effectiveness of IRS efforts, including the effectiveness of the Treasury Strategy.

3. Continue Improvements in Information Technology. Continued improvements to technology, including continued development of and additions to Modernized e-File, will provide the IRS with better tools to improve compliance through early detection, better case selection, and better case management.

4. Improve Compliance Activities. IRS actions have produced a steady climb in enforcement revenues since 2001, and an increase in both the number of examinations and the coverage rate in virtually every major category. By further improving examination, collection, and document matching activities, the IRS will be better able to prevent, detect, and remedy noncompliance. These activities will increase compliance --not only among those directly contacted by the IRS, but also among those who will be deterred from noncompliant behavior as a consequence of a more visible IRS enforcement presence. Aided by results from the recent NRP study of individual taxpayers, the IRS continues to reengineer examination and collection procedures and invest in technology, resulting in efficiency gains and better targeting of examination efforts. These efficiency gains translate into expanded examination coverage, higher audit yields, and reduced burden on compliant taxpayers.

5. Enhance Taxpayer Service. Service is especially important to help taxpayers avoid unintentional errors. Given the increasing complexity of the tax code, providing taxpayers with assistance and clear and accurate information before they file their tax returns reduces unnecessary post-filing contacts, allowing the IRS to focus enforcement resources on taxpayers who intentionally evade their tax obligations. The IRS also is working to provide service more efficiently and effectively through new and existing tools, such as the IRS website. The Taxpayer Assistance Blueprint (TAB), which was completed in April 2007, outlines a five-year strategic plan for taxpayer service. The TAB includes a process for assessing the needs and preferences of taxpayers and partners and a decision model for prioritizing service initiatives and funding.

6. Reform and Simplify the Tax Law. Simplifying the tax law would reduce unintentional errors caused by a lack of understanding. Simplification would also reduce the opportunities for intentional evasion and make it easier for the IRS to administer the tax laws. For example, the Administration's FY 2008 Budget request includes proposals to simplify tax credits for families and tax treatment of savings by consolidating existing programs and clarifying eligibility requirements. These initiatives will continue to be supplemented by IRS efforts to reduce taxpayer burden by simplifying forms and procedures.

7. Coordinate with Partners and Stakeholders. Enhanced coordination is needed between the IRS and state and foreign governments to share information and compliance strategies. Expanded coordination also is needed with practitioner organizations, including bar and accounting associations, to maintain and improve mechanisms to ensure that advisors provide appropriate tax advice. Through contacts with practitioner organizations, the Treasury Department and IRS learn about recent developments in tax practice and hear directly from practitioners about taxpayer concerns and potentially abusive practices. Similarly, contacts with taxpayers and their representatives, including small business representatives and low-income taxpayer advocates, provide the Treasury Department and the IRS with needed insight on ways to protect taxpayer rights and minimize the potential burdens associated with compliance strategies.



The IRS Strategic Planning Process

The more detailed steps outlined for improving compliance are, in part, contingent upon the budget process for FY 2008 and beyond. Accordingly, adoption of the Administration's proposed FY 2008 Budget for the IRS along with the enactment of the legislative recommendations included as part of that budget are critical components of the strategy to reduce the tax gap.

The IRS has an extensive annual strategic planning process through which each of its operating divisions develop and estimate resource requirements needed to achieve functional priorities and performance targets based on budget allocations. Detailed action plans, which are part of the IRS' strategic planning process and are coordinated with this report, identify specific subgoals and measures as well as accountable parties. Progress toward these plans is monitored internally and reported to the Treasury Department and the Office of Management and Budget (OMB) throughout the year.



UNDERSTANDING THE TAX GAP

The Internal Revenue Code places three primary obligations on taxpayers: (1) to file timely returns; (2) to make accurate reports on those returns; and (3) to pay the required tax voluntarily and timely. Taxpayers are compliant when they meet these obligations. Noncompliance --and the tax gap --results when taxpayers do not meet these obligations.

The tax gap is defined as the aggregate amount of true tax liability imposed by law for a given tax year that is not paid voluntarily and timely. True tax liability for any given taxpayer means the amount of tax that would be determined for the tax year in question if all relevant aspects of the tax law were correctly applied to all of the relevant facts of that taxpayer's situation. For a variety of reasons, this amount often differs from the amount of tax that a taxpayer reports on a return. The taxpayer might not understand the law, might make inadvertent mistakes, or might misreport intentionally.

To be paid voluntarily, a tax liability must be paid without direct IRS intervention. Taxpayers have the responsibility to determine and report their correct tax liability, and to make sure that amount is paid (whether through withholding, estimated tax payments, payments with a filed return, etc.). The IRS focuses its enforcement where it is needed most, but the overall rate of tax compliance in the United States is as high as it is because the vast majority of taxpayers meet their obligations with little or no involvement from the IRS. To be paid timely, a tax liability must be paid in full on or before the date on which all payments for the given tax year were legally due.

It is important to emphasize that IRS estimates of the tax gap are associated with the legal sector of the economy only. Although tax is due on income from whatever source derived, legal or illegal, the tax attributable to income earned from illegal activities is extremely difficult to estimate. Moreover, the government's interest in pursuing this type of noncompliance is, ultimately, to stop the illegal activity, not merely to tax it.

Although they are related, the tax gap is not synonymous with the "underground economy." Definitions of the "underground economy" vary widely. However, most people characterize it in terms of the value of goods and services that elude official measurement. Furthermore, there are some items in the "underground economy" that are not included in the tax gap (such as tax due on illegal-source income), and there are contributors to the tax gap that no one would include in the "underground economy" (such as the tax associated with overstated exemptions, adjustments, deductions, or credits, or with claiming the wrong filing status). The greatest area of overlap between these two concepts is sometimes called the "cash economy," in which income (usually of a business nature) is received in cash, which helps to hide it from taxation.

Equally important, the tax gap does not arise solely from tax evasion or cheating. It includes a significant amount of noncompliance due to tax law complexity that results in errors of ignorance, confusion, and carelessness. This distinction is important even though, at this point, the IRS does not have sufficient data to distinguish clearly the amount of noncompliance that arises from willful, as opposed to unintentional, mistakes. Moreover, the line between intentional and unintentional mistakes is often a grey one, particularly in areas such as basis reporting, where a taxpayer may know that his or her reporting is inaccurate but does not have ready access to accurate information. This is an area where additional research is needed to improve understanding.



MEASURING THE TAX GAP

Historically, estimates of federal tax compliance were based on special studies, including the Taxpayer Compliance Measurement Program (TCMP), which covered income and self-employment taxes and groups of taxpayers, and consisted of line-by-line audits of random samples of returns. These studies provided the IRS with information on compliance trends and allowed the IRS to update audit selection formulas regularly. However, this method of data gathering was extremely burdensome on the taxpayers whose returns were selected. As a result of concerns raised by taxpayers, Congress, and other stakeholders, the last TCMP audits were done in 1988.

The IRS conducted several much narrower compliance studies between 1988 and 2001, but nothing that would provide a comprehensive perspective on the overall tax gap. Until recently, all of these subsequent estimates of the tax gap have been rough projections that basically assume no change in compliance rates among the major tax gap components even though the magnitude of these projections reflects growth in tax receipts in these major tax gap categories.

The NRP, which the IRS has used to estimate the most recent tax gap updates, arose out of a desire to find a less intrusive means of measuring tax compliance. The IRS used a focused statistical selection process that resulted in the selection of approximately 46,000 individual income tax returns for Tax Year (TY) 2001 - somewhat fewer than previous compliance studies, even though the population of individual tax returns had grown over time.

Like the compliance studies of the past, the NRP was designed to allow the IRS to meet certain objectives --to estimate the overall extent of reporting compliance among individual income tax filers and to update the audit-selection formulas. It also introduced several innovations designed to reduce the burden imposed on taxpayers whose returns were selected for the study.

The first NRP innovation was to compile a comprehensive set of data to supplement what was reported on the selected returns. The sources of the "case building" data included third-party information returns from payers of income (e.g., Form W-2 and Form 1099) and prior-year returns filed by taxpayers. Also, for the first time, the IRS added data on dependents obtained from various government sources, as well as data obtained from public records (e.g., current and prior addresses, real estate holdings, business registrations, and involvement with corporations). Together, these data reduced the amount of information requested from taxpayers, with some of the selected taxpayers not requiring any contact from the IRS. In effect, these data allowed the IRS to focus its efforts on return information that could not otherwise be verified. This pioneering approach was so successful it is being expanded in regular operational audit programs.

A second major NRP innovation was to introduce a "classification" process, whereby the randomly selected returns and associated case-building data were first reviewed by experienced auditors (referred to as classifiers) who identified not only which issues needed to be examined, but also the best way to handle each return in the sample. In this way, each return was either: (1) accepted as filed, without contacting the taxpayer at all (although, sometimes, minor adjustments were noted for research purposes); (2) selected for correspondence audit of up to three focused issues; or (3) selected for an in-person audit where there were numerous items that needed to be verified. In addition, the classifiers identified compliance issues that the auditor was required to evaluate, although the examiners had the ability to expand the audit to investigate other issues as warranted.

Other NRP innovations included streamlining the collection of data, providing auditors with new tools to detect noncompliance, and involving stakeholders (including representatives of tax professional associations) in the design and implementation of the study. Clearly, the NRP approach was much less burdensome on taxpayers than the old TCMP audits, which examined every line item on every return.



TAX GAP ESTIMATES

As noted above, for the 2001 tax year, the overall gross tax gap was estimated to be approximately $345 billion, corresponding to a noncompliance rate of 16.3 percent. After accounting for enforcement efforts and late payments, the amount was reduced to $290 billion, corresponding to a net noncompliance rate of 13.7 percent.

Noncompliance takes three forms:

Ÿ not filing required returns on time (nonfiling);

Ÿ not reporting one's full tax liability on a timely filed return (underreporting); and

Ÿ not timely paying the full amount of tax reported on a timely return (underpayment).

The IRS has separate tax gap estimates for each of these three types of noncompliance. Underreporting (in the form of unreported receipts and overstated expenses) constitutes over 82 percent of the gross tax gap, up slightly from earlier estimates. Underpayment constitutes nearly 10 percent and nonfiling almost 8 percent of the gross tax gap.



Nonfiling

The nonfiling gap is defined as the amount of true tax liability that is not paid on time by taxpayers who do not file a required return on time (or at all). It is reduced by amounts paid on time, such as through withholding, estimated payments, and other credits. The nonfiler population does not include legitimate nonfilers (i.e., those who have no obligation to file).



Underreporting

The underreporting gap is defined as the amount of tax liability not voluntarily reported by taxpayers who file required returns on time. For income taxes, the underreporting gap arises from three errors: underreporting taxable income, overstating offsets to income or to tax, and net math errors. Taxable income includes such items as wages and salaries, rents and royalties, and net business income. Offsets to income include income exclusions, exemptions, statutory adjustments, and deductions. Offsets to tax are tax credits. Net math errors involve arithmetic mistakes or transcription errors made by taxpayers that are corrected at the time the return is processed. In addition to developing an estimate of the aggregate underreporting gap, it is possible to break aspects of this estimate down into measures of the underreporting gap attributable to specific line items on the tax return.



Underpayment

The underpayment gap is the portion of the total tax liability that taxpayers report on their timely filed returns but do not pay on time. This arises primarily from insufficient remittances from taxpayers themselves. However, it also includes employer under-deposits of withheld income tax. In the case of withheld income tax, it is the responsibility of the employees to report the corresponding tax liability on timely filed returns, and it is the responsibility of their employers to deposit those withholdings with the government on time.



THE TAX GAP MAP

Figure 1 summarizes the key components of the tax gap and how they relate to one another. It has come to be known as the "Tax Gap Map." As the Tax Gap Map indicates, the IRS estimates that, for 2001, approximately $55 billion of the gross tax gap will eventually be paid through enforcement or other late payments, leaving a net tax gap of about $290 billion. This projection of what will eventually be paid is based on fiscal year tabulations of past enforcement revenue and on prior studies of amounts that are paid late without enforcement efforts. Obviously, this projection depends directly on actions that both the IRS and taxpayers will take in the future, and the past is not likely to be a perfect predictor of that. Moreover, the IRS does not have good data on the amounts that are paid late without enforcement efforts. Consequently, this estimate of enforcement revenues and other late payments is necessarily subject to some uncertainty.

The Tax Gap Map distinguishes between "good" and "weak" estimates. For example, the corporation income tax estimates are acknowledged as weak because compliance behavior may have changed since the mid-1980s, which is the last time the IRS collected data on corporate compliance. Moreover, the underreporting tax gap is estimated as the difference between true tax liability and reported amounts. Determining true tax liability for large multinational corporations can be difficult, given the complexity of the tax law, economic activities undertaken by these taxpayers, and the difficulty of making any kind of statistically valid assumptions based on a limited population of taxpayers. Weaknesses in general arise from two causes: using old data and using data and methods that do not adequately reflect the full extent of noncompliance.

Figure 2 organizes these estimates by type of tax and by type of noncompliance. As with tax gap estimates for prior tax years, the overall tax gap is dominated by the underreporting of individual income tax, which results in part from the dominant role that the individual income tax plays in overall federal tax receipts.

The individual income tax accounted for about half of all tax receipts in 2001. Individual income tax underreporting, however, was approximately $197 billion, or about 57 percent of the overall tax gap. While a comparison with 1988 data would suggest a slight decrease in individual income tax reporting compliance, it is important to remember that the data tell nothing about the years just before or just after TY 2001 and, as such, cannot show whether compliance trends today are improving or getting worse. Moreover, many aspects of the data and estimating methodologies used now are not comparable to earlier studies. In addition, broader changes in the economy over the past 20 years have made comparisons between the data difficult.


Figure 1 Tax Gap Map for Tax Year 2001


Figure 2

Tax Year 2001 Gross Tax Gap by Type of Tax and Type of Noncompliance (in $ billions)



__________________________________________________________________________________
Type of Noncompliance TOTAL

Type of Tax
________________________________________________
NonfilingUnderreportingUnderpaymentAmount Percent
Gap Gap Gap* Distribution

__________________________________________________________________________________
Individual Income Tax 25 197 23.4 245 71.1%

__________________________________________________________________________________
Corporation Income Tax # 30 2.3 32 9.3%

__________________________________________________________________________________
Employment Tax # 54 5.0 59 17.0%

__________________________________________________________________________________
Estate & Gift Tax 2 4 2.1 8 2.4%

__________________________________________________________________________________
Excise Tax # # 0.5 1 0.1%

__________________________________________________________________________________
TOTAL 27 285 33.3 345

Percent Distribution 7.8% 82.5% 9.7% 100.0%

__________________________________________________________________________________
* Since the underpayment gap figures are generally actual amounts rather than
estimates, they are presented here to the closest $0.1 billion.

# No estimates are available for these components.

Amounts may not add to totals due to rounding. See Figure 1 regarding the
reliability of estimates.




The estimate of the self-employment tax underreporting gap is $39 billion, which accounts for about 11 percent of the overall tax gap. Self-employment tax is underreported primarily because self-employment income is underreported for income tax purposes. Taking individual income tax and self-employment tax together, then, it can be seen that individual underreporting contributes approximately 68 percent of the overall tax gap.

Figure 3 presents the same information, broken out by type of taxpayer (as defined by the IRS operating divisions that serve the taxpayer) rather than by type of noncompliance. This indicates that most of the underreporting of individual income tax is associated with individuals who have business income. The underreporting of self-employment tax is closely associated with the underreporting of business income by individuals; sole proprietors who understate their business income for income tax purposes are not likely to report the unreported income for employment tax purposes either.

Figure 3

Tax Year 2001 Gross Tax Gap by Type of Tax and IRS Operating Division (in $ billions)



________________________________________________________________________________
IRS Operating Division TOTAL


________________________________________________________________
Type of Tax Wage & Small Business / Large & Tax-ExemptTax Gap Non-Com-
Invest- Self-Employed Mie-Size& Gov't pliance
ment BusinessEntities Rate

________________________

Indi- Corpor Total
viduals ations

________________________________________________________________________________
Individual 50 195 N/A 195 N/A N/A 245 20.9%
Income Tax

________________________________________________________________________________
Corporation N/A N/A 6 6 25 1 32 18.5%
Income Tax*

________________________________________________________________________________
Employment Tax 0 40 7 47 8 4 59 8.1%

________________________________________________________________________________
Self-Employment N/A 39 N/A 39 N/A N/A 39 51.9%

________________________________________________________________________________
FICA and FUTA 0 1 7 8 8 4 20 3.0%

________________________________________________________________________________
Estate & Gift # 8 N/A 8 N/A N/A 8 22.9%
Tax

________________________________________________________________________________
Excise Tax† 0 0 0 0 0 0 1

________________________________________________________________________________
TOTAL Gap 50 243 14 257 34 4 345
Percent of 14.5% 70.5% 4.0% 74.5% 9.8% 1.2% 100.0%
Total

________________________________________________________________________________
Noncompliance 12.1% 27.1% 5.3% 22.3% 8.0% 3.4% 16.3%
Rate

________________________________________________________________________________
* Unrelated Business Income Tax is shown as corporation income tax.

† Includes underpayment gap only.

# No estimate is available for this component.

Amounts may not add to totals due to rounding. Zeros indicate amounts less than
$0.5 billion. See Figure 1 regarding reliability of estimates.




Individual income tax accounts for over 71 percent of the overall tax gap estimate of $345 billion. This is due, in part, to the fact that individual income tax is the largest single source of federal receipts.

The individual income tax underreporting gap can be broken out by the various line items on a typical return - income sources, offsets to income (i.e., exemptions, adjustments, and deductions), and offsets to tax (i.e., credits). Figure 4 provides updated estimates of both the tax gap arising from misreporting on each line item and the corresponding Net Misreporting Percentage (NMP).1 These estimates are based on thorough audits of a representative sample of returns, but they also account for underreporting that is not detected in those audits.

As in previous compliance studies, the NRP data suggest that well over half ($109 billion) of the individual underreporting gap came from understated net business income (e.g., unreported receipts and overstated expenses). Approximately 28 percent ($56 billion) came from underreported non-business income, such as wages, tips, interest, dividends, and capital gains. The remaining $32 billion came from overstated subtractions from income (i.e., statutory adjustments, deductions, and exemptions) and from overstated tax credits.

An obvious conclusion from Figure 4 is that the accuracy of reporting the various line items on the average income tax return varies widely, depending on the type of income or offset being reported. Figure 5 presents the same line items grouped by the degree to which the items are "visible" to the IRS - that is, the extent to which they are subject to information reporting and withholding. The conclusion is striking: reporting compliance is strongest in the presence of substantial information reporting and withholding. This is illustrated graphically in Figure 6. Although the contribution to the underreporting gap depends on the dollars of income or offset at stake, the NMP is clearly inversely related to the degree of visibility.

It appears that compliance rates for sections of the Form 1040 where the most noncompliance occurs have not changed dramatically since the last compliance study for TY 1988. The amounts least likely to be misreported on tax returns are subject to both third-party information reporting and withholding and are, therefore, the most visible (e.g., wages and salaries). The net misreporting percentage for wages and salaries is only 1.2 percent.

Amounts subject to third-party information reporting, but not to withholding (e.g., interest and dividend income), exhibit a somewhat higher misreporting percentage. For example, there is about a 4.5 net misreporting percentage rate for items subject to substantial information reporting, such as interest, dividends, pensions, and social security benefits.

Amounts subject to partial reporting by third parties (e.g., capital gains) have a still higher net misreporting percentage rate of 8.6 percent. As expected, amounts not subject to withholding or third-party information reporting (e.g., sole proprietor income and the "other income" line on Form 1040) are the least visible and, therefore, are most likely to be misreported. The net misreporting percentage for this group of line items is 53.9 percent.

Figure 4

Tax Year 2001 Individual Income Tax Underreporting Gap and Net Misreporting Percentage (NMP) Associated with Income and Offset Line Items



___________________________________________________________________________________
Type of Income or Offset Underreporting Net Misreporting
Gap ($B) Percentage†

___________________________________________________________________________________
Total Underreporting Gap 197 18%

___________________________________________________________________________________
Underreported Income 166 11%

___________________________________________________________________________________
Non-Business Income 56 4%

___________________________________________________________________________________
Wages, salaries, tips 10 1%

___________________________________________________________________________________
Interest income 2 4%

___________________________________________________________________________________
Dividend income 1 4%

___________________________________________________________________________________
State income tax refunds 1 12%

___________________________________________________________________________________
Alimony income * 7%

___________________________________________________________________________________
Pensions & annuities 4 4%

___________________________________________________________________________________
Unemployment compensation * 11%

___________________________________________________________________________________
Social Security benefits 1 6%

___________________________________________________________________________________
Capital gains 11 12%

___________________________________________________________________________________
Form 4797 income 3 64%

___________________________________________________________________________________
Other income 23 64%

___________________________________________________________________________________
Business Income 109 43%

___________________________________________________________________________________
Non-farm proprietor income 68 57%

___________________________________________________________________________________
Farm income 6 72%

___________________________________________________________________________________
Rents & royalties 13 51%

___________________________________________________________________________________
Partnership, S-Corp, Estate & Trust, etc. 22 18%

___________________________________________________________________________________
Overreported Offsets to Income 15 4%

___________________________________________________________________________________
Adjustments -3 -21%

___________________________________________________________________________________
SE Tax deduction§ -4 -51%

___________________________________________________________________________________
All other adjustments 1 6%

___________________________________________________________________________________
Deductions 14 5%

___________________________________________________________________________________
Exemptions 4 5%

___________________________________________________________________________________
Credits 17 26%

___________________________________________________________________________________
Net Math Errors (non-EITC) *

___________________________________________________________________________________
† The amount of income or offset misreported divided by the amount that should
have been reported. The NRP contains an adjustment for income amounts that were
underreported, but does not have a corresponding adjustment for offset amounts
that were not claimed.

* Less than $0.5 billion.

§ Taxpayers understate this adjustment because they understate their
self-employment income and, thereby, their self-employment tax. Therefore, the gap
associated with this item is negative.




Figure 5

Tax Year 2001 Individual Income Tax Underreporting Gap and Net Misreporting Percentage (NMP) Associated with Income and Offset Line Items, By Visibility Groups



____________________________________________________________________________________
Visibility Group Type of Income or Offset Underreporting Net Misreporting
Gap ($B) Percentage†

____________________________________________________________________________________
Total Underreporting Gap 197 18%

____________________________________________________________________________________
Items Subject to Substantial Information 10 1%
Reporting and Withholding

____________________________________________________________________________________
Wages, salaries, tips 10 1%

____________________________________________________________________________________
Items Subject to Substantial Information 9 5%
Reporting

____________________________________________________________________________________
Interest income 2 4%

____________________________________________________________________________________
Dividend income 1 4%

____________________________________________________________________________________
State income tax refunds 1 12%

____________________________________________________________________________________
Pensions & annuities 4 4%

____________________________________________________________________________________
Unemployment compensation * 11%

____________________________________________________________________________________
Social Security benefits 1 6%

____________________________________________________________________________________
Items Subject to Some Information Reporting 51 9%

____________________________________________________________________________________
Partnership, S-Corp, Estate & Trust, etc. 22 18%

____________________________________________________________________________________
Alimony income * 7%

____________________________________________________________________________________
Capital gains 11 12%

____________________________________________________________________________________
Deductions 14 5%

____________________________________________________________________________________
Exemptions 4 5%

____________________________________________________________________________________
Items Subject to Little or No Information 110 54%
Reporting

____________________________________________________________________________________
Non-farm proprietor income 68 57%

____________________________________________________________________________________
Farm income 6 72%

____________________________________________________________________________________
Rents & royalties 13 51%

____________________________________________________________________________________
Form 4797 income 3 64%

____________________________________________________________________________________
Other income 23 64%

____________________________________________________________________________________
Total statutory adjustments -3 -21%

____________________________________________________________________________________
Not Shown on Figure 6§ 17 26%

____________________________________________________________________________________
Credits 17 26%

____________________________________________________________________________________
† The aggregate amount of income or offset misreported divided by the sum of the
absolute values of the amount that should have been reported. The estimates of the
amounts that should have been reported account for underreported income that was
not detected by the audits, but do not have a corresponding adjustment for
unclaimed offsets (e.g., deductions, exemptions, statutory adjustments, and
credits) that were not detected.

* Less than $0.5 billion.

§ Since credits are offsets to tax, it is difficult to combine them with income and
income offset items when calculating a combined NMP.





Figure 6 Tax Year 2001 Individual Income Tax Underreporting Gap


With transactions that are less visible to the IRS, and with very low audit rates by historical standards, some sole proprietors may have become emboldened to cut corners on their taxes. Other small business owners may fail to comply fully because they are overwhelmed by the cost and complexity of meeting their tax obligations and their business requirements. Whatever the reasons, there is a serious problem with underreporting for those items not subject to information reporting.

The underpayment gap is the simplest component of the tax gap to measure since, for the most part, it is observed in full. The underpayment gap is the difference between the tax that taxpayers report on their timely filed returns and the amount that is actually paid by the payment due date. The first amount is tabulated from the Individual Master File. With the exception of employer under-deposit of withheld income tax, the amount paid is also tabulated from the Individual Master File.

Figure 7 summarizes the underpayment gap and rates for TY 2001 arrayed by taxpayer type (rather than tax type as in Figure 1). Almost all of what is voluntarily reported is also paid on time, and more than two-thirds of the balance is paid within two years. Individual income tax contributes almost two-thirds of the total underpayment gap, and over three-quarters of the individual income tax underpayment gap is associated with taxpayers who have business income.

Since sole proprietors report their self-employment tax on their individual income tax returns (Form 1040), the TY 2001 NRP study provided new compliance data with which to estimate this component of the tax gap. Self-employment tax is sometimes not reported correctly (or at all) in connection with reported self-employment income that is reported. However, most of this component of the tax gap is associated with unreported self-employment income. The NRP auditors detected some of this unreported income, but not all of it. The IRS estimate of the selfemployment tax underreporting gap accounts for this undetected income. Estimates also account for the fact that some of this unreported income would not be subject to full selfemployment tax, given the annual cap on Social Security taxes. Accounting for all of these factors, the updated estimate of the self-employment tax gap for TY 2001 is $39 billion.

The remaining tax gap estimates shown on the Tax Gap Map (Figure 1) are based on data older than TY 2001. In order to develop estimates based on the latest data, but for a common tax year, the IRS projected the most recent previous estimates to TY 2001 using a simple approach. Lacking information to the contrary, the IRS assumed that the compliance rate for each major component remained constant. The tax gap in a given component was projected to grow at the same rate as tax receipts in that component. The IRS plans to update these estimates as newer compliance data become available.

The main lesson from the Tax Gap Map is that noncompliance is worst where the barriers to voluntary compliance or the opportunities for noncompliance are greatest. This is seen even more vividly in Figure 6, which shows the importance of third-party information reporting.

Figure 7

Tax Year 2001 Underpayment Gap By Type of Taxpayer



_________________________________________________________________________________
Type of Taxpayer Gross Voluntary Net Cumulative Payment
Underpayment Payment Underpayment Compliance Rate†
Gap ($
Billions)


________________________________________
Gap Compliance After After After After
($ Rate† 1 Year 2 Years 1 Year 2 Years
Billions)

_________________________________________________________________________________
All Taxes* 31.7 98.6%

_________________________________________________________________________________
Wage & 4.3 98.9% 2.1 1.8 99.4% 99.6%
Investment

_________________________________________________________________________________
Small Business / 23.7 97.6% 7.3 6.5 99.2% 99.3%
Self-Employed

_________________________________________________________________________________
Large & Mid-Size 3.3 99.6% 2.0 2.0 99.7% 99.7%
Business

_________________________________________________________________________________
Tax Exempt 0.4 99.87% 0.2 0.1 99.95% 99.97%
/Government
Entities

_________________________________________________________________________________
† The Voluntary Payment Compliance Rate is the portion of tax reported on timely
filed returns that is paid on time. The Cumulative Payment Compliance Rate is
the portion of tax reported on timely filed returns that is paid as of a certain
date.

* The $31.7 billion total for all taxes excludes $1.6 billion of individual
income taxes withheld by employers but neither reported on timely filed
employment tax returns nor paid by employers.






VOLUNTARY COMPLIANCE

A wide range of factors influence voluntary compliance, although there is little empirical confirmation as to the most important of these factors or their magnitudes. However, it is generally agreed that IRS actions are not the sole - or perhaps even the primary - determinants of voluntary compliance. In addition to whether information reporting and withholding requirements exist as mentioned previously, other important factors include the following:

Ÿ Tax law changes, including:


o opening or closing opportunities for noncompliance

o tax law complexity may confuse taxpayers or make noncompliance more difficult to observe

o tax rates may affect incentives to report income

Ÿ The economy, including:


o income and unemployment levels

o the mix of industries

Ÿ Demographics, including:


o the aging of the population

o changing household arrangements

o growth in the number of non-English-speaking taxpayers

Ÿ Socio-political factors, including:


o swings in patriotic sentiments

o taxpayer perceptions of whether they are getting their money's worth from their taxes

Additionally, there are both direct and indirect effects of enforcement activities. Direct effects refer to the collection of additional revenue from taxpayers who are subject to enforcement actions. Indirect effects refer to "spillover" effects when enforcement activity on one set of taxpayers has positive effects on the compliance behavior of the rest of the taxpayer population in response to heightened enforcement activity.



MEASURING VOLUNTARY COMPLIANCE

It is very difficult to determine the impact that any IRS activity has on voluntary compliance. While the direct effect of IRS enforcement activities is identifiable through the impact on collections, the IRS cannot easily estimate the indirect effects. That is partly because the IRS cannot observe taxpayers' true tax liabilities (they must be estimated), and partly because so many factors may influence the extent to which they pay their tax voluntarily and timely - including many factors outside of IRS control. The challenge is to estimate the impact of each IRS activity on observable behaviors - returns filed, tax reported, and tax paid - controlling for other influences as much as possible. Only then will the IRS know the best mix of activities that will foster the greatest degree of voluntary compliance.



Long-Term Goal for Voluntary Compliance

The Voluntary Compliance Rate (VCR) is the amount of tax for a given tax year that is paid voluntarily and timely, expressed as a percentage of the corresponding amount of tax that the IRS estimates should have been paid. It reflects taxpayers' compliance with their filing, reporting, and payment obligations. The latest estimate of VCR is 83.7 percent for all taxes and all taxpayers for TY 2001.

In the Administration's budget request for FY 2007, the IRS established a long-term goal of an 85 percent voluntary compliance by TY 2009. In February of 2007, the IRS Oversight Board, as part of establishing a strategic direction for the IRS, established a long-term goal of an 86 percent voluntary compliance rate by TY 2009. Senator Baucus, Chairman of the Senate Finance Committee, has asked for a 90 percent voluntary compliance goal by TY 2017.

An increase in the VCR to 86 percent by TY 2009 may not seem large, but the available evidence suggests that the VCR has not changed dramatically over the last 20 to 30 years. For example, based on TCMP data from the 1960s through the 1980s, the IRS estimates that the VCR has moved within a range of two percentage points and was virtually the same in TY 2001 as it had been in TY 1985.

Much of the estimated fluctuation during this time likely was due to the inherently imprecise nature of these estimates, the impact of the Tax Reform Act of 1986, and the changing relative sizes of revenues from different taxes. Since the IRS has estimated the overall VCR for just a few selected years in that period, it is possible that compliance may have fluctuated in the intervening years. However, the evidence from individual income tax underreporting - by far the largest portion of the tax gap, and the component most frequently measured - indicates that there was no consistent trend over this time period.

The IRS and the public must have realistic expectations about the magnitude and timing of the impact of any reasonable actions to reduce the tax gap, particularly if it is not accompanied by broader simplification and reform of the tax code, or significant advances in compliance technology. Implementing efforts to reduce the tax gap will take time; changing taxpayer behavior significantly will also take time. Accordingly, results from these efforts will be realized incrementally over a number of years. As part of the actions outlined in this report, the IRS will, for example, acquire and analyze new data, improve document-matching programs, refine examination selection criteria, purchase and test new technology, and train employees to handle new enforcement and customer service responsibilities.

Moreover, while it may be possible to take action to reduce the tax gap, it is not possible to implement a policy that eliminates the tax gap without an unacceptable change in the fundamental nature of the current tax compliance system. The IRS is, however, committed to addressing all levels of noncompliance. Therefore, the efforts to reduce the tax gap will continue to be developed and refined to achieve the highest level of compliance possible.



COMPONENTS

With an estimated net tax gap of $290 billion for TY 2001, no single approach will be successful at substantially reducing noncompliance. Accordingly, the Treasury Strategy set out a comprehensive, integrated, multi-year strategy that must be implemented within the context of the annual budget process. This report builds on the work of the Treasury Strategy to provide a comprehensive framework that will be institutionalized by the IRS as part of sound tax administration.

This report includes seven components, detailed below:

1. Reduce Opportunities for Evasion (pages 20-25)

2. Make a Multi-Year Commitment to Research (pages 26-27)

3. Continue Improvements in Information Technology (pages 28-32)

4. Improve Compliance Activities (pages 33-41)

5. Enhance Taxpayer Service (pages 42-49)

6. Reform and Simplify the Tax Law (page 50-52)

7. Coordinate with Partners and Stakeholders (page 53-56)



Component 1



Reduce Opportunities for Evasion

Legislative changes and published guidance will reduce opportunities for evasion.



Legislative Proposals

The Administration's FY 2007 Budget contained five legislative proposals that would reduce evasion opportunities by focusing on employment taxes, information reporting, streamlining collection procedures, and problem return preparers. The Administration's FY 2008 Budget expands on those five and contains several additional proposals that would further reduce opportunities for evasion without unduly burdening honest taxpayers. Collectively, the Department of Treasury estimates that these16 legislative proposals would generate $29.5 billion over the next 10 years. The IRS is encouraged to see that three of the proposals have already become law (in modified form) and that Congress is taking action on a number of the remaining proposals.

Public Law 110-28, Title VIII, the Small Business and Work Opportunity Tax Act of 2007, enacted proposals on amending the collection due process procedures for employment tax liabilities, expanding preparer penalties, and creating an erroneous refund claim penalty. These proposals, along with others contained in the FY 2008 Budget, are described below in more detail:

Expanding Information Reporting: Third-party reporting is critical for ensuring voluntary compliance. Without reliable third-party data, the IRS cannot easily detect errors in the absence of expensive and intrusive audits. The IRS receives over 1.5 billion information returns a year, reporting income from employers, financial institutions, third-party payers, and state and federal governments. However, the IRS still lacks reliable information on certain types of income, most notably income earned by small businesses and the self-employed. Information reporting proposals in the Administration's FY 2008 Budget would:

Ÿ Require information reporting on payments to corporations. This proposal would require a business to file an information return for payments aggregating to $600 or more in a calendar year to a corporation (except a tax-exempt corporation). This proposal is estimated to generate $7.7 billion over the next ten years.

Ÿ Require basis reporting on security sales. This proposal would require certain brokers to report information regarding adjusted basis in connection with the sale of certain publicly traded securities. Brokers would also be required to report acquisition or disposition dates to help determine gain or loss for taxpayers. This proposal is estimated to generate $6.7 billion over the next ten years.

Ÿ Expand broker information reporting. This proposal would require a broker who is an auctioneer or operates a consignment business (electronic or other) to file an information return showing customer information and gross proceeds from the sale of tangible personal property. The requirement would apply only for customers with 100 or more separate transactions generating at least $5,000 in gross proceeds in a year. This proposal is estimated to generate $2.0 billion over the next ten years.

Ÿ Require information reporting on merchant payment card reimbursements. This proposal would provide the IRS with authority to put into effect regulations requiring merchant acquiring banks (organizations that process card payments for merchants) to report to the IRS annually the gross reimbursement payments made to merchants in a calendar year. This proposal is estimated to generate $10.7 billion over the next ten years.

Ÿ Require a certified Taxpayer Identification Number from contractors. This proposal requires a contractor receiving payments of $600 or more in a calendar year from a particular business to furnish to the business its certified Taxpayer Identification Number (TIN). This proposal would require a business to verify the TIN with the IRS, which would be authorized to disclose whether the TIN-name combination matches IRS records. If a contractor fails to furnish an accurate certified TIN, the business would then be required to withhold a flat rate. This proposal is estimated to raise $749 million over the next ten years.

Ÿ Require increased information reporting for certain government payments for property and services. This proposal would authorize the IRS and Treasury Department to issue regulations requiring information reporting on all non-wage payments by federal, state and local governments to procure property and services. This proposal is estimated to generate $390 million over the next ten years.

Ÿ Increase information return penalties. This proposal would increase the $50 and $100 penalty amounts to $100 and $250, respectively, and would increase the $250,000 and $100,000 penalty caps to $1,500,000 and $500,000, respectively. This proposal is estimated to generate $546 million over the next ten years.

Improving Compliance by Businesses: More efficient filing mechanisms, clearer rules on who is liable for employment taxes, and streamlined collection due process will contribute to improved business tax compliance.

Ÿ Require e-filing by certain large organizations. This proposal would require all corporations and partnerships required to file Schedule M-3 to file their income tax returns electronically. In the case of large taxpayers not required to file Schedule M-3, such as exempt organizations, the regulatory authority to require electronic filing would be expanded beyond the current 250-return minimum.

Ÿ Implement standards clarifying when employee leasing companies can be held liable for their clients' federal employment taxes. This proposal would set standards for holding employee leasing companies jointly and severally liable with their clients for federal employment taxes. This proposal would provide standards for holding employee leasing companies solely liable if they meet specified requirements. This proposal is estimated to generate $57 million over the next ten years.

Ÿ Amend collection due process procedures for employment tax liabilities. Legislation was signed May 25, 2007, implementing a modified version of this proposal. It expands the exception to the requirement for pre-levy Collection Due Process proceedings to include certain levies issued to collect federal employment taxes. The change will generate an estimated $364 million over the next ten years.

Strengthening Tax Administration: Tax administration will be strengthened through disclosure revisions and stronger penalties for nonfiling.

Ÿ Expand IRS access to information in the National Directory of New Hires (NDNH) for tax administration purposes. This proposal would amend the Social Security Act to expand IRS access to NDNH data for general tax administration purposes, including data matching, verification of taxpayer claims during return processing, preparation of substitute returns for noncompliant taxpayers, and identification of levy sources.

Ÿ Permit disclosure of prison tax scams. This proposal would authorize the IRS to disclose certain limited return information about tax violations by inmates so prison officials could punish and deter such conduct through administrative sanctions. This is expected to generate $5 million over the next ten years.

Ÿ Make repeated willful failure to file a tax return a felony. This proposal would subject any person who willfully fails to file tax returns in any three years within any five year period, if the aggregated tax liability for such period is at least $50,000, to a new aggravated failure to file criminal penalty. This proposal is estimated to generate $12 million over the next ten years.

Strengthening Penalties: Enhanced penalties will help to deter noncompliance.

Ÿ Expand preparer penalties. Legislation was signed May 25, 2007, implementing a modified version of this proposal. It expands the scope of the existing preparer penalties to include non-income tax returns and related documents. The proposal also increases related penalty amounts. The change will generate an estimated $80 million over the next ten years.

Ÿ Impose penalty on failure to comply with electronic filing requirement. This proposal would establish a penalty for failure to comply with e-file requirements. The amount of the penalty would be $25,000 for a corporation or $5,000 for a tax-exempt organization.

Ÿ Create an erroneous refund claim penalty. Legislation was signed May 25, 2007, implementing a version of this proposal. It imposes a penalty of up to 20 percent of a disallowed portion of a claim for refund or credit for which there is no reasonable basis for the claimed tax treatment, or for which the taxpayer did not have reasonable cause. The change will generate an estimated $98 million over the next ten years.

The Treasury Department and the IRS will continue to explore additional possibilities for legislative proposals, as well as improved methods for using external data and data from information reports.



Published Guidance

Published guidance in the form of regulations, revenue rulings, revenue procedures, notices, and announcements is a critical element in the IRS' efforts to reduce tax avoidance, improve taxpayer compliance, and close the tax gap.

Published guidance:

Ÿ Enhances compliance by providing detailed substantive and procedural rules;

Ÿ Helps compliant taxpayers better understand how to determine and pay their tax liability;

Ÿ Reduces disputes between the IRS and taxpayers regarding the proper interpretation of the tax law and the procedures necessary to comply with it; and

Ÿ Makes it more difficult for noncompliant taxpayers to avoid detection or incorrectly claim that their behavior is permitted under the tax law.

Some tax statutes specifically direct the Treasury Department and the IRS to issue regulations or other guidance. Certain statutory provisions have little or no effect until implemented by regulations or other administrative guidance, and some provide only general direction and broadly delegate authority to publish regulations. Published guidance interprets the tax law and articulates how it applies in different circumstances, thus helping taxpayers determine how to comply with their tax obligations.

The Treasury Department and the IRS continue to resolve many difficult issues and remove impediments to voluntary compliance through published guidance. The ever-increasing complexity of, continuing changes in, and temporary nature of the tax law also present significant challenges to addressing long-standing compliance problems through guidance. The published guidance program also aids in identification of issues that guidance cannot address and serves a significant role in developing suggestions for legislative solutions.

Each year, the Treasury Department and the IRS issue a Priority Guidance Plan (PGP) that sets forth the guidance projects targeted for completion over the course of the following 12 months. The PGP typically includes more than 250 separate guidance projects.

Examples of published guidance designed to improve compliance recently issued by the Treasury Department and the IRS include:

Ÿ Regulations clarifying the tax rules and information reporting requirements for widely held fixed investment trusts;

Ÿ Regulations implementing and explaining new tax shelter disclosure rules and penalties;

Ÿ Regulations and other guidance on reporting and inclusion in income of deferred compensation from nonqualified deferred compensation plans;

Ÿ Regulations and other guidance clarifying and explaining the new deduction for domestic production activities;

Ÿ Guidance explaining the rules governing charitable contributions of vehicles;

Ÿ Guidance on transfer pricing issues related to cross-border services and cost-sharing agreements;

Ÿ Proposed regulations addressing the tax treatment of private annuities;

Ÿ Guidance designating a loss importation strategy as a listed transaction;

Ÿ Guidance implementing a new excise tax on tax-exempt entities and their managers in connection with participation in certain potentially abusive transactions;

Ÿ Guidance improving information reporting for certain wagering activities;

Ÿ Proposed regulations addressing when expenditures for tangible property may be deducted or must be capitalized; and

Ÿ Rulings addressing the consequences, including potential penalties, of filing returns (or failing to file returns) based on frivolous tax positions.

Issuing published guidance is an important tool for the IRS in closing the tax gap. Notwithstanding the inherent challenges, the Treasury Department and the IRS will continue to provide published guidance to improve compliance by addressing abusive tax avoidance transactions, providing clarifications and explanations of the tax laws, ensuring consistency of treatment of similarly situated taxpayers, and where possible, reducing burden on compliant taxpayers.

Some projects currently underway include development of guidance in these areas:

Ÿ Transfer pricing (Internal Revenue Code (IRC) section 482)

Ÿ Foreign tax credits (IRC section 901)

Ÿ Patent cross licensing

Ÿ International restructurings (IRC section 367)



Initiatives

Ÿ Work with Congress to enact remaining legislative proposals included in Administration's FY 2008 Budget:


o Require information reporting on payments to corporations;

o Require basis reporting on security sales;

o Expand broker information reporting;

o Require information reporting on merchant payment card reimbursements;

o Require a certified Taxpayer Identification Number from contractors;

o Require increased information reporting for certain government payments for property and services;

o Increase information return penalties;

o Require e-filing by certain large organizations;

o Implement standards clarifying when employee leasing companies can be held liable for their clients' federal employment taxes;

o Expand IRS access to information in the NDNH for tax administration purposes;

o Permit disclosure of prison tax scams;

o Make repeated willful failure to file a tax return a felony; and

o Impose penalty on failure to comply with electronic filing requirement.

Ÿ Develop new legislative proposals for consideration in the Administration's FY 2009 Budget. Approaches under consideration include:


o Improvements in coordination with State governments, including coordination concerning licensing activities; and

o Further expansions of information reporting requirements, including reporting of financial activity that currently may not be subject to information reporting.

Ÿ Develop regulations and other published guidance clarifying ambiguous areas of the law, targeting specific areas of noncompliance, and preventing abusive behavior.



Component 2



Make a Multi-Year Commitment to Research

Research is critical in helping the IRS understand behavior, develop strategies, and measure progress.

Research enables the IRS to develop strategies to combat specific areas of noncompliance, improve voluntary compliance, allocate resources more effectively, and reduce the tax gap. Compliant taxpayers benefit when the IRS uses the most up-to-date research to improve workload selection formulas, because this reduces the burden of unnecessary taxpayer contacts and because it enables the IRS to collect more with a given level of resources. Research is also critical in helping the IRS establish benchmarks against which to measure progress in improving compliance.

The NRP demonstrates the importance of comprehensive compliance data. In addition, accurate NRP data provides a critical benchmark for determining the sources of noncompliance and for measuring changes in compliance over time. Data from the NRP reporting compliance study have allowed the IRS to:

Ÿ Target examinations and other compliance activities better, thus increasing the dollar-per-case yield and reducing "no change" audits of compliant taxpayers; and

Ÿ Improve operational audits by using innovations pioneered during the 2001 NRP to reduce taxpayer burden.

Continued compliance research is a vital component of a sound tax gap strategy. An NRP reporting compliance study of 5,000 S corporation tax returns filed in 2003 and 2004 is currently in process. Since 1985, S corporation return filings have increased dramatically. In that year, there were 722,444 Forms 1120S filed. In 2004, that number had grown by nearly five times to over 3.6 million, while other corporate returns declined by approximately 500,000 for the same period.

By 1997, S corporations had become the most common corporate entity. In 2004, tax returns filed by S corporations accounted for over 63 percent of all corporate returns filed. The last time the IRS conducted an S corporation study was 1984. As a result, the IRS does not have reliable reporting compliance data for these entities. The current S corporation study represents the first time that the IRS has conducted a reporting compliance study across tax years, and it will require that the data be knitted together to provide a comprehensive picture. The study will continue through 2007.

Without new reporting compliance studies, the IRS must rely on studies conducted over 20 years ago to estimate compliance for areas other than individual income tax or S corporations. Moreover, with each passing year, the data from the 2001 study on individual income tax compliance becomes more outdated. Without up-to-date studies in all areas, the IRS is hampered in its ability to respond rapidly to trends and emerging vulnerabilities in the tax system. A multi-year commitment to research ensures that the IRS can efficiently target resources and effectively respond to new sources of noncompliance as they emerge.

The Administration's FY 2008 Budget request for the IRS funds for three significant research initiatives. These include:

Ÿ Increasing compliance studies. The IRS will conduct reporting compliance studies for additional segments of taxpayers for which the IRS now relies on very old data (e.g., corporation income tax, employment tax, and partnerships), or for which the IRS has never conducted any compliance studies at all (e.g., excise tax).

Ÿ Updating existing data from the 2001 NRP study. The IRS will conduct an annual study of compliance among Form 1040 filers based on a smaller sample size than the 2001 NRP study. This will provide fresh compliance data each year and, by combining samples over several years, will provide a regular update to the larger sample size needed to keep the IRS' targeting systems and compliance estimates up to date.

Ÿ Researching the effect of service on taxpayer compliance. This project will undertake new research on the needs, preferences, and behaviors of taxpayers. The research will focus on four areas:


1. Meeting taxpayer needs by providing the right channel of communication;

2. Better understanding taxpayer burden;

3. Understanding taxpayer needs through the errors they make; and

4. Researching the impact of service on overall levels of voluntary compliance.



Initiatives

Ÿ Undertake additional compliance studies, including S corporations and individuals.

Ÿ Update tax gap estimates using new and existing data.

Ÿ Research the effect of service on taxpayer compliance.

Ÿ Research the relationship between complexity, burden, and compliance.



Component 3



Continue Improvements in Information Technology

A combination of new systems and enhancements to existing systems is critical to a productive use of resources.

Information technology (IT) modernization is critical to ensuring the most productive use of both taxpayer service and compliance resources. It provides the necessary infrastructure that allows the most efficient utilization of resources, which in turn allows the IRS to target key components of the tax gap better. Because IT modernization is a cornerstone to efficient and effective tax administration, the IRS is committed to strong oversight and accountability of IT projects.

The IRS information technology vision includes systems that:

Ÿ Allow for better identification of the cases to be worked;

Ÿ Route those cases to the most appropriate workstream; and

Ÿ Employ cost effective technology analytics to best manage cases once they reach the correct workstream.

The IRS' current investment in technology infrastructure includes a combination of new systems and enhancements to existing systems, with emphasis on improving both effectiveness and efficiency. Included in this infrastructure are tools to increase taxpayer compliance through early detection, improved case selection, more efficient case delivery, and better case management:

Ÿ Case Selection. The NRP provides significant data for improving case selection criteria. NRP data facilitates selection of the most productive returns to examine. This not only reduces the tax gap, but also allows the IRS to update tax gap estimates. The case selection process is further enhanced through automated classification processes. The IRS also uses current audit information from "issue management" systems to provide for immediate identification of emerging issues. For Collection programs, the IRS will use improved decision analytics to select cases and route them to the most appropriate workstream.

Ÿ Case Delivery. Delivery systems also are being modified to move audit work into the system more effectively and efficiently. Both return classification and delivery will move toward digital rather than paper-based returns, eliminating the time consuming and expensive process of ordering returns and sending examiners out to IRS campus locations for classification details. Additionally, the IRS will replace manual processes with electronic case building and instant access to multi-year tax return information.

Ÿ Case Management. Automated systems are being deployed to allow more batched processing of high volume types of examinations. Technology enhancements will allow employees to work cases in an online environment, where returns and case-related data can be downloaded, and actions can be tracked electronically. The IRS will continue to link multiple internal and external databases to enhance overall effectiveness, allowing better identification, management, and performance monitoring for compliance workload. The IRS also has several projects that will enhance criminal enforcement, with spillover effects to civil cases.

The Administration's FY 2008 Budget request includes an additional $81 million in funding to improve the IRS' information technology infrastructure, which is vital to improving IRS' enforcement and services capabilities. The investments proposed in the Budget will allow the IRS to:

Ÿ Upgrade critical IT infrastructure. This will provide funding to upgrade the backlog of IRS equipment that has exceeded its life cycle. Failure to replace the IT infrastructure will lead to increased maintenance costs and will increase the risk of disrupting business operations. Planned expenditures in FY 2008 include procuring and replacing desktop computers, automated call distributor hardware, and Wide Area Network/Local Area Network routers and switches.

Ÿ Enhance the Computer Security Incident Response Center (CSIRC) and the network infrastructure security. This will allow the CSIRC to keep pace with the ever-changing security threat environment through enhanced detection and analysis capability, improved forensics, and the capacity to identify and respond to potential intrusions before they occur.

Ÿ Enhance the IRS' network infrastructure security. This will provide the capability to perform continuous monitoring of the security of operational systems using security tools, tactics, techniques, and procedures to perform network security compliance monitoring of all IT assets on the network.

The FY 2008 Budget request also includes a total of $282 million to continue the development and deployment of the IRS' Business Systems Modernization (BSM) program in line with the recommendations identified in the IRS' Modernization, Vision, and Strategy. This funding will allow the IRS to continue progress on modernization projects, such as the Customer Account Data Engine (CADE), Account Management Services (AMS), Modernized e-File (MeF), and Common Services Projects (CSP).

Ÿ Continue development of CADE and AMS. The development of CADE and AMS systems is the heart of IRS' IT modernization. These two systems, working together, will enable the IRS to process tax returns and deal with taxpayer issues in a near real-time manner. The objective is for the IRS to operate similarly to a bank, where account transactions occurring during the business day are posted and available by the next business day. In addition, AMS will enable the IRS representatives who work with taxpayers to have access to all current information regarding that taxpayer, including electronic access to tax return data and electronic copies of correspondence. Armed with such comprehensive and up-to-date information, IRS representatives will be in a much better position to help taxpayers resolve their issues, which benefits both the IRS and taxpayers while promoting voluntary compliance.



The development of CADE and AMS also includes a comprehensive re-working of the notice system to streamline the process and enhance its efficiency. In July 2008, CADE is scheduled to post and settle tax returns with a balance due condition and amended tax returns, Form 1040X. The daily settlement of these accounts through CADE and the linkage with AMS will enable the balance due notices to be sent on a daily basis and delivered to the taxpayer as much as eight days faster than current time lines.

Ÿ Continue development of MeF. MeF is the future of electronic filing. It provides a standard data format for all electronically filed tax returns, which will reduce the cost and time to add and maintain additional tax form types. MeF is a flexible real-time system that streamlines the processing of e-filed tax returns, resulting in a quicker filing acknowledgement to the taxpayer or their representative. In FY 2007, the IRS is beginning the development and implementation of the Form 1040 on the MeF platform. The MeF system will enable the IRS to better analyze tax compliance issues and address noncompliance among taxpayers by removing the impediments caused by lack of data availability and completeness, access, and data accuracy. MeF will allow the re-engineering of much of the current manual and time consuming compliance processes including the following:


o Completeness of Data. The MeF system provides 100 percent of the data contained within the returns, their schedules and attachments, third-party documents, and amended returns in an electronic form. All documentation will be available completely and electronically, which is equivalent to a paper copy of the entire return file, but in a more usable and transportable form. The current e-filing system only provides returns and does not have the ability to provide supplemental documentation, including attachments, electronically. Paper submissions provide only limited transcriptions of return data or an image of the return. All other documentation is recalled and analyzed using time consuming manual processes.

o Data Availability and Access. Currently, IRS electronic systems capture an average of 20 percent of the data contained within tax and information returns. To gather additional information for compliance needs, the IRS must conduct manual transcriptions, which are costly and time consuming. For each form, the amount of information retained or transcribed varies by form type, complexity, and size. For those returns submitted through MeF, 100 percent of the data will be available to the IRS in electronic format, including associated schedules and attachments, regardless of the form type and without additional expense.

o Data Accuracy. The IRS currently expends time and resources ensuring the data received from tax and information filers and transcriptions are accurate and reliable. The MeF system and its processes increase data accuracy by reducing the incidence of errors and by minimizing the need for manual transcriptions. This is made possible by validating the information prior to submission. The use of business rules also ensures that the returns are free of computation errors.

o Cost Effective Data Capture & Storage. The manual processing of return data, attachments, and schedules is time consuming and costly. E-filing is the most effective means of capturing, storing, and recalling data. Savings include a reduction in submission processing and storage costs. Additional savings will be achieved from reduced cost for retrieving and re-filing returns for examinations and transcription for identification of compliance trends or research.

Ÿ Fed/State Electronic Federal Tax Payment System. The IRS and the Treasury Department's Financial Management Service are developing a pilot in conjunction with South Carolina and Illinois. The pilot will enable Illinois taxpayers (South Carolina will participate in a later phase) to pay all their federal and certain state taxes online via the Treasury's Electronic Federal Tax Payment System (EFTPS). This initiative will provide one stop for taxpayers to make their federal and state tax payments.

Ÿ Compliance Monitoring Process. Compliance monitoring is premised on the notion that the IRS should make use of every available tool and public data source in trying to bring corporations into compliance. The Large and Mid-Size Business (LMSB) division has designed a Compliance Monitoring Process (CMP). LMSB developed and will be implementing an enhanced compliance initiative dependent on information technology that leverages the increases in transparency mandated by Sarbanes-Oxley and other laws. This program also leverages the increased transparency of public companies' financial statements that will result from implementation of Financial Accounting Standards Board Interpretation No. 48 (FIN 48).

The benefits accruing from the delivery and implementation of BSM projects not only provide value to taxpayers, and the business community, but also contribute to operational improvements and efficiencies within the IRS.



Initiatives

Ÿ Improve high income and non-EITC exam workload selection and method of delivery and assess the effectiveness of the exam treatment stream on selected nonfiler cases. (Also supports Component 4)

Ÿ Expand Automated Underreporter (AUR) Auto Notice Generation to include additional income types and all Form 1040 family returns. (Also supports Component 4)

Ÿ Develop system requirements for expanding the AUR Soft Notice Test, which involves asking taxpayers to voluntarily self-correct for future years. (Also supports Component 4)

Ÿ Evaluate the AUR matching process, and implement an improved case scoring and selection concept to select the most productive cases. (Also supports Component 4)

Ÿ Develop enhancements to the Compliance Data Warehouse to improve workload identification and prioritization algorithms, allowing better evaluation of alternative treatment streams and ensuring Collection cases receive the most efficient and effective treatments. (Also supports Component 4)

Ÿ Update the Collection inventory management system to improve functionality navigation, performance, and efficiency. (Also supports Component 4)

Ÿ Automate lien delivery, recording, and release processes with state and local jurisdictions to improve the timeliness of lien filings and the payment of fees. (Also supports Component 4)

Ÿ Test the use of statistical modeling techniques within the Tax Exempt and Government Entities Division (TEGE) to detect high-risk compliance patterns in order to use data to expand and improve examination case selection. (Also supports Component 4)

Ÿ Develop and implement a set of compliance decision analytical tools that will support analysis of TEGE returns and other data to detect compliance trends and improve case and issue selection. (Also supports Component 4)

Ÿ Implement a new TEGE electronic examination system (TREES) that will consolidate agent tools to increase the accuracy and efficiency of the examination process.

Ÿ Build and implement MeF receipt of electronic transmissions for additional tax forms.



Component 4



Improve Compliance Activities

Obtaining maximum coverage and yield from available resources is necessary for the greatest impact on compliance.

The IRS has made significant progress in reducing the tax gap through improvements in enforcement efforts. The following examples demonstrate this progress:

Ÿ Enforcement revenues have grown by nearly $15 billion since FY 2001, totaling $48.7 billion in FY 2006.

Ÿ Examinations of individual taxpayer returns increased by 77 percent between FY 2001 and FY 2006, when the IRS conducted nearly 1.3 million examinations. Similarly, the coverage rate rose from 0.58 percent to 0.98 percent during that period.

Ÿ The IRS has focused more resources on examinations of individuals with income over $1 million. The number of examinations in this category rose by almost 80,000 in FY 2006 as compared to FY 2004, the first year the IRS began tracking them separately. The coverage rate has similarly risen from 5.03 percent to 6.30 percent in that period.

Ÿ Audits of business returns increased by 29 percent between FY 2001 and FY 2006. The coverage rate over the same period rose from 0.55 percent to 0.60 percent.

Ÿ Audits of corporations with assets over $10 million grew from 8,718 in FY 2001 to 10,578 in FY 2006, and the coverage rate increased from 15.1 percent to 18.6 percent.

Ÿ Examinations of the very largest corporations, those with assets over $250 million, increased by nearly 30 percent growing from 3,305 in FY 2001 to 4,276 in FY 2006.

Ÿ For audits of taxpayers with assets greater than $10 million, the cycle time per audit has been reduced by 22.6 percent from 23 months in FY 2001 to 17.8 months in FY 2006. This allows IRS to use its resources more efficiently and increase the number of corporate audits conducted.

Ÿ The IRS has placed more emphasis on tax-exempt organizations by increasing the number of examinations by nearly 33 percent from 5,342 in FY 2001 to 7,079 in FY 2006.

Ÿ The IRS achieved a 91.4 percent conviction rate on criminal investigation cases from FY 2001 through December 31, 2006.

Ÿ The IRS established the position of Deputy Commissioner, International to improve oversight of and focus on global taxation issues.

These results reflect the direct impact of IRS enforcement initiatives. Though difficult to quantify, there is also a significant indirect effect of IRS enforcement, which some research suggests could be at least three times the direct effect of enforcement efforts. This indirect effect is seen when an individual thinks twice about failing to report income or overstate a deduction if he or she knows a neighbor or friend has been audited. Similarly, if taxpayers are aware that the IRS is more active, voluntary compliance increases.

The IRS' compliance strategy attacks the tax gap by balancing three critical enforcement principles.

Ÿ Coverage. Balanced audit coverage is important from an IRS presence and noncompliance deterrence perspective.

Ÿ Yield. It is important that IRS resources address those noncompliant returns that will yield the greatest revenue impact for the Treasury Department.

Ÿ Intentional Noncompliant Behavior. The larger components of the tax gap involve more complex issues and/or unreported income that usually require more in-depth audits or in flagrant cases of tax evasion, criminal investigation.

Where possible, the IRS will use low-cost, highly automated systems and resources to maintain or increase compliance coverage levels. Many of these systems will not involve face-to-face interactions with taxpayers. This includes programs such as Automated Underreporter, Automated Collection System, Automated Substitute for Return, correspondence exam, and "soft notices."

The IRS will use a combination of low-cost, highly automated systems and face-to-face interactions with taxpayers to address high yield and complex compliance issues. These include field audits, field collection contacts, and large corporate audits. Resources will be devoted to addressing major and persistent areas of noncompliance through face-to-face interactions with taxpayers.

To ensure coordination of IRS efforts to address all aspects of the tax gap, the Deputy Commissioner for Services and Enforcement has formed an executive level tax gap committee. This committee analyzes compliance data and makes recommendations on the proper allocation of compliance resources so that the IRS can maximize its ability to address the tax gap components. This group is currently quantifying:

Ÿ Coverage rates;

Ÿ Resource utilization;

Ÿ Return on investment (ROI); and

Ÿ Effectiveness of compliance programs.

Though it is not feasible to eliminate the tax gap completely, it is possible to maximize the use of existing resources to address coverage, yield, and noncompliant behavior better. As resources are made available due to shifts in return filing patterns, or from efficiencies achieved from systemic changes (both technology and process), resources will be redirected to address significant components of the tax gap, keeping the factors mentioned above in the proper balance. For example, the IRS cannot simply allocate resources to the highest yielding activities and thereby sacrifice balanced coverage across all elements of noncompliance. Audit coverage rates and return on investment information is provided in Figures 8 and 9.

Figure 8

FY 2006 Coverage Rates for Key Taxpayer Categories



_____________________________________________________________________________________
Enforcement Area Coverage Rate

_____________________________________________________________________________________
Corporations Corporations with Assets > $250M 35.3%


____________________________________________________________________
Corporations with Assets $10M - $50M 14.2%


____________________________________________________________________
1120S Corporations 0.38%

_____________________________________________________________________________________
Individual
Income Individuals > $1M 5.23%


____________________________________________________________________
Tax Individuals > $100,000 1.67%


____________________________________________________________________
Individuals < $100,000 0.89%


____________________________________________________________________
All Individuals 0.98%

_____________________________________________________________________________________
Employment Tax Employment Tax Returns 0.11%

_____________________________________________________________________________________
Estate Tax Estate Tax with Gross Estate > $5M 28.12%

_____________________________________________________________________________________



Figure 9

Estimated Program Marginal Direct Return on Investment (ROI) for FY 2008 Hiring Initiatives*



_____________________________________________________________________________________
IRS Program ROI

_____________________________________________________________________________________
Large Corporate Exam Program 3:1

_____________________________________________________________________________________
Small Business Exam and Collection Program 3:1

_____________________________________________________________________________________
Individual Document Matching 9:1

_____________________________________________________________________________________
Automated NonFiling Program 14:1

_____________________________________________________________________________________



* Marginal ROIs are computed by applying an assumed "marginality" factor to the
observed average return on investment.




Some specific examples of IRS efforts to allocate resources to target specific noncompliance attributed to the tax gap include addressing:

Ÿ Promoters of abusive tax avoidance transactions. While these cases are time consuming to investigate, civil injunction actions often lead to the identification of scheme participants, including many small corporate and individual taxpayers. The IRS then allocates resources to examine and correct the abusive transactions. The IRS also assesses civil penalties as appropriate against abusive promoters and preparers.

Ÿ High income nonfilers. The IRS has campus Taxpayer Delinquency Investigation (TDI) and Automated Substitute for Return (ASFR) programs that address nonfilers. Some highincome cases are not typical and require complex skills to examine. The IRS allocates field resources to investigate and resolve these cases.

Ÿ Offshore activity. Taxpayers who engage in offshore activity for the purposes of underreporting income or participating in a tax haven taxation regime must be addressed. The IRS is improving its ability to identify these cases and the specialized skills of the examiners who handle them.

Ÿ Unscrupulous return preparers. Most return preparers are professional, provide valuable service to their clients, and are effective advocates for good tax administration. Unfortunately, a few unscrupulous preparers can have a significant negative effect on compliance. The IRS allocates resources to conduct visits to Electronic Return Originators (EROs), pursue preparer examinations with the goal of penalizing improper behavior, and seek civil injunctions and/or criminal indictments against the most egregious behavior.

Ÿ Small businesses. Because research indicates there is a greater likelihood of misreporting and underreporting by small businesses, the IRS plans to increase the level of Form 1040, Schedule C examinations.

Improving audit currency and identifying issues for examination are key elements of the IRS' effort to target noncompliance. These efforts often involve finding ways to streamline examinations of compliant taxpayers, so that examination resources can be focused on more problematic areas. Efforts to improve currency and transparency include:

Ÿ Schedule M-3. To improve transparency of corporate taxpayers, the IRS mandated a new Schedule M-3 for large business taxpayers. The Schedule M-3 provides more detail on book-tax differences, enabling the IRS to identify and focus more quickly and precisely on those tax returns and issues that present the highest potential compliance risk.

Ÿ Compliance Assurance Program. The IRS is also expanding the Compliance Assurance Program (CAP), to improve both currency and transparency. The CAP program is a realtime approach to compliance review that allows the IRS, working in conjunction with the taxpayer, to determine tax return accuracy prior to filing. CAP is more efficient than a postfiling examination -- as it provides corporations certainty about their tax liability for a given year within months, rather than years, of filing a tax return. This provides compliant taxpayers with greater certainty as to their tax and financial reporting positions, and allows the IRS to focus its examination resources on more problematic areas.

Ÿ Pre-Filing Agreement. The Pre-Filing Agreement (PFA) program provides taxpayers an opportunity to request that revenue agents examine and resolve potential issues before tax returns are filed. The IRS continues to explore other ways to work with LMSB taxpayers on a pre-filing basis to address their federal tax liability compliance.

Ÿ Leverage Corporate E- file. The IRS is improving issue identification and the selection for examination of high-risk returns through new mandatory e-filing. Many corporations are now required to file their tax returns electronically and this mandate will expand in future tax years. E-filing will provide more consistent treatment and data analysis for efficient, near real time identification of high-risk issues and taxpayers. E-filing and Schedule M-3 together also allow the IRS to identify and exclude more efficiently lower-risk taxpayers from full examinations.

Additional compliance initiatives in process on IRS campuses include:

Ÿ International support. The IRS is expanding investigations of individuals who report income to Puerto Rico but fail to file a Form 1040PR to report social security, begin or end bona fide residence in a U.S. possession, and request to limit partnership withholding from foreign sources.

Ÿ Form 941 nonfilers. The IRS is expanding employment tax compliance efforts through matching information returns filed with the Social Security Administration to the filing of related employment tax returns.

Ÿ Form 1120-S compliance. The IRS is increasing reviews of invalid S corporation returns and their shareholders. Entities that do not have valid elections, and their shareholders' returns, will be adjusted to reflect the proper tax effect.

Ÿ Fed/State referrals. The IRS actively pursues leads obtained through information sharing with the states, as well as initiates examinations based on outcomes of state audits.

IRS employees play a critical role in the effort to improve compliance in terms of both taxpayer service and enforcement. In addition to implementing elements of any strategy to improve compliance, IRS employees also serve as a source for developing these elements in the first place. In order to ensure that the IRS' workforce is responsive to the need to improve compliance, the IRS recently published regulations that remove limitations on the use of quantity measures in evaluating the performance of, or imposing or suggesting goals for, IRS organizational units. These regulations will improve accountability while not changing current provisions that bar the use of performance measures based on quantity measures when evaluating employees' performance.

There are six specific initiatives in the FY 2008 Budget request that are aimed at significantly improving compliance activities. Collectively these initiatives should generate an additional $699 million in revenue when all of the new hires reach full potential in FY 2010. These initiatives will:

Ÿ Improve compliance among small business and self-employed taxpayers in the elements of reporting, filing, and payment compliance. This funding will be allocated for increasing audits of high-risk tax returns, collecting unpaid taxes, and investigating for possible criminal referral persons who have evaded taxes.

Ÿ Increase examination coverage for large, complex business returns, foreign residents, and smaller corporations with significant international activity. Using information from Form 1120, Schedule M-3 and enhanced data resulting from mandatory e-filing, this initiative will address risks arising from the rapid increase in globalization, and the related increase in foreign business activity and multinational transactions where the potential for noncompliance is significant. Improved business processes along with this funding will allow IRS to maintain its attention to the very largest businesses while expanding the overall coverage rate for large corporate and flow-through returns from 7.9 percent to 8.2 percent in FY 2008.

Ÿ Expand document matching in existing sites and the inclusion of document matching at a new site. This enforcement initiative will increase coverage within the Automated Underreporter (AUR) document matching program, resulting in an increase in AUR closures from 2.05 million in FY 2007 to 2.64 million in FY 2010. In addition, a new document matching program will be established at the IRS' Kansas City campus. The establishment of this new AUR site is estimated to result in over $183 million in additional enforcement revenue per year beginning in FY 2010.

Ÿ Increase individual filing compliance through the Automated Substitute for Return Refund Hold Program. This will minimize revenue loss by holding the current-year refunds of taxpayers who are delinquent in filing individual income tax returns and are expected to owe additional taxes. It is estimated that this initiative will result in securing more than 90,000 delinquent returns in FY 2008.

Ÿ Improve tax-exempt entity compliance by preventing the misuse of such entities by third parties for tax avoidance or other unintended purposes. This funding will aid in increasing the number of TEGE compliance contacts by 1,700 (6 percent) and employee plan/exempt organization determinations closures by over 9,000 (8 percent) annually by FY 2010.

Ÿ Increase criminal tax investigations, which will aggressively attack abusive tax schemes, corporate fraud, nonfilers, and employment tax fraud. These investigations will also address other tax and financial crimes identified through Bank Secrecy Act related examinations and case development efforts, which include an emphasis on the fraud referral program.

In addition to these initiatives, the IRS is beginning to realize benefits from the Private Debt Collection program. Pursuant to Congressional authorization, taxpayers receive the same treatment from private collection agencies (PCAs) that they would from the IRS, including access to the Taxpayer Advocate Service. The PCAs only work cases where the taxpayer does not dispute the liability and collect money the IRS could not collect otherwise. Ninetyseven percent of the taxpayers who responded to the IRS customer satisfaction survey regarding contact by a PCA were satisfied with the service received.

Improving compliance in the cash economy is also a focus. A joint IRS/Taxpayer Advocate team is exploring alternatives for improving compliance in this portion of the tax gap. The team has reviewed data from multiple existing studies and is surveying both internal and external sources for potential recommendations.

Another focus is to ensure that attorneys, accountants, and other tax practitioners adhere to high professional standards. The Office of Professional Responsibility (OPR) recently obtained a wholesale review of practitioner tax filing patterns. In addition to providing a statistical analysis of practitioner tax noncompliance, this review identified practitioners whose personal filing patterns were problematic. Circular 230 enforcement action in this area has had the collateral effect of prompting well over 75 percent of the delinquent practitioner returns to be filed after contact by OPR. This enforcement effort reinforces the message that OPR considers tax compliance to be an important matter and expects tax professionals to remain compliant.

OPR is also a participant and lead facilitator of a new return preparer strategy designed to maximize resources and coverage in the noncompliant tax preparer arena. The Servicewide Enforcement Preparer Strategy is comprised of a team representing all functions involved with the return preparer/parallel investigation workload. In addition to an annual planning meeting that has taken place, monthly conference calls are conducted among all members to coordinate between functions to ensure issues and enforcement actions such as injunctions and penalties are consistent, timely, and effective.

Criminal Investigation (CI) supports compliance initiatives and sends a strong public message by investigating egregious tax evaders, chronic noncompliance, promoters and participants in abusive schemes, employment tax evasion, high-income nonfilers, and unscrupulous return preparers. IRS CI has one of the highest conviction rates in federal law enforcement. Over 79 percent of convicted offenders are sentenced to prison terms averaging 22 months. To address offshore and cross-border compliance risks (through enforcement and by issuing guidance), the IRS has formed Issue Management Teams in the following areas:

Ÿ Cost sharing;

Ÿ Abusive foreign tax credit generators;

Ÿ Section 936 exit strategies;

Ÿ Foreign earnings repatriation;

Ÿ Hybrid instruments; and

Ÿ Transfer pricing.

Tax Treaties and Tax Information Exchange Agreements (TIEAs) are two additional important tools in addressing and enhancing international compliance through the exchange of information with other national tax authorities. Through TIEAs and the Exchange of Information Article of Tax Treaties, the IRS is able to develop cross-border information to identify and address abusive transactions for civil and criminal purposes.

Americans seem less tolerant of tax cheating than they did only a few years ago and are generally supportive of IRS compliance activities against tax scofflaws. According to a 2003 Roper poll conducted for the IRS Oversight Board, 81 percent of Americans said it is unacceptable to cheat on income taxes. A 2005 survey for the IRS Oversight Board shows that the number is now 88 percent, as demonstrated in Figure 10.


Figure 10 Percent of Taxpayers Opposed to Cheating


In addition, attitudinal support for compliance remains high as illustrated by the following statistics:

Ÿ Nearly three out of four taxpayers agree that it is everyone's civic duty to pay their fair share of taxes.

Ÿ Nearly one in every three Americans (30 percent) agree that it is everyone's personal responsibility to report anyone who cheats on their taxes, a six point increase from 2004 and 11 point increase from 2003.

Ÿ Although the public continues to feel strongly that the IRS should target large corporations and those at high-income levels who do not comply, increasing numbers feel that it is important to ensure compliance from small businesses (73 percent) and lower-income taxpayers (66 percent), as well.

Ÿ An increasing number of taxpayers cite third-party reporting as a deterrent to noncompliance (41 percent).

Ÿ Over 82 percent of Americans say that their own personal integrity has the greatest influence on whether they report and pay their taxes honestly. This is double the number citing any other factor.

According to the Pew Research Center study "A Barometer of Modern Morals," 79 percent of Americans consider not reporting all income on one's tax return to be morally wrong, while just 5 percent consider it morally acceptable and 14 percent say it is not a moral issue. Of those who said this behavior is morally wrong, cheating on one's taxes ranked second only to cheating on one's spouse.



Initiatives

Ÿ Increase audit coverage and better target returns for examination.

Ÿ Enhance the ability to identify and address tax schemes of business and individuals involving offshore activity, address illegitimate use of tax havens to shelter income, and increase information matching and examination activity for individuals living abroad.

Ÿ Enhance collection programs and increase the Federal Payment Levy Program using thirdparty data.

Ÿ Work with other federal agencies regarding the Federal Payment Levy Program. (Also supports Component 7)

Ÿ Improve compliance by tax preparers through implementation of the Service Wide Enforcement Preparers Strategy. (Also supports Components 3 and 7)

Ÿ Improve collection selection criteria and filters for balance due and nonfiler cases, including identifying and addressing potential high-income nonfilers. (Also supports Component 3)

Ÿ Litigate cases, work settlements, and design large scale resolution initiatives for tax shelter transactions to deter noncompliance. (Also supports Component 1)

Ÿ Initiate a project using Combined Annual Wage Reporting (CAWR) data to identify taxexempt organizations that may not be properly reporting and paying employment taxes. (Also supports Component 3)

Ÿ Increase criminal enforcement on abusive schemes, corporate fraud, employment tax, egregious nonfilers, and on Bank Secrecy Act violations.

Ÿ Improve the alignment and allocation of service-wide resources to identify, develop, and resolve challenges better in the global taxation arena.

Ÿ Improve tax administration to deal more effectively with increased emphasis on globalization by all corporate and individual taxpayers.

Ÿ Increase industry and global issue focus by aligning resources to cases and issues with the highest compliance risk.

Ÿ Leverage the efforts of examiners as well as external partnerships with foreign tax administrators to identify and address emerging issues of significant compliance risk. (Also supports Component 7)

Ÿ Address offshore and cross-border compliance risks through enforcement and by issuing guidance in the following areas:


o Cost sharing;

o Abusive foreign tax credit generators;

o Section 936 exit strategies;

o Foreign earnings repatriation;

o Hybrid instruments; and

o Transfer pricing.



Component 5



Enhance Taxpayer Service

Effective taxpayer service has a significant effect on voluntary compliance.

Taxpayer service is especially important for helping taxpayers avoid making unintentional errors. The IRS provides year-round assistance to millions of taxpayers through many sources, including outreach and education programs, tax forms and publications, regulations and other published guidance, toll-free call centers, the Internet, and Taxpayer Assistance Centers (TACs). In addition, during the filing season, IRS-supported Volunteer Income Tax Assistance (VITA) and Tax Counseling for the Elderly (TCE) sites provide free return preparation services for low-income, elderly, and limited-English-proficiency taxpayers.

Assisting taxpayers with their tax questions before they file their returns reduces burdensome postfiling notices and other correspondence from the IRS and reduces overall inadvertent noncompliance and the need for downstream enforcement.

According to a survey commissioned by the IRS Oversight Board in 2006, taxpayers increasingly recognize that the IRS provides good quality service through a variety of channels, such as its website, toll-free telephone lines, and TACs. This is supported by the metrics used to measure the effectiveness of the IRS' taxpayer service efforts. In category after category, there is improvement in the levels of telephone services, electronic filing, and access to IRS.gov. This is demonstrated by the following statistics:

Ÿ E-filing by individuals has continued to increase, up three percentage points in TY 2005, from 51 percent to 54 percent of all individual returns.

Ÿ The level of service for toll-free assistance was 82 percent, about the same level as in 2005 and up substantially from 2001. (Level of service is a measure that reflects the percentage of calls answered through the IRS' toll-free taxpayer assistance program compared to total call attempts, including calls answered, busy, disconnected, and abandoned.)

Ÿ The level of customer satisfaction with the toll-free line remains 94 percent, the same as in 2005.

Ÿ The tax law accuracy of toll-free response edged up to 91 percent from 89 percent in 2005.

Ÿ Taxpayers continued to find IRS.gov a useful source of information for complying with their tax obligations. Visits to the IRS website jumped nearly 10 percent in 2006 to more than 197 million visits.

Ÿ More taxpayers used the online refund status tool "Where's My Refund." In 2006, there were 24.7 million status checks, up nearly 12 percent from 2005.

Expanded outreach activities to individuals currently underway include:

Ÿ Military Initiative. During FY 2008 the IRS will analyze and determine the results of prior year targeted outreach to retired and soon-to-be retired military on the taxability of military pensions.



Using a control group approach, the comparison of post-outreach delinquency rates with preoutreach rates will assist the IRS in determining the effectiveness and impact of its efforts. Once results are analyzed, strategic direction will be determined for future years for the entire federal employee and retiree population.

Ÿ Disability Initiative. The IRS is partnering with national and local organizations that serve taxpayers with disabilities in an effort to provide education on available tax credits and tax preparation assistance. Initially 30 cities participated and in 2007 it has been expanded to 54 cities.

Ÿ Limited English Proficiency Hispanic Initiative. The IRS is supporting an aggressive multimedia and grassroots outreach campaign targeting communities with a significant number of Hispanic individuals to disseminate tax information and distribute Spanish products.

Ÿ Native American Initiative. Partnering with national and local volunteer organizations to reach hard-to serve areas, such as Indian Reservations, the focus of this initiative is to develop new and enhance existing relationships to increase distribution of educational products and information, expand tax preparation assistance and provide access to a broader array of resources for implementing strategies that include the Earned Income Tax Credit (EITC).

Ÿ Rural Initiative. Building alliances with groups that have extensive pre-existing rural infrastructures and knowledge to reach rural populations, the IRS will partner with the W.K. Kellogg Foundation to bring the Rural Strategy to a national scale. In FY 2007, the Kellogg Foundation agreed to fund rural initiatives in seven states. The IRS will also partner with the U.S. Department of Health and Human Services Welfare Peer Technical Assistance to develop state-wide rural strategies in two states.



The Taxpayer Assistance Blueprint

In July 2005, the Senate Committee on Appropriations issued report language requesting that the IRS conduct a comprehensive review of its current portfolio of services and develop a five-year plan for taxpayer services. This review, conducted jointly with the National Taxpayer Advocate and the IRS Oversight Board, was designed to achieve the following objectives:

Ÿ Establish a credible taxpayer/partner baseline of needs, preferences, and behaviors;

Ÿ Implement a transparent process for making service-related resource and operational decisions;

Ÿ Develop a framework for institutionalizing key research, operational, and assessment activities to plan and manage improved service delivery; and

Ÿ Utilize both short-term performance and long-term business outcome goals and metrics to assess service value.

In April 2006, the Taxpayer Assistance Blueprint (TAB) Phase 1 report was completed and the results presented to Congress. Phase 1 identified and reported five strategic service improvement themes for enhancing taxpayer and practitioner service needs and preferences:

Ÿ Improve and expand education and awareness activities. This theme addresses the critical need for making taxpayers and practitioners aware of the most effective and efficient IRS service options and delivery channels for meeting their tax obligations and receiving benefits they are due.

Ÿ Optimize the use of partner services. This theme emphasizes the critical role of third parties in the delivery of taxpayer services, and calls for improving the level of support and direction provided to partners to ensure consistent and accurate administration of the tax law.

Ÿ Elevate self-service options to meet the expectations of taxpayers. This theme focuses on providing clear, standard, and easily customized automated content to deliver accurate, consistent, and understandable self-assistance service options.

Ÿ Improve and expand training and support tools to enhance assisted services. This theme highlights the need for ensuring accurate information across all channels by improving and expanding training, technology infrastructure, and support for employees, partners, and taxpayers.

Ÿ Develop short-term performance and long-term outcome goals and metrics. This theme provides for the development of a comprehensive set of performance goals and metrics to evaluate how effectively the IRS is meeting taxpayer expectations, and how efficiently it is delivering services.

TAB Phase 2 focused on developing refined data around taxpayer and partner needs, preferences, and behaviors. Phase 2 also identified current planning documents, decision processes, and existing commitments affecting IRS service strategy. The TAB Phase 2 Report, delivered to Congress in April 2007, includes analysis of research results as well as details of a five-year strategic plan for taxpayer service. The TAB Strategic Plan outlines a multi-year commitment to research, including conducting research on the impact of taxpayer service on compliance. This will help the IRS better target taxpayer services and develop programs that can improve voluntary compliance and contribute to reducing the tax gap. The TAB Strategic Plan includes performance measures, service improvement initiatives, and a decision-making and governance process to prioritize service and research initiatives and funding proposals. Continued stakeholder, partner, and employee engagement is incorporated into all aspects of the TAB Strategic Plan.

The IRS does not know what percent of the tax gap is due to inadvertent, unintentional noncompliance that arises from the complexity and confusion surrounding our tax laws, having very little research currently available that addresses this issue. Several research studies are currently underway as part of the TAB Phase 2 to measure the impact of service on reducing inadvertent errors. Additional studies will be included in the proposed five-year research plan. Current research includes:

Benchmark Survey of Taxpayers. This survey will ask 40,000 taxpayers if they have used IRS taxpayer services to help prepare and file their tax returns - and which services and channels (e.g., phone, walk-in, Internet, publications) they used to get this help. The IRS will test to see if there are differences in average values for measures of filing, reporting, and payment compliance for respondents who did or did not use various IRS taxpayer services.

Ÿ NRP Study. The IRS is working to add survey questions to the next set of NRP audits to (1) find out whether taxpayers who used customer service programs had fewer reporting errors on their returns and (2) try to collect useful data on the root causes of inadvertent errors and possible treatments. The IRS is exploring the possibility of incorporating these types of questions into field examination audits on a pilot basis.

Ÿ The Compliance Impact of Preparer, IRS and Self-Prepared Returns. This analysis will divide all returns processed into groups based on who prepared the return: self-prepared, practitioner prepared, IRS prepared, software prepared and other options. The IRS will test to see if measures of filing, reporting, and payment compliance among these groups are significantly different.

Ÿ The Impact of Taxpayer Advocate Service (TAS) Programs on Compliance. This analysis will use Master File transaction codes to determine which taxpayers used TAS services in a particular fiscal year. This group will serve as a test group, and their subsequent filing, payment, and reporting compliance will be tracked. A control group comprised of a random sample of taxpayers who did not use TAS services or IRS services during the same fiscal year will be tracked to determine whether there are significant differences in compliance rates between the two groups.

Ÿ Behavior Testing Lab. This initiative will measure the accuracy of sample tax returns prepared by several focus groups of taxpayers, with and without access to IRS taxpayer services. This is another methodology for measuring the impact of service on compliance.

Analysis of the wealth of taxpayer data compiled as part of TAB Phase 2 revealed certain recurring findings about taxpayer needs, preferences, and behavior. The findings, combined with ongoing policy considerations and priorities, led to the development of TAB Guiding Principles that provide the groundwork for the development of the TAB Strategic Plan for taxpayer service. The TAB Guiding Principles are:

1. The primary goal of service for individual taxpayers is to facilitate compliance with federal tax obligations.

2. A portion of the tax gap is attributable to errors by individual taxpayers. IRS service programs should be designed to prevent, minimize, and correct such errors with due consideration of taxpayer burden.

3. IRS service investments will focus on preventing, minimizing, and correcting taxpayer noncompliance.

4. Enhance the IRS website so that it becomes the first choice of more taxpayers for obtaining the information and services needed to comply with tax obligations.

5. The IRS recognizes the significant role that partners play in tax administration. As such, the IRS will look for opportunities to assist these third parties in helping taxpayers understand and meet their tax obligations.

Based on these principles and extensive research analysis, the TAB Strategic Plan was designed to outline the vision for taxpayer service delivery over the next five years. Key components of the TAB Strategic Plan include the Performance Measures Portfolio, the Service Improvement Portfolio, and the Implementation Strategy. The IRS' ability to conduct research and to improve the delivery of services, and consequently improve compliance, is dependent on a number of variables that contribute to the constant evolution of the TAB Strategic Plan, including tax legislation, the IRS budget, technology, and the public marketplace. Therefore, the implementation strategy must be institutionalized before specific elements of the plan can be realized.

Based on recommendations in the TAB Strategic Plan, consideration is being given to the funding necessary to enhance IRS.gov so that becomes the first choice of individual taxpayers and their preparers when they need to contact the IRS for help. Consideration is also being given to other program initiatives that will address inadvertent, unintentional errors caused by:

Ÿ Language barriers. Pursuing strategies that focus on providing tax information in languages other than English.

Ÿ Educational barriers. Pursuing strategies that focus on expanding and improving the quality of voluntary assistance though VITA/TCE and similar partnership efforts.

Ÿ Misunderstanding of tax law. Pursuing strategies that focus on clarifying and improving forms, instructions and publications to reduce the burden that taxpayers experience in attempting to comply.

Ÿ Communication barriers. Pursuing strategies that focus on improving the quality, ease of use, and access to printed, electronic, and telephonic assistance channels; as well as placement of face-to-face assistance resources to effectively serve taxpayers unlikely to use other service channels.

Ÿ Practitioners' lack of knowledge/understanding of tax law. Pursuing strategies designed to enhance the quality and accessibility of practitioner assistance through education, tailored assistance channels, and effective monitoring of practitioner behavior and return preparation quality.

The Administration's FY 2008 Budget request includes the funding necessary to implement many of the telephone service and website enhancements recommended by the TAB Strategic Plan, as well as funding for research to understand better individual taxpayer noncompliance and the effect of service on compliance. Specific taxpayer service initiatives in the request include:

Ÿ Expand Volunteer Income Tax Assistance (VITA) programs. This will help expand IRS volunteer return preparation, outreach and education, and asset-building services to low income, elderly, Limited English Proficiency (LEP), and disabled taxpayers. It will increase the ability to recruit, train, and support partners for outreach and tax assistance, and to identify those partners best suited to reach special populations.

Ÿ Begin initial implementation of TAB Strategic Plan recommendations. Based on the findings of the TAB, the funding for this initiative will implement telephone service and website electronic interaction enhancements, including the following:


o Contact Analytics. This will provide tools for evaluating contact center experiences by recording, storing, and analyzing every element of a taxpayer's service call. It will provide the capability to drill down to individual recordings, improving the ability to measure call accuracy, timeliness, and professionalism - leading to process improvements and cost savings. It also will improve the ability to identify and respond to problems - leading to more accurate, clearer responses to taxpayers. Employee satisfaction will increase through improved work processes that allow assistors to handle more complex calls with fewer transfers.

o Estimated Wait Time. This will provide a real-time message on the telephone service channel that informs taxpayers about their expected wait time in queue, allowing them to make more informed decisions based on the status of their call. This will reduce taxpayer burden and increase customer satisfaction.

o Expanded Portfolio of Tax Law Decision Support Tools. This enhancement to IRS.gov will provide a common set of support tools to maximize use by taxpayers, partners, and IRS employees. It will enable users to conduct key word and natural language queries on a Frequently Asked Questions (FAQs) database and to receive answers to tax-law questions on an interactive basis. By monitoring taxpayer use, the IRS can continuously improve the information provided to taxpayers, thereby increasing customer satisfaction and operational savings.

o Spanish "Where's My Refund?" This adds the refund status feature to the Spanish webpage on IRS.gov to provide the Spanish-speaking community with the same level of customer service available on the English webpage.

Ÿ Conduct research on the effect of service on taxpayer compliance. This will provide additional resources for a long-term, concerted research effort to identify ways to close the tax gap and to base the allocation of resources to both service and enforcement activities on a clearer understanding of how these activities affect voluntary compliance. This will require compiling more comprehensive data over a number of years, culminating in yearly analyses designed to quantify the effect of most IRS activities on the voluntary compliance of specific taxpayer populations. The research will focus on four areas:


o Meeting taxpayer needs through the most effective and efficient service channels;

o Developing a better understanding of taxpayer burden;

o Understanding taxpayer needs through the errors they make; and

o Examining the effect of service on overall levels of voluntary compliance.



Electronic Tax Administration

There is perhaps no area with greater potential for reducing burden for both taxpayers and the IRS than Electronic Tax Administration (ETA). The benefits of electronic interaction with taxpayers are clear and compelling. Many taxpayers find it more convenient and beneficial to do business electronically than to send paper through the mail. In addition, taxpayers can get their questions answered and can download the form they need at their convenience, at any time of the day or night. For the IRS, handling taxpayer contacts electronically means that employees can be refocused to other high-benefit purposes.

Significant challenges remain in transitioning from a paper-based environment to an electronic-based environment. The IRS has developed an E-Strategy for Growth, which outlines the IRS' plans to reduce taxpayer burden. To achieve the strategic goals, the IRS will develop and implement e-file marketing strategies, continue to expand the use of electronic signatures, and enhance IRS website services for both practitioners and taxpayers. Ultimately, the goal of the IRS is to offer all taxpayers and their representatives the ability to conduct nearly all of their interactions with the IRS electronically.

A key component of ETA for the IRS is e-filing. This system has demonstrated measurable success with regard to individual taxpayer satisfaction. From its modest beginning as a pilot program in 1986 - when 25,000 returns were filed electronically - the number of e-filed returns has dramatically increased, with more than 71 million returns filed electronically in the last filing season. The benefits to these taxpayers include:

Ÿ Faster refunds;

Ÿ More accurate returns;

Ÿ Quick electronic confirmation;

Ÿ Free Internet filing;

Ÿ Easy payment options; and

Ÿ Federal/State e-filing.

An additional service that allows tax professionals and payers to do business with the IRS electronically is e-Services, a suite of Internet based products. These services include Preparer Taxpayer Identification Number (PTIN) applications with instant delivery, Taxpayer Identification Number (TIN) matching for third-party payers, on-line registration for electronic e-Services, and on-line initiation of the electronic return originator application. The e-Services' Incentives Products offered to increase e-filing are on-line Disclosure Authorization, Electronic Account Resolution, and Transcript Delivery System. Due to industry demand, the availability of incentives to those tax professionals and payers that e-file has been lowered from 100 to 5 individual returns filed.

Another electronic service success launched recently is the new Online Payment Agreement available on IRS.gov. Over 90 percent of taxpayers entering into payment agreements with the IRS can now request an agreement and receive confirmation of its approval through this application.



Initiatives

Ÿ Enable taxpayers with disabilities to understand available tax credits and receive tax preparation assistance through partnerships with national and local organizations that serve this unique group of taxpayers. (Also supports Component 7)

Ÿ Increase accuracy on toll-free telephone customer inquiries, processing functions, and paper adjustments.

Ÿ Improve the quality of volunteer-prepared returns through enhancements to the VITA program, including quality training and sample processing reviews.

Ÿ Enhance services to persons with limited English proficiency through: the Taxpayer Assistance Blueprint; development of a Multi-Lingual Strategic Plan; development of a Virtual Translation Office; and launch of a revised version of the Spanish IRS.gov webpage.

Ÿ Improve quality and timeliness of taxpayer contacts by maintaining an enhanced integrated quality assurance process with internal and external partners. (Also supports Component 4) Enhance IRS.gov.

Ÿ Improve services through programs at both the national and local level by expanding collaborations with organizations serving the disabled, Native American communities, and pre-existing rural infrastructures.

Ÿ Expand and enhance the Spanish website to increase electronic options, including options for Spanish language delivery of applications currently only available in English. (Also supports Component 3)

Ÿ Provide Reporting Agents with access to e-Services. (Also supports Component 3)

Ÿ Implement Taxpayer Assistance Blueprint Phase 2, which includes a five-year strategic plan for taxpayer service based on extensive research to understand taxpayer and stakeholder needs.

Ÿ Implement Internet-Customer Account Services (I-CAS) Release 1, which will enable taxpayers to view account information. (Also supports Component 3)

Ÿ Implement I-CAS Release 2, which will enable taxpayers to change their address, file an extension, submit a Power of Attorney, and calculate a payoff amount on balances due via a secure Internet link. (Also supports Component 3)

Ÿ Continue publicity efforts encouraging use of Online Payment Agreement.



Component 6



Reform and Simplify the Tax Law

Current tax law complexity is a substantial barrier to compliance.

The complexity of the tax code makes it difficult for taxpayers to understand their tax obligations and for the IRS to administer the tax law. Special rules, subtle distinctions in the tax law and complicated computations add to this complexity and foster a sense of unfairness in our tax system, which ultimately discourages compliance. Notwithstanding an increasing awareness of the discrepancy in taxes due and taxes paid, the tax law continues to move in a direction of increasing complexity, which frustrates efforts to reduce the tax gap. In 2006 alone, Congress passed six items of legislation that affected the tax law. Within these bills, 223 provisions required over 1,200 actions by the IRS to implement the new requirements. These changes to the tax law further increased complexity and, therefore, lessened the IRS' ability to increase voluntary compliance. Simplification may require a paradigm shift.

Taxpayers who want to comply with the tax law often make unintentional errors on their returns as they struggle to understand complicated rules and forms. Complexity also provides opportunities for those who are willing to exploit the system. Furthermore, complexity makes it difficult for the IRS to detect noncompliance. Simplifying the tax code will reduce unintentional errors by well-meaning taxpayers and reduce opportunities for evasion. A simpler tax code will also be easier for the IRS to administer.

The Administration's FY 2008 Budget provides several proposals that would assist with simplification, reduce errors, and improve taxpayers' understanding of available tax benefits. These proposals would:

Ÿ Clarify the uniform definition of a child;

Ÿ Simplify Earned Income Tax Credit (EITC) eligibility requirements regarding filing status, presence of children, and work and immigrant status; and

Ÿ Reduce computational complexity of the refundable child tax credit.

The complexity of the tax law necessitates that limited IRS resources are increasingly committed to administering a wide array of targeted tax provisions created to meet social policy goals. These targeted provisions divert IRS resources from basic compliance efforts. The IRS has taken a number of steps to reduce taxpayer burden, including the establishment of the Office of Taxpayer Burden Reduction (TBR). Recent improvements in IRS forms, processes, and procedures include:

Ÿ Simplifying the filing requirements for Form 944 (Employer's Annual Federal Tax Return);

Ÿ Eliminating the need for filing Form 2688 (Application for Additional Extension of Time to File U.S. Individual Income Tax Return) by allowing taxpayers to get an automatic six month extension to file; and

Ÿ Creating the EITC Assistant, an on-line tool that helps taxpayers determine their eligibility for the earned income tax credit (EITC) and their estimated EITC amount.

Additional projects to simplify tax forms and processes are currently under review by TBR.

Another IRS resource commitment aimed at addressing the issue of helping taxpayers understand complex tax rules involves form and publication improvement efforts. The IRS originates and improves tax forms, instructions and publications to ensure they are technically accurate, timely, understandable, and as easy to use as possible in order for taxpayers to fulfill their tax filing and payment obligations. There are currently over 1,000 tax products, including forms, instructions, publications, and Spanish tax products. Each year the IRS reviews its products with the goal of simplifying, reducing burden, increasing understanding, eliminating redundancy, and fostering compliance. Based on taxpayer feedback, research, and tax law changes, existing products are revised and new products developed regularly. Recent examples include the Schedule M-3, Form 944, Employer's Annual Federal Tax Return, and the new draft Form 990, Return for Organization Exempt from Income Tax, which is now available for public comment. There are also compliance proposals under review for Forms 1120, U.S. Corporation Income Tax Return, and Form 1065, U.S. Return of Partnership Income. To address potential compliance issues for small businesses and individuals with limited English proficiency, chapters in Publication 17, Your Federal Income Tax, and Publication 334, Tax Guide for Businesses, are being translated into Spanish.

IRS.gov is used to disseminate tax product information and changes. It contains draft forms, final forms, and a What's Hot in Tax Forms, Publications, and Other Tax Products, which includes articles on tax product changes. In addition, there is an email address - taxforms@irs.gov - for submitting comments on IRS tax products.

Focus groups are conducted regularly to obtain taxpayer information relative to product changes. Public interaction is also a focal point of the IRS Nationwide Tax Forums, an annual venue that provides another opportunity for feedback regarding tax forms and publications, and other interactions with stakeholder groups.



Initiatives

Ÿ Work with Congress to enact simplification legislative proposals in Administration's FY 2008 Budget to:


o Clarify the uniform definition of a child;

o Simplify EITC eligibility requirements regarding filing status, presence of children, and work and immigrant status; and

o Reduce computational complexity of the refundable child tax credit.

Ÿ Continue Taxpayer Burden Reduction projects involving:


o Simplifying the S-corporation election process;

o Simplifying employment tax return amendments (Forms 941, 943, 944, and 945); and

o Redesigning Form 8857, Request for Innocent Spouse Relief.

Ÿ Continue Tax Form and Publication improvements.



Component 7



Coordinate with Partners and Stakeholders

Conducting outreach and leveraging external partnerships is a key component.

The IRS is partnering and leveraging resources with local, state, and federal agencies across the country. Examples of accomplishments resulting from these relationships include the following:

Ÿ Centralizing the process for IRS assessments based on state audit reports;

Ÿ Implementing a Questionable Employment Tax Practices (QETP) Initiative to develop a federal and state interagency approach to combat employment tax schemes and increase voluntary compliance. To date, 16 states have agreed to partner with the IRS on this initiative;

Ÿ Obtaining 88 agreements in 27 states with stakeholders such as state professional licensing agencies and local business licensing agencies to distribute educational information to small business applicants;

Ÿ Establishing the Leeds Castle Group with the tax administration agencies of China, India, South Korea, the United Kingdom, Japan, Australia, Canada, France, and Germany to meet regularly to consider and discuss issues related to global and national tax administration;

Ÿ Developing a Joint Operations Center (JOC) for National Fuel Tax Compliance in partnership with the Federal Highway Administration (FHWA) and participating states to act as one seamless organization leveraging resources at the state and federal level to develop fuel tax compliance strategies, including joint examinations and investigations based on JOC data analysis;

Ÿ Utilizing state/federal data for Combined Annual Wage Reporting (CAWR)/Federal Unemployment Tax (FUTA) matches; and

Ÿ Partnering with foreign tax agencies as part of the Organization for Economic Cooperation and Development's (OECD) Forum on Tax Administration.

The IRS, in connection with the OECD Working Party on Aggressive Tax Planning, is currently designing a database of various cross-border tax avoidance schemes in order to share knowledge and information among the OECD members. In addition, several Tax Information Exchange Agreements (TIEAs) recently became effective that will be useful in gathering valuable information (i.e., financial institution information) in the effort to reduce the tax gap.

The United States, Canada, Australia, and the United Kingdom continue their collaboration at the Joint International Tax Shelter Information Center (JITSIC) to supplement the ongoing work of each of the tax administrations in identifying and curbing abusive tax avoidance transactions, arrangements, and schemes. The objectives of JITSIC are to deter promotion and investment in abusive tax schemes, primarily through exchange of information. Exchange of information in JITSIC is done in accordance with the provisions of the bilateral treaties between each of the four countries involved.

Initiatives under development include the following:

Ÿ Data Warehouse/Mining: Conducting a test to evaluate the tax administration benefits of utilizing the state data warehouse concept.

Ÿ State Reverse File Match Initiative (SRFMI): Developing a system where states match IRS master file extracts against state master files to identify those who filed state but not federal returns, and those who reported different amounts on their state and federal returns.

Ÿ Tax Education: Entering into agreements with state education departments and federal immigration agencies to promote "Understanding Taxes" materials to educate younger citizens and foreign taxpayers going through naturalization about U.S. tax responsibilities.

Ÿ Small Business Assistance: Expansion of partnerships with the Small Business Administration (SBA) and its Service Corps of Retired Executives (SCORE) program and Small Business Development Centers (SBDCs), as well as other partners to deliver expanded educational messages directly to business owners.

The IRS also has a robust outreach and education program accomplished through relationships with national and local payroll, practitioner, small business, and industry stakeholder organizations. Examples of accomplishments include:

Ÿ Development of relationships with over 1,500 small business industry and tax professional organizations to deliver expeditiously key tax-related messages to small business audiences.

Ÿ Delivering information through Phone Forums to practitioners, industry representatives, and small business owners.

Ÿ Implementing Small Business Forums with industry representatives and small business owners.

Ÿ Offering multiple educational products, such as:


o Electronic newsletters including "e-news for Tax Professionals" and "e-news for Small Businesses";

o The Virtual Small Business Tax Workshop DVD, a 10-lesson interactive video;

o The Small Business Resource Guide CD-Rom;

o The Tax Calendar for Small Businesses and Self-Employed; and

o "Tax Talk Today," a monthly web cast for tax professionals featuring IRS representatives discussing significant tax issues.

Ÿ Developing and widely distributing educational information on areas of high noncompliance, such as computation of business income, cost of goods sold, and various business expenses.

Ÿ Establishing a system to track resolution of problem issues identified by stakeholders (Issue Management Resolution System);

Ÿ Delivering an outreach campaign to industries that includes Audit Technique Guides and Tax Tips, which provide specific information for small businesses; and

Ÿ Providing Ethics Seminars for Practitioners addressing requirements from the Circular 230.

Initiatives include development of strategies to:

Ÿ Provide outreach and education to unaffiliated tax professionals - those who provide tax preparation services but do not align themselves with a professional organization; and

Ÿ Increase outreach and education regarding e-Commerce issues, including taxability of sales transactions on auction sites.

In addition, the IRS works with partners to disseminate tax information on subjects such as the EITC, child tax credit, e-file, life-cycle events, and compliance issues and to provide free income tax preparation to specific taxpayer populations (i.e., low income, elderly, limited English proficiency, disabled). Relationships exist with 60 national partners such as AARP, Armed Forces Tax Council, United Way, Health & Human Services, Annie E. Casey, and the Kellogg Foundation. In addition, the IRS supports more than 300 coalitions nationwide, comprised of thousands of community partners who educate or serve millions of taxpayers. This effort facilitated the opening of over 12,000 VITA and Tax Counseling for the Elderly sites with more than 68,000 volunteers during the 2006 filing season.



Initiatives

Ÿ Further enhance the centralized process to maximize the utilization of State Audit Reports (SARs) by IRS for federal assessments. (Also supports Component 4)

Ÿ Implement a Questionable Employment Tax Practices (QETP) initiative in partnership with the Department of Labor, the National Association of State Workforce Agencies, the Federation of Tax Administrators, and state workforce agencies, to provide a collaborative national approach to combat employment tax schemes. (Also supports Component 4)

Ÿ Further enhance the Fed/Fed program by facilitating and expanding partnerships with other federal agencies to improve tax administration. (Also supports Component 4)

Ÿ Engage all 50 states through the State Reverse File Match Initiative (SRFMI) - a process that matches IRS extracts received through the Governmental Liaison Data Exchange Program against state master files to identify individuals and businesses who filed a state return but not a federal return and to identify differences in federal and state income reporting. (Also supports Component 4)

Ÿ Determine tax administration benefits of utilizing state date warehouse concept. (Also supports Components 3 and 4)

Ÿ Develop an educational targeted outreach DVD for military personnel preparing for retirement. (Also supports Component 5)

Ÿ Enhance outreach efforts to industry audiences about available Audit Technique Guides and Tax Tips.

Ÿ Establish links to IRS.gov on industry, practitioner, educational, and governmental stakeholders' websites.

Ÿ Develop and widely distribute educational fact sheets on areas of high noncompliance.

Ÿ Develop a strategy to reach practitioners without affiliation to a professional organization.

Ÿ Leverage key partners such as the SBA and its SCORE program and SBDCs to deliver small business workshops to the new business community.

Ÿ Deliver educational messages through existing relationships with universities and colleges.

Ÿ Develop audio educational messages for toll-free wait times.

Ÿ Customize outreach to specific industries to encourage voluntary compliance.

Ÿ Request feedback from internal and external stakeholders on existing outreach and educational programs to identify best practices and enhancements.

Ÿ Develop strategies to educate first-time business filers.

Ÿ Expand relationships and collaboration with foreign tax administrations to increase the informal and formal communications on international tax administration matters.



SUMMARY

To implement the steps outlined in this report successfully, it is imperative for the IRS to have a highly trained and engaged workforce. While not addressed in detail in this report, the IRS is committed to employee engagement, ongoing training assessments and delivery, ongoing agency-wide communications, employee and managerial burden reduction, leadership empowerment, and succession planning. The IRS has extensive action plans and strategies in each of these areas. For example, in the area of succession planning, the IRS has established a Leadership Succession Planning office and is implementing a Leadership Succession Review (LSR) process in FY 2007. The LSR process involves leadership assessments of all senior managers, executive review of the assessments, and one-on-one feedback and discussion of executive potential.

The actions outlined in this report address improving compliance through a balanced approach. This report describes steps currently being taken, and those under development, by the IRS to reduce opportunities for tax evasion, details how the IRS will leverage technology, recognizes the critical need for a strong taxpayer service program, discusses development of taxpayer service initiatives, and describes legislative proposals that, when implemented, will improve compliance. At the same time, the initiatives maintain respect for taxpayer rights, limit burden on compliant taxpayers, and present an outreach approach to ensure all taxpayers understand their tax obligations. This report also details the importance of having a multi-year research program that will assist both in understanding the scope and reasons for noncompliance.

It is important to take all reasonable steps to improve voluntary compliance. As more is learned about the causes of noncompliance and ways to improve voluntary compliance, strategies will be modified to reflect the latest information.

It is clear that consistent efforts to keep the complexity and unnecessary burden of the tax system to a minimum, to provide the level of service that the taxpaying public deserves, and to maintain a strong and well-targeted enforcement presence are necessary to improve compliance rates. The IRS is committed to applying its resources where they are of most value in reducing noncompliance while ensuring fairness, observing taxpayer rights, and reducing the burden on taxpayers who comply.



APPENDIX



Timeframes for Initiative Implementation



___________________________________________________________________________________
Initiatives Related Treasury FY 2008 FY 2009 Beyond
Strategy Milestones Milestones FY
Component(s)† 2009†
(Bold = Primary)

___________________________________________________________________________________
Work with 1, 6 Ongoing 2/09 ü
Congress to IRS will continue to IRS will continue to
enact identify legislative identify legislative
remaining proposals in proposals in
legislative partnership with partnership with
proposals Treasury Treasury
included in
the
Administration's
FY 2008
Budget.

___________________________________________________________________________________
Develop 1 6/30/08 6/30/09 ü
regulations Request Request
and other recommendations from recommendations from
published stakeholders for stakeholders for
guidance topics on which topics on which
clarifying guidance should be a guidance should be a
ambiguous priority priority
areas of
the law, 7/30/08 7/30/09
targeting Identify Identify
specific approximately 250 approximately 250
areas of items for which items for which
noncompliance guidance is a guidance is a
and priority priority
preventing
abusive 8/30/08 8/30/09
behavior. Release the Release the
2008-2009 Priority 2009-2010 PGP
Guidance Plan (PGP)
9/30/09
9/30/08 Release at least 85%
Release at least 80% of the items
of the items appearing on the
appearing on the 2008-2009 PGP
2007-2008 PGP

___________________________________________________________________________________
Undertake 2 10/1/07 10/1/08 ü
additional Begin reporting Begin reporting
compliance compliance study for compliance study for
studies, TY 2006 individual TY 2007 individual
including S income tax returns income tax returns
corporations income tax returns
and
individuals. 6/30/08
Complete S
corporation
compliance study

___________________________________________________________________________________
Update tax 2 6/30/08 6/30/09 ü
gap Release S Update payment and
estimates corporation filing compliance
using new reporting compliance estimates
and study tabulations
existing
data. 6/30/08
Update payment
compliance estimates

___________________________________________________________________________________
Research 2 9/30/08 9/30/09
the effect Undertake at least Undertake at least
of service three significant three significant
on taxpayer research projects research projects
compliance. linking service to linking service to
compliance (e.g., compliance (e.g.,
study relationship study how particular
between taxpayer types of service
attitudes and delivery affect
compliance) individual
compliance)

___________________________________________________________________________________
Research 2 9/30/09 ü
the Undertake survey of
relationship individual taxpayers
between to improve burden
complexity, estimates (e.g.,
burden, and conduct a new survey
compliance. of individual
taxpayer burden)

9/30/09
Begin at least three
research projects
focusing on the
relationships
between complexity,
burden, and
compliance

___________________________________________________________________________________
Improve 3, 4 10/1/07 10/1/08
high income Begin selecting, Begin evaluating the
and classifying, and productivity of
non-EITC auditing individual high-income taxpayer
exam returns based on cases identified
workload updated selection using the revised
selection scores derived from scores and activity
and method NRP TY 2001 results codes
of delivery
and assess 1/30/08 9/30/09
the Implement initial Complete
effectiveness phase of an implementation of
of the exam automated case the automated case
treatment screening and screening and
stream on selection process selection process
selected
nonfiler
cases.

___________________________________________________________________________________
Expand AUR 3, 4 9/30/08 9/30/09 ü
Auto Notice Expand the volume of Expand the volume of
Generation auto notices auto notices
to include bypassing the bypassing the
additional screening phase on screening phase by
income 1040 series returns including the entire
types and ELF Form 1040 series
all Form and add cases from
1040 family SB/SE inventories
returns.
Add withholding to
the auto notice
income issues in an
effort to work the
most productive
cases

___________________________________________________________________________________
Evaluate 3, 4 12/31/07 9/30/09
the AUR Reengineer the AUR Implement additional
matching matching process to improvements to
process, improve coverage and workload selection
and maximize resource tools (e.g.,
implement utilization incorporating
an improved resulting in results as feedback
case increased AUR to validate
scoring and closures rules/score, and
selection adding the
concept to 9/30/08 capability to select
select the Streamline overhead cases for different
most costs by reducing treatments)
productive manual screening
cases.
9/30/08
Complete studies and
implement an
enhanced workload
selection system

___________________________________________________________________________________
Develop 3, 4 9/30/08 9/30/09 ü
system Develop and complete Implement initiative
requirements programming for approximately
for requirements 250,000 taxpayers
expanding
the AUR
Soft Notice
Test, which
involves
asking
taxpayers
to
voluntarily
self-correct
for future
years.

___________________________________________________________________________________
Develop 3, 4 1/1/08 1/1/09
enhancements Release Phase 1 Release Phase 2
to the
Compliance
Data
Warehouse
to improve
workload
identification
and
prioritization
algorithms,
allowing
better
evaluation
of
alternative
treatment
streams and
ensuring
Collection
cases
receive the
most
efficient
and
effective
treatments.

___________________________________________________________________________________
Update the 3, 4 9/30/08 11/1/08
Collection Completion of coding Begin piloting of
inventory and integration the updated system
management testing
system to 1/1/09
improve Begin nationwide
functionality deployment of
and updated system
navigation
and provide 6/30/09
capability Nationwide
to deployment completed
interface
with other
modernized
systems.

___________________________________________________________________________________
Automate 3, 4 9/30/08 8/31/09
lien Complete cost Establish and fully
delivery, analysis, design test prototype
recording, specifications, and
and release establish enterprise 9/30/09
processes standards Full deployment
with state
and local
jurisdictions
to improve
the
timeliness
of lien
filings,
lien
releases,
and the
payment of
fees.

___________________________________________________________________________________
Test the 3, 4 1/31/08
use of All test
statistical examinations
modeling completed
techniques
within TEGE 4/30/08
to detect Final report
highrisk completed
compliance
patterns in
order to
use data to
expand and
improve
examination
case
selection.

___________________________________________________________________________________
Develop and 3, 4 1/15/08
implement a Complete logical and
set of physical design
compliance phase
decision
analytic 5/31/08
tools that Complete system
will development
support
analysis of 7/31/08
TEGE Deploy system to all
returns and users
other data
to detect
compliance
trends and
improve
case and
issue
selection.

___________________________________________________________________________________
Implement a 3 Deployment began in
new TEGE May 2007
electronic
examination 11/30/07
system Complete roll-out of
(TREES) TREES to all TEGE
that will examination revenue
consolidate agents
agent tools
to increase
the
accuracy
and
efficiency
of the
examination
process.

___________________________________________________________________________________
Build and 3 1/08 9/09
implement Deploy Form 1120F on Deploy first phase
MeF receipt the MeF platform of Form 1040 on the
of MeF platform
electronic 1/08
transmissions Deploy Form 990N
for (ePostcard) on the
additional MeF platform
tax forms.

___________________________________________________________________________________
Increase 4 10/1/07 10/1/08 ü
audit Begin selecting, Begin evaluating the
coverage classifying, and effectiveness of the
and better auditing individual updated DIF scores
target returns based on
returns for updated selection 9/30/09
examination. scores (DIF) derived Increase number of
from NRP TY 2001 Schedule C audits by
results an additional 5% to
address the
9/30/08 individual business
Increase number of income tax
Schedule C audits by underreporting gap
7% to address the
individual business 9/30/09
income tax Utilize information
underreporting gap obtained from the
Subchapter S
9/30/08 Corporation National
Migrate Research Project to
correspondence exam enhance return
telephone customers selection and
to the enterprise examinations
call routing
platform, which will 9/30/09
expedite case Begin screening
closures amended returns
through the
Dependent Database

9/30/09
Improve the number
of correspondence
audits that are
closed by enhancing
the case selection
methodology with
real-time
information

1/31/09
Improve
correspondence case
selection
methodologies based
on real-time
information

___________________________________________________________________________________
Enhance the 4 9/30/08 9/30/09 ü
ability to Complete the Analyze results of
identify examination of cases cases in the Broker
and address in the pilot phase Compliance
tax schemes of the Broker Initiative Pilot
of business Compliance phase and update
and Initiative Project. selection criteria
individuals Make IRC section for future cases.
involving 6700 promoter Make IRC section
offshore investigation 6700 promoter
activity, referrals for those investigation
address individuals and referrals for those
illegitimate large businesses individuals and
use of tax identified as large businesses
havens to facilitating abusive identified as
shelter offshore facilitating abusive
income, and transactions as a offshore
increase result of this transactions
information project
matching 9/30/09
and 9/30/08 Implement pilot
examination Develop compliance phase for any
activity initiative projects approved compliance
for in the areas of initiative projects
individuals private banking and
living offshore merchant
abroad. accounts to address
offshore
noncompliance

___________________________________________________________________________________
Enhance 4 8/31/08 3/31/09 ü
collection Work with Centers Work with Financial
programs for Medical Services Management Service (
and ( CMS) to modify FMS) to determine
increase levy processing and feasibility of
the Federal improve offsets of including CMS
Payment Medicare Medicare payments in
Levy reimbursements for the Treasury Offset
Program tax debts Program/FPLP
using
thirdparty
data.

___________________________________________________________________________________
Work with 4, 7 6/30/08 3/31/09
other Increase dollars Increase dollars
federal collected by collected by
agencies expanding FPLP to: pursuing agreements
regarding l Defense Finance with the Department
the Federal and Accounting of Defense to add
Payment Service salary additional Federal
Levy payment files wage and other
Program ( l Department of payments
FPLP). Defense Civilian
Employees
l Department of
Health and Human
Services
l Environmental
Protection Agency
l Department of
Energy

___________________________________________________________________________________
Improve 3, 4, 7 10/1/07 10/1/08 ü
compliance Convene servicewide Update, as
by tax preparer strategy necessary,
preparers summit servicewide preparer
through strategy based on
implementation 3/30/08 research study
of the Finalize and begin findings
Servicewide implementation of
Enforcement servicewide preparer
Preparers strategy
Strategy.
1/1/08
Initiate research
study of preparer
compliance

___________________________________________________________________________________
Improve 3, 4 12/31/07 12/31/08
collection Expand use of Refine Decision
selection third-party Analytics rules to
criteria information and improve inventory
and filters research to enhance delivery
for balance case selection
due and 12/31/08
nonfiler 12/31/07 Develop a new model
cases, Finalize Servicewide to enhance
including Nonfiler Strategy collection case
identifying selection criteria
and
addressing
potential
high income
nonfilers.

___________________________________________________________________________________
Litigate 1, 4 3/31/08 9/30/09
cases, work Complete examination Complete audits of
settlements, of Global Settlement GSI nonparticipants
and design Initiative (GSI)
large scale participants 9/30/09
resolution Continue to litigate
initiatives 9/30/08 unresolved Son of
for tax Litigate unresolved Boss cases, cases of
shelter Son of Boss cases, GSI
transactions cases of GSI non-participants,
to deter nonparticipants, and and promoter penalty
noncompliance. promoter penalty cases that opted not
cases that opted not to take the
to take the resolution
resolution initiative
initiative

___________________________________________________________________________________
Initiate a 3, 4 11/30/07
project Identify
using opportunities for
Combined other employment tax
Annual Wage related projects
Reporting (
CAWR) data 2/28/08
to identify Analyze results of
tax-exempt FY 2007 CAWR
organizations examinations and
that may document lessons
not be learned for future
properly CAWR projects
reporting
and paying
employment
taxes.

___________________________________________________________________________________
Increase 4 9/30/08 9/30/09 ü
criminal Achieve an average Achieve an average
enforcement conviction rate of conviction rate of
on abusive 92% for the combined 92% for the combined
schemes, component programs component programs
corporate
fraud, 9/30/08 9/30/09
employment Achieve an average Achieve an average
tax, publicity rate of publicity rate of
egregious 80% for the combined 80% for the combined
nonfilers, component programs component programs
and on Bank
Secrecy Act
violations.

___________________________________________________________________________________
Improve the 4 12/31/07 3/31/09 ü
alignment Realign LMSB Increase
and International International
allocation Resources to Improve Examiner hiring with
of Integration/Leverage emphasis upon
servicewide Expertise highrisk geographic
resources areas
to 12/31/07
identify, Utilize 12/31/08
develop, International Enhance
and resolve Planning and cross-divisional
challenges Operations Council coordination to
better in to identify ensure coverage and
the global opportunities to development of
taxation conduct significant issues
arena. cross-divisional while reducing
examinations burden

6/30/09
Promote
identification and
assessment of
emerging
international/U.S.
Possessions
compliance issues
through development
of a process for
referrals and a
system for timely
evaluation of those
referrals

___________________________________________________________________________________
Improve tax 4 3/31/08 9/30/09 ü
administration Expand Introduce revised
to deal information-sharing Form 5471 for
more through increased international
effectively membership in the transactions that
with Joint International have potential U.S.
increased Tax Shelter tax issues
emphasis on Information Centre (
globalization JITSIC), by adding 9/30/09
by all Japan and expanding Pilot issue
corporate JITSIC offices to identification and
and London workload selection
individual using filings of the
taxpayers. 3/31/08 revised form 1120F
Introduce new M-3 with Schedule M-3
for Form 1120F to
gather information
on foreign
controlled
corporations

Ongoing
Increase education
and guidance to U.S.
taxpayers of their
withholding
responsibilities on
Fixed Determinable
Annual Periodic (
FDAP) payments to
non-U.S. persons and
expand similar
activities with
qualified
intermediaries

___________________________________________________________________________________
Increase 4 9/30/08 6/30/09
industry Pilot the Shelter Fully implement the
and global Data Management Shelter Data
issue focus system and the Management System (
by aligning automated SDM) and pilot the
resources international issue larger Selection and
to cases selection process Workload
and issues Classification
with the 9/30/08 system, of which SDM
highest Use Transactions of is a part
compliance Interest under
risk. proposed regulation 9/30/09
6011 ( when Integrate
finalized) to international issue
identify emerging identification into
issues overall workload
selection process

9/30/09
Expand use of
Transactions of
Interest approach

___________________________________________________________________________________
Leverage 4, 7 12/31/07 9/30/09 ü
the efforts Expand the use of Complete Basic level
of the Organization for International
examiners Economic Cooperation Training of LMSB
as well as and Development ( Front-line and
external OECD) Abusive Senior Managers to
partnerships Transaction Database improve Issue
with to identify emerging Identification and
foreign tax abusive Familiarity
administrators transactions/ issues
to identify
and address 9/30/08
emerging Hire additional
issues of International
significant Examiners in areas
compliance with high risk
risk. international issues

___________________________________________________________________________________
Address 4 12/31/07 9/30/09 ü
offshore Initiate Project on Issue additional
and Foreign Athletes & regulations on
cross-border Entertainers ( FAE) transfer pricing
compliance to ensure guidance, foreign
risks appropriate tax credit, and
through reporting and foreign trusts, and
enforcement sourcing of income new regulations on
and by cross border
issuing 12/31/07 restructuring
published Complete Voluntary
guidance. Settlement
Initiative for
embassy/consular
employees and begin
enforcement
activities on
nonelectors

9/30/08
Issue regulations on
transfer pricing,
foreign tax credit,
and foreign trusts

___________________________________________________________________________________
Enable 5, 7 12/30/08 12/31/09
taxpayers Partner at the local Partner at the local
with and national levels and national levels
disabilities to expand efforts to expand efforts
to with organizations with organizations
understand that serve people that serve people
available with disabilities, with disabilities
tax credits to increase return and to increase
and receive preparation return preparation
tax assistance space
preparation
assistance 3/31/09
through Work with select
partnerships government entities
with to increase the
national availability of free
and local tax assistance
organizations programs
that serve
this unique
group of
taxpayers.

___________________________________________________________________________________
Increase 5 1/31/08 1/31/09 ü
accuracy on Implement an Continue to develop
toll-free Interactive Tax Law and enhance the
telephone Assistant ( ITLA) Interactive Tax Law
customer tool to assist Assistant ( ITLA)
inquiries, employees in tool to assist
processing providing accurate, employees in
functions, efficient, and providing accurate,
and paper complete responses efficient, and
adjustments. to basic tax law complete responses
telephone inquiries to a wider variety
of more complex tax
1/31/08 law telephone
Continue to develop inquiries
Accessory Manager
Tools that provide 1/31/09
standard research Review nationwide
paths, consolidate error trends to
account data, and determine the areas
automatically where implementation
populate input of an Accessory
fields Manager Tool would
have the most
9/30/08 significant impact,
Implement and develop tools
recommendations from based on this
the Correspondence analysis
Accuracy Improvement
Study 1/31/09
Continue to utilize
program review teams
to conduct annual
quality reviews to
seek improvement
opportunities and
identify best
practices

___________________________________________________________________________________
Improve the 5 3/31/08 12/31/09 ü
quality of Conduct on-site Replace current
volunteer-prepared workshops to address knowledgebased tax
returns quality concerns law preparation
through identified while training with a
enhancements making visits during process-based
to the filing season training approach
Volunteer
Income Tax
Assistance
(VITA)
Program,
including
quality
training
and sample
processing
reviews.

___________________________________________________________________________________
Enhance 5 1/31/08 Ongoing
services to The Internet Maintain the
persons application "Where's application and
with My Refund" allows upgrade annually as
limited taxpayers to access needed
English their refund
proficiency information. This Ongoing
(LEP) application will be Continue expansion
through: offered on the efforts
the Spanish IRS.gov
Taxpayer
Assistance 9/30/08
Blueprint The Multi-Lingual
(TAB); Project Office will
development work with Research
of a to pinpoint isolated
Multi-Lingual community locations
Strategic and identify actions
Plan; to customize
development assistance
of a
Virtual 9/30/08
Translation Launch targeted
Office; and outreach messages
launch of a for LEP taxpayers in
revised isolated communities
version of
the Spanish 9/30/08
irs.gov Expand the Virtual
webpage. Translation Office (
VTO) to increase and
enhance VTO
translations. The
VTO will:
l translate
glossaries of tax
terms into multiple
languages
l produce the tax
forms and
publications
currently published
in Spanish
l create additional
forms and
educational
materials in Spanish
l produce new
educational
materials in other
languages
l lay the foundation
for translating
products into other
IRS-priority
languages

___________________________________________________________________________________
Improve 4, 5 12/31/08 6/30/09
quality and Develop and deliver Engage partners and
timeliness Site Coordinator's employees in
of taxpayer Training feedback
contacts by solicitation through
maintaining 12/31/08 roundtable
an enhanced Define volunteer discussions and via
integrated training levels and partner satisfaction
quality focus on consistent surveys
assurance use of intake and
process interview sheets and
with volunteers
internal performing quality
and reviews
external
partners. 6/30/08
Engage partners and
employees in
feedback
solicitation through
roundtable
discussions and
partner satisfaction
surveys

___________________________________________________________________________________
Enhance 5 9/30/08 9/30/09 ü
IRS.gov. Deploy an Deploy enhancements
interactive tax law to the interactive
decision support tax law decision
tool as recommended support tool to
in the Taxpayer deliver Probe and
Assistance Blueprint Response Capability
report and deliver
improved Frequently
Asked Questions
(FAQs) support

___________________________________________________________________________________
Improve 5 9/30/08 3/31/09
services Increase Work with U.S.
through availability of EITC Department of
programs at education and Agriculture to
both the financial education increase the
national in hard to serve availability of free
and local Native American tax assistance
level by communities through programs
expanding network of
collaborations partnerships 12/31/09
with involving Native Collaborate with
organizations community financial Rural Funding
serving the institutions, Foundations to
disabled, community expand tax related
Native development services in rural
American corporations, areas
communities, financial education
and providers, and
pre-existing Native American
rural advocates
infrastructures.

___________________________________________________________________________________
Expand and 3, 5 1/31/08 Ongoing ü
enhance the Launch Spanish Maintain the
Spanish version of the application and
Website to internet application upgrade annually as
increase "Where's My Refund," needed
electronic which allows
options, taxpayers to access
including their refund
options for information
Spanish
language 9/30/08
delivery of Expand and enhance
applications the Spanish website
currently to educate Spanish
only speaking taxpayers
available about tax
in English. responsibilities for
determining various
tax eligibility

___________________________________________________________________________________
Provide 3, 5 Deployed access to Ongoing
Reporting Electronic Account Maintain the
Agents with Resolution (EAR) and application and
access to Transcript Delivery upgrade annually as
e-Services. System (TDS) for needed
Reporting Agents in
June 2007

10/1/07
Market availability
of new services to
all Reporting Agents

6/30/08
Monitor access and
modify as necessary

9/30/08
Work with Reporting
Agents to explore
opportunities for
electronic delivery
of bulk notices

___________________________________________________________________________________
Implement 5 9/30/08 9/30/09 ü
Taxpayer Identify attributes Pending success of
Assistance of intentional model development,
Blueprint versus unintentional determine causes for
Phase 2, taxpayer taxpayer errors and
which noncompliance begin to develop
includes a appropriate
five-year treatments
Strategic
Plan for
taxpayer
service,
based on
extensive
research to
understand
taxpayer
and
stakeholder
needs.

___________________________________________________________________________________
Implement 3, 5 9/30/08
Internet-Customer Implement I-CAS
Account Release 1 to enable
Services taxpayers filing
(I-CAS) Form 1040 to view
Release 1, account information
which will via a secure
enable Internet link. I-CAS
taxpayers will offer online
to view tax account services
account that will emulate an
information. online banking
experience

___________________________________________________________________________________
Implement 3, 5 9/30/09
I-CAS Implement I-CAS
Release 2, Release 2 to enable
which will taxpayers to change
enable their address, file
taxpayers an extension, submit
to change a Power of Attorney,
their and calculate a
address, payoff amount on
file an balances due via a
extension, secure Internet Link
submit a
Power of
Attorney,
and
calculate a
payoff
amount on
balances
due via a
secure
Internet
link.

___________________________________________________________________________________
Continue 5 Ongoing During Ongoing During
publicity Filing Season Issue Filing Season
efforts News Releases and Issue News Releases
encouraging other communications and other
use of encouraging use of communications
Online on-line application encouraging use of
Payment for tax year 2007 on-line application
Agreement. balance due returns for tax year 2008
balance due returns
Ongoing
Promote ease of Ongoing
using Online Payment Promote ease of
Agreement via using Online Payment
multifaceted Agreement via
stakeholder multifaceted
distribution stakeholder
networks distribution
networks

___________________________________________________________________________________
Work with 1, 6 Ongoing 2/09
Congress to Treasury and IRS and Treasury and IRS and
enact will work with will recommend
simplification Congress to enact additional
legislative legislative legislative
provisions proposals. initiatives to
in Congress
Administration's
FY 2008
Budget.