Under section 6404(e)(1), the IRS may abate part or all of an assessment of interest on any deficiency or payment of tax if (a) either (1) the deficiency was attributable to an unreasonable error or delay by an IRS official in performing a ministerial or managerial act, 5 or (2) an error or delay by the taxpayer in paying his or her tax is attributable to an IRS official's being erroneous or dilatory in performing a ministerial or managerial act; and (b) the taxpayer caused no significant aspect of the delay. Interest can be abated only after the Commissioner has contacted the taxpayer in writing about the deficiency or payment in question. See sec. 6404(e) (flush language); Krugman v. Commissioner, 112 T.C. 230 (1999).



David H. Baral v. Commissioner.

Dkt. No. 546-08 , TC Memo. 2009-113, May 26, 2009.



[ Code Sec. 6404]

The IRS did not abuse its discretion when it refused to abate interest on an individual's tax deficiency. The IRS properly assessed statutory interest on the taxpayer's deficiency, which was properly calculated, and the taxpayer did not allege or show that there was any unreasonable error or delay in performance of a managerial or ministerial act during the processing of his case that resulted in the accrual of interest. The taxpayer's argument that the underlying deficiency would have been less had the IRS not previously corrected his unrelated miscalculation on his tax return was rejected.









P timely filed his 2001 Federal income tax return reporting an income tax liability of $3,303. After a correction of a patent error on P's return, R determined P's tax liability to be $1,076 and issued a refund to P based on that recalculated liability. Subsequently, R discovered P had unreported income, wholly unrelated to the prior adjustment, which resulted in a deficiency. R determined P's deficiency using the correct tax liability less the $1,076 of liability P had already paid and assessed the deficiency with interest. Pursuant to I.R.C. sec. 6404, P sought an abatement of interest, arguing that because P initially reported an income tax liability of $3,303, R should have taken that into consideration and should have charged interest only on the amount of the deficiency that exceeded the $3,303 that P had originally reported. R denied P's abatement request. P petitioned this Court for a review of R's denial of abatement of interest.



Held: R did not abuse his discretion in denying P's abatement of interest request and requiring P to pay interest on his entire deficiency. Thus, P is not entitled to relief under I.R.C. sec. 6404.





MEMORANDUM FINDINGS OF FACT AND OPINION



GUSTAFSON, Judge: This case is before the Court on petitioner David H. Baral's petition for review of the Internal Revenue Service's (IRS) failure to abate interest under section 6404. 1 The issue for decision is whether the IRS's denial of Mr. Baral's request to abate interest with respect to his income tax deficiency for 2001 was an abuse of discretion. We hold that it was not.





FINDINGS OF FACT



Some of the facts have been stipulated and are so found. The stipulation of facts filed November 5, 2008, and the attached exhibits are incorporated herein by this reference. At the time Mr. Baral filed his petition, he resided in Washington, D.C.



Mr. Baral timely filed his Form 1040, U.S. Individual Income Tax Return, for tax year 2001. On that return Mr. Baral incorrectly computed the taxable portion of his Social Security benefits, reported too large an amount on line 20b of his return, and consequently reported a higher income tax liability than he was liable for with respect to those benefits. Mr. Baral reported that his income tax liability for 2001 was $3,303. Because of this patent defect on the face of Mr. Baral's 2001 return, the IRS reduced Mr. Baral's income tax liability to $1,075.96 to reflect the proper taxable portion of his Social Security benefits. On May 20, 2002, the IRS sent Mr. Baral a letter explaining the changes it had made to his return and indicating that since Mr. Baral had made $7,038 in total payments to the IRS --through withholdings, estimated payments and/or amounts applied from his 2000 return --he would be due a larger refund than he originally reported on his 2001 return. 2



On May 20, 2002, the IRS refunded to Mr. Baral an overpayment of income tax of $5,962.04. This was $2,227.04 more than Mr. Baral was expecting, but Mr. Baral did not contact the IRS regarding the higher refund amount.



Almost 2 years later, on March 1, 2004, the IRS discovered that Mr. Baral had failed to report $9,552 of pension/annuity income on his 2001 return. The IRS issued to Mr. Baral a Notice CP2000, proposing changes to his 2001 return to reflect the previously unreported pension/annuity income. This unreported income, which was wholly unrelated to the prior adjustment, resulted in additional tax due from Mr. Baral. As a result, on July 26, 2004, the IRS issued to Mr. Baral a statutory notice of deficiency, in which it determined an income tax deficiency of $2,640. 3 Mr. Baral timely petitioned this Court for a redetermination of that deficiency at docket No. 20136-04S.



On November 2, 2005, a stipulated decision was entered in docket No. 20136-04S, in which Mr. Baral agreed to the full income tax deficiency that had been determined in the notice of deficiency --i.e., $2,640. On the decision document that Mr. Baral signed, the parties stipulated, inter alia --



It is further stipulated that interest will be assessed as provided by law on the deficiency due from petitioner.



Mr. Baral paid that deficiency in full on or about March 13, 2006. On June 26, 2006, the IRS assessed the interest of $598.27 due on that deficiency. Mr. Baral paid the interest in full on or about July 14, 2006.



On December 11, 2006, Mr. Baral submitted a Form 843, Claim for Refund and Request for Abatement, seeking an abatement of a portion of the interest that was assessed and paid with respect to the 2001 deficiency. Mr. Baral's contention was that the IRS's unsolicited adjustment to the taxable portion of his Social Security benefit resulted in more money being refunded to him in May 2002 than he had requested on his return. Consequently, his 2001 deficiency was higher than it would have been if that adjustment had never been made. Mr. Baral argues that had the IRS not made the initial adjustment to his return, his deficiency would have only been $413, i.e., the correct tax liability of $3,716 less the $3,303 amount Mr. Baral had initially reported as his income tax liability. So Mr. Baral contends that the IRS, instead of charging interest on a deficiency of $2,640, should have charged interest on a deficiency of only $413. By letter dated July 9, 2007, which served as the IRS's final determination, the IRS denied Mr. Baral's request for abatement of interest. In support of this denial, the IRS stated:



--There was no unreasonable error or delay relating to the performance of a ministerial or managerial act in processing the examination of your return.



--The excess refund you received was the result of the Service Center correction of an error you made on your 2001 return. You received a correction notice which granted an opportunity for your [sic] to confirm or dispute the correction made. You did not return the excess refund until after you had been examined and your case processed through the Tax Courts.



On January 7, 2008, 4 Mr. Baral timely filed a petition for this Court's review of the IRS's failure to abate interest under section 6404, disputing the IRS's determination not to abate and refund him a portion of the interest he paid on his 2001 deficiency. Mr. Baral's petition repeated the same argument he made on his Form 843, i.e., that because he initially reported an income tax liability of $3,303, the IRS should have taken that into consideration and should have charged interest only on a deficiency amount equal to the correct tax liability less the $3,303 he had originally reported.





OPINION




I. The Commissioner Has Authority To Abate Interest, and the Tax Court Has Authority To Review that Determination.


Under section 6404(e)(1), the IRS may abate part or all of an assessment of interest on any deficiency or payment of tax if (a) either (1) the deficiency was attributable to an unreasonable error or delay by an IRS official in performing a ministerial or managerial act, 5 or (2) an error or delay by the taxpayer in paying his or her tax is attributable to an IRS official's being erroneous or dilatory in performing a ministerial or managerial act; and (b) the taxpayer caused no significant aspect of the delay. Interest can be abated only after the Commissioner has contacted the taxpayer in writing about the deficiency or payment in question. See sec. 6404(e) (flush language); Krugman v. Commissioner, 112 T.C. 230 (1999).



If the IRS denies the abatement request, the taxpayer may petition the Tax Court for a review of that determination. Sec. 6404(h)(1); see Hinck v. United States, 550 U.S. 501, 506 (2007) (holding that the Tax Court provides the exclusive forum for judicial review of the IRS's refusal to abate interest). Since the IRS's authority to abate interest is discretionary and not mandatory, the Tax Court may order the abatement of interest only if it finds that the IRS abused its discretion by failing to abate the interest. Sec. 6404(h)(1); sec. 301.6404-2(a)(1), Proced. & Admin. Regs. (26 C.F.R.) In order to prevail, a taxpayer must prove that the IRS exercised its discretion arbitrarily, capriciously, or without sound basis in fact or law. See Woodral v. Commissioner, 112 T.C. 19, 23 (1999).



In Mr. Baral's case, we have jurisdiction to determine whether the IRS's failure to abate interest under section 6404(e)(1) was an abuse of discretion because (i) Mr. Baral filed a claim with the IRS under section 6404(e) seeking an abatement of interest, (ii) the IRS issued a final determination which disallowed Mr. Baral's claim to abate interest, and (iii) Mr. Baral timely filed a petition to review the failure to abate interest. See sec. 6404(h).




II. The IRS's Refusal To Abate a Portion of Mr. Baral's Interest With Respect to The 2001 Deficiency Was Not an Abuse of Discretion.


For a taxpayer to be eligible for an abatement of interest on a deficiency, the Code requires that the accrual of interest result from an unreasonable error or delay due to a managerial or ministerial act. Sec. 6404(e)(1). Mr. Baral has neither alleged nor shown that there was any managerial or ministerial act during the processing of his case that resulted in the accrual of interest. Instead, Mr. Baral contends that the IRS should be allowed to charge deficiency interest only on a $413 deficiency, as opposed to a $2,640 deficiency. Mr. Baral's position is not unsympathetic: He initially reported $3,303 as his income tax liability. He was willing to pay and did pay that amount as his tax liability. But for the IRS's reduction of his income tax liability --which Mr. Baral never requested --the IRS would have retained $3,303 of his tax payments. Therefore (he reasons), if the IRS later determined that Mr. Baral was deficient in his income tax payments, then most of that deficiency was attributable not to Mr. Baral's underreporting but to the IRS's unsolicited refund.



Unfortunately, there are several flaws in Mr. Baral's position. First, the reduction that the IRS made in Mr. Baral's income tax liability for 2001 was entirely proper, since it was due to a patent error on the return. Mr. Baral reported his Social Security income as $16,548 and reported the taxable portion thereof as $14,070. The IRS, upon an inspection of the numbers on Mr. Baral's return, recognized this as an error and corrected it. Mr. Baral makes no argument that the IRS's correction of the taxable portion of his Social Security benefits was incorrect; he complains only that the IRS made the correction of its own accord. When the IRS accurately spots an error on a return and fixes it to give the taxpayer a larger refund, the IRS can hardly be criticized.



Second, irrespective of the adjustment to the taxable portion of the Social Security benefits, Mr. Baral had income --wholly unrelated to the IRS's prior adjustment --that he failed to report and that was missing from his 2001 return because of his own error. This discrepancy did not come to light until after the IRS had made the initial correction to Mr. Baral's return and had issued him a refund based on that corrected information. Mr. Baral makes no argument that the failure to report his pension/annuity income was due to anything other than his own error.



Third, Mr. Baral desires for statutory interest to be assessed on an amount --$413 --that was not the amount determined to be his deficiency. In Mr. Baral's deficiency suit at docket No. 20136-04S, the Court entered a stipulated decision that Mr. Baral had an income tax deficiency of $2,640. Mr. Baral stipulated the truism that the deficiency would bear interest "as provided by law". The relevant law here is section 6601(a), which provides that statutory interest shall be charged on the amount of the deficiency, until the deficiency is paid in full. By entering into a stipulated decision in docket No. 20136-04S, Mr. Baral agreed that his deficiency for 2001 was $2,640. Section 6601(a) mandates that interest be charged on that amount, i.e., the deficiency amount.



To some extent Mr. Baral's argument that the deficiency interest should be charged only on a deficiency of $413 is an attempt to repudiate the deficiency amount already determined to be $2,640. That $413 amount however, is a fictitious "deficiency" that never existed, and it is the higher amount of $2,640 that was Mr. Baral's actual deficiency, as defined in the statute. Section 6211(a) defines a deficiency as follows:



SEC. 6211(a). In General. --For purposes of this title in the case of income, estate, and gift taxes imposed by subtitles A and B and excise taxes imposed by chapters 41, 42, 43, and 44 the term "deficiency" means the amount by which the tax imposed by subtitle A or B, or chapter 41, 42, 43, or 44 exceeds the excess of --



(1) the sum of



(A) the amount shown as the tax by the taxpayer upon his return, if a return was made by the taxpayer and an amount was shown as the tax by the taxpayer thereon, plus



(B) the amounts previously assessed (or collected without assessment) as a deficiency, over --



(2) the amount of rebates, as defined in subsection (b)(2), made. 6



Mr. Baral's deficiency for 2001 was determined as "the amount by which the tax imposed by subtitle A or B" (i.e., $3,716) exceeds the sum of "the amount shown as the tax by the taxpayer upon his return" (i.e., $3,303) over "the amount of rebates * * * made" (i.e., $2,227). Therefore, Mr. Baral's properly computed deficiency in his deficiency suit at docket No. 20136-04S was, as it should have been, $2,640.



Since the IRS properly assessed statutory interest on Mr. Baral's deficiency calculated according to the statute, and since Mr. Baral has neither alleged nor shown that there was any unreasonable error or delay in performance of a managerial or ministerial act during the processing of his case that resulted in the accrual of interest, we cannot find that the IRS abused its discretion in denying Mr. Baral's request for abatement under section 6404(e)(1).



If Mr. Baral's abatement request had been treated as a request for abatement of "the assessment of * * * interest on [an] erroneous refund" under section 6404(e)(2) (i.e., treating the interest at issue as attributable to the May 2002 erroneous refund) instead of as a request for abatement of the assessment of interest on a deficiency under section 6404(e)(1), then interest might not have started running against Mr. Baral until sometime in 2004, and a portion of the interest might be abated on that ground. The Court therefore invited the parties to consider the possible applicability of section 6404(e)(2). However, as respondent correctly argued, it is section 6404(e)(1) that, by its terms, addresses abatement of interest when, as here, the interest has been assessed on account of a deficiency. Section 6404(e)(2) deals with abatement of interest when the IRS prevails in an erroneous refund suit and interest is assessed thereafter. Because the IRS chose to pursue deficiency procedures against Mr. Baral, interest accrued on the deficiency; and any abatement of interest --i.e., interest on that deficiency --must be addressed under section 6404(e)(1), not section 6404(e)(2). The IRS considered Mr. Baral's abatement request under the proper Code section, section 6404(e)(1), when making its determination.




III. Conclusion


The IRS properly assessed interest on Mr. Baral's 2001 income tax deficiency of $2,640 according to law and according to his stipulation in docket No. 20136-04S. His argument that the IRS should have charged interest on only a hypothetical deficiency of $413 has no legal basis. The IRS made no error in processing the refund that gave rise to the deficiency. Rather, the errors here were Mr. Baral's --i.e., erroneously computing the taxable portion of his Social Security benefits and erroneously omitting his pension/annuity income. Accordingly, we hold that the IRS did not abuse its discretion in denying Mr. Baral's request for interest abatement under section 6404.



To reflect the foregoing,



Decision will be entered for respondent.


1 Unless otherwise indicated, all citations of sections refer to the Internal Revenue Code of 1986 (26 U.S.C.), as amended, and all citations of Rules refer to the Tax Court Rules of Practice and Procedure.

2 Mr. Baral originally reported that he overpaid his 2001 taxes by $3,735, i.e., his $7,038 payments less his $3,303 income tax liability. However, when the IRS reduced Mr. Baral's income tax liability to $1,075.96, that increased Mr. Baral's overpayment of income tax to $5,962.04, i.e., payments of $7,038 less the adjusted income tax liability of $1,075.96.

3 Mr. Baral's total income tax liability for 2001 --taking into consideration the proper taxable portion of his Social Security benefits and the unreported income --was $3,716. The IRS retained only $1,075.96 of Mr. Baral's tax payments after processing his prior refund, so the resulting deficiency was $2,640, i.e., $3,716 minus $1,076.

4 The last day on which Mr. Baral had to file a petition with the Tax Court was January 5, 2008. However, because January 5, 2008, fell on a Saturday, Mr. Baral had until the next business day, i.e., Monday, January 7, 2008, to timely file his petition. See Rule 25(a)(2)(B).

5 A "ministerial act" is defined as a "procedural or mechanical act that does not involve the exercise of judgment of discretion, and that occurs during the processing of a taxpayer's case after all prerequisites to the act * * * have taken place." Sec. 301.6404-2(b)(2), Proced. & Admin. Regs. A "managerial act" is defined as "an administrative act that occurs during the processing of a taxpayer's case involving the temporary or permanent loss of records or the exercise of judgment or discretion related to management of personnel." Sec. 301.6404-2(b)(1), Proced. & Admin. Regs. Under these definitions, a decision concerning the proper application of Federal tax law is neither a managerial nor a ministerial act.

6 The Internal Revenue Code recognizes two types of refunds: rebate and nonrebate. Acme Steele Co. v. Commissioner, T.C. Memo. 2003-118 (citing O'Bryant v. United States, 49 F.3d 340, 342 (7th Cir. 1995)). A rebate refund is issued on the basis of a substantive recalculation of a taxpayer's liability, e.g., the amount of tax due is less than the tax shown on the return. Mr. Baral initially reported his tax liability to be $3,303. The IRS substantively recalculated his liability because of an error on the return and determined his tax liability to be $1,076. This recalculation of Mr. Baral's income tax liability resulted in an increased refund to Mr. Baral of $2,227. By definition, this $2,227 was a rebate refund. See sec. 6211(b)(2); Acme Steele Co. v. Commissioner, supra

Green Book - Treasury Tax Plans 2010 Fiscal Year
Part of the Proposal is to eliminate the 20$ deposit for Offers in Compromise

Treasury Department General Explanations of the Administration's Fiscal Year 2010 Revenue Proposals (Green Book)

May 12, 2009

Treasury Department : Treasury Green Book : Fiscal year 2010 : Revenue proposals : General explanations .


General Explanations of the Administration's Fiscal Year 2010 Revenue Proposals

Department of the Treasury

May 2009

This document is available in Adobe Acrobat format on the Internet at: http://www.treas.gov/offices/tax-policy/library/grnbk09.pdf

The free Adobe Acrobat Reader is available at: http://get.adobe.com/reader/


Table of Contents 1


TAX CUTS FOR FAMILIES AND INDIVIDUALS
Provide the "Making Work Pay" Credit

Expand the Earned Income Tax Credit (EITC): Provide Marriage Penalty Relief and Enhamced Benefits for Larger Families

Expand the Refundability of the Child Tax Credit: Make Permanent the $3,000 Earnings Threshold and Eliminate Indexing

Expand the Saver's Credit and Provide for Automatic Enrollment in IRAs

Provide the American Opportunity Tax Credit

TAX CUTS FOR BUSINESS
Eliminate Capital Gains Taxation on Investments in Small Business Stock

Make the Research & Experimentation (R&E) Tax Credit Permanent

Expand Net Operating Loss Carryback

MODIFY FEDERAL AVIATION ADMINISTRATION FINANCING

CONTINUE CERTAIN EXPIRING PROVISIONS THROUGH CALENDAR YEAR 2010

OTHER REVENUE CHANGES AND LOOPHOLE CLOSERS
Reinstate Superfund Excise Taxes

Reinstate Superfund Environmental Income Tax

Tax Carried (Profit) Interests as Ordinary Income

Codify "Economic Substance" Doctrine

Repeal the Last-In, First-Out (LIFO) Method of Accounting for Inventories

Reform U.S. International Tax System

Reform Business Entity Classification Rules for Foreign Entities

Defer Deduction of Expenses, Except R&E Expenses, Related to Deferred Income

Reform Foreign Tax Credit: Determine the Foreign Tax Credit on a Pooling Basis

Reform Foreign Tax Credit: Prevent Splitting of Foreign Income and Foreign Taxes

Limit Shifting of Income Through Intangible Property Transfers

Limit Earnings Stripping by Expatriated Entities

Prevent Repatriation of Earnings in Certain Cross-Border Reorganizations

Repeal 80/20 Company Rules

Prevent the Avoidance of Dividend Withholding Taxes

Modify the Tax Rules for Dual Capacity Taxpayers

Combat Under-Reporting of Income Through Use of Accounts and Entities in Offshore Jurisdictions

Require Greater Reporting by Qualified Intermediaries Regarding U.S. Account Holders

Require Withholding on Payments of FDAP Income Made Through Nonqualified Intermediaries

Require Withholding on Gross Proceeds Paid to Certain Nonqualified Intermediaries

Require Reporting of Certain Transfers of Money or Property to Foreign Financial Accounts

Require Disclosure of FBAR Accounts to be Filed with Tax Return

Require Third-Party Information Reporting Regarding the Transfer of Assets to Foreign Financial Accounts and the Establishment of Foreign Financial Accounts

Require Third-Party Information Reporting Regarding the Establishment of Offshore Entities

Negative Presumption for Foreign Accounts with Respect to Which an FBAR has not Been Filed

Negative Presumption Regarding Failure to File an FBAR For Accounts with Nonqualified Intermediaries

Negative Presumption Regarding Withholding on FDAP Payments to Certain Foreign Entities

Extend Statute of Limitations for Certain Reportable Cross-Border Transactions and Foreign Entities

Double Accuracy-Related Penalties on Understatements Involving Undisclosed Foreign Accounts

Improve the Foreign Trust Reporting Penalty

Require Information Reporting for Rental Property Expense Paymentss

Eliminate Oil and Gas Company Preferences

Levy Tax on Certain Offshore Oil and Gas Production

Repeal Credit for Enhanced Oil Recovery (EOR) Projects

Repeal Credit for Production from Marginal Wells

Repeal Expensing of Intangible Drilling Costs

Repeal Deduction for Tertiary Injectants

Repeal Passive Loss Exception for Working Interests in Oil and Gas Properties

Repeal Percentage Depletion

Repeal Domestic Manufacturing Deduction for Oil and Gas Production

Increase the Amortization Period for Geological and Geophysical Costs to Seven Years

Eliminate the Advanced Earned Income Tax Credit

UPPER-INCOME TAX PROVISIONS DEDICATED TO DEFICIT REDUCTION
Reinstate the 39.6-Percent Rate

Reinstate the 36-Percent Rate for Taxpayers with Income Over $250,000 (Married Filing a Joint Return) and $200,000 (Single)

Reinstate the Limitation on Itemized Deductions for Taxpayers with Income Over $250,000 (Married Filing a Joint Return) and $200,000 (Single)

Reinstate the Personal Exemption Phase-Out (PEP) for Taxpayers with Income Over $250,000 (Married Filing a Joint Return) and $200,000 (Single)

Impose a 20-Percent Rate on Dividends and Capital Gains for Taxpayers with Income Over $250,000 (Married Filing a Joint Return) and $200,000 (Single)

USER FEES
Preserve Cost-Sharing of Inland Waterways Capital Costs

OTHER INITIATIVES
Implement Unemployment Insurance Integrity Legislation

Restructure Assistance to New York City

Provide Tax Incentives for Transportation Infrastructure

Levy Payments to Federal Contractors with Delinquent Tax Debt

Improve Debt Collection Adminstrative Procedures

Increase Levy Authority to 100 Percent for Vendor Payments

REVENUES DEDICATED TO THE HEALTH REFORM RESERVE FUND
Limit the Tax Rate at Which Itemized Deductions Reduce Tax Liability to 28 Percent

REDUCE THE TAX GAP AND MAKE REFORMS

Expand Information Reporting

Require Information Reporting for Private Separate Accounts of Life Insurance Companies

Require Information Reporting on Payments to Corporations

Require a Certified Taxpayer Identification Number From Contractors and Allow Certain Withholding

Require Increased Information Reporting for Certain Government Payments for Property and Services

Increase Information Return Penalties

Improve Compliance by Business

Require E-Filing by Certain Large Organizations

Implement Standards Clarifying When Employee Leasing Companies can be Held Liable for Their Clients' Federal Employment Taxes

Strengthen Tax Administratio

Allow Assessment of Criminal Restitution as Tax

Revise Offer-In-Compromise Application Rules

Expand IRS Access to Information in the National Directory of New Hires for Tax Administration Purposes

Make Repeated Willful Failure to File a Tax Return a Felony

Facilitate Tax Compliance with Local Jurisdictions

Extension of Statute of Limitations where State Tax Adjustment Affects Federal Tax Liability

Improve Investigative Disclosure Statute

Expand Required Electronic Filing by Tax Return Preparers

Expand Penalties

Clarify that the Bad Check Penalty Applies to Electronic Checks and Other Payment Forms

Impose a Penalty on Failure to Comply with Electronic Filing Requirements

Make Reforms to Close Tax Loopholes

Financial Institutions and Products

Require Accrual of Income on Forward Sale of Corporate Stock

Require Ordinary Treatment for Certain Dealers of Equity Options and Commodities

Modify Definition of Control for Purposes of the Section 249 Deduction Limit

Insurance Companies and Products

Modify Rules that Apply to Sales of Life Insurance Contracts

Modify Dividends-Received Deduction for Life Insurance Company Separate Accounts

Expand Pro Rata Interest Expense Disallowance for Corporate-Owned Life Insurance (COLI)

Tax Accounting Methods

Deny Deduction for Punitive Damages

Repeal Lower-Of-Cost-Or-Market Inventory Accounting Method

Modify Estate and Gift Tax Valuation Discounts and Make Other Reforms

Require Consistency in Value for Transfer and Income Tax Purposes

Modify Rules on Valuation Discounts

Require Minimum Term for Grantor Retained Annuity Trusts (GRATs)

Modify Alternative Fuel Mixture Credit

APPENDIX: EXTENDING CURRENT POLICIES

TABLES OF REVENUE ESTIMATES


TAX CUTS FOR FAMILIES AND INDIVIDUALS




PROVIDE THE "MAKING WORK PAY" CREDIT



Current Law

In 2009 and 2010, individual taxpayers are eligible for a refundable tax credit of 6.2 percent of earned income up to a maximum credit of $400 ($800 for joint filers). Thus, workers receive a credit on the first $8,065 of earned income ($16,130 for joint filers). The credit phases out at a rate of 2 percent for taxpayers with modified adjusted gross income in excess of $75,000 ($150,000 for joint filers). Dependent filers are not eligible for the credit. Neither the maximum credit amount nor the beginning of the phase-out range is indexed for inflation.

The IRS withholding schedules are modified to reflect the Making Work Pay (MWP) credit, with reconciliation of overwithholding and underwithholding on annual income tax returns.



Reasons for Change

The MWP credit partially offsets the regressivity of the Social Security payroll tax. It effectively raises the income of workers eligible for the credit, which encourages individuals to enter the labor force. Permanency and indexing the beginning of the phase-out range for inflation would ensure that workers continue to receive some of the benefits of the credit and low-income workers continue to receive a work incentive. In addition, the MWP credit could be extended to more people by raising the phase-out range.

The MWP credit contributes to the high marginal tax rates faced by workers in the phase-out range. Lowering the phase-out rate would produce fewer distortions.



Proposal

The proposal would make the MWP credit permanent and index the beginning of the phase-out range for inflation. In addition, the phase-out rate would be reduced to 1.6 percent.

The proposal is effective for tax years beginning after December 31, 2010.



EXPAND THE EARNED INCOME TAX CREDIT (EITC): PROVIDE MARRIAGE PENALTY RELIEF AND ENHANCED BENEFITS FOR LARGER FAMILIES



Current Law

Low and moderate-income workers may be eligible for a refundable earned income tax credit (EITC). Eligibility for the EITC is based on the presence and number of qualifying children in the worker's household, adjusted gross income (AGI), earned income, investment income, filing status, age, and immigration and work status in the United States. The amount of the EITC is based on the presence and number of qualifying children in the worker's household, AGI, earned income, and filing status.

The EITC has a phase-in range (where each additional dollar of earned income results in a larger credit), a maximum range (where additional dollars earned or AGI have no effect on the size of the credit), and a phase-out range (where each additional dollar of the larger of earned income or AGI results in a smaller total credit). The EITC for childless workers is much smaller and phases out at a lower income level than does the EITC for workers with qualifying children. The EITC is larger for workers with more qualifying children, reaching a maximum amount at three qualifying children. The phase-out range for joint filers begins at a higher income level than for an individual with the same number of qualifying children who files as a single filer or as a head of household. The width of the phase-in range and the beginning of the phase-out range are indexed for inflation. Hence, the maximum amount of the credit and the end of the phase-out range are effectively indexed. The following chart summarizes the EITC for 2009.


_____________________________________________________________________________________
Childless
Taxpayers Taxpayers with Qualifying Children


___________________________________________________
One Child Two Children Three or More

_____________________________________________________________________________________
Phase-in rate 7.65% 34.00% 40.00% 45.00%

_____________________________________________________________________________________
Minimum earnings $5,970 $8,950 $12,570 $12,570
for maximum
credit

_____________________________________________________________________________________
Maximum credit $457 $3,043 $5,028 $5,657

_____________________________________________________________________________________
Phase-out rate 7.65% 15.98% 21.06% 21.06%

_____________________________________________________________________________________
Phase-out begins $7,470 ($12,470 $16,420 ($21,420 $16,420 ($21,420 $16,420 ($21,420
joint) joint) joint) joint)

_____________________________________________________________________________________
Phase-out ends $13,440 ($18,440 $35,463 ($40,463 $40,295 ($45,295 $43,279 ($48,279
joint) joint) joint) joint)

_____________________________________________________________________________________


To be eligible for the EITC, workers may have a maximum of $3,100 of investment income. (This amount is indexed for inflation.)

In 2009 and 2010, the beginning of the phase-out range for joint filers is $5,000 higher than for other filers. (The amount will be indexed in 2010.) Under current law, beginning in 2011 the EITC for workers with the same number of qualifying children will phase-out over the same income range regardless of filing status. Under the assumption that certain provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) are made permanent, the additional $5,000 for married filers will revert in 2011 to $3,000 indexed from 2007.

In 2009 and 2010, the EITC phases in at a faster rate for workers with three or more qualifying children than for workers with two qualifying children (45 and 40 percent, respectively). The accelerated phase-in rate results in a higher credit and a longer phase-out range. This provision expires after 2010, at which point workers with three or more qualifying children will receive the same EITC as similarly situated workers with two qualifying children.



Reasons for Change

The beginning of the phase-out range for joint filers is higher than for other workers with the same number of qualifying children in order to reduce the "EITC marriage penalty." This marriage penalty occurs because the income of both spouses is counted toward eligibility for joint filers, but the income of only the "head of household" filer is considered if the individuals are not married. Extending marriage penalty relief improves fairness and removes financial impediments to marriage for some low-income households.

Families with many children face larger expenses related to raising their children than do smaller families and as a result have higher poverty rates. The steeper phase-in rate and larger maximum credit for workers with three or more qualifying children helps them meet their expenses while maintaining work incentives.



Proposal

The proposal would make permanent the $5,000 (indexed) increase in the beginning of the phase-out range for joint filers relative to other individuals.

Furthermore, the proposal would make permanent the expansion of the EITC for workers with three or more qualifying children. Specifically, the phase-in rate of the EITC for workers with three or more qualifying children under the American Recovery and Reinvestment Act of 2009 (ARRA) would be maintained at 45 percent, resulting in a higher maximum credit amount and longer phase-out range.

The proposal would be effective for tax years beginning after December 31, 2010.



EXPAND THE REFUNDABILITY OF THE CHILD TAX CREDIT: MAKE PERMANENT THE $3,000 EARNINGS THRESHOLD AND ELIMINATE INDEXING



Current Law

An individual may claim a $1,000 tax credit for each qualifying child. A qualifying child must meet the following four tests:
(1) Relationship - The child generally must be the taxpayer's son, daughter, grandchild, sibling, niece, nephew, or foster child.

(2) Residence - The child must live with the taxpayer in the same principal place of abode for over half the year.

(3) Support - The child must not have provided more than half of his or her own support.

(4) Age - The child must be under the age of 17.

For purposes of the child tax credit, a qualifying child must be a citizen, national, or resident of the United States. The child tax credit is phased out for individuals with income over certain thresholds, 1 and is partially refundable.

In 2009 and 2010, individuals may be eligible for a refundable amount (the additional child tax credit) equal to the lesser of 15 percent of earned income in excess of $3,000 and any child credit unclaimed due to insufficient tax liability. 2 Under the assumption that certain provisions of EGTRRA are made permanent, in 2011 the earned income threshold reverts to an amount indexed from $10,000 in 2000.

Families with three or more children may determine the additional child tax credit using an alternative formula based on the extent to which a taxpayer's social security taxes exceed the taxpayer's EITC.



Reasons for Change

Because the wages of low-income families have failed to keep up with inflation, continued indexing will result in a decreasing number of low-income families able to take advantage of the credit each year and smaller credits for the families who receive the credit.

Furthermore, if the threshold increases to $12,700 in 2011 as scheduled, an estimated 11 million low-income families would have a tax increase as a result.



Proposal

The proposal would make permanent the $3,000 earnings threshold for refundability of the child credit. In addition the earnings threshold would no longer be indexed for inflation.

The proposal would be effective for tax years beginning after December 31, 2010.



EXPAND THE SAVER'S CREDIT AND PROVIDE FOR AUTOMATIC ENROLLMENT IN IRAS



Expand the Saver's Credit



Current Law

A nonrefundable tax credit is available for eligible individuals who make voluntary contributions to 401(k) plans and other retirement plans, including IRAs. The maximum annual contribution eligible for the credit is $4,000 for married couples filing jointly and $2,000 for single taxpayers or married individuals filing separately, resulting in maximum credits of $2,000 and $1,000, respectively. The credit rate is 10 percent, 20 percent or 50-percent, depending on the taxpayer's adjusted gross income (AGI) (the amount of which is adjusted each calendar year based on the cost-of-living adjustment). In 2009, "eligible individuals" who may claim the credit are
 Married couples filing jointly with incomes up to $55,500;

 Heads of households with incomes up to $41,625; and

 Married individuals filing separately and singles with incomes up to $27,750,

who are 18 or older, other than individuals who are full-time students or claimed as a dependent on another taxpayer's return.

The credit is available with respect to an eligible individual's "qualified retirement savings contributions." These include (i) elective deferrals to a section 401(k) plan, section 403(b) plan, section 457 plan, SIMPLE, or simplified employee pension (SEP); (ii) contributions to a traditional or Roth IRA; and (iii) other voluntary employee contributions to a qualified retirement plan, including voluntary after-tax contributions and voluntary contributions to a defined benefit pension plan. The eligible individual may direct that the amount of any refund attributable to the credit may be directly deposited by the IRS into an IRA or certain other accounts.

The credit is nonrefundable and, therefore, offsets regular tax liability or minimum tax liability. The credit is in addition to any deduction or exclusion that would otherwise apply with respect to the contribution.



Reason for Change

The saver's credit should be amended to more effectively encourage moderate- and lower-income individuals to save for retirement. Because it is currently nonrefundable, the saver's credit only offsets a taxpayer's income tax liability and therefore gives no saving incentive to tens of millions of households without income tax liability. In addition, the current three-tier credit rate structure should be simplified, the eligibility income threshold should be raised to increase the number of households eligible for the credit, and the credit rate should be increased for most eligible households. Finally, making the saver's credit more like a matching contribution would enhance the likelihood that the credit would be saved and would increase the salience of the incentive by framing it as a match similar to the familiar employer matching contributions to 401(k) plans.



Proposal

The proposal would make the saver's credit fully refundable and would provide for the credit to be deposited automatically in the qualified retirement plan account or IRA to which the eligible individual contributed. Making the saver's credit more like a matching contribution would enhance the likelihood that the credit would be saved and would increase the salience of the incentive by framing it as a match similar to the familiar employer matching contributions to 401(k) plans. The proposal would offer a meaningful saving incentive to tens of millions of additional households while simplifying the current three-tier credit structure and raising the eligibility income threshold to cover millions of additional moderate-income taxpayers.

In place of the current 10-percent/20-percent/50-percent credit for qualified retirement savings contributions up to $2,000 per individual, the proposal would match 50-percent of such contributions up to $500 per individual (indexed annually for inflation beginning in taxable year 2011). The eligibility income threshold would be increased to $65,000 for married couples filing jointly, $48,750 for heads of households, and $32,500 for singles and married individuals filing separately, with the amount of savings eligible for the credit phased out at a 5-percent rate for AGI exceeding those levels.

The proposal would be effective December 31, 2010.



Automatic Enrollment in IRAS



Current Law

A number of tax-preferred, employer-sponsored retirement savings programs exist under current law. These include section 401(k) cash or deferred arrangements, section 403(b) programs for public schools and charitable organizations, section 457 plans for governments and nonprofit organizations, and simplified employee pensions and SIMPLE IRAs for small employers. Individuals who do not have access to an employer-sponsored retirement saving arrangement may be eligible to make smaller tax-favored contributions to individual retirement accounts or individual retirement annuities (IRAs).

IRA contributions are limited to $5,000 a year (plus $1,000 for those age 50 or older). Section 401(k) plans permit contributions (employee plus employer contributions) of up to $49,000 a year (of which $16,500 can be pre-tax employee contributions) plus $5,500 of additional pre-tax employee contributions for those age 50 or older.



Reasons for Change

For many years, until the current recession, the personal saving rate in the United States has been exceedingly low. In addition, tens of millions of U.S. households have not placed themselves on a path to become financially prepared for retirement, and the proportion of U.S. workers participating in employer-sponsored plans has remained stagnant for decades at no more than about half the total work force notwithstanding repeated private-sector and congressional attempts to expand coverage. Participation in employer-sponsored retirement saving plans such as 401(k) plans typically has ranged from two thirds to three quarters of eligible employees, but making saving easier by making it automatic has been shown to be remarkably effective at boosting participation. Automatic enrollment in 401(k) plans (enrolling employees by default unless they opt out) has tended to increase participation to more than 9 out of 10 eligible employees. In contrast, for workers who lack access to a retirement plan at their workplace and are eligible to engage in tax-favored retirement saving by taking the initiative and making the decisions required to establish and contribute to an IRA, the IRA participation rate tends to be less than 1 out of 10.

Numerous employers, especially those with smaller or lower-wage work forces, have been reluctant to adopt a retirement plan for their employees, in part out of concern about their ability to afford the cost of making employer contributions or the per-capita cost of complying with tax-qualification or ERISA (Employee Retirement Income Security Act) requirements. These employers could help their employees save --without employer contributions or plan qualification or ERISA compliance --simply by making their payroll systems available as a conduit for regularly transmitting employee contributions to an employee's IRA. Such "payroll deduction IRAs" could build on the success of workplace-based payroll-deduction saving by using the excess capacity to promote saving that is inherent in employer payroll systems, especially those that use automatic enrollment. However, despite efforts a decade ago by Treasury, the IRS, and the Department of Labor to approve and promote the option of payroll deduction IRAs, few employers have adopted them or even are aware that this option exists.

Accordingly, requiring employers that do not sponsor any retirement plan (and that are above a certain size) to make their payroll system available to employees and automatically enroll them in IRAs could achieve a major breakthrough in retirement saving coverage. Many employers may then be more willing to take the next step and adopt an employer plan (permitting much greater tax-favored employee contributions than an IRA plus the option of employer contributions). In addition, the process of saving and choosing investments could be simplified for employees, and costs minimized, through a standard default investment as well as electronic information and fund transfers. Workplace retirement savings arrangements made accessible to most workers also could be used as a platform to provide and promote retirement distributions annuitized over the worker's lifetime.



Proposal

Employers in business for at least two years that have 10 or more employees would be required to offer an automatic IRA option to employees on a payroll-deduction basis, under which regular payroll-deduction contributions would be made to an IRA. If the employer sponsored a qualified retirement plan or SIMPLE for its employees, it would not be required to provide an automatic IRA option for any employee. Thus, for example, a qualified plan sponsor would not have to offer automatic IRAs to employees it excludes from qualified plan eligibility because they are collectively bargained, under age 18, nonresident aliens, or have not completed the plan's eligibility waiting period. However, if the qualified plan excluded from eligibility a portion of the employer's work force or a class of employees such as all employees of a subsidiary or division, the employer would be required to offer the automatic IRA option to those excluded employees.

The employer offering automatic IRAs would give employees a standard notice and election form informing them of the automatic IRA option and allowing them to elect to participate or opt out. Any employee who did not provide a written participation election would be enrolled at a default rate of three percent of the employee's compensation. Employees could opt for a lower or higher contribution rate up to the IRA dollar limits. For most employees, the payroll deductions would be made by direct deposit similar to the direct deposit of employees' paychecks to their accounts at financial institutions.

Payroll-deduction contributions from all participating employees could be transferred, at the employer's option, to a single private-sector IRA trustee or custodian designated by the employer. Alternatively, the employer, if it preferred, could allow each participating employee to designate the IRA provider for that employee's contributions or could designate that all contributions would be forwarded to a savings vehicle specified by statute or regulation.

Employers making payroll deduction IRAs available would not have to choose or arrange default investments. Instead, a low-cost, standard type of default investment and a handful of standard, low-cost investment alternatives would be prescribed by statute or regulation. In addition, this approach would involve no employer contributions, no employer compliance with qualified plan requirements, and no employer liability or responsibility for determining employee eligibility to make tax-favored IRA contributions or for opening IRAs for employees. A national web site would provide information and basic educational material regarding saving and investing for retirement, including IRA eligibility, but, as under current law, individuals (not employers) would bear ultimate responsibility for determining their IRA eligibility.

Employers could claim a temporary tax credit for making automatic payroll-deposit IRAs available to employees. The amount of the credit would be $25 per enrolled employee up to $250 each year for two years. The credit would be available both to employers required to offer automatic IRAs and employers not required to do so (for example, because they have fewer than ten employees).

Contributions by employees to automatic IRAs would qualify for the saver's credit (to the extent the contributor and the contributions otherwise qualified), and the proposed expanded saver's credit would be deposited to the IRA to which the eligible individual contributed.

The proposal would become effective January 1, 2012.



PROVIDE THE AMERICAN OPPORTUNITY TAX CREDIT



Current Law

Prior to ARRA an individual taxpayer could claim a nonrefundable Hope Scholarship credit for 100 percent of the first $1,200 and 50-percent of the next $1,200 in qualified tuition and related expenses (for a maximum credit of $1,800) per student. The Hope Scholarship credit was limited to the first two years of postsecondary education.

Alternatively, a taxpayer could claim a nonrefundable Lifetime Learning Credit (LLC) for 20 percent of up to $10,000 in qualified tuition and related expenses (for a maximum credit of $2,000) per taxpayer. Both the Hope Scholarship credit and LLC were phased out in 2009 between $50,000 and $60,000 of adjusted gross income ($100,000 and $120,000 if married filing jointly). In addition, through 2009, a taxpayer could claim an above-the-line deduction for qualified tuition and related expenses. The maximum amount of the deduction was $4,000.

ARRA created the American Opportunity Tax Credit (AOTC) to replace the Hope Scholarship Credit for taxable years 2009 and 2010. The new tax credit is partially refundable, has a higher maximum credit amount, is available for the first four years of postsecondary education, and has higher phase-out limits.

The AOTC equals 100 percent of the first $2,000 plus 25 percent of the next $2,000 of qualified tuition and related expenses (for a maximum credit of $2,500). Under ARRA, the definition of related expenses for both the LLC and the AOTC was expanded to include course materials. Forty percent of the otherwise allowable AOTC is refundable (for a maximum refundable credit of $1,000). The credit is available for the first four years of postsecondary education. The credit phases out for taxpayers with adjusted gross income between $80,000 and $90,000 ($160,000 and $180,000 if married filing jointly).

All other aspects of the Hope Scholarship credit are retained under the AOTC. These include the requirement that AOTC recipients be enrolled at least half-time.



Reasons for Change

The AOTC makes college more affordable for millions of middle-income families and for the first time makes college tax incentives partially refundable. If college is not made more affordable, our nation runs the risk of losing a whole generation of potential and productivity.

Making the AOTC partially refundable increases the likelihood that low-income families will send their children to college. Under prior law, low-income families (those without sufficient tax liability) could not benefit from the Hope Scholarship credit because it was not refundable. Under the proposal, low-income families could benefit from both Federal Pell Grants and the refundable portion of the AOTC. In combination, these grants and credits would cover all tuition and fees at an average 2-year public college and about half of tuition and fees at an average 4-year public college.

Moreover, the new credit applies to the first four years of college, instead of only the first two years of college, increasing the likelihood that students will stay in school and attain their degrees. More years of schooling translates into higher future incomes for students and a more educated work force for the country.

Finally, the higher phase-out thresholds under the AOTC give targeted tax relief to an even greater number of middle-income families facing the high costs of college.



Proposal

The proposal would make the AOTC a permanent replacement for the Hope Scholarship credit. To preserve the value of the AOTC, the proposal would index the $2,000 tuition and expense amounts, as well as the phase-out thresholds, for inflation.

This proposal would be effective for taxable years beginning after December 31, 2010.


TAX CUTS FOR BUSINESS




ELIMINATE CAPITAL GAINS TAXATION ON INVESTMENTS IN SMALL BUSINESS STOCK



Current Law

Taxpayers other than corporations may exclude 50-percent (60 percent for certain empowerment zone businesses) of the gain from the sale of certain small business stock acquired at original issue and held for at least five years. Under ARRA the exclusion is increased to 75 percent for stock acquired in 2009 (after February 17, 2009) and in 2010. The taxable portion of the gain is taxed at a maximum rate of 28 percent. Under current law, 7 percent of the excluded gain is a tax preference subject to the alternative minimum tax (AMT). The AMT preference is scheduled to increase to 28 percent of the excluded gain on eligible stock acquired after December 31, 2000 and to 42 percent of the excluded gain on stock acquired on or before that date.

The amount of gain eligible for the exclusion by a taxpayer with respect to any corporation during any year is the greater of (1) ten times the taxpayer's basis in stock issued by the corporation and disposed of during the year, or (2) $10 million reduced by gain excluded in prior years on dispositions of the corporation's stock. To qualify as a small business, the corporation, when the stock is issued, may not have gross assets exceeding $50 million (including the proceeds of the newly issued stock) and may not be an S corporation.

The corporation also must meet certain active trade or business requirements. For example, the corporation must be engaged in a trade or business other than: one involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services or any other trade or business where the principal asset of the trade or business is the reputation or skill of one or more employees; a banking, insurance, financing, leasing, investing or similar business; a farming business; a business involving production or extraction of items subject to depletion; or a hotel, motel, restaurant or similar business. There are limits on the amount of real property that may be held by a qualified small business, and ownership of, dealing in, or renting real property is not treated as an active trade or business.



Reasons for Change

Because the taxable portion of gain from the sale of qualified small business stock is subject to tax at a maximum of 28 percent and a percentage of the excluded gain is a preference under the AMT, the current 50-percent provision provides little benefit. Increasing the exclusion would encourage and reward new investment in qualified small business stock.



Proposal

Under the proposal the percentage exclusion for qualified small business stock sold by an individual or other non-corporate taxpayer would be increased to 100 percent and the AMT preference item for gain excluded under this provision would be eliminated. The stock would have to be held for at least five years and other provisions applying to the section 1202 exclusion would also apply. The proposal would include additional documentation requirements to assure compliance with the statute.

The proposal would be effective for qualified small business stock issued after February 17, 2009.



MAKE THE RESEARCH & EXPERIMENTATION (R&E) TAX CREDIT PERMANENT



Current Law

The research and experimentation (R&E) tax credit is 20 percent of qualified research expenses above a base amount. The base amount is the product of the taxpayer's "fixed base percentage" and the average of the taxpayer's gross receipts for the four preceding years. The taxpayer's fixed base percentage generally is the ratio of its research expenses to gross receipts for the 1984-88 period. The base amount cannot be less than 50-percent of the taxpayer's qualified research expenses for the taxable year. Taxpayers can elect the alternative simplified research credit (ASC), which is equal to 14 percent of qualified research expenses that exceed 50-percent of the average qualified research expenses for the three preceding taxable years. Under the ASC, the rate is reduced to 6 percent if a taxpayer has no qualified research expenses in any one of the three preceding taxable years. An election to use the ASC applies to all succeeding taxable years unless revoked with the consent of the Secretary.

The R&E tax credit also provides a credit for 20 percent of basic research payments in excess of a base amount and payments to an energy research consortium for energy research. The credit for energy research applies to all qualified expenditures, not solely those in excess of a base amount.

The R&E credit is scheduled to expire on December 31, 2009.



Reasons for Change

The R&E tax credit encourages technological developments that are an important component of economic growth. However, uncertainty about the future availability of the R&E tax credit diminishes the incentive effect of the credit because it is difficult for taxpayers to factor the credit into decisions to invest in research projects that will not be initiated and completed prior to the credit's expiration. To improve the credit's effectiveness, the R&E tax credit should be made permanent.



Proposal

The proposal would make the R&E credit permanent.



EXPAND NET OPERATING LOSS CARRYBACK



Current Law

A net operating loss (NOL) generally is the amount by which a taxpayer's business deductions exceed its gross income. For taxpayers other than certain eligible small businesses, an NOL may be carried back two years and carried forward 20 years to offset taxable income in such years. NOLs offset taxable income in the order of the taxable years to which the NOL may be carried. The AMT rules provide that a taxpayer's NOL deduction cannot reduce the taxpayer's alternative minimum taxable income (AMTI) by more than 90 percent of the AMTI.

Different rules apply with respect to NOLs arising in certain circumstances. A three-year carryback applies with respect to: (1) losses arising from casualty or theft losses of individuals, and (2) losses attributable to Presidentially declared disasters for taxpayers engaged in a farming business or a small business. A five-year carryback applies to: (1) farming losses (regardless of whether the loss was incurred in a Presidentially declared disaster area); (2) certain losses related to Hurricane Katrina, Gulf Opportunity Zone, and Midwestern Disaster Area; and (3) qualified disaster losses. Special rules also apply to real estate investment trusts (no carryback), specified liability losses (10-year carryback), and excess interest losses (no carryback to any year preceding a corporate equity reduction transaction). Additionally, a special rule applies to certain electric utility companies. In the case of a life insurance company, present law allows a deduction for the taxable year for operations loss carryovers and carrybacks in lieu of the deduction for NOLs allowed to other corporations. A life insurance company is permitted to treat a loss from operations for any taxable year as an operations loss carryback to each of the three taxable years preceding the loss year and an operations loss carryover to each of the 15 taxable years following the loss year. Special rules apply to new life insurance companies.

Most recently, the ARRA extended the carryback period for applicable 2008 NOLs to up to five years by certain eligible small businesses whose average annual gross receipts do not exceed $15,000,000.



Reasons for Change

The NOL carryback and carryover rules are designed to allow taxpayers to smooth out swings in business income (and Federal income taxes thereon) that result from business cycle fluctuations. The recent economic conditions have resulted in many taxpayers incurring significant financial losses. A temporary extension of the NOL carryback period provides taxpayers in all sectors of the economy that experience such losses with the ability to obtain refunds of income taxes paid in prior years. These refunds can be used to fund capital investment or other operating expenses.



Proposal

The Administration looks forward to working with the Congress to make a lengthened NOL carryback period available to more taxpayers.


MODIFY FEDERAL AVIATION ADMINISTRATION FINANCING




Current Law

The Airport and Airway Trust Fund is supported by taxes on air passenger transportation, domestic air freight transportation, and aviation fuel. The tax on domestic air passenger transportation is 7.5 percent of the amount paid for the transportation plus a segment fee of $3.60 per segment. The tax on international air transportation is $16.10 on each international arrival or departure. Both the segment fee and the international arrival and departure fee are adjusted annually for inflation. The tax on domestic air freight transportation is 6.25 percent of the amount paid for the transportation. The tax on aviation fuel, to the extent dedicated to the Airport and Airway Trust Fund, is 4.3 cents per gallon for kerosene used in commercial aviation, 21.8 cents per gallon for kerosene used in noncommercial (general) aviation, and 19.3 cents per gallon for aviation gasoline. The tax is generally imposed when the fuel is removed from a terminal.

The taxes that support the Airport and Airway Trust Fund expire on September 30, 2009. The taxes on air transportation do not apply to amounts paid after September 30, 2009. The taxes on aviation fuel do not apply to fuel removed from a terminal after September 30, 2009. The authority to make expenditures from the Trust Fund for airport and airway programs also expires on October 30, 2009.



Reasons for Change

The Federal Aviation Administration's (FAA's) financing system should be more cost based. The current excise tax system, to the extent based on taxes on the amount paid for air transportation, does not provide a direct relationship between the taxes paid by users and the air traffic control services provided by the FAA. The Administration believes that the FAA should move toward a model whereby FAA's funding is related to its costs, the financing burden is distributed more equitably, and funds are used to pay directly for services the users need.

To provide for necessary Federal airport and airway expenditures until a cost-based system is developed, the aviation excise taxes and the expenditure authority from the Airport and Airway Trust Fund should be temporarily extended.



Proposal

The taxes on air transportation and aviation fuel would be extended through September 30, 2011, at their current rates. Beginning October 1, 2011, the Budget assumes that the air traffic control system will be funded with direct charges levied on users of the system. The Budget reflects such a reform being in place starting in 2011, with a user charge collecting $9.6 billion in that year and with aviation excise taxes being commensurately reduced. Expenditure authority from the Airport and Airway Trust Fund would be extended through September 30, 2019.



CONTINUE CERTAIN EXPIRING PROVISIONS THROUGH CALENDAR YEAR 2010



Current Law

The existing tax code includes a number of provisions that are scheduled to expire before December 31, 2010. These provisions include the optional deduction for State and local general sales taxes, Subpart F "active financing" and "look-through" exceptions, the exclusion from unrelated business income of certain payments to controlling exempt organizations, the new markets tax credit, the modified recovery period for qualified leasehold improvements and qualified restaurant property, incentives for empowerment and community renewal zones, credits for biodiesel and renewable diesel fuels, and several trade agreements, including the Generalized System of Preferences and the Caribbean Basin Initiative.



Reasons for Change .

In the past, these expiring provisions have been routinely extended. Extending them before they expire helps to provides certainty to taxpayers.



Proposal

This proposal would extend these provisions through December 31, 2010.


OTHER REVENUE CHANGES AND LOOPHOLE CLOSERS




REINSTATE SUPERFUND EXCISE TAXES



Current Law

The following Superfund excise taxes were imposed before January 1, 1996:

(1) An excise tax on domestic crude oil and on imported petroleum products at a rate of 9.7 cents per barrel;

(2) An excise tax on listed hazardous chemicals at a rate that varied from $0.22 to $4.87 per ton; and

(3) An excise tax on imported substances that use as materials in their manufacture or production one or more of the hazardous chemicals subject to the excise tax described in (2) above.

Amounts equivalent to the revenues from these taxes were dedicated to the Hazardous Substance Superfund Trust Fund (the Superfund Trust Fund). Amounts in the Superfund Trust Fund are available for expenditures incurred in connection with releases or threats of releases of hazardous substances into the environment under specified provisions of the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (as amended).



Reasons for Change

The Superfund excise taxes should be reinstated because of the continuing need for funds to remedy damages caused by releases of hazardous substances.



Proposal

The three Superfund excise taxes would be reinstated for periods after December 31, 2010.



REINSTATE SUPERFUND ENVIRONMENTAL INCOME TAX



Current Law

For taxable years beginning before January 1, 1996, a corporate environmental income tax was imposed at a rate of 0.12 percent on the amount by which the modified alternative minimum taxable income of a corporation exceeded $2 million. Modified alternative minimum taxable income was defined as a corporation's alternative minimum taxable income, determined without regard to the alternative minimum tax net operating loss deduction and the deduction for the corporate environmental income tax.

The tax was dedicated to the Hazardous Substance Superfund Trust Fund (the Superfund Trust Fund). Amounts in the Superfund Trust Fund are available for expenditures incurred in connection with releases or threats of releases of hazardous substances into the environment under specified provisions of the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (as amended).



Reasons for Change

The corporate environmental income tax should be reinstated because of the continuing need for funds to remedy damages caused by releases of hazardous substances.



Proposal

The corporate environmental income tax would be reinstated for taxable years beginning after December 31, 2010.



TAX CARRIED (PROFIT) INTERESTS AS ORDINARY INCOME



Current Law

A partnership is not subject to federal income tax. Instead, income and loss of the partnership retains its character and flows through to its partners, who must include such items on their tax returns. Generally, certain partners receive partnership interests in exchange for contributions of cash and/or property, while certain partners (not necessarily other partners) receive partnership interests, typically interests in future profits ("profits interests") in exchange for services. Accordingly, if and to the extent a partnership recognizes long-term capital gain, the partners, including partners who provide services, will reflect their shares of such gain on their tax returns as long-term capital gain. If the partner is an individual, such gain would be taxed at the reduced rates for long-term capital gains. Gain recognized on the sale of a partnership interest, whether it was received in exchange for property, cash or services, is generally treated as capital gain.

Under current law, income attributable to a profits interest of a general partner is generally subject to self-employment tax, except to the extent the partnership generates types of income that are excluded from self employment taxes, e.g., capital gains, certain interest and dividends.



Reason for Change

Although profits interests are structured as partnership interests, the income allocable to such interests is received in connection with the performance of services. A service provider's share of the income of a partnership attributable to a carried interest should be taxed as ordinary income and subject to self-employment tax because such income is derived from the performance of services. By allowing service partners to receive capital gains treatment on labor income without limit, the current system creates an unfair and inefficient tax preference. The recent explosion of activity among large private equity firms has increased the breadth and cost of this tax preference, with some of the highest-income Americans benefiting from the preferential treatment.



Proposal

A partner's share of income on a "services partnership interest" (SPI) would be subject to tax as ordinary income, regardless of the character of the income at the partnership level. Accordingly, such income would not be eligible for the reduced rates that apply to long-term capital gains. In addition, the proposal would require the partner to pay self-employment taxes on such income. Gain recognized on the sale of an SPI would generally be taxed as ordinary income, not as capital gain.

An SPI is a carried interest held by a person who provides services to the partnership. To the extent that the partner who holds an SPI contributes "invested capital" and the partnership reasonably allocates its income and loss between such invested capital and the remaining interest, income attributable to the invested capital would not be recharacterized. Similarly, the portion of any gain recognized on the sale of an SPI that is attributable to the invested capital would be treated as capital gain. "Invested capital" is defined as money or other property contributed to the partnership. However, contributed capital that is attributable to the proceeds of any loan or other advance made or guaranteed by any partner or the partnership is not treated as "invested capital."

Also, any person who performs services for an entity and holds a "disqualified interest" in the entity is subject to ordinary income tax on any income or gain received with respect to the interest. A "disqualified interest" is defined as convertible or contingent debt, an option, or any derivative instrument with respect to the entity (but does not include a partnership interest or stock in certain taxable corporations). This is an anti-abuse rule designed to prevent the avoidance of the proposal through the use of compensatory arrangements other than partnership interests.

The proposal is not intended to adversely impact qualification of a real estate investment trust owning a carried interest in a real estate partnership.

The proposal would be effective for taxable years beginning after December 31, 2010.



CODIFY "ECONOMIC SUBSTANCE" DOCTRINE



Current Law

Economic Substance Doctrine. The common-law "economic substance" doctrine generally denies tax benefits from a transaction that does not meaningfully change a taxpayer's economic position, other than tax consequences, even if the transaction literally satisfies the requirements of the Internal Revenue Code. Although courts have applied the economic substance doctrine with increasing frequency, they have not applied it uniformly. Some courts require both (i) a meaningful change to the taxpayer's economic position (referred to as "objective" economic substance), and (ii) a substantial non-tax business purpose, while other courts require only one of the two factors to satisfy the economic substance doctrine. Still other courts consider objective economic substance and business purpose to be only two factors in a general investigation into whether a transaction has economic effects other than tax benefits.

Accuracy-Related Penalties. Current law contains an accuracy-related penalty that applies to an underpayment of tax attributable to a substantial understatement of income tax. The penalty equals 20 percent of the tax underpayment. Except in the case of tax shelters, the penalty may be reduced if (i) the taxpayer's treatment is supported by substantial authority or (ii) the relevant facts were adequately disclosed, and there is a reasonable basis for the item's tax treatment. A separate 20-percent penalty applies to an understatement of income tax attributable to a "listed transaction" or a "reportable transaction" with a significant purpose of tax avoidance or evasion. The penalty rate is increased to 30 percent if the taxpayer has not disclosed the transaction as required by law. Either penalty may be set aside or reduced if the taxpayer can demonstrate that there was "reasonable cause" for the taxpayer's position and that the taxpayer acted in good faith.

Denial of Interest Deduction. Current law denies any deduction for interest paid with respect to a reportable transaction understatement where the relevant facts were not adequately disclosed.



Reason for Change

Clarifying the economic substance doctrine and increasing the penalty for transactions that lack economic substance will further deter transactions designed solely to obtain tax benefits.



Proposal

Clarification of Economic Substance Doctrine. The proposal would clarify that a transaction satisfies the economic substance doctrine only if (i) it changes in a meaningful way (apart from federal tax effects) the taxpayer's economic position, and (ii) the taxpayer has a substantial purpose (other than a federal tax purpose) for entering into the transaction. The proposal would also clarify that a transaction will not be treated as having economic substance solely by reason of a profit potential unless the present value of the reasonably expected pre-tax profit is substantial in relation to the present value of the net federal tax benefits arising from the transaction. The proposal would allow the Treasury Department to publish regulations to carry out the purposes of the proposal.

New Understatement Penalty. The proposal would impose a 30-percent penalty on an understatement of tax attributable to a transaction that lacks economic substance, reduced to 20 percent if there were adequate disclosure of the relevant facts in the taxpayer's return. The proposed penalty would be imposed with regard to an understatement due to a transaction's lack of economic substance in lieu of other accuracy-related penalties that might be levied with respect to the tax understatement, although any understatement arising from a lack of economic substance would be taken into account in determining whether there is a substantial understatement of income tax under current law.

The IRS could assert and abate the new economic substance penalty. The IRS could assert the penalty even if there has not been a court determination that the economic substance doctrine was relevant. Any abatement of the economic substance penalty would have to be proportionate to the abatement of the underlying tax liability.

Denial of Interest Deduction. The proposal would deny any deduction for interest attributable to an understatement of tax arising from the application of the economic substance doctrine.

The proposal would apply to transactions entered into after the date of enactment. The denial of interest deduction component would be effective for taxable years ending after the date of enactment with respect to transactions entered into after such date.



REPEAL THE LAST-IN, FIRST-OUT (LIFO) METHOD OF ACCOUNTING FOR INVENTORIES



Current Law

The Internal Revenue Code (Code) permits a taxpayer with inventories to determine the value of its inventory and its cost of goods sold using a number of different methods. The most prevalent method is the first-in, first-out (FIFO) method, which matches current sales with the costs of the earliest acquired (or manufactured) inventory items. As an alternative, a taxpayer may elect to use the last-in, first-out (LIFO) method, which treats the most recently acquired (or manufactured) goods as having been sold during the year. The LIFO method can provide a tax benefit for a taxpayer facing rising inventory costs, since the cost of goods sold under this method is based on more recent, higher inventory values, resulting in lower taxable income. If inventory levels fall during the year, however, a LIFO taxpayer must include lower-cost LIFO inventory values (reflecting one or more prior-year inventory accumulations) in the cost of goods sold, and its taxable income will be correspondingly higher. To be eligible to elect LIFO for tax purposes, a taxpayer must use LIFO for financial accounting purposes.



Reasons for Change

The repeal of LIFO would eliminate a tax deferral opportunity that is available to taxpayers that possess inventories whose costs increase over time. In addition, LIFO repeal would simplify the Code by removing a complex and burdensome accounting method that has been the source of controversy between taxpayers and the IRS.

International Financial Reporting Standards do not permit the use of the LIFO method, and their adoption by the Security and Exchange Commission would cause violations of the current LIFO book/tax conformity requirement. Repealing LIFO removes this possible impediment to the implementation of these standards in the United States.



Proposal

The proposal would not allow the use of the LIFO inventory accounting method for Federal income tax purposes. Taxpayers that currently use the LIFO method would be required to write up their beginning LIFO inventory to its FIFO value in the first taxable year beginning after December 31, 2011. However, this one-time increase in gross income would be taken into account ratably over the first taxable year and the following seven taxable years.



Reform U.S. International Tax System



REFORM BUSINESS ENTITY CLASSIFICATION RULES FOR FOREIGN ENTITIES



Current Law

Under current Treasury regulations, an eligible business entity can elect its classification for federal tax purposes. An eligible business entity with a single owner may elect to be treated as a corporation or as an entity disregarded as an entity separate from its owner (a "disregarded entity"). An eligible business entity with at least two owners may elect to be treated as a partnership or as a corporation. Certain foreign entities are always treated as corporations for federal tax purposes (so called "per se corporations").



Reasons for Change

As applied to foreign eligible entities, the entity classification rules may result in the unintended avoidance of current U.S. tax, particularly if a foreign eligible entity elects to be treated as a disregarded entity. In certain cases, locating a foreign disregarded entity under a centralized holding company (or partnership) may permit the migration of earnings to low-taxed jurisdictions without a current income inclusion of the amount of such earnings to a U.S. taxpayer under the subpart F provisions of the Code.



Proposal

Under the proposal, a foreign eligible entity may be treated as a disregarded entity only if the single owner of the foreign eligible entity is created or organized in, or under the law of, the foreign country in, or under the law of, which the foreign eligible entity is created or organized. Therefore, a foreign eligible entity with a single owner that is organized or created in a country other than that of its single owner would be treated as a corporation for federal tax purposes. Except in cases of U.S. tax avoidance, the proposal would generally not apply to a first-tier foreign eligible entity wholly owned by a United States person. The tax treatment of the conversion to a corporation of a foreign eligible entity treated as a disregarded entity would be consistent with current Treasury regulations and relevant tax principles.

The proposal would be effective for taxable years beginning after December 31, 2010.



DEFER DEDUCTION OF EXPENSES, EXCEPT R&E EXPENSES, RELATED TO DEFERRED INCOME



Current Law

Taxpayers generally may deduct ordinary and necessary expenses paid or incurred in carrying on any trade or business. The Internal Revenue Code and the regulations thereunder contain detailed rules regarding allocation and apportionment of expenses for computing taxable income from sources within and without the United States.



Reasons for Change

Under current law, a U.S. person that incurs expenses properly allocable and apportioned to foreign-source income may deduct those expenses even if the expenses exceed the taxpayer's gross foreign-source income or if the taxpayer earns no foreign-source income. For example, a U.S. person that incurs debt to acquire stock of a foreign corporation is generally permitted to deduct currently the interest expense from the acquisition indebtedness even if no income is derived currently from such stock. The U.S. person is also permitted to deduct currently other expenses properly allocated or apportioned to the stock of the foreign corporation. Current law includes provisions that may require a U.S. person to recapture as U.S.-source income the amount by which foreign-source expenses exceed foreign-source income for a taxable year. However, if in a taxable year the U.S. person earns sufficient foreign-source income of the same statutory grouping in which the stock of the foreign corporation is classified, the interest and other expenses properly allocated and apportioned to the stock of the foreign corporation may not be subject to recapture in a subsequent taxable year. This ability to deduct expenses from overseas investments while deferring U.S. tax on the income from the investment may cause U.S. businesses to shift their investments and jobs overseas, harming our domestic economy.



Proposal

The proposal would defer a deduction for expenses (other than research and experimentation expenditures) of a U.S. person that are properly allocated and apportioned to foreign-source income to the extent the foreign-source income associated with the expenses is not currently subject to U.S. tax. The amount of expenses properly allocated and apportioned to foreignsource income generally would be determined under current Treasury regulations. The amount of deferred expenses for a particular year would be carried forward to subsequent years and combined with the foreign-source expenses of the U.S. person for such year before determining the impact of the proposal in such year.

The proposal would be effective for taxable years beginning after December 31, 2010.



REFORM FOREIGN TAX CREDIT: DETERMINE THE FOREIGN TAX CREDIT ON A POOLING BASIS



Current Law

Section 901 provides that, subject to certain limitations, a taxpayer may choose to claim a credit against its U.S. income tax liability for income, war profits, and excess profits taxes paid or accrued during the taxable year to any foreign country or any possession of the United States. Under section 902, a domestic corporation is deemed to have paid the foreign taxes paid by certain foreign subsidiaries from which it receives a dividend (the deemed paid foreign tax credit). The foreign tax credit is limited to an amount equal to the pre-credit U.S. tax on the taxpayer's foreign-source income. This foreign tax credit limitation is applied separately to foreign-source income in each of the separate categories described in section 904(d), i.e., the passive category and general category.



Reasons for Change

The purpose of the foreign tax credit is to mitigate the potential for double taxation when U.S. taxpayers are subject to foreign taxes on their foreign-source income. The reduction to two foreign tax credit limitation categories for passive category income and general category income under the American Jobs Creation Act of 2004 enhanced U.S. taxpayers' ability through "crosscrediting" to reduce the residual U.S. tax on foreign-source income.



Proposal

Under the proposal, a U.S. taxpayer would determine its deemed paid foreign tax credit on a consolidated basis by determining the aggregate foreign taxes and earnings and profits of all of the foreign subsidiaries with respect to which the U.S. taxpayer can claim a deemed paid foreign tax credit (including lower tier subsidiaries described section 902(b)). The deemed paid foreign tax credit for a taxable year would be determined based on the amount of the consolidated earnings and profits of the foreign subsidiaries repatriated to the U.S. taxpayer in that taxable year.

The proposal would be effective for taxable years beginning after December 31, 2010.



REFORM FOREIGN TAX CREDIT: PREVENT SPLITTING OF FOREIGN INCOME AND FOREIGN TAXES



Current Law

Section 901 provides that, subject to certain limitations, a taxpayer may choose to claim a credit against its U.S. income tax liability for income, war profits, and excess profits taxes paid or accrued during the taxable year to any foreign country or any possession of the United States. Under current law, the person considered to have paid the foreign tax is the person on whom foreign law imposes legal liability for such tax.



Reasons for Change

Current law permits inappropriate separation of creditable foreign taxes from the associated foreign income in certain cases such as those involving hybrid arrangements.



Proposal

The proposal would adopt a matching rule to prevent the separation of creditable foreign taxes from the associated foreign income.

The proposal would be effective for taxable years beginning after December 31, 2010.



LIMIT SHIFTING OF INCOME THROUGH INTANGIBLE PROPERTY TRANSFERS



Current Law

Section 482 permits the Commissioner to distribute, apportion, or allocate gross income, deductions, credits, and other allowances between or among two or more organizations, trades, or businesses under common ownership or control whenever "necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses." Section 482 also provides that in the case of any transfer (or license) of intangible property (as defined in section 936(h)(3)(B)), the income with respect to such transfer or license must be commensurate with the income attributable to the intangible property. Further, under section 367(d), if a U.S. person transfers intangible property (as defined in section 936(h)(3)(B)) to a foreign corporation in certain nonrecognition transactions, the U.S. person is treated as selling the intangible property for a series of payments contingent on the productivity, use, or disposition of the property that are commensurate with the transferee's income from the property. The payments generally continue annually over the useful life of the property.



Reasons for Change

Controversy often arises concerning the value of intangible property transferred between related persons. Further, the scope of the intangible property subject to sections 482 and 367(d) is not entirely clear or consistent. This lack of clarity and consistency may result in the inappropriate avoidance of U.S. tax and misuse of the rules applicable to transfers of intangible property to foreign persons.



Proposal

To prevent inappropriate shifting of income outside the United States, the proposal would clarify the definition of intangible property for purposes of sections 367(d) and 482 to include workforce in place, goodwill and going concern value. The proposal would also clarify that in a transfer of multiple intangible properties, the Commissioner may value the intangible properties on an aggregate basis where that achieves a more reliable result. The proposal would also clarify that intangible property must be valued at its highest and best use, as it would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.

The proposal would be effective for taxable years beginning after December 31, 2010.



LIMIT EARNINGS STRIPPING BY EXPATRIATED ENTITIES



Current Law

Section 163(j) applies to limit the deductibility of certain interest paid by a corporation to related persons. The limitation applies to a corporation that fails a debt-to-equity safe harbor (greater than 1.5 to 1) and that has net interest expense in excess of 50 percent of adjusted taxable income (computed by adding back net interest expense, depreciation, amortization and depletion, and any net operating loss deduction). Disallowed interest expense may be carried forward indefinitely for deduction in a subsequent year. In addition, the corporations's excess limitation for a tax year (i.e., the amount by which 50 percent of adjusted taxable income exceeds net interest expense) may be carried forward to the three subsequent tax years.

Section 7874 provides special rules for expatriated entities and the acquiring foreign corporations. The rules apply to certain defined transactions in which a U.S. parent company (the expatriated entity) is essentially replaced with a foreign parent (the surrogate foreign corporation). The tax treatment of an expatriated entity and a surrogate foreign corporation varies depending on the extent of continuity of shareholder ownership following the transaction. The surrogate foreign corporation is treated as a domestic corporation for all purposes of the Code if shareholder ownership continuity is at least 80 percent (by vote or value). If shareholder ownership continuity is at least 60 percent, but less than 80 percent, the surrogate foreign corporation is treated as a foreign corporation but any applicable corporate-level income or gain required to be recognized by the expatriated entity generally cannot be offset by tax attributes. Section 7874 generally applies to transactions occurring on or after March 4, 2003.



Reasons for Change

Under current law, opportunities are available to reduce inappropriately the U.S. tax on income earned from U.S. operations through the use of foreign related-party debt. In its recent study of earnings stripping, the Treasury Department found strong evidence of the use of such techniques by expatriated entities. Consequently, amending the rules of section 163(j) for expatriated entities is necessary to prevent these inappropriate income-reduction opportunities. Because the study did not find conclusive evidence of earnings stripping by foreign-controlled domestic corporations that have not expatriated, additional information is needed to determine whether changes to section 163(j) should be made with respect to those companies. The new Form 8926, Disqualified Corporate Interest Expense Disallowed Under Section 163(j) and Related Information , should assist in obtaining this information.



Proposal

The proposal would revise section 163(j) to tighten the limitation on the deductibility of interest paid by an expatriated entity to related persons. The current law debt-to-equity safe harbor would be eliminated. The 50 percent adjusted taxable income threshold for the limitation would be reduced to 25 percent of adjusted taxable income with respect to disqualified interest other than interest paid to unrelated parties on debt that is subject to a related-party guarantee ("guaranteed debt"). The 50 percent adjusted taxable income threshold would generally contine to apply to interest on guaranteed debt. The carryforward for disallowed interest would be limited to ten years and the carryforward of excess limitation would be eliminated.

An expatriated entity would be defined by applying the rules of section 7874 and the regulations thereunder as if section 7874 were applicable for taxable years beginning after July 10, 1989. This special rule would not apply, however, if the surrogate foreign corporation is treated as a domestic corporation under section 7874.

The proposal would be effective for taxable years beginning after December 31, 2010.



PREVENT REPATRIATION OF EARNINGS IN CERTAIN CROSS-BORDER REORGANIZATIONS



Current Law

Under section 356(a)(1), if as part of a reorganization transaction an exchanging shareholder receives in exchange for its stock of the target corporation both stock and property that cannot be received without the recognition of gain (so-called "boot"), the exchanging shareholder is required to recognize gain equal to the lesser of the gain realized in the exchange or the amount of boot received (commonly referred to as the "boot within gain" limitation). Further, under section 356(a)(2), if the exchange has the effect of the distribution of a dividend, then all or part of the gain recognized by the exchanging shareholder is treated as a dividend to the extent of the shareholder's ratable share of the corporation's earnings and profits. The remainder of the gain (if any) is treated as gain from the exchange of property.



Reasons for Change

In cross-border reorganizations, the boot-within-gain limitation of current law can permit U.S. shareholders to repatriate previously-untaxed earnings and profits of foreign subsidiaries with minimal U.S. tax consequences. For example, if the exchanging shareholder's stock in the target corporation has little or no built-in gain at the time of the exchange, the shareholder will recognize minimal gain even if the exchange has the effect of the distribution of a dividend and/or a significant amount (or all) of the consideration received in the exchange is boot. This result applies even if the corporation has previously untaxed earnings and profits equal to or greater than the boot. This result is inconsistent with the principle that previously untaxed earnings and profits of a foreign subsidiary should be subject to U.S. tax upon repatriation.



Proposal

The proposal would repeal the boot-within-gain limitation of current law in the case of any reorganization in which the acquiring corporation is foreign and the shareholder's exchange has the effect of the distribution of a dividend, as determined under section 356(a)(2).

The proposal would be effective for taxable years beginning after December 31, 2010.



REPEAL 80/20 COMPANY RULES



Current Law

Dividends and interest paid by a domestic corporation are generally U.S.-source income to the recipient and are generally subject to gross basis withholding tax if paid to a foreign person. A limited exception to these general rules applies with respect to a domestic corporation (a socalled "80/20" company) if at least 80 percent of the corporation's gross income during a threeyear testing period is foreign-source and attributable to the active conduct of a foreign trade or business. Look-through rules apply to determine the character of certain income of the 80/20 company for this purpose.



Reasons for Change

The 80/20 company provisions can be manipulated and should be repealed.



Proposal

The proposal would repeal the 80/20 company provisions under current law.

The proposal would be effective for taxable years beginning after December 31, 2010.



PREVENT THE AVOIDANCE OF DIVIDEND WITHHOLDING TAXES



Current Law

A withholding agent generally must withhold a tax of 30 percent from the gross amount of all U.S.-source fixed or determinable annual or periodical (FDAP) income, profits, or gains of a nonresident alien individual, foreign corporation, or foreign partnership. In general, dividends paid with respect to the stock of a domestic corporation are U.S.-source dividends. Thus, foreign investors holding stock in domestic corporations are generally subject to 30 percent tax on dividends paid with respect to that stock. This rate may be reduced where the dividends are paid to a resident of a jurisdiction with which the United States has entered into a tax treaty.

The source of income from notional principal contracts is generally determined based on the residence of the investor. As a result, substitute dividend payments made to a foreign investor with respect to an equity swap referencing U.S. equities are treated as foreign-source and are therefore not subject to U.S. withholding tax.



Reason for Change

Foreign portfolio investors seeking to benefit from the appreciation in value and dividends paid with respect to the stock of a domestic corporation are not limited to holding stock in the corporation. Instead, such an investor can enter into an equity swap. The U.S. tax consequences of these two alternative investments differ significantly. By entering into equity swaps, foreign portfolio investors receive the economic benefit of dividends paid and appreciation in value with respect to U.S. stock without being subject to gross-basis withholding tax.



Proposal

In order to address the avoidance of U.S. withholding tax through the use of securities lending transactions, the Treasury Department plans to revoke Notice 97-66 and issue guidance that eliminates the benefits of such transactions but minimizes over-withholding.

Further, income earned by foreign persons with respect to equity swaps that reference U.S. equities would be treated as U.S.-source to the extent that the income is attributable to (or calculated by reference to) dividends paid by a domestic corporation. An exception to this source rule would apply to swaps with all of the following characteristics:
 the terms of the equity swap do not require the foreign person to post more than 20 percent of the value of the underlying stock as collateral;

 the terms of the equity swap do not include any provision addressing the hedge position of the counterparty to the transaction;

 the underlying stock is publicly traded and the notional amount of the swap represents less than 5 percent of the total public float of that class of stock and less than 20 percent of the 30-day average daily trading volume;

 the foreign person does not sell the stock to the counterparty at the inception of the contract, or buy the stock from the counterparty at the termination of the contract;

 the prices of the equity that are used to measure the parties' entitlements or obligations are based on an objectively observable price; and

 the swap has a term of at least 90 days.

The Treasury Department would be given regulatory authority to provide additional exceptions to implement the purpose of the rule.

The proposal would be effective for payments made after December 31, 2010.



MODIFY THE TAX RULES FOR DUAL CAPACITY TAXPAYERS



Current Law

Section 901 provides that, subject to certain limitations, a taxpayer may choose to claim a credit against its U.S. income tax liability for income, war profits, and excess profits taxes paid or accrued during the taxable year to any foreign country or any possession of the United States. To be a creditable tax, a foreign levy must be substantially equivalent to an income tax under U.S. tax principles, regardless of the label attached to the levy under foreign law. Under current Treasury regulations, a foreign levy is a tax if it is a compulsory payment under the authority of a foreign government to levy taxes and is not compensation for a specific economic benefit provided by the foreign country. Taxpayers that are subject to a foreign levy and that also receive a specific economic benefit from the levying country (dual-capacity taxpayers) may not credit the portion of the foreign levy paid for the specific economic benefit. The current Treasury regulations provide that, if a foreign country has a generally imposed income tax, the dual-capacity taxpayer may treat as a creditable tax the portion of the levy that application of the generally imposed income tax would yield (provided that the levy otherwise constitutes an income tax or an in lieu of tax). The balance of the levy is treated as compensation for the specific economic benefit. If the foreign country does not generally impose an income tax, the portion of the payment that does not exceed the applicable federal tax rate applied to net income is treated as a creditable tax. A foreign tax is treated as generally imposed even if it applies only to persons who are not residents or nationals of that country.

There is no section 904 foreign tax credit separate category for foreign oil and gas income. However, under section 907, the amount of creditable foreign taxes imposed on foreign oil and gas income is limited in any year to the applicable U.S. tax on that income.



Reasons for Change

The purpose of the foreign tax credit is to mitigate double taxation of income by the United States and a foreign country. When a payment is made to a foreign country in exchange for a specific economic benefit, there is no double taxation. Current law recognizes the distinction between creditable taxes and non-creditable payments for a specific economic benefit but fails to achieve the appropriate split between the two in a case where a foreign country imposes a levy on, for example, oil and gas income only, but has no generally imposed income tax.



Proposal

In the case of a dual-capacity taxpayer, the proposal would treat a foreign levy that would otherwise qualify as an income tax or in lieu of tax as a creditable tax only if the foreign country generally imposes an income tax. An income tax would be considered generally imposed for this purpose only if the income tax applies to trade or business income from sources in that country, and only if the income tax has substantial application to non-dual-capacity taxpayers and to persons who are nationals or residents of that country. The proposal would replace the part of the regulatory safe harbor that applies when a foreign country does not generally impose an income tax. The proposal generally would retain the rule of present law where the foreign country does generally impose an income tax. The proposal also would convert the special foreign tax credit limitation rules of section 907 into a separate category within section 904 for foreign oil and gas income. The proposal would yield to U.S. treaty obligations that allow a credit for taxes paid or accrued on certain oil or gas income.

The proposal would be effective for taxable years beginning after December 31, 2010.



Combat Under-Reporting of Income Through Use of Accounts and Entities in Offshore Jurisdictions

The Administration is concerned about the use of offshore accounts and entities by certain U.S. and foreign persons to evade U.S. tax. To reduce such evasion, the Administration is proposing a series of measures to strengthen the information reporting and withholding systems that support U.S. taxation of income earned or held through offshore accounts or entities.

The qualified intermediary (QI) program is intended to bring foreign financial institutions more directly into the U.S. information reporting and withholding tax system, thereby helping to ensure that foreign persons are subject to the proper U.S. withholding tax. Strengthening the withholding and reporting rules under which QIs operate with respect to U.S. and foreign persons while creating incentives for more foreign financial institutions to become QIs will help to ensure that U.S. persons are properly paying tax in connection with foreign income and accounts and that proper withholding tax applies with respect to foreign persons.



REQUIRE GREATER REPORTING BY QUALIFIED INTERMEDIARIES REGARDING U.S. ACCOUNT HOLDERS



Current Law

A withholding agent generally must withhold tax at a rate of 30 percent from the gross amount of all U.S.-source fixed or determinable annual or periodical gains, profits, or income (FDAP income) of a nonresident alien individual or foreign entity. A payor is generally required to withhold tax at a rate of 28 percent on a reportable payment made to a U.S. non-exempt recipient if the payee fails to provide a taxpayer identification number or fails to certify, when required, that the payee is not subject to backup withholding, or the payor is notified by the IRS or a broker that the payee is subject to backup withholding.

Treasury regulations address certification, documentation, withholding, and reporting of payments to U.S. and foreign persons through foreign financial institutions. Foreign financial institutions may contract with the IRS to operate according to a set of withholding and reporting rules under the so-called "qualified intermediary" (QI) program. QIs agree to collect identifying documentation from their customers, file withholding tax returns and information returns, and submit to periodic audits performed by external auditors supervised by IRS examiners. QIs may furnish a withholding certificate to a withholding agent in lieu of transmitting to the withholding agent documentation for persons for whom the QI receives the payment and, in the case of U.S. non-exempt recipients, assumes primary Form 1099 reporting and backup withholding responsibility.

QIs need not assume primary Form 1099 reporting and backup withholding responsibility. If a QI nevertheless assumes primary Form 1099 reporting and backup withholding responsibility with respect to accounts held by U.S. persons, such reporting may be limited to certain income earned through those accounts. Further, a QI that assumes primary Form 1099 reporting and backup withholding responsibility with respect to U.S. persons is not required to assume that responsibility for all accounts. Moreover, in the case of financial institutions that are part of a controlled group, one member of the controlled group may contract to be a QI while other members of the controlled group do not, and thus accounts and clients may be divided between commonly-controlled QI and non-QI institutions.



Reasons for Change

Strengthening the withholding and reporting rules under which QIs operate with respect to U.S. persons while creating incentives for the use of QIs would help to ensure that U.S. persons are properly paying tax on income earned through foreign accounts and that proper withholding tax applies with respect to foreign persons. In order to facilitate operation of this strengthened QI program, a list of QIs must be made publicly available.



Proposal

Under the proposal, no foreign financial institution would qualify as a QI unless it identifies all of its account holders that are U.S. persons. A QI would be required to report all reportable payments (for this purpose, treating the QI as a U.S. payor) received on behalf of all U.S. account holders. Thus, a QI would file Form 1099s with respect to payments to those U.S. account holders as though the QI were a U.S. financial institution. The Treasury Department would be authorized to issue regulations to implement the purposes of this proposal, including authority to require that for any financial institution to be a QI, commonly-controlled foreign financial institutions must meet certain reporting obligations with respect to account holders or that a financial institution may be a QI only if all commonly-controlled financial institutions are also QIs, and including authority to provide that for any financial institution to be a QI it must collect information indicating the beneficial owners of foreign entity account holders and specifically report if a U.S. person is a beneficial owner. The proposal would also clarify that under section 6103 of the Code the IRS may publish the list of QIs.

The proposal would be effective beginning after December 31 of the year of enactment.



REQUIRE WITHHOLDING ON PAYMENTS OF FDAP INCOME MADE THROUGH NONQUALIFIED INTERMEDIARIES



Current Law

In general, payments of U.S.-source fixed or determinable annual or periodical gains, profits, or income (FDAP income) to nonresident alien individuals and foreign entities are subject to withholding tax at a rate of 30 percent. This 30-percent withholding tax may be reduced or eliminated pursuant to certain statutory provisions or pursuant to the terms of a tax treaty.

To determine whether the recipient of a payment is exempt from withholding tax or eligible for a reduced rate, withholding agents generally must rely on beneficial ownership documentation provided by the payee certifying that the payee is entitled to an exemption from withholding tax or a reduced rate of withholding tax under a Code provision or relevant tax treaty. In general, withholding agents are entitled to rely on the self-certification they receive absent actual knowledge or reason to know that the information provided is incorrect or unreliable. In the case of payments made through an intermediary, the intermediary generally provides to the withholding agent the appropriate documentation on behalf of the payment's beneficial owners.



Reasons for Change

The Administration is concerned that some persons that are not entitled to an exemption from withholding tax or a reduced rate of withholding tax may attempt to avoid U.S. tax by arranging to receive payments through foreign intermediaries that are not qualified intermediaries (nonqualified intermediaries). The proposal would discourage U.S. and foreign persons from attempting to avoid U.S. tax or to obtain a lower rate of withholding tax by providing incorrect self-certification or otherwise relying on the lack of information reporting associated with using nonqualified intermediaries. The proposal would also encourage use of the strengthened qualified intermediary system, by requiring withholding of tax on payments made through nonqualified intermediaries.



Proposal

Any withholding agent making a payment of FDAP income to a nonqualified intermediary would be required to treat the payment as made to an unknown foreign person (and therefore to withhold tax at a rate of 30 percent). The Treasury Department would receive regulatory authority to provide exceptions, including exceptions for payments collected by nonqualified intermediaries for foreign government, central bank, foreign pension fund, and foreign insurance company payees, and other similar investors, and for payments that the Treasury Department concludes present a low risk of tax evasion. The rules will be designed so as not to disrupt ordinary and customary market transactions. Foreign persons that are subject to overwithholding as a result of this proposal would be permitted to apply for a refund of any excess tax withheld.

The proposal would be effective for payments made after December 31 of the year of enactment.



REQUIRE WITHHOLDING ON GROSS PROCEEDS PAID TO CERTAIN NONQUALIFIED INTERMEDIARIES



Current Law

Brokers are generally required to withhold tax at a rate of 28 percent on certain reportable payments made to a U.S. non-exempt recipient if the payee fails to provide a taxpayer identification number or fails to certify that the payee is not subject to backup withholding, or the payor is notified by the IRS or a broker that the payee is subject to backup withholding. Reportable payments include the gross proceeds from certain transactions effected by brokers for their customers. A broker is exempt from reporting a payment (and thus backup withholding) where the broker can, prior to payment, associate the payment with documentation upon which it can rely to either treat the customer as a foreign beneficial owner, or treat the payment as made or presumed to be made to a foreign payee. With respect to payments through foreign intermediaries that are not qualified intermediaries (nonqualified intermediaries), brokers may rely on the beneficial owner's self-certification of non-U.S. status passed on by the nonqualified intermediary to determine whether certain third-party information reporting, and therefore backup withholding, may be required.

A withholding agent generally must withhold tax at a rate of 30 percent from the gross amount of all U.S.-source fixed or determinable annual or periodical gains, profits, or income (FDAP income) of a nonresident alien individual or foreign entity. FDAP income includes interest and dividends, but generally does not include gross proceeds or gains from sales. A foreign payee may claim a refund of any overpayment of tax which is withheld at source.



Reasons for Change

U.S. persons seeking to evade U.S. tax may arrange to receive payments, with respect to which gross proceeds would otherwise be reported, through nonqualified intermediaries and certify that they qualify as foreign persons. A broker making a payment through a nonqualified intermediary is unlikely to be in a position to verify whether self-certification regarding foreign status is accurate. The proposal would discourage U.S. persons from attempting to evade U.S. tax by providing incorrect self-certification or otherwise relying on the lack of information reporting associated with using nonqualified intermediaries. The proposal would also encourage use of the strengthened qualified intermediary system by requiring withholding on gross proceeds on the sale of securities held through nonqualified intermediaries.



Proposal

Under the proposal, a withholding agent would be required to withhold tax at a rate of 20 percent on gross proceeds from the sale of any security of a type that would be reported to a U.S. nonexempt payee, when paid by the withholding agent to a nonqualified intermediary that is located in a jurisdiction with which the United States does not have a comprehensive income tax treaty that includes a satisfactory exchange of information program. The Treasury Department would receive regulatory authority to provide exceptions, including exceptions for payments collected by nonqualified intermediaries for foreign government, central bank, foreign pension fund, and foreign insurance company payees, and other similar investors; payments to nonqualified intermediaries located in jurisdictions with which the United States has a tax information exchange agreement; and payments that the Treasury Department concludes present a low risk of tax evasion. The rules will be designed so as not to disrupt ordinary and customary market transactions. Nonqualified intermediaries would be eligible to claim a refund on behalf of their direct account holders for any taxable year in which they identified all of their direct account holders that are U.S. persons and reported all reportable payments received on behalf of U.S. account holders. Foreign persons that are subject to withholding tax in excess of their income tax liability as a result of this proposal, and on whose behalf a refund claim is not made by a nonqualified intermediary, would be permitted to apply for a refund of any tax withheld.

The proposal would be effective for payments made after December 31 of the year of enactment.



REQUIRE REPORTING OF CERTAIN TRANSFERS OF MONEY OR PROPERTY TO FOREIGN FINANCIAL ACCOUNTS



Current Law

United States persons must disclose whether, at any time during the preceding year, they had an interest in, or signature or other authority over, financial accounts in a foreign country, if the aggregate value of these accounts exceeds $10,000. United States persons must also report certain information with respect to certain foreign business entities that they control. Under Treasury regulations, a U.S. person controls a foreign corporation for this purpose if the person owns, actually or constructively, more than 50 percent of the corporation's stock, by vote or by value. Current law does not contain a provision that generally requires reporting of transfers of money or property to, or receipt of money or property from, a foreign bank, brokerage, or other financial account by U.S. individuals.



Reason for Change

The Administration is concerned about the use of foreign accounts by U.S. citizens and residents to evade U.S. tax. To reduce such evasion, the Administration proposes to increase information reporting requirements with respect to transfers to and from certain foreign accounts.



Proposal

A U.S. individual would be required to report, on the individual's income tax return, any transfer of money or property made to, or receipt of money or property from, any foreign bank, brokerage, or other financial account by the individual, or by any entity of which the individual owns, actually or constructively, more than 50 percent of the ownership interest. Transfers to accounts held at qualified intermediaries and receipts from accounts held by U.S. persons at qualified intermediaries would not be required to be reported. In addition, individuals would be exempt from the reporting requirement if the cumulative amount or value of transfers and the cumulative amount or value of receipts that would otherwise be reportable on the individual's income tax return for a given year were each less than $10,000. Failure to report a covered transfer would result in the imposition of a penalty equal to the lesser of $10,000 per reportable transfer or 10 percent of the cumulative amount or value of the unreported covered transfers. No penalty would be imposed for a failure to report due to reasonable cause. The Treasury Department would receive regulatory authority to issue rules to prevent abuse of the reporting exemptions and to provide exceptions to the reporting requirement, such as an exception for arm's-length payments in the ordinary course of business for services or tangible property.

The proposal would be effective for transfers made after December 31 of the year of enactment.



REQUIRE DISCLOSURE OF FBAR ACCOUNTS TO BE FILED WITH TAX RETURN



Current Law

Individual taxpayers currently must indicate on their income tax returns whether they had an interest in or signature or other authority over a financial account in a foreign country during the year to which the tax return relates. If a taxpayer has a foreign account, the tax return refers the taxpayer to the Report of Foreign Bank and Financial Accounts, Form TD F 90-22.1 (FBAR). The FBAR requires a citizen, resident, or person in and doing business in the United States to disclose whether, at any time during the preceding year, that person had an interest in, or signature authority over, financial accounts, if the aggregate value of these accounts exceeds $10,000. The FBAR further requires the person to disclose certain information regarding the foreign account, including the account number, financial institution, and maximum value during the year. The FBAR is not required to be filed until June 30 of the year following the calendar year to which it relates. The FBAR is filed with the Treasury Department generally and not directly with the IRS.



Reasons for Change

Disclosure of more detailed information regarding foreign accounts on the income tax return itself would assist the IRS in identifying and investigating instances where taxpayers have used foreign accounts to evade U.S. taxes. Further, associating the FBAR disclosure requirements with a taxpayer's obligation to file an income tax return would improve awareness and compliance with the FBAR disclosure obligations and improve the IRS's ability to review FBAR compliance.



Proposal

Individual taxpayers required to file an FBAR would be required to disclose certain information on their income tax returns. The information would be disclosed on a schedule that would be considered part of the individual's income tax return. The schedule would be consistent with the information disclosure obligations of the FBAR itself, and would require the taxpayer to provide information such as the account number, financial institution, and maximum value during the year. The disclosures would be required when the income tax return is due, even if Title 31 does not require the FBAR to be filed until a later date.

The tax return disclosure would not replace or mitigate the individual's obligation to separately file an FBAR with the Treasury Department as required under Title 31. The penalties imposed under Title 31 for failing to file an FBAR would continue to apply to a failure to file an FBAR as required under Title 31. Failure to disclose the foreign accounts with the income tax return would not be subject to the Title 31 penalties, although it could give rise to penalties and other consequences imposed under the Code, including extension of the statute of limitations.

The proposal would be effective for taxable years beginning after December 31 of the year of enactment.



REQUIRE THIRD-PARTY INFORMATION REPORTING REGARDING THE TRANSFER OF ASSETS TO FOREIGN FINANCIAL ACCOUNTS AND THE ESTABLISHMENT OF FOREIGN FINANCIAL ACCOUNTS



Current Law

United States persons must disclose whether, at any time during the preceding year, they had an interest in, or signature or other authority over, financial accounts in a foreign country, if the aggregate value of these accounts exceeds $10,000. Current law does not generally require thirdparty information reporting to the IRS with regard to the transfer of money or property to, or receipt of money or property from, a foreign bank, brokerage, or other financial account on behalf of a U.S. person, or with regard to the establishment of a foreign bank, brokerage, or other financial account on behalf of a U.S. person.



Reasons for Change

The Administration is concerned that U.S. persons are failing to comply with the requirement to report certain foreign financial accounts. Establishing a third-party reporting requirement with respect to transfers to foreign financial accounts, receipts from such accounts, and the establishment of such accounts would lead to greater disclosure of foreign financial accounts, and consequently would discourage the evasion of U.S. taxation. These third-party reporting requirements complement taxpayer reporting requirements.



Proposal

Any U.S. financial intermediary and any qualified intermediary that transfers money or property with a value of more than $10,000 to a foreign bank, brokerage, or other financial account on behalf of a U.S. person (or on behalf of any entity of which a U.S. person owns, actually or constructively, more than 50 percent of the ownership interest) would be required to file an information return regarding such transfer. Any U.S. financial intermediary and any qualified intermediary that receives a transfer of money or property with a value of more than $10,000 from a foreign bank, brokerage, or other financial account on behalf of a U.S. person (or on behalf of any entity of which a U.S. person owns, actually or constructively, more than 50 percent of the ownership interest) would be required to file an information return regarding such transfer. Any U.S. financial intermediary and any qualified intermediary that opens a foreign bank, brokerage, or other financial account on behalf of a U.S. person (or on behalf of any entity of which a U.S. person owns, actually or constructively, more than 50 percent of the ownership interest) would be required to file an information return with the IRS regarding such account, including reporting any amounts of money or property transferred by the financial intermediary to such account. Exceptions to the reporting requirement would be provided for 1) accounts opened and amounts transferred to, from, or on behalf of, publicly traded companies and their subsidiaries, 2) accounts opened at and transfers made to qualified intermediaries on behalf of a U.S. person (or on behalf of any entity of which a U.S. person owns, actually or constructively, more than 50 percent of the ownership interest) or 3) transfers received by or on behalf of a U.S. person (or on behalf of any entity of which a U.S. person owns, actually or constructively, more than 50 percent of the ownership interest) from accounts held by a U.S. person at a qualified intermediary. The Treasury Department would receive regulatory authority to provide additional exceptions to the reporting requirement, to require that certain additional information be reported, and to permit U.S. financial intermediaries and qualified intermediaries to report additional transfers of money or property to a foreign bank, brokerage, or other financial account on behalf of a U.S. person (or on behalf of an entity of which the U.S. person owns, actually or constructively, more than 50 percent of the ownership interest).

The proposal would be effective for amounts transferred and accounts opened beginning after December 31 of the year of enactment.



REQUIRE THIRD-PARTY INFORMATION REPORTING REGARDING THE ESTABLISHMENT OF OFFSHORE ENTITIES



Current Law

United States persons must report certain information with respect to certain foreign business entities that they control. Current law does not generally require third-party information reporting in connection with the acquisition or formation of a foreign business entity on behalf of a U.S. individual. Current law does not require withholding agents to ascertain the ownership of foreign payees that may be entities with respect to which U.S. persons have a U.S. reporting or income tax obligation.



Reasons for Change

Because no information is reported to the IRS by third parties with respect to the formation of foreign business entities, the IRS cannot readily ascertain whether U.S. individuals are complying with their reporting obligations in regard of foreign business entities that they control. Requiring third-party reporting, and providing for additional information collection by withholding agents, would supplement the reporting requirements of current law and help the IRS to enforce U.S. tax law and reduce tax evasion through the use of foreign entities.



Proposal

Any U.S. person, or any qualified intermediary, that forms or acquires a foreign entity on behalf of a U.S. individual (or on behalf of any entity of which the individual owns, actually or constructively, more than 50 percent of the ownership interest) would be required to file an information return with the IRS regarding the foreign entity that is formed or acquired. The Treasury Department would receive regulatory authority to determine the information to be reported and to provide exceptions to the reporting requirement. In addition, the Treasury Department would receive regulatory authority to require, as necessary, withholding agents to collect additional information to determine whether a U.S. person is the beneficial owner of a foreign entity and specifically report if a U.S. person is a beneficial owner.

The proposal would be effective for entities formed or acquired after December 31 of the year of enactment.



NEGATIVE PRESUMPTION FOR FOREIGN ACCOUNTS WITH RESPECT TO WHICH AN FBAR HAS NOT BEEN FILED



Current Law

A citizen or resident of the United States, or a person in and doing business in the United States, who has a financial interest in, or signature or other authority over, financial accounts in a foreign country must file a Report of Foreign Bank and Financial Accounts (FBAR) if the aggregate value of these accounts exceeds $10,000 at any time during the preceding year. The civil penalty for failing to disclose a foreign financial account on an FBAR will not exceed $10,000 absent a willful violation. The penalty may not be imposed if the violation was due to reasonable cause and the balance in the account was properly reported. For willful violations, the maximum civil penalty is the greater of $100,000 or 50 percent of the balance in the account at the time of the violation. The criminal penalties for willfully failing to report a foreign bank account include a maximum fine of $250,000, a maximum term of imprisonment of five years, or both, with higher penalties if the defendant violates any other U.S. law, or if the violation was part of a pattern of any illegal activity involving more than $100,000 in a 12-month period. Civil and criminal penalties may be imposed together.



Reasons for Change

The Administration is concerned that U.S. persons are failing to comply with FBAR filing obligations. Under current law, the civil penalty provisions associated with the requirement to file an FBAR may be difficult to apply in cases where the IRS is aware of the existence of unreported foreign financial accounts but cannot ascertain without documentation from the foreign financial institution whether those accounts contain more than $10,000. Imposing a rebuttable evidentiary presumption would encourage voluntary disclosure of account information and assist the IRS in its enforcement efforts with respect to undisclosed foreign financial accounts.



Proposal

A rebuttable evidentiary presumption would be applicable in a civil administrative or judicial proceeding providing that any foreign bank, brokerage, or other financial account in which a citizen or resident of the United States, or a person in and doing business in the United States, has a financial interest in or signature or other authority over the account contains enough funds to require that an FBAR be filed. An exception would apply for accounts held through a qualified intermediary. The Treasury Department would receive regulatory authority to provide additional exceptions. The rebuttable evidentiary presumption would not apply in criminal proceedings.

The proposal would be effective for FBARs due to be filed beginning after the date of enactment.



NEGATIVE PRESUMPTION REGARDING FAILURE TO FILE AN FBAR FOR ACCOUNTS WITH NONQUALIFIED INTERMEDIARIES



Current Law

A citizen or resident of the United States, or a person in and doing business in the United States, who has a financial interest in, or signature or other authority over, financial accounts in a foreign country must file a Report of Foreign Bank and Financial Accounts (FBAR) if the aggregate value of these accounts exceeds $10,000 at any time during the preceding year. The civil penalty for failing to disclose a foreign financial account on an FBAR will not exceed $10,000 absent a willful violation. The penalty may not be imposed if the violation was due to reasonable cause and the balance in the account was properly reported. For willful violations, the maximum civil penalty is the greater of $100,000 or 50 percent of the balance in the account at the time of the violation. The criminal penalties for willfully failing to report a foreign bank account include a maximum fine of $250,000, a maximum term of imprisonment of five years, or both, with higher penalties if the defendant violates any other U.S. law, or if the violation was part of a pattern of any illegal activity involving more than $100,000 in a 12-month period. Civil and criminal penalties may be imposed together.



Reasons for Change

The Administration is concerned that U.S. persons are failing to comply with FBAR filing obligations. Although qualified intermediaries must perform certain information reporting with respect to U.S. accountholders, foreign intermediaries that are not qualified intermediaries (nonqualified intermediaries) do not perform such information reporting. As a result, the ability of the IRS to discover unreported accounts and enforce compliance with respect to those accounts is limited. Imposing a rebuttable evidentiary presumption with respect to accounts held with nonqualified intermediaries would encourage voluntary disclosure of account information and assist the IRS in its enforcement efforts with respect to undisclosed foreign financial accounts.



Proposal

A rebuttable evidentiary presumption would be applicable in a civil administrative or judicial proceeding providing that failure to file an FBAR with respect to any foreign bank, brokerage, or other financial account held with a nonqualified intermediary is willful if the account has a balance of greater than $200,000 at any point during the calendar year. The evidentiary presumption would not apply to accounts in which the person has signature or other authority by virtue of being an officer or employee of a corporation, but otherwise has no more than a de minimis financial interest in that corporation. The Treasury Department would receive regulatory authority to provide additional exceptions to the evidentiary presumption. The evidentiary presumption would not apply in criminal proceedings.

The proposal would be effective for FBARs due to be filed beginning after the date of enactment.



NEGATIVE PRESUMPTION REGARDING WITHHOLDING ON FDAP PAYMENTS TO CERTAIN FOREIGN ENTITIES



Current Law

In general, payments of U.S.-source fixed or determinable annual or periodical gains, profits, or income (FDAP income) to nonresident alien individuals and foreign entities are subject to withholding tax at a rate of 30 percent. This 30 percent withholding tax may be reduced or eliminated pursuant to certain statutory provisions or pursuant to the terms of a tax treaty.

To determine whether the recipient of a payment is exempt from withholding tax or eligible for a reduced rate, withholding agents generally must rely on beneficial ownership documentation provided by the payee certifying that the payee is entitled to an exemption from withholding tax or a reduced rate of withholding tax under a Code provision or relevant tax treaty. In general, withholding agents are entitled to rely on the self-certification they receive absent actual knowledge or reason to know that the information provided is incorrect or unreliable. In the case of payments made through an intermediary, the intermediary generally provides to the withholding agent the appropriate documentation on behalf of the payment's beneficial owners.



Reasons for Change

Persons that are not entitled to an exemption from withholding tax or a reduced rate of withholding tax may arrange to receive payments through entities that appear to qualify for an exemption or a reduced rate. A withholding agent making a payment to such an entity is unlikely to be in a position to determine whether the entity's self-certification regarding its qualification is accurate.



Proposal

Any withholding agent making a payment of FDAP income to a foreign entity would be required to treat the payment as made to an unknown person (and therefore subject to 30 percent grossbasis withholding tax), unless the foreign entity provides documentation of the entity's beneficial owners. Exceptions would be provided for payments to publicly traded companies and their subsidiaries, foreign governments, and pension funds. In addition, the Treasury Department would receive regulatory authority to provide additional exceptions for payments to entities engaged in the active conduct of a trade or business in their country of residence, charities, widely-held investment vehicles, entities that enter into an agreement with the IRS to collect documentation for all owners and report all U.S. non-exempt owners to the IRS, and for any other payment that the Treasury Department concludes presents a low risk of tax evasion.

The proposal would be effective for payments made after December 31 of the year of enactment.



EXTEND STATUTE OF LIMITATIONS FOR CERTAIN REPORTABLE CROSS-BORDER TRANSACTIONS AND FOREIGN ENTITIES



Current Law

In general, additional Federal tax liabilities in the form of tax, interest, penalties, and additions to tax must be assessed by the IRS within three years after the date a return is filed. If an assessment is not made within the required time period, the additional liabilities generally cannot be assessed or collected at any future time. Section 6501(c)(8) of the Code provides an exception to this general statute of limitations with respect to any tax relating to any event or period for which certain information returns are required with respect to certain foreign transfers, foreign entities, and foreign-owned entities. In these cases, the statute of limitations does not expire until three years after the taxpayer furnishes the information required to be reported.

Section 6038A of the Code requires certain foreign-owned domestic corporations to file information returns containing specified information with respect to related-party transactions, and to maintain such records as may be appropriate to determine the correct treatment of such transactions. Failure to file the required information returns triggers the section 6501(c)(8) extension of the statute of limitations.



Reasons for Change

Compliance with reporting and recordkeeping obligations is essential in order to enable the IRS to enforce the tax laws. The three-year period provided by section 6501(c)(8) does not always allow sufficient time for the IRS to determine a taxpayer's tax liability. Furthermore, the information returns to which section 6501(c)(8) applies do not include some of the information returns the IRS requires in order to enforce the tax law with respect to foreign entities and accounts, including certain newly proposed information returns. The generally applicable threeyear statute of limitations also does not always allow sufficient time for the IRS to determine a taxpayer's tax liability if a violation of record maintenance obligations under section 6038A has occurred.



Proposal

The proposal would extend the period during which the statute of limitations provided by section 6501(c)(8) does not expire to six years after the taxpayer furnishes the information required to be reported. The information returns with respect to which section 6501(c)(8) applies would be broadened to include the information returns filed by qualifying electing funds pursuant to regulations under section 1295(b) of the Code, the proposed tax return disclosure of FBAR information, and the information returns proposed to be required of U.S. individuals with respect to certain transfers of money or property to and receipts from certain foreign bank, brokerage, or other financial accounts. The extended statute of limitations provided by section 6501(c)(8) would also apply in the case of failure to furnish information or maintain records as required by section 6038A(a). The section 6501(c)(8) exception to the general statute of limitations would be made applicable to the entire income tax return. The Treasury Department would receive regulatory authority to provide exceptions to these rules.

The proposal would be effective for returns due to be filed after the date of enactment.



DOUBLE ACCURACY-RELATED PENALTIES ON UNDERSTATEMENTS INVOLVING UNDISCLOSED FOREIGN ACCOUNTS



Current Law

Current law imposes a 20-percent accuracy-related penalty on (i) a substantial understatement of income tax, (ii) an understatement resulting from negligence or disregard of rules or regulations, and (iii) an understatement related to a reportable transaction. The 20-percent accuracy-related penalty increases to 30 percent in the case of an understatement from a reportable transaction that was not properly disclosed. The accuracy-related penalty is not imposed when the taxpayer demonstrates "reasonable cause" for the position and acted in good faith. In the case of a reportable transaction, the reasonable cause exception to the imposition of penalties only applies if the taxpayer disclosed the reportable transaction as required by law and certain other requirements are met.

Individual taxpayers must indicate on their income tax returns whether they had an interest in or signature or other authority over a financial account in a foreign country during the year to which the tax return relates. If the taxpayer had a foreign financial account, the income tax return instructs the taxpayer to refer to the Report of Foreign Bank and Financial Accounts (FBAR), which requires the taxpayer to disclose information regarding certain foreign accounts.



Reason for Change

United States persons may seek to evade U.S. tax liability by transferring assets to foreign accounts. Increasing the penalties on understatements from transactions that involve undisclosed foreign accounts would encourage proper disclosure of such accounts and deter the use of foreign accounts to evade U.S. tax liability.



Proposal

The 20-percent accuracy-related penalty imposed on (i) substantial understatements of income tax, (ii) understatements resulting from negligence or disregard of rules or regulations, or (iii) a reportable transaction understatement, would be doubled to 40 percent when the understatement arises from a transaction involving a foreign account that the taxpayer failed to disclose properly under the proposed requirement that taxpayers disclose FBAR-related information on their income tax returns. In addition, in the case of a reportable transaction understatement, the reasonable cause exception would not be available with respect to this increased penalty.

The proposal would be effective for taxable years beginning after December 31 of the year of enactment.



IMPROVE THE FOREIGN TRUST REPORTING PENALTY



Current Law

Certain information must be reported to the IRS with respect to certain foreign trusts. A civil penalty applies to persons who fail to file a timely return as required or who file an incomplete or incorrect return. Generally, the penalty is equal to 35 percent of the "gross reportable amount," which is defined as the gross value of property involved in a reportable event such as a gratuitous transfer to the trust, the gross value of the portion of the trust's assets at the close of the year that is treated as owned by a United States person, or the gross amount of distributions received from the trust. In the case of a failure to report that continues for more than 90 days after the IRS mails notice of such failure, the penalty (in addition to the 35 percent penalty) is $10,000 for each 30-day period (or fraction thereof) during which the failure continues. The total penalty with respect to any failure may not exceed the gross reportable amount.



Reasons for Change

In many instances, the IRS obtains information relating to the creation of a foreign trust from third parties, or the IRS discovers funding of a foreign trust from public records. Without the cooperation of persons actually involved with the trust, however, it is often difficult for the IRS to determine the gross reportable amount. If the IRS cannot determine the gross reportable amount, the IRS may not be able to assess the penalties, including the $10,000 penalty for continued failure to report. The current penalty regime therefore may create an incentive for persons subject to the reporting requirement not to report or cooperate with the IRS in the hope that the IRS will not be able to determine the gross reportable amount, which is essential to presenting a prima facie case sufficient to meet the Code section 7491(c) burden of production to support the penalty.



Proposal

The penalty provision would be amended to impose an initial penalty of the greater of $10,000 or 35 percent of the gross reportable amount (if the gross reportable amount is known). The additional $10,000 penalty for continued failure to report would remain unchanged. Thus, even if the gross reportable amount is not known, the IRS may impose a $10,000 penalty on a person who fails to report timely or correctly as required, and may impose a $10,000 penalty for each 30-day period (or fraction thereof) that the failure to report continues. If the person subsequently provides enough information for the IRS to determine the gross reportable amount, the total penalties would be capped at that amount and any excess penalty already paid would be refunded. Accordingly, a person can stop the compounding of penalties by cooperating with the IRS so that it can determine the gross reportable amount.

The proposal would be effective for information reports required to be filed after December 31 of the year of enactment.



REQUIRE INFORMATION REPORTING FOR RENTAL PROPERTY EXPENSE PAYMENTS



Current Law

Generally, a taxpayer making payments in the course of a trade or business to a noncorporate recipient aggregating to $600 or more for services or determinable gains in a calendar year is required to send an information return to the IRS setting forth the amount, as well as name and address of the recipient of the payment (generally on Form 1099). If the taxpayer making payments is not engaged in a trade or business, such information reporting is not required.

At present, there is limited third-party information reporting related to rental real estate expenses because only taxpayers whose rental real estate activity is considered a trade or business are required to report payments. Additionally, whether a taxpayer's rental real estate activity should be considered a trade or business requires a case-by-case analysis that depends on the facts and circumstances of each taxpayer.



Reasons for Change

Information reporting requirements generally improve taxpayer compliance. Requiring information reporting by taxpayers receiving rental income and deducting expenses on rental activities would improve the reporting compliance by taxpayers providing services to those rental activities. In addition, increased third-party reporting of major rental expenses is likely to improve reporting compliance on rental real estate income.



Proposal

The proposal would, in general, subject recipients of rental income from real estate would, in general, be subject to the same information reporting requirements as are taxpayers engaging in a trade or business. In particular, rental income recipients making payments of $600 or more to a service provider (such as a plumber, painter, or accountant) in the course of earning rental income would be required to send an information return, generally a Form 1099-MISC, to the IRS and to the service provider. Exceptions to the reporting requirement would be made for particularly burdensome situations, such as for taxpayers (including members of the military) who rent their principal residence on a temporary basis, or for those who receive only small amounts of rental income.

The proposal would be effective for tax years beginning after December 31, 2009.



Eliminate Oil and Gas Company Preferences



LEVY TAX ON CERTAIN OFFSHORE OIL AND GAS PRODUCTION



Current Law

No Federal tax is imposed on the production of oil and gas on the Outer Continental Shelf (OCS).



Reasons for Change

According to the Government Accountability Office, the return to the taxpayer from OCS production is among the lowest in the world, despite other factors that make the United States a comparatively good place to invest in oil and gas development. An excise tax on OCS production would advance important policy objectives, such as providing a more level playing field among producers, raising the return to the taxpayer, and encouraging sustainable domestic oil and gas production.



Proposal

The Administration is developing a proposal to impose an excise tax on certain oil and gas produced offshore in the future. The Administration will work with Congress to develop the details of this proposal.



REPEAL CREDIT FOR ENHANCED OIL RECOVERY (EOR) PROJECTS



Current Law

The general business credit includes a 15-percent credit for eligible costs attributable to EOR projects. If the credit is claimed with respect to eligible costs, the taxpayer's deduction (or basis increase) with respect to those costs is reduced by the amount of the credit. Eligible costs include the cost of constructing a gas treatment plant to prepare Alaska natural gas for pipeline transportation and any of the following costs with respect to a qualified EOR project: (1) the cost of depreciable or amortizable tangible property that is an integral part of the project; (2) intangible drilling and development costs (IDCs) that the taxpayer can elect to deduct; and (3) deductible tertiary injectant costs. A qualified EOR project must be located in the United States and must involve the application of one or more of nine listed tertiary recovery methods that can reasonably be expected to result in more than an insignificant increase in the amount of crude oil which ultimately will be recovered. The allowable credit is phased out over a $6 range for a taxable year if the annual average unregulated wellhead price per barrel of domestic crude oil during the calendar year preceding the calendar year in which the taxable year begins (the reference price) exceeds an inflation adjusted threshold. The credit was completely phased out for taxable years beginning in 2008, because the reference price ($66.52) exceeded the inflation adjusted threshold ($41.06) by more than $6.



Reasons for Change

The credit, like other oil and gas preferences the Administration proposes to repeal, distorts markets by encouraging more investment in the oil and gas industry than would occur under a neutral system. To the extent the credit encourages overproduction of oil, it is detrimental to long-term energy security and is also inconsistent with the Administration's policy of reducing carbon emissions and encouraging the use of renewable energy sources through a cap-and-trade program. Moreover, the credit must ultimately be financed with taxes that result in underinvestment in other, potentially more productive, areas of the economy.



Proposal

The investment tax credit for enhanced oil recovery projects would be repealed for taxable years beginning after December 31, 2010.



REPEAL CREDIT FOR PRODUCTION FROM MARGINAL WELLS



Current Law

The general business credit includes a credit for crude oil and natural gas produced from marginal wells. The credit rate is $3.00 per barrel of oil and $0.50 per 1,000 cubic feet of natural gas for taxable years beginning in 2005 and is adjusted for inflation in taxable years beginning after 2005. The credit is available for production from wells that produce oil and gas qualifying as marginal production for purposes of the percentage depletion rules or that have average daily production of not more than 25 barrel-of-oil equivalents and produce at least 95 percent water. The credit per well is limited to 1,095 barrels of oil or barrel-of-oil equivalents per year. The credit rate for crude oil is phased out for a taxable year if the annual average unregulated wellhead price per barrel of domestic crude oil during the calendar year preceding the calendar year in which the taxable year begins (the reference price) exceeds the applicable threshold. The phase-out range and the applicable threshold at which phase-out begins are $3.00 and $15.00 for taxable years beginning in 2005 and are adjusted for inflation in taxable years beginning after 2005. The credit rate for natural gas is similarly phased out for a taxable year if the annual average wellhead price for domestic natural gas exceeds the applicable threshold. The phase-out range and the applicable threshold at which phase-out begins are $0.33 and $1.67 for taxable years beginning in 2005 and are adjusted for inflation in taxable years beginning after 2005. The credit has been completely phased out for all taxable years since its enactment. Unlike other components of the general business credit, the marginal well credit can be carried back up to five years.



Reasons for Change

The credit, like other oil and gas preferences the Administration proposes to repeal, distorts markets by encouraging more investment in the oil and gas industry than would occur under a neutral system. To the extent the credit encourages overproduction of oil, it is detrimental to long-term energy security and is also inconsistent with the Administration's policy of reducing carbon emissions and encouraging the use of renewable energy sources through a cap-and-trade program. Moreover, the credit must ultimately be financed with taxes that result in underinvestment in other, potentially more productive, areas of the economy.



Proposal

The production tax credit for oil and gas from marginal wells would be repealed for production in taxable years beginning after December 31, 2010.



REPEAL EXPENSING OF INTANGIBLE DRILLING COSTS



Current Law

In general, costs that benefit future periods must be capitalized and recovered over such periods for income tax purposes, rather than being expensed in the period the costs are incurred. In addition, the uniform capitalization rules require certain direct and indirect costs allocable to property to be included in inventory or capitalized as part of the basis of such property. In general, the uniform capitalization rules apply to real and tangible personal property produced by the taxpayer or acquired for resale.

Special rules apply to intangible drilling and development costs (IDCs). IDCs include all expenditures made by an operator for wages, fuel, repairs, hauling, supplies, etc., incident to and necessary for the drilling of wells and the preparation of wells for the production of oil and gas. In addition, IDCs include the cost to operators of any drilling or development work (excluding amounts payable only out of production or gross or net proceeds from production, if the amounts are depletable income to the recipient, and amounts properly allocable to the cost of depreciable property) done by contractors under any form of contract (including a turnkey contract). IDCs include amounts paid for labor, fuel, repairs, hauling, and supplies which are used in the drilling, shooting, and cleaning of wells; in such clearing of ground, draining, road making, surveying, and geological works as are necessary in preparation for the drilling of wells; and in the construction of such derricks, tanks, pipelines, and other physical structures as are necessary for the drilling of wells and the preparation of wells for the production of oil and gas. Generally, IDCs do not include expenses for items which have a salvage value (such as pipes and casings) or items which are part of the acquisition price of an interest in the property.

Under the special rules applicable to IDCs, an operator (i.e., a person who holds a working or operating interest in any tract or parcel of land either as a fee owner or under a lease or any other form of contract granting working or operating rights) who pays or incurs IDCs in the development of an oil or gas property located in the United States may elect either to expense or capitalize those costs. The uniform capitalization rules do not apply to otherwise deductible IDCs.

If a taxpayer elects to expense IDCs, the amount of the IDCs is deductible as an expense in the taxable year the cost is paid or incurred. Generally, IDCs that a taxpayer elects to capitalize may be recovered through depletion or depreciation, as appropriate; or in the case of a nonproductive well ("dry hole"), the operator may elect to deduct the costs. In the case of an integrated oil company (i.e., a company that engages, either directly or through a related enterprise, in substantial retailing or refining activities) that has elected to expense IDCs, 30 percent of the IDCs on productive wells must be capitalized and amortized over a 60-month period.

A taxpayer that has elected to deduct IDCs may, nevertheless, elect to capitalize and amortize certain IDCs over a 60-month period beginning with the month the expenditure was paid or incurred. This rule applies on an expenditure-by-expenditure basis; that is, for any particular taxable year, a taxpayer may deduct some portion of its IDCs and capitalize the rest under this provision. This allows the taxpayer to reduce or eliminate IDC adjustments or preferences under the AMT.

The election to deduct IDCs applies only to those IDCs associated with domestic properties. For this purpose, the United States includes certain wells drilled offshore.



Reasons for Change

The expensing of IDCs, like other oil and gas preferences the Administration proposes to repeal, distorts markets by encouraging more investment in the oil and gas industry than would occur under a neutral system. To the extent expensing encourages overproduction of oil and gas, it is detrimental to long-term energy security and is also inconsistent with the Administration's policy of reducing carbon emissions and encouraging the use of renewable energy sources through a cap-and-trade program. Moreover, the tax subsidy for oil and gas must ultimately be financed with taxes that result in underinvestment in other, potentially more productive, areas of the economy. Capitalization of IDCs would place them on a cost recovery system similar to that employed by other industries and reduce economic distortions.



Proposal

Expensing of intangible drilling costs and 60-month amortization of capitalized intangible drilling costs would not be allowed. Intangible drilling costs would be capitalized as depreciable or depletable property, depending on the nature of the cost incurred, in accordance with the generally applicable rules.

The proposal would be effective for costs paid or incurred after December 31, 2010.



REPEAL DEDUCTION FOR TERTIARY INJECTANTS



Current Law

Taxpayers are allowed to deduct the cost of qualified tertiary injectant expenses for the taxable year. Qualified tertiary injectant expenses are amounts paid or incurred for any tertiary injectant (other than recoverable hydrocarbon injectants) that is used as a part of a tertiary recovery method. The deduction is treated as an amortization deduction in determining the amount subject to recapture upon disposition of the property.



Reasons for Change

The deduction for tertiary injectants, like other oil and gas preferences the Administration proposes to repeal, distorts markets by encouraging more investment in the oil and gas industry than would occur under a neutral system. To the extent expensing encourages overproduction of oil and gas, it is detrimental to long-term energy security and is also inconsistent with the Administration's policy of reducing carbon emissions and encouraging the use of renewable energy sources through a cap-and-trade program. Moreover, the tax subsidy for oil and gas must ultimately be financed with taxes that result in underinvestment in other, potentially more productive, areas of the economy. Capitalization of tertiary injectants would place them on a cost recovery system similar to that employed by other industries and reduce economic distortions.



Proposal

The deduction for qualified tertiary injectant expenses would not be allowed for amounts paid or incurred after December 31, 2010.



REPEAL PASSIVE LOSS EXCEPTION FOR WORKING INTERESTS IN OIL AND GAS PROPERTIES



Current Law

The passive loss rules limit deductions and credits from passive trade or business activities. Deductions attributable to passive activities, to the extent they exceed income from passive activities, generally may not be deducted against other income, such as wages, portfolio income, or business income that is not derived from a passive activity. A similar rule applies to credits. Suspended deductions and credits are carried forward and treated as deductions and credits from passive activities in the next year. The suspended losses and credits from a passive activity are allowed in full when the taxpayer completely disposes of the activity.

Passive activities are defined to include trade or business activities in which the taxpayer does not materially participate. An exception is provided, however, for any working interest in an oil or gas property that the taxpayer holds directly or through an entity that does not limit the liability of the taxpayer with respect to the interest.



Reasons for Change

The special tax treatment of working interests in oil and gas properties, like other oil and gas preferences the Administration proposes to repeal, distorts markets by encouraging more investment in the oil and gas industry than would occur under a neutral system. To the extent this special treatment encourages overproduction of oil and gas, it is detrimental to long-term energy security and is also inconsistent with the Administration's policy of reducing carbon emissions and encouraging the use of renewable energy sources through a cap-and-trade program. Moreover, the working interest exception for oil and gas must ultimately be financed with taxes that result in underinvestment in other, potentially more productive, areas of the economy. Eliminating the working interest exception would subject oil and gas properties to the same limitations as other activities and reduce economic distortions.



Proposal

The exception from the passive loss rules for working interests in oil and gas properties would be repealed for taxable years beginning after December 31, 2010.



REPEAL PERCENTAGE DEPLETION



Current Law

The capital costs of oil and gas wells are recovered through the depletion deduction. Under the cost depletion method, the basis recovery for a taxable year is proportional to the exhaustion of the property during the year. This method does not permit cost recovery deductions that exceed basis or that are allowable on an accelerated basis.

A taxpayer may also qualify for percentage depletion with respect to oil and gas properties. The amount of the deduction is a statutory percentage of the gross income from the property. For oil and gas properties, the percentage ranges from 15 to 25 percent and the deduction may not exceed 100 percent of the taxable income from the property. In addition, the percentage depletion deduction for oil and gas properties may not exceed 65 percent of the taxpayer's overall taxable income (determined before the deduction and with certain other adjustments).

Other limitations and special rules apply to the percentage depletion deduction for oil and gas properties. In general, only independent producers and royalty owners (as contrasted to integrated oil companies) qualify for the percentage depletion deduction. In addition, oil and gas producers may claim percentage depletion only with respect to up to 1,000 barrels of average daily production of domestic crude oil or an equivalent amount of domestic natural gas (applied on a combined basis in the case of taxpayers that produce both). This quantity limitation is allocated, at the taxpayer's election, between oil and gas production and then further allocated within each class among the taxpayer's properties. Special rules apply to oil and gas production from marginal wells (generally, wells for which the average daily production is less than 15 barrels of oil or barrel-of-oil equivalents or that produce only heavy oil). Only marginal well production can qualify for percentage depletion at a rate of more than 15 percent. The rate is increased in a taxable year that begins a calendar year following a calendar year during which the annual average unregulated wellhead price per barrel of domestic crude oil is less than $20 by one percentage point for each whole dollar of difference between the two amounts. In addition, marginal wells are exempt from the 100-percent-of-net-income limitation described above in taxable years beginning during the period 1998- 2007 and in taxable years beginning in 2009. Unless the taxpayer elects otherwise, marginal well production is given priority over other production in applying the 1,000-barrel limitation on percentage depletion.

A qualifying taxpayer determines the depletion deduction for each oil and gas property under both the percentage depletion method and the cost depletion method and deducts the larger of the two amounts. Because percentage depletion is computed without regard to the taxpayer's basis in the depletable property, a taxpayer may continue to claim percentage depletion after all the expenditures incurred to acquire and develop the property have been recovered.



Reasons for Change

Percentage depletion effectively provides a lower rate of tax with respect to a favored source of income. The lower rate of tax, like other oil and gas preferences the Administration proposes to repeal, distorts markets by encouraging more investment in the oil and gas industry than would occur under a neutral system. To the extent the lower tax rate encourages overproduction of oil and gas, it is detrimental to long-term energy security and is also inconsistent with the Administration's policy of reducing carbon emissions and encouraging the use of renewable energy sources through a cap-and-trade program. Moreover, the tax subsidy for oil and gas must ultimately be financed with taxes that result in underinvestment in other, potentially more productive, areas of the economy.

Cost depletion computed by reference to the taxpayer's basis in the property is the equivalent of economic depreciation. Limiting oil and gas producers to cost depletion would place them on a cost recovery system similar to that employed by other industries and reduce economic distortions.



Proposal

Percentage depletion would not be allowed with respect to oil and gas wells. Taxpayers would be permitted to claim cost depletion on their adjusted basis, if any, in oil and gas wells.

The proposal would be effective for taxable years beginning after December 31, 2010.



REPEAL DOMESTIC MANUFACTURING DEDUCTION FOR OIL AND GAS PRODUCTION



Current Law

A deduction is allowed with respect to income attributable to domestic production activities (the manufacturing deduction). For taxable years beginning in 2009, the manufacturing deduction is equal to 6 percent of the lesser of qualified production activities income for the taxable year or taxable income for the taxable year, limited to 50-percent of the W-2 wages of the taxpayer for the taxable year. For taxable years beginning after 2009, the deduction is computed at a 9 percent rate, except that the deduction for income oil and gas production activities is computed at a 6 percent rate.

Qualified production activities income is generally calculated as a taxpayer's domestic production gross receipts (i.e., the gross receipts derived from any lease, rental, license, sale, exchange, or other disposition of qualifying production property manufactured, produced, grown, or extracted by the taxpayer in whole or significant part within the U.S.; any qualified film produced by the taxpayer; or electricity, natural gas, or potable water produced by the taxpayer in the U.S.) minus the cost of goods sold and other expenses, losses, or deductions attributable to such receipts.

The manufacturing deduction generally is available to all taxpayers that generate qualified production activities income, which under current law includes income from the sale, exchange or disposition of oil, natural gas or primary products produced in the United States.



Reasons for Change

The manufacturing deduction effectively provides a lower rate of tax with respect to a favored source of income. The lower rate of tax, like other oil and gas preferences the Administration proposes to repeal, distorts markets by encouraging more investment in the oil and gas industry than would occur under a neutral system. To the extent the lower tax rate encourages overproduction of oil and gas, it is detrimental to long-term energy security and is also inconsistent with the Administration's policy of reducing carbon emissions and encouraging the use of renewable energy sources through a cap-and-trade program. Moreover, the tax subsidy for oil and gas must ultimately be financed with taxes that result in underinvestment in other, potentially more productive, areas of the economy.



Proposal

The proposal would exclude from the definition of domestic production gross receipts all gross receipts derived from the sale, exchange or other disposition of oil, natural gas or a primary product thereof for taxable years beginning after December 31, 2010.



INCREASE THE AMORTIZATION PERIOD FOR GEOLOGICAL AND GEOPHYSICAL COSTS TO SEVEN YEARS



Current Law

Geological and geophysical expenditures are costs incurred for the purpose of obtaining and accumulating data that will serve as the basis for the acquisition and retention of mineral properties. The amortization period for geological and geophysical expenditures incurred in connection with oil and gas exploration in the United States is two years for independent producers and seven years for integrated oil and gas producers.



Reasons for Change

The accelerated amortization of geological and geophysical expenditures incurred by independent producers, like other oil and gas preferences the Administration proposes to repeal, distorts markets by encouraging more investment in the oil and gas industry than would occur under a neutral system. To the extent accelerated amortization encourages overproduction of oil and gas, it is actually detrimental to long-term energy security and is also inconsistent with the Administration's policy of reducing carbon emissions and encouraging the use of renewable energy sources through a cap-and-trade program. Moreover, the tax subsidy for oil and gas must ultimately be financed with taxes that result in underinvestment in other, potentially more productive, areas of the economy.

Increasing the amortization period for geological and geophysical expenditures incurred by independent oil and gas producers from two years to seven years would provide a more accurate reflection of their income and more consistent tax treatment for all oil and gas producers.



Proposal

The proposal would increase the amortization period from two years to seven years for geological and geophysical expenditures incurred by independent producers in connection with all oil and gas exploration in the United States. Seven-year amortization would apply even if the property is abandoned and any remaining basis of the abandoned property would be recovered over the remainder of the seven-year period. The proposal would be effective for amounts paid or incurred after December 31, 2010.



ELIMINATE THE ADVANCED EARNED INCOME TAX CREDIT



Current Law

Under current law, low- and moderate-income individuals may be eligible for the refundable EITC. The amount of EITC an eligible individual may claim is a function of income and earnings, the number of children in the household, and filing status. In 2009, families with one child are eligible for a maximum EITC of $3,043. Eligible individuals with more children receive a larger credit.

Since 1978, most eligible individuals have had the option of requesting advance payments of the EITC from their employers throughout the year. Self-employed and childless individuals are not eligible. Under current law, the advance payment is limited to 60 percent of the maximum credit to which a worker with one child would be entitled. In 2009, the maximum advance payment is $1,826.

Employers offset the costs of the advance payments by reducing their payments of withheld income and employment taxes. During the year, employers periodically notify the IRS of the aggregate amount of advance payments withheld from tax payments. After the tax year is over, the employer notifies the IRS of employees' receipts of advance payments. The information is also provided to the employees. Upon filing their tax returns, individuals must reconcile any advance payments received during the year with the amount of EITC for which they actually were eligible. If they received too little, they can obtain the remaining amount; conversely, if they received too much, they must repay the overpayment with their tax return. Individuals who have received an advance payment are required to file a tax return, even if their income is below the filing threshold. In view of the risk of overpayments, the advance payment is limited to 60 percent of the one-child maximum credit.



Reason for Change

The advance payment option provides a mechanism for individuals to receive payments on a timely basis, instead of as a single payment during the filing season. Advance payments could help cash-constrained households meet their daily needs. However, advance payments have been extremely unpopular among eligible taxpayers - at most, 3 percent of eligible individuals participate, and IRS' efforts to increase participation have not had a meaningful impact. Furthermore, recent research shows evidence of significant non-compliance by employers and workers. As a consequence, repealing the advance payment option would affect adversely few individuals who are eligible for this benefit.



Proposal

The proposal would repeal the advance payment option of the EITC. Workers would no longer be able to receive an advance against their expected EITC through their employer. (Individuals with positive tax liability would still be able to receive any non-refundable portion of the EITC during the year through adjustments in their withholding.)

The proposal would be effective for taxable years beginning after December 31, 2009.


UPPER-INCOME TAX PROVISIONS DEDICATED TO DEFICIT REDUCTION




REINSTATE THE 39.6-PERCENT RATE



Current Law

Prior to the enactment of EGTRRA, the highest individual income tax rate was 39.6-percent. EGTRRA reduced the 39.6-percent tax rate temporarily to 35 percent, with the reduction phased in over several years. The Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) accelerated the reduction, and since 2003, the highest statutory individual income tax rate has been 35 percent. For 2009, it applies to taxable income over $372,950 ($186,475 if married filing separately). The 35-percent tax rate sunsets after 2010.



Reason for Change

Increasing the income tax liability of wealthy taxpayers would make the income tax system more progressive and would distribute the cost of government more fairly among taxpayers of various income levels.



Proposal

The Administration's tax receipts baseline would permanently extend the EGTRRA tax rates. This proposal would permit the EGTRRA reduction in the highest income tax rate to sunset after 2010. Thus, beginning in 2011, the highest income tax rate would be 39.6 percent. The taxable income levels at which this rate begins to apply would vary by filing status and would be indexed annually for inflation.



REINSTATE THE 36-PERCENT RATE FOR TAXPAYERS WITH INCOME OVER $250,000 (MARRIED FILING A JOINT RETURN) AND $200,000 (SINGLE)



Current Law

Prior to the enactment of EGTRRA, the second highest individual income tax rate was 36 percent. EGTRRA reduced the 36-percent tax rate temporarily to 33 percent, with the reduction phased in over several years. JGTRRA accelerated the reduction, and since 2003, the second highest statutory individual income tax rate has been 33 percent. In 2009, it applies to taxable income over $208,850 if married filing jointly ($171,550 if single). The 33-percent tax rate sunsets after 2010.



Reason for Change

Increasing the income tax liability of wealthy taxpayers would make the income tax system more progressive and would distribute the cost of government more fairly among taxpayers of various income levels.



Proposal

The Administration's tax receipts baseline would permanently extend the EGTRRA tax rates. This proposal would permit the EGTRRA reduction in the second highest income tax rate to sunset after 2010. Thus, beginning in 2011, the second highest tax rate would be 36 percent. The taxable income levels at which that rate begins to apply would vary by filing status and would be indexed annually for inflation. The 36-percent tax rate would apply to taxable income above the following amounts but less than the income levels at which the 39.6-percent rate would apply: $250,000 less the standard deduction and two personal exemptions, indexed from 2009, for married taxpayers filing jointly; $200,000 less the standard deduction and one personal exemption, indexed from 2009, for single filers. The 28-percent tax rate bracket would be expanded so that taxpayers earning less than these amounts would not see their taxes rise as a result of the increased tax rate brackets.



REINSTATE THE LIMITATION ON ITEMIZED DEDUCTIONS FOR TAXPAYERS WITH INCOME OVER $250,000 (MARRIED FILING A JOINT RETURN) AND $200,000 (SINGLE)



Current Law

Individual taxpayers may elect to itemize their deductions instead of claiming a standard deduction. In general, itemized deductions include medical and dental expenses (in excess of 7.5 percent of AGI), state and local property taxes and either income or sales taxes, interest paid, gifts to charities, casualty and theft losses (in excess of 10 percent of AGI), job expenses and certain miscellaneous expenses (some only in excess of 2 percent of AGI).

Prior to the enactment of EGTRRA, otherwise allowable itemized deductions (other than medical expenses, investment interest, theft and casualty losses, and gambling losses) were reduced by 3 percent of the amount by which AGI exceeded a statutory floor that was indexed annually for inflation, but not by more than 80 percent of the otherwise allowable deductions. EGTRRA reduced the itemized deduction limitation in three steps. For 2006 and 2007, itemized deductions were reduced by 2 percent of AGI over the threshold, but not by more than 53-1/3 percent. For 2008 and 2009, itemized deductions were reduced by 1 percent of AGI over the threshold, but not by more than 26-2/3 percent. For 2010, the reduction was to be completely eliminated. However, beginning in 2011, the full itemized deduction reduction of 3 percent of AGI exceeding the floor is scheduled to be reinstated.

For 2009, the AGI floor is $166,800 ($83,400 if married filing separately).



Reason for Change

By limiting the tax benefit of higher-income taxpayers' itemized deductions, the income tax system would be made more progressive and the cost of government would be shared more fairly by taxpayers in all levels of income.



Proposal

The Administration's tax receipts baseline would permanently extend the EGTRRA repeal of the limitation on itemized deductions. This proposal would allow the elimination of the limitation on itemized deduction enacted in EGTRRA to sunset after 2010. Thus, itemized deductions (other than medical expenses, investment interest, theft and casualty losses, and gambling losses) would be reduced by 3 percent of the amount by which AGI exceeds statutory floors which are higher than under current law, but not by more than 80 percent of the otherwise allowable deductions. The floors would be indexed annually for inflation. For 2011, the AGI floors would be adjusted for inflation starting with a value of $250,000 in 2009 for married taxpayers filing jointly and $200,000 in 2009 for single taxpayers.



REINSTATE THE PERSONAL EXEMPTION PHASE-OUT (PEP) FOR TAXPAYERS WITH INCOME OVER $250,000 (MARRIED FILING A JOINT RETURN) AND $200,000 (SINGLE)



Current Law

Individual taxpayers generally are entitled to a personal exemption for the taxpayer and for each dependent. The amount of each personal exemption is $3,650 for 2009 and is indexed annually for inflation.

Prior to the enactment of EGTRRA, all personal exemptions were reduced or completely phased out simultaneously for higher-income taxpayers. For a taxpayer with AGI in excess of the threshold amount for the taxpayer's filing status, the amount of each personal exemption was reduced by 2 percent of the exemption amount for that year for each $2,500 ($1,250 if married filing separately) or fraction thereof by which AGI exceeded that threshold. EGTRRA reduced the otherwise applicable reduction of personal exemptions by one-third for 2006 and 2007, by two-thirds for 2008 and 2009, and eliminated it completely for 2010. However, beginning in 2011, the full personal exemption phase-out is scheduled to be reinstated.

For 2009, personal exemptions are reduced by 0.6667 percentage points for each $2,500 ($1,250 if married filing separately) or fraction thereof by which AGI exceeds the threshold, but not by more than one-third of the unreduced exemption amount. Thus, even the highest-income taxpayers are entitled to claim $2,433.33 for each personal exemption. For 2009, the thresholds at which personal exemptions begin to be reduced if AGI exceeds these amounts are $166,800 for single taxpayers, $208,500 for heads of household, $250,200 for married taxpayers filing jointly, and $125,100 for married taxpayers filing separately.



Reason for Change

By limiting the tax benefit of higher-income taxpayers' personal exemptions, the income tax system would be made more progressive, and the cost of government would be shared more fairly by taxpayers in all levels of income.



Proposal

The Administration's tax receipts baseline would permanently extend the EGTRRA repeal of the personal exemption phase-out. This proposal would allow the elimination of the personal exemption phase-out enacted in EGTRRA to sunset after 2010. The AGI levels at which the phase-out begins would be adjusted. For 2011, the AGI floors would be adjusted for inflation starting with a value of $250,000 in 2009 for married taxpayers filing jointly ($125,000 if filing separately) and $200,000 in 2009 for single taxpayers.



IMPOSE A 20-PERCENT RATE ON DIVIDENDS AND CAPITAL GAINS FOR TAXPAYERS WITH INCOME OVER $250,000 (MARRIED FILING A JOINT RETURN) AND $200,000 (SINGLE)



Current Law

A separate rate structure applies to long-term capital gains and dividends. Under current law, the maximum rate of tax on the adjusted net capital gain of an individual is 15 percent. In addition, any adjusted net capital gain otherwise taxed at a 10- or 15-percent rate is taxed at a zero-percent rate. These rates apply for purposes of both the regular tax and the AMT. Qualified dividends generally are taxed at the same rate as capital gains.

Capital losses generally are deductible in full against capital gains. In addition, individual taxpayers may deduct up to $3,000 of capital losses from ordinary income in each year. Any remaining unused capital losses may be carried forward indefinitely to a future year.

The zero- and 15-percent rates for dividends and capital gains are scheduled to sunset for taxable years beginning after December 31, 2010. In 2011, the maximum rate on capital gains would increase to 20 percent, while the tax rates for dividends would go back to the higher ordinary tax rates of up to 39.6 percent.



Reasons for Change

The Administration supports keeping income tax rates low on corporate dividends and capital gains (including sales and exchanges of corporate stock). Lower- and middle-income taxpayers should be protected from the tax increase that would otherwise occur in 2011. Allowing the 15- percent rate to expire for high-income taxpayers who are most able to absorb it would still keep the top rate at historically low levels. The 20-percent maximum rate on capital gains would be the same as the maximum capital gains rate enacted in 1987, and is the same as the top rate enacted in 1981. Taxing qualified dividends at the same low rate as capital gains reduces the tax bias against equity investment and helps promote more efficient allocation of capital since investors can choose to reallocate their dividends to the most productive investments.



Proposal

The Administration's tax receipts baseline would permanently extend the zero- and 15-percent tax rates for dividends and capital gains. The zero- and 15-percent tax rates for capital gains and qualified dividends would be extended permanently for taxpayers with incomes up to $250,000 for joint returns and $200,000 for single taxpayers. The 20-percent tax rate on long-term capital gains and qualified dividends would apply for married taxpayers filing jointly with income over $250,000 less the standard deduction and two personal exemptions (indexed from 2009) and for single taxpayers with income over $200,000 less the standard deduction and one personal exemption (indexed from 2009). The reduced rates on gains on assets held over 5 years would be repealed.

This proposal is effective on the date of enactment for taxable years beginning after December 31, 2010.


USER FEES




PRESERVE COST-SHARING OF INLAND WATERWAYS CAPITAL COSTS



Current Law

The Inland Waterways Trust Fund is supported by a 20-cents-per-gallon tax on liquids used as fuel in a vessel in commercial waterway transportation. Commercial waterway transportation is defined as any use of a vessel on any inland or intracoastal waterway of the United States (1) in the business of transporting property for compensation or hire or (2) in the business of the owner, lessee, or operator of the vessel (other than fish or other aquatic animal life caught on the voyage). The inland or intracoastal waterways of the United States are the inland and intracoastal waterways of the United States described in section 206 of the Inland Waterways Revenue Act of 1978. Exceptions are provided for deep-draft ocean-going vessels, passenger vessels, State and local governments, and certain ocean-going barges.



Reasons for Change

The fuel excise tax does not raise enough revenue to pay for the users' 50-percent share of the capital costs of the locks and dams that make barge transportation possible on inland and intracoastal waterways. Moreover, the tax is not the most efficient method for financing expenditures on those waterways. Adequate funding for inland and intracoastal waterways can be provided through a more efficient user fee system that is based on lock usage and is tied to the level of spending for inland waterways construction, replacement, expansion, and rehabilitation work.



Proposal

The tax on liquids used as fuel in a vessel in commercial waterway transportation would be phased out and replaced by a fee system based on lock usage. The tax rate would be reduced to 10 cents per gallon beginning January 1, 2012. The tax would be repealed for periods after December 31, 2013. The fee system based on lock usage would be phased in beginning on January 1, 2010. For calendar year 2014 and each subsequent calendar year, the fee schedule would be adjusted as necessary to maintain an appropriate level of net assets in the Inland Waterways Trust Fund.


OTHER INITIATIVES




IMPLEMENT UNEMPLOYMENT INSURANCE INTEGRITY LEGISLATION



Current Law

The Federal Unemployment Tax Act (FUTA) currently imposes a Federal payroll tax on employers of 6.2 percent of the first $7,000 paid annually to each employee. Generally, these funds support the administrative costs of the unemployment insurance system. Employers in States that meet certain Federal requirements are allowed a credit against FUTA taxes of up to 5.4 percent, making the minimum net Federal rate 0.8 percent. States also impose an unemployment tax on employers. A State's unemployment insurance taxes are first placed in the State's own clearing account and then deposited into its Federal unemployment insurance trust fund account from which the State pays unemployment benefits. State recoveries of overpayments of unemployment insurance benefits must be similarly deposited and used exclusively to pay unemployment benefits.

While States may assess penalties for overpayments of benefits, amounts collected as penalties or interest on benefit overpayments may be treated as general receipts by the States.



Reasons for Change

States' abilities to reduce benefit overpayments and increase overpayment recoveries are limited by funding. The mandatory redeposit of the collection of all unemployment benefits overpayments prevents States from redirecting some of these amounts to future recovery activity. Although States might use penalties or interest on overpayments to increase collections, there is no requirement that such amounts be directed for additional enforcement activities.



Proposal

The proposal would increase resources for the recovery of State unemployment benefit overpayments and delinquent employer taxes. The proposal would allow States to redirect up to 5 percent of overpayment recoveries to additional enforcement activity. The proposal would require States to impose a penalty of at least 15 percent on recipients of fraudulent overpayments, and penalty revenue would be used exclusively for additional enforcement activity. The proposal would expand the ability to collect benefit overpayments due to a State from income tax refunds owed to a benefit recipient. The proposal would allow States to deposit up to 5 percent of moneys recovered in the course of an unemployment insurance tax investigation into a special fund dedicated to implementing the State Unemployment Tax Act (SUTA) Dumping Prevention Act of 2004 or enforcing State laws relating to employer fraud or tax evasion. The proposal would require employers to report a "start work date" to the National Directory of New Hires for all new hires.

The proposal would be effective upon the date of enactment.



Restructure Assistance to New York City



PROVIDE TAX INCENTIVES FOR TRANSPORTATION INFRASTRUCTURE



Current Law

The Job Creation and Worker Assistance Act of 2002 (the Act) provided tax incentives for the area of New York City damaged or affected by the terrorist attacks on September 11, 2001. The Act created the "New York Liberty Zone," defined as the area located on or south of Canal Street, East Broadway (east of its intersection with Canal Street), or Grand Street (east of its intersection with East Broadway) in the Borough of Manhattan in the City of New York, New York. New York Liberty Zone tax incentives included: (1) an expansion of the work opportunity tax credit (WOTC) for New York Liberty Zone business employees; (2) a special depreciation allowance for qualified New York Liberty Zone property; (3) a five-year recovery period for depreciation of qualified New York Liberty Zone leasehold improvement property; (4) $8 billion of tax-exempt private activity bond financing for certain nonresidential real property, residential rental property and public utility property; (5) $9 billion of additional tax-exempt, advance refunding bonds; (6) increased section 179 expensing; and (7) an extension of the replacement period for nonrecognition of gain for certain involuntary conversions. 3

The expanded WOTC credit provided a 40 percent subsidy on the first $6,000 of annual wages paid to New York Liberty Zone business employees for work performed during 2002 or 2003.

The special depreciation allowance for qualified New York Liberty Zone property equals 30 percent of the adjusted basis of the property for the taxable year in which the property is placed in service. Qualified nonresidential real property and residential rental property must be purchased by the taxpayer after September 10, 2001, and placed in service before January 1, 2010. Such property is qualified property only to the extent it rehabilitates real property damaged, or replaces real property destroyed or condemned, as a result of the September 11, 2001, terrorist attacks. The provision is no longer applicable for other property.

The five-year recovery period for qualified leasehold improvement property applied, in general, to buildings located in the New York Liberty Zone if the improvement was placed in service after September 10, 2001, and before January 1, 2007, and no written binding contract for the improvement was in effect before September 11, 2001.

The $8 billion of tax-exempt private activity bond financing is authorized to be issued by the State of New York or any political subdivision thereof after March 9, 2002, and before January 1, 2010.

The $9 billion of additional tax-exempt, advance refunding bonds was available after March 9, 2002, and before January 1, 2006, with respect to certain State or local bonds outstanding on September 11, 2001.

Businesses were allowed to expense the cost of certain qualified New York Liberty Zone property placed in service prior to 2007, up to an additional $35,000 above the amounts generally available under section 179. 4 In addition, only 50 percent of the cost of such qualified New York Liberty Zone property counted toward the limitation under which section 179 deductions are reduced to the extent the cost of section 179 property exceeds a specified amount.

A taxpayer may elect not to recognize gain with respect to property that is involuntarily converted if the taxpayer acquires within an applicable period (the replacement period) property similar or related in service or use. In general, the replacement period begins with the date of the disposition of the converted property and ends two years (three years if the converted property is real property held for the productive use in a trade or business or for investment) after the close of the first taxable year in which any part of the gain upon conversion is realized. The Act extended the replacement period to five years for property in the New York Liberty Zone that was involuntarily converted as a result of the terrorist attacks on September 11, 2001, if substantially all of the use of the replacement property is in New York City.



Reasons for Change

Some of the tax benefits that were provided to New York following the attacks of September 11, 2001, likely will not be usable in the form in which they were originally provided. State and local officials in New York have concluded that improvements to transportation infrastructure and connectivity in the Liberty Zone would have a greater impact on recovery and continued development than would some of the existing tax incentive provisions.



Proposal

The proposal would sunset certain existing New York Liberty Zone tax benefits and provide in their place tax credits to New York State and New York City for expenditures relating to the construction or improvement of transportation infrastructure in or connecting to the New York Liberty Zone. New York State and New York City each would be eligible for a tax credit for expenditures relating to the construction or improvement of transportation infrastructure in or connecting to the New York Liberty Zone. The tax credit would be allowed in each year from 2010 to 2019, inclusive, subject to an annual limit of $200 million (for a total of $2 billion in tax credits), and would be divided evenly between the State and the City. Any unused credits below the annual limit would be added to the $200 million annual limit for the following year, including years after 2019. Similarly, expenditures that exceed the annual limit would be carried forward and subtracted from the annual limit in the following year. The credit would be allowed against any payments (other than payments of excise taxes and social security and Medicare payroll taxes) made by the City and State under any provision of the Code, including income tax withholding. The Treasury Department would prescribe such rules as are necessary to ensure that the expenditures are made for the intended purposes. The amount of the credit received would be considered State and local funds for the purpose of any Federal program.



Repeal Certain New York City Liberty Zone Incentives

The special depreciation allowance for qualified New York Liberty Zone property that is either nonresidential real property or residential rental property would be terminated as of the date of enactment. Property placed in service after the date of enactment would be ineligible for this incentive unless a binding written contract is in effect on the date of enactment and the property is placed in service before the original sunset dates set forth in the Act.



Levy Payments to Federal Contractors with Delinquent Tax Debt



IMPROVE DEBT COLLECTION ADMINSTRATIVE PROCEDURES



Current Law

Before the IRS can issue a levy for an unpaid federal tax liability, it must give the taxpayer an opportunity for an administrative collection due process (CDP) hearing. As exceptions to this general rule, a CDP hearing is not required prior to the IRS issuing a levy for liabilities that arise from either a state tax refund or federal employment taxes. When these exceptions apply, the CDP hearing takes place within a reasonable time after the levy.

Prior to making a disbursement to federal contractors, an automated check for federal tax liabilities generally occurs using the Federal Payment Levy Program (FPLP). When a tax liability is identified, the IRS issues a CDP notice to the federal contractor, but cannot levy the payment until the CDP requirements are complete.



Reason for Change

When the FPLP identifies a federal contractor as having federal tax liabilities, the opportunity to levy payments to the contractor may be lost because the CDP requirements cannot be completed before the payment is made.



Proposal

The proposal would allow the IRS to issue levies prior to a CDP hearing for federal tax liabilities of federal contractors identified under the FPLP. When a levy is issued prior to a CDP hearing under this proposal, the taxpayer would have an opportunity for a CDP hearing within a reasonable time after the levy.

The proposal would be effective for levies issued after December 31, 2009.



INCREASE LEVY AUTHORITY TO 100 PERCENT FOR VENDOR PAYMENTS



Current Law

If a federal vendor has an unpaid tax liability, the IRS can levy 100 percent of any payment due to the vendor for goods or services sold or leased to the federal government.



Reason for Change

The statutory language "goods or services sold or leased" has been interpreted as excluding payments for the sale or lease of real estate or other types of property not considered "goods or services."



Proposal

The proposal would clarify that the IRS can levy 100 percent of any payment due to a federal vendor with unpaid tax liabilities, including payments made for the sale or lease of real estate and other types of property not considered "goods or services."

The proposal would be effective for payments made after the proposal's date of enactment.


REVENUES DEDICATED TO THE HEALTH REFORM RESERVE FUND




LIMIT THE TAX RATE AT WHICH ITEMIZED DEDUCTIONS REDUCE TAX LIABILITY TO 28 PERCENT



Current Law

Current law permits the allowable portion of an individual taxpayer's itemized deductions to reduce the amount of taxable income. This, in effect, applies those deductions first to the taxable income in the highest tax bracket, and then to the next lower tax brackets in descending order.

Individual taxpayers may elect to itemize their deductions instead of claiming a standard deduction. In general, itemized deductions include medical and dental expenses (in excess of 7.5 percent of AGI), state and local property taxes and either income or sales taxes, interest paid, gifts to charities, casualty and theft losses (in excess of 10 percent of AGI), and job expenses and certain miscellaneous expenses (some only in excess of 2 percent of AGI).

For higher-income taxpayers, otherwise allowable itemized deductions (other than medical expenses, investment interest, theft and casualty losses, and gambling losses) are reduced if AGI exceeds a statutory floor that is indexed annually for inflation. Prior to the enactment of EGTRRA, itemized deductions were reduced by 3 percent of AGI over the threshold but not by more than 80 percent of the otherwise allowable deductions. EGTRRA reduced the itemized deduction limitation in three steps. For 2006 and 2007, itemized deductions were reduced by 2 percent of AGI over the threshold, but not by more than 53-1/3 percent. For 2008 and 2009, itemized deductions were reduced by 1 percent of AGI over the threshold, but not by more than 26-2/3 percent. For 2010, the reduction was to be completely eliminated. However, beginning in 2011, the full itemized deduction reduction of 3 percent of AGI exceeding the floor, but not by more than 80 percent, is scheduled to be reinstated.

For 2009, the AGI floor is $166,800 ($83,400 if married filing separately).

A separate Budget proposal would adjust the 2011 income thresholds beyond which itemized deductions are reduced to $250,000 (indexed for inflation from 2009) for married taxpayers filing jointly and $200,000 (indexed from 2009) for single taxpayers. Thereafter, the thresholds would be indexed for inflation annually.



Reason for Change

Many itemized deductions reflect social policies of encouraging taxpayers to engage in certain activities by reducing the after-tax cost of those activities. Many worthwhile activities compete for the resources that are available. The Administration believes that limiting the benefits from certain itemized deductions to not more than 28 percent of the taxpayer's outlays would provide some of the resources necessary to fund important reforms to the medical care and medical insurance systems.



Proposal

The proposal would limit the value of all itemized deductions by limiting the tax value of those deductions to 28 percent whenever they would otherwise reduce taxable income in the 36 or 39.6 percent tax brackets. A similar limitation also would apply under the AMT.

This proposal would apply to itemized deductions after they have been reduced under a separate budget proposal that would reinstate the pre-EGTRRA limitation on certain itemized deductions, but with adjusted AGI thresholds in 2011 of $250,000 (indexed from 2009) for married taxpayers filing jointly and $200,000 (indexed from 2009) for other taxpayers. After 2011, these thresholds would be indexed.

The proposal is effective for taxable years beginning after December 31, 2010.



REDUCE THE TAX GAP AND MAKE REFORMS



Expand Information Reporting



REQUIRE INFORMATION REPORTING FOR PRIVATE SEPARATE ACCOUNTS OF LIFE INSURANCE COMPANIES



Current Law

Earnings from direct investment in securities generally result in taxable income to the holder. In contrast, investments in comparable assets through a separate account of a life insurance company generally give rise to tax-free or tax-deferred income. This favorable tax treatment for investing through a life insurance company is not available if the policyholder has so much control over the investments in the separate account that the policyholder, rather than the insurance company, is treated as the owner of those investments.



Reasons for Change

In some cases, private separate accounts are being used to avoid tax that would be due if the assets were held directly. Better reporting of investments in private separate accounts will help the IRS to ensure that income is properly reported. Moreover, such reporting will enable the IRS to identify more easily which variable insurance contracts qualify as insurance contracts under current law and which contracts should be disregarded under the investor control doctrine.



Proposal

The proposal would require life insurance companies to report to the IRS, for each contract whose cash value is partially or wholly invested in a private separate account for any portion of the taxable year, the policyholder's taxpayer identification number, the policy number, the amount of accumulated untaxed income, the total contract account value, and the portion of that value that was invested in one or more private separate accounts. For this purpose, a private separate account would be defined as any account with respect to which a related group of persons owned policies whose cash values, in the aggregate, represented at least 10 percent of the value of the separate account.

The proposal would be effective for taxable years beginning after December 31, 2010.



REQUIRE INFORMATION REPORTING ON PAYMENTS TO CORPORATIONS



Current Law

Generally, a taxpayer making payments to a recipient aggregating to $600 or more for services or determinable gains in the course of a trade or business in a calendar year is required to send an information return to the IRS setting forth the amount, as well as name and address of the recipient of the payment (generally on Form 1099). Under a longstanding regulatory regime, there are certain exceptions for payments to corporations, as well as tax-exempt and government entities.



Reasons for Change

Generally, compliance increases significantly for payments that a third party reports to the IRS. In the case of tax-exempt or government entities that are generally not subject to income tax, information returns may not be necessary. On the other hand, during the decades in which the regulatory exception for payments to corporations has become established, the number and complexity of corporate taxpayers have increased. Moreover, the longstanding regulatory exception from information reporting for payments to corporations has created compliance issues. Although the exception for information reporting to corporations is set forth in existing regulations, because it has been in place for many years and because Congress, during that time period, has made numerous changes to the information reporting rules, elimination of the exception should be made by legislative change.



Proposal

A business would be required to file an information return for payments aggregating to $600 or more in a calendar year to a corporation (except a tax-exempt corporation).

The proposal would be effective for payments made to corporations after December 31, 2009.



REQUIRE A CERTIFIED TAXPAYER IDENTIFICATION NUMBER FROM CONTRACTORS AND ALLOW CERTAIN WITHHOLDING



Current Law

In the course of a trade or business, service recipients ("businesses") making payments aggregating to $600 or more in a calendar year to any non-employee service provider ("contractor") that is not a corporation are required to send an information return to the IRS setting forth the amount, as well as name, address, and taxpayer identification number (TIN) of the contractor. The information returns, required annually after the end of the year, are made on Form 1099-MISC based on identifying information furnished by the contractor but not verified by the IRS. Copies are provided both to the contractor and to the IRS. Withholding is not required or permitted for payments to contractors. Since contractors are not subject to withholding, they may be required to make quarterly payments of estimated income taxes and self-employment (SECA) taxes near the end of each calendar quarter. The contractor is required to pay any balance due when the annual income tax return is subsequently filed.



Reasons for Change

Without accurate taxpayer identifying information, information reporting requirements impose avoidable burdens on businesses and the IRS, and cannot reach their potential to improve compliance.

Estimated tax filing is relatively burdensome, especially for less sophisticated and lower-income taxpayers. Moreover, by the time estimated tax payments (or final tax payments) are due, some contractors will not have put aside the necessary funds. Given that the SECA tax rate is 15.3 percent (up to certain income limits), the required tax payments can be more than 25 percent of a contractor's gross receipts, even for a contractor with modest income.

An optional withholding method for contractors would reduce the burdens of having to make quarterly payments, would help contractors automatically set aside funds for tax payments, and would help increase compliance.



Proposal

A contractor receiving payments of $600 or more in a calendar year from a particular business would be required to furnish to the business (on Form W-9) the contractor's certified TIN. A business would be required to verify the contractor's TIN with the IRS, which would be authorized to disclose, solely for this purpose, whether the certified TIN-name combination matches IRS records. If a contractor failed to furnish an accurate certified TIN, the business would be required to withhold a flat-rate percentage of gross payments. Contractors receiving payments of $600 or more in a calendar year from a particular business could require the business to withhold a flat-rate percentage of their gross payments, with the flat-rate percentage of 15, 25, 30, or 35 percent being selected by the contractor.

The proposal would be effective for payments made to contractors after December 31, 2009.



REQUIRE INCREASED INFORMATION REPORTING FOR CERTAIN GOVERNMENT PAYMENTS FOR PROPERTY AND SERVICES



Current Law

Businesses, governments, and other taxpayers are subject to a number of information reporting and withholding requirements. Generally, a taxpayer making payments aggregating to $600 or more for services or determinable gains in the course of a trade or business in a calendar year is required to send an information return to the IRS (except if the recipient is a corporation) setting forth the amount, as well as the name and address of the recipient of the payment (generally on Form 1099). In addition, any service recipient engaged in a trade or business is required to file an information return if the aggregate of payments for services is $600 or more in a calendar year. This requirement specifically applies to government agencies, even if the service provider is a corporation. Moreover, Federal agencies must file information returns with respect to contractors, generally on Form 8596 (Information Return for Federal Contracts) and Form 8596A (Quarterly Transmittal of Information Returns for Federal Contracts). Under recently enacted legislation that will take effect in 2012, Federal, State and local government agencies generally must withhold 3 percent of payments for goods or services. Exceptions apply to certain payments such as those actually subjected to backup withholding, wages and public assistance.



Reasons for Change

Generally, compliance increases significantly for payments that a third party reports to the IRS. Some government vendors fail to meet their tax filing and payment obligations.



Proposal

The IRS and Treasury Department would be authorized to promulgate regulations requiring information reporting on all non-wage payments by Federal, State and local governments to procure property or services. It is expected that certain categories of payments would be excluded from the new information reporting requirements, including payments of interest, payments for real property, payments to tax-exempt entities or foreign governments, intergovernmental payments, and payments made pursuant to a classified or confidential contract.

The proposal would be effective for payments made after December 31, 2009.



INCREASE INFORMATION RETURN PENALTIES



Current Law

There are a number of information reporting requirements under the Code. When these requirements are not followed, penalties may apply based on whether and when a correct information return is filed. If a person subject to the information reporting requirements files a correct information return after the prescribed filing date, but on or before the date that is thirty days after the prescribed filing date, the amount of the penalty is $15 per return (the "first-tier penalty"), not to exceed $75,000 per calendar year. If such a person files a correct information return more than thirty days after the prescribed filing date but on or before August 1, the amount of the penalty is $30 per return (the "second-tier penalty"), not to exceed $150,000 per calendar year. If such a person does not file a correct information return on or before August 1, the amount of the penalty is $50 per return (the "third-tier penalty"), not to exceed $250,000 in a calendar year. For certain small filers whose average annual gross receipts do not exceed $5,000,000, the maximum calendar year limit is $25,000 (instead of $75,000) for the first-tier penalty, $50,000 (instead of $150,000) for the second-tier penalty, and $100,000 (instead of $250,000) for the third-tier penalty. If a failure is due to intentional disregard of a filing requirement, the minimum penalty for each failure is $100, with no calendar year limit.



Reasons for Change

Generally, compliance increases significantly with respect to amounts reported on information returns. In some cases, filers may have failed to comply with existing information reporting requirements because the amount of the potentially applicable penalties is too small to discourage non-compliance. Increasing the penalty amounts, which were established in 1989 and have not been increased, will help to ensure the timely filing of accurate information returns.



Proposal

The first-tier penalty would be increased from $15 to $30, and the calendar year maximum would be increased from $75,000 to $250,000. The second-tier penalty would be increased from $30 to $60, and the calendar year maximum would be increased from $150,000 to $500,000. The third-tier penalty would be increased from $50 to $100, and the calendar year maximum would be increased from $250,000 to $1,500,000. For small filers, the calendar year maximum would be increased from $25,000 to $75,000 for the first-tier penalty, from $50,000 to $200,000 for the second-tier penalty, and from $100,000 to $500,000 for the third-tier penalty. The minimum penalty for each failure due to intentional disregard would be increased from $100 to $250. The proposal would also provide that every five years the penalty amounts would be adjusted to account for inflation.

The proposal would be effective for information returns required to be filed after December 31, 2010.



Improve Compliance by Business



REQUIRE E-FILING BY CERTAIN LARGE ORGANIZATIONS



Current Law

Effective for tax years ending on or after December 31, 2005, corporations with assets of $10 million or more filing Form 1120 are required to file Schedule M-3 (Net Income (Loss) Reconciliation for Corporations with Total Assets of $10 Million or More). Effective for tax years ending on or after December 31, 2006, this Schedule M-3 filing requirement also applies to S corporations, life insurance corporations, property and casualty insurance corporations, and cooperative associations filing various versions of Form 1120 and having $10 million or more in assets. Schedule M-3 is also required for partnerships with assets of $10 million or more and certain other partnerships.

Corporations and tax-exempt organizations that have assets of $10 million or more and file at least 250 returns during a calendar year, including income tax, information, excise tax, and employment tax returns, are required to file electronically their Form 1120/1120S income tax returns and Form 990 information returns for tax years ending on or after December 31, 2006. In addition, private foundations and charitable trusts that file at least 250 returns during a calendar year are required to file electronically their Form 990-PF information returns for tax years ending on or after December 31, 2006, regardless of their asset size. Taxpayers can request waivers of the electronic filing requirement if they cannot meet that requirement due to technological constraints, or if compliance with the requirement would result in undue financial burden on the taxpayer. Although electronic filing is required of certain corporations and other taxpayers, others may convert voluntarily to electronic filing.

Generally, regulations may require electronic filing by taxpayers (other than individuals, estates and trusts) that file at least 250 returns annually. Before requiring electronic filing, the IRS and Treasury Department must take into account the ability of taxpayers to comply at a reasonable cost.



Reasons for Change

Generally, compliance increases when taxpayers are required to provide better information to the IRS in usable form. Large organizations with assets of $10 million or more generally maintain financial records in electronic form, and generally either hire tax professionals who use tax preparation software or use tax preparation software themselves although they may not currently file electronically.

Electronic filing supports the broader goals of improving IRS service to taxpayers, enhancing compliance, and modernizing tax administration. Overall, increased electronic filing of returns may improve customer satisfaction and confidence in the filing process, and it may be more cost effective for affected entities. Expanding electronic filing to certain additional large entities will help provide tax return information in a more uniform electronic form. This will enhance the ability of the IRS to more productively focus its audit activities. This can reduce burdens on businesses where the need for an audit can be avoided.

In the case of a large business, adopting the same standard for electronic filing as for filing Schedule M-3 provides simplification benefits.



Proposal

All corporations and partnerships required to file Schedule M-3 would be required to file their tax returns electronically. In the case of certain other large taxpayers not required to file Schedule M-3 (such as exempt organizations), the regulatory authority to require electronic filing would be expanded to allow reduction of the current threshold of filing 250 or more returns during a calendar year. Nevertheless, any new regulations would balance the benefits of electronic filing against any burden that might be imposed on taxpayers, and implementation would take place incrementally to afford adequate time for transition to electronic filing. Taxpayers would be able to request waivers of this requirement if they cannot meet the requirement due to technological constraints, if compliance with the requirement would result in undue financial burden, or if other criteria specified in regulations are met.

The proposal would be effective for tax years ending after December 31, 2009.



IMPLEMENT STANDARDS CLARIFYING WHEN EMPLOYEE LEASING COMPANIES CAN BE HELD LIABLE FOR THEIR CLIENTS' FEDERAL EMPLOYMENT TAXES



Current Law

Employers are required to withhold and pay Federal Insurance Contribution Act (FICA) and income taxes, and are required to pay Federal Unemployment Tax Act (FUTA) taxes (collectively "Federal employment taxes") with respect to wages paid to their employees. Liability for Federal employment taxes generally lies with the taxpayer that is determined to be the employer under a multi-factor common law test or under specific statutory provisions. For example, a third party that is not the common law employer can be a statutory employer if the third party has control over the payment of wages. In addition, certain designated agents are jointly and severally liable with their principals for employment taxes with respect to wages paid to the principals' employees. These designated agents prepare and file employment tax returns using their own name and employer identification number. In contrast, reporting agents (often referred to as payroll service providers) are generally not liable for the employment taxes reported on their clients' returns. Reporting agents prepare and file employment tax returns for their clients using the client's name and employer identification number.

Employee leasing is the practice of contracting with an outside business to handle certain administrative, personnel, and payroll matters for a taxpayer's employees. Employee leasing companies (often referred to as professional employer organizations) typically prepare and file employment tax returns for their clients using the leasing company's name and employer identification number, often taking the position that the leasing company is the statutory or common law employer of their clients' workers.



Reasons for Change

Under present law, there is often uncertainty as to whether the employee leasing company or its client is liable for unpaid Federal employment taxes arising with respect to wages paid to the client's workers. Thus, when an employee leasing company files employment tax returns using its own name and employer identification number, but fails to pay some or all of the taxes due, or when no returns are filed with respect to wages paid by a taxpayer that uses an employee leasing company, there can be uncertainty as to how the Federal employment taxes are assessed and collected.

Providing standards for when an employee leasing company and its clients will be held liable for Federal employment taxes will facilitate the assessment, payment and collection of those taxes and will preclude taxpayers who have control over withholding and payment of those taxes from denying liability when the taxes are not paid.



Proposal

The proposal would set forth standards for holding employee leasing companies jointly and severally liable with their clients for Federal employment taxes. The proposal would also provide standards for holding employee leasing companies solely liable for such taxes if they meet specified requirements.

The provision would be effective for employment tax returns required to be filed with respect to wages paid after December 31, 2009.



Strengthen Tax Administration



ALLOW ASSESSMENT OF CRIMINAL RESTITUTION AS TAX



Current Law

In criminal tax cases, a District Court may issue an order requiring the defendant to pay restitution of existing tax liabilities. The District Court has authority to order restitution under the criminal provisions of Title 18, not the Internal Revenue Code (Code). Because the assessment procedures under the Code apply only to taxes imposed by the Code, those procedures do not apply to restitution orders issued under Title 18, even if the restitution order relates to an existing tax liability.



Reasons for Change

Because court-ordered restitution in criminal tax cases cannot be assessed as a tax, the IRS cannot use its existing assessment systems to collect and enforce the restitution obligation. This leads to unnecessary duplication of efforts, delays, and confusion in the administration of courtordered restitution.



Proposal

The proposal would allow the IRS and the Treasury Department to immediately assess, without issuing a statutory notice of deficiency, and collect as a tax debt court-ordered restitution. The taxpayer would not be able to collaterally attack the amount of restitution ordered by the court, but would retain the ability to challenge the method of collection.

The proposal would be effective after December 31, 2010.



REVISE OFFER-IN-COMPROMISE APPLICATION RULES



Current Law

Current law provides that the IRS may compromise any civil or criminal case arising under the internal revenue laws prior to a reference to the Department of Justice for prosecution or defense. In 2006, a new provision was enacted to require taxpayers to make certain nonrefundable payments with any initial offer-in-compromise of a tax case. The new provision requires taxpayers making a lump-sum offer-in-compromise to include a nonrefundable payment of 20 percent of the lump-sum with the initial offer. In the case of an offer-in-compromise involving periodic payments, the initial offer must be accompanied by a nonrefundable payment of the first installment that would be due if the offer were accepted.



Reasons for Change

Requiring nonrefundable payments with an offer-in-compromise may substantially reduce access to the offer-in-compromise program. The offer-in-compromise program is designed to settle cases in which taxpayers have demonstrated an inability to pay the full amount of a tax liability. The program allows the IRS to collect the portion of a tax liability that the taxpayer has the ability to pay. Reducing access to the offer-in-compromise program makes it more difficult and costly to obtain the collectable portion of existing tax liabilities.



Proposal

The proposal would eliminate the requirements that an initial offer-in-compromise include a nonrefundable payment of any portion of the taxpayer's offer.

The proposal would be for offers-in-compromise submitted after the date of enactment.



EXPAND IRS ACCESS TO INFORMATION IN THE NATIONAL DIRECTORY OF NEW HIRES FOR TAX ADMINISTRATION PURPOSES



Current Law

The Office of Child Support Enforcement of the Department of Health and Human Services (HHS) maintains the National Directory of New Hires (NDNH), which is a database that contains newly-hired employee data from Form W-4, quarterly wage data from State and Federal employment security agencies, and unemployment benefit data from State unemployment insurance agencies. The NDNH was created to help State child support enforcement agencies enforce obligations of parents across State lines.

Under current provisions of the Social Security Act, the IRS may obtain data from the NDNH, but only for the purpose of administering the EITC and verifying employment reported on a tax return.

Generally, the IRS obtains employment and unemployment data less frequently than quarterly, and there are significant internal costs of preparing these data for use. Under various State laws, the IRS may negotiate for access to employment and unemployment data directly from State agencies that maintain these data.



Reasons for Change

Employment data are useful to the IRS in administering a wide range of tax provisions beyond the EITC, including verifying taxpayer claims and identifying levy sources. Currently, the IRS may obtain employment and unemployment data on a State-by-State basis, which is a costly and time-consuming process. NDNH data are timely, uniformly compiled, and electronically accessible. Access to the NDNH would increase the productivity of the IRS by reducing the amount of IRS resources dedicated to obtaining and processing data without reducing the current levels of taxpayer privacy.



Proposal

The Social Security Act would be amended 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 non-compliant taxpayers, and identification of levy sources. Data obtained by the IRS from the NDNH would be protected by existing taxpayer privacy law, including civil and criminal sanctions.

The proposal would be effective upon enactment.



MAKE REPEATED WILLFUL FAILURE TO FILE A TAX RETURN A FELONY



Current Law

Current law provides that willful failure to file a tax return is a misdemeanor punishable by a term of imprisonment for not more than one year, a fine of not more than $25,000 ($100,000 in the case of a corporation), or both. A taxpayer who fails to file returns for multiple years commits a separate misdemeanor offense for each year.



Reasons for Change

Increased criminal penalties would help to deter multiple willful failures to file tax returns.



Proposal

Any person who willfully fails to file tax returns in any three years within any five consecutive year period, if the aggregated tax liability for such period is at least $50,000, would be subject to a new aggravated failure to file criminal penalty. The proposal would classify such failure as a felony and, upon conviction, impose a fine of not more than $250,000 ($500,000 in the case of a corporation) or imprisonment for not more than five years, or both.

The proposal would be effective for returns required to be filed after December 31, 2009.



FACILITATE TAX COMPLIANCE WITH LOCAL JURISDICTIONS



Current Law

Although Federal tax returns and return information (FTI) generally are confidential, the IRS and Treasury Department may share FTI with States as well as certain local government entities that are treated as States for this purpose. Generally, the purpose of information sharing is to facilitate tax administration. Where sharing of FTI is authorized, reciprocal provisions generally authorize disclosure of information to the IRS by State and local governments. State and local governments that receive FTI must safeguard it according to prescribed protocols that require secure storage, restricted access, reports to IRS, and shredding or other proper disposal. See, e.g., IRS Publication 1075. Criminal and civil sanctions apply to unauthorized disclosure or inspection of FTI. Indian Tribal Governments (ITGs) are treated as States by the tax law for several purposes, such as certain charitable contributions, excise tax credits, and local tax deductions, but not for purposes of information sharing.



Reasons for Change

IRS and Treasury compliance activity, especially with respect to alcohol, tobacco and fuel excise taxes, may necessitate information sharing with ITGs. For example, the IRS may wish to confirm if a fuel supplier's claim to have delivered particular amounts to adjacent jurisdictions is consistent with that reported to the IRS. If not, the IRS in conjunction with the ITG, which would have responsibility for administering taxes imposed by the ITG, can take steps to ensure compliance with both Federal and ITG tax laws. Where the local government is treated as a State for information sharing purposes, IRS, Treasury, and local officials can support each other's efforts. Where the local government is not so treated, there is an impediment to compliance activity.



Proposal

ITGs that impose alcohol, tobacco, or fuel excise or income or wage taxes would be treated as States for purposes of information sharing to the extent necessary for ITG tax administration. An ITG that receives FTI would be required to safeguard it according to prescribed protocols. The criminal and civil sanctions would apply.

The proposal would be effective for disclosures made after enactment.



EXTENSION OF STATUTE OF LIMITATIONS WHERE STATE TAX ADJUSTMENT AFFECTS FEDERAL TAX LIABILITY



Current Law

In general, additional Federal tax liabilities in the form of tax, interest, penalties and additions to tax must be assessed by the IRS within three years after the date a return is filed. If an assessment is not made within the required time period, the additional liabilities generally cannot be assessed or collected at any future time. The Code contains exceptions to the general statute of limitations. In general, the statute of limitations with respect to claims for refund expires three years from the time the return was filed or two years from the time the tax was paid, whichever is later.

State and local authorities employ a variety of statutes of limitations for State and local tax assessments. Pursuant to agreement, the IRS and State and local revenue agencies exchange reports of adjustments made through examination so that corresponding adjustments can be made by each taxing authority. In addition, States provide the IRS with reports of potential discrepancies between State returns and Federal returns.



Reasons for Change

The general statute of limitations serves as a barrier to the effective use by the IRS of State and local tax adjustment reports when the reports are provided by the State or local revenue agency to the IRS with little time remaining for assessments to be made at the Federal level. Under the current statute of limitations framework, taxpayers may seek to extend the State statute of limitations or postpone agreement to State proposed adjustments until such time as the Federal statute of limitations expires in order to preclude assessment at the Federal level. In addition, it is not always the case that a taxpayer that files an amended State or local return reporting additional liabilities at the State or local level that also affect Federal tax liability will file an amended return at the Federal level.



Proposal

The proposal would create an additional exception to the general three-year statute of limitations for assessment of Federal tax liability resulting from adjustments to State or local tax liability. The statute of limitations would be extended the greater of: (1) one year from the date the taxpayer first files an amended tax return with the IRS reflecting adjustments to the State or local tax return; or (2) two years from the date the IRS first receives information from the State or local revenue agency under an information sharing agreement in place between the IRS and a State or local revenue agency. The statute of limitations would be extended only with respect to the increase in Federal tax attributable to the State or local tax adjustment. The statute of limitations would not be further extended if the taxpayer files additional amended returns for the same tax periods as the initial amended return or if the IRS receives additional information from the State or local revenue agency under an information sharing agreement. The statute of limitations on claims for refund would be extended correspondingly so that any overall increase in tax assessed by the IRS as a result of the State or local examination report would take into account agreed-upon tax decreases or reductions attributable to a refund or credit.

The proposal would be effective for returns required to be filed after December 31, 2009.



IMPROVE INVESTIGATIVE DISCLOSURE STATUTE



Current Law

Generally, tax return information is confidential, unless a specific exception in the Code applies. In the case of tax administration, the Code permits Treasury and IRS officers and employees to disclose return information to the extent necessary to obtain information not otherwise reasonably available, in the course of an audit or investigation, as prescribed by regulation. Thus, for example, a revenue agent may identify himself or herself as affiliated with the IRS, and may disclose the nature and subject of an investigation, as necessary to elicit information from a witness in connection with that investigation. Criminal and civil sanctions apply to unauthorized disclosures of return information.



Reasons for Change

Treasury Regulations effective since 2003 state that the term "necessary" in this context does not mean essential or indispensable, but rather appropriate and helpful in obtaining the information sought. In other contexts, a "necessary" disclosure is one without which performance cannot be accomplished reasonably without the disclosure. Determining if an investigative disclosure is "necessary" is inherently factual, leading to inconsistent opinions by the courts. Eliminating this uncertainty from the statute would facilitate investigations by IRS officers and employees, while setting forth clear guidance for taxpayers, thus enhancing compliance with the tax Code.



Proposal

The taxpayer privacy law would be clarified by stating that it does not prohibit Treasury and IRS officers and employees from identifying themselves, their organizational affiliation, and the nature and subject of an investigation, when contacting third parties in connection with a civil or criminal tax investigation.

The proposal would be effective for disclosure made after enactment.



EXPAND REQUIRED ELECTRONIC FILING BY TAX RETURN PREPARERS



Current Law

The Department of the Treasury currently may issue regulations regarding when tax returns must be filed electronically on magnetic media or in other machine-readable form. But the regulations may not require individuals, estates, or trusts to file their tax returns electronically. In addition, the regulations may not require any person to file electronically unless the person files at least 250 tax returns during the calendar year.



Reasons for Change

Electronic filing benefits taxpayers and the IRS because it decreases processing errors, expedites processing and payment of tax refunds, and allows the IRS to efficiently maintain up-to-date taxpayer records.



Proposal

The proposal generally would maintain the current rule that regulations may not require any person to file electronically unless the person files at least 250 tax returns during the calendar year. But the proposal also would provide an exception to this rule under which regulations may require electronic filing by tax return preparers (as currently defined in the Internal Revenue Code) who file more than 100 tax returns in a calendar year. The proposal also would allow regulations requiring tax return preparers who file more than 100 returns (or any other person who files more than 250 returns) to file electronically tax returns for individuals, estates, or trusts.

The proposal would be effective for tax returns required to be filed after December 31, 2010.



Expand Penalties



CLARIFY THAT THE BAD CHECK PENALTY APPLIES TO ELECTRONIC CHECKS AND OTHER PAYMENT FORMS



Current Law

The Code imposes a penalty on any taxpayer who attempts to satisfy a tax liability with a check or money that is not duly paid. The penalty is 2 percent of the amount of the bad check or money order. If the bad check or money order is for less than $1,250, the penalty is the lesser of $25 or the amount of the check or money order.



Reasons for Change

Taxpayers use a variety of commercially acceptable instruments to pay tax liabilities, but only two types of instruments are covered by the Code's bad check penalty: checks and money orders.



Proposal

The proposal would expand the bad check penalty to cover all commercially acceptable instruments of payment that are not duly paid.

The proposal would be effective for returns required to be filed after December 31, 2009.



IMPOSE PENALTY ON FAILURE TO COMPLY WITH ELECTRONIC FILING REQUIREMENTS



Current Law

Certain corporations and tax-exempt organizations (including certain charitable trusts and private foundations) are required to file their returns electronically. Generally, filing on paper instead of electronically is treated as a failure to file if electronic filing is required. Additions to tax are imposed for the failure to file tax returns reporting a liability. For failure to file a corporate return, the addition to tax is 5 percent on the amount required to be shown as tax due on the return, for the first month of failure, and an additional 5 percent for each month or part of a month thereafter, up to a maximum of 25 percent.

For failure to file a tax-exempt organization return, the addition to tax is $20 a day for each day the failure continues. The maximum amount per return is $10,000 or 5 percent of the organization's gross receipts for the year, whichever is less. Organizations with annual gross receipts exceeding $1 million, however, are subject to an addition to tax of $100 per day, with a maximum of $50,000.



Reasons for Change

Although there are additions to tax for the failure to file returns, there is no specific penalty in the tax Code for a failure to comply with a requirement to file electronically. Because the addition to tax for failure to file a corporate return is based on an underpayment of tax, no addition is imposed if the corporation is in a refund, credit, or loss status. Thus, the existing addition to tax may not provide an adequate incentive for certain corporations to file electronically. Generally, electronic filing increases efficiency of tax administration because the provision of tax return information in an electronic form enables the IRS to focus audit activities where they can have the greatest impact. This also assists taxpayers where the need for audit is reduced.



Proposal

The proposal would establish an assessable penalty would be established for a failure to comply with a requirement of electronic (or other machine-readable) format for a return that is filed. The amount of the penalty would be $25,000 for a corporation or $5,000 for a tax-exempt organization. For failure to file in any format, the existing penalty would remain, and the proposed penalty would not apply.

The proposal would be effective for returns required to be electronically filed after December 31, 2010.



MAKE REFORMS TO CLOSE TAX LOOPHOLES



Financial Institutions and Products



REQUIRE ACCRUAL OF INCOME ON FORWARD SALE OF CORPORATE STOCK



Current Law

A corporation generally does not recognize gain or loss on the issuance or repurchase of its own stock. Thus, a corporation does not recognize gain or loss on the forward sale of its own stock. A corporation sells its stock forward by agreeing to issue its stock in the future in exchange for consideration to be paid in the future.

Although a corporation does not recognize gain or loss on the issuance of its own stock, a corporation does recognize interest income upon the current sale of stock for deferred payment.



Reasons for Change

There is little substantive difference between a corporate issuer's current sale of its stock for deferred payment and an issuer's forward sale of the same stock. The only difference between the two transactions is the timing of the stock issuance. In a current sale, the stock is issued at the inception of the transaction, while, in a forward sale, the stock is issued at the time the deferred payment is received. In both cases, a portion of the deferred payment economically compensates the corporation for the time-value of the deferred payment. It is inappropriate to treat these two transactions differently.



Proposal

The proposal would require a corporation that enters into a forward contract to issue its stock to treat a portion of the payment on the forward issuance as a payment of interest.

The proposal would be effective for forward contracts entered into after December 31, 2010.



REQUIRE ORDINARY TREATMENT FOR CERTAIN DEALERS OF EQUITY OPTIONS AND COMMODITIES



Current Law

Under current law, commodities dealers (within the meaning of section 1402(i)(2)(B)), commodities derivatives dealers (within the meaning of section 1221(b)(1)(A)), dealers in securities (within the meaning of section 475(c)(1)) and options dealers (within the meaning of section 1256(g)(8)), treat the income from certain of their day-to-day dealer activities as giving rise to capital gain. Under section 1256, these dealers treat 60 percent of their income (or loss) from their dealer activities as long-term capital gain (or loss) and 40 percent of their income (or loss) from their dealer activities as short-term capital gain (or loss). Dealers in other types of property generally treat the income from their day-to-day dealer activities as giving rise to ordinary income.



Reasons for Change

There is no reason to treat dealers in commodities, commodities derivatives dealers, dealers in securities and dealers in equity options differently than dealers in other types of property. Dealers earn their income from their day-to-day dealing activities and should be taxed at ordinary rates.



Proposal

The proposal would require commodities derivatives dealers, dealers in securities and dealers in equity options and commodities and to treat the income from their day-to-day dealer activities as ordinary in character, not capital.

The proposal would be effective for taxable years beginning after the date of enactment.



MODIFY DEFINITION OF CONTROL FOR PURPOSES OF THE SECTION 249 DEDUCTION LIMIT



Current Law

In general, if a corporation repurchases a debt instrument that is convertible into its stock, or into stock of a corporation in control of or controlled by the corporation, section 249 may disallow or limit the issuer's deduction for a premium paid to repurchase the debt instrument. For this purpose, "control" is determined by reference to section 368(c), which encompasses only direct relationships ( e.g. , a parent corporation and its wholly-owned, first tier subsidiary).



Reasons for Change

The definition of "control" in section 249 is unnecessarily restrictive, and has resulted in situations in which the limitation in section 249 is too easily avoided. Indirect control relationships ( e.g. , a parent corporation and a second-tier subsidiary) present the same economic identity of interests as direct control relationships, and should be treated in a similar manner.



Proposal

Under the proposal, the definition of "control" in section 249(b)(2) would be amended to incorporate indirect control relationships, of the nature described in section 1563(a)(1).

The proposal would be effective on the date of enactment.



Insurance Companies and Products



MODIFY RULES THAT APPLY TO SALES OF LIFE INSURANCE CONTRACTS



Current Law

The seller of a life insurance contract generally must report as taxable income the difference between the amount received from the buyer and the adjusted basis in the contract, unless the buyer is a viatical settlement provider and the insured person is terminally or chronically ill.

Under a transfer-for-value rule, the buyer of a previously-issued life insurance contract who subsequently receives a death benefit generally is subject to tax on the difference between the death benefit received and the sum of the amount paid for the contract and premiums subsequently paid by the buyer. This rule does not apply if the buyer's basis is determined in whole or in part by reference to the seller's basis, nor does the rule apply if the buyer is the insured, a partner of the insured, a partnership in which the insured is a partner, or a corporation in which the insured is a shareholder or officer.

Persons engaged in a trade or business that make payments of premiums, compensations, remunerations, other fixed or determinable gains, profits and income, or certain other types of payments in the course of that trade or business to another person generally are required to report such payments of $600 or more to the IRS. However, reporting may not be required in some circumstances involving the purchase of a life insurance contract.



Reasons for Change

Recent years have seen a significant increase in the number and size of life settlement transactions, wherein individuals sell previously-issued life insurance contracts to investors. Compliance is sometimes hampered by a lack of information reporting. In addition, the current law exceptions to the transfer-for-value rule may give investors the ability to structure a transaction to avoid paying tax on the profit when the insured person dies.



Proposal

The proposal would require a person or entity who purchases an interest in an existing life insurance contract with a death benefit equal to or exceeding $1 million to report the purchase price, the buyer's and seller's taxpayer identification numbers (TINs), and the issuer and policy number to the IRS, to the insurance company that issued the policy, and to the seller.

The proposal also would modify the transfer-for-value rule to ensure that exceptions to that rule would not apply to buyers of policies. Upon the payment of any policy benefits to the buyer, the insurance company would be required to report the gross benefit payment, the buyer's TIN, and the insurance company's estimate of the buyer's basis to the IRS and to the payee.

The proposal would apply to sales or assignment of interests in life insurance policies and payments of death benefits for taxable years beginning after December 31, 2010.



MODIFY DIVIDENDS-RECEIVED DEDUCTION FOR LIFE INSURANCE COMPANY SEPARATE ACCOUNTS



Current Law

Corporate taxpayers may generally qualify for a dividends-received deduction (DRD) with regard to dividends received from other domestic corporations, in order to prevent or limit taxable inclusion of the same income by more than one corporation. In the case of a life insurance company, the DRD is permitted only with regard to the "company's share" of dividends received, reflecting the fact that some portion of the company's dividend income is used to fund tax-deductible reserves for its obligations to policyholders. Likewise, the net increase or net decrease in reserves is computed by reducing the ending balance of the reserve items by the policyholders' share of tax-exempt interest. The regime for computing the company's share and policyholders' share of net investment income is sometimes referred to as proration.

A life insurance company's separate account assets, liabilities, and income are segregated from those of the company's general account in order to support variable life insurance and variable annuity contracts. A company's share and policyholders' share are computed for the company's general account and separately for each separate account.

The policyholders' share equals 100 percent less the company's share, whereas the latter is equal to the company's share of net investment income divided by net investment income. The company's share of net investment income is the excess, if any, of net investment income over certain amounts, including "required interest," that are set aside to satisfy obligations to policyholders. Required interest with regard to an account is calculated by multiplying a specified account earnings rate by the mean of the reserves with regard to the account for the taxable year.



Reasons for Change

The proration methodology currently used by some taxpayers may produce a company's share that greatly exceeds the company's economic interest in the net investment income earned by its separate account assets, generating controversy between life insurance companies and the IRS. The purposes of the proration regime would be better served if the company's share bore a more direct relationship to the company's actual economic interest in the account.



Proposal

As under current law, required interest under the proposal would equal an earnings rate times the mean of reserves. For a separate account, the earnings rate would equal a gross earnings rate (net investment income of the account, divided by the mean of the account's assets), minus a company-retained percentage (amounts retained by the company from the account's net investment income, if any, divided by the mean of reserves). For this purpose, amounts retained by the company would be treated as funded proportionately by items included in net investment income and items not so included. It is intended that this formula would generally produce a company's share with regard to a separate account that approximates the ratio of the mean of the surplus attributable to the account to the mean of the account's assets.

The proposal would be effective for taxable years beginning after December 31, 2010.



EXPAND PRO RATA INTEREST EXPENSE DISALLOWANCE FOR CORPORATEOWNED LIFE INSURANCE (COLI)



Current Law

In general, no Federal income tax is imposed on a policyholder with respect to the earnings credited under a life insurance or endowment contract, and Federal income tax generally is deferred with respect to earnings under an annuity contract (unless the annuity contract is owned by a person other than a natural person). In addition, amounts received under a life insurance contract by reason of the death of the insured generally are excluded from gross income of the recipient.

Interest on policy loans or other indebtedness with respect to life insurance, endowment or annuity contracts generally is not deductible, unless the insurance contract insures the life of a key person of the business. A key person includes a 20-percent owner of the business, as well as a limited number of the business' officers or employees. However, this interest disallowance rule applies to businesses only to the extent that the indebtedness can be traced to a life insurance, endowment or annuity contract.

In addition, the interest deductions of a business other than an insurance company are reduced to the extent the interest is allocable to unborrowed policy cash values based on a statutory formula. An exception to the pro rata interest disallowance applies with respect to contracts that cover individuals who are officers, directors, employees, or 20-percent owners of the taxpayer. In the case of both life and non-life insurance companies, special proration rules similarly require adjustments to prevent or limit the funding of tax-deductible reserve increases with tax preferred income, including earnings credited under life insurance, endowment and annuity contracts that would be subject to the pro rata interest disallowance rule if owned by a non-insurance company.



Reasons for Change

Leveraged business can fund deductible interest expenses with tax-exempt or tax-deferred income credited under life insurance, endowment or annuity contracts insuring certain types of individuals. For example, these businesses frequently invest in investment-oriented insurance policies covering the lives of their employees, officers, directors or owners. These entities generally do not take out policy loans or other indebtedness that is secured or otherwise traceable to the insurance contracts. Instead, they borrow from depositors or other lenders, or issue bonds. Similar tax arbitrage benefits result when insurance companies invest in certain insurance contracts that cover the lives of their employees, officers, directors or 20-percent shareholders and fund deductible reserves with tax-exempt or tax-deferred income.



Proposal

The proposal would repeal the exception from the pro rata interest expense disallowance rule for contracts covering employees, officers or directors, other than 20-percent owners of a business that is the owner or beneficiary of the contracts.

The proposal would apply to contracts entered into after the date of enactment.



Tax Accounting Methods



DENY DEDUCTION FOR PUNITIVE DAMAGES



Current Law

No deduction is allowed for a fine or similar penalty paid to a government for the violation of any law. If a taxpayer is convicted of a violation of the antitrust laws, or the taxpayer's plea of guilty or nolo contendere to such a violation is entered or accepted in a criminal proceeding, no deduction is allowed for two-thirds of any amount paid or incurred on a judgment or in settlement of a civil suit brought under section 4 of the Clayton Antitrust Act on account of such or any related antitrust violation. Where neither of these two provisions is applicable, a deduction is allowed for damages paid or incurred as ordinary and necessary expenses in carrying on any trade or business, regardless of whether such damages are compensatory or punitive.



Reasons for Change

The deductibility of punitive damage payments undermines the role of such damages in discouraging and penalizing certain undesirable actions or activities.



Proposal

No deduction would be allowed for punitive damages paid or incurred by the taxpayer, whether upon a judgment or in settlement of a claim. Where the liability for punitive damages is covered by insurance, such damages paid or incurred by the insurer would be included in the gross income of the insured person. The insurer would be required to report such payments to the insured person and to the Internal Revenue Service.

The proposal would apply to damages paid or incurred after December 31, 2010.



REPEAL LOWER-OF-COST-OR-MARKET INVENTORY ACCOUNTING METHOD



Current Law

Taxpayers required to maintain inventories are permitted to use a variety of methods to determine the cost of their ending inventories, including methods such as the last-in, first-out ("LIFO") method, the first-in, first-out ("FIFO") method, and the retail method. Taxpayers not using a LIFO method may write down the carrying values of their inventories by applying the lower-of-cost-or-market ("LCM") method and may write down the cost of "subnormal" goods (i.e., those that are unsalable at normal prices or unusable in the normal way because of damage, imperfection or other similar causes). Taxpayers using the retail method for tax currently are not required to use that method for financial statement reporting purposes.



Reasons for Change

The allowance of inventory write-downs under the LCM and subnormal goods provisions is an exception from the realization principle, and is essentially a one-way mark-to-market regime that understates taxable income. Thus, a taxpayer is able to obtain a larger cost-of-goods-sold deduction by writing down an item of inventory if its replacement cost falls, but need not increase an item's inventory value if its replacement cost increases. This asymmetric treatment is unwarranted. Also, the market value used under LCM for tax purposes generally is the replacement or reproduction cost of an item of inventory, not the item's net realizable value, as is required under generally accepted financial accounting rules. While the operation of the retail method is technically symmetric, it also allows retailers to obtain deductions for write-downs below inventory cost because of normal and anticipated declines in retail prices.



Proposal

The proposal would statutorily prohibit the use of the LCM and subnormal goods methods. Appropriate wash-sale rules also would be included to prevent taxpayers from circumventing the prohibition. The retail method would be allowed only if the taxpayer employs the method for purposes of financial accounting. The proposal would be treated as a change in the method of accounting for inventories, and any resulting section 481(a) adjustment generally would be included in income ratably over a four-year period beginning with the year of change.

The proposal would be effective for taxable years beginning after 12 months from the date of enactment.



Modify Estate and Gift Tax Valuation Discounts and Make Other Reforms



REQUIRE CONSISTENCY IN VALUE FOR TRANSFER AND INCOME TAX PURPOSES



Current Law

Section 1014 provides that the basis of property acquired from a decedent generally is the fair market value of the property on decedent's date of death. Similarly, property included in the decedent's gross estate for estate tax purposes generally must be valued at its fair market value on date of death. Although the same valuation standard applies to both provisions, current law does not explicitly require that the recipient's basis in that property be the same value at which that property was reported for estate tax purposes.

Section 1015 provides that the donee's basis in property received by gift during the life of the donor generally is the donor's adjusted basis in the property, increased by gift tax paid on the transfer. If, however, the donor's basis exceeds the fair market value of the property on the date of the gift, the donee's basis is limited to that fair market value for purposes of determining any subsequent loss.

Section 6034A imposes a consistency requirement - specifically, that the recipient of a distribution of income from a trust or estate must report on the recipient's own income tax return the exact information included on the Schedule K-1 of the trust's or estate's income tax return - but this provision applies only for income tax purposes, and the Schedule K-1 does not include basis information.



Reasons for Change

Taxpayers should be required to take consistent positions in dealing with the Internal Revenue Service, whether or not principles of privity apply. If the logic underlying the new basis in property acquired on the death of the owner is that the new basis is the amount used to determine the decedent's estate tax liability, then the law should require that the same value be used by the recipient, unless that value is in excess of the accurate value. In the case of property transferred on death or by gift during life, often the executor of the estate or the donor, respectively, will be in the best position to ensure that the recipient receives the necessary information that will determine that recipient's basis in the transferred property.



Proposal

This proposal would require both consistency and a reporting requirement. The basis of property received by reason of death under section 1014 would have to equal the value of that property for estate tax purposes. The basis of property received by gift during the life of the donor would have to equal the donor's basis determined under section 1015. This proposal would require that the basis of the property in the hands of the recipient be no greater than the value of that property as determined for estate or gift tax purposes (subject to subsequent adjustments). A reporting requirement would be imposed on the executor of the decedent's estate and on the donor of a lifetime gift to provide the necessary information to both the recipient and the IRS. A grant of regulatory authority would be included to provide details about the implementation and administration of these requirements, including rules for situations in which no estate tax return is required to be filed or gifts are excluded from gift tax under section 2503, for situations in which the surviving joint tenant or other recipient may have better information than the executor, and for the timing of the required reporting in the event of adjustments to the reported value subsequent to the filing of an estate or gift tax return.

The proposal would be effective as of the date of enactment.



MODIFY RULES ON VALUATION DISCOUNTS



Current Law

The fair market value of property transferred, whether on the death or during the life of the transferor, generally is subject to estate or gift tax at the time of the transfer. Sections 2701 through 2704 of the Internal Revenue Code were enacted to prevent the reduction of taxes through the use of "estate freezes" and other techniques designed to reduce the value of the transferor's taxable estate and discount the value of the taxable transfer to the beneficiaries of the transferor when the economic benefit to the beneficiaries is not reduced by these techniques. Generally, section 2704(b) provides that certain "applicable restrictions" (that would normally justify discounts in the value of the interests transferred) are to be ignored in valuing interests in family-controlled entities if those interests are transferred (either by gift or on death) to or for the benefit of other family members. The application of these special rules results in an increase in the transfer tax value of those interests above the price that a hypothetical willing buyer would pay a willing seller, because section 2704(b) generally directs an appraiser to ignore the rights and restrictions that would otherwise support significant discounts for lack of marketability and control.



Reasons for Change

Judicial decisions and the enactment of new statutes in most states have, in effect, made section 2704(b) inapplicable in many situations, specifically, by recharacterizing restrictions such that they no longer fall within the definition of an "applicable restriction". In addition, the Internal Revenue Service has identified additional arrangements designed to circumvent the application of section 2704.



Proposal

This proposal would create an additional category of restrictions ("disregarded restrictions") that would be ignored in valuing an interest in a family-controlled entity transferred to a member of the family if, after the transfer, the restriction will lapse or may be removed by the transferor and/or the transfer's family. Specifically, the transferred interest would be valued by substituting for the disregarded restrictions certain assumptions to be specified in regulations. Disregarded restrictions would include limitations on a holder's right to liquidate that holder's interest that are more restrictive than a standard identified in regulations. A disregarded restriction also would include any limitation on a transferee's ability to be admitted as a full partner or holder of an equity interest in the entity. For purposes of determining whether a restriction may be removed by member(s) of the family after the transfer, certain interests (to be identified in regulations) held by charities or others who are not family members of the transferor would be deemed to be held by the family. Regulatory authority would be granted, including the ability to create safe harbors to permit taxpayers to draft the governing documents of a family-controlled entity so as to avoid the application of section 2704 if certain standards are met. This proposal would make conforming clarifications with regard to the interaction of this proposal with the transfer tax marital and charitable deductions.

This proposal would apply to transfers after the date of enactment of property subject to restrictions created after October 8, 1990 (the effective date of section 2704).



REQUIRE MINIMUM TERM FOR GRANTOR RETAINED ANNUITY TRUSTS (GRATS)



Current Law

Section 2702 provides that, if an interest in a trust is transferred to a family member, the value of any interest retained by the grantor is valued at zero for purposes of determining the transfer tax value of the gift to the family member(s). This rule does not apply if the retained interest is a "qualified interest". A fixed annuity, such as the annuity interest retained by the grantor of a GRAT, is one form of qualified interest, so the gift of the remainder interest in the GRAT is determined by deducting the present value of the retained annuity during the GRAT term from the fair market value of the property contributed to the trust.

Generally, a GRAT is an irrevocable trust funded with assets expected to appreciate in value, in which the grantor retains an annuity interest for a term of years that the grantor expects to survive. At the end of that term, the assets then remaining in the trust are transferred to (or held in further trust for) the beneficiaries, who generally are descendants of the grantor. If the grantor dies during the GRAT term, however, the trust assets (at least the portion needed to produce the retained annuity) are included in the grantor's gross estate for estate tax purposes. In this event, although the beneficiaries will own the remaining trust assets, the estate tax benefit of creating the GRAT (specifically, the tax-free transfer of the appreciation during the GRAT term in excess of the annuity payments) is not realized.



Reasons for Change

GRATs have proven to be a popular and efficient technique for transferring wealth while minimizing the gift tax cost of transfers, providing that the grantor survives the GRAT term and the trust assets do not depreciate in value. The greater the appreciation, the greater the transfer tax benefit achieved. Taxpayers have become more adept at maximizing the benefit of this technique, often by minimizing the term of the GRAT (thus reducing the risk of the grantor's death during the term), in many cases to 2 years, and by retaining annuity interests significant enough to reduce the gift tax value of the remainder interest to zero or to a number small enough to generate only a minimal gift tax liability.



Proposal

This proposal would require, in effect, some downside risk in the use of this technique by imposing the requirement that a GRAT have a minimum term of 10 years. 5 Although a minimum term would not prevent "zeroing-out" the gift tax value of the remainder interest, it would increase the risk of the grantor's death during the GRAT term and the resulting loss of any anticipated transfer tax benefit.

This proposal would apply to trusts created after the date of enactment.



MODIFY ALTERNATIVE FUEL MIXTURE CREDIT



Current Law

The Code provides excise tax credits for alternative fuel and alternative fuel mixtures. Alternative fuel means liquefied petroleum gas, P Series fuels (as defined by the Secretary of Energy under 42 U.S.C. sec. 13211(2)), compressed or liquefied natural gas, liquefied hydrogen, certain liquid fuel derived from coal through the Fischer-Tropsch process, compressed or liquefied gas derived from biomass, and liquid fuel derived from biomass, but does not include ethanol, methanol, or biodiesel. The alternative fuel credit is 50 cents per gallon for liquid fuel and 50 cents per gasoline gallon equivalent for nonliquid fuel. The alternative fuel credit is available only for fuel sold by the taxpayer for use as a fuel in a motor vehicle or motorboat or so used by the taxpayer. The alternative fuel mixture credit is computed at the same rate on each gallon of alternative fuel used in producing a mixture of alternative fuel and taxable fuel for sale or use in the taxpayer's trade or business. The mixture must be sold by its producer for use as a fuel or used as a fuel by the producer. Both credits are allowed against fuel excise tax liability. In addition, a person may file a claim for payment equal to the amount of the alternative fuel and alternative fuel mixture credits. Except in the case of liquefied hydrogen, the credits expire on December 31, 2009.



Reasons for Change

Alternative fuels include liquid byproducts derived from the processing of paper or pulp (known as "black liquor" when derived from the kraft process), which paper companies burn to produce energy in their mills. Certain paper companies, to take advantage of the alternative fuels mixture credit, have recently begun mixing diesel fuel with black liquor, burning the mixture, and claiming the alternative fuel mixture credit. This is resulting in substantial revenue losses and provides a windfall to the paper industry.



Proposal

The Administration proposes to limit the credit for mixtures containing alternative fuel derived from the processing of paper or pulp to mixtures that are sold for use or used as fuel in a motor vehicle or motorboat. Accordingly, black liquor mixtures used as a fuel in paper processing would no longer be eligible for the credit.

The change would be effective after the date of enactment.



APPENDIX: EXTENDING CURRENT POLICIES

The first step in addressing the nation's fiscal problems is to be upfront about them - and to establish an honest baseline that measures where we are before new policies are enacted. The Administration's Budget does so by adjusting the Budget Enforcement Act (BEA) baseline to reflect the true cost of the current policy path. The BEA baseline, which is commonly used in budgeting and is defined in a now expired statute, with some exceptions reflects the projected receipts level under current law. But, under current law, relief from the AMT would expire at the end of this year, causing millions of Americans to begin paying this additional tax, and, furthermore, the 2001 and 2003 tax cuts would expire entirely at the end of 2010. These expirations were not written into law for policy reasons; instead, they reflect decisions made to artificially reduce the cost estimates of AMT relief and the 2001 and 2003 tax cuts to fit these policies within certain budget process rules. Because of this, the BEA's "current law" baseline is not an accurate reflection of what it would mean to continue forward with current policies. The Administration's Budget uses an adjusted tax baseline that continues AMT relief and the 2001 and 2003 tax cuts, so as to project future receipts under current policy and to better measure the effects of the Administration's proposed policy changes.

Index to inflation the 2009 parameters of the AMT as enacted in the American Recovery and Reinvestment Act of 2009. The Administration's baseline projection of current policy reflects annual indexation of the AMT exemption amounts in effect for taxable year 2009 ($46,700 for single taxpayers, $70,950 for married taxpayers filing a joint return and surviving spouses, and $35,475 for married taxpayers filing a separate return and for estates and trusts); the income thresholds for the 28-percent rate ($87,500 for married taxpayers filing a separate return and $175,000 for all other taxpayers); and the income thresholds for the phaseout of the exemption amounts ($150,000 for married taxpayers filing a joint return and surviving spouses, $112,500 for single taxpayers, and $75,000 for married taxpayers filing a separate return). The baseline projection of current policy also extends AMT relief for nonrefundable personal credits.

Continue the 2001 and 2003 tax cuts. Most of the tax reductions enacted in 2001 and 2003 expire on December 31, 2010. The Administration's baseline projection of current policy continues all of these expiring provisions except for repeal of estate and generation-skipping transfer taxes. Estate and gift taxes are assumed to be extended at parameters in effect for calendar year 2009 (a top rate of 45 percent and an exemption amount of $3.5 million).


TABLES OF REVENUE ESTIMATES


Revenue estimates begin on next page.

View Document


1 The Administration's primary policy proposals reflect changes from a tax baseline that modifies current law by "patching" the alternative minimum tax, freezing the estate tax, and making permanent a number of the tax cuts enacted in 2001 and 2003. The baseline changes to current law are described in the Appendix. In some cases, the policy descriptions in the body of this report make note of the baseline (e.g., descriptions of upper-income tax provisions), but elsewhere the baseline is implicit.

1 Specifically, the otherwise allowable child tax credit is reduced by $50 for each $1,000 (or fraction thereof) of modified adjusted gross income over $75,000 for single individuals or heads of households, $110,000 for married individuals filing joint returns, and $55,000 for married individuals filing separate returns.

2 Earned income for purposes of the refundable amount is defined as the sum of wages, salaries, tips, and other taxable employee compensation plus net self-employment earnings to the extent that these amounts are included when computing taxable income.

3 The Working Families Tax Relief Act of 2004 amended certain of the New York Liberty Zone provisions relating to tax-exempt bonds.

4 Section 179 provides that, in place of depreciation, certain taxpayers, typically small businesses, may elect to deduct up to $125,000 of the cost of section 179 property placed in service each year. In general, section 179 property is defined as depreciable tangible personal property that is purchased for use in the active conduct of a trade or business.

5 Cf. section 673 as applicable to a so-called Clifford trust created before or on March 1, 1986, with a 10-year minimum term.

Economic substance - Son of Boss case

Klamath Strategic Investment Fund, by and through St Croix Ventures (Managing member), Plaintiff-Appellee-Cross-Appellant v. United States of America Defendant-Appellant-Cross-Appellee; Kinabalu Strategic Investment Fund, by and through Rogue Ventures LLC (Managing member), Plaintiff-Appellee-Cross-Appellant v. United States of America, Defendant-Appellant-Cross-Appellee.

U.S. Court of Appeals, 5th Circuit; 07-4086, May 15, 2009.

Affirming in part, vacating and remanding in part, a DC Tex. decision, 2007-1 USTC ¶50,223.





Before: Garwood, Garza and Owen, Circuit Judges.

GARZA, Circuit Judge: In this tax case, Plaintiffs Klamath Strategic Investment Fund ("Klamath") and Kinabalu Strategic Investment Fund ("Kinabalu") (collectively, the "Partnerships") filed suit against defendant the United States of America for readjustment of partnership items. Both parties appeal various aspects of the district court's readjustment determination. For the following reasons, we affirm in part, vacate in part, and remand.


I


This case involves a highly complex series of financial transactions, which the district court categorized as a tax shelter known as Bond Linked Issue Premium Structure ("BLIPS"). The transactions were undertaken by two law partners, Cary Patterson and Harold Nix. Patterson and Nix's law firm represented the State of Texas in litigation against the tobacco industry and each partner earned around $30 million between 1998 and 2000. Interested in managing this wealth, Patterson and Nix requested their long-time accounting firm, Pollans & Cohen, to investigate investment opportunities.

The accountants identified Presidio Advisory Services ("Presidio"), an investment advisory firm purporting to specialize in foreign currency trading. Presidio advocated a complex plan involving strategic investments in foreign currencies pegged to the U.S. dollar. Patterson and Nix agreed to invest in Presidio's plan. Generally, the Presidio strategy was structured as a three-stage, seven-year investment program. Stage I lasted 60 days and entailed relatively low risk investments. Stage II lasted from day 60 through day 180, and the risk was somewhat higher. Stage III extended from day 180 through the end of the seventh year and involved the highest risk as well as potentially the highest return. At each stage of the plan, Presidio required the investors to contribute significantly more capital. The investors retained the right to exit the plan at the end of Stage I and at each 60-day period thereafter.

To implement the strategy Presidio formed Klamath and Kinabalu as limited liability companies, taxed as partnerships. Next, Presidio formed two single-member LLCs, which are disregarded for tax purposes: St. Croix for Patterson and Rogue for Nix. Patterson owned 100% of St. Croix, and St. Croix became a 90% partner of Klamath. The other 10% partners of Klamath were Presidio Resources LLC and Presidio Growth LLC. Presidio Growth was the managing partner. Kinabalu had a similar structure. Nix owned 100% of Rogue, and Rogue was a 90% partner of Kinabalu. The other 10% partners of Kinabalu were Presidio Growth and Presidio Resources, with Presidio Growth acting as the managing partner.

To fund Klamath and Kinabalu, Patterson and Nix (acting through St. Croix and Rogue) made two distinct contributions. First, they each contributed $1.5 million to their respective partnership. Second, they entered into loan transactions with National Westminster Bank ("NatWest"), where the bank loaned each company $66.7 million. This included $41.7 million denominated as the "Stated Principal Amount" and $25 million as a "loan premium." The classification of the $25 million as something different than the principal loan amount is central to this case. The loan premium was given in exchange for Patterson and Nix paying NatWest a higher than market interest rate on the principal: 17.97%. To protect NatWest from the possibility that the loans would be repaid early and the benefit of the higher interest rate would not be realized, the credit agreements required that a prepayment amount be paid if the loans were paid off early. The prepayment amount would vary depending on when the loan was repaid, starting at about $25 million and decreasing over seven years. After year seven, no prepayment amount would apply.

Patterson and Nix each contributed the $66.7 million to Klamath and Kinabalu and assigned the corresponding loan obligations to the Partnerships. The Partnerships deposited the funds into accounts controlled by NatWest. Presidio directed Klamath and Kinabalu to use these funds to purchase very low risk contracts on U.S. dollars and Euros. They also made small, short 60- to 90-day term forward contract trades in foreign currencies. These were the only investments the Partnerships ever made, and Patterson and Nix elected to withdraw from Klamath and Kinabalu before the end of Stage I. They received cash and Euros on liquidation, and they sold the Euros in 2000, 2001, and 2002.

On their income tax returns for 2000, 2001, and 2002, Patterson claimed total losses of $25,277,202 arising from Klamath's activities and Nix claimed total losses of $25,272,344 arising from Kinabalu's. These massive losses occurred because each partner claimed a significant tax basis in their respective partnership. Generally, a partner's basis in a partnership is determined by the amount of capital he contributes to the partnership, and when a partnership loses money the partners can only deduct the losses from their taxable income to the extent of their basis in the partnership. When a partnership assumes a partner's individual liabilities, the liability amount is subtracted from the partner's basis. 1 Patterson and Nix were able to report such high losses because when they each calculated their basis in the partnership, they did not reduce it by the $25 million loan premium amount. When Patterson and Nix contributed the $66.7 million plus the $1.5 million to Klamath and Kinabalu, they would have each had a $68.2 million basis in their partnership. However, the Partnerships also assumed the loan obligations, so Patterson and Nix's bases had to be reduced by the amount of the liabilities. Patterson and Nix did not consider the loan premiums to be liabilities, so they only subtracted the $41.7 million principal amount. Therefore, each claimed a taxable basis in the partnership in excess of $25 million. This meant that when Patterson and Nix sold the Euros, they were able to deduct over $25 million from their taxable income. 2

The IRS disagreed with this basis calculation, and in 2004 issued Final Partnership Administrative Adjustments ("FPAAs") to Klamath and Kinabalu stating that under 26 U.S.C. § 752 of the Internal Revenue Code (the "Code"), the partners should have treated the entire $66.7 million as a liability. Alternatively, the IRS argued that the transactions were shams or lacked economic substance and should be disregarded for tax purposes. The FPAAs also made adjustments to operational expenses reported by the Partnerships and asserted accuracy-related penalties. Patterson and Nix paid the taxes owed based on the FPAAs, and then re-formed the partnerships in order to seek readjustment in the district court.

The Partnerships filed suit against the Government under 26 U.S.C. § 6226 for readjustment of partnership items. The Partnerships moved for partial summary judgment, and the Government cross-moved for summary judgment on the issue of whether the partners' tax bases were properly calculated; specifically, whether the loan premiums constituted liabilities under § 752 of the Code. The district court granted the Partnerships' motion and denied the Government's, holding that the loan premiums were not liabilities under § 752 and therefore the partners' bases were properly calculated under the Code. However, following a bench trial the district court held that the loan transactions must nonetheless be disregarded for federal tax purposes because they lacked economic substance. The district court also concluded that the penalties asserted by the IRS did not apply and the Partnerships' operational expenses were deductible. The Government moved the court to reconsider and vacate its summary judgment decision, arguing that the decision was mooted by the bench trial judgment. The court denied this motion. Finally, the court issued an order holding that it had jurisdiction to order a refund to the Partnerships, and that Patterson and Nix could deduct the $250,000 management fee paid to their accountants.

The Government appeals the district court's partial summary judgment in favor of the Partnerships, arguing that the "loan premiums" constitute liabilities under § 752. The Government also argues that the Partnerships are liable for penalties, that operating expenses and fees may not be deducted, and that the district court lacked jurisdiction to order a refund to the Partnerships. The Partnerships cross-appeal the district court's bench trial judgment, arguing that the loan transactions had economic substance.


II


We review the district court's grant of summary judgment de novo, applying the same standard as the district court. Kornman & Assocs. v. United States, 527 F.3d 443, 450 (5th Cir. 2008). On appeal from a bench trial, we review findings of fact for clear error and legal issues de novo. Houston Exploration Co. v. Halliburton Energy Servs., Inc., 359 F.3d 777, 779 (5th Cir. 2004). Specifically, we have held that a district court's characterization of a transaction for tax purposes is a question of law subject to de novo review, but the particular facts from which that characterization is made are reviewed for clear error. See Compaq Computer Corp. and Subsidiaries v. Comm'r, 277 F.3d 778, 780 (5th Cir. 2001) (citing Frank Lyon Co. v. United States, 435 U.S. 561, 581 n.16 (1978)).


III


We first consider the Partnerships' cross-appeal, namely whether the district court erred in determining that the loan transactions lacked economic substance and must be disregarded for tax purposes.

The economic substance doctrine allows courts to enforce the legislative purpose of the Code by preventing taxpayers from reaping tax benefits from transactions lacking in economic reality. See Coltec Indus., Inc. v. United States, 454 F.3d 1340, 1353-54 (Fed. Cir. 2006). As the Supreme Court has recognized, taxpayers have the right to decrease or avoid taxes by legally permissible means. See Gregory v. Helvering, 293 U.S. 465, 469 (1935). However,"transactions[ ] which do not vary control or change the flow of economic benefits[ ] are to be dismissed from consideration." See Higgins v. Smith, 308 U.S. 473, 476 (1940). In a more recent pronouncement, the Supreme Court held that "[w]here ... there is a genuine multiple-party transaction with economic substance which is compelled or encouraged by business or regulatory realities, is imbued with tax-independent considerations, and is not shaped solely by tax-avoidance features that have meaningless labels attached, the Government should honor the allocation of rights and duties effectuated by the parties." Frank Lyon, 435 U.S. at 583-84.

The law regarding whether a transaction should be disregarded as lacking economic reality is somewhat unsettled in the Fifth Circuit, and a split exists among other Circuits. The Fourth Circuit applies a rigid two-prong test, where a transaction will only be invalidated if it lacks economic substance and the taxpayer's sole motive is tax avoidance. See Rice's Toyota World, Inc. v. Comm'r, 752 F.2d 89, 91-92 (4th Cir. 1985). The majority view, however, is that a lack of economic substance is sufficient to invalidate the transaction regardless of whether the taxpayer has motives other than tax avoidance. See, e.g., Coltec, 454 F.3d at 1355; United Parcel Serv. of Am., Inc. v. Comm'r, 254 F.3d 1014, 1018 (11th Cir. 2001); ACM Partnership v. Comm'r, 157 F.3d 231, 247 (3d Cir. 1998); James v. Comm'r, 899 F.2d 905, 908-09 (10th Cir. 1990). We have previously declined to explicitly adopt either approach. See Compaq, 277 F.3d at 781-82 (finding that the transaction in question had both economic substance and a legitimate business purpose, so it would be recognized for tax purposes under either the minority or majority approach).

We conclude that the majority view more accurately interprets the Supreme Court's prescript in Frank Lyon. The Court essentially set up a multifactor test for when a transaction must be honored as legitimate for tax purposes, with factors including whether the transaction (1) has economic substance compelled by business or regulatory realities, (2) is imbued with taxindependent considerations, and (3) is not shaped totally by tax-avoidance features. See Frank Lyon, 435 U.S. at 583-84. Importantly, these factors are phrased in the conjunctive, meaning that the absence of any one of them will render the transaction void for tax purposes. Thus, if a transaction lacks economic substance compelled by business or regulatory realities, the transaction must be disregarded even if the taxpayers profess a genuine business purpose without tax-avoidance motivations.

The following facts found by the district court are critical to this issue: Presidio and NatWest understood that the transactions would not last beyond Stage I, despite the purported seven-year term --meaning that the high risk foreign currency transactions were never intended to occur. If the investors failed to withdraw voluntarily, NatWest could use economic pressure to force them out because the credit agreements required the borrowers to maintain collateral on deposit at NatWest that exceeded the value of the maximum obligations owed to the bank by some varying amount. At the time the loans were issued, this amount was at least 101.25% of the total $66.7 million. NatWest had the discretion to determine whether the ratio was satisfied and could accelerate the ratio to declare a default if the bank wished to force an investor to withdraw. This requirement also meant that none of the $66.7 million loan could ever be used for investments --it had to stay in the accounts at NatWest. NatWest and Presidio understood that the bank would hold the money in relatively risk-free time deposits. Presidio's management fee was calculated as a percentage of the tax losses generated by the investment plan. The district court determined, however, that Patterson and Nix pursued the transactions with a genuine profit motive and were not solely driven by the desire to avoid taxes.

Here, the evidence supports the district court's conclusion that the loan transactions lacked economic substance. Numerous bank documents stated that despite the purported seven-year term, the loans would only be outstanding for about 70 days. NatWest's profit in the loan transactions was calculated based on a 72-day period. In the event that the investors wanted to remain with the plan beyond 72 days, NatWest would force them out. The bank noted in an internal memo that it "had no legal or moral obligation to deal [with the investors] after Day 60." During that 60- to 70-day window the loan funds could not be used to facilitate the investment strategy that Presidio designed. The requirement of keeping at least 101.25% of the $66.7 million in the NatWest account meant, as the Government's expert testified, that the Partnerships could not make any investments without supplying their own funds in excess of the loan amount.

The Partnerships contend that the loan funds were critical to the high-risk foreign currency transactions even if the funding amount could not be spent because the money provided the necessary security for the high-risk transactions. However, the structure of the plan shows that these high-risk transactions could not occur until Stage III, which was never intended to be reached. As the district court found, NatWest would force the investors out long before Stage III, so the loan transactions served no real purpose beyond creating a massive tax benefit for Nix and Patterson.

The Partnerships further argue that the loan transactions had a reasonable possibility of profit, as evidenced by the fact that two small, low-risk investments were actually made in foreign currencies. However, these investments were made using the $1.5 million that Patterson and Nix contributed to the Partnerships, not the funding amounts of the loans. Various courts have held that when applying the economic substance doctrine, the proper focus is on the particular transaction that gives rise to the tax benefit, not collateral transactions that do not produce tax benefits. See Coltec, 454 F.3d at 1356-57; Nicole Rose Corp. v. Comm'r, 320 F.3d 282, 284 (2d Cir. 2002). Here, the transactions that provided the tax benefits at issue were the loans from NatWest. Therefore, the proper focus is on whether the loan transactions presented a reasonable possibility of profit, not whether the capital contributions from Patterson and Nix could have produced a profit. The loan transactions could never have been profitable because the funding amount could not actually be used for investments, and the high-risk investments for which the funding amount might have provided security were never intended to occur.

The evidence clearly shows that Presidio and NatWest designed the loan transactions and the investment strategy so that no reasonable possibility of profit existed and so that the funding amount would create massive tax benefits but would never actually be at risk. Regardless of Patterson and Nix's desire to make money, they entered into transactions controlled by Presidio and NatWest that were not structured or implemented to make a profit. This particular situation highlights the logic of following the majority approach to the economic substance doctrine, because the minority approach would allow tax benefits to flow from transactions totally lacking in economic substance as long as the taxpayers offered some conceivable profit motive. In cases such as the instant one, this approach would essentially reward a "head in the sand" defense where taxpayers can profess a profit motive but agree to a scheme structured and controlled by parties with the sole purpose of achieving tax benefits for them. We therefore agree with the district court that since the loan transactions lacked economic substance, they must be disregarded for tax purposes.


IV


Next we consider the Government's appeal, namely whether the district court properly granted the Partnerships' motion for partial summary judgment, declined to impose various penalties on the Partnerships, allowed the Partnerships to deduct operational expenses and fees, and ordered a refund.


A


The Government argues that the district court erred in granting the Partnership's motion for partial summary judgment, determining that the loan premiums were not liabilities for purposes of § 752. The Government states in its brief that they are appealing this issue "as a protective matter, due to possible collateral estoppel implications" in several lawsuits pending against Presidio in California.

Despite this adverse summary judgment ruling, the Government ultimately prevailed at trial on economic substance grounds and received the relief it requested when the loan transactions were disregarded for tax purposes. As a general matter, a party who is not aggrieved by a judgment does not have standing to appeal it. See Ward v. Santa Fe Indep. Sch. Dist., 393 F.3d 599, 603 (5th Cir. 2004). In some situations, adverse collateral estoppel implications may show that a party is aggrieved by a particular ruling. See In re DES Litig., 7 F.3d 20, 23 (5th Cir. 1993). However, an interlocutory ruling will only have collateral estoppel effect in subsequent litigation if the ultimate judgment in the case was dependent upon the interlocutory ruling. Id. (finding that a prevailing party had no standing to appeal adverse interlocutory rulings, regarding jurisdiction and choice of law, because the ultimate judgment in the case was not dependent on those rulings). Accordingly, where a party who ultimately prevails in a case attempts to show they have standing to appeal an earlier adverse ruling by arguing that the earlier ruling could have collateral estoppel effect in other pending cases, standing will only exist where the ultimate judgment in the case was "dependent" on the earlier adverse ruling. Id.

Here, the district court's summary judgment ruling has no collateral estoppel effect. The judgment following the bench trial was entirely based on the district court's conclusion that the loan transactions lacked economic substance and must be disregarded for tax purposes. This determination was totally independent of the partial summary judgment ruling that the loan premiums were not liabilities under § 752. Though the Government further argues that "[i]t could be concluded that [it] is aggrieved by the [summary] judgment [ruling] to the extent it played a part in the District Court's rejection of the IRS's imposition of penalties," we conclude that the district court's penalty decision was likewise not dependent on the partial summary judgment determination. Therefore, we hold that the Government lacks standing to appeal the district court's partial summary judgment ruling that neither § 752 nor Treas. Reg. § 1.752-6 operates to eliminate the claimed tax benefits arising from the Partnerships' participation in the loan transactions.


B


The Government also appeals the district court's ruling that no penalties may be imposed on the Partnerships. 3 The district court found that the Partnerships' actions did not meet the statutory requirements for imposition of the penalties, and that even if they were met, none of these penalties apply because the Partnerships acted in good faith and with reasonable cause. Specifically, the Government argues that the district court erred in finding that the Partnerships' actions did not meet the statutory requirements for the imposition of penalties, and that the district court lacked jurisdiction to consider the reasonable cause and good faith defenses. Since the issue of whether the Partnerships' conduct met the requirements for the penalties is moot if the district court had jurisdiction to consider the reasonable cause and good faith defenses, we first consider the jurisdictional issue.

This issue is governed by the Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA"), 26 U.S.C. § § 6221-6233. Under TEFRA, "the tax treatment of any partnership item (and the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item) shall be determined at the partnership level." 26 U.S.C. § 6221. TEFRA specifically sets forth the scope of judicial review:
A court with which a petition is filed in accordance with this section shall have jurisdiction to determine all partnership items of the partnership for the partnership taxable year to which the notice of final partnership administrative adjustment relates; the proper allocation of such items among the partners, and the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item.

26 U.S.C. § 6226(f) (emphasis added). This provision clearly grants the district court jurisdiction to determine the applicability of any penalty relating to an adjustment of a partnership item. The Code also makes clear that if a taxpayer acts in good faith and with reasonable cause in the calculation of his or her taxes, penalties may not be applied: "[n]o penalty shall be imposed under section 6662 or 6663 with respect to any portion of an underpayment if it is shown that there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion." 26 U.S.C. § 6664(c)(1).

The Government argues that the district court lacked jurisdiction to consider the reasonable cause and good faith defense because the court's jurisdiction in a TEFRA proceeding is limited to assessment of partnership-level items. Here, the Government claims, reasonable cause and good faith is a partner-level defense that can only be asserted in separate refund proceedings. To support this argument, the Government cites Temporary Treasury Regulation § 301.6221-1T, which states that assessment of penalties or any addition to tax related to partnership items is determined at the partnership level, and "[p]artner-level defenses to any penalty, addition to tax, or additional amount that relates to an adjustment to a partnership item may not be asserted in the partnership-level proceeding, but may be asserted through separate refund actions following assessment and payment." Temp. Treas. Reg. § 301.6221-1T(c)-(d) (1999). 4 The regulation defines partner-level defenses as "those that are personal to the partner or are dependent upon the partner's separate return and cannot be determined at the partnership level ... [including] ... whether the partner has met the criteria of ... section 6664(c)(1) (reasonable cause exception)." Temp. Treas. Reg. § 301.6221-1T(d).

The TEFRA structure enacted by Congress does not permit a partner to raise an individual defense during a partnership-level proceeding, but when considering the determination of penalties at the partnership level the court may consider the defenses of the partnership. See New Millennium Trading, LLC v. Comm'r, 131 T.C. No. 18, 2008 WL 5330940 at * 7 (2008). Though Temp. Treas. Reg. § 301.6221-1T(d) lists the reasonable cause exception as an example of a partner-level defense, it does not indicate that reasonable cause and good faith may never be considered at the partnership level. Several courts have found that a reasonable cause and good faith defense may be considered during partnership-level proceedings if the defense is presented on behalf of the partnership. See Santa Monica Pictures v. Comm'r, 89 T.C.M. 1157, 1229-30 (2005) (considering the reasonable cause and good faith defense asserted by the partnership to determine whether accuracy-related penalties should apply); See also Stobie Creek Investments, LLC v. United States, 82 Fed. Cl. 636, 703-04, 717-21 (2008) (considering the reasonable cause defense at the partnership level). Here, reasonable cause and good faith were asserted on behalf of Klamath and Kinabalu, by the current managing partners. Accordingly, we hold that the district court did not err in considering the defenses.

The plaintiff bears the burden of proof on a reasonable cause defense. See Montgomery v. Comm'r, 127 T.C. 43, 66 (2006). The most important factor is the extent of the taxpayer's effort to assess his proper liability in light of all the circumstances. Treas. Reg. § 1.6664-4(b). Reliance on the advice of a professional tax adviser does not necessarily demonstrate reasonable cause and good faith; rather, the validity of this reliance turns on "the quality and objectivity of the professional advice which they obtained." Swayze v. United States, 785 F.2d 715, 719 (9th Cir. 1986). The district court found that Patterson and Nix sought legal advice from qualified accountants and tax attorneys concerning the legal implications of their investments and the resulting tax deductions. They hired attorneys to write a detailed tax opinion, providing the attorneys with access to all relevant transactional documents. This tax opinion concluded that the tax treatment at issue complied with reasonable interpretations of the tax laws. At trial, the Partnerships' tax expert concluded that the opinion complied with standards established by Treasury Circular 230, which addresses conduct of practitioners who provide tax opinions. Overall, the district court found that the Partnerships proved by a preponderance of the evidence that they relied in good faith on the advice of qualified accountants and tax lawyers.

The Government argues only that the district court lacked jurisdiction to consider the reasonable cause and good faith defense; it has not alleged error in the substance of the district court's finding that Patterson and Nix acted with reasonable cause and in good faith. Therefore, having concluded that the district court had jurisdiction to consider this defense, we affirm the district court's conclusion that no penalties should apply.


C


The Government also appeals the district court's order that the Partnerships may deduct "operational expenses" associated with the loan and foreign currency transactions. These operational expenses include interest on the loans, a breakage fee, a management fee paid to Presidio, and a $250,000 fee paid to Pollans & Cohen. 5 The Government argues that the district court erred because no deduction may be taken for expenses related to a sham transaction.

The Code governs the deductibility of actual economic expenditures. Although the district court did not specify the provision under which the operating expenses are deductible, the Partnerships argue that they are entitled to the deductions under 26 U.S.C. §§ 163, 165(c)(2), and 212. Section 163 governs the deductibility of interest expenses, stating generally that "[t]here shall be allowed as a deduction all interest paid or accrued within the taxable year on indebtedness." 26 U.S.C. § 163(a). Under § 165, deductions are permitted for "any loss sustained during the taxable year and not compensated for by insurance or otherwise." 26 U.S.C. § 165(a). Particularly, deductions for losses of individuals are limited to "losses incurred in any transaction entered into for profit ...." 26 U.S.C. § 165(c)(2). Section 212 allows deductions for "all the ordinary and necessary expenses paid or incurred during the taxable year [ ] for the production or collection of income." 26 U.S.C. § 212.

Generally, when a transaction is disregarded for lack of economic substance, deductions for costs expended in furtherance of the transaction are prohibited. See Winn-Dixie Stores, Inc. v. Comm'r, 113 T.C. 254, 294 (1999) (observing that "a transaction that lacks economic substance is not recognized for Federal tax purposes" and that "denial of recognition means that such a transaction cannot be the basis for a deductible expense") ; see also Salley v. Comm'r, 464 F.2d 479, 483 (5th Cir. 1972); Lerman v. Comm'r, 939 F.2d 44, 45 (3d Cir. 1991); Kirchman v. Comm'r, 862 F.2d 1486, 1490 (11th Cir. 1989). This makes sense in light of the fact that the effect of disregarding a transaction for lack of economic substance is that, for taxation purposes, the transaction is viewed to have never occurred at all. 6 Courts have determined that they may not disregard a transaction for some purposes but not for others. See ACM P'ship, 157 F.3d at 261 (observing that "we are not aware of any cases applying the economic substance doctrine selectively to recognize the consequences of a taxpayer's actions for some tax purposes but not others"). This also supports the idea that a transaction may not be disregarded under the economic substance doctrine for purposes of determining a partner's tax basis in a partnership, yet still support the deduction of operational expenses and fees. However, courts have upheld deductions based on genuine debts, where the debts are elements of a transaction that overall is lacking in economic substance. See Rice's Toyota World, Inc. v. Comm'r, 752 F.2d 89, 95-96 (4th Cir. 1985) (allowing deductions based on recourse note debt that was an element of a sham purchase transaction, because the notes represented actual indebtedness).

Here, the district court concluded that the interest payments were deductible because they were real economic losses. However, § 163 does not base the deductibility of interest on whether or not the interest paid was a real economic loss. Rather, the test is simply whether the interest was paid or accrued on indebtedness. See Salley, 464 F.2d at 485 (disallowing interest deductions under § 163 because the taxpayers did not take on actual indebtedness: "[i]n no sense can it be said that taxpayers paid any interest ... as compensation for the use or forbearance of money ... which is the standard business test of indebtedness") (internal quotations and citation omitted). Further, "the fact that an enforceable debt exists between the borrower and lender is not dispositive of whether interest arising from that debt is deductible under section 163." Winn-Dixie Stores, 113 T.C. at 279. The overall transaction must have economic substance in order to show genuine indebtedness, otherwise "every tax shelter ... could qualify for an interest expense deduction as long as there was a real creditor in the transaction that demanded repayment." Id.

In concluding that the loan transactions in this case lacked economic substance, the district court found that "[i]n truth, NatWest did not make any loans" and "[t]he loans ... were not loans at all." These findings preclude the conclusion that the Partnerships took on actual indebtedness. As we found above, the loan transactions in this case lacked economic substance partly because they were structured such that the Partnerships could never actually spend the loaned funds --101.25% of the funding amount had to stay in the accounts at NatWest to prevent a default. Therefore, despite the appearance of a loan, functionally the Partnerships never took on any actual debt. Since the loans did not constitute indebtedness, the Partnerships may not deduct the interest paid under § 163. 7

Presumably, though not specified, the district court found the remainder of the operating expenses and fees deductible under § 212 as necessary expenses incurred. This provision requires a profit motive. See Agro Science, 934 F.2d at 576 (noting that an expenditure is deductible under § 212 "only ... if the facts and circumstances indicate that the taxpayer made them primarily in furtherance of a bona fide profit objective independent of tax consequences"). The Government argues that the profit motive must be determined based on Presidio's subjective intentions because Presidio acted as managing partner when the transactions occurred. The district court, however, determined that the proper focus is on the motives of Patterson and Nix. Having concluded that Patterson and Nix entered into the transactions genuinely seeking to make a profit, the district court allowed the deductions.

The profit motive of a partnership is determined at the partnership level. Id.; Simon v. Comm'r, 830 F.2d 499, 507 (3d Cir. 1987). We have previously observed that the "testimony of general partners and promoters taken as a whole is relevant in determining a partnership's profit motive, because these individuals control a partnership's activities." Agro Science, 934 F.2d at 576 (internal citations omitted). Here, the district court concluded that the partners had different motivations: Nix and Patterson at all times pursued the investment strategy with a genuine profit motive, while Presidio's primary intent was to achieve a tax benefit. The crucial inquiry, then is which partner's intentions should be attributed to the Partnership. Under Agro Science, this answer depends on which partner effectively controlled the partnership's activities. Id.; Simon, 830 F.2d at 507 (observing that "a determination of [a partnership's] profit objective can only be made with reference to the actions of those ... who manage the partnership affairs").

During the time of the transactions in question, Presidio acted as the managing partner but had less than 10% ownership of Klamath and Kinabalu. Patterson and Nix each had 90% ownership. After reforming the Partnerships to bring this lawsuit they became managing partners. Though Patterson and Nix were never limited partners, the LLC agreements state that "the overall management and control of the business and affairs of the Company shall be vested solely in the Managing Member." The district court, however, did not analyze which partner retained control over the partnership. The district court appears to have concluded, with little explanation, that Patterson and Nix's motives must be attributed to the Partnerships because they paid the expenses at issue here and reported them on their individual tax returns. 8 However, for purposes of determining the deductibility of expenses it is the motive of the Partnership that matters, regardless of whether certain operating expenses were borne by one partner or another. None of the arguments articulated by the Partnerships or the district court persuade us that the motives of Patterson and Nix, to whom the overall control and management of the Partnerships was expressly denied under the LLC agreements, should be attributed to the Partnerships. We therefore hold that the district court erred as a matter of law by failing to consider which partners effectively controlled the management of the Partnerships' affairs, at the time the transactions occurred, in determining whether the operating expenses and fees are deductible.


D


We turn now to the Government's argument that the district court lacked jurisdiction to order a refund.

The district court based its authority to order the refund on its jurisdiction to order readjustment of partnership items, see 26 U.S.C. § 6226(f), and the Code provision stating that a partner should not have to file a claim for a refund following this readjustment. See 26 U.S.C. § 6230(d)(5) ("any overpayment by a partner which is attributable to a partnership item (or an affected item) and which may be refunded under this subchapter [26 U.S.C. §§ 6221 et seq.], to the extent practicable credit or refund of such overpayment shall be allowed or made without any requirement that the partner file a claim therefor"). The district court interpreted this provision to mean that it may order a refund following a readjustment of partnership items under § 6226, since the refund is permitted without the taxpayers filing a claim.

The Government argues, however, that the Code imposes a strict "exhaustion of administrative remedies" jurisdictional prerequisite with respect to tax refund actions, and that nothing in the Code grants the district court the authority to eliminate this prerequisite by ordering a refund as part of readjustment proceedings under § 6226. As the Government contends, § 6230(d)(5) only grants the IRS the authority to provide a refund attributable to partnership items without requiring the party to file a claim first --it does not expand the district court's specifically defined jurisdiction to include the authority to order a refund.

We have not previously confronted this question, and the few cases available reach mixed conclusions. The Government cites an unpublished opinion from the Ninth Circuit holding that "a district court does not have jurisdiction to order a refund in an action brought pursuant to 26 U.S.C. § 6226." See Gold Coast Hotel and Casino v. United States, 139 F.3d 904, 1998 WL 74991, at *2 (9th Cir. 1998) (unpublished). Another court has ordered refunds in a § 6226 action, though it did not explain its jurisdictional basis for doing so, and the Second Circuit reversed on appeal such that no refund was ultimately awarded. See TIFD III-E Inc. v. United States, 342 F. Supp. 2d 94, 121-22 (D. Conn. 2004), rev'd on other grounds, 459 F.3d 220 (2d Cir. 2006).

We conclude that the Code does not grant the district jurisdiction to order a refund in a readjustment action brought pursuant to § 6226. This provision specifically sets forth the scope of the district court's jurisdiction in readjustment proceedings. See § 6226(f). Though the provision specifies the district court's jurisdiction to determine partnership items, allocate those items to individual partners, and apply penalties, taxes, or additional amounts, it does not grant jurisdiction to order a refund.

Generally, no suit or proceeding may be maintained for the recovery of a refund "until a claim for refund or credit has been duly filed with the Secretary ...." See § 7422(a). Section 7422(h) provides a special rule for refund actions with respect to partnership items: "No action may be brought for a refund attributable to partnership items ... except as provided in section 6228(b) or section 6230(c)." The applicable provision here, § 6230(c), does not grant refund authority to the district court; rather, it sets forth the grounds on which a partner of a TEFRA partnership may file an administrative refund claim following a final partnership administrative adjustment. Specifically, a partner may file a claim for refund on the grounds that (1) the Secretary failed to allow a credit or to make a refund to the partner in the amount of the overpayment attributable to the application to the partner of a settlement, a final partnership administrative adjustment, or the decision of a court in an action brought under § 6226, or (2) the Secretary erroneously imposed any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item. See § 6230(c)(1)(B)-(C).

We agree with the Government that the provision upon which the district court based its jurisdiction, § 6230(d)(5), merely contemplates that "to the extent practicable" the IRS may grant a refund for an overpayment attributable to partnership items without any requirement that the partner file an administrative claim. Nothing in § 6230(d)(5) authorizes the district court to grant a refund pursuant to readjustment proceedings under § 6226, and it would be unreasonable to conclude that this provision --which is not referenced in § 6226(f) and is placed under the heading "Additional administrative proceedings" --alters the clearly defined limits of a district court's jurisdiction in readjustment proceedings.

We accordingly hold that the district court was without jurisdiction to order a refund. The Partnerships may seek a refund through administrative proceedings, as governed by § 7422.


V


For the foregoing reasons, we AFFIRM the district court's judgment that the loan transactions lacked economic substance and must be disregarded for tax purposes. We also AFFIRM the district court's judgment that no penalties apply. We VACATE the district court's order allowing the deduction of interest and operating expenses and REMAND for reconsideration in accordance with this opinion. We also VACATE the district court's order directing the IRS to grant the Partnerships a refund.

1 These rules are defined in 26 U.S.C. § 752 et seq. of the Internal Revenue Code, described more fully below.

2 Specifically, the losses occurred from the following. Patterson received 67,341.88 Euros when Klamath liquidated. He treated these Euros as having a tax basis of $25,316,393, calculated as:
Premium amount 25,000,000
Cash contributions 1,500,000
Interest income 91,307
Advisory fee to Pollans & Cohen 250,000
Cash distributions from Klamath (359,635)
Klamath partnership loss (1,165,279)
_________________________
Basis 25,316,393


This meant that since Patterson was able to treat the loan premium as money he had put into the partnership (i.e. not a liability that the partnership had to repay), he could claim a tax basis of $365.94 in each Euro he received from Klamath. When he sold the Euros for much less than this amount, large losses were created. Nix's basis calculation was nearly identical.

3 In the FPAAs, the IRS asserted four penalties against the Partnerships, all based on § 6662 of the Code: (1) a 40% penalty for gross valuation misstatement; (2) a 20% penalty for substantial valuation misstatement; (3) a 20% penalty for substantial understatement of income tax; and (4) a 20% penalty for negligence or disregard of rules and regulations. See 26 U.S.C. § 6662(a), (b)(1), (2), (3).

4 This regulation was temporary for the taxable years at issue. See Temporary Proced. & Admin. Regs., 64 Fed. Reg. 3838 (Jan. 26, 1999). However, it was made final and applicable to partnership taxable years beginning on or after Oct. 4, 2001. See § 301.6221-1(f), Proced. & Admin. Regs.

5 The Government concedes the deductibility of the trading losses suffered by the Partnerships in the foreign currency transactions.

6 The Partnerships rely extensively on Fabreeka Prods. Co. v. Comm'r, 34 T.C. 290, 299-300 (1960), vacated on other grounds by 294 F.2d 876 (1st Cir. 1961), for the proposition that operational expenses incurred in connection with a sham transaction may be deducted as long as they are "separable" from the underlying transaction. To the extent that this proposition can be supported by the since-vacated opinion in Fabreeka, we conclude that the Tax Court has subsequently failed to follow Fabreeka's approach to the deduction of operational expenses, and has instead maintained that expenses incurred in connection with a sham transaction are generally not deductible. See Winn-Dixie, 113 T.C. at 294 (finding that administrative fees "were incurred in connection with, and were an integral part of, a sham transaction and, as a result, were not deductible").

7 The Partnerships may likewise not deduct interest under other provisions of the Code as a business expense or an expense paid for the production of income. See Salley, 464 F.2d at 483 (noting that if lack of economic substance prevents the deduction of interest under § 163, the interest is likewise not deductible under §§ 162(a) or 212).

8 In its brief, the Government contends that it was the Partnerships that paid the expenses, citing to Plaintiff's Exhibits 49, 50, 142, and 143. Since these exhibits have apparently not made it into the record on appeal, and have not been able to be obtained from the district court, we cannot verify the Government's contention. Nonetheless, whether it was an individual partner or the Partnership that paid the expenses is not dispositive of the issue of who effectively controlled the Partnerships' activities, and we conclude that the district court erred in relying on this fact to allow the deductions.

United States of America, Plaintiff v. Darrell L. Kadunce, Defendant.

U.S. District Court, West. Dist. Pa.; Civ. 07-1704, USTC October 20, 2008.

[Code Secs. 7122 and 7401]

The government was entitled to reduce to judgment federal income, employment and unemployment taxes assessed against an individual. The individual's claim that the IRS had selectively prosecuted the action against him was rejected because he did not provide evidence that the government had singled him out for prosecution. The individual also did not show that the decision to prosecute was made on the basis of an unjustifiable standard or that the prosecution was intended to prevent his exericse of a fundamental right. Furthermore, because the individual did not timely appeal the denial of his offer in compromise to the IRS Office of Appeals, he could not later request a review of that denial in the district court.

Procedure. --Compromises: Procedure

The IRS has released procedures applicable to the submission and processing of offers to compromise a tax liability under Code Sec. 7122. The procedures reflect IRS imposition of an offer in compromise application fee, effective November 1, 2003.
[Full Text --Rev. Proc. 2003-71]




SECTION 1. PURPOSE

The purpose of this revenue procedure is to explain the procedures applicable to the submission and processing of offers to compromise a tax liability under section 7122 of the Internal Revenue Code. These procedures reflect changes to the law made by the Internal Revenue Service Restructuring and Reform Act of 1998, Public Law 105-206 (112 Stat. 685, 764).



SECTION 2. BACKGROUND

.01 Section 7122 permits the Secretary of the Treasury or his delegate to compromise any civil or criminal liability arising under the internal revenue laws before the case is referred to the Department of Justice for prosecution or defense.

.02 The Secretary has developed guidelines and procedures for the submission and evaluation of offers to compromise under section 7122. These guidelines can be found in § 301.7122-1 of the Regulations on Procedure and Administration, the Internal Revenue Manual, and various forms and publications issued by the Internal Revenue Service (Service). This revenue procedure supplements and clarifies the procedures identified in § 301.7122-1.

.03 This revenue procedure includes provisions relating to the offer in compromise application fee, required under § 300.3 of the Regulations on User Fees and effective November 1, 2003.



SECTION 3. SCOPE

This revenue procedure applies to all offers to compromise a civil or criminal liability under section 7122 submitted to the Service, except for those offers submitted directly to the Office of Appeals. This revenue procedure does not apply to offers to compromise a tax liability after a case involving a civil or criminal liability has been referred to the Department of Justice for prosecution or defense.



SECTION 4. SUBMITTING AN OFFER TO COMPROMISE

.01 An offer to compromise a tax liability must be submitted in writing on the Service's Form 656, Offer in Compromise. None of the standard terms may be stricken or altered, and the form must be signed under penalty of perjury. The offer should include all liabilities to be covered by the compromise, the legal grounds for compromise, the amount the taxpayer proposes to pay, and the payment terms. Payment terms include the amounts and due dates of the payments. The offer should also contain any other information required by Form 656. The Service occasionally revises Form 656 and may require offers to be submitted on the most recent version of the form. The most recent version of the form and instructions are available on the Service's website at www.irs.gov.

.02 An offer to compromise a tax liability should set forth the legal grounds for compromise and should provide enough information for the Service to determine whether the offer fits within its acceptance policies.

(1) Doubt as to liability. Doubt as to liability exists where there is a genuine dispute as to the existence or amount of the correct tax liability under the law. Doubt as to liability does not exist where the liability has been established by a final court decision or judgment concerning the existence of the liability.

An offer to compromise based on doubt as to liability generally will be considered acceptable if it reasonably reflects the amount the Service would expect to collect through litigation. This analysis includes consideration of the hazards of litigation that would be involved if the liability were litigated. The evaluation of the hazards of litigation is not an exact science and is within the discretion of the Service.

(2) Doubt as to collectibility. Doubt as to collectibility exists in any case where the taxpayer's assets and income cannot satisfy the full amount of the liability.

An offer to compromise based on doubt as to collectibility generally will be considered acceptable if it is unlikely that the tax can be collected in full and the offer reasonably reflects the amount the Service could collect through other means, including administrative and judicial collection remedies. See Policy Statement P-5-100. This amount is the reasonable collection potential of a case. In determining the reasonable collection potential of a case, the Service will take into account the taxpayer's reasonable basic living expenses. In some cases, the Service may accept an offer of less than the total reasonable collection potential of a case if there are special circumstances.

(3) Promotion of effective tax administration.

(a) The Service may compromise to promote effective tax administration where it determines that, although collection in full could be achieved, collection of the full liability would cause the taxpayer economic hardship. Economic hardship is defined as the inability to pay reasonable basic living expenses. See § 301.6343-1(d). No compromise may be entered into on this basis if compromise of the liability would undermine compliance by taxpayers with the tax laws.

An offer to compromise based on economic hardship generally will be considered acceptable when, even though the tax could be collected in full, the amount offered reflects the amount the Service can collect without causing the taxpayer economic hardship. The determination to accept a particular amount will be based on the taxpayer's individual facts and circumstances.

(b) If there are no other grounds for compromise, the Service may compromise to promote effective tax administration where compelling public policy or equity considerations identified by the taxpayer provide a sufficient basis for compromising the liability. Compromise will be justified only where, due to exceptional circumstances, collection of the full liability would undermine public confidence that the tax laws are being administered in a fair and equitable manner. The taxpayer will be expected to demonstrate circumstances that justify compromise even though a similarly situated taxpayer may have paid his liability in full. No compromise may be entered into on this basis if compromise of the liability would undermine compliance by taxpayers with the tax laws.

An offer to compromise based on compelling public policy or equity considerations generally will be considered acceptable if it reflects what is fair and equitable under the particular facts and circumstances of the case.

.03 The offer should include all information necessary to verify the grounds for compromise. Except for offers to compromise based solely on doubt as to liability, this includes financial information provided in a manner approved by the Service. Individual or self-employed taxpayers must submit a Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, together with any attachments or other documentation required by the Service. Corporate or other business taxpayers must submit a Form 433-B, Collection Information Statement for Businesses, together with any attachments or other documentation required by the Service. The Service may require the corporate officers or individual partners of a business taxpayer to complete a Form 433-A.

.04 An offer to compromise a tax liability should be mailed to the appropriate address listed on Form 656. The Service may, in its discretion, receive offers to compromise in other manners. Simply because the Service has received an offer does not mean that it has accepted the offer for processing such that the offer is considered pending within the meaning of section 6331(k)(1). Accepting an offer for processing is addressed in Section 5.01 of this revenue procedure.

.05 If a deposit is submitted with the offer to compromise and the taxpayer authorizes application of a deposit to tax liabilities, it will be credited to the taxpayer's account as of the day the deposit is first received.



SECTION 5. WHEN AN OFFER BECOMES PENDING AND RETURN OF OFFERS

.01 Section 6331(k)(1) generally prohibits the Service from making a levy on a taxpayer's property or rights to property while an offer to compromise a liability is pending with the Service, for 30 days after the rejection of an offer to compromise, or while an appeal of a rejection is pending. The statute of limitations on collection is suspended while levy is prohibited. An offer to compromise becomes pending when it is accepted for processing. The Service accepts an offer to compromise for processing when it determines that: the offer is submitted on the proper version of Form 656 and Form 433-A or B, as appropriate; the taxpayer is not in bankruptcy; the taxpayer has complied with all filing and payment requirements listed in the instructions to Form 656; the taxpayer has enclosed the application fee, if required; and the offer meets any other minimum requirements established by the Service. A determination that the offer meets these minimum requirements means that the offer is processable.

.02 A determination is made to accept an offer to compromise for processing when a Service official with delegated authority to accept an offer for processing signs the Form 656. The date the Service official signs the Form 656 is recorded on the Service's computers. As of this date, levy is prohibited unless the Service determines that collection of the liability is in jeopardy.

.03 If the Service determines that an offer to compromise a liability does not meet the minimum requirements the Service has established for a processable offer, the offer to compromise is not processable and may be returned to the taxpayer. Because the offer to compromise was never accepted for processing, it was never pending and levy was never prohibited.

.04 If an offer to compromise accepted for processing does not contain sufficient information to permit the Service to evaluate whether the offer should be accepted, the Service will request that the taxpayer provide the needed additional information. These requests for information are described in Section 6 below. If the taxpayer does not submit the additional information that the Service has requested within a reasonable time period after such a request, the Service may return the offer to the taxpayer. The Service also may return the offer after it has been accepted for processing if:

(1) The Service determines that the offer was submitted solely to delay collection;

(2) The taxpayer fails to file a return or pay a liability;

(3) The taxpayer files for bankruptcy;

(4) The offer is no longer processable; or

(5) The offer was accepted for processing in error.

When an offer is returned under this Section 5.04, the Service will not refund the application fee submitted with the offer unless the offer was accepted for processing in error.

.05 If a determination is made to return the offer to compromise as described in Sections 5.03 and 5.04, the return of the offer does not constitute a rejection. The taxpayer is not entitled to appeal the matter to Appeals under the provisions of § 301.7122-1(f)(5). If the Service initiates collection action following a return of an offer to compromise, the taxpayer may be able to appeal the collection action under section 6320, section 6330, or under the Collection Appeals Program.

.06 An offer to compromise is considered to be returned on the day the Service mails, or personally delivers, a written letter to the taxpayer informing the taxpayer of the decision to return the offer. An offer returned following acceptance for processing is deemed pending only for the period between the date the offer is accepted for processing and the date the offer is returned. The Service may levy to collect the liability that was the subject of the offer anytime after it returns the offer to the taxpayer.



SECTION 6. CASE BUILDING, INVESTIGATION, AND EVALUATION

.01 Once the Service accepts an offer to compromise for processing, it begins to gather the basic information necessary to begin evaluating the offer. During this initial processing, the Service may contact the taxpayer to secure information or documentation that was incorrect or omitted from the offer documents.

.02 After all of the basic information has been obtained from the taxpayer, the Service evaluates the information and determines whether the taxpayer's offer is acceptable. In the course of evaluating the offer to compromise, the Service may request additional information or documentation from the taxpayer.

.03 The decision whether and when to accept an offer to compromise a liability is within the discretion of the Service. In keeping with Policy Statement P-5-100, an offer will only be accepted if it is determined to be in the best interest of both the taxpayer and the Service. In addition to the criteria discussed in Section 4.02, the Service may take into account public policy and tax administration concerns in determining whether an offer to compromise is acceptable.

.04 For all offers to compromise, except for those based solely on doubt as to liability, the Service verifies the taxpayer's income and assets according to the Service's policies and procedures. Verification allows the Service to determine whether or not the taxpayer can fully pay the liability and, if not, to determine the reasonable collection potential of the liability.

(1) The Service uses a variety of sources to verify the taxpayer's valuation of the taxpayer's property. The Service relies on internal sources, such as its computer databases or other records, public and electronic sources, such as state motor vehicle records and credit bureau reports, and taxpayer supplied documentation.

(2) Section 7122 requires the Service to prescribe and publish guidelines to ensure that taxpayers entering into a compromise have an adequate means to provide for basic living expenses. The amount of basic living expenses will be determined based on an evaluation of the individual facts and circumstances presented by the taxpayer's case. The Service maintains a schedule of national and local allowances to account for the basic living expenses of taxpayers seeking to compromise. To determine whether an offer is adequate, the Service uses these schedules to analyze the income and expenses of the taxpayer to determine the monthly income available to pay the liability. These schedules are available in the Financial Analysis Handbook, IRM 5.15, and on the Service's website at www.irs.gov. The schedules are not applied when doing so would leave the taxpayer without adequate means to provide for basic living expenses.

(3) For purposes of evaluating an offer to compromise, the Service allows expenses only to the extent it determines they are necessary for the health and welfare of the taxpayer or the taxpayer's family or are necessary for the production of income.



SECTION 7. WITHDRAWING AN OFFER TO COMPROMISE

.01 The taxpayer may withdraw an offer to compromise a liability anytime prior to acceptance of the offer. An offer that has been withdrawn is no longer pending and the Service may levy to collect the liability that was the subject of the offer. When an offer is withdrawn the Service will not refund the application fee submitted with the offer.

.02 The taxpayer may withdraw an offer to compromise by delivery of written notification of the withdrawal in person, by mail, or by fax. An offer assigned to Centralized Offer in Compromise Units, however, may not be withdrawn by personal delivery, because documents cannot be personally delivered to these units. A taxpayer may also request withdrawal of an offer telephonically. A notice of intent to withdraw an offer should be directed to the Service office assigned to the case.

(1) If the taxpayer withdraws an offer to compromise by personal delivery, the offer will be considered withdrawn when written notification of the withdrawal is received by the Service.

(2) If the taxpayer withdraws an offer to compromise by mailing written notification of the withdrawal via U.S. certified mail, the offer will be considered withdrawn on the date the Service receives the certified mail.

(3) In all other cases, including withdrawal by non-certified mail, fax, or phone, the offer will be considered withdrawn on the date the Service mails, or personally delivers, a written letter to the taxpayer acknowledging the withdrawal.



SECTION 8. ACCEPTING AN OFFER TO COMPROMISE

.01 An offer to compromise has not been accepted until the Service issues written notification of acceptance to the taxpayer. Acceptance is effective as of the date on the acceptance letter.

.02 Acceptance of an offer to compromise will conclusively settle the liability of the taxpayer specified in the offer. Compromise with one taxpayer does not extinguish the liability of any person not named in the offer who is also liable for the tax to which the offer relates. The Service may take action to collect from any person not named in the offer.



SECTION 9. REJECTING AN OFFER TO COMPROMISE

.01 An offer to compromise has not been rejected until the Service issues written notification of rejection to the taxpayer. Section 7122(d) requires the Service to conduct an independent administrative review before the rejection of an offer to compromise is communicated to the taxpayer. The Service reviews each case to determine if the proposed rejection is reasonable based on the facts and circumstances of the case. Rejection is effective as of the date on the rejection letter. When an offer is rejected the Service will not refund the application fee submitted with the offer.

.02 The taxpayer may appeal the rejection of an offer to compromise to Appeals. The taxpayer must timely file the appeal with the Service office that rejected the offer. An appeal is timely filed if it is delivered to the Service or postmarked within thirty days from the date of the letter of rejection.

.03 Pursuant to section 6331, the Service may not make a levy on the taxpayer's property or rights to property for thirty days following the rejection of an offer to compromise or while an appeal of a rejection is pending.



SECTION 10. EFFECT ON OTHER DOCUMENTS

Rev. Proc. 96-38 is obsoleted.



SECTION 11. EFFECTIVE DATE

This revenue procedure is effective August 21, 2003, the date this revenue procedure was announced by news release, except that the provisions relating to the offer in compromise application fee are not effective for offers submitted prior to November 1, 2003.



SECTION 12. DRAFTING INFORMATION

The principal author of this revenue procedure is Sheara L. Krvaric of the Office of the Associate Chief Counsel (Procedure and Administration), Collection, Bankruptcy & Summonses Division. For further information regarding this revenue procedure contact Branch 2 of Collection, Bankruptcy & Summonses on (202) 622-3620 (not a toll free call).

Rev. Proc. 2003-71, 2003-2 CB 517 , obsoleting Rev. Proc. 96-38, 1996-2 CB 44.

The IRS Commissioner did not abuse his discretion by rejecting a married couple's offer-in-compromise based on economic hardship and exceptional circumstances. The couple's considerable accumulation of wealth and the speculative nature of their medical expenses did not support their argument that medical expenses for the husband's progressive dementia would bankrupt them in about a decade. The couple's ability to pay basic living expenses would not be impaired by significantly greater health care expenses. Further, the legislative history did not support the conclusion that denial of the offer was an abuse of discretion nor was the IRS Appeals officer required to negotiate with the couple on their offer.

C.G. Fargo, CA-9, 2006-1 USTC ¶50,326, 447 F3d 706.

Followed.

The IRS was not arbitrary and capricious when it rejected an offer in compromise made with respect to a deficiency arising from the taxpayers' participation in a Hoyt partnership. The IRS properly followed its guidelines when it determined that the taxpayers' offer did not qualify as an offer to promote effective tax administration because the taxpayers did not have sufficient assets to pay the full amount of their liability; and that the offer was too low, in relation to the deficiency and to the taxpayers' assets, to qualify as an offer due to doubts as to collectibility with special circumstances. The taxpayers' case was not a "longstanding" case that was entitled to special treatment with respect to interest and penalties; C.G. Fargo, CA-9, 2006-1 USTC ¶50,326, 447 F3d 706, followed. The IRS Appeals Officer who rejected the offer did not fail to consider the taxpayers' alleged unique circumstances; fail to balance efficient collection against the use of the least intrusive means possible; or fail to consider their request to abate interest. She was not required to discuss her decision with the taxpayers before she issued her notice of determination. The taxpayers failed to support their claim that they would suffer severe economic hardship if they had to pay more than the offered amount. Their claim that they were the victims of fraud did not obligate the IRS to accept their offer based on public policy, especially since acceptance would tend to undermine voluntary tax compliance. Finally, the taxpayers' claim that their assessment was untimely was frivolous.

R.D. Catlow, 93 TCM 946, Dec. 56,850(M), TC Memo. 2007-47.

The IRS did not abuse its discretion when it rejected a delinquent corporation's proposed offer in compromise. An IRS agent properly considered the taxpayer's other tax liabilities in assessing its ability to pay its federal liabilities, and she did not abuse her discretion when she concluded that the taxpayer did not demonstrate the ability to make the payments proposed in the offer, despite its improving financial condition.

Action Employment Resources, Inc., CA-9, 2006-1 USTC ¶50,130, 158 FedAppx 67.

The trial court properly determined that the IRS did not abuse its discretion when it attempted to collect unpaid employment taxes and penalties owed by an individual through the levy process. Although the taxpayer filed a formal offer in compromise to settle his tax liability, he did not supply the financial information that the IRS requested and believed necessary to evaluate the offer in compromise. The IRS was also justified in requesting financial information about the taxpayer's spouse since it appeared that the taxpayer may have transferred some of his assets to his spouse and since the IRS needed to verify each spouse's responsibility for the couple's living expenses. Further, the IRS's failure to negotiate and make a counteroffer during consideration of the compromise offer did not violate the taxpayer's due process rights since the taxpayer did not provide requested financial information.

R.E. Olsen, CA-1, 2005-2 USTC ¶50,637, 414 F3d 144.

An individual could not overcome the government's motion for summary judgment on his claim that an IRS Appeals officer was not aware of the taxpayer's "separate property" contention with respect to levied property. The officer's decision to proceed with collection was based on the taxpayer's failure to make an offer in compromise. That the Appeals officer insisted on the filing of returns for the tax years at issue as a condition for processing and considering an offer in compromise did not create a genuine issue of material fact as to whether the IRS abused its discretion in issuing notice of determination. The taxpayer was charged with the knowledge that the officer's oral representations were not binding, and that a written offer was necessary.

A. Richter, DC Calif., 2002-2 USTC ¶50,607.

The IRS was entitled to reject married taxpayers' offer in compromise of their tax liability because under Code Sec. 7122 it has discretion as to whether it will accept such an offer.

A.C. Addington, DC W.Va., 99-1 USTC ¶50,441.

The IRS Appeals Office did not abuse its discretion by rejecting a married couple's offer-in-compromise where the taxpayers had underreported their income for several tax years due to claimed losses and credits from Hoyt partnership tax shelter investments. The taxpayers argued that their offer should have been accepted because of their age, health and anticipated postretirement earnings. However, the court found that the taxpayers failed to show that payment of more than they offered would render them unable to meet their basis living expenses in retirement.

R. Bergevin, 95 TCM 1031, Dec. 57,307(M) , TC Memo. 2008-6.

A taxpayer and his late wife's estate failed to establish that the IRS abused its discretion by refusing to grant them additional time to submit an offer in compromise (OIC) because the Commissioner is not required to wait a certain length of time before proceeding with a levy. The IRS also did not abuse its discretion in proceeding with a levy because the taxpayers repeatedly delayed the proceedings and failed to remit the necessary financial information required for an installment agreement or OIC.

M.A. Gazi, 94 TCM 474, Dec. 57,176(M), TC Memo. 2007-342.

The IRS Appeals Office did not abuse its discretion in rejecting a married couple's offer-in-compromise where the taxpayers had underreported their income for several tax years due to claimed losses and credits from Hoyt partnership tax shelter investments. The IRS Appeals officer considered all of the evidence submitted, and reasonably applied the guidelines for evaluating an offer-in-compromise. The offer was unacceptable because, among other reasons, the taxpayers were not forthcoming in establishing their financial status, acceptance of the offer would undermine compliance with the tax laws by taxpayers in general, and the taxpayers had the financial wherewithal to pay more than the offered amount. The officer adequately considered the taxpayers' unique facts and circumstances, and the taxpayers did not show that requiring them to pay more than the offer amount would result in an economic hardship. Public policy did not demand that the taxpayers' offer be accepted because they were victims of fraud, and acceptance of the offer would not enhance voluntary compliance by other taxpayers.

M. Smith, 93 TCM 1047, Dec. 56,880(M), TC Memo. 2007-73.

The IRS did not abuse its discretion when it rejected an elderly couple's compromise offer that amounted to less than half of their estimated tax liability. The IRS was not required to compromise the couple's tax liability in order to promote effective tax administration based on economic hardship or public policy or equity grounds because the taxpayers were able to pay more than the amount that they offered. The IRS determined that the taxpayers had sufficient equity in their assets to pay the tax amounts owed and still meet their necessary living expenses for the foreseeable future. Further, it did not abuse its discretion in disregarding the couple's speculative future medical expenses. In addition, the IRS was not required to accept the offer based on the taxpayers' claim that they were the victims of fraud because the couple's situation was typical of many tax shelter participants who claimed deductions, obtained tax advantages and were now required to pay their tax liability. Thus, the IRS's determination to reject the offer-in-compromise was not arbitrary, capricious, or without a sound basis in fact or law, and it was not abusive or unfair to the taxpayers.

D. Clayton, 92 TCM 222, Dec. 56,612(M), TC Memo. 2006-188.

An IRS Appeals officer's refusal to accept a married couple's offer in compromise regarding tax liabilities arising from a tax shelter investment was sustained. His determination that the taxpayers' resources were sufficient to warrant collection of the entire outstanding liability was not an abuse of discretion. The possibility that they might sustain a substantial economic hardship in the future did not bar a finding that they could pay their taxes. The delay in informing the taxpayers of their pending tax liability was attributable to the deliberate pace at which the TEFRA partnership audit of their tax shelter progressed. The IRS was not compelled to accept their settlement offer because it is generally their tax matters partner's responsibility to keep them informed. Finally, the mere fact that one participant in the same tax shelter was granted an interest abatement did not establish that the Appeals officer acted improperly in denying this offer in compromise.

C.G. Fargo, 87 TCM 815 , Dec. 55,514(M), TC Memo. 2004-13.

An IRS Appeals officer properly rejected an individual's offer in compromise for $100 to settle his unpaid tax liabilities in three years. The taxpayer offered no evidence to indicate that a rejection of his offer was an abuse of discretion. The Appeals officer properly reviewed the financial records of the taxpayer and his mother, whom the taxpayer supported. Moreover, the Appeals officer's refusal to refer the taxpayer's offer to IRS collection personnel for further evaluation did not constitute an abuse of discretion. As a result, the Tax Court upheld the IRS's Collection Due Process determination.

J.L. Tillman, 87 TCM 806, Dec. 55,509(M), TC Memo. 2004-8.

In consolidated cases, the IRS did not abuse its discretion in rejecting offers in compromise submitted by individuals who challenged their underlying tax liabilities as transferees of a corporation for its tax liability. Each taxpayer previously had entered into a stipulated decision agreeing to transferee liability and there was no doubt as to the taxpayers' liabilities within the meaning of the applicable regulations or otherwise. Thus, the IRS reasonably rejected the offers in compromise on grounds that the transferee liabilities had been determined in the transferee liability cases and that the taxpayers did not comply with filing requirements.

D.L. Oyer, 85 TCM 1510, Dec. 55,193(M), TC Memo. 2003-178.

Individual taxpayers were not entitled to loss deductions on account of their book tax shelters notwithstanding an IRS policy statement that, according to the taxpayers, gave them the right to settle the book shelter issue by being allowed deductions to the extent of their cash investment. The policy statement issue was not timely raised. Furthermore, the policy statement did not grant settlement rights to taxpayers but rather described procedures for arriving at such settlements.

R. Helstoski, 60 TCM 233, Dec. 46,748(M), TC Memo. 1990-382.

The IRS has identified 43 frivolous positions that have been deemed frivolous by courts or have no basis for validity in existing law. These positions are determined to be frivolous for purposes of the Code Sec. 6702(a) penalty for filing frivolous tax returns, and the Code Sec. 6702(b) penalty for filing specified frivolous submissions, which include applications for offers in compromise. Included in the list are four new positions that relate to a misinterpretation of the Ninth Amendment regarding objections to military spending, erroneous claims that taxes are owed only by persons with a fiduciary relationship to the U.S. or IRS, a nonexistent "Mariner's Tax Deduction," or something similar, related to invalid deductions for meals and misuse or excessive use of the credit for fuels under Code Sec. 6421.

Notice 2008-14, I.R.B. 2008-4, 310; modifying and superseding Notice 2007-30, I.R.B. 2007-14, 883.

IRS News Release, IR-2008-8, January 14, 2008.

The IRS has announced that a revised taxpayer application for an offer in compromise (OIC), the Form 656 package, is now available. The new form reflects procedural changes to the OIC program made by the Tax Increase Prevention and Reconciliation Act of 2005 ( P.L. 109-222). The changes to the Form 656 package include new payment terms and offer submission rules, a processability checklist, a matrix to assist taxpayers in determining the number of forms and payments that must be submitted to the IRS, a checklist of items and documents that must be completed prior to submitting an OIC, and a new payment voucher to be used to remit required partial payments to the IRS.

IRS News Release, IR-2007-50, March 5, 2007.

IRS Fact Sheet FS-2007-16, March 5, 2007.

The IRS has issued guidance outlining the protections in place for the new private debt collection program in connection with administrative review. If the taxpayer proposes an installment agreement to the private collection agency (PCA) and the IRS rejects the proposed installment agreement, the taxpayer may appeal the rejection to the IRS. If the IRS assigns a PCA to monitor an installment agreement and the PCA determines the taxpayer is in default, the taxpayer may appeal to the IRS if the installment agreement is terminated. In both situations, the taxpayer must first appeal to the IRS office supervising the PCA's day-to-day work, but if not satisfied the taxpayer may continue the appeal to the IRS Office of Appeals, pursuant to the IRS review procedures for installment agreements and compromises.

Announcement 2006-63, I.R.B. 2006-37, 445.

The IRS issued information and guidance on the major changes made to the offer in compromise program by the Tax Increase Prevention and Reconciliation Act of 2005 (P.L. 109-222) which tightened the rules for lump-sum and periodic payment offers received by the IRS on or after July 16, 2006. Taxpayers submitting requests for lump-sum OICs must include a payment of 20 percent of the amount offered. A lump-sum OIC is an 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 and continue making payments under the terms proposed while the offer is being evaluated. The IRS will treat the payments as payments of tax, rather than refundable deposits under Code Sec. 7809(b) or Reg. §301.7122-1(h). Unless a waiver applies, failure to pay the 20 percent on a lump-sum offer, or the first installment payment on a periodic payment offer may result in the IRS returning the offer to the taxpayer as nonprocessable. Taxpayers qualifying as low-income or filing an offer based solely on doubt as to liability can receive a waiver of the new partial payment requirements. The IRS will deem an OIC accepted that is not withdrawn, returned or rejected within 24 months after receipt of the offer. When submitting Form 656, taxpayers must include user fee of $150 unless they qualify for a waiver. Offers are submitted using Form 656, Offers in Compromise. Taxpayers may continue to use the 2004 revision of the form until the new version, revised to reflect the new law, is available.

Notice 2006-68, I.R.B. 2006-31, 105.

IRS News Release, IR-2006-106, July 11, 2006.

IRS Fact Sheet FS-2006-22, July 11, 2006.

A new check-the-box disclosure authorization for the appointment of a third party to discuss and obtain information to facilitate the initial processing of an offer in compromise was added July 2004 to Form 656. This authorization is limited to this specific purpose and does not authorize the designated party to represent the taxpayer before the IRS or during a Collection Due Process hearing.

Announcement 2005-6, I.R.B. 2005-4, 377.

The IRS is warning taxpayers to beware of tax practitioners who encourage the use of an offer in compromise as a way to settle tax claims for "pennies on the dollar." The IRS's warning targets the actions of "unscrupulous promoters" who charge excessive fees when there is no chance that the taxpayer will qualify for the offer in compromise. Although the IRS has the authority to settle tax claims for less than their full amount, an offer in compromise may be considered only after other options, such as an installment agreement, are considered.

IRS News Release, IR-2004-130, October 25, 2004.

A revised taxpayer application for an offer in compromise (OIC), the Form 656 package, is now available. The revised form provides a signature block for paid preparers and also includes a Form 656-A, Income Certification for OIC Application Fee, and a worksheet to help taxpayers determine if they qualify for the income exception to $150 application fee. Other features of the new package include a checklist to determine eligibility for an OIC, an OIC process step-by-step guide, a third-party designee section and a summary checklist. The package can be obtained from the IRS by calling 1-800-829-3676 or by going to the IRS website "www.irs.gov.".

IRS News Release, IR-2004-129, October 25, 2004.

The IRS has issued a consumer alert advising taxpayers to beware of promoters' claims that tax debts can be settled for "pennies on the dollar" through the IRS Offer in Compromise Program. According to the IRS, some promoters are inappropriately advising indebted taxpayers to apply for an offer in compromise before exhausting other payment options, such as monthly installment agreements.

IRS News Release, IR-2004-17, February 3, 2004.

Beginning on November 1, 2003, the IRS will charge, with certain exceptions, a $150 application fee for the processing of offers in compromise (OICs). Individuals whose monthly income falls at or below levels based on the Department of Health and Human Services guidelines, and taxpayers that file OICs based solely on doubt as to liability, will be exempt from the fee. Individuals claiming the poverty guideline exception must certify their eligibility using Form 656-A, Offer in Compromise Application Fee Instructions and certification. To submit an OIC, taxpayers are to use the May 2001 version of Form 656, Offer in Compromise. The application fee for OICs that do not qualify for an exception must be submitted using a check or money order payable to the United States Treasury.

IRS News Release, IR-2003-124, October 23, 2003.

Chief Counsel concluded that a Code Sec. 7122 compromise would not legally bind a minor in a compromise agreement with the IRS. A minor child may repudiate, avoid or disaffirm a contract under state laws; thus, Chief Counsel advised against the IRS entering into compromise agreements with minors. Moreover, status as the legal guardian of a minor's property does not include the capacity to compromise the minor's tax liability.

CCA Letter Ruling 200220026, March 28, 2002.

Chief Counsel provided background information regarding Code Sec. 7122 and its legislative history as they relate to Chief Counsel Notice CC-2001-036. The notice set forth procedures to be followed by Associate Chief Counsel (SB/SE) offices when issuing the statutorily required opinion in offer in compromise cases. It also clarified procedures for the review of offers based on doubt as to collectibility and/or liability. Further, the notice added procedures and standards for the review of offers based upon the promotion of effective tax administration.

CCA Letter Ruling 200131029, July 2, 2001.

Chief Counsel concluded that the IRS need not require that individual offers in compromise submitted by married taxpayers specify that the offers were made in conjunction with each other in order to protect the collectability of the couple's joint and separate liabilities. Moreover, the offers did not have to specify that a failure to pay the entire amount of either offers would result in a default of both offers.

CCA Letter Ruling 200051043, October 26, 2000.

The government was entitled to reduce to judgment federal income, employment and unemployment taxes assessed against an individual. . Because the individual failed to timely appeal the denial of his offer in compromise to the IRS Office of Appeals, he could not later request a review of that denial in the district court.

D.L. Kadunce, DC Pa., 2008-2 USTC ¶50,669.

With the start of the 2009 tax filing season, the IRS has announced steps to help financially distressed taxpayers receive their refunds faster, as well as provided additional help to individuals who are struggling to meet their tax obligations. Several suggestions are offered to taxpayers who owe back taxes, such as additional review of offers-in-compromise and expedited levy releases.

IRS News Release IR-2009-2.

The Tax Court properly upheld the IRS's determination of an individual's federal income tax liability. The notice of federal tax lien was not prematurely filed because the IRS had considered the individual's offer in compromise, and gave him ample notice before issuing the lien. Furthermore, the individual's charitable contributions were not "necessary expenses" with respect to his proposed offer in compromise.

G.E. Freeman, CA-9, 2009-1 USTC ¶50,320.

Suits by the United States: Complaint

A complaint, as amended, alleged sufficient facts to give the defendants notice of the Government's theory of their liability as officers of an unincorporated association.

Communist Party of the U.S., DC, 63-1 USTC ¶9158.

The District Court permitted an amendment of the Government's complaint in a suit to collect taxes where the amendment did not state an additional cause of action nor did it prejudice the taxpayer's right to raise any available defenses.

S. Saladoff, DC, 64-1 USTC ¶9149.

The government's complaint to reduce assessments of federal tax liabilities to judgment was sufficient although it failed to allege either (1) that the taxpayers were sent deficiency notices prior to assessment and prior to expiration of the statute of limitations or (2) that they had waived such notice and consented to an extension of the limitation period. Proof of one of these points would, however, be required before judgment could be rendered for the government.

J. Forma, DC N.Y., 90-1 USTC ¶50,326.

The government's motion to vacate a default judgment and to dismiss the counterclaim on which it was based for lack of subject matter jurisdiction, following the decision in J. Forma ( 90-1 USTC ¶50,326), above, was denied. However, the default judgment was vacated for the limited purpose of holding a hearing to determine whether the taxpayers were entitled to the damages sought.

J. Forma, DC N.Y., 92-1 USTC ¶50,156, 784 FSupp 1132.

The IRS failed to establish that the notice of deficiency was sent for two of the tax years at issue; therefore, the taxpayer was not liable for the amounts assessed. However, the district court lacked subject matter jurisdiction over a claim of damages resulting from the sale of the taxpayer's house since he did not bring the required suit within the limitation period.

J. Forma, DC N.Y., 93-1 USTC ¶50,076. Vac'd and rem'd on another issue, CA-2, 95-1 USTC ¶50,012, 42 F3d 759.

The government stated a proper claim for relief in a suit to recover an individual's unpaid income taxes from the transferee who received the transferor's assets. The complaint stated with particularity the amount that the government sought to recover and the source of the liability.

H.B. Matzner, DC Fla., 97-1 USTC ¶50,413.

Answers by trustees to a government complaint that the trustees neglected, failed or refused to fully pay taxes assessed against the trusts were struck because the trusts were not represented by an attorney. The trustees' argument that certain treaties to which the United States was a signatory protected their right to defend the trusts in propria persona was without merit. Procedural rules governed the requirement that the trusts be represented by counsel.

M. Carey, DC Calif., 2006-1 USTC ¶50,338.

Documents filed by an individual that purported to be a response to a government complaint alleging unpaid federal taxes were struck. The response failed to comply with the Federal Rules of Civil Procedure and the local rules because they did not bear a caption setting forth the proper title of the action. Instead, the response contained only insufficient defenses and immaterial matters.

H.A. Wesselman, DC Ill., 2006-2 USTC ¶50,375.

The government was entitled to reduce to judgment federal income, employment and unemployment taxes assessed against an individual. The individual's claim that the IRS had selectively prosecuted the action against him was rejected because he did not provide evidence that the government had singled him out for prosecution. The individual also did not show that the decision to prosecute was made on the basis of an unjustifiable standard or that the prosecution was intended to prevent his exericse of a fundamental right.

D.L. Kadunce, DC Pa., 2008-2 USTC ¶50,669.

A federal district court had subject matter jurisdiction over the government's complaint seeking to reduce outstanding tax liabilities to judgment and to foreclose tax liens on a couple's real property. The government complied with the applicable procedural and pleading requirements, the government's claims were not time barred, the complaint provided sufficient information regarding the underlying tax assessments and the government sufficiently pled the existence of property rights based on the federal tax liens at issue.

D.R. Black, DC Wash., 2009-1 USTC ¶50,154.

A corporation's motion to strike certain allegations in the government's complaint regarding an individual's involvement in an abusive tax shelter scheme was denied. There was a reasonable chance that the allegations were relevant and pertinent to the government's action seeking a determination that the corporation was the individual's nominee and that the tax liability allegedly owed by the individual should be satisfied by foreclosing a federal tax lien upon real properly held by the corporation. The allegations were not immaterial, impertinent or scandalous, but addressed matters that had a bearing upon the government's claims that the individual owed federal taxes and that he used the corporation as a nominee to conceal his assets.

I. Cohen, DC Ill., 2009-1 USTC ¶50,287.

tax return preparer was permanently enjoined from promoting an abusive mining development scheme and preparing returns fraudulently claiming mining development deductions for customers who had not incurred mining development expenses. He was aware that the deductions reported on his customers' tax returns were improper and would result in an understatement of tax. He knowingly made materially false and misleading statements to his customers regarding the deductions and advised them not to cooperate with the IRS. Injunctive relief was necessary since he did not admit that the returns he prepared were false and would likely, unless enjoined, continue to promote his tax scheme and prepare false returns. . In order to obtain an injunction under § 7407, the United States must prove that the return preparer engaged in conduct subject to penalty under I.R.C. §§ 6694 or 6695. This is quite interesting because the defenses to the 6694 penalty, like “reasonable cause” can prevent an injunction. The transactions in the Camp case below were clearly tax motivated, but there are 6694 defenses that could be available even in tax motivated situations if you apply the rationale of this case to its logical conclusion.


United States of America, Plaintiff v. William H. Camp, Jr., d/b/a Universal Business Systems, Defendant.

U.S. District Court, West. Dist. Wash., Seattle Div.; Civ. 2:08-cv-00292-RSM, April 29, 2009.


ORDER GRANTING PLAINTIFF'S MOTION FOR SUMMARY JUDGMENT



FINAL JUDGMENT OF PERMANENT INJUNCTION


MARTINEZ, United States District Judge: Plaintiff, United States of America, moves for summary judgment of permanent injunction, pursuant to Federal Rule of Civil Procedure 56 and Internal Revenue Code (I.R.C., 26 U.S.C.) §§ 7402, 7407, and 7408, against Defendant William H. Camp, Jr., individually and doing business as Universal Business Systems. The United States seeks to prevent Camp from further promoting an unlawful tax scheme in violation of I.R.C. §§ 6700 and 6701, and from preparing federal tax returns for others. Defendant Camp did not respond to the United States' motion. The Court construes Defendant Camp's silence as an admission that the motion has merit. See Local Rule CR 7(b)(2). Accordingly, the Court makes the following findings of fact and conclusions of law and enters this permanent injunction.


Findings of Fact


The Court finds that because Camp has failed to answer the Requests for Admissions properly served on him by the United States, the matters therein are deemed admitted pursuant to FRCP 36(a)(3). Based on a full review of all of the evidence, the Court finds as follows:
1. Defendant William Camp resides in and operates his business, Universal Business Systems, in the District of Columbia. Camp prepared tax returns on behalf of many state of Washington residents. (Pl.'s St. of Undisputed Facts ¶ 2.)

2. Camp is not a certified public accountant, and has never held an accounting license, but is a non-CPA accountant and an income tax return preparer who prepares federal income tax returns. Camp has described, or allowed himself to be described, as an accountant. He continues to advertise his accounting services. (Pl.'s St. of Undisputed Facts ¶ 3, 4, 31.)

3. Camp assisted in the organization and planning of the Mining Interest Development Action Strategy ("MIDAS") program, a scheme promoted through Merendon Mining (Colorado), Inc. ("Merendon"), a Colorado corporation that indicated that it owned two formerly active gold mines in Colorado and Arizona. Merendon affiliates told investors that, with new technology, the mines might be able to produce gold and other minerals. Camp provided Merendon prospectuses to clients. (Pl.'s St. of Undisputed Facts ¶ 5.)

4. The prospectus provides that Merendon has developed a mineral program that allows participants to obtain an interest in minerals produced at a mine in Jamestown, Colorado. It provides that the investors must collectively invest $100 million annually and investors will receive 50% of the minerals extracted as a result of their respective ownership share of the total investment. (Pl.'s St. of Undisputed Facts ¶ 6.)

5. Between and including 2003 and 2005, Camp was contacted by, or he otherwise communicated with, persons who had received his name from a Structurist (Merendon marketing representatives) or other persons affiliated with the Institute for Financial Learning, Capital Alternatives, Merendon, Merendon Mining (Nevada), Inc. or any of their affiliates. (Pl.'s St. of Undisputed Facts ¶ 7.)

6. Between and including 2003 and 2005, Camp participated in communications with customers, prospective customers, investors or prospective investors, or members or prospective members of the Institute for Financial Learning, Capital Alternatives, Merendon Mining (Colorado), Inc., Merendon Mining (Nevada), Inc. or any of their affiliates, concerning the MIDAS program. (Pl.'s St. of Undisputed Facts ¶ 8.)

7. During one or more of the communications described in Paragraph 6, Camp stated that one was eligible for a deduction pursuant to Internal Revenue Code (26 U.S.C., I.R.C.) § 616 because of one's participation in the MIDAS program. (Pl.'s St. of Undisputed Facts ¶ 9.)

8. Persons who participated in MIDAS were required to sign Mining Agreements obligating them to contribute a certain amount of funds toward the development of mines owned by Merendon. The investments in Merendon were treated as "development expenditure payments." (Pl.'s St. of Undisputed Facts ¶ 10.)

9. Camp told Merendon investors about the tax consequences of mining development deductions pursuant to § 616 of the Internal Revenue Code. Specifically, Camp stated that it was legal or otherwise consistent with the internal revenue laws to claim a federal income tax deduction for mining development expenses pursuant to I.R.C. § 616, upon participation in the MIDAS program. (Pl.'s St. of Undisputed Facts ¶ 11.)

10. After he prepared their tax returns, Camp stated to one or more customers that the returns he had prepared were legal or otherwise in compliance with the internal revenue laws. (Pl.'s St. of Undisputed Facts ¶ 12.)

11. Camp told participants in the MIDAS program that they did not have to pay the amounts provided in their Mining Agreements prior to submitting the tax returns he prepared. (Pl.'s St. of Undisputed Facts ¶ 13.)

12. Between and including 2003 and 2005, Camp contacted, or was contacted by, potential or actual participants in the MIDAS program concerning his preparation of federal income tax returns for such persons. Camp requested and obtained the federal income tax returns of individuals for one or several of the tax years including 1997, 1998, 1999, 2000, 2001, and 2002. (Pl.'s St. of Undisputed Facts ¶ 14.)

13. Between and including 2003 and 2005, Camp prepared amended federal income tax returns for all of the persons listed in his letter to the Internal Revenue Service (IRS) of November 14, 2006. (Pl.'s St. of Undisputed Facts ¶ 15.)

14. Camp prepared amended income tax returns for at least 22 MIDAS customers, claiming a deduction pursuant to I.R.C. § 616. Camp prepared tax returns claiming Merendonrelated deductions for clients from Washington, Florida, California, Texas, Georgia, and New York. (Pl.'s St. of Undisputed Facts ¶ 16.)

15. On each of those amended federal income tax returns, Camp determined the amount of the claimed § 616 deduction based on the amount of taxes reported on the taxpayers' original federal income tax returns. When he prepared each of the amended returns, Camp knew that the taxpayers had not paid toward the development or production of any mine the amounts Camp listed on the amended tax returns. (Pl.'s St. of Undisputed Facts ¶ 17.)

16. Instead of reporting deductions based on amounts customers had actually invested in the mining scheme - which would have been zero in many cases - Camp reported deductions based on the entire amount of customers' purported ten-year contractual investment. Camp prepared the amended income tax returns for Merendon investors for the year 2002 including the contractual expenditures as ordinary deductions. (Pl.'s St. of Undisputed Facts ¶ 18.)

17. Camp, either independently or in collaboration with other persons involved in Merendon, prepared amended federal income tax returns indicating that customers made a mining investment in the year 2002, in part because in the year 2002, internal revenue laws allowed losses to be carried back five years, rather than the otherwise applicable three-year period. (Pl.'s St. of Undisputed Facts ¶ 19.)

18. None of the persons for whom Camp prepared federal income tax returns had paid any amounts toward the development of any mines to Merendon, Merendon Mining (Nevada), Inc., the Institute for Financial Learning, Capital Alternatives, or any predecessors, successors or affiliates thereto prior to and including December 31, 2002. None of the Mining Agreements signed by MIDAS participants for whom Camp prepared federal income tax returns were completed and signed prior to December 31, 2002. (Pl.'s St. of Undisputed Facts ¶ 20.)

19. Camp similarly knew or had reason to know that Merendon, Merendon Mining (Nevada), Inc., the Institute for Financial Learning, or any other person or entity on their behalf, had not paid, on behalf of MIDAS participants, the amounts he reported on the tax returns, toward the development of any mining facility. (Pl.'s St. of Undisputed Facts ¶ 21.)

20. Camp knew that any mining expenses actually spent between and including 2002 and 2005 by Merendon, Inc., Merendon Mining (Nevada), Inc., the Institute for Financial Learning, or any other person or entity on their behalf, were for the production of ores or minerals, rather than the development of a mine. (Pl.'s St. of Undisputed Facts ¶ 22.)

21. Camp, either independently or in collaboration with other persons involved in Merendon, prepared the tax returns for MIDAS customers in part to increase the total amount of reported deductions. Camp reported that one or more persons had paid, as mining development expenses, amounts in excess of their income for the applicable tax year, in order that those persons could obtain a refund of taxes previously paid to the United States. (Pl.'s St. of Undisputed Facts ¶ 23.)

22. Neither Camp nor his customers knew, or had a reasonable basis to believe, that ore or minerals had been disclosed to investors (with respect to the mines described in the MIDAS prospectus and accompanying documents), in commercially marketable quantities sufficient to reasonably justify commercial exploitation. (Pl.'s St. of Undisputed Facts ¶ 24.)

23. Camp knew that the persons for whom he prepared returns had not paid or incurred the expenditures he reported as deductions under § 616 on the returns. (Pl.'s St. of Undisputed Facts ¶ 25.)

24. Camp knew that his Merendon customers did not materially participate in any activity concerning the mines identified in the MIDAS prospectus or the operation of Merendon, Merendon Mining (Nevada), Inc., the Institute for Financial Learning, or any other affiliated entity. (Pl.'s St. of Undisputed Facts ¶ 26.)

25. At all times prior to and after the preparation of the income tax returns for MIDAS customers, Camp knew that the investments for which he reported a deduction pursuant to I.R.C. § 616 were not "at risk," as provided by the internal revenue laws. (Pl.'s St. of Undisputed Facts ¶ 27.)

26. In preparing each of the federal income tax returns described above, Camp knew that the taxpayers were likely to submit the documents and returns he prepared to the IRS in affiliation with the determination of their federal tax liabilities, or otherwise in connection with a material matter arising under the internal revenue laws. (Pl.'s St. of Undisputed Facts ¶ 28.)

27. Camp knew that the tax returns or documents would result in an understatement of the tax liability for the persons for whom Camp prepared the returns. Camp knew that the reported deductions under I.R.C. § 616 were matters material to the determination of the taxpayers' federal tax liabilities. (Pl.'s St. of Undisputed Facts ¶ 29.)

28. Camp prepared an additional opinion letter dated November 1, 2003 in which he represented that he was an accountant and purported to advise Merendon about how customers could report their Merendon "investments" on their tax returns. (Pl.'s St. of Undisputed Facts ¶ 30.)

29. At the time he prepared the opinion letter, Camp had not read or otherwise consulted any legal authority concerning the applicability of the deduction under I.R.C. § 616. In addition, he knew that MIDAS participants had not paid any money directly toward any mining development or production activity. (Pl.'s St. of Undisputed Facts ¶ 32.)

30. At the time he prepared the opinion letter, Camp knew that MIDAS participants were not engaged in the business activity of mining, and did not intend to become so engaged. (Pl.'s St. of Undisputed Facts ¶ 33.)

31. Camp knew that the opinion letter was likely to be distributed or would potentially be distributed to prospective and actual participants in the MIDAS program. (Pl.'s St. of Undisputed Facts ¶ 34.)

32. Some investors in Merendon received tax opinion letters, which stated that the development expenses paid by customers were deductible. (Pl.'s St. of Undisputed Facts ¶ 35.)

33. Camp charged his customers fees based on the complexity of the returns prepared, and charged one Seattle customer $4,000 to prepare one original tax return and five amended tax returns. Camp charged each of his MIDAS customers amounts up to $4,000 to prepare the amended tax returns. (Pl.'s St. of Undisputed Facts ¶ 36.)

34. One Camp customer paid over $3 million in federal income tax for the years 1997 through 2002 based on total income of approximately $8 million reported on his federal income tax returns. Camp prepared amended returns eliminating the vast majority of the customer's income tax liability for 1997 through 2002, and claiming large tax refunds for those years. (Pl.'s St. of Undisputed Facts ¶ 37.)

35. The majority of Camp's customers in the MIDAS program had Net Operating Loss ("NOL") carrybacks, as a result of Camp's claimed deductions under § 616. Camp did not treat the losses generated by the MIDAS deductions as passive activity losses, pursuant to § 469 of the Internal Revenue Code. (Pl.'s St. of Undisputed Facts ¶ 38.)

36. Camp prepared and submitted to the IRS one or more Forms 2848 granting him authorization to act as a Power of Attorney on behalf of the MIDAS participants for whom he prepared amended federal income tax returns. (Pl.'s St. of Undisputed Facts ¶ 39.)

37. Camp represented participants for whom he and Eric Peterson had prepared tax returns containing Merendon-related deductions. Peterson was enjoined by the United States District Court for the Southern District of Texas in January 2009. Camp maintained contact with his customers who were participants in Merendon during 2006 when he represented some of them during IRS examinations. (Pl.'s St. of Undisputed Facts ¶ 40.)

38. In a December 7, 2004 meeting with the IRS in connection with its audit of three MIDAS participants, Camp admitted that he had prepared a number of federal income tax returns claiming mining deductions, but he refused to name other customers for whom he prepared similar returns. In the meeting, Camp claimed that Merendon had asked him to appear at the interview in order to explain the transaction and facilitate acceptance of the refund claims. After Camp received a formal request from an IRS Area Director, he supplied to the IRS a list of some customers for whom he had prepared tax returns. (Pl.'s St. of Undisputed Facts ¶ 41.)

39. In the same meeting, Camp claimed that he had researched I.R.C. § 616 extensively and was knowledgeable about preparing amended income tax returns. Camp also stated that the federal tax returns he prepared were correct and complied with the internal revenue laws regarding mining development investment deductions, though he knew or had reason to know that the tax returns were not correct or in compliance with the internal revenue laws. (Pl.'s St. of Undisputed Facts ¶ 42.)

40. With respect to IRS audits, Camp requested that customers have the IRS direct inquiries regarding their tax returns directed to him. Camp told his MIDAS customers not to agree to the IRS's proposed treatment of their tax returns or other matters concerning the returns. (Pl.'s St. of Undisputed Facts ¶ 43.)

41. The IRS issued refunds to some Merendon investors. (Pl.'s St. of Undisputed Facts ¶ 44.)

42. Camp did not tell any persons for whom he prepared federal income tax returns pursuant to the MIDAS program that they could be subject to penalties or criminal prosecution for failing to accurately report their income, deductions, or other information on their federal income tax returns. (Pl.'s St. of Undisputed Facts ¶ 45.)


Conclusions of Law


This Court has jurisdiction of this matter pursuant to 28 U.S.C. §§ 1340 and 1345, and 26 U.S.C. §§ 7202(a), 7407, and 7408 because Camp has prepared tax returns and promoted the MIDAS program to persons within the state of Washington. In order to obtain an injunction under § 7407, the United States must prove that Camp, an income tax return preparer, engaged in conduct subject to penalty under I.R.C. §§ 6694 or 6695. For an injunction under § 7408, the United States must prove that Camp engaged in conduct subject to penalty under I.R.C. §§ 6700 or 6701. Finally, for an injunction under § 7402, the United States must show that an injunction is necessary or appropriate for the enforcement of the internal revenue laws.

The United States has met the requirements for an injunction under the statutes cited above. Camp violated I.R.C. § 6700 by promoting and selling the MIDAS mining development scheme, and knowingly making materially false or fraudulent statements to customers regarding the allowability of deductions under I.R.C. § 616. Camp made materially false statements to customers regarding the amounts they had to pay in order to be eligible to claim mining development deductions, Merendon Mining's use of customer contributions, and the legality of the claimed mining development expenses. Camp also prepared an opinion letter for distribution to customers falsely claiming that the mining deductions were legal. Camp knew that his statements were false. Camp knew that customers were not actually eligible for deductions under I.R.C. § 616 because none of the customers, or Merendon Mining, had paid any amounts toward the development of any mines in the year 2002. Furthermore, neither Camp nor his customers knew, or had a reasonable basis to believe, that ore or minerals had been disclosed in commercially marketable quantities sufficient to reasonably justify commercial exploitation.

Camp violated I.R.C. §§ 6701 and 6694 by preparing tax returns for customers claiming fraudulent mining deductions for customers who had not incurred the expenses reported, had not made any payments in the year 2002 (the year that Camp reported the deductible payments occurred), and whose payments, even if made, would not have been deductible under I.R.C. § 616. The deductions Camp reported for customers' purported development expenditures did not meet the required factors for § 616 because neither Camp nor the customers knew that ore or minerals existed in commercially marketable quantities. Any amounts paid by Merendon or Camp's customers were toward production, rather than development expenses, and were not actually at risk pursuant to the terms of the Mining Agreement. Finally, Camp offset the claimed mining development expenses against non-passive income in violation of the internal revenue laws. Camp knew that the mining deductions he reported on customers' tax returns were not proper, would more likely than not be not sustained on the merits, and would result in understatements of customers' true income tax liabilities.

Injunctive relief fulfills the legislative purposes of I.R.C. §§ 7402, 7407, and 7408 because Camp has demonstrated a pattern of promoting abusive tax schemes. Camp failed to consult with any tax professional prior to drafting his 2003 opinion letter, and admits he is not a licensed CPA, though he claims to be. There is a significant likelihood Camp will continue promoting the MIDAS tax schemes and preparing false and fraudulent tax returns absent an injunction. He prepared amended returns for at least 22 MIDAS customers, and his conduct is likely to continue absent an injunction because, even when the IRS confronted him with the incorrect returns, Camp continued to insist the deductions were proper, though he had not consulted any tax professional on the matter. Further, Camp advised customers not to cooperate with the IRS, and failed to notify them that they could be subject to civil and criminal penalties as a result of the tax returns he prepared. Finally, Camp's occupation as an accountant, without the necessary license to practice, and tax return preparer place him in a position where further violations are likely.

The United States has met the factors for injunctive relief under I.R.C. §§ 7402, 7407, and 7408. Further, a limited injunction prohibiting Camp only from participating in the prohibited conduct is not sufficient because of his failure to admit the falsity of the returns he prepared, and continued pattern of violations. Camp admits that he continues to hold himself out as an accountant though he has no CPA license, and has willfully prepared returns in blatant disregard for the internal revenue laws claiming millions in fraudulent deductions. Camp continued to advise customers that his positions on the tax laws are correct despite numerous IRS audits indicating otherwise. An injunction is necessary and promotes the goals of the statute because, absent an injunction, Camp will continue to promote this or other fraudulent tax schemes. Camp has made no acknowledgment that the MIDAS scheme he promoted was fraudulent, that the tax returns he prepared were false, and he has made no defense in this action and therefore offers the Court no reason to believe he will not continue to violate the internal revenue laws absent an injunction.

The United States has made the requisite showing that an injunction is warranted under I.R.C. §§ 7402, 7407, and 7408. The government's Motion for Summary Judgment is hereby GRANTED. The Court enters the following permanent injunction against William Camp, individually and doing business as Universal Business Systems.


Permanent Injunction


IT IS HEREBY ORDERED that Defendant Camp, and all those in active concert or participation with him, are permanently ENJOINED pursuant to I.R.C. §§ 7402, 7407, and 7408 from directly or indirectly:
(a) Organizing, promoting, or selling the Mining Interest Development Action Strategy ("MIDAS") program associated with Merendon Mining, Inc. and its subsidiary corporations;

(b) Making false or fraudulent statements, in connection with the organization or sale of a partnership, plan, or other arrangement, about the allowability of any deduction or credit, the excludability of any income, or the securing of any other tax benefit by reason of participating in the partnership, plan, or other arrangement;

(c) Organizing, promoting, selling, or advising participation in any other partnership, plan, investment, business venture, or arrangement that makes false or fraudulent representations about federal tax benefits or treatment because of participation in such tax shelter, plan, investment, business venture, or arrangement;

(d) Causing or assisting other persons and entities to understate their federal tax liabilities and avoid paying federal taxes;

(e) Preparing or assisting others in the preparation of any tax forms or documents on behalf of any other person or entity including a claimed deduction under I.R.C. § 616 for which the taxpayer has not made any mining development investment;

(f) Engaging in any other conduct subject to penalty under I.R.C. § 6700, including making or furnishing, in connection with the organization or sale of a partnership, plan, or arrangement, a statement that he knows or has reason to know to be false or fraudulent as to any material federal tax matter, or by making a gross valuation overstatement;

(g) Engaging in conduct subject to penalty under I.R.C. § 6701, including preparing or assisting others in the preparation of any tax forms or other documents to be used in connection with any material matter arising under the internal revenue laws and which he knows will (if so used) result in the understatement of another person's tax liability;

(h) Engaging in any conduct subject to penalty under I.R.C. § 6694, including preparing tax returns for customers reporting an understatement of liability due to an unreasonable position without substantial authority or more likely than not to not be sustained on its merits;

(i) Engaging in any conduct subject to any penalty under the I.R.C.; and

(j) Preparing or filing, or helping others to prepare or file, federal tax returns, amended returns, or any other tax-related documents or forms for any other person or entity other than himself.

(k) Falsely representing himself to be a certified public accountant, a non-certified accountant, or other tax professional;

(l) Falsely representing his experience or education as a tax return preparer; and

(m) Misrepresenting the terms of this injunction to customers or prospective customers, or anyone else.

IT IS FURTHER ORDERED that Camp mail a copy of this Order and a cover letter informing all persons for whom he prepared one or more tax return(s) including a deduction under I.R.C. § 616 or who otherwise participated in the M.I.D.A.S. program of the entry of the Court's findings and injunction, that their tax returns are likely false, that they may be subject to penalties because of the fraudulent tax returns. Camp must mail the Order and cover letter to these identified persons within 20 days of the date of this Order, and must file a sworn certificate stating that he has complied with this requirement and listing the names and addresses of all persons he has notified, within 22 days of the date of this Order.

IT IS FURTHER ORDERED that the Court retains jurisdiction for purposes of implementing and enforcing the final judgment and any additional orders necessary and appropriate to the public interest. The United States may engage in post-judgment discovery to monitor Camp's compliance with this injunction

IT IS FURTHER ORDERED that this Order of Permanent Injunction shall serve as a final judgment in this matter, with each party to bear its own costs.

Dated this 29 day of April, 2009.

Injunction issued. --Injunctions Against Tax Return Preparers: Injunction issued

The defendant was permanently enjoined from acting as a tax return preparer. This was to preclude him from preparing for compensation any federal income tax return (or any portion thereof), including any work papers or summaries from which the return might be prepared, or from employing any persons to prepare such returns or portions of returns at his direction or control.

C. Owens, Jr., DC, 79-2 USTC ¶9742.

Similarly.

C.E. Bullard, DC Tex., 89-2 USTC ¶9620.

An injunction may be issued against a tax adviser under Code Sec. 7402 without showing that a particular provision of the Internal Revenue Code has been violated. On remand, if the district court determines that an accounting firm, accused by the IRS of enticing clients to claim invalid tax credits, acted as a tax adviser, an injunction may be issued to prevent such conduct without tying it to a specific statute prohibiting the activity. If the district court views the firm as a tax preparer, only a partial injunction may be issued under Code Sec. 7407. Since the firm posted bond, an injunction cannot be issued against activities subject to the penalty under Code Sec. 6694: namely, advising clients to claim unjustified credits and using misleading documentation to show clients how bogus credits may be claimed. But the firm may be enjoined from promoting and marketing its services despite posting of the bond, since this activity is not encompassed by the penalty provision.

Ernst & Whinney, CA-11, 84-2 USTC ¶9618, 735 F2d 1296. Cert. denied, 105 SCt 2018.

An individual was permanently enjoined from the promotion and sale of an abusive tax shelter in the form of an estate guardian educational trust. Such individual was also enjoined from engaging in conduct as a tax return preparer that hinders or interferes with an IRS investigation and audit of persons who utilized such educational trusts in the computation of their tax liability.

B. Hutchinson, DC, 83-1 USTC ¶9322.

An injunction could be issued against an income tax preparer compelling production of a list of the names of taxpayers whose returns were prepared by him, despite the fact that the IRS could have uncovered the same information through a summons procedure. Moreover, the court concluded that willfulness was an essential element to justify the issuance of an injunction under Code Sec. 7407(b). However, the appellate court reversed and remanded the action to the trial court since the lower court judge erred by not considering whether the return preparer's refusal to turn over such information was in reliance upon the advice of his attorney, which could be a defense to willfulness under certain circumstances.

N.T. Nordbrock, CA-9, 87-2 USTC ¶9538, 828 F2d 1401.

A lower court decision, which enjoined a tax return preparer from preparing returns and imposed a penalty on him for refusing to provide a list of clients to the IRS, was reversed and remanded. The District Court erred in denying the preparer's demand for a jury trial. By proceeding with a bench trial on the issue of willfulness in refusing to provide the list, his Seventh Amendment right to a jury trial was violated. The preparer did not waive his right to a jury trial by signing a pretrial order which set his case for a bench trial.

N.T. Nordbrock, CA-9, 91-2 USTC ¶50,391.

A federal district court's imposition of a lifetime injunction prohibiting an individual from preparing tax returns for others was not in error because he continually engaged in prohibited conduct by refusing to comply with IRS requests for taxpayer information. In addition, a post-trial motion for a new trial was properly denied because subsequently obtained evidence was substantially the same as that in the return preparer's possession at the time of trial.

N.T. Nordbrock, CA-9, 94-2 USTC ¶50,532, 38 F3d 440.

An individual who referred to himself as a "personal income tax specialist" and who signed taxpayers' returns on the paid preparer's signature line was considered to be an income tax preparer within the meaning of Code Sec. 7701(a)(36). The court determined that he had consistently engaged in the type of conduct for which an injunction can be entered under Code Sec. 7407.

A.G. Venie, DC Pa., 88-1 USTC ¶9326, 691 FSupp 834.

An individual who described himself as a tax accountant, financial consultant and notary public was considered an income tax preparer. Further, the evidence established that he had continually and repeatedly prepared fraudulent and deceptive income tax returns. A preliminary injunction was appropriate. However, since permanently enjoining him from his livelihood would be too harsh, the court set a hearing on the merits in six months.

T.C. Franchi, DC Pa., 91-1 USTC ¶50,086, 756 FSupp 889. Aff'd, CA-3 (unpublished opinion 1/20/92).

A husband and wife were permanently enjoined from acting as income tax return preparers because they repeatedly and willfully understated their clients' tax liabilities and consistently took frivolous or unrealistic positions without adequately disclosing those positions on the returns. The wife's two daughters, who had actively participated in the couple's income tax preparation business, were also enjoined from acting as income tax return preparers unless they became enrolled agents and accepted no tax preparation advice from their mother and stepfather.

C. Bailey, DC Tex., 92-1 USTC ¶50,246. Aff'd, CA-5 (unpublished opinion 6/18/93).

An individual was permanently enjoined from acting as an income tax preparer because he regularly misapprehended, misconstrued and misapplied the tax code and regulations in the information he gave his customers and in the preparation of their returns. Although he did not act with fraudulent intent, he was negligent in his efforts to understand the law, and the positions he advised his clients to take were unrealistic and frivolous.

S.H. Olsen, DC Colo., 97-2 USTC ¶50,730. Aff'd, CA-10 (unpublished opinion), 98-1 USTC ¶50,152.

A tax preparer and his financial services organization were enjoined from organizing, promoting and selling "pure" or "common-law" trusts, and from acting as federal income tax return preparers pending a final determination on the merits. The evidence established that the trusts were created to aid in the illegal avoidance of taxation. Moreover, based upon its fining that the tax preparer continually engaged in such conduct, the court was entitled to enjoin the individual and his organization from acting as tax return preparers until complete compliance with the statutory disclosure requirements had been established.

L.W. Ratfield, DC Fla., 2002-2 USTC ¶50,765.

The government was entitled to a permanent injunction to prohibit a tax return preparer from misrepresenting his education and experience and for guaranteeing tax refunds. Evidence established that the individual continually and repeatedly represented to customers and to the IRS that has was an attorney, when he was not licensed to practice in any state and was not a graduate of an accredited law school. He also frequently guaranteed that his customers would receive tax refunds, although no such guarantees are permitted under the internal revenue laws.

D.J. Gleason, DC Tenn., 2004-1 USTC ¶50,183.

A federal district court did not abuse its discretion when it granted a preliminary injunction enjoining several individuals and businesses from promoting "zero-income" tax theories. Because one of the individuals had an extensive history of tax avoidance and because the individuals operated a bookstore devoted to introducing others to his tax-avoidance schemes, there was a strong likelihood that the promoters would violate Code Sec. 6700 in the future, which was sufficient grounds for a preliminary injunction. Furthermore, the injunction was not an impermissible restraint on First Amendment rights of free speech. The book at the heart of this controversy was determined to consist of commercial speech, which is not entitled to the same protections as political or expressive speech. Ordering that a copy of the injunction be placed on the promoters' websites also did not violate the First Amendment, since requiring disclosure of factual commercial information warning customers of the hazards of a product is regularly allowed.

I.A. Schiff, CA-9, 2004-2 USTC ¶50,328, 379 F3d 621.

Two individuals were enjoined from organizing, promoting and selling abusive tax shelters and acting as tax return preparers. The individuals promoted and participated in an abusive trust scheme known as the "Common Law Business Organization" and asserted under Code Sec. 861 that U.S. residents' domestic income is not taxable. These activities resulted in tax liabilities that were substantially understated, generated over $18 million estimated revenue loss for the government and were subject to penalties under Code Secs. 6694, 6700 and 6701. Further, they engaged in fraudulent, deceptive conduct that interfered with the administration of the tax laws and, absent an injunction, were likely to continue engaging in such activities.

J.L. Binge, DC Ohio, 2005-1 USTC ¶50,121.

A tax preparer and his financial services organization were permanently enjoined from organizing, promoting and selling "common-law" trust arrangements and from acting as tax return preparers.

L.W. Ratfield, DC Fla., 2005-1 USTC ¶50,187.

A permanent injunction that enjoined individuals from continuing to act as income tax return preparers was warranted because an injunction prohibiting them from engaging in fraudulent conduct was insufficient. The individuals had actively solicited customers with promises of large refunds, manipulated or disregarded customers' taxable income, reported fictitious expenses and deductions, filed fraudulent returns and asserted fallacious justifications when questioned by their customers. The permanent injunction reduced the risk that they would cause additional harm to customers, the government and the public.

E. Ferrand, DC La., 2006-1 USTC ¶50,287.

Permanent injunctions were granted against return preparers. The government showed that the preparers had engaged in conduct described in Code Sec. 7407(b) and that injunctive relief was appropriate to prevent the recurrence of such conduct.

E. May, DC, 83-1 USTC ¶9220.

M.D. Rotzinger, DC Ill., 88-1 USTC ¶9303.

A. Abdo, Jr., DC N.C., 2001-2 USTC ¶50,591.

D.P. Rosile, Sr. DC Fla., 2002-2 USTC ¶50,566.

R.L. Foster, DC Va., 2002-2 USTC ¶50,785.

A. Abdo, Jr., DC N.C., 2003-1 USTC ¶50,107. Aff'd, per curiam, CA-4 (unpublished opinion), 2003-1 USTC ¶50,483.

J.D. Hubacek, DC Nev., 2004-2 USTC ¶50,346.

J.E. Wolf, DC Okla., 2005-1 USTC ¶50,319.

C.B. Eden, DC Mo., 2005-1 USTC ¶50,366.

L.A. Baxter, DC Ala., 2005-1 USTC ¶50,423.

J.A. Fernandez, DC Fla., 2005-2 USTC ¶50,611.

J.E. Rosamond, DC La., 2005-2 USTC ¶50,639.

B.J. Hill, DC Ariz., 2006-1 USTC ¶50,252.

L.A.P. Moser, DC Hawaii, 2007-1 USTC ¶50,104.

E. Sonibare, DC Minn., 2007-1 USTC ¶50,353.

A.J. Pugh, Jr., DC N.Y., 2007-2 USTC ¶50,814.

P.M. Ballard, DC Texas, 2008-1 USTC ¶50,267.

D.L. Prewett, DC Fla., 2008-1 USTC ¶50,325.

R. Kyle, DC Calif., 2008-2 USTC ¶50,559.

A first-instance permanent injunction from tax preparation business was issued against two return preparers; however, the preparers were allowed to continue their tax return preparation business. The preparers knowingly misrepresented their eligibility to practice before the IRS and prepared or aided in the preparation of their customers' returns that understated their customers' tax liabilities based on positions which they knew or had reason to know were without a reasonable basis. Because the government had suffered irreparable harm and had no adequate remedy at law, injunctive relief was warranted to prevent a recurrence of such conduct. However, a balance of the hardships and consideration of the public interest favored allowing the preparers to continue their tax return preparation business, while enjoining the offending conduct. The delay in enforcement by the IRS, coupled with the preparers' good faith effort towards eradicating past unlawful behavior and implementing procedures and practices designed to minimize or eliminate errors or mistakes in their tax preparation practice weighed against a permanent bar.

A.E. Cruz, DC Fla., 2009-1 USTC ¶50,145.

A certified public accountant (CPA) was permanently enjoined from preparing returns claiming that mariners were entitled to deductions for meal expenses while working on board a ship, even though no meal expenses were actually incurred. The injunction was necessary to prevent recurrence because the CPA acted in a manner contrary to the assurances he provided to the government, and continued to claim deductions for deep sea mariners in spite of clear contradictory authority. The CPA incorrectly argued that mariners did not have to incur meal expenses in order to claim a deduction because the regulations under Code Sec. 274 allow certain expenses to be deemed substantiated without documentation. However, the regulations do not eliminate the requirement that expenses must be incurred before they can be deducted. His position regarding the deduction was unreasonable, not supported by substantial authority and had less than a one in three chance of being sustained on the merits. The CPA's discussions with government officials regarding deductions for common carrier meals, his interactions with IRS attorneys, his reliance on the advice of other attorneys, and "no change" audit letters issued by the IRS did not support a good faith defense under Code Sec. 6694. The audit letters had no precedential value, and the individuals he contacted did not fall within the definition of a preparer. Further, reliance on their advice was unreasonable because they did not have all the relevant facts.Affirming an unreported DC Calif. decision. M.A. Kapp, CA-9, 2009-1 USTC ¶50,376

United States of America, Plaintiff-Appellee v. Martin A. Kapp, Defendant-Appellant.

U.S. Court of Appeals, 9th Circuit; 07-56408, May 4, 2009.

Affirming an unreported DC Calif. decision.

[ Code Sec. 6694]

Tax return preparer: Mariner's tax deduction: Reasonableness: Good faith defense. --
A certified public accountant (CPA) was permanently enjoined from preparing returns claiming that mariners were entitled to deductions for meal expenses while working on board a ship, even though no meal expenses were actually incurred. His position regarding the mariner's tax deduction was unreasonable and not supported by substantial authority. His discussions with government officials regarding common carrier meals, his interactions with IRS attorneys, his reliance on the advice of other attorneys, and "no change" audit letters issued by the IRS did not establish good faith under Code Sec. 6694. The audit letters had no precedential value, and the individuals he contacted did not fall within the definition of a preparer. Further, reliance on their advice was unreasonable because they did not have of all the relevant facts. Back reference: ¶39,960.60.



[ Code Sec. 7407]

Tax return preparer: Permanent injunction: Mariner's tax deduction. --
A certified public accountant (CPA) was permanently enjoined from preparing returns claiming that mariners were entitled to deductions for meal expenses while working on board a ship, even though no meal expenses were actually incurred. His position was unreasonable and was not supported by substantial authority. The injunction was necessary because the CPA continued to claim the deduction even though he assured the government that he would not and in spite of clear contradictory authority. Back reference: ¶41,668.10.


Alan F. Broidy, Esq., Law Offices of Alan F. Broidy, APC, for the defendant-appellant; Richard T. Morrison, Deputy Assistant Attorney General, Gilbert S. Rothenberg, Jonathan S. Cohen and Gretchen M. Wolfinger, Attorneys, U.S. Department of Justice, for the plaintiff-appellee.

Before: Farris, Wardlaw, Circuit Judges, and Schwarzer, District Judge.

Before: Jerome Farris and Kim McLane Wardlaw, Circuit Judges, and William W Schwarzer, District Judge. *


OPINION


SCHWARZER, District Judge: Martin A. Kapp appeals the district court's entry of a permanent injunction preventing him from preparing or assisting in preparing federal tax returns that assert the position that mariners are entitled to an unreimbursed deduction for meal expenses while working on board a ship, when no meal expenses are actually incurred (the "mariner's tax deduction"). He also appeals the grant of summary judgment for the government and the denial of his cross motion for summary judgment. We have jurisdiction of this timely appeal under 28 U.S.C. § 1291, and affirm the judgment of the district court.



I. Facts and Procedural History

Kapp is a Certified Public Accountant who specializes in preparing federal income tax returns for individuals employed in the transportation industry. This case relates to his preparation of federal tax returns for mariners who work on oceangoing ships and who are at sea for long periods without returning to port ("deep sea mariners"), and mariners who work on tug boats and barges ("tug and barge mariners"), which return to port more frequently. Deep sea mariners are provided meals by their employer while working on board the ship. Tug and barge mariners also typically do not incur meal related expenses.

Between approximately January 1997 and February 2006 Kapp prepared tax returns for mariners who lived on vessels in the course of their employment that claimed the mariner's tax deduction. Two of these returns were for Marin Johnson and Jim Westling, who were employed as deep sea mariners during the tax year in question. Both individuals were provided meals at no cost, but claimed a deduction based on the number of days at sea multiplied by the full meals and incidental expenses ("M&IE") rate.

The Internal Revenue Service ("IRS") disallowed the deductions, and Johnson and Westling filed petitions in the Tax Court. In 2000, the Tax Court held that although the mariners could deduct travel expenses while working away from home, Johnson and Westling could not deduct the full M&IE rate because they had not actually incurred meal expenses. Johnson v. Comm'r, 115 T.C. 210, 215 (2000); Westling v. Comm'r, 80 T.C.M. (CCH) 373, 373 (2000). They were permitted to deduct the incidental expenses portion of the M&IE rate, however, because the mariners paid for items including personal hygiene supplies and bottled water at the ship's store. Johnson, 115 T.C. at 215; Westling, 80 T.C.M. (CCH) at 376. After these rulings, the IRS modified its Revenue Procedures and issued two Chief Counsel Advisories which concluded that the taxpayer may not claim the full M&IE rate when only incidental expenses are incurred. See, e.g., Rev. Proc. 2002-63 § 4.05, 2002-2 C.B. 691; I.R.S. Chief Counsel Advisory 200242038 (October 18, 2002), 2002 WL 31341876, at *13; I.R.S. Chief Counsel Advisory 200343025 (October 24, 2003), 2003 WL 22422671, at *6.

After the Johnson and Westling decisions, Kapp wrote several articles in a trade publication, The Professional Mariner, discussing potential tax deductions available to mariners. Kapp theorized about the different deductions available to deep sea mariners, and acknowledged that "claiming this additional meal deduction [when meals are provided] is considered double dipping." He asserted that tug and barge mariners were entitled to claim the full M&IE deduction, reduced by the amount of their grocery allowance. 1 Although he temporarily stopped claiming deductions on behalf of deep sea mariners, he continued to file returns claiming the deduction on behalf of his tug and barge mariner clients.

In November 2003 the IRS notified Kapp that he was under investigation for conducting a tax shelter promotion. Attorney Dennis Perez represented Kapp. Perez and Kapp met with George Campos, the IRS agent in charge of the investigation, several times in 2004 and 2005. In a March 2005 meeting, the IRS informed Kapp that the mariner's tax deduction was not allowed under the Internal Revenue Code ("I.R.C."). A memorandum dated April 18, 2005 drafted by an attorney in Perez's firm concluded that little authority supported Kapp's position that either deep sea mariners or tug and barge mariners were entitled to deduct the full M&IE amount, because both types of mariners are typically provided meals by their employer at no cost. 2

On May 2, 2005 Perez wrote a letter to Campos detailing Kapp's position on deductions for tug and barge mariners. He followed with a second letter on July 27, 2005 which stated that "although Mr. Kapp does not necessarily agree with the position you articulated for the first time in our meeting last month ... he has agreed to cease claiming meal deductions as he has done previously." Campos did not respond to the letters. After completing his investigation, Campos prepared a final report concluding that "Mr. Kapp is instrumental in preparing erroneous returns and incorrectly interpreting the Internal Revenue Code." The government filed a complaint in April 2006 seeking an injunction that would prevent Kapp from claiming deductions for meals that are provided to an employee without cost.

During the course of the litigation, Kapp was deposed by the government. He stated that he did not routinely ask mariners whether they were provided meals free of charge by their employer before claiming a deduction on their behalf. Additionally, he acknowledged that while he stopped claiming the full M&IE deduction for deep sea mariners after the Johnson decision, he began claiming it again in late 2005 or early 2006 based on purported endorsement of his position by Campos, and because he needed to be more aggressive in claiming deductions to provide negotiating room with the IRS.

Both parties moved for summary judgment in February 2007. Kapp asserted that he was entitled to summary judgment because his position regarding the deemed substantiated deductions for mariners was legally correct and taken in good faith. The government argued that an injunction was proper because Kapp continued to claim the mariner's tax deduction even though he knew the deduction was improper. In August 2007 the district court granted summary judgment for the government and permanently enjoined Kapp from preparing tax returns that claim a deduction for meals that are provided to mariners without cost. The injunction also required that Kapp provide a list of clients for whom he prepared returns claiming these deductions, post a link to the court's order on his websites, and explain to his clients that the court determined that he had incorrectly advised them about the mariner's tax deduction.

Subsequent to the judgment enjoining Kapp, the Tax Court published two cases specifically addressing Kapp's position regarding tug and barge mariners. See Zbylut v. Comm'r, 95 T.C.M. (CCH) 1172, 1175 (2008); Balla v. Comm'r, 95 T.C.M. (CCH) 1090, 1093 (2008). Relying on the Johnson decision, both cases held that tug and barge mariners could not use the regulations that permit deemed substantiated deductions for meals when no expense was incurred by the taxpayer. Zbylut, 95 T.C.M. (CCH) at 1175; Balla, 95 T.C.M. (CCH) at 1093 .



II. Statutory Overview

[1] The I.R.C. § 162 permits taxpayers to deduct reasonable business expenses paid or incurred during the taxable year, including travel expenses such as meals and lodging. 3 I.R.C. § 162(a). However, § 274 disallows such deductions unless the taxpayer meets strict substantiation requirements. I.R.C. § 274(d). Section 274(d) also contains a provision that allows the Secretary of the Treasury ("Secretary") to create regulations that eliminate some or all of the substantiation requirements when the expense is below a prescribed amount. I.R.C. § 274(d). The applicable § 274 regulations authorize the Commissioner of Internal Revenue ("Commissioner") to create optional methods of computing travel expenses, including a per diem deduction for meals and incidental expenses, which satisfy the substantiation requirements of § 274(d). Treas. Reg. § 1.274-5(j)(1).

[2] The Commissioner issued Revenue Procedures which specify the Federal Travel Regulations M&IE rate as the amount that a taxpayer may deduct in lieu of substantiating the actual cost of meals. 4 Rev. Proc. 90-60, §§ 3.02, 4.03, 1990-2 C.B. 651 . The Commissioner updates these Revenue Procedures annually, but the relevant provisions have remained substantially the same since 2000. See, e.g., Rev. Proc. 2000-39, 2000-2 C.B. 340; 2001-47, 2001-2 C.B. 332; 2004-60, 2004-2 C.B. 682; 2005-67, 2005-2 C.B. 729. Travel expenses below the threshold M&IE amounts are deemed substantiated and the taxpayer is not required to provide documentation in order to deduct the expense. Rev. Proc. 90-60, § 4.03, 1990-2 C.B. 651.

[3] Additionally, the Federal Travel Regualtions provide that the M&IE rate must be adjusted for a meal furnished to the taxpayer (except as provided in § 301-11.17) by deducting the appropriate amount. 41 C.F.R. § 301-11.18. However, "[a] meal provided by a common carrier or a complimentary meal provided by a hotel/motel does not affect your per diem." 41 C.F.R. § 301-11.17. Ships are included within the definition of common carriers. 41 C.F.R. § 301-10.100.



III. Standard of Review

A summary judgment granting a permanent injunction is generally reviewed for abuse of discretion. Sprint Tel. PCS, L.P. v. County of San Diego, 490 F.3d 700, 708 (9th Cir. 2007). However, we review "any determination underlying the grant of an injunction by the standard that applies to that determination." Id. (quoting Ting v. AT & T, 319 F.3d 1126, 1134-35 (9th Cir. 2003)). "Thus, we review a district court's findings of fact for clear error and its determinations of law ... de novo". Id.

The determination that there are no genuine issues of material fact that preclude the entry of summary judgment is reviewed de novo, viewing the evidence in the light most favorable to the nonmoving party. See United States v. Alameda Gateway Ltd., 213 F.3d 1161, 1164 (9th Cir. 2000).



IV. Entry of the Injunction



A. Standard for injunctive relief.

[4] The district court enjoined Kapp from preparing tax returns claiming the mariner's tax deduction under I.R.C. § 7407. An injunction is proper under § 7407 if the court finds that the tax preparer has engaged in conduct subject to penalty under § 6694, and an injunction is appropriate to prevent recurrence of the violation. Section 6694 provides that a tax return preparer is subject to penalty if he prepares a return with understated liability due to an unreasonable position not supported by substantial authority. I.R.C. § 6694.

[5] The applicable regulations further define what conduct is subject to penalty under § 6694. The regulations provide that a person has a reasonable basis for his position "if a reasonable and well-informed analysis by a person knowledgeable in tax law would lead such a person to conclude that the position has approximately a one in three, or greater, likelihood of being sustained on the merits ..." Treas. Reg. § 1.6694-2(b)(1). Additionally, the substantial authority standard is objective, and is not affected by the taxpayer's subjective belief in the correctness of his position. Treas. Reg. § 1.6662-4(d)(3)(i). The government bears the burden of proving each element for enjoining a tax preparer by a preponderance of the evidence. See United States v. Estate Pres. Servs., 202 F.3d 1093, 1102 (9th Cir. 2000).

Thus, the district court properly enjoined Kapp if (1) he prepared a return that understated liability, (2) due to an unreasonable position, i.e., a position that objectively had a less than one in three chance of being sustained on the merits, and (3) an injunction is appropriate to prevent recurrence.



B. Kapp prepared returns that understated tax liability.

Kapp argues that mariners do not have to pay or incur meal expenses in order to claim a deduction under the regulations that allow certain expenses to be deemed substantiated without documentation. He notes that meals provided by common carriers are not required to be subtracted from the allowed per diem deduction amount, and that ships are included within the definition of common carriers. C.F.R. § 301-11.17, -10.100. Therefore, he reasons that mariners who are provided meals while on board a ship should be allowed to claim the full M&IE allowance for days at sea, even though no meal expense is incurred. Kapp also creates several complicated hypothetical examples to support his argument that under the § 274 regulations, certain travelers could claim a deduction for deemed substantiated expenses when no actual costs are incurred.

[6] Kapp's argument is based on a misunderstanding of the regulations that create the deemed substantiated exception. He essentially argues that Executive Branch agency regulations can be manipulated to subvert provisions of the I.R.C. enacted by Congress. The regulations are intended to interpret and assist in the enforcement of the I.R.C., not to undermine it. The I.R.C. gives the Secretary and the Commissioner discretionary authority to issue regulations to ease the burden on taxpayers, who would otherwise have to meet the extensive substantiation requirements of § 274 in order to claim deductions for business related travel. I.R.C. § 274(d); see additionally Balla, 95 T.C.M. (CCH) at 1092. The regulations, however, do not eliminate the requirement in § 162 that expenses must be paid or incurred in order to be deducted. 5

[7] The regulations reflect the requirements of § 162. In the first section outlining their purpose, the regulations state that they "provide[ ] an optional method for employees and selfemployed individuals who pay or incur meal costs to use in computing the deductible costs of business meal and incidental expenses paid or incurred while traveling away from home." Rev. Proc. 90-60, §1, 1990-2 C.B. 651 (emphasis added). After the Johnson decision, the regulations were altered to provide a method for computing the applicable deduction for incidental expenses when no meal costs are paid and incurred. See, e.g., Rev. Proc. 2002-63 § 4.05, 2002-2 C.B. 691.

[8] Therefore, a meal provided by a common carrier need not be deducted from the per diem M&IE rate under 41 C.F.R. § 301-11.17, but a taxpayer cannot take the per diem deduction if he does not incur any meal related expenses. Rev. Proc. 90-60, §1, 1990-2 C.B. 651. Additionally, Kapp's examples of individuals who may attempt to manipulate the regulations to claim impermissible deductions when they do not incur expenses does not alter the requirement in § 162 that expenses must be paid or incurred in order to be deducted. Because Kapp claimed deductions on behalf of mariners who did not pay or incur meal expenses, he prepared returns that understated liability.



C. Kapp's position was unreasonable.

Kapp argues that even if he incorrectly claimed the mariner's tax deduction for taxpayers who incurred no meal costs, his position was not unreasonable and was supported by substantial authority. The analysis of the reasonableness of his position differs slightly for deep sea and tug and barge mariners, and we discuss each group separately.



1. Deep sea mariners

[9] Kapp's assertion that deep sea mariners were permitted to take the mariners tax deduction is patently unreasonable in light of the ruling in the Johnson case. In that case, which arose from conduct nearly identical to the conduct that is the basis of the injunction, the court stated "[w]e do not read the revenue procedures to allow a taxpayer to use the full M&IE rates when he or she incurs only incidental expenses." Johnson, 115 T.C. at 227. Kapp unsuccessfully attempts to distinguish Johnson, but the clear implication of the holding is that taxpayers may not deduct meal expenses when no such expenses are incurred. Id. Kapp acknowledged as much himself in his The Professional Mariner articles.

Kapp claims that he recently resumed the practice of taking a deduction on behalf of his deep sea mariner clients based on alleged approval of the position by Campos. In his declaration submitted in opposition to the government's summary judgment motion Kapp stated that:
I had a long meeting with IRS Agent George Campos on August 12, 2005, during which I reviewed my legal position with him in detail ... . At the end of the meeting, Mr. Campos sort of threw his arm around me and stated 'Now I understand.' Since Mr. Campos at no time during or after the ... meeting stated that he disagreed with my position, or that my position was frivolous, I interpreted Mr. Campos'[s] statement as an endorsement of my legal position ...

[10] Even accepting the accuracy of Kapp's description of his interaction with Campos, the conduct is not an affirmation of Kapp's position allowing him to claim the deduction on behalf of deep sea mariners, especially in light of the Johnson ruling. Because a well-informed analysis of the issue by a person knowledgeable in tax law would not lead to the conclusion that Kapp's position had at least a one in three chance of being sustained on the merits, his position was unreasonable and not based on substantial authority.



2. Tug and barge mariners

[11] Kapp argues that claiming the mariner's tax deduction for tug and barge mariners was reasonable because Johnson applied only to deep sea mariners. He contends that taking the deduction on behalf of tug and barge mariners, who return to port more frequently, presented novel issues. Although the Johnson case arose from a slightly different factual situation, the principles of the Tax Court's holding clearly extend to tug and barge mariners. The essence of the court's holding is that individuals may not deduct the full M&IE rate when they do not incur meal expenses. Johnson, 115 T.C. at 227. By extension, if tug and barge mariners do not incur meal expenses, they may not take a deduction. The frequency of a mariner's return to port is irrelevant to the holding of the case.

[12] A memorandum prepared by an associate of Kapp's lawyer Perez concluded there was little support for Kapp's position that tug and barge mariners could deduct meal expenses when no cost was incurred. Although Kapp claims that he asked Perez to play "devil's advocate" and draft a memorandum that laid out the arguments in opposition to his position, the memorandum presents an even-handed examination of the issues and states that "little if any authority relied on by Mr. Kapp supports the position that he takes." After thoroughly analyzing a host of Tax Court cases and IRS publications, the memorandum concludes that although the "analysis does not foreclose the possibility that Mr. Kapp could ultimately be successful on the issue ... . it appears to me that the weight of authority favors the Government on this issue." Shortly after the date of this memorandum, Perez wrote a letter to Campos stating that although Kapp did not agree with the position taken by the IRS, he agreed to stop claiming the deduction.

[13] Additionally, in two rulings issued after the district court entered the injunction against Kapp, the Tax Court rejected the contention that tug and barge mariners were entitled to deduct the full M&IE allowance when no meal costs were incurred. Zbylut, 95 T.C.M. (CCH) at 1175; Balla, 95 T.C.M. (CCH) at 1093. 6 While we cannot evaluate the reasonableness of Kapp's position in light of these rulings issued after the IRS investigation, it is worth noting that the Tax Court stated that the issues presented were not novel, and relied heavily on the reasoning in Johnson to reach its conclusion. Zbylut, 95 T.C.M. (CCH) at 1175; Balla, 95 T.C.M. (CCH) at 1093.

[14] Although there was no precedent at the time Kapp prepared the returns that specifically stated tug and barge mariners may not claim the mariner's tax deduction, a wellinformed analysis by a person knowledgeable in tax law would have led to the conclusion that Kapp's position had less than a one in three chance of being sustained on the merits. Therefore, his position was unreasonable and not supported by substantial authority.



D. The injunction was necessary to prevent recurrence.

The district court's finding that an injunction is necessary is a fact sensitive determination which we review for clear error. See Sprint Tel. PCS, 490 F.3d at 708.

[15] Kapp acknowledged that although he stopped claiming the mariner's tax deduction for deep sea mariners after the Johnson case, he later began claiming it based on a purported endorsement of his position by Campos, and because he needed negotiating room with the IRS. Kapp's weak justification for claiming the deduction in light of clear precedent to the contrary supports the issuance of an injunction as to deep sea mariners.

[16] The injunction is also appropriate as to deductions for tug and barge mariners. Kapp asserts that he would never claim the deduction after the Balla and Zbylut cases, unless they are overturned on appeal, and that an injunction is not warranted. Kapp's conduct, however, suggests that an injunction is necessary. Although his attorney represented that Kapp would stop claiming the deduction for tug and barge mariners, he continued to claim these deductions. Given that Kapp acted in a manner contrary to the assurances he provided to the government, and continued to claim deductions for deep sea mariners in spite of clear authority to the contrary, the district court did not abuse its discretion in issuing the injunction.



E. Good faith defense

[17] A tax preparer who prepares a return that understates liability due to an unreasonable position may still avoid a penalty under § 6694 if he can show that there is reasonable cause for the understatement and he acted in good faith. I.R.C. § 6694(a)(2)(B), (a)(3). The associated § 6694 regulations list five factors to consider in evaluating whether the tax preparer can assert the good faith defense: (1) the nature of the error, (2) the frequency of the errors, (3) the materiality of the errors, (4) the preparer's normal office practice, and (5) reliance on advice of another preparer. Treas. Reg. § 1.6694 2(d). The taxpayer bears the burden of establishing a good faith defense. I.R.C. § 6694(a)(3); Treas. Reg. § 1.6694-2(e)(2).

Kapp argues that he is not subject to a penalty because he acted in good faith by seeking the advice of numerous government officials and attorneys. He asserts that he contacted several attorneys at the main IRS office in Washington, D.C. to seek comment on his Professional Mariner articles, and to discuss the ability of tug and barge mariners to take the mariner's tax deduction in light of the Johnson ruling. He also contacted a high ranking General Services Administration ("GSA") employee responsible for administering the Federal Travel Regulations, to confirm his understanding that meals provided by a common carrier need not be deducted from the per diem M&IE amount. Additionally, he claims to have relied on the advice of Steven Stolar and Ellin Palmer, two private sector attorneys. Finally, he asserts that he is entitled to assert a good faith defense because several of the returns he prepared claiming the mariner's tax deduction were audited by the IRS, and the agency did not require any changes.

[18] Although Kapp made efforts to seek comment on and support for his position, his efforts do not allow him to claim the good faith defense. The government employees contacted by Kapp do not qualify as preparers under the regulations, and he was not entitled to rely on their advice. See Treas. Reg. § 301.7701-15(a); 301.7701-15(a)(6) (defining a "preparer" as a person who prepares returns for compensation and specifically excluding IRS employees performing official duties). Even if the government employees qualified as preparers under the regulations, Kapp is not entitled to rely on their advice unless he can demonstrate that they were aware of all the relevant facts. Treas. Reg. § 1.6694-2(d)(5)(ii). The correspondence between the GSA employee and Kapp does not demonstrate that the GSA employee was aware that the taxpayers in question do not pay or incur any meal expenses. Additionally, the IRS attorneys contacted by Kapp informed him that they could not officially comment on his articles, and that there was no procedure to set up a meeting to provide advice specific to his situation.

[19] Kapp also claims to have relied on the advice of private sector attorneys Stolar and Palmer, but he has failed to show that either attorney qualifies as a preparer. Even assuming that they qualify, Kapp failed to demonstrate that either was aware of all of the relevant facts underlying the returns he filed claiming the mariner's deduction. The record shows that he had general conversations with Palmer about travel regulations and the Johnson case, and that Stolar reviewed and agreed with his Professional Mariner articles. General conversations about regulations and cases and review of an article, however, do not demonstrate that either Stolar or Palmer analyzed the relevant facts and advised Kapp that his position was correct. Kapp's counsel during the investigation, the only attorneys who appear to have analyzed his position in light of all the relevant facts, concluded that he was not entitled to claim the deduction.

[20] Finally, Kapp is not entitled to rely on "no change" determinations made in IRS audits. See I.R.C. § 6110(k)(3) ("a written determination may not be used or cited as precedent"). Therefore, Kapp is not entitled to assert a good faith defense for his violations of § 6694, and the district court did not err in entering the injunction against him under § 7407.



V. Scope of the Injunction

Kapp argues that the injunction is vague and overbroad for two reasons. First, he claims that it prevents him from claiming deductions that other tax preparers are allowed to claim. Second, he claims that it prevents him from claiming tax deductions that are available to his other transportation industry clients, such as airline pilots.

[21] The district court's injunction prevents Kapp from preparing returns claiming a tax deduction for meals that are provided to mariners at no cost. The Tax Court's decisions in Johnson, Balla and Zbylut, however, prevent any tax preparer from claiming such a deduction. The injunction does not place Kapp at a unique disadvantage relative to other tax preparers.

[22] Additionally, the injunction does not prevent Kapp from claiming deductions for mariners that he is entitled to claim for other clients. 7 Section 162 requires that all business expenses must be paid or incurred in order to be deducted. The Commissioner has discretionary authority to issue regulations that alter substantiation requirements under § 274. Treas. Reg. § 1.274-5(j)(1). It is possible that some of these regulations, intended to ease the burden on taxpayers, create situations where an unscrupulous taxpayer may claim a deemed substantiated deduction when no expense is actually incurred. The regulations do not, however, eliminate the requirement that expenses must be paid and incurred before they can be deducted. All taxpayers, regardless of occupation, must first pay or incur expenses before they are entitled to take a deduction. I.R.C. § 162.



VI. Summary Judgment

[23] Kapp asserts that there are several disputed material facts related to his ability to claim a good faith defense and that the district court erred in granting summary judgment for the government. A disputed fact is material only if it can affect the outcome of the suit under governing law. In re Barboza, 545 F.3d 702, 707 (9th Cir. 2008), ( citing Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986)).

Kapp argues that there were disputed facts related to his discussions with a GSA official regarding deductions for common carrier meals, his interactions with IRS attorneys, his reliance on the advice of his own counsel, and numerous "no change" audit letters issued by the IRS. However, even if we accept Kapp's assertions, these facts are not material because they would not entitle him to assert a good faith defense under § 6694 and the associated regulations. Treas. Reg. § 1.6694-2(d). As discussed in Section IV(E), supra, the individuals Kapp consulted do not fall within the definition of a preparer, and he was not entitled to rely on their advice because they were not aware of all the relevant facts. Additionally, audit letters he relies on are not precedential. I.R.C. § 6110(k)(3). Therefore, the district court did not err in granting summary judgment for the government.

AFFIRMED.

* The Honorable William W Schwarzer, Senior United States District Judge for the Northern District of California, sitting by designation.

1 A per person grocery allowance is typically provided to the captain of a ship to cover the costs of providing meals to the mariners while they are working. The captain uses the money to obtain groceries for the entire crew, and the food is cooked on board the ship.

2 Although Kapp may have been able to assert the attorney-client privilege and work product protection, the memorandum was produced by his counsel during discovery.

3 Unless otherwise indicated, all section references are to the Internal Revenue Code in effect during the years at issue.

4 Revenue Procedure 90-60 § 4.03 provides in relevant part:

"In lieu of using actual expenses, employees and self-employed individuals, in computing the amount allowable as a deduction for ordinary and necessary meal and incidental expenses paid or incurred for travel away from home, may use an amount computed at the Federal M&IE rate for the locality of travel for each calendar day ... the employee or self-employed individual is away from home." Rev. Proc. 90-60, § 4.03, 1990-2 C.B. at 653.

5 Kapp points to an opinion issued by the General Counsel for the Office of the Inspector General at the Department of Justice that examines the per diem travel allowances paid to border patrol agents. He claims that the opinion supports his position that expenses need not be paid or incurred to be deducted. The opinion concludes that border patrol agents can accept complimentary meals provided by their hotel without affecting their per diem. However, the border patrol agents, unlike mariners, incur other meal related expenses while traveling.

6 Kapp argues that these cases are distinguishable because the court found that neither taxpayer worked on board a common carrier. Therefore, they could not benefit from the provisions of 41 C.F.R. § 301-11.17, which provides that common carrier meals are not counted against the federal M&IE rate. As explained above, however, the common carrier exception only comes into play if the taxpayer is entitled to a per diem deduction for travel expenses in the first place, i.e., pays or incurs some travel related expenses.

7 Kapp notes that the regulations permit employees to receive tax-free per diem or hourly travel allowance payments instead of deducting expenses on their tax returns. Rev. Proc. 90-60, §§ 3.03, 4.01, 1990-2 C.B. 651. He argues that an employee, such as an airline pilot, can collect this payment when traveling regardless of whether he pays or incurs expenses. However, the code limits per diem allowances to the amount that the payor reasonably anticipates will be incurred by the employee. Rev. Proc. 90-60, § 3.01(1), 1990-2 C.B. 651.

Assessment, Refund and Appeal: Reasonable cause and good faith exception

The IRS has set forth guidelines for the application of the former Code Sec. 6694(a) penalty for "negligent disregard of the rules and regulations." These guidelines are substantially similar to those incorporated into Reg. §1.6694-2(d), which provides the factors to be taken into account in determining the applicability of the reasonable cause and good faith exception to the current Code Sec. 6694(a) penalty on understatements due to an unrealistic position.

Rev. Proc. 80-40, 1980-2 CB 774.

Where the preparer failed to list the amounts shown on one Form 1099-INT and on one Form 1099-DIV, made an error totalling the itemized deductions on Schedule A, and used the wrong tax table in determining the tax, the former Code Sec. 6694(a) penalty for "negligent disregard of rules or regulations" was imposed even though the resulting understatement was not substantial and the preparer's normal office procedure indicated that this type of error would rarely occur.

Rev. Rul. 80-263, 1980-2 CB 376.

Under former Code Sec. 6694(a), the penalty for "negligent disregard of the rules and regulations" did not apply where a preparer omitted one item of interest income, the amount of the resulting understatement was not substantial and the omission was the only error on the return. Similarly, the penalty did not apply where the preparer made an error in totalling the amounts shown on Form-1099 INT on Schedule B of Form 1040, the understatement was not substantial and the error was the only one on the return.

Rev. Rul. 80-262, 1980-2 CB 375.

The former Code Sec. 6694(a) penalty for "negligent disregard of the rules or regulations" did not apply where the preparer showed that his normal office practice, taken together with other facts and circumstances, indicated that the error in question would rarely occur and that normal office practice was followed in preparing the return in question. Although the amount of the understatement was substantial and the error could have been discovered by reviewing the return, the failure to report minimum tax was the only error on the return and it was not flagrant.

Rev. Rul. 80-264, 1980-2 CB 277, distinguishing Rev. Rul. 80-28, 1980-1 CB 304.

A preparer who prepared both an individual's return and that of his wholly-owned corporation, was not the auditor of the corporation and had no knowledge of any loans by the individual to the corporation. The preparer deducted interest paid by the corporation to the individual on the corporation's return, but did not report the interest as income on the individual's return. The information provided by the corporation to the preparer did not state the payee of the interest and the individual did not indicate the receipt of such payment. In this situation the former Code Sec. 6694(a) penalty for "negligent disregard of the rules or regulations" did not apply. However, had the individual reported the payment to the preparer, the preparer would have been subject to the former Code Sec. 6694(a) penalty.

Rev. Rul. 80-265, 1980-2 CB 378.

The former Code Sec. 6694(a) penalty for "negligent disregard of the rules and regulations" did not apply to a preparer who prepared a return for a taxpayer who claimed to have deductible entertainment expenses, even though the IRS subsequently disallowed the deductions for lack of substantiation. The preparer inquired whether the taxpayer had the proper substantiation for the deductions and the taxpayer indicated that he had. However, the penalty would have been imposed had the preparer failed to inquire as to whether the taxpayer had adequate records, the taxpayer did not say he had adequate records, and the preparer failed to show that his normal office practice should prevent assertion of the penalty. The penalty would also have been imposed if the preparer completed the taxpayer's return for the following year, inquired whether the taxpayer had substantiation for claimed entertainment deductions, was answered in the affirmative, but failed to make further inquiry even though he was aware that the taxpayer could not substantiate certain entertainment deductions for the prior year.

Rev. Rul. 80-266, 1980-2 CB 378.

The trial court committed reversible error by permitting the introduction, by the preparer, of a congressional resolution passed two years after the investigation, because it was not relevant to a determination of the preparer's good faith and reasonableness in disregarding the statute.

C.M. Judisch, CA-11, 85-1 USTC ¶9281, 755 F2d 823.

A tax return preparer, who had been convicted of filing fraudulent returns, was collaterally estopped from relitigating the issue of willfulness in a civil action for negligence and willful understatement of tax liabilities. The U.S. Supreme Court's decision in J.L. Cheek (SCt, 91-1 USTC ¶50,012), which interpreted the meaning of willfulness in instances where a good-faith mistake was made as to the meaning of a tax law, did not constitute an intervening change in the law. The Supreme Court's decision in Cheek, which was based on settled principles, did not overrule any prior precedent or overturn any widespread practice in the lower courts. Further, the willfulness addressed in both the civil and criminal actions referred to the same act. Thus, because the issue of willfulness was the same in both actions and no intervening change in the law had occurred, the tax preparer was collaterally estopped from relitigating the question of his willfulness. The lower court also erred in its jury instructions on the negligence standard when it failed to instruct that the tax preparer must have a reasonable basis for the position he takes in preparing a return.

L.M. Richey, CA-9, 93-2 USTC ¶50,647.

A tax return preparer was not entitled to a refund of penalties assessed against her for preparation of falsified income tax returns. No good faith reliance exception to liability existed because the taxpayer failed to support her contention that she relied on her husband's preparations of the returns when signing, under penalty of perjury, that the returns were true to the best of her knowledge.

K.P.V. Bui, DC Wash., 2001-2 USTC ¶50,670. Aff'd, CA-9 (unpublished opinion), 2002-2 USTC ¶50,605, 44 FedAppx 847.

IRA Distribution Issues and Annotations - this is a frequent IRS examination issue

Gregory T. and Kim D. Benz v. Commissioner. Dkt. No. 15867-07 , 132 TC --, No. 15, May 11, 2009.


Held: A distribution for higher education expenses is not a modification of P-W's election to receive a series of substantially equal periodic payments.


OPINION

GOEKE, Judge: Respondent determined a Federal income tax deficiency of $8,959 for 2004. The deficiency results from the imposition of the 10-percent additional tax under section 72(t) on early distributions from an individual retirement account (IRA). 1 The sole issue for decision is whether a distribution for qualified higher education expenses is an impermissible modification of a series of substantially equal periodic payments. We hold that a distribution for qualified higher education expenses is not a modification of a series of substantially equal periodic payments.


Background

This case was submitted to the Court fully stipulated pursuant to Rule 122. The stipulation of facts and the attached exhibits are incorporated herein by this reference. Petitioners resided in Ohio at the time the petition was filed.

While employed by Proctor & Gamble, petitioner wife maintained an IRA. In January 2002 after separating from her employment with Proctor & Gamble, petitioner wife made an election to receive distributions from her IRA in a series of substantially equal periodic payments. This election included an annual fixed distribution of $102,311.50 to be made on January 15 each year for a period based on petitioner wife's life expectancy. On or before January 15, 2004, petitioner wife received a $102,311.50 distribution from her IRA in accordance with her election to receive a series of substantially equal periodic payments. During 2004 petitioner wife received two additional distributions from the IRA: A $20,000 distribution in January 2004 and a $2,500 distribution in December 2004. Petitioner wife had not attained age 59-1/2 when she received these additional distributions. Petitioner wife used the $20,000 and $2,500 distributions for qualified higher education expenses as defined in section 72(t)(7) relating to her son's college expenses. For 2004 petitioners spent $35,221.50 in qualified higher education expenses for their son.

Petitioners timely filed Form 1040, U.S. Individual Income Tax Return, for 2004, reporting the $124,811.50 in distributions from petitioner wife's IRA during 2004. Petitioners did not report the 10-percent additional tax for an early withdrawal from an IRA pursuant to section 72(t) with respect to any portion of the distributions. Petitioners attached Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts, to their return and reported that the withdrawals were not subject to any additional tax under section 72(t)(2).

On June 22, 2007, respondent issued a notice of deficiency to petitioners for 2004, determining a Federal income tax deficiency of $8,959. Respondent determined that $89,590 of the $124,811.50 distributed from petitioner wife's IRA was subject to the 10-percent additional tax imposed by section 72(t)(1) on early distributions. Respondent determined that the exception for qualified higher education expenses under section 72(t)(2)(E) applied to the remaining $35,221.50.


Discussion

In general, amounts distributed from an IRA are includable in gross income as provided in section 72. Sec. 408(d)(1). Section 72(t) provides for a 10-percent additional tax on early distributions from qualified retirement plans, unless the distribution falls within a statutory exception. Sec. 72(t)(1) and (2). Section 72(t)(2)(A)(iv) provides an exception from the 10-percent additional tax for distributions that are "part of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the employee or the joint lives (or joint life expectancies) of such employee and his designated beneficiary". 2 If the series of substantially equal periodic payments is modified within 5 years of the date of the first distribution (other than by reason of death or disability), then the 10-percent additional tax will be imposed retroactively on prior distributions made before the taxpayer attains age 59-1/2 (referred to as the recapture tax), plus interest. Sec. 72(t)(4)(A)(ii)(I). The recapture tax also applies when a modification occurs after the initial 5-year period but before the employee has attained age 59-1/2. Sec. 72(t)(4)(A)(ii)(II).

Independent from the equal periodic payment exception, section 72(t)(2)(E) provides an exception from the 10-percent additional tax for distributions for qualified higher education expenses. Section 72(t)(2)(E) provides:

Distributions from individual retirement plans for higher education expenses. --Distributions to an individual from an individual retirement plan to the extent such distributions do not exceed the qualified higher education expenses (as defined in paragraph (7)) of the taxpayer for the taxable year. Distributions shall not be taken into account under the preceding sentence if such distributions are described in subparagraph (A), (C), or (D) or to the extent paragraph (1) does not apply to such distributions by reason of subparagraph (B).

By specifically creating an exception for distributions used for higher education expenses, Congress recognized "it is appropriate and important to allow individuals to withdraw amounts from their IRAs for purposes of paying higher education expenses without incurring an additional 10-percent early withdrawal tax." H. Rept. 105-148, at 330 (1997), 1997-4 (Vol. 1) C.B. 319, 652. Distributions for qualified higher education expenses serve one of numerous purposes Congress identified as deserving special treatment. Those purposes include paying a tax levy, paying for medical care, paying for health insurance during periods of unemployment, and purchasing a first home. Sec. 72(t)(2)(A)(vii), (B), (C), (D), and (F).

Petitioner wife's two additional distributions for qualified higher education expenses were made within 5 years of the first annual periodic payment and before petitioner wife had attained age 59-1/2. Respondent maintains that the two additional distributions constitute an impermissible modification to the periodic payment election under section 72(t)(4). According to respondent, the substantially equal periodic payment exception is no longer effective for the 2004 distribution. Respondent concedes that $35,221.50 of the total 2004 distributions satisfied the exception for qualified higher education expenses under section 72(t)(2)(E) and is not subject to the 10-percent additional tax.

The sole issue for decision is whether a distribution that qualifies for a statutory exception to the 10-percent additional tax under section 72(t)(1) constitutes a modification of a series of substantially equal periodic payments triggering the recapture tax under section 72(t)(4). Respondent argues that an employee who elects a series of substantially equal periodic payments is not allowed any further distributions within the first 5 years of the election irrespective of whether the distribution would qualify for another statutory exception to the section 72(t) tax unless the employee dies or becomes disabled. Petitioners argue that a distribution used for a purpose that qualifies for a statutory exception is not a modification of a series of substantially equal periodic payments that triggers the recapture tax under section 72(t)(4). In Arnold v. Commissioner, 111 T.C. 250, 255-256 (1998), the Court held that an additional distribution that did not qualify for a statutory exception was an impermissible modification to a series of substantially equal periodic payments. In Arnold, we stated: "In order to avoid the section 72(t) tax, petitioners must show that the November 1993 distribution falls within one of the exceptions provided under section 72(t)(2)(A). They have not done so." Id. at 255. Today we also recognize that distributions under section 72(t)(2)(E), enacted in 1997 and after the year in issue in Arnold, do not trigger the section 72(t) additional tax where the taxpayer receives the distribution within 5 years after the taxpayer begins receiving distributions under a series of substantially equal periodic payments.

The last sentence of section 72(t)(2)(E) recognizes that an employee may qualify for more than one statutory exception to the 10-percent additional tax. It provides that the amount of distributions attributable to higher education expenses does not take into account distributions described in subparagraph (A), (B), (C), or (D). Sec. 72(t)(2)(E). If a distribution qualifies for more than one statutory exception, the employee is exempt from the 10-percent additional tax on the basis of the applicable exception under subparagraph (A), (B), (C), or (D) and need only rely on the higher education expense exception for the additional amount of the distribution. Subparagraph (A) includes the periodic payments exception. Similar language is included in subparagraphs (B) (relating to distributions for medical expenses) and (F) (relating to distributions for first home purchases). Sec. 72(t)(2)(B) and (F). A modification occurs for purposes of section 72(t)(4) when the method of determining the periodic payments changes to a method that no longer qualifies for the exception. The legislative history explains the 5-year prohibition of modifications to a series of substantially equal periodic payments as follows:

if distributions to an individual are not subject to the tax because of application of the substantially equal payment exception, the tax will nevertheless be imposed if the individual changes the distribution method prior to age 59 1/2 to a method which does not qualify for the exception. * * * For example, if, at age 50, a participant begins receiving payments under a distribution method which provides for substantially equal payments over the individual's life expectancy, and, at age 58, the individual elects to receive the remaining benefits in a lump sum, the additional tax will apply to the lump sum and to amounts previously distributed.

In addition, the recapture tax will apply if an individual does not receive payments under a method that qualifies for the exception for at least 5 years, even if the method of distribution is modified after the individual attains age 59 1/2. Thus, for example, if an individual begins receiving payments in substantially equal installments at age 56, and alters the distribution method to a form that does not qualify for the exception prior to attainment of age 61, the additional tax will be imposed on amounts distributed prior to age 59 1/2 as if the exception had not applied.

H. Conf. Rept. 99-841 (Vol. II), at II-457 (1986), 1986-3 C.B. (Vol. 4) 1, 457 (emphasis added). The method of calculating petitioner wife's annual periodic payments will not change as a result of the additional distributions for higher education expenses. Congress enacted the recapture tax under section 72(t)(4) to apply to prior distributions received under a series of periodic payments where the employee fails to adhere to the payment schedule elected for at least 5 years. There is no indication that Congress intended to disallow all additional distributions within the first 5 years of the election to receive periodic payments.

The legislative purpose of the 10-percent additional tax under section 72(t) is that "Premature distributions from IRAs frustrate the intention of saving for retirement, and section 72(t) discourages this from happening." Dwyer v. Commissioner, 106 T.C. 337, 340 (1996) (citing S. Rept. 93-383, at 134 (1973), 1974-3 C.B. (Supp.) 80, 213). This legislative purpose is not frustrated where an employee receives distributions for more than one of the purposes that Congress has recognized as deserving special treatment.

We hold that a distribution that satisfies the statutory exception for higher education expenses is not a modification of a series of substantially equal periodic payments. Because we find that a distribution for higher education expenses is not a modification, the 5-year rule prohibiting modifications except in the case of death or disability is not violated.

To reflect the foregoing,

Decision will be entered for petitioners.

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 The Internal Revenue Service has provided three examples of methods to determine a series of substantially equal periodic payments for purposes of sec. 72(t)(2)(A)(iv). See Notice 89-25, Q&A-12, 1989-1 C.B. 662, 666, modified by Rev. Rul. 2002-62, sec. 2.01, 2002-2 C.B. 710. Rev. Rul. 2002-62, sec. 2.02(e), 2002-2 C.B. at 711, provides specific instances that would cause a modification to occur. They focus on tax-free additions to or distributions from the account and are not applicable here.




Carl Robert Wagenknecht, Jr. v. Commissioner. Dkt. No. 8293-07 , TC Memo. 2008-288, 96 TCM 472, December 22, 2008.

A high school vice principal and licensed attorney who advanced shopworn arguments characteristic of tax-defier rhetoric that has been universally rejected by the courts was liable for a 10-percent additional tax under Code Sec. 72(t)(1) because he received a distribution from a qualified retirement plan. None of the exceptions set forth in Code Sec. 72(t)(2) applied. He was liable for an addition to tax under Code Sec. 6651(a)(1) for failing to file a federal income tax return. His failure to file was not due to reasonable cause and was due to willful neglect. The penalty under Code Sec. 6651(a)(2) for failure to timely pay was also imposed because his failure to pay was not due to reasonable cause. Further, he engaged in behavior warranting the imposition of a penalty under Code Sec. 6673(a). His conduct convinced the court that he maintained the proceeding primarily for delay and to advance his frivolous and groundless arguments.




MEMORANDUM FINDINGS OF FACT AND OPINION

VASQUEZ, Judge: Respondent determined deficiencies of $13,438, $11,533, and $16,014 in petitioner's income tax for 2002, 2003, and 2004, respectively. Respondent also determined additions to tax pursuant to section 6651(a)(1) and (2) for 2004. 1

The issues for decision are: (1) Whether petitioner is liable for the deficiencies; (2) whether petitioner is liable for an addition to tax for failing to file a Federal income tax return for 2004; (3) whether petitioner is liable for an addition to tax for failing to pay Federal income tax for 2004; (4) whether petitioner is liable for a 10-percent additional tax pursuant to section 72(t) for 2004; and (5) whether petitioner engaged in behavior warranting the imposition of a penalty pursuant to section 6673(a).


FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference. At the time he filed the petition, petitioner resided in Ohio.

Petitioner did not file a Form 1040, U.S. Individual Income Tax Return, for 2002, 2003, or 2004. On or about December 29, 2004, for 2002 and 2003, respectively, and March 28, 2005, for 2004, petitioner mailed to respondent virtually identical "affidavits", 2 approximately 50 pages long, titled "Notice of Affidavit Statement of :Carl R.: Wagenkneckt, Jr. In Protest of Internal Revenue Code Section 6011 For Year Period Ending December 31," 2002, 2003, or 2004. The aforementioned three affidavits contained frivolous and groundless arguments, including (but not limited to):

1. The frivolous affidavits were submitted to respondent under coercion and duress;

2. petitioner was neither an "employee" nor "personnel" under a contract of employment for personal services with the "United States" or [with] any "regulated public utility" as "employer" as the foregoing quoted terms are specially defined and used under the "Public Salary Tax Act of 1939";

3. petitioner was not a "person," nor "individual," nor "U.S. person," nor "U.S. individual," nor "taxpayer," nor "non-resident alien," nor any other "legal entity" "made liable for" or "subject to" any "internal revenue tax" or "U.S. Individual Income Tax";

4. petitioner received no "wages" includable in "gross income";

5. petitioner was not domiciled "within" the borders and jurisdiction of the "United States;" "a State" or "a political subdivision thereof;" the District of Columbia; any Federal Enclave; or Federal territory or possession;

6. petitioner was not a "United States Person;"

7. arguments regarding the Sixteenth Amendment made petitioner not liable for taxes;

8. Title 26 is not a positive law applicable to the people of the United States;

9. petitioner was born "within" the outer borders and jurisdiction of the compact dejure [sic] state of Ohio, one of the compact states of the United States of America;

10. petitioner is an American national; a national of the grand republic of the United States; a Citizen of the United States as the term "Citizen" is used in Article I, Section 2, Clause b of the Constitution of the United States of America; a Citizen of the compact dejure [sic] state of Ohio, as the term "Citizen" is used in the Constitution compact of the dejure [sic] state of Ohio;

11. petitioner is a natural free-born man in propria persona and consequently of freeman legal character; is one of the sovereign people of America by the grace of his God and Creator, and consequently of sui juris legal character; is a member of the grantor class entitled to grant power to a republican form of government; am a child of God, created by God, not by any government authority;

12. the Christian appellation of petitioner is ":Carl R.: Wagenkneckt, Jr." and any intentional abbreviation or misspelling of said Christian appellation is legally vague and consequently voidable by petitioner, or any "unauthorized capitalization" is in violation of the peonage laws;

13. petitioner was not domiciled in the District of Columbia, a Federal Enclave, or Federal territory or possession of the United States; petitioner was domiciled "without" the "United States"; and petitioner was not a "person," nor "individual," nor "U.S. person," nor "U.S. individual," nor "taxpayer," nor "non-resident alien" nor any other "legal entity" "made liable for" or "subject to" any "internal revenue tax" as used under Title 26 U.S.C. and Title 26 C.F.R.;

14. petitioner was not a "person" required to either "make such returns" or "keep such records" nor made subject to the requirements of Title 26 U.S.C. § 6001;

In summary petitioner claimed that he was not obligated to file a Federal income tax return and that he did not have Federal income tax liabilities for 2002, 2003, and 2004.

During 2002, 2003, and 2004 petitioner was a vice principal of a high school and a licensed attorney. Petitioner earned wages of $67,691, $66,542, and $69,107 from the Akron Public Schools in 2002, 2003, and 2004, respectively. In 2004 petitioner also received $488 in interest and $9,942 from qualified retirement plans.

Pursuant to section 6020(b), respondent filed Federal income tax returns for petitioner for 2002, 2003, and 2004 ( section 6020(b) returns).


OPINION




I. Burden of Proof
As a general rule, the taxpayer bears the burden of proving the Commissioner's deficiency determinations incorrect. Rule 142(a); Welch v. Helvering [ 3 USTC ¶1164], 290 U.S. 111, 115 (1933). Section 7491(a), however, provides that if a taxpayer introduces credible evidence and meets certain other prerequisites, the Commissioner shall bear the burden of proof with respect to factual issues relating to the liability of the taxpayer for a tax imposed under subtitle A or B of the Code.

We found petitioner's testimony to be evasive, vague, conclusory, and/or questionable. Petitioner introduced no credible evidence regarding his income for 2002, 2003, or 2004, and he introduced no evidence to establish that he met the prerequisites of section 7491(a). Accordingly, petitioner bears the burden of proof.



II. Section 61
Section 61(a) defines gross income as all income from whatever source derived.

A. Income From Akron Public Schools

Gross income includes compensation for services. Sec. 61(a)(1). In 2002, 2003, and 2004 petitioner earned wages of $67,691, $66,542, and $69,107, respectively, from the Akron Public Schools.

B. Interest Income

Gross income includes interest. Sec. 61(a)(4). In 2004 petitioner received $488 in interest.

C. Pension/Annuity Income

Gross income includes income from annuities and pensions. Sec. 61(a)(9), (11). In 2004 petitioner received $9,942 from qualified retirement plans.

D. Conclusion

In the petition, a status report, at trial, and on brief, petitioner advanced shopworn arguments characteristic of tax-defier rhetoric, see Custer v. Commissioner, T.C. Memo. 2008-266, that has been universally rejected by this and other courts, Wilcox v. Commissioner [ 88-1 USTC ¶9387], 848 F.2d 1007 (9th Cir. 1988), affg. [ Dec. 43,889(M)], T.C. Memo. 1987-225; Carter v. Commissioner [ 86-1 USTC ¶9279], 784 F.2d 1006, 1009 (9th Cir. 1986). We shall not painstakingly address petitioner's assertions "with somber reasoning and copious citation of precedent; to do so might suggest that these arguments have some colorable merit." Crain v. Commissioner [ 84-2 USTC ¶9721], 737 F.2d 1417, 1417 (5th Cir. 1984). On the basis of the foregoing, we sustain respondent's determination of petitioner's unreported income.



III. Section 72(t)
Section 72(t) provides for a 10-percent additional tax on early distributions from a qualified retirement plan. However, the 10-percent additional tax does not apply to certain distributions. Section 72(t)(2) excepts qualified retirement plan distributions from the 10-percent additional tax if the distributions are, inter alia: (1) Made on or after the date on which the employee attains the age of 59-1/2; (2) made to a beneficiary (or to the estate of the employee) on or after the death of the employee; (3) attributable to the employee's being disabled within the meaning of section 72(m)(7); (4) part of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the employee or joint lives (or joint life expectancies) of such employee and his designated beneficiary; or (5) dividends paid with respect to stock of a corporation which are described in section 404(k). Sec. 72(t)(2)(A). A limited exception is also available for distributions made to an employee for medical care expenses. See sec. 72(t)(2)(B).

Petitioner has the burden of proving his entitlement to any of these exceptions. See Bunney v. Commissioner [ Dec. 53,839], 114 T.C. 259, 265 (2000); see also supra p. 5. The evidence does not establish that any of the exceptions set forth in section 72(t)(2) applies in this case. Thus, the distributions to petitioner in 2004 are subject to the 10-percent additional tax under section 72(t)(1).



IV. Additions to Tax
Section 7491(c) provides that the Commissioner shall bear the burden of production with respect to the liability of any individual for additions to tax. "The Commissioner's burden of production under section 7491(c) is to produce evidence that it is appropriate to impose the relevant penalty". Swain v. Commissioner [ Dec. 54,732], 118 T.C. 358, 363 (2002); see also Higbee v. Commissioner [ Dec. 54,356], 116 T.C. 438, 446 (2001). If a taxpayer files a petition alleging some error in the determination of the penalty, the taxpayer's challenge generally will succeed unless the Commissioner produces evidence that the penalty is appropriate. Swain v. Commissioner, supra at 364-365. The Commissioner, however, does not have the obligation to introduce evidence regarding reasonable cause or substantial authority. Higbee v. Commissioner, supra at 446-447.

A. Section 6651(a)(1)

Respondent determined that petitioner is liable for an addition to tax pursuant to section 6651(a)(1) for 2004. Section 6651(a)(1) imposes an addition to tax for failure to file a return on the date prescribed (determined with regard to any extension of time for filing) unless such failure is due to reasonable cause and not due to willful neglect.

Petitioner stipulated he did not file a return for 2004. Thus, petitioner must come forward with evidence sufficient to persuade the Court that respondent's determination is incorrect or that an exception applies. See Rule 142(a); Welch v. Helvering, 290 U.S. at 115; see also Higbee v. Commissioner, supra at 447. Petitioner presented no evidence that his failure to file was due to reasonable cause and not due to willful neglect. We hold that petitioner is liable for the addition to tax pursuant to section 6651(a)(1).

B. Section 6651(a)(2)

Section 6651(a)(2) provides for an addition to tax where payment of tax is not timely "unless it is shown that such failure is due to reasonable cause and not due to willful neglect". At trial petitioner stipulated a substitute return for 2004 that satisfied section 6020(b). The section 6020(b) return for 2004 shows a $16,014 deficiency and a balance due of $2,615.

On the basis of the evidence, we find that petitioner did not pay on time a portion of his tax for 2004. Petitioner did not present evidence indicating that his failure to pay was due to reasonable cause and not due to willful neglect. See Higbee v. Commissioner, supra at 446-447 (stating that the taxpayer bears the burden of proof regarding reasonable cause). Accordingly, on this issue we sustain respondent's determination.



V. Section 6673(a)(1)
Section 6673(a)(1) authorizes this Court to penalize up to $25,000 a taxpayer who institutes or maintains a proceeding primarily for delay or pursues in this Court a position which is frivolous or groundless.

Petitioner's conduct has convinced us that he maintained this proceeding primarily for delay and to advance his frivolous and groundless arguments. At trial the Court advised petitioner that his arguments were frivolous and groundless.

Petitioner's actions have resulted in a waste of limited judicial and administrative resources that could have been devoted to resolving bona fide claims of other taxpayers. See Cook v. Spillman [ 87-1 USTC ¶9121], 806 F.2d 948 (9th Cir. 1986). Petitioner's insistence on making frivolous tax-defier arguments indicates an unwillingness to respect the tax laws of the United States. Accordingly, we shall require petitioner to pay a penalty of $5,000 to the United States pursuant to section 6673.

To reflect the foregoing,

Decision will be entered for respondent.

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 We use the term "affidavit" for convenience only.
David A. Hughes v. Commissioner. Dkt. No. 4486-07 , TC Memo. 2008-249, 96 TCM 314, November 3, 2008.

-
An individual failed to include in income distributions from a qualified retirement plan as required under Code Secs. 61 and 72. Further, he was subject to additional tax on the distribution under Code Sec. 72(t) because he received the distribution while under the age of 59 1/2 and failed to provide any evidence that he was excepted from the additional tax. --CCH.



P claimed numerous deductions on his 2001 Federal income tax return and did not include distribution income in his taxable income. R determined a deficiency, an addition to tax pursuant to sec. 6651(a)(1), I.R.C., and an accuracy-related penalty pursuant to sec. 6662(a), I.R.C.

Held: P is liable for the deficiency, the addition to tax, and the accuracy-related penalty.


MEMORANDUM FINDINGS OF FACT AND OPINION

WHERRY, Judge: This case is before the Court on a petition for redetermination of a Federal income tax deficiency, an addition to tax under section 6651(a)(1), and a penalty under section 6662(a) that respondent determined with respect to petitioner's 2001 tax year. 1 The issues for decision are:

(1) Whether petitioner is entitled to $40,936 of deductions for unreimbursed employee business expenses, tax preparation fees, tax advice, job search expenses, and medical and dental expenses claimed on Schedule A, Itemized Deductions;

(2) whether petitioner is entitled to deductions of $6,410 for expenses related to pension and profit-sharing plans and $2,888 for depreciation and section 179 expenses, claimed on Schedule C, Profit or Loss From Business;

(3) whether the $18,312 in distributions that petitioner received from Wescom Credit Union is includable in his taxable income;

(4) whether petitioner is liable for the 10-percent additional tax under section 72(t);

(5) whether petitioner is liable under section 6651(a)(1) for a $3,161.75 addition to tax; and

(6) whether petitioner is liable under section 6662(a) for a $2,557.80 accuracy-related penalty.


FINDINGS OF FACT

Some of the facts have been stipulated, and the stipulated facts and accompanying exhibits are hereby incorporated by reference into our findings. At the time he filed his petition, petitioner resided in California.

Petitioner filed his 2001 Form 1040, U.S. Individual Income Tax Return, with respondent on March 3, 2004. On his return, petitioner reported receiving $18,312 in distributions from Wescom Credit Union in 2001. Petitioner also claimed deductions on Schedule A and Schedule C.

On Schedule A petitioner deducted, inter alia, (1) $35,256 for unreimbursed employee business expenses, specifically $20,159 for vehicle expenses, $4,450 for nonovernight travel expenses, $7,225 for overnight travel expenses, $1,654 for other business expenses, and $1,768 for meals and entertainment expenses; (2) $625 for tax preparation fees; (3) $1,500 for tax advice; and (4) $2,536 for job search expenses. On Schedule C he deducted, among other things, $6,410 for expenses related to pension and profit-sharing plans and $2,888 for depreciation and section 179 expenses.

On November 28, 2006, respondent issued a notice of deficiency to petitioner for his 2001 tax year. Petitioner filed a timely petition with this Court on February 26, 2007. Therein, he states that (1) "the company I was employed by was purchased by another company and has been unable to supply T & E policy for the year in question"; (2) he "had gone through a divorse [sic] and spouse at the time will not supply copies of important tax info in their care"; and (3) "Several personnal [sic] address changes as well as divorse [sic] and time passed caused some information to be misplaced". He also asserts that "any penalties due for any tax that may be due should be waived since there was no malace [sic] simply errors". A trial was held on May 7, 2008, in Los Angeles, California.


OPINION




I. Whether Petitioner is Entitled to Deductions Claimed on Schedules A and C
Deductions are a matter of legislative grace, and taxpayers bear the burden of proving entitlement to any claimed deductions. INDOPCO, Inc. v. Commissioner [ 92-1 USTC ¶50,113], 503 U.S. 79, 84 (1992). As part of their burden, taxpayers must substantiate the amount of their claimed deductions. A taxpayer is required to maintain records sufficient to establish the amount of any deduction claimed. Sec. 6001; sec. 1.6001-1(a), Income Tax Regs.

Even when a taxpayer is unable to substantiate the amount of a deduction, the Court may still allow the deduction, or a portion thereof, if there is an evidentiary basis for doing so. Cohan v. Commissioner [ 2 USTC ¶489], 39 F.2d 540, 543-544 (2d Cir. 1930); Vanicek v. Commissioner [ Dec. 42,468], 85 T.C. 731, 742-743 (1985). In those instances, the Court may estimate the allowable expense, bearing heavily if appropriate against the taxpayer whose inexactitude is of his or her own making. Cohan v. Commissioner, supra at 544. The Cohan rule does not apply, however, with respect to deductions that are subject to the strict substantiation requirements of section 274. Sec. 1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985).

Petitioner claimed a variety of deductions on his 2001 return, each of which has its own specific rules and requirements. Although we will address each of them in turn, petitioner is ultimately unable to establish entitlement to any of them because he has failed to provide any substantiating evidence.

A. Unreimbursed Employee Business Expenses

Section 162(a) authorizes a deduction for "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business". An expense is ordinary if it is normal or customary within a particular trade, business, or industry. Deputy v. du Pont [ 40-1 USTC ¶9161], 308 U.S. 488, 495 (1940). An expense is necessary if it is "appropriate and helpful" for the development of the business. Welch v. Helvering [ 3 USTC ¶1164], 290 U.S. 111, 113 (1933). Services performed as an employee generally constitute a trade or business for purposes of section 162(a). O'Malley v. Commissioner [ Dec. 45,008], 91 T.C. 352, 363-364 (1988). However, if an employee's expenses are reimbursable by his or her employer, those expenses are not necessary and cannot be deducted. Orvis v. Commissioner [ 86-1 USTC ¶9386], 788 F.2d 1406, 1408 (9th Cir. 1986), affg. [ Dec. 41,537(M)], T.C. Memo. 1984-533.

As mentioned, certain business expenses described in section 274(d) are subject to strict substantiation rules that supersede the Cohan rule. Sanford v. Commissioner [ Dec. 29,122], 50 T.C. 823, 827-828 (1968), affd. [ 69-2 USTC ¶9491], 412 F.2d 201 (2d Cir. 1969); sec. 1.274-5T(a), Temporary Income Tax Regs., supra. Section 274(d) applies to: (1) Any traveling expense, including meals and lodging away from home; (2) entertainment, amusement, and recreational expenses; (3) any expense for gifts; or (4) the use of listed property, as defined in section 280F(d)(4), including passenger automobiles. To deduct such expenses, the taxpayer must substantiate by adequate records or evidence sufficient to corroborate the taxpayer's own testimony: (1) The amount of the expenditure or use, which includes mileage in the case of automobiles; (2) the time and place of the travel, entertainment, or use; (3) its business purpose; and in the case of entertainment, (4) the business relationship to the taxpayer of each expenditure or use. Sec. 274(d) (flush language).

B. Tax Preparation Fees and Tax Advice

Section 212(3) provides that "there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year * * * in connection with the determination, collection, or refund of any tax."

C. Job Search Expenses

Section 162(a) allows a taxpayer to deduct expenses incurred in searching for new employment within the same trade or business. See Primuth v. Commissioner [ Dec. 29,985], 54 T.C. 374, 378-379 (1970); see also Murata v. Commissioner [ Dec. 51,448(M)], T.C. Memo. 1996-321. A deduction is not allowed for expenses incurred while seeking employment in a new trade or business. See Frank v. Commissioner [ Dec. 19,702], 20 T.C. 511, 513-514 (1953).

D. Employer Contributions to Pension or Profit-Sharing Plans

An employer's contributions to pension or profit-sharing plans are not deductible under section 404 unless they are deductible under section 162 as ordinary and necessary expenses. See Edwin's, Inc. v. United States [ 74-2 USTC ¶9669], 501 F.2d 675, 679 (7th Cir. 1974); sec. 1.404(a)-1(b), Income Tax Regs. Section 162(a)(1) allows as a deduction "a reasonable allowance for salaries or other compensation for personal services actually rendered".

E. Depreciation and Section 179 Expense

A taxpayer may elect to deduct as a current expense the cost, within certain dollar limitations, of any section 179 property that is used in an active trade or business and placed in service during the taxable year. Sec. 179(a), (b), (d)(1); see sec. 1.179-4(a), Income Tax Regs. The election must specify the total section 179 expense deduction claimed and the portion of that deduction allocable to each specific item. Sec. 179(c)(1); sec. 1.179-5(a), Income Tax Regs. The taxpayer must make a separate election for each taxable year, and such election must be made on the first income tax return for the taxable year to which the election applies. Sec. 179(c)(1)(B); sec. 1.179-5(a), Income Tax Regs. The taxpayer must also maintain records reflecting how and from whom the section 179 property was acquired and when it was placed in service. Sec. 1.179-5(a), Income Tax Regs. A taxpayer who fails to make the election is not entitled to section 179 treatment. See Jackson v. Commissioner, T.C. Memo. 2008-70; Visin v. Commissioner [ Dec. 55,269(M)], T.C. Memo. 2003-246, affd. 122 Fed. Appx. 363 (9th Cir. 2005).

F. Petitioner Failed to Substantiate the Amounts of the Deductions He Claimed on Schedules A and C

There is no evidence of record to substantiate any of petitioner's claimed deductions. Petitioner admits as much. At trial, he claimed that his accountant has the necessary evidence. In his petition, he asserts that his former spouse or the acquirer of his former employer has the evidence or that it was simply misplaced. Even assuming that substantiating evidence exists and is in the possession of third parties, petitioner has had ample time to collect it but has failed to do so. If the third parties were uncooperative, Rule 147 permitted petitioner to issue subpoenas duces tecum that would have required third parties to appear at trial and bring written records. In addition, there is no indication that petitioner made an election under section 179.

Petitioner sought a continuance only days before the trial session ostensibly to permit him to locate the documents necessary to substantiate his deductions. Because petitioner had in respondent's opinion not cooperated in the pretrial process, respondent opposed the continuance. The Court then denied the continuance but set the trial for a date 9 days later to provide petitioner time to locate his documents. Nevertheless, no documents were forthcoming at the trial. Accordingly, our conclusion is inescapable: Petitioner has failed to demonstrate entitlement to any of the deductions at issue. 2



II. Whether the $18,312 in Distributions Petitioner Received from Wescom Credit Union Should be Included in His Taxable Income
Section 63(a) generally defines taxable income as gross income minus deductions. Section 61(a) in turn specifies that, "Except as otherwise provided", gross income includes "all income from whatever source derived". Generally, income from annuities and pensions is included in gross income. Sec. 61(a)(9), (11). Section 72 further provides that distributions from qualified retirement plans are included in gross income. See secs. 72(a), 402(a).

In addition, a taxpayer who receives a distribution from a qualified retirement plan before attaining the age of 59-1/2 is generally subject to an additional 10-percent tax pursuant to section 72(t)(1) on the amount of the distribution unless the taxpayer can prove that an exception under section 72(t)(2) applies. See Bunney v. Commissioner [ Dec. 53,839], 114 T.C. 259, 265-266 (2000).

The Commissioner's determination of a deficiency is generally presumed correct, and the taxpayer bears the burden of proving that the determination is improper. See Rule 142(a); Welch v. Helvering, 290 U.S. at 115. Although section 7491(a) may shift the burden of proof to the Commissioner in specified circumstances, petitioner has not satisfied the prerequisites under section 7491(a)(1) and (2) for such a shift.

Petitioner concedes that he "[received] distributions from pensions and annuities in the amount of $18,312.00 in the 2001 taxable year from Wescom Credit Union." On his Federal income tax return, he reported receiving that amount as "Total IRA distributions", but he did not include it in his gross income. At trial, he stated that he invested the money into his business and that his accountant had told him that he would have losses to offset the distribution income. These are not reasons to exclude the distributions from petitioner's gross income, and petitioner has not otherwise met his burden of proving that respondent's determination of a deficiency is improper. Accordingly, we will sustain the deficiency determined by respondent with respect to the $18,312 in distributions received from Wescom Credit Union in 2001.

We will also sustain respondent's imposition of a 10-percent additional tax under section 72(t) for petitioner's early distributions from a qualified retirement plan. Petitioner does not dispute that he was under the age of 59-1/2 when he received the distributions and has not otherwise disputed the additional tax or shown that an exception under section 72(t)(2) applies.



III. Section 6651(a)(1) Addition to Tax
Respondent determined that petitioner was liable for an addition to tax under section 6651(a)(1). Section 6651(a)(1) imposes an addition to tax for failure to file a timely return unless the taxpayer proves that such failure is due to reasonable cause and not willful neglect. See United States v. Boyle [ 85-1 USTC ¶13,602], 469 U.S. 241, 245 (1985). Pursuant to section 7491(c), respondent has the burden of production with respect to this addition to tax and is therefore required to "come forward with sufficient evidence indicating that it is appropriate to impose the relevant penalty." See Higbee v. Commissioner [ Dec. 54,356], 116 T.C. 438, 446 (2001).

Petitioner concedes that he filed his 2001 Federal income tax return on March 3, 2004 --well beyond the April 15, 2002, due date. Moreover, he has not disputed the addition to tax or presented any evidence to suggest that his failure to file timely was due to reasonable cause. Accordingly, we shall sustain respondent's imposition of the addition to tax under section 6651(a)(1).



IV. Section 6662 Penalty
Respondent determined that petitioner was liable for a penalty under section 6662(a). Respondent bears the burden of production with respect to petitioner's liability for that penalty. See sec. 7491(c). This means that respondent "must come forward with sufficient evidence indicating that it is appropriate to impose the relevant penalty." Higbee v. Commissioner, supra at 446.

Section 6662(a) imposes an accuracy-related penalty of 20 percent of any underpayment that is attributable to one of the causes listed in subsection (b). One such cause is negligence or disregard of rules or regulations, with negligence including "any failure by the taxpayer to keep adequate books and records or to substantiate items properly." Sec. 6662(b)(1); sec. 1.6662-3(b)(1), Income Tax Regs. Another cause is any substantial understatement of income tax, defined for individuals as an understatement that exceeds the greater of (1) 10 percent of the tax required to be shown on the return for the taxable year or (2) $5,000. Sec. 6662(b)(2), (d)(1)(A).

There is an exception to the section 6662(a) penalty when a taxpayer can demonstrate (1) reasonable cause for the underpayment and (2) that the taxpayer acted in good faith with respect to the underpayment. Sec. 6664(c)(1). Regulations promulgated under section 6664(c) provide further that the determination of reasonable cause and good faith "is made on a case-by-case basis, taking into account all pertinent facts and circumstances." Sec. 1.6664-4(b)(1), Income Tax Regs.

Respondent asserts that petitioner is liable for the section 6662 penalty "because there has been a substantial understatement of income tax" and "because he acted with negligence and disregard of the rules." Respondent explains that petitioner "has failed to provide respondent with evidence that he maintained books or records".

On his 2001 return, petitioner indicated that the total tax due was $2,133. Respondent determined a deficiency of $12,789. Petitioner's understatement of tax is substantial under section 6662(d)(1)(A) because it exceeds $5,000 and is greater than 10 percent of the amount required to be shown on the return. Although petitioner argues in his petition that the penalties should be waived because he did not act with malice, he has not shown that he acted with reasonable cause or in good faith, which is the proper statutory test. Accordingly, we sustain respondent's determination that petitioner is liable for the section 6662(a) penalty for the 2001 tax year.

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

To reflect the foregoing,

Decision will be entered for respondent.

1 All section references are to the Internal Revenue Code of 1986, as amended an in effect for the tax year at issue. The Rule references are to the Tax Court Rules of Practice and Procedure.

2 At trial, the parties mentioned that petitioner may have reported his $6,410 deduction for pension and profit-sharing plans incorrectly and that he may have intended to claim that amount as a deduction for rental expenses for business, machinery, vehicles, and equipment. There is no evidence to substantiate that deduction either.

In addition, as a result of petitioner's failure to demonstrate entitlement to the deductions described above, a portion of his deduction for medical and dental expenses must be disallowed. Sec. 213(a) allows for the deduction of personal medical and dental expenses to the extent that they exceed 7.5 percent of the taxpayer's adjusted gross income (AGI). In light of our conclusion above, petitioner's AGI and 7.5-percent floor must be adjusted upward, which precludes petitioner from deducting the entire amount of medical and dental expenses reported on his 2001 return

Early distribution, additional tax. --Distributions From Retirement Plans: Early distribution, additional tax

The 10% tax against early withdrawals of pension and profit-sharing plan investments was properly treated as a penalty, not a tax, by the U.S. Bankruptcy Court in a Chapter 11 voluntary bankruptcy proceeding. The penalty was punitive in nature rather than compensatory, making the IRS's claim for payment of the tax from the bankrupt taxpayer ineligible for priority status vis-a-vis the claims of other creditors for payment from the taxpayer.

L.F. Cassidy, Jr., CA-10, 93-1 USTC ¶50,006, 983 F2d 161.

An estate in bankruptcy was liable for the 10% additional tax on amounts distributed to the estate from an IRA and a pension account of the debtor before the debtor reached age 59 1/2. After the petition in bankruptcy was filed, the estate succeeded to the IRA, which was not a taxable event. When the trustee subsequently invaded the IRA, the estate became liable for the penalty as well as for the income tax.

R.L. Kochell, CA-7, 86-1 USTC ¶9757, 804 F2d 84.

There was no premature distribution where instead of transferring funds from one investment fund to another, a bank erroneously transferred the proceeds to the taxpayer, who promptly forwarded the proceeds to the new fund.

K.L. Doing, 58 TC 115, Dec. 31,349 (Acq.).

A taxpayer constructively received the amount in his Keogh account when it was levied upon to pay his tax debt and the amount was includible in his income for that year. However, he was not liable for the premature distribution penalty since the withdrawal was not voluntary.

J. Larotonda, 89 TC 287, Dec. 44,115.

An individual was not liable for the 10% addition to tax despite early withdrawal from his IRA. The withdrawal resulted from a decree of forfeiture, and he never had control over or the use of the IRA distributions. He also had no realistic choice in the matter and did not voluntarily make the withdrawal. The reasoning in J. Larotonda, 89 TC 287, Dec. 44,115, above, was adopted.

F.A. Murillo, 75 TCM 1564, Dec. 52,515(M), TC Memo. 1998-13 (Acq.). Aff'd on another issue, CA-2 (unpublished opinion), 99-1 USTC ¶50,170.

A distribution to a participant in an employer's defined benefit pension plan, which was made solely on account of the plan's termination, was subject to the 10% additional income tax. The distribution was made before the employee reached age 59 1/2, and there was no evidence that it qualified under any other exception to imposition of the additional tax.

K.L. Clark, 101 TC 215, Dec. 49,278.

The transfer of a husband's lump-sum distribution from his qualified profit-sharing plan into individual retirement accounts established in his wife's name did not qualify as a tax-free rollover. The transfer subjected the husband to the 10% tax on an early distribution.

M. Rodoni, 105 TC 29, Dec. 50,765.

A stock trader suffering from clinical depression was not disabled within the definition of Code Sec. 72(m)(7) and was liable for the 10% additional tax on a premature withdrawal from his individual retirement account. The trader did not meet the definition of disabled because he was not prevented by his illness from engaging in any substantial gainful activity. The term substantial gainful activity was equated with an actual and honest objective of making a profit, which the trader was determined to have had, even though he lost a large part of the IRA withdrawal.

R.J. Dwyer, 106 TC 337, Dec. 51,340.

An individual was liable for the 10-percent additional tax on an early pension distribution because he could not establish that he qualified for an exception to the tax on account of being disabled. Although the individual received disability payments from an insurer, his uncorroborated testimony that he suffered from depression was insufficient to prove that he was disabled for purposes of the additional tax. No doctors testified on his behalf and no affidavits from medical professionals were presented.

W. Kowsh, 96 TCM 123, Dec. 57,525(M), TC Memo. 2008-204.

The 10% penalty on premature distributions applied to recipients who had not yet attained the age 59 1/2where the distribution proceeds were not rolled over into a qualified IRA. The IRA was not qualified because the purported trustee was not eligible to serve in that capacity. A letter from the IRS to the individual approved an amendment to the form of the IRA trust; it did not approve him to serve as the IRA trustee. Furthermore, the letter was addressed to a financial services company, not to the individual or the trust.

G.J. Schoof, 110 TC 1, Dec. 52,501.

A married couple failed to carry their burden of proving that the lump-sum distribution they received, upon termination of the 38-year-old account executive's employment, was from a source other than a qualified retirement plan to which a 10% additional tax on early distributions was applicable. The taxpayer did not roll over any part of the distribution received into an IRA or other qualified plan, nor did he introduce evidence to support his contentions that the money came from either a discriminatory plan or an incentive stock option plan.

T.M. Riffey, 64 TCM 289, Dec. 48,379(M), TC Memo. 1992-426.

A laid-off employee who elected to defer distribution of his benefits from a qualified retirement plan was liable for the 10% early distribution penalty. Although he made the irrevocable election before the penalty was enacted, the provision was effective by the time the taxpayer received his deferred distribution. The taxpayer fell outside of the fail-safe period provided by the transitional rules that accompanied the penalty and, therefore, could not avoid the additional 10% tax.

R.V. Panos, 64 TCM 542, Dec. 48,435(M), TC Memo. 1992-474.

Similarly.

H.D. Dean, 65 TCM 2757, Dec. 49,055(M), TC Memo. 1993-326.

The recipient of two distributions from his profit-sharing plan representing his balance in the plan was not subject to the early withdrawal penalty on the first distribution, which was treated as received prior to the effective date of the early withdrawal penalty. However, he was subject to the penalty with respect to the second distribution because it was received after the effective date of the penalty. The first distribution was treated as having been received in the year of the taxpayer's separation from service under a transitional rule.

D.A. Samonds, 66 TCM 235, Dec. 49,175(M), TC Memo. 1993-329.

An individual who suffered from depression was liable for the 10% penalty on premature distributions from qualified plans that he received over a two-year period. Although the individual's depression had diminished his ability to earn a living, he had not established that his condition was irremediable.

P.A. Kovacevic, 64 TCM 1076, Dec. 48,580(M), TC Memo. 1992-609.

An individual who received a distribution from the qualified retirement plan of a company that discontinued its operations was liable for the 10% additional tax on early distributions. The tax applied even though the distribution was subject to the "separate" tax under Code Sec. 402(e). The word "separate" appears under Code Sec. 402(e) to distinguish it from the tax imposed under Code Sec. 402(a). The tax on early distributions under Code Sec. 72(t) is an "additional tax" because it is a tax in addition to the taxes imposed under Code Sec. 402.

G. Bullard, 65 TCM 1844, Dec. 48,845(M), TC Memo. 1993-39.

A couple who utilized funds from their individual retirement account to make a down payment on a home intended for use as a personal residence during their retirement years received a taxable distribution and was liable for the penalty for early withdrawals.

G.M. Harris, 67 TCM 1983, Dec. 49,624(M), TC Memo. 1994-22.

An individual was taxable and subject to the 10% penalty on early distributions on amounts he withdrew from his profit-sharing plan to use as a down payment on a home when he was relocated by his employer. No portion of the withdrawn amount was rolled over into another retirement account. The taxpayer's investment in a house with a 30-year mortgage was not akin to a retirement account.

S.M. Grow, 70 TCM 1576, Dec. 51,056(M), TC Memo. 1995-594.

An individual, who withdrew funds from a qualified retirement plan consisting of his after-tax contributions and earnings on such contributions, had to include in gross income the amount received, except to the extent attributable to his contributions. The taxpayer's investment of the withdrawn funds in a personal residence did not constitute a transfer to an eligible retirement plan pursuant to Code Sec. 402(a)(5)(A)(ii). Accordingly, the taxpayer was liable for the Code Sec. 72(t) 10% additional tax on the portion of the withdrawal includible in gross income because none of the specifically enumerated exceptions applied.

T.W. Coffield, 72 TCM 338, Dec. 51,494(M), TC Memo. 1996-365.

A retiree who made an irrevocable election within the requisite 60-day period to roll over the taxable amount of a qualified total distribution from a qualified pension plan into an individual retirement account, but who then withdrew that amount from the IRA six months later, was liable for the 10% tax on early distributions.

S.O. Barnes, 67 TCM 2341, Dec. 49,707(M), TC Memo. 1994-95.

A couple was liable for an additional amount of tax and penalties because they had not included distributions from their qualified IRA in their gross income for the tax year in question. The amounts withdrawn by the wife to pay household expenses after her husband became disabled did not meet any of the enumerated exceptions of Code Sec. 72(t). Furthermore, the couple failed to produce any evidence to support their contention that the amounts received were not subject to Code Secs. 408(d)(1) and 72(t)(1).

W.P. Boulden, Jr., 70 TCM 216, Dec. 50,788(M), TC Memo. 1995-347. Aff'd, per curiam, CA-4, 96-1 USTC ¶50,127. Cert. denied, 10/7/96.

A married couple who received a lump-sum distribution from the wife's qualified retirement plan was taxable on the distribution in the year of receipt and was liable for the 10% additional tax on early plan distributions. The wife did not roll over the funds into another qualified plan and the couple failed to demonstrate that any exceptions to the penalty applied.

T.L. Hobson, 71 TCM 3172, Dec. 51,396(M), TC Memo. 1996-272.

A self-employed insurance agent who participated in a simplified employee pension plan and a Keogh plan was liable for the 10% additional tax imposed under Code Sec. 72(t) on early distributions from the qualified retirement plans. Even though the taxpayer made the early withdrawals due to financial hardship, none of the exceptions to the Code Sec. 72(t) penalty applied to him. The court rejected the taxpayer's argument that the limited exceptions to the penalty violated his constitutional right of equal protection. The taxpayer failed to prove that the omission in the statute of an exception from the penalty for financial hardships, as opposed to those resulting from death and disability, was not reasonable and, therefore, that the statute was unconstitutional. The Tax Court, a court of limited jurisdiction and lacking equitable powers, rejected the taxpayer's argument that Code Sec. 72(t) was contrary to public policy and inequitable.

B.A. Pulliam, 72 TCM 307, Dec. 51,481(M), TC Memo. 1996-354.

The amount of an individual's withdrawal from a qualified individual retirement account (IRA) was includible in his gross income and he was liable for an additional 10% tax on the early distribution. The individual's alleged transfer of the funds to a foreign bank did not qualify him to exclude the withdrawal as a rollover contribution. He did not prove that the amount transferred included the amount withdrawn from the IRA, and he failed to establish that the transfer was made into another qualified IRA.

D.W. Chiu, 73 TCM 2679, Dec. 52,018(M), TC Memo. 1997-199.

Taxpayers were liable for the 10% additional tax on premature distributions received from qualified retirement plans or IRAs. They did not fall within any of the exceptions to the additional tax.

F.R. Edwards, 64 TCM 728, Dec. 48,505(M), TC Memo. 1992-540. Aff'd, vac'd and rem'd, CA-4 (unpublished opinion 9/21/94).

Similarly.

C. Simmons, 67 TCM 2979, Dec. 49,853(M), TC Memo. 1994-222.

M.E. Huff, 68 TCM 674, Dec. 50,113(M), TC Memo. 1994-451.

J.E. Copley, 70 TCM 1040, Dec. 50,956(M), TC Memo. 1995-501.

K.F. Marason, 71 TCM 1690, Dec. 51,109(M), TC Memo. 1996-7. Aff'd on other issues, CA-9 (unpublished opinion), 97-2 USTC ¶50,590.

A. Malesa, 72 TCM 495, Dec. 51,527(M), TC Memo. 1996-396.

J.A. Robinson, 72 TCM 1320, Dec. 51,661(M), TC Memo. 1996-517.

C. Swaim, 72 TCM 1501, Dec. 51,691(M), TC Memo. 1996-545.

A.P. Duffy, 72 TCM 1552, Dec. 51,702(M), TC Memo. 1996-556.

D.J. Dickerson Est., 73 TCM 2506, Dec. 51,978(M), TC Memo. 1997-165.

W.L. Reese, 74 TCM 232, Dec. 52,175(M), TC Memo. 1997-346.

A.R. Cujas, Jr., 74 TCM 298, Dec. 52,194(M), TC Memo. 1997-363.

W.S. Bach, 75 TCM 1722, Dec. 52,553(M), TC Memo. 1998-47. Aff'd, per curiam, CA-4 (unpublished opinion), 99-1 USTC ¶50,550.

R.E. Dunham, 75 TCM 1739, Dec. 52,561(M), TC Memo. 1998-52.

H.E. Villarroel, 76 TCM 43, Dec. 52,781(M), TC Memo. 1998-247. Aff'd, CA-6 (unpublished opinion), 2000-1 USTC ¶50,176.

D.R. Edmonds, 76 TCM 710, Dec. 52,925(M), TC Memo. 1998-379.

R.H. Schmalzer, 76 TCM 803, Dec. 52,948(M), TC Memo. 1998-399.

D.E. Conway, 111 TC 350, Dec. 53,010.

T.M. Peaslee, 77 TCM 1195, Dec. 53,207(M), TC Memo. 1999-4.

M.J. Roman, CA-11 (unpublished opinion), 99-1 USTC ¶50,458, aff'g, per curiam, an unreported Tax Court decision.

C.L. Udoh, 77 TCM 2056, Dec. 53,392(M), TC Memo. 1999-174.

M.M. Morin, 78 TCM 127, Dec. 53,466(M), TC Memo. 1999-240.

A. Tinsman, 79 TCM 1529, Dec. 53,758(M), TC Memo. 2000-55. Aff'd, per curiam, CA-8 (unpublished opinion), 2001-2 USTC ¶50,572.

P.L. Hart, 79 TCM 1619, Dec. 53,787(M), TC Memo. 2000-78. Aff'd, CA-9 (unpublished opinion), 2001-2 USTC ¶50,584.

R.J. Robertson, 79 TCM 1725, Dec. 53,813(M), TC Memo. 2000-100. Aff'd, CA-9 (unpublished opinion), 2001-2 USTC ¶50,567.

M.G. Bunney, 114 TC 259, Dec. 53,839.

A.F. Emerson, 79 TCM 1921, Dec. 53,854(M), TC Memo. 2000-137.

S.R. Jones, 80 TCM 76, Dec. 53,957(M), TC Memo. 2000-219.

A.P. Gallagher, 81 TCM 1149, Dec. 54,242(M), TC Memo. 2001-34.

C.W. Plotkin, 81 TCM 1395, Dec. 54,285(M), TC Memo. 2001-71.

M.T. Chappell, 81 TCM 1781, Dec. 54,375(M), TC Memo. 2001-146.

W. Machen, FedCl, 2001-2 USTC ¶50,606.

D.A. Rayner, 83 TCM 1161, Dec. 54,635(M), TC Memo. 2002-30. Aff'd, per curiam, on another issue, CA-5 (unpublished opinion), 2003-2 USTC ¶50,552

L.B. Williams, 85 TCM 1113, Dec. 55,105(M), TC Memo. 2003-97. Aff'd on another issue, CA-10 (unpublished opinion), 2005-1 USTC ¶50,163.

M.A. Cabirac, 120 TC 163, Dec. 55,124.

M. Vulic, 87 TCM 1036, Dec. 55,560(M), TC Memo. 2004-51.

R. Wos, 86 TCM 138, Dec. 55,245(M), TC Memo. 2003-223. Aff'd on another issue, CA-7 (unpublished opinion), 2005-1 USTC ¶50,363.

N.A. Cohen, 88 TCM 330, Dec. 55,769(M), TC Memo. 2004-227.

A.F. Millard, 90 TCM 136, Dec. 56,115(M), TC Memo. 2005-192.

S.A. Cole, 91 TCM 888, Dec. 56,450(M), TC Memo. 2006-44.

T.J. Jordan, 91 TCM 1129, Dec. 56,509(M), TC Memo. 2006-95.

D. Cote, 91 TCM 1288, Dec. 56,548(M), TC Memo. 2006-129.

B.K. Bhattacharyya, 93 TCM 711, Dec. 56,820(M), TC Memo. 2007-19.

S.A. Lewis, CA-9, 2008-1 USTC ¶50,317, 523 F3d 1272.

C.L. Belmont, 93 TCM 1034, Dec. 56,873(M), TC Memo. 2007-68.

M.A. Jackson, 93 TCM 1211, Dec. 56,929(M), TC Memo. 2007-116.

G.E. Thompson, 94 TCM 430, Dec. 57,158(M), TC Memo. 2007-327.

M. Cabirac, 95 TCM 1555, Dec. 57,453(M), TC Memo. 2008-142.

H.T. Huynh, 95 TCM 1111, Dec. 57,330(M), TC Memo. 2008-27.

J.R. Banister, 96 TCM 114, Dec. 57,522(M), TC Memo. 2008-201.

The distribution of IRA proceeds from a state agency as receiver of an insolvent financial institution was includible in the taxpayers' gross income as premature IRA distributions. Because the taxpayers were not age 59 1/2when the received the funds and did not reinvest them in other IRAs within 60 days of receipt of the funds, they were liable for the additional 10% tax under Code Sec. 72(t).

A.J. Aronson, 98 TC 283, Dec. 48,076.

Followed.

S.N. Swihart, 76 TCM 855, Dec. 52,956(M), TC Memo. 1998-407.

A distribution from an individual's individual retirement account to his former spouse in satisfaction of a judgment for arrearages in child support payments was subject to the additional tax imposed by Code Sec. 72(t) because the individual failed to establish that any of the statutory exceptions applied.

M.J. Vorwald, 73 TCM 1697, Dec. 51,816(M), TC Memo. 1997-15.

The entire lump-sum distribution from a qualified pension plan to an individual upon his termination of employment was taxable to him because no amounts were excludable as payments made pursuant to a qualified domestic relations order. Therefore, the entire distribution was subject to the 10% tax on early distributions from a qualified retirement plan.

J.L. Burton, 73 TCM 1729, Dec. 51,822(M), TC Memo. 1997-20.

A commercial airline pilot who suffered from respiratory problems and high blood pressure and who voluntarily retired was subject to the additional 10% tax on early distributions from his retirement pension plan because he was not disabled within the meaning of Code Sec. 72(m)(7). The pilot did not attach to his amended return that claimed a refund for the 10% tax a physician's statement substantiating his physical condition.

G. Black, BC-DC Tex., 97-1 USTC ¶50,297, 204 BR 701.

Funds received by an individual from an employer-provided pension plan and an individual retirement account were subject to the 10% additional tax on early distributions absent proof that the distributions were attributable to his being disabled. The taxpayer, who was a Christian Scientist, offered no medical evidence of his disability.

R.C. Fohrmeister, 73 TCM 2483, Dec. 51,971(M), TC Memo. 1997-159.

A distribution from a law firm partnership's salary reduction plan was includible in the income of a terminating attorney. He was subject to the additional 10% tax for early distributions because none of the distribution was rolled over to another qualified pension plan within 60 days of receipt. Also, the distribution represented the attorney's balance in the plan less the amount of unpaid funds borrowed from the plan. Moreover, equitable principles did not entitle the attorney to leniency because he was properly notified of cancellation of the promissory note he executed when he borrowed funds from the plan.

S.E. Scott, 74 TCM 1157, Dec. 52,348(M), TC Memo. 1997-507. Aff'd, per curiam, CA-5 (unpublished opinion), 99-2 USTC ¶50,619.

An additional 10% early withdrawal tax was imposed on an individual who realized taxable income on a lump-sum distribution directly to him from his company's profit-sharing retirement plan because he had not attained the age of 59 1/2at the time of the distribution.

B.L. Moon, FedCl, 97-2 USTC ¶50,668.

Individuals who received loans that were not bona fide from their qualified profit-sharing plan were automatically liable for the 10% additional tax on premature distributions from qualified retirement plans. They offered no evidence or arguments in support of the application of any of the exceptions to the additional tax.

B. Patrick, 75 TCM 1629, Dec. 52,534(M), TC Memo. 1998-30. Aff'd, per curiam, CA-6 (unpublished opinion), 99-1 USTC ¶50,532.

Part of the premature distributions from an individual retirement account made to a member of an American Indian Tribe consisted of nondeductible employee contributions and were nontaxable. However, a portion of the distribution was net income attributable to contributions to the account in the year at issue and was includible in gross income and subject to the premature distribution tax. The remainder of the taxpayer's distribution after determination of the nontaxable amount was income subject to the 10% premature distribution tax and was to be determined in a Rule 155 computation.

R.A. Hall, 76 TCM 473, Dec. 52,881(M), TC Memo. 1998-336.

An additional individual retirement account (IRA) distribution received by a taxpayer less than five years after beginning a series of substantially equal periodic payments was an impermissible modification that triggered application of the 10% recapture tax on early withdrawals. The distribution was received within the five-year period that began on the date of the first payment, in violation of Code Sec. 72(t)(4). In addition, the taxpayer failed to prove that the distribution was part of a permissible cost of living adjustment. Finally, although there was some evidence that the distribution was made as a result of sudden financial hardship, there is no hardship exception to the recapture tax.

R.C. Arnold, 111 TC 250, Dec. 52,888.

The 10% additional assessment against an early withdrawal from a qualified retirement account was not discharged in married debtors' bankruptcy proceeding. Although the assessment was in the nature of a penalty rather than a tax, it was a nondischargeable penalty under Sec. 523(a)(8) of the Bankruptcy Code. Therefore, post-discharge collection efforts by the IRS did not violate the discharge injunction.

D. Mounier, BC-DC Calif., 98-2 USTC ¶50,833.

Lump-sum distributions received by two federal employees under the alternative annuity option of the Civil Service Retirement System were subject to the Code Sec. 72(t) 10% additional tax on early distributions. The distributions were not part of a series of substantially equal periodic payments made for the lives of the employees. Also, they were not payments made as an annuity but, rather, were payments made under an annuity contract. The imposition of the 10% additional tax was not in direct conflict with the statutory scheme of the Civil Service Retirement Act (CSRA). The CSRA provisions for early retirement simply mean that the employees may retire at age 50 without having the amount of their CSRA annuities reduced because of their retirement age. Further, by electing the alternative annuity, they received their full retirement benefits, and they chose to receive part of the unreduced benefits as an early distribution.

R.L. Siano, DC Pa., 96-2 USTC ¶50,661.

A retired federal employee who received an accelerated distribution of annuity payments from the Civil Service Retirement System (CSRS) was liable for the 10% additional tax on early plan distributions. The CSRS constituted a "qualified retirement plan" and none of the statutory exemptions to the liability for the 10% tax were applicable to the CSRS.

E.D. Roundy, CA-9, 97-2 USTC ¶50,625, 122 F3d 835.

A teacher's refund distribution, which resulted from his transfer from a state retirement system to a state pension system, was subject to the 10% additional tax on early distributions from a qualified retirement plan. The teacher had not attained age 59 1/2at the time of the refund and no exceptions to liability applied.

L.B. Wheeler, 66 TCM 1444, Dec. 49,434(M), TC Memo. 1993-561.

Similarly.

R.J. O'Connor, 67 TCM 2708, Dec. 49,795(M), TC Memo. 1994-70.

L.H. Dorsey, 69 TCM 2041, Dec. 50,508(M), TC Memo. 1995-97. Appeal dism'd on another issue, CA-4 (unpublished opinion), 96-2 USTC ¶50,355.

W.H. Huebl, 69 TCM 2264, Dec. 50,551(M), TC Memo. 1995-134.

H.L. Humberson, 70 TCM 886, Dec. 50,923(M), TC Memo. 1995-470.

G.L. Wittstadt, Jr., 70 TCM 994, Dec. 50,945(M), TC Memo. 1995-492.

R.B. Ross, 70 TCM 1596, Dec. 51,063(M), TC Memo. 1995-599.

R.J. Montgomery, 71 TCM 3154, Dec. 51,387(M), TC Memo. 1996-263. Aff'd sub nom. A.R. Powell, CA-4, 97-2 USTC ¶50,820.

J.G. Thompson, 71 TCM 3160, Dec. 51,390(M), TC Memo. 1996-266.

P.J. Conway, DC Md., 96-1 USTC ¶50,041, 908 FSupp 292.

A disabled, retired engineering technician for a state (Maryland) highway administration, who received a transfer refund as a result of his transfer from a state employees' retirement system to a state employees' pension system, was not liable for the 10% additional tax imposed on early distributions from qualified retirement plans because the distribution was rolled over into an individual retirement account (IRA).

J.M. Brown, 72 TCM 651, Dec. 51,556(M), TC Memo. 1996-421.

The district court properly determined that a lump-sum payment of pension benefits made to a retired police officer was subject to the 10% tax imposed on early distributions from qualified retirement plans. Although the taxpayer conceded that the retirement system was a qualified plan, he contended that the benefit was attributable to an arbitration award that eliminated age requirements and provided benefits based on length of service that was exempt from Code Sec. 72(t). The fact that the distribution involved benefits that arose from the arbitration award, rather than from the state's retirement system, however, did not mean that the distribution did not come "from a qualified plan." Under state (Pennsylvania) law, the arbitration award was an inseparable part of the retirement plan, and it was not an independent contractual obligation.

W.T. Kute, CA-3, 99-2 USTC ¶50,853, 191 F3d 371.

An individual who failed to timely elect income averaging of a lump-sum distribution that she received from her employer's qualified retirement plan due to her separation from service was subject to the additional tax on early withdrawals that was in effect at the time she received it.

I.H. Dzuris, FedCl, 99-2 USTC ¶50,780, 44 FedCl 452. Aff'd, per curiam, CA-FC (unpublished opinion), 2000-1 USTC ¶50,348.

A taxpayer who initiated, received, and controlled the withdrawals from an individual retirement account in order to pay his ex-wife pursuant to a family court order was liable for the 10% addition to tax on early distributions of retirement income because he failed to show that he qualified for any statutory exceptions.

R.D. Czepiel, 78 TCM 378, Dec. 53,523(M), TC Memo. 1999-289. Aff'd without discussion, CA-1, 2001-1 USTC ¶50,134.

R.C. Baas, 83 TCM 1744, Dec. 54,758(M), TC Memo. 2002-130.

An individual who received a distribution from an individual retirement account (IRA) prior to attaining age 59 1/2, and who did not roll those funds over into another qualified IRA, was liable for the 10% premature distribution penalty. Although her purported reliance on erroneous advice obtained from IRS employees was unfortunate, that advice did not have the force of law. Further, she was not relieved of liability for the additional tax based on her present financial hardship because there is no financial hardship exception to Code Sec. 72(t).

L. Deal, 78 TCM 638, Dec. 53,597(M), TC Memo. 1999-352.

The retroactive imposition of a 10% additional tax for married taxpayers' nonqualified withdrawal from the husband's Roth IRA did not violate either the Fifth or Eighth Amendment of the U.S. Constitution. Congress clearly did not intend to exempt nonqualified withdrawals from newly converted Roth IRAs from the 10% additional tax. Application of Code Sec. 72(t) to the taxpayers' situation did not violate the Excessive Fines Clause of the Eighth Amendment since the imposition of the tax was not a punishment. Although the husband's withdrawal from his rolled-over Roth IRA subjected him to the 10% additional tax, it violated no law and, as the taxpayers recognized, was not a criminal offense.

D.Q. Kitt, CA-FC, 2002-1 USTC ¶50,167, 277 F3d 1330.

A separated individual was not liable for taxes or the early distribution penalty on income associated with distributions from an IRA held by her husband. Despite the fact that the couple resided in a community property state and had no matrimonial agreement opting out of the community property regime, distributions from the IRA to the husband were not attributable to the wife as community property under the guidelines of Code Sec. 408(g).

A.C. Morris, 83 TCM 1104, Dec. 54,620(M), TC Memo. 2002-17.

Early distributions that married taxpayers received from retirement annuity contracts which were used as collateral to obtain a personal loan were includible in income and subject to an early distribution penalty. There was no dispute that the funds were actually withdrawn as a result of the taxpayers' default, or that Code Sec. 72(p)(1) applied. Therefore, the IRS did not err in assessing taxes as a result of the transaction.

L. Armstrong, CA-8, 2004-1 USTC ¶50,238.

A divorced individual did not qualify for an exception from the early retirement withdrawal penalty for retirement distributions that he used to satisfy the terms of his divorce decree. The taxpayer failed to establish that the retirement distributions were received pursuant to a qualified domestic relations order.

E.A. Bougas III, Dec. 55,212(M), TC Memo. 2003-194.

An individual was required to include unreported retirement distributions in income. The record demonstrated that the taxpayer received distributions from his retirement fund, which he used to purchase a bank certificate of deposit that was cashed out shortly thereafter. The court rejected the taxpayer's claim that he rolled over the funds to an eligible retirement plan. Because the taxpayer was required to include the distributions in income, he was liable for the 10-percent addition to tax on premature retirement distributions.

J.C. Jensen, 86 TCM 293, Dec. 55,272(M), TC Memo. 2003-249.

A divorced husband who used a premature plan distribution to pay a money judgment to his ex-wife that was acknowledged in their divorce decree was liable for the 10 percent additional tax on the early distribution. His contention that his wife was an alternate payee who should bear the burden of the additional tax was rejected. The funds were disbursed by the plan administrator directly to the husband as his sole and separate property. Moreover, the divorce decree did not constitute a qualified domestic relations order within the meaning of the Code Sec. 72(t)(2)(C) exception to the additional tax.

R.S. Simpson, I, 86 TCM 470, Dec. 55,325(M), TC Memo. 2003-294.

An individual did not qualify under Code Sec. 72(t)(2)(B) for the exception to the 10 percent early withdrawal penalty for her premature retirement plan distributions. The taxpayer failed to present sufficient evidence that she used the premature distributions for medical care.

G. Berry, 87 TCM 812, Dec. 55,512(M), TC Memo. 2004-11.

An individual was subject to the 10-percent early distribution penalty resulting from a distribution of funds from his employer-sponsored pension plan. The taxpayer's claim that the issuing bank withheld the 10-percent tax from the gross amount of the withdrawal was rejected.

F.J. Mendes, 121 TC 308, Dec. 55,372.

The additional 10-percent tax imposed on early distributions from qualified retirement plans applied to a distribution to a 53-year-old taxpayer despite his contentions of hardship. The taxpayer argued that the imposition of the 10-percent tax would cause him undue hardship due apparently to the loss of his job and his wife's inability to work due to medical problems. The Tax Court found no support from any relevant authorities for the taxpayer's argument which it dubbed "an umbrella hardship exception applicable on a case-by-base basis."

J.J. Milner, 87 TCM 1287, Dec. 55,629(M), TC Memo. 2004-111.

An individual who had a digestive disorder, resigned her position and received an IRA distribution was liable for the 10-percent additional tax on premature distributions. The former employee did not establish that she met the disability exception under Code Sec. 72(t)(2)(iii). She failed to show that she was incapable of engaging in any substantial gainful activity as defined in Code Sec. 72(m)(7).

M.E. Robertson, 88 TCM 294, Dec. 55,758(M), TC Memo. 2004-217.

The taxpayer did not qualify for the exception to the 10-percent penalty for early withdrawals because his spouse was disabled. The exception for a disability applies only to an employee or participant of a qualified pension plan. The wife was not a vested participant of the plan by virtue of state community property laws.

M.J. Barkley, 88 TCM 634, Dec. 55,832(M), TC Memo. 2004-287.

The 10-percent additional tax on early distributions from qualified retirement plans did not apply to the taxable portion of a distribution from the 401(k) plan of the taxpayer's former spouse. The taxpayer was an alternate payee pursuant to a qualified domestic relations order and Code Sec. 72(t)(2)(C) provides an exception from the penalty for distributions to such alternate payees. However, the penalty was imposed with respect to an early distribution received by the taxpayer from her own 401(k) plan.

L.D. Seidel, 89 TCM 972, Dec. 55,977(M), TC Memo. 2005-67.

Taxpayers were subject to the 10-percent additional tax for an early pension distribution because the distribution could not qualify for the exception for higher education expenses. Although the 10-percent additional tax does not apply to distributions from individual retirement plans for higher education expenses, for these purposes an individual retirement plan is defined as an individual retirement account or individual retirement annuity. The distribution in this case was from a section 401(k) account, which is separate and distinct from classification within the IRA category, and such a distribution would not qualify for the exception.

H. Uscinski, 89 TCM 1337, Dec. 56,040(M), TC Memo. 2005-124.

A taxpayer who used part of an early distribution from her individual retirement account to pay down her credit card debts, which were incurred to pay qualified higher education expenses for two years prior to the distribution, was subject to the 10-percent penalty. The higher education expense exception under Code Sec. 72(t)(2)(E) requires that qualified expenses be incurred in the tax year of the distribution

L.L. Lodder-Beckert, 90 TCM 4, Dec. 56,082(M), TC Memo. 2005-162.

The unpaid balance of an individual's qualified retirement plan loan was a taxable distribution subject to the early distribution penalty in the year the taxpayer failed repay the loan, not in the year that the loan was made. In addition, the taxpayer's medical expenses for the year that the loan was made could not be applied to reduce the taxable amount of the distribution because those expenses were not "paid during the taxable year" of the distribution, which was a subsequent tax year.

S.A. Duncan, 90 TCM 35, Dec. 56,093(M), TC Memo. 2005-171.

An individual was liable for the penalty for early withdrawal from a qualified retirement plan because she had not yet attained the age of 59 1/2at the time of withdrawal. She was not eligible for the disability exception since her medical condition did not prevent her from substantial gainful activities.

J.M. Thomas, 90 TCM 477, Dec. 56,187(M), TC Memo. 2005-258.

A taxpayer who received early distributions from certain Code Sec. 403(b) retirement annuity accounts was subject to the 10-percent tax imposed by Code Sec. 72(t). Because the accounts were funded by a Code Sec. 501(c)(3) organization, the taxpayer argued that her distributions were subject to Code Sec. 72(q) and, therefore, avoided the penalty. However, Code Sec. 72(t)(1) explicitly imposes early withdrawal penalties on retirement accounts established and funded by Code Sec. 501(c)(3) organizations.

E. D. Mitchell, 91 TCM 1172, Dec. 56,516(M), TC Memo. 2006-101.

A distribution from an individual's retirement fund was taxable income since he used it to purchase gold coins, rather than rolling it over into another retirement plan. The ten-percent early distribution penalty was properly imposed because he had not reached age 59-1/2 when the distribution was made.

R.L. Minteer, CA-9 (unpublished opinion), 2006-1 USTC ¶50,353, 168 FedAppx 790 , aff'g an unreported Tax Court opinion.

A taxpayer who rolled over a distribution from her deceased husband's individual retirement account (IRA) into her separate IRA, and subsequently received an early distribution from her IRA, was liable for the 10-percent additional tax. The taxpayer argued that the distribution was an amount received as a distribution to a beneficiary upon a decedent's death and, therefore, was exempt from the 10-percent additional tax under Code Sec. 72(t)(2)(A)(ii). However, the amount received by the taxpayer from her deceased husband's IRA lost its character as a distribution to a beneficiary upon a decedent's death when she rolled over the funds into her separate IRA. Once the taxpayer chose to roll over the funds into her own IRA, the source of the funds became irrelevant and she lost the ability to qualify for the exception from the 10-percent additional tax on early distributions.

C. Gee, 127 TC 1, Dec. 56,568.

An individual who received an early distribution from her IRA was subject to the 10-percent additional tax on the taxable amount of the distribution. The distribution did not qualify for the qualified education exception because the taxpayer did not establish that she paid any of her son's educational expenses in the year she received the early distribution.

R.F. Duronio, 93 TCM 1112, Dec. 56,901(M), TC Memo. 2007-90.

An individual failed to show that the distributions from a retirement plan were loans that satisfied the exemption requirements of Code Sec. 72.

T.J. Jordan, 91 TCM 1129, Dec. 56,509(M), TC Memo 2006-95. Aff'd per curiam, CA-1 (unpublished opinion) 2007-2 USTC ¶50,606.

An individual received early distributions from qualified plans was subject to a 10-percent addition to tax.

A.B. Rhodes, Jr., 94 TCM 109, Dec. 57,024(M), TC Memo. 2007-206.

An attorney was liable for the 10-percent additional tax on an early distribution from an individual retirement account plan because he failed to qualify for any of the statutory exceptions. The use of the distribution to pay his son's secondary educational expenses did not qualify for the higher education expense exception because the high school was not an eligible educational institution as defined in Code Sec. 529(e)(5). The evidence did not show that the taxpayer used any of the distribution to pay medical expenses as he claimed or that the distribution qualified for any other exception to the penalty.

D.B. Nolan, 94 TCM 378, Dec. 57,134(M), TC Memo. 2007-306.

Guidance is provided as to the taxation under Code Sec. 72(t) on early distributions from qualified retirement plans.
[Full Text Excerpts --Notice 87-13]

* * *


Until further guidance is published, the guidance provided by these questions and answers may be relied on by taxpayers to design and administer plans and to determine the tax treatment of plan contributions and distributions.

D. New Section 72(t) of the Code ( Section 1123 of TRA '86)

Q-20: What additional tax on early distributions from qualified plans applies under section 72(t) (as added by TRA '86)?

A-20: Section 72(t) (as added by TRA '86) applies an additional tax equal to 10% of the portion of any "early distribution" from a qualified retirement plan (as defined in section 4974(c) of the Code) that is includible in the taxpayer's gross income. A distribution (including deemed distributions under section 72(p)) is treated as an "early distribution" unless it is described in section 72(t)(2)(A) (taking into account section 72(t)(3) & (4)). A distribution to an employee from a qualified plan will be treated as within section 72(t)(2)(A)(v) if (i) it is made after the employee has separated from service for the employer maintaining the plan and (ii) such separation from service occurred during or after the calendar year in which the employee attained age 55.

A distribution that is an "early distribution" will not be subject to the additional tax to the extent provided under section 72(t)(2)(B) (relating to deductible medical expenses under section 213), section 72(t)(2)(C) (relating to certain distributions from employee stock ownership plans), or section 72(t)(2)(D) (relating to distributions pursuant to qualified domestic relations orders). The determination of whether the additional tax under section 72(t) applies to a distribution is to be made without regard to whether the distribution is treated as a mandatory distribution for purposes of section 411(a)(11) or section 417(e).

The payor (or, if applicable, plan administrator) is not liable under section 3405 to withhold any amount on account of the additional income tax imposed under section 72(t). However, the taxpayer may have estimated tax liability with respect to such additional income tax.

Notice 87-13, 1987-1 CB 432, modified by Notice 98-49, 1998-2 CB 365.

The IRS has provided guidance regarding the definition of substantially equal payments for purposes of avoiding the Code Sec. 72(t) 10% additional tax on early withdrawals. [See ¶6140.0686.]

Notice 89-25, 1989-1 CB 662, modified by Rev. Rul. 2002-62, 2002-2 CB 710.

Relief is provided to taxpayers who could prematurely deplete their retirement account assets due to a decline in market value. Taxpayers who selected either the fixed amortization method or the fixed annuitization method as a distribution safe harbor, as provided in Notice 89-25, 1989-1 CB 662, may, in any subsequent year, switch to the required minimum distribution method to determine the payment for the year of the switch and for all subsequent years. The change in method will not be treated as a modification within the meaning of Code Sec. 72t)(4). If a change is made, the required minimum distribution method must be followed in all subsequent years. Any subsequent change will be considered a modification under Code Sec. 72(t)(4). This guidance replaces the guidance in Q&A-12 of Notice 89-25for any series of payments commencing on or after January 1, 2003, and may be used for distributions commencing in 2002.

Rev. Rul. 2002-62, 2002-2 CB 710.

The IRS has provided a definition of "academic period" for purposes of an exception from the penalty on early withdrawals from individual retirement arrangements (IRAs) for educational expenses (as provided by the Taxpayer Relief Act of 1997 ( P.L. 105-34)). The exception applies to IRA distributions made after December 31, 1997, with respect to expenses paid after that date, for education provided in academic periods beginning after that date. An academic period includes a semester, trimester, quarter, or other academic term designated by the educational institution, begins on the first day of classes, and does not include periods of orientation, counseling or vacation.

Notice 97-53, 1997-2 CB 306.

The 10% early withdrawal penalty will not apply to certain IRA withdrawals used to pay for qualified higher education expenses. The early withdrawal tax does not apply to a distribution from an IRA to the extent that the amount of the distribution does not exceed the qualified higher education expenses for the taxpayer, the taxpayer's spouse, and the child or grandchild of the taxpayer or the taxpayer's spouse at an eligible educational institution. For purposes of this rule, the term "qualified higher education expenses" means tuition, fees, books, supplies and equipment required for the enrollment or attendance of the student at an eligible educational institution. Qualified higher education expenses paid with an individual's earnings, a loan, a gift, an inheritance given to the student or the individual claiming the credit, or personal savings (including savings from a qualified state tuition program) are included in determining the amount of the IRA withdrawal which is not subject to the 10% early withdrawal tax. Qualified higher education expenses paid with a Pell Grant or other tax-free scholarship, a tax-free distribution from an Education IRA, or tax-free employer-provided educational assistance are excluded. A taxpayer may also make a withdrawal from a Roth IRA to pay qualified higher educational expenses without paying the 10% early withdrawal tax.

Notice 97-60, 1997-2 CB 310.

For a qualified Hurricane Katrina distribution (Katrina distribution), section 101 of the Katrina Emergency Tax Relief Act of 2005 (KETRA) ( P.L. 109-73) allows the distribution to be included in income ratably over 3 years. A Katrina distribution is any distribution from an eligible retirement plan made on or after August 25, 2005, and before January 1, 2007, to a qualified individual who designates the distribution as a Katrina distribution. Any distribution received by a qualified individual as a beneficiary can be treated as a Katrina distribution. A reduction or offset of a participant's account balance in order to pay certain plan loans can also be treated as a Katrina distribution. No more than $100,000 of distributions, however, can be treated as Katrina distributions. Katrina distributions are permitted without regard to the qualified individual's need. In addition, the amount of the distribution does not have to correspond to the amount of the economic loss that the person suffered.

Notice 2005-92, 2005-2 CB 1165.

Early distributions to active duty military reservists from an IRA (including a Roth IRA) and distributions attributable to elective deferrals under a Code Sec. 401(k) plan or a Code Sec. 403(b) annuity, are not subject to the 10% penalty of Code Sec. 72(t) ( Code Sec. 72(t)(2)(G), as added by the Pension Protection Act of 2006). To qualify, the distributee reservist must have been called to active duty for at least 180 days, or for an indefinite period, between September 11, 2001, and December 31, 2007. Reservists who have already paid tax under Code Sec. 72(t) on an eligible distribution may claim a refund using an IRS Form 1040X, Amended U.S. Individual Income Tax Return. In addition, the reservist can recontribute part or all of the distribution to an IRA. Generally, such recontribution must take place within two years after the reservist's active duty period ends. However, reservists whose duty period ended before August 17, 2006, may recontribute the distribution until August 17, 2008. There is no deduction for making such a recontribution.

IRS News Release IR-2006-152, September 28, 2006.

An individual may withdraw funds from his individual retirement account for personal use without tax consequences provided that he redeposits the funds in the same or another IRA within the 60-day rollover period. The transaction is treated as a rollover and the distribution is not subject to the early withdrawal penalty.

IRS Letter Ruling 9010007, December 14, 1989.

A resident of the United Kingdom who was a participant in a defined benefit pension plan was not liable for the additional 10% tax on early distributions when he received a distribution from an IRA that was funded, in part, with a rolled-over, lump-sum payment from the plan. The distribution was governed by the "Other Income" provision of the income tax treaty between the United States and the United Kingdom rather than the pension provision because an IRA is not a pension.

IRS Letter Ruling 9253049, October 6, 1992.

A loan that did not comply with the level amortization rules was deemed an early plan distribution and subject to the 10% additional tax on early distributions. The loan was made by a profit-sharing plan to a plan participant before the effective date of the level amortization rules contained in the Tax Reform Act of 1986, but was subject to the rules because the loan was extended twice after the effective date of the Act. The extensions were sufficient to cause the loan to be treated as a new loan on each of the extension dates.

IRS Letter Ruling 9344001, April 12, 1993.

A distribution from two individual retirement accounts received by an individual who took early retirement did not constitute a payment that was part of a series of substantially equal periodic payments. The amount of the distribution was not computed on the total aggregate balance of the IRAs. Therefore, the 10% tax under Code Sec. 72(t)(1) applied to the distribution.

IRS Letter Ruling 9705033, November 8, 1996.

Distributions from an individual's IRAs, calculated as a joint and last survivor annuity for the life of the individual and her beneficiary, which began prior to the individual reaching age 59 1/2, were not subject to the 10% tax on early distributions from qualified plans. The method of determining payments satisfied the requirements of Notice 89-25, 1989-1 CB 662, and resulted in substantially equal periodic payments within the meaning of Code Sec. 72(t)(2)(A)(iv). Furthermore, the life expectancies and the interest rate used were reasonable.

IRS Letter Ruling 9824047, March 18, 1998.

An IRA owner who was under the age of 59 1/2could not modify his annual payments to include a cost of living adjustment (COLA) without triggering the 10% early distribution penalty, even though the stock market's success had caused his account balance to be much larger than originally anticipated. The COLA would result in a modification of his substantially equal period payments under Code Sec. 72(t)(4). The distribution of a one-time catch up payment, equal to the amount of annual COLA distributions for prior years, would also result in a modification of substantially equal periodic payments under Code Sec. 72.

IRS Letter Ruling 199943050, August 3, 1999.

An individual was liable for the 10% additional tax on premature distributions received from a qualified retirement plan because he did not fall within any of the exceptions to the additional tax.

D.A. Hughes, Dec. 57,577(M), TC Memo. 2008-249.

6654 compliance

Counsel Notice CC-2009-014

May 11, 2009

Chief Counsel Notice : CC-2009-014 : Penalties : Failure to pay estimated tax, individuals : Burden of production on IRS : Procedures to sustain burden of production .



Department of the Treasury



Internal Revenue Service



Office of Chief Counsel



Notice
CC-2009-014

May 7, 2009

Subject: Litigation Position to Meet the Burden of Production for Section 6654 Addition to Tax

Cancel Date : Effective until further notice



Purpose

This Notice describes procedures that should be followed in Tax Court cases in which the addition to the tax for failure to pay estimated tax under section 6654 has been determined and the respondent has the burden of production under section 7491(c).



Background

In general, in a court proceeding, the burden of proof is on the taxpayer. See T.C. Rule 142(a); I.R.C. § 7491(a). The burden of proof is the ultimate burden of persuasion placed on a party to establish facts by a certain standard, for example by a preponderance of the evidence, clear and convincing evidence, or beyond a reasonable doubt. Pursuant to section 7491(a), if, in a court proceeding, a taxpayer introduces credible evidence regarding a factual issue, the burden of proof may shift to the respondent if the taxpayer complies with all the limitations set forth in section 7491(a)(2).

Pursuant to section 7491(c), the respondent has the burden of production in any court proceeding with respect to any penalty or addition to tax. In contrast with the burden of proof, the burden of production is the burden of producing sufficient evidence on an issue to prevail assuming that the other party produces no evidence. See Higbee v. Commissioner , 116 T.C. 438, 446 (2001). Generally, this means that, with respect to penalties or additions to tax, the Commissioner must make a prima facie case that imposition of the penalty or addition to tax is appropriate. Once the Commissioner meets his burden of production, the taxpayer must present evidence sufficient to "persuade a Court that the Commissioner's determination is incorrect." Higbee , 116 T.C. at 446-47. Questions about the burden of production on the section 6654 addition to tax have arisen when the taxpayer fails to place the penalty in dispute in the petition and when the taxpayer fails to prosecute properly the case.



Discussion

In general, if the taxpayer fails to dispute the section 6654 addition to the tax in the petition, then respondent will not be required to produce evidence that the penalty is appropriate, since the taxpayer is deemed to have conceded the penalty under T.C. Rule 34(b)(4). Funk v. Commissioner , 123 T.C. 213, 217-18 (2004); Swain v. Commissioner , 118 T.C. 358, 363-65 (2002); Robleto v. Commissioner , T.C. Memo. 2008-195; Jackson v. Commissioner , T.C. Memo. 2007-116. If the taxpayer disputes the penalty or addition to the tax, the respondent must introduce sufficient evidence to establish that the imposition of the penalty or addition to the tax is appropriate.

Section 6654 imposes an addition to tax on taxpayers who underpay their annual estimated tax liability. The estimated tax liability is generally (farmers and fishermen only have to make one payment) paid through four required installment payments, which in total equal the required annual payment. I.R.C. § 6654(c). The required annual payment is the lesser of: (1) 90 percent of the tax shown on an individual's return for the tax year in question (or, if no return is filed, 90 percent of the tax for such year), or (2) if an individual filed a return for the immediately preceding year, 100 percent of the tax shown on that return. 1 I.R.C. § 6654(d)(1)(B).

Sections 6654(e)(1) and (2) provide two mechanical exceptions to the section 6654 addition to tax. 2 First, the addition to tax is not applicable if the tax shown on the taxpayer's return for the year at issue (or, if no return is filed, the tax for that year), reduced by any allowable credit for wage withholding (I.R.C. § 31) is less than $1,000. 3 Second, the addition to tax is not applicable if the taxpayer's tax for the preceding year was zero. Mackey v. Commissioner , T.C. Memo. 2004-70.

In Wheeler v. Commissioner , 127 T.C. 200 (2006), the Tax Court held that the Commissioner failed to satisfy his burden of production with respect to section 6654 because he failed to demonstrate that the taxpayer was required to make estimated payments in 2003, the year in dispute. The court noted that respondent introduced sufficient evidence to show that the taxpayer was required to file a Federal income tax return for 2003, that the taxpayer failed to file a Federal income tax return for 2003, and that the taxpayer failed to make any estimated tax payments that year. Nevertheless, the Tax Court did not sustain the section 6654 addition to tax because "respondent did not introduce evidence sufficient to prove that petitioner had an obligation to make any estimated tax payments for 2003." Wheeler , 127 T.C. at 211 (emphasis in original). To show the taxpayer's obligation to make estimated tax payments, respondent, "at a minimum," must produce evidence to show whether the taxpayer filed a return for the preceding tax year and, if so, the amount of tax shown on that return. Id. at 212.

Similarly, in Mackey , the court refused to sustain the addition to tax under section 6654 for 1995, the first of the three years in dispute. The court found that respondent failed to produce evidence that the taxpayer's tax liability in 1994 was greater than zero. Because it was possible that the section 6654(e)(2) exception applied to 1995, the court concluded that respondent failed to satisfy the section 7491(c) burden of production on the addition to tax for that year.

To sustain the burden of production for section 6654 addition to tax, respondent must introduce evidence to show: (1) that the taxpayer failed to make required estimated tax payments for the year in which the section 6654 addition to tax is determined; (2) that the taxpayer filed a return for the preceding tax year; and (3) that the taxpayer's liability for the preceding year was greater than zero. I.R.C. § 6654(d)(1)(B); Wheeler , 127 T.C. at 210-12; Mackey , T.C. Memo. 2004-70.

The simplest way to meet this burden of production is to have the parties stipulate to exhibits and factual statements that support the required annual payment calculations defined in section 6654. When stipulation is not possible, certified transcripts and other documents to support the calculation of tax liability for the year in dispute and the preceding year in accordance with section 6654(d)(1) should establish the prima facie case required by section 7491(c) that the addition to tax is appropriate.

For taxpayers who filed a valid income tax return for the preceding tax year, but failed to file a valid tax return for the year at issue, the following information should establish the section 7491(c) prima facie case that the section 6654 addition to the tax is appropriate:
 Copies of the taxpayer's Federal income tax return for the preceding tax year;

 Certified transcripts for the tax year at issue and for the preceding tax year, reflecting the IRS's records regarding the taxpayer's account balances. These transcripts can also be used for establishing the amount of tax due if the field attorney has not secured copies of the taxpayer's Federal income tax returns. If a copy of the taxpayer's Federal income tax return for the preceding year has not been secured, either a TFRFP return transcript 4 or a Transcript Delivery System readable format return transcript 5 should be obtained. If neither of these transcripts can be obtained, a RTVUE return transcript 6 should be obtained; and

 The statutory notice of deficiency for the tax year at issue, and any other documentation and evidence reflecting that the taxpayer has an outstanding tax liability.

For taxpayers who did not file a Federal income tax return for the preceding tax year, the following information should establish the section 7491(c) prima facie case that the section 6654 addition to the tax is appropriate:
 A Certificate of Lack of Record that shows that the IRS's records reflect that the taxpayer did not file a return for the preceding tax year. See I.R.C. § 6654(d)(1)(B) flush language (stating the 100 percent of tax shown on the preceding tax year "safe harbor" provision of I.R.C. § 6654(d)(1)(B)(ii) does not apply if the preceding tax year was not a taxable year of 12 months or the individual did not file a return for the preceding year);

 If the taxpayer did not file a return for the year at issue, the Substitute for Return package, the statutory notice of deficiency, and any other documentation and evidence reflecting that the taxpayer has an outstanding tax liability. For information regarding the procedures for obtaining a Substitute for Return package, refer to Chief Counsel Notices CC-2007-005 and CC-2007-014;

 If the taxpayer filed a return for the year at issue, a copy of that return, the statutory notice of deficiency, and any other documentation and evidence reflecting that the taxpayer has an outstanding tax liability. If a copy of the taxpayer's Federal income tax return cannot be obtained for trial, either a TFRFP return transcript, a Transcript Delivery System readable format return transcript, or a RTVUE return transcript should be obtained; and

 Certified transcripts for the tax year at issue and for the preceding tax year, reflecting the IRS's records regarding the taxpayer's account balances.

If the respondent cannot meet the prima facie case that the imposition of the penalty or addition to tax is appropriate, as required by section 7491(c), the section 6654 addition to the tax should be conceded.



Questions

For further guidance on section 6654, please contact Branch 1 or 2 of Procedure & Administration at (202) 622-4910 or (202) 622-4940, respectively. For further guidance on section 7491, and burden of proof generally, please contact Branch 6 or 7 of Procedure & Administration at (202) 622-7950 or (202) 622-4570, respectively.

/s/

Deborah A. Butler

Associate Chief Counsel

(Procedure & Administration)

Distribute to: X All Personnel
X Electronic Reading Room

Filename: CC-2009-014 File copy in: CC:FM:PF

1 If an individual's adjusted gross income shown on the previous year's return is greater than $150,000, a higher percentage may apply. I.R.C. § 6654(d)(1)(C).

2 I.R.C. § 6654(e)(3) also provides waiver of the addition to tax in "certain cases" , including when the addition would be against equity and good conscience and when the addition would be imposed against newly retired or disabled individuals meeting certain criteria.

3 The threshold amount of $1,000 is effective for taxable years beginning after December 31, 1997. The threshold amount for taxable years before that date is $500. Taxpayer Relief Act of 1997, Pub. L. 105-34, § 1202, 111. Stat. 994.

4 The TFRFP return transcript is available for all tax years after 1997, but is only available for taxpayers who e-filed for the requested tax year.

5 The Transcript Delivery System readable format return transcript is available for the current tax year and the three previous tax years. This transcript is available for all taxpayers who filed for the requested tax year.

6 Although a RTVUE return transcript contains the information necessary for the Tax Court to make the calculations to determine the section 6654 penalty, it is a technical transcript that may be difficult for the court and petitioner to read. The TFRFP return transcript and the Transcript Delivery System readable format return transcript usually appear similar to a Form 1040 series tax return.

Section 6404 - abatement of interest CCH Dec. 57,809(M)]
Thomas W. Corson v. Commissioner.Dkt. No. 12491-07 , TC Memo. 2009-95, May 7, 2009.


A participant in a tax shelter was entitled to a partial abatement of interest that accrued on his tax deficiency because the IRS delayed the performance of a ministerial act when it failed to promptly assess the interest within 30 days after the taxpayer waived restrictions on his deficiency assessment. However, requests for additional abatements were denied because there were no other delays in the performance of ministerial acts. The IRS's assessment of penalty interest on the deficiency because it arose from a tax-motivated transaction, and an alleged delay in assessment after a test case was resolved both required the IRS to exercise judgment. In addition, his claim that the IRS improperly failed to abate interest for other periods while his case was pending failed to identify an IRS error and link it to a specific time period. Finally, the Tax Court had jurisdiction to review all of the taxpayer's requests for abatement, but it did not have jurisdiction over his claim that interest should be abated because his deficiency assessment was untimely.





MEMORANDUM OPINION



COHEN, Judge: This action was commenced under section 6404(h) in response to a final determination by the Appeals Office that petitioner is not entitled to a full abatement of interest associated with his 1981 Federal income tax liability. The case is now before the Court on respondent's motion for summary judgment and petitioner's objection to respondent's motion for summary judgment. The issue for decision is whether the Appeals officer abused his discretion in rejecting in part petitioner's claim for abatement of interest. References to section 6404(a) and (b) are to the Internal Revenue Code in effect for the year in issue. References to section 6621(c) are to section 6621(c) after amendment by the Tax Reform Act of 1986, Pub. L. 99-514, sec. 1511(a) and (c)(1), 100 Stat. 2744. References to section 6404(e) are to section 6404(e) before amendment by the Taxpayer Bill of Rights 2 (TBOR 2), Pub. L. 104-168, sec. 301, 110 Stat. 1457 (1996). Unless otherwise stated, all other section references are to the Internal Revenue Code as amended, and all Rule references are to the Tax Court Rules of Practice and Procedure.





Background



Petitioner resided in Arizona at the time his petition was filed.



During 1981, petitioner participated in a type of tax shelter limited partnership arrangement commonly referred to as "Elektra Hemisphere". Petitioner and his then wife filed a joint Federal income tax return for 1981. Petitioner and his wife divorced in 1984. The Internal Revenue Service (IRS) sent to petitioner and his ex-wife a joint notice of deficiency for 1981, in which it determined a $21,711 deficiency that resulted largely from disallowance of losses relating to petitioner's investments in the tax shelter partnership arrangement. Petitioner and his ex-wife filed a petition with this Court on July 15, 1985, contesting the notice of deficiency.



A test case ( Krause/ Hildebrand test case) for the over 2,000 Elektra Hemisphere related cases, including petitioner's case, was litigated, and the Court held that the related investment losses were nondeductible. See Krause v. Commissioner, 99 T.C. 132 (1992), affd. sub nom. Hildebrand v. Commissioner, 28 F.3d 1024 (10th Cir. 1994). On the basis of the resulting Krause/ Hildebrand test case decisions, petitioner and his ex-wife stipulated an income tax deficiency of $21,711 for 1981. The parties reached a stipulated decision agreement that reflected this deficiency and, after application of section 6015(c), that petitioner and his ex-wife each owed one-half of the income tax deficiency ($10,855.50).



The stipulated decision agreement also provided that interest would be assessed as provided by law on the deficiency and that petitioner waived the restrictions in section 6213(a) that prohibit assessment and collection of the deficiency and statutory interest until the decision of the Court becomes final. The parties further stipulated that the deficiency was a substantial underpayment attributable to tax-motivated transactions (TMT), and thus the related interest was to be calculated by an increased rate pursuant to section 6621(c) (before amendment by the Omnibus Budget Reconciliation Act of 1989 (OBRA), Pub. L. 101-239, sec. 7721(b), 103 Stat. 2399). The Court entered the stipulated decision agreement as a decision on October 3, 2000.



On March 5, 2001, 153 days after the decision was entered, the IRS sent to petitioner a Form 3552, Prompt Assessment Billing Assembly, that notified him of the assessment of $10,855.50 for the deficiency and $81,394.56 for the related interest that had accrued as of November 2, 2000. The Form 3552 did not show the interest rate or any computation as to how the IRS calculated the interest charged. For over 2 years, petitioner tried to obtain from the IRS a payoff balance that included a computation of interest, but the IRS did not respond to the request. The IRS sent a statement on March 3, 2003, which reflected the $92,250.06 owed and an additional late payment penalty of $1,302.66 but no computation of interest.



Through the aid of the Taxpayer Advocate Service, petitioner finally received a computation of interest on April 7, 2003. On April 21, 2003, the IRS received a check from petitioner for $108,873.24 to pay in full the deficiency and the related interest as calculated through April 30, 2003. Along with the check, petitioner sent a letter dated April 17, 2003, stating that he retained his right to dispute items with respect to his payment.



On October 3, 2003, petitioner sent to the IRS a Form 843, Claim for Refund and Request for Abatement. In his Form 843, petitioner claimed that all interest for the period from March 5, 2001 to April 7, 2003 ($16,623), should be abated because the IRS had failed to provide petitioner with proper notice showing the computation of interest. Petitioner also claimed any other interest that had accrued between April 15, 1982 and March 5, 2001, should also be abated for any delays the IRS caused.



The IRS rejected petitioner's request and returned it unprocessed, asserting that



the Audit of $21,711.00 has been canceled on Mar. 3, 1986. The interest charges for that Audit of $13,143.45 were also cancelled [sic] at the same time. There is no interest charged on this tax year [1981], the account is in zero balance due.



Petitioner, responding through a certified letter, requested either a refund of his payment or the processing of his Form 843. The IRS did not respond to this letter. On May 5, 2005, petitioner filed a Form 911, Application for Taxpayer Assistance Order, wherein he again sought either a refund or the processing of his Form 843. On June 29, 2005, the IRS denied any errors or delays on its part and ultimately denied any abatement of interest. Petitioner sent a request for appeal of the IRS's determination on July 15, 2005.



On December 8, 2006, the Appeals Office sent to petitioner a Partial Allowance --Final Determination letter wherein $23,078.93 was abated from the $98,017.74 total interest that had accrued as of April 21, 2003. The letter detailed the abatement as follows:





Abatement
of
Period Interest

June 30, 1994 to June 30, 1995 $6,455.75

March 5, 2001 to April 30, 2003 16,623.18





The balance of petitioner's abatement of interest request, however, was disallowed because the Appeals officer could find no errors or delays on the IRS's part for the periods from April 15, 1982 to June 29, 1994, and July 1, 1995 to March 4, 2001. The letter did not contain any specific information as to why the Appeals officer granted or denied abatement for the different periods.



Within a Case Memorandum dated November 29, 2006, however, the Appeals officer explained his analysis and recommendation for partial abatement. In making his decision, he reviewed all available information and considered all concerns voiced by petitioner. The Appeals officer abated interest for the period from March 5, 2001 to April 30, 2003 because he determined that the failure to provide petitioner with the requested interest computation and current payoff was an "unreasonable delay by an officer or employee of the IRS in performing a ministerial act." The Appeals officer found that the IRS caused no delay from July 15, 1985 through January 3, 1991, and May 17, 1996 through October 3, 2000, because Court records showed significant activity taking place during that time with respect to petitioner's cases. He also found that the period of accrual caused by the pendency of the Krause/ Hildebrand test case, which was decided on appeal in June 1994, was not due to the delay of any ministerial act of the IRS.



The Appeals officer thus determined that the only unexplained gap in time was from June 1994 until May 17, 1996, during which there was no Court activity and no record of IRS activity. However, the Appeals officer also concluded that some actions with respect to the Court proceedings and settlement deliberations must have occurred during the unexplained 2-year period, even though none were reflected in the materials he reviewed. The Appeals officer allowed a 1-year period of abatement of interest for petitioner, which he designated to be from June 30, 1994 to June 30, 1995.





Discussion



Under Rule 121, a summary adjudication may be made



if the pleadings, answers to interrogatories, depositions, admissions, and any other acceptable materials, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law. A partial summary adjudication may be made which does not dispose of all the issues in the case. [Rule 121(b).]



For reasons set forth below, we conclude that there is no genuine issue as to any material fact.



Petitioner bears the burden of proof. See Rule 142(a). However, respondent is in the best position to know what actions were taken by IRS officers and employees during the period for which a taxpayer's abatement request was made and during any subsequent inquiry based upon that request. See Jacobs v. Commissioner, T.C. Memo. 2000-123. To prove that abatement of interest is appropriate, a taxpayer must identify an error or delay caused by a ministerial act on the part of the IRS and must directly link the mistake to a specific time period during which interest accrued. Sec. 6404(e); accord Guerrero v. Commissioner, T.C. Memo. 2006-201; Braun v. Commissioner, T.C. Memo. 2005-221.



Petitioner contends that the Appeals officer's final determination, denying abatement of interest for the periods April 15, 1982 to June 29, 1994, and July 1, 1995 to March 4, 2001, was an abuse of discretion. Petitioner seeks judicial review under section 6404(h)(1) and Rule 280(b) for abatement of the remaining interest of $74,938.81. Respondent argues that the Appeals officer did not abuse his discretion and denies that any errors or delays occurred on the part of the IRS during these periods with respect to the interest assessed.



The Court may order an abatement if it was an abuse of discretion to refuse to abate interest in the final determination. Sec. 6404(h)(1); see Hinck v. United States, 550 U.S. 501, 506 (2007) (holding that the Tax Court provides the exclusive forum for judicial review of the IRS's refusal to abate interest). In order to prevail, a taxpayer must prove that the Appeals officer acted arbitrarily, capriciously, or without sound basis in fact or law. See Woodral v. Commissioner, 112 T.C. 19, 23 (1999).



Petitioner raises four arguments to show an abuse of discretion by the Appeals officer: (1) Failure to abate interest because the IRS failed timely to assess the interest; (2) failure to abate interest caused by the IRS's erroneous application of the section 6621(c) 120-percent TMT interest rate; (3) failure to abate interest that accrued because the IRS delayed in applying the Krause/ Hildebrand test case decisions to petitioner's case; and (4) failure to investigate, review, or abate interest for any other periods during the time petitioner's case was pending. We address each of petitioner's arguments.




1. Error of Untimely Assessment


Petitioner alleges in his petition that the IRS made an untimely assessment after the decision entered by this Court on October 3, 2000. As a result, he asserts that "the principal and interest due" should have been abated by the Appeals officer. Respondent originally viewed this allegation as merely referring to a delay in assessment despite the section 6213(d) waiver paragraph in the stipulated settlement. After further discussion with petitioner, however, respondent now understands petitioner's argument to encompass more than just a delay in the assessment. Rather, petitioner claims that the period of limitations on assessment of the deficiency expired before the assessment. See sec. 6501(a). Thus, he asserts, the deficiency and the interest that stems from it should be abated because section 6404(a)(2) provides that the Commissioner is authorized to abate a tax liability that is assessed after the expiration of the period of limitations. Alternatively, petitioner argues that material facts, such as the dates of the notice of deficiency and the assessment of interest, are in issue.



Respondent contends that section 6404(b) precludes petitioner from requesting abatement with regard to an assessment of an income tax except as provided by section 6404(e). Because petitioner is prohibited in this manner, respondent argues that "the Tax Court lacks jurisdiction to consider petitioner's Statute of Limitations argument."



The Court has jurisdiction under section 6404(h) to review the Commissioner's failure to abate interest under all subsections of section 6404, and our jurisdiction is not limited to reviewing only cases under section 6404(e). Woodral v. Commissioner, supra at 22-23. However, section 6404(h) does not authorize us to decide whether the underlying deficiency was properly assessed in order to determine whether interest should be abated. See Kosbar v. Commissioner, T.C. Memo. 2003-190. Given that this case is one "in respect of an assessment of * * * [income] tax imposed under subtitle A", petitioner does not qualify for an abatement of interest under section 6404(a)(2). Sec. 6404(b); Corson v. Commissioner, 123 T.C. 202, 207 n.6 (2004); Asciutto v. Commissioner, T.C. Memo. 1992-564, affd. per order 26 F.3d 108 (9th Cir. 1994). Because section 6404(b) applies, any dispute as to the factual dates of events that might determine the expiration of the period of limitations on assessment is not dispositive.



Section 6404(e)(1) provides in part:



(1) In general. --In the case of any assessment of interest on --



(A) any deficiency attributable in whole or in part to any error or delay by an officer or employee of the Internal Revenue Service (acting in his official capacity) in performing a ministerial act, or



(B) any payment of any tax described in section 6212(a) to the extent that any error or delay in such payment is attributable to such officer or employee being erroneous or dilatory in performing a ministerial act,



the Secretary may abate the assessment of all or any part of such interest for any period. * * *



(Amendments enacted in 1996 expanded the scope of section 6404(e) to include "managerial" as well as ministerial acts, and they qualified that the error or delay be "unreasonable". See TBOR 2, sec. 301(a), 110 Stat. 1457. Because these amendments are not effective retroactively for tax years beginning before August 1, 1996, they do not apply to the instant case. While the Appeals officer made his determination using an "unreasonable" standard for the errors and delays examined, that erroneous standard was never a deciding factor in his review.)



The term "ministerial act" means a procedural or mechanical act that does not involve the exercise of judgment or discretion and that occurs during the processing of a taxpayer's case after all prerequisites to the act, such as conferences and review by supervisors, have taken place. Sec. 301.6404-2T(b)(1), Temporary Proced. & Admin. Regs., 52 Fed. Reg. 30163 (Aug. 13, 1987). (While the final regulations under section 6404 were issued on Dec. 18, 1998, they generally apply to interest accruing on deficiencies or payments of tax for tax years beginning after July 30, 1996, and, therefore, are inapplicable to the instant case. See sec. 301.6404-2(d), Proced. & Admin. Regs.; see also sec. 301.6404-2T(c), Temporary Proced. & Admin. Regs., 52 Fed. Reg. 30163 (Aug. 13, 1987) (effectuating the temporary regulations cited for taxable years beginning after Dec. 31, 1978 (but on or before July 30, 1996)).



The assessment of tax, including interest pursuant to section 6601(e), is a procedural action that does not require the use of judgment or discretion, much like the issuance of a notice of deficiency. See Corson v. Commissioner, supra at 208. In Fruit of the Loom, Inc. v. Commissioner, T.C. Memo. 1994-492, affd. 72 F.3d 1338 (7th Cir. 1996), we observed that "[a]ssessment is the ministerial act of recording a taxpayer's Federal tax liability in the office of the District Director." Therefore, the assessment of petitioner's interest is a ministerial act and qualifies for review under section 6404(e).



In his examination of petitioner's case, the Appeals officer considered both the assessment issue and the period between the entered decision and the assessment date. He found no "unreasonable error or delays" by the IRS in making the assessment.



Section 6213(d) permits a taxpayer to waive the restrictions under section 6213(a) that prohibit the IRS from assessing or collecting a deficiency until the decision of the Court has become final. When a section 6213(d) waiver on the assessment applies, however, interest is to be suspended if a notice and demand for payment is not made within 30 days after the filing of the waiver. Sec. 6601(c). Thus, interest cannot be imposed on the deficiency for the period beginning immediately after the 30th day and ending with the date of notice and demand, and "interest shall not be imposed during such period on any interest with respect to such deficiency for any prior period." Id.



In the stipulated settlement, petitioner executed a section 6213(d) waiver, which was recorded as part of the decision on October 3, 2000. The IRS did not send a notice and demand until March 5, 2001. The Appeals officer failed to apply section 6601(c). As a matter of law, interest is to be abated from November 2, 2000 (30 days after October 3, 2000) until March 4, 2001.




2.Error in Applying Section 6621(c) TMT Interest Rate


Petitioner's second argument is that the Appeals officer should have abated a portion of the interest because the IRS erred in applying the section 6621(c) TMT interest rate.



Section 6621(c) applies an increased rate of interest on substantial underpayments of tax resulting from tax-motivated transactions. ( Sec. 6621(c) was repealed as of Dec. 31, 1989, by OBRA, sec. 7721(b), 103 Stat. 2399.) Application of this section to Elektra Hemisphere investors was upheld by the Court of Appeals for the Ninth Circuit in Hill v. Commissioner, 204 F.3d 1214, 1219-1221 (9th Cir. 2000) (following Hildebrand v. Commissioner, 28 F.3d 1024 (10th Cir. 1994)). A decision concerning the proper application of Federal tax law is not a ministerial act. Sec. 301.6404-2T(b)(1), Temporary Proced. & Admin. Regs., supra. As the application of section 6621(c) is an application of Federal tax law, petitioner's argument fails. The Appeals officer did not abuse his discretion in denying abatement with respect to the section 6621(c) TMT interest rate.




3.Delay in Applying Krause/Hildebrand


Petitioner's third argument is that the Appeals officer failed to abate all interest for the period during which the IRS delayed applying the final result of the Krause/ Hildebrand test case to petitioner's case. The Appeals officer, in considering petitioner's concern, determined this period to be from approximately June 1994, the month the Krause/ Hildebrand test case was decided on appeal, until October 3, 2000, the day the stipulated settlement was entered as a decision in petitioner's earlier Court case. The Appeals officer determined that the only unexplained gap within this period was from June 1994 until May 17, 1996, because there was no record of Court or IRS activity during this timeframe. Even after determining a gap, however, the Appeals officer still believed that some actions arising from Court proceedings and settlement deliberations must have occurred during that time. Weighing the argument and considering Jacobs v. Commissioner, T.C. Memo. 2000-123, the Appeals officer allowed a 1-year period of abatement of interest, which he designated to be from June 30, 1994 to June 30, 1995.



Petitioner argues that this period of abatement should be greater in scope because of the recognized "delay" in applying the Krause/ Hildebrand test case final decision to his case. However, the mere passage of time during the litigation phase of a tax dispute does not establish error or delay by the Commissioner in performing a ministerial act. Lee v. Commissioner, 113 T.C. 145, 150 (1999); see Beagles v. Commissioner, T.C. Memo. 2003-67. Respondent's decision on how to proceed in the litigation phase of the case necessarily required the exercise of judgment and is not a ministerial act. See Lee v. Commissioner, supra at 150-151. The Appeals officer acted within his discretion in granting this 1-year abatement, and respondent does not contest his decision. Petitioner has not established that greater abatement is justified. See Beagles v. Commissioner, supra.




4. Any Other Delay


Petitioner's last argument is that the Appeals officer failed to investigate, review, or abate interest for any other periods during the time his case was pending in this Court.



Section 6404(e) is not intended to be routinely used to avoid payment of interest; rather, Congress intended abatement of interest only where failure to do so "would be widely perceived as grossly unfair." H. Rept. 99-426, at 844 (1985), 1986-3 C.B. (Vol. 2) 1, 844; S. Rept. 99-313, at 208 (1986), 1986-3 C.B. (Vol. 3) 1, 208. A request demanding abatement of all interest charged does not satisfy the required link; it merely represents a request for exemption from interest. See Braun v. Commissioner, T.C. Memo. 2005-221. Such a broad claim extends beyond the intention of the statute. See H. Rept. 99-426, supra at 844, 1986-3 C.B. (Vol. 2) at 844; S. Rept. 99-313, supra at 208, 1986-3 C.B. (Vol. 3) at 208. The Appeals officer's determination not to abate interest based on petitioner's blanket request was not an abuse of discretion. See Donovan v. Commissioner, T.C. Memo. 2000-220.



Taking into account all the facts and circumstances of this case, we hold that the Appeals officer erred as a matter of law in denying petitioner's request for an abatement of interest with respect to the period of November 2, 2000 to March 4, 2001, because of a belated assessment under section 6601(c). The Appeals officer's determination is otherwise sustained. In reaching our decision, we have considered all arguments made, and, to the extent not mentioned, we conclude that they are irrelevant, moot, or without merit.



To reflect the foregoing,



An appropriate order granting partial summary judgment will be issued, and a decision will be entered under Rule 155.

Trust fund penalty

[ Code Sec. 6672] - TRUST FUND PENALTY - to withhold or pay over withholding taxes: Responsible person: Willfulness. --
The majority shareholder of a home health care corporation was liable for trust fund recovery penalties. For purposes of imposing the penalties, the notice requirement was satisfied by a proper mailing of Letter 1153 to the taxpayer's last known address. Actual receipt of the notice was not required. As the majority shareholder, officer and employee of the corporation who had the authority to hire and fire employees, write checks and manage the corporation, the taxpayer possessed six indicia of a responsible person. While initially unaware of the bookkeeper's failure to remit employment taxes, once she became aware of the failure, she continued to authorize payments to other creditors. Accordingly, her failure to pay over employment taxes was willful and the defense of reasonable cause was not available to her. -


Mattie Marie Mason, pro se; Susan K. Greene, for respondent.

Mattie Marie Mason v. Commissioner. kt. No. 4908-07 , 132 TC --, No. 14, May 6, 2009.





P is majority owner and principal officer of C, which failed to pay employment taxes. R mailed a notice of intent to assess sec. 6672, I.R.C., trust fund penalties to P at P's last known address. P did not receive R's notice and the penalties were assessed. R notified P of the intent to file a notice of Federal tax lien with respect to the penalties. P administratively appealed and also filed a request to abate the penalties. After administrative review of R's decision to file a lien, R determined to proceed with the lien filing. P's abatement request was also denied. P appealed both decisions to R's Appeals Office. During the hearing, an Appeals officer simultaneously considered R's intent to file a lien and denial of P's abatement request. The Appeals officer determined that P was not entitled to contest the penalties as part of the hearing as it related to the lien filing. During the same hearing the Appeals officer did consider the merits of the penalties as it related to review of P's abatement request.

The questions presented are: (1) Whether pursuant to sec. 6330(c)(2)(B), I.R.C, a taxpayer has "otherwise [had] an opportunity to dispute" a sec. 6672, I.R.C., penalty and therefore is precluded from challenging the merits of that penalty at a collection due process hearing where the taxpayer never received a notice of intent to assess the penalty; (2) whether at any juncture during the administrative proceedings P "otherwise [had] an opportunity to dispute" the sec. 6672, I.R.C., penalties, thereby precluding P from challenging the merits of the penalties at P's collection due process hearing, and if not, whether P's underlying liabilities are before the Court for de novo review; (3) whether, for purposes of sec. 6672, I.R.C., the validity of R's notice of intent to assess trust fund recovery penalties depends upon a taxpayer's receipt of that notice; (4) whether P is liable for sec. 6672, I.R.C., penalties because P is a "responsible person" who willfully failed to pay over C's employment taxes; and (5) whether R's decision to uphold the lien filing was an abuse of discretion.

1. Held: A taxpayer must receive a sec. 6672, I.R.C., notice of intent to assess a trust fund recovery penalty to have "otherwise [had] an opportunity to dispute" that tax liability under sec. 6330(c)(2)(B), I.R.C. P did not receive R's notice of intent to assess sec. 6672, I.R.C., penalties and did not "otherwise have an opportunity to dispute" the underlying tax liability.

2. Held, further, P did not "otherwise have an opportunity to dispute" P's underlying tax liability at any time during the administrative proceedings. Held, further, P raised P's liability for the sec. 6672, I.R.C., penalties at P's collection due process hearing. P's liability for the trust fund recovery penalties is, therefore, before this Court for de novo review.

3. Held, further, a assess sec. 6672, I.R.C., purposes of assessing the taxpayer does not receive notice of intent to penalties is valid for penalties even where a the notice. Consequently, even though P did not receive R's notice, R validly assessed trust fund penalties.

4. Held, further, P is a "responsible person" who willfully failed to pay over C's withholding taxes and P is liable for the trust fund penalties.

5. Held, further, R's decision to uphold the lien filing was not an abuse of discretion.


OPINION

GERBER, Judge: This case arises from a petition for judicial review filed in response to a Notice of Determination Concerning Collection Actions(s) Under Section 6320 and/or 6330 (notice of determination) issued to petitioner Mattie Marie Mason. 1 The overall question is whether respondent may proceed with the collection action. The answer depends upon whether petitioner is liable for trust fund penalties assessed against her as a responsible person for failure to collect and pay over withholding taxes of New Life Perinatal Health Care Services Inc. (New Life), for tax periods ended December 31, 2001, March 31, June 30, and September 30, 2002, and September 30, 2003. 2


Background 3

Petitioner resided in Texas at the time her petition was filed. 4 She earned a bachelor of science degree in nursing in 1978 and thereupon commenced a 30-year career as a registered nurse. The focus of that career has been on providing services to pregnant and parenting women, especially teenagers. In 1989 petitioner incorporated New Life under the laws of the State of Texas. Corporate shares of New Life have at all relevant times been held 75 percent by petitioner and 25 percent by her husband Phillip Mason (Mr. Mason). Petitioner served as president and treasurer of New Life, while Mr. Mason served as vice president and secretary. New Life elected to be treated as an S corporation for Federal tax purposes.

New Life was licensed in the State of Texas as a home health agency. Through New Life, petitioner engaged in her primary business activities of providing services to pregnant and parenting women, especially teenagers. New Life's mission included, among other things, home health care services, case management services for public and private third-party entities, health care education and consulting services and programs (e.g., programs aimed at prevention of pregnancy, school dropout, and illicit drug use among at-risk youth).

Case management programs accounted for the majority of New Life's business and revenues. In conducting that portion of the business, New Life would enter into contracts with entities such as school districts or hospitals to administer the provision of services to targeted high-risk groups. New Life, in turn, would hire independent contractors with backgrounds as registered nurses or social workers to serve as "case managers" providing care services to the particular patients or "clients" referred through the entities. Because the clients were principally high-risk pregnant and parenting women, especially teenagers, much of the revenue earned by New Life for their care was obtained through the Medicaid programs of the Texas Department of Health.

As New Life grew throughout the 1990s, petitioner assembled an administrative staff of approximately seven employees to manage the business and perform clerical support functions. Petitioner used a team management approach in conducting New Life's day-to-day operations. She delegated substantial authority to staff members so that they could independently handle their administrative portion of New Life's operation.

Key members of that team during the late 1990s to early 2000s included petitioner, Walterene Reed (Ms. Reed), Shelly Morton (Ms. Morton), and Mabel Hatton (Ms. Hatton). Petitioner served as administrator overseeing management and was responsible for hiring and firing staff and establishing and maintaining business contracts. Ms. Reed was employed as New Life's office manager to oversee the activities of case managers, the referrals of patients/clients, and the billing process. Ms. Morton was a billing specialist responsible for handling Medicaid claims.

Ms. Hatton served as New Life's internal accountant. Petitioner delegated to her full authority for the financial, tax, and accounting matters of the business, including oversight of accounts payable and receivable, payment of bills and compensation, bank deposits, and preparation and filing of Federal employment tax returns. Although petitioner and Mr. Mason were the sole signatories on New Life's corporate bank account, it was petitioner's practice to sign blank checks for Ms. Hatton to complete and use in performing her duties. Petitioner likewise relied on Ms. Hatton's expertise in handling financial affairs, and she signed employment tax returns prepared by Ms. Hatton relying completely on Ms. Hatton's expertise.

By late 2000 and early 2001 the business of New Life reached its apex. With approximately 2,000 clients and 10 case managers, the corporation income approached $1 million. During spring 2001 New Life began to experience internal and external problems. In particular, New Life experienced difficulties with respect to the management staff, the independent contractors serving as case managers, and the receipt of payments from Government agencies and from other programs.

During March 2001 Ms. Reed became unable to continue working for New Life because of a serious illness that resulted in her death before the end of the year. A replacement for Ms. Reed was hired but proved to be incapable of handling the office manager's duties. In addition, other departures of administrative staff exacerbated New Life's problems. The loss of Ms. Reed left a significant gap in the operations of New Life and led to problems with, among other things, billing processes. Mounting unbilled or incorrectly billed claims in many instances foreclosed expected payments from Government programs, particularly Medicaid. Compounding these problems, some of the case managers began to use New Life's client base to start their own businesses, effectively taking New Life's clients and corresponding ability to generate revenue.

During this period petitioner was consumed with efforts to save the business; i.e., handling duties formerly covered by Ms. Reed and personally serving clients on account of the reduced number of case managers. Ms. Hatton continued to be responsible for accounting and financial matters, paying creditors to the extent funds allowed and filing Federal employment tax returns without remitting payment. The failure to pay employment taxes began with the tax return for the quarter ending September 30, 2001, and continued into the first three quarters of 2002 and again for the quarter ended September 30, 2003. It was not until March 2002 that petitioner became aware that New Life's Federal employment taxes were not being paid.

On July 8, 2002, the collection of New Life's delinquent taxes was assigned to Revenue Officer Elvina Davis (RO Davis) of the Internal Revenue Service (IRS). RO Davis first contacted New Life by leaving a telephone message on July 16, 2002. On August 8, 2002, RO Davis reached Ms. Hatton and told her that she would need to obtain a power of attorney from petitioner in order for RO Davis to deal directly with Ms. Hatton. Near the end of August RO Davis received the power of attorney and began initial conversations with Ms. Hatton. It was not until November of 2002 that petitioner engaged in personal interaction with RO Davis. She also completed and provided RO Davis with a Form 4180, Report of Interview with Individual Relative to Trust Fund Recovery Penalty or Personal Liability for Excise Tax, signed and dated November 5, 2002. Form 4180 contained details of petitioner's relationship to and oversight of New Life.

Throughout the fall of 2002 and during 2003 investigation and collection activities continued in the form of conversations, meetings, requests for records, lien filing, etc. On February 12, 2003, RO Davis advised petitioner about options to settle New Life's debt and the potential for assessment of trust fund penalties against petitioner personally.

During September 2003, the State of Texas instituted massive changes to the case management program and concomitant Medicaid payment processes, which caused a substantial reduction of New Life's revenue stream. In response, petitioner laid off the New Life administrative staff and worked with volunteers to keep the business afloat and restructure for the new environment. In addition to those reductions, petitioner returned to work as a nurse in a local hospital to generate funds.

On January 23, 2004, petitioner submitted an offer-in-compromise for New Life's employment tax liabilities. That offer, however, could not be processed because New Life was not in compliance with return filing and payment obligations at that time. RO Davis contacted petitioner on that date to so inform her, and the two discussed how to proceed. RO Davis calculated an arrangement under which New Life could pay $1,150 per month through an installment agreement until an offer-in-compromise could be processed, to which petitioner agreed. In addition, RO Davis advised petitioner that if she signed a waiver extending the period of limitations for assessment of trust fund penalties, made timely payments under the installment agreement, filed timely Federal tax returns, and made timely tax deposits, then the IRS would forbear from assessing trust fund penalties against petitioner.

Early in March 2004 an installment agreement was approved for the liabilities of New Life that provided for payments of $1,150 on the 28th of each month. The installment agreement was assigned to Revenue Officer Avis Smith (RO Smith), a case processor who monitors accounts and payments for respondent. Petitioner made installment payments under the agreement on April 27, 2004 ($1,150), May 28, 2004 ($1,150), September 10, 2004 ($1,150), November 19, 2004 ($1,100), December 28, 2004 ($1,150), January 28, 2005 ($1,150), March 4, 2005 ($550), March 10, 2005 ($600), and May 25, 2005 ($1,150), after which payments ceased. Payments made under the agreement were personally delivered by petitioner to respondent's office.

Throughout the entire period, petitioner, on repeated occasions, communicated with RO Smith and/or RO Davis regarding financial problems and difficulty in making payments. Petitioner also raised the possibility of decreasing the monthly payment to $500, but she did not formally pursue a reduction, opting instead to proceed with preparation of a second offer-in-compromise. On December 17, 2004, petitioner submitted the second offer-in-compromise. However, like the first offer, the second was not processed because an employment tax return for New Life had not been filed. Petitioner, however, continued her effort to perfect an offer.

Sometime during March 2005 the installment agreement was deemed in default on account of missed payments. On April 14, 2005, petitioner contacted RO Smith in an attempt to perfect an offer-in-compromise. During that conversation, although petitioner was advised of the installment agreement default, she did not fully comprehend what was being explained. Accordingly, the default was again explained to petitioner when she spoke to respondent's personnel in June. New Life did not receive formal, written notification of the default, apparently because of confusion regarding a change of the corporation's address. After the April 14, 2005, conversation with RO Smith, New Life's case was transferred to RO Davis on account of the default, but petitioner did not learn of the case transfer until some time later. Sometime during June 2005 petitioner's frustrations in her attempts to deal with various IRS personnel led her to contact the Taxpayer Advocate Service, thereby adding an additional layer of complexity to petitioner's involvement and communications with respondent.

On August 8, 2005, petitioner hand-delivered a third offer-in-compromise of New Life's tax debt, along with a $150 filing fee, to RO Davis. RO Davis forwarded the offer materials, first to her manager for approval and then, on August 15, 2005, to the IRS Service Center in Memphis, Tennessee, responsible for processing offers. Thereafter, the offer materials were returned to petitioner, absent the $150 cashier's check, with a form letter dated September 12, 2005, advising, without further explanation, that the "offer is closed". The return of the offer-in-compromise was caused by an error on the part of the IRS when it misapplied the $150 filing fee to payment of outstanding New Life liabilities. Petitioner at that juncture began to make inquiries regarding what had transpired with regard to the offer, and on September 21, 2005, she faxed a copy of the $150 cashier's check to the Memphis Service Center.

It was not until December 2005 that New Life finally received respondent's written notification concerning the earlier return of the August 8, 2005, offer-in-compromise. A brief form letter advised that a Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, had not been included and that the $150 application fee had not been paid.

Meanwhile in early September 2005 a determination was made by the IRS to commence proceedings against petitioner personally with respect to New Life's employment tax liabilities. RO Davis prepared a Letter 1153, Trust Funds Recovery Penalty Letter, proposing assessment of section 6672 trust fund penalties against petitioner as a person required to collect, account for, and pay over withheld taxes of the business for the unpaid liabilities. That letter further informed petitioner that if she did not agree, she could contact the individual identified therein (RO Davis) within 10 days of the date of the letter or could submit a written appeal within 60 days.

The Letter 1153 was mailed on September 2, 2005, hand-addressed to petitioner at what was then her address of record. Although a certified mail label and return receipt were affixed to the envelope, postage was placed thereon with a private postage meter and the letter was posted without being presented to a U.S. Postal Service (USPS) employee. As a result, no USPS postmark was date-stamped on the envelope, nor was the item number on the certified label entered into the USPS certified mail tracking system. Notations made on the envelope by the USPS indicate that delivery was attempted and notice was left for petitioner on September 3, 2005; that a second notice was left on September 8, 2005; and that the document was returned to the IRS marked "UNCLAIMED" on September 18, 2005. The unopened envelope, return receipt still attached, was received by the IRS on September 29, 2005. Petitioner did not receive the Letter 1153 or notification of its attempted delivery.

On December 19, 2005, trust fund penalties were assessed against petitioner for the trust fund portion of New Life's outstanding employment tax liabilities, and notices of balance due were issued to her. Petitioner, surprised by the turn of events, began to investigate by contacting various individuals at the IRS. Her inquiries also led to internal inquiries by several of respondent's offices. It was discovered that the $150 filing fee petitioner submitted with the August 8, 2005, offer-in-compromise had been misapplied as a payment toward New Life's taxes for the period ended September 30, 2001.

A meeting was held on February 16, 2006, among, inter alia, petitioner, RO Davis, and RO Davis's supervisor. The participants discussed the mailing of the Letter 1153 and assessment of the trust fund penalties, petitioner's desire to appeal the assessments, and the procedures for such an appeal and for the continued pursuit of an offer-in-compromise. Shortly thereafter, RO Davis faxed to petitioner a copy of the envelope in which the Letter 1153 had been returned to the IRS. Petitioner took that information to the post office and spoke to USPS employees in an attempt to track the item as a certified letter. Such efforts, however, were unsuccessful on account of the mailing procedures that had been used by respondent's personnel.

During the period March to May 2006, in addition to continuing work to perfect an offer-in-compromise, petitioner submitted various forms and letters in an attempt to forestall the filing of a Federal tax lien against her. To address the assessment of the trust fund penalties, petitioner needed to file a Form 843, Claim for Refund and Request for Abatement, disputing that she was a responsible person within the meaning of the employment tax statutes. Her early attempts to file could not be processed. For example, in March she sent a letter of appeal to RO Davis, rather than submitting a Form 843. Later, her initial Form 843, submitted in April and assigned to Revenue Officer Advisor Ken McNeil (ROA McNeil) in the IRS Technical Services Advisory, was returned to petitioner for failure to submit the requisite payment therewith of the amount of tax attributable to one individual for each tax period included in the claim; i.e., $2,927.

Meanwhile, on April 12, 2006, petitioner was given notice that the IRS was proposing and preparing to file liens against her for the assessed trust fund tax penalties. Petitioner was also advised that in order to dispute that proposal, she needed to file with the IRS a Form 9423, Collection Appeal Request. On April 13, 2006, petitioner submitted a Form 9423, thereby initiating her participation in the IRS Collection Appeal Program (CAP) for prefiling challenge of the lien proposal.

The CAP appeal was assigned to Settlement Officer Liana White (SO White) of the IRS Office of Appeals. SO White held a face-to-face conference with petitioner on April 26, 2006. During that conference and followup telephone calls, petitioner alleged that she had never received the Letter 1153 proposing assessment of the trust fund penalties, and she argued that if the installment agreement for New Life had been renegotiated to an affordable amount, then assessment of the penalties would not have been necessary and no filing of a notice of lien would be needed. SO White explained the distinction between the corporate and individual proceedings and that the trust fund penalties can be assessed and liens filed regardless of whether the underlying corporation is under an installment agreement. SO White also communicated with ROA McNeil regarding the Form 843 abatement request and its rejection for lack of payment, and further explained those issues, and the steps to perfect the Form 843 claim, to petitioner.

SO White concluded the CAP process by means of a closing letter dated May 1, 2006. Because petitioner's Form 843 could not be processed at that time, SO White sustained the proposed lien filing but recommended that the filing be delayed until petitioner had been afforded an opportunity to perfect a Form 843 and then, if perfected, until a decision on the claim, including any attendant appeals, was made by the IRS. Because she was considering only petitioner's challenge to the proposed lien filing, SO White was willing to postpone her recommendations pending the outcome of ROA McNeil's investigation into petitioner's liability for the trust fund penalties. Petitioner was given until May 24, 2006, to perfect the claim for abatement of the penalties by providing ROA McNeil with a proper Form 843 accompanied by a payment. If that was not done, the closing letter directed that the IRS compliance function would file the notice of tax lien. Upon closure of the CAP process with the issuance of the May 1, 2006, letter, petitioner's case was returned to RO Davis for monitoring, and the letter advised that petitioner should contact RO Davis with any questions.

In late May 2006 petitioner telephoned ROA McNeil concerning financial hardship she was encountering in securing payment to perfect her Form 843 claim. She indicated that she could remit payment by June 1, 2006. ROA McNeil responded that petitioner could resubmit the Form 843 abatement request with payment at any time and that there existed no deadline for submission of such a claim. Petitioner believed that ROA McNeil spoke for respondent's organization and that the CAP recommendations would be extended as well, even though ROA McNeil advised she should also speak with other of respondent's employees, because she believed that respondent coordinated all activities concerning New Life's and her trust fund tax liabilities. Petitioner did contact SO White who, because the CAP matter had been closed, informed petitioner that she needed to speak to RO Davis. Petitioner, in her confusion over who had authority over her case, did not do so.

On May 30, 2006, RO Davis inquired of ROA McNeil whether petitioner had submitted a perfected Form 843 claim. ROA McNeil answered in the negative. On June 1, 2006, RO Davis, acting on the CAP recommendations and without further inquiry of petitioner, prepared and filed notices of Federal tax lien against petitioner for the unpaid trust fund penalties. Also on that date, petitioner called ROA McNeil again and told him that she was sending the completed Form 843 and payment. That claim and payment were received by the IRS on June 2, 2006, and handled by ROA McNeil. After receiving petitioner's Form 843 abatement request, ROA McNeil reviewed it, along with information petitioner supplied when she completed the Form 4180, New Life's employment tax returns for the periods at issue, and canceled checks she had signed on behalf of New Life. On June 22, 2006, ROA McNeil issued his decision on petitioner's claim and disallowed petitioner's request for abatement of the trust fund penalties. He also informed her of her right to appeal his determination with the IRS Office of Appeals or file suit in either a U.S. District Court or the U.S. Court of Federal Claims.

While petitioner's Form 843 abatement request was being reviewed and ultimately denied by ROA McNeil, the IRS, on June 7, 2006, mailed petitioner a Letter 3172, Notice of Federal Tax Lien Filing and Your Right to a Hearing under IRC 6320, informing her that notices of Federal tax liens were filed for the unpaid trust fund penalties assessed against her for the tax periods ended September 30 and December 31, 2001, March 31, June 30, and September 30, 2002, and September 30, 2003. The Letter 3172 informed petitioner of her right to appeal the lien filing by submitting a Form 12153, Request for a Collection Due Process Hearing. On July 10, 2006, respondent received petitioner's completed Form 12153 disputing the lien filing. Her collection due process (CDP) lien appeal was assigned to Settlement Officer Bart A. Hill (SO Hill) in the IRS Office of Appeals.

On July 20, 2006, respondent received a letter from petitioner stating she did not agree with ROA McNeil's decision to disallow her Form 843 abatement request for the trust fund penalties and requesting review by IRS Office of Appeals. Her trust fund penalty abatement appeal was also assigned to SO Hill. In a letter dated November 1, 2006, petitioner was instructed that at her CDP hearing she could raise collection alternatives, challenge the appropriateness of the lien filing, challenge the underlying tax liability if she had not otherwise had a prior opportunity to do so, and raise spousal defenses. She was also informed in that letter that SO Hill was responsible for considering her appeal of her denied Form 843 abatement request.

After filing her appeals requests, on August 22, 2006, petitioner filed an amended offer-in-compromise on behalf of New Life for its unpaid employment tax liabilities. The corporation offered to pay $33,660 at a rate of $330 a month over 102 months, which was the period remaining by statute for the IRS to collect. On or around September 20, 2006, the IRS accepted New Life's August 22, 2006, offer-in-compromise. However, respondent also informed petitioner that she was still personally responsible for the trust fund penalties that had been assessed against her.

On December 5, 2006, SO Hill held a telephone conference with petitioner to discuss the appeal of the lien filing. SO Hill notified her that she was not permitted to discuss her liability for the trust fund penalties at her CDP hearing. However, during the CDP conference, petitioner asserted that the trust fund penalty assessment was invalid. She raised other concerns pertaining to the lien filing with SO Hill, specifically that she had reached an agreement with ROA McNeil to extend the time for perfecting her Form 843, and more generally that the IRS did not follow proper procedures when it failed to send New Life a formal default letter and when it improperly returned New Life's August 8, 2005, offer-in-compromise. Finally, she made a general claim that the notice of Federal tax lien for the trust fund penalties should be released.

At the same time, SO Hill also held, concurrent with petitioner's CDP hearing, a conference with petitioner to discuss her Form 843 abatement request appeal. During the conference SO Hill considered the validity of petitioner's liability for the assessed trust fund penalties. His consideration consisted of a full review of her status as a responsible person who willfully failed to pay over employment taxes.

On January 30, 2007, SO Hill issued his determination sustaining the denial of petitioner's Form 843 abatement request for trust fund penalties. He based his determination upon a finding that petitioner was a responsible person who willfully failed to pay over trust fund taxes.

On February 2, 2007, SO Hill issued his determination in which the filing of the Federal tax liens for the trust fund penalties was sustained. Finding that petitioner had had a prior opportunity to dispute her underlying liability for the trust fund penalties, SO Hill declined to consider petitioner's underlying liability as part of that determination. His finding that she had had a prior opportunity to dispute the liability was based on the IRS's attempted delivery of the Letter 1153 and his consideration of her Form 843 Appeal. He also determined through discussions with SO White and ROA McNeil that neither had granted petitioner an extension of the May 24, 2006, deadline to perfect her Form 843 abatement request. In that regard, petitioner provided SO Hill with permission to conduct ex parte communications with ROA McNeil and SO White. SO Hill did not consider petitioner's concerns with the IRS's mishandling of New Life's offer-in-compromise or respondent's failure to provide formal notice when New Life defaulted on its installment agreement, citing his lack of jurisdiction over matters pertaining to the corporation. Instead, he noted that after accepting a long-term payment offer from the corporation it was appropriate for respondent to file trust fund recovery penalty liens because respondent needed to "protect the government's interest in the taxpayer's assets in case the corporate offer defaults." SO Hill also considered whether any reason existed to release the lien but found no reason to do so and recommended against release.

Finally, SO Hill noted that petitioner had neither supplied him with a collection information statement nor proposed any collection alternatives for her trust fund penalties. He reviewed the procedures followed to file the notice of lien and concluded they were proper. He determined that the notice of lien filing "balances the need for efficient collection of taxes with the taxpayer's legitimate concern the action is no more intrusive than necessary."

In response to the notice of determination, petitioner timely filed a petition with this Court challenging the decision to sustain the notice of tax lien filing and the denial of her refund claim.


Discussion 5

Petitioner's corporation incurred an employment tax liability. Petitioner, an educated and intelligent person, had great difficulty navigating the administrative process to arrange for payment. While she was in the process of dealing with the corporate liability, an assessment was made against her for trust fund tax. Notices of lien were filed with respect to the trust fund assessment, though she argues an agreement to delay had been made. One major reason for petitioner's difficulty was that she had to deal with a different person for each type of procedure concerning the employment tax liability. At one point in the process she was dealing with as many as five of respondent's representatives regarding different aspects of the same underlying tax liability; i.e., offers, installment payments, claim for refund, etc. Respondent's balkanized approach to collection procedures was also detrimental to respondent, because important dates and events were not being internally coordinated. For petitioner, it presented Kafkaesque circumstances and confusion. The administrative record in this case is complex and convoluted. Ultimately, we have sorted out the underlying circumstances and we must decide whether petitioner is entitled to relief from the Appeals officer's determination.

Respondent filed notices of Federal tax lien with respect to petitioner's trust fund tax assessments. See secs. 6321, 6322, and 6323. Section 6320 provides that the Secretary shall furnish taxpayers with written notice of the filing of a notice of lien under section 6323. This notice must be provided not more than 5 business days after the date the notice of lien is filed and must advise the taxpayer of the opportunity for administrative review in the form of a hearing. Sec. 6320(a)(2) and (3). Petitioner has not shown or asserted any omission in the procedures with respect to the filing, or notice with respect to the filing, and none is disclosed in the record.

Section 6320(b) provides taxpayers with the right to request a "Fair Hearing" before an "Impartial" Appeals officer. The hearing generally shall be conducted consistent with the procedures set forth in section 6330(c), (d), and (e). Sec. 6320(c). Section 6330(c)(1) requires the Appeals officer to obtain verification that the requirements of any applicable law or administrative procedure have been met. Under section 6330(c)(2)(A) a taxpayer may raise any relevant issue at the hearing including challenges to "the appropriateness of collection actions" and may make "offers of collection alternatives, which may include the posting of a bond, the substitution of other assets, an installment agreement, or an offer-in-compromise." The taxpayer may also challenge the existence and amount of the underlying tax liability if no notice of deficiency was received or the taxpayer did not otherwise have an opportunity to dispute such tax liability. Sec. 6330(c)(2)(B).

Section 6330(c)(3) provides that a determination of the Appeals officer shall take into consideration the verification under section 6330(c)(1), the issues raised by the taxpayer, and whether 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. Section 6330(d)(1) allows the taxpayer to appeal a determination to the Tax Court.

Where the underlying tax liability is properly at issue in the hearing, we review that issue on a de novo basis. Goza v. Commissioner, 114 T.C. 176, 181-182 (2000). However, where the underlying tax liability is not at issue, we review the determination for an abuse of discretion. Nicklaus v. Commissioner, 117 T.C. 117, 120 (2001).



I. Scope and Standard of Review
The Tax Court recently acquired exclusive jurisdiction to review appeals from the Commissioner's lien and levy determinations made after October 16, 2006, irrespective of the type of tax making up the underlying liability. See Ginsberg v. Commissioner, 130 T.C. 88 (2008); Callahan v. Commissioner, 130 T.C. 44 (2008); McClure v. Commissioner, T.C. Memo. 2008-136. A taxpayer's "underlying tax liability" includes all "amounts a taxpayer owes pursuant to the tax laws that are the subject of the Commissioner's collection activities." Callahan v. Commissioner, supra at 49. Because respondent's determination sustaining the filing of notices of Federal tax lien for unpaid trust fund penalties was issued on February 2, 2007, we are authorized to review the trust fund penalties assessed against petitioner unless precluded by section 6330(c)(2)(B).

Generally, a taxpayer must raise an issue at a collection due process hearing to preserve it for this Court's consideration. Perkins v. Commissioner, 129 T.C. 58, 63 (2007) (de novo review); Magana v. Commissioner, 118 T.C. 488, 493 (2002) (abuse of discretion review); sec. 301.6330-1(f)(2), Q&A-F5, Proced. & Admin. Regs. 6 At her hearing, held in conjunction with the conference concerning the trust fund penalties, petitioner disputed that she received the Letter 1153 and also contended that she did not willfully fail to pay over the trust fund taxes. 7 The Appeals officer testified that these conferences were held simultaneously and that petitioner contested her liability for the penalties. In these circumstances there is no reason to draw an invisible curtain between issues that have been administratively merged by respondent. As far as petitioner was concerned, her CDP hearing and Form 843 abatement request were being addressed by the same Appeals officer within one proceeding. Moreover, the Appeals officer's explanation of the hearing at trial reflects that he handled both of petitioner's claims concurrently. 8 Petitioner challenged her liability for the trust fund penalties at her hearing. Accordingly, we may consider the merits of that assessment provided she was not statutorily precluded from raising it during her CDP appeal.

A taxpayer cannot challenge an underlying liability in a CDP hearing, and therefore this Court cannot review that liability, if the taxpayer received a notice of deficiency or otherwise had an opportunity to dispute the underlying liability. Sec. 6330(c)(2)(B). Because the assessments against petitioner were trust fund penalties, respondent would not have issued and mailed a notice of deficiency. See sec. 6212(a). The question is whether petitioner "otherwise [had] an opportunity to dispute" the trust fund penalty assessments. The Appeals officer concluded that petitioner had such an opportunity when respondent mailed a Letter 1153 to her. Similarly, respondent argues that the Letter 1153 was sent by certified mail to petitioner's last known address and that petitioner did not avail herself of her opportunity to contest the proposed assessment within the time prescribed by the letter. On these facts, respondent asserts that petitioner was barred from challenging her underlying liability before the Appeals officer.

A section 6672(b)(1) notice provides a taxpayer with the means for protesting a proposed trust fund penalty assessment administratively with the Commissioner. It follows that where a taxpayer has not received a section 6672(b)(1) notice, then that taxpayer has missed an opportunity to dispute the underlying tax liability. 9 Documentary evidence of mailing may suffice as proof that a notice of deficiency was properly mailed to a taxpayer. Coleman v. Commissioner, 94 T.C. 82, 90-91 (1990). When a Letter 1153 is mailed, the Commissioner must follow the same mailing procedures that are provided for notices of deficiency in section 6212(b). Sec. 6672(b)(1). It follows that the same evidence that establishes that the Commissioner mailed a notice of deficiency to a taxpayer's last known address should be sufficient to establish that the Commissioner properly sent a Letter 1153. See Hickey v. Commissioner, T.C. Memo. 2009-2. Respondent has established that a Letter 1153 was mailed, by certified mail, to petitioner's last known address, as required by section 6672(b)(1). 10

The record also reflects that the letter was returned to respondent undelivered and marked "unclaimed". Petitioner's circumstances are therefore distinguishable from those of the taxpayers in McClure v. Commissioner, T.C. Memo. 2008-136, and Pelliccio v. United States, 253 F. Supp. 2d 258 (D. Conn. 2003). The taxpayer in McClure received a Letter 1153 and contested his liability in response. This Court held that that was his opportunity to dispute the trust fund penalty assessment. Likewise, in Pelliccio the taxpayer received a Letter 1153 before each assessment, and the District Court concluded that the taxpayer had the requisite opportunity. We conclude that a section 6672(b)(1) notice that was not received, but not deliberately refused, by a taxpayer does not constitute an opportunity to dispute that taxpayer's liability.

We note that during the prolonged course of her dealings with respondent, petitioner received numerous notices and documents from respondent, some by certified mail. She not only received them, but unlike the taxpayer in Sego v. Commissioner, 114 T.C. 604 (2000), she responded or took other appropriate action in response to them. 11 The Letter 1153 was the sole instance where petitioner made no response nor took other action. Further, respondent has neither argued nor presented any evidence that petitioner refused delivery of the Letter 1153.

We recently addressed what it means to "otherwise have an opportunity to dispute" a tax liability in the context of section 6330(c)(2)(B). See Perkins v. Commissioner, 129 T.C. 58 (2007); Lewis v. Commissioner, 128 T.C. 48 (2007). Neither the Internal Revenue Service Restructuring and Reform Act of 1998 (RRA), Pub. L. 105-206, sec. 3401, 112 Stat. 746, nor the Internal Revenue Code defines what Congress intended by the phrase "otherwise have an opportunity to dispute" a tax liability. The Commissioner has defined this phrase to some extent by promulgating a regulation indicating that an opportunity "includes a prior opportunity for a conference with Appeals". Sec. 301.6330-1(e)(3), Q&A-E2, Proced. & Admin. Regs. (emphasis added).

The Commissioner's limited definition leaves open the opportunity for deciding what other circumstances do or do not constitute an "opportunity". Lewis v. Commissioner, supra at 55. Regarding this subject, this Court has explained:

As we see it, if Congress had intended to preclude only those taxpayers who previously enjoyed the opportunity for judicial review of the underlying liability from raising the underlying liability again in a collection review proceeding, the statute would have been drafted to clearly so provide. The fact that Congress chose not to use such explicit language leads us to believe that Congress also intended to preclude taxpayers who were previously afforded a conference with the Appeals Office from raising the underlying liabilities again in a collection review hearing and before this Court.

Id. at 61. We concluded our analysis by holding that "A conference with the Appeals Office provides a taxpayer a meaningful opportunity to dispute an underlying tax liability." Id.

In his determination sustaining the filing of the notice of tax liens, the Appeals officer decided that petitioner had had an opportunity to dispute her liability for the trust fund penalties when he reviewed her Form 843 abatement request. We find the Appeals officer's conclusion unsupportable. As explained in Perkins v. Commissioner, supra at 65, section 6330(c)(2)(B) "utilizes the past tense in reference to the opportunity to dispute, indicating that Congress contemplated that the dispute opportunity would have already transpired when the hearing under section 6330 occurred." It was also noted that the Commissioner's regulation specifies that a prior conference with Appeals is an opportunity to dispute a liability. Id. The analysis and reasoning we applied in Perkins is equally applicable to petitioner's situation. Petitioner's concurrent appeal of the denial of her abatement request was not an "opportunity" as contemplated by section 6330(c)(2)(B). To hold otherwise would unduly limit judicial review. Accordingly, a simultaneous collection due process appeal and underlying tax liability appeal is not an "opportunity" to contest the underlying tax liability within the meaning of section 6330(c)(2)(B).

To challenge the propriety of the proposed lien filing, petitioner filed an appeal with respondent's CAP. The CAP Settlement Officer, an Appeals officer, was fully aware of petitioner's pending Form 843 abatement request. The CAP Settlement Officer did not consider petitioner's underlying tax liability and instead focused her review solely on the propriety of the proposed notice of lien filing. 12 Petitioner's CAP prelien filing hearing did not rise to the level of an "opportunity to dispute" her underlying tax liability where the Appeals officer limited her review to the propriety of filing the notice of liens.

Where a taxpayer has not received a notice of deficiency or had an opportunity to contest her liability and raises her underlying liability at her CDP hearing, we review the underlying liability. Sec. 6330(c)(2)(B); see, e.g., Bach v. Commissioner, T.C. Memo. 2008-202, affd. without published opinion 103 AFTR 2d 1340, 2009-1 USTC par. 50,286 (4th Cir. 2009). Where a taxpayer is incorrectly advised at a CDP hearing that she had a prior opportunity to contest her underlying liability, we consider the underlying liability. Petitioner raised the underlying liability, and it was reviewed and considered in her abatement hearing. The Appeals officer conducting petitioner's CDP hearing mistakenly believed she had had a prior opportunity to raise her underlying tax liability. We find that petitioner did not have an opportunity to dispute her liability for the trust fund penalty assessments before her CDP hearing with SO Hill. Petitioner's liability for the trust fund penalties is accordingly before this Court for de novo review.



II. Trust Fund Penalty
Section 6672 imposes a penalty for the willful failure to collect, account for, and pay over income and employment taxes of employees. Income and employment tax withholding is commonly referred to as "trust fund tax" because the Internal Revenue Code characterizes such withholding as a "special fund in trust for the United States." Sec. 7501(a). As set forth in section 6671, penalties for the failure to collect, account for, and pay over trust fund taxes are assessed and collected in the same manner as tax against a person including "an officer or employee of a corporation, or a member or employee of a partnership, who as such officer, employee, or member is under a duty to perform" the duties referred to in section 6672. Sec. 6671(b). Such persons are referred to as "responsible persons" and the term may be broadly applied. See generally Logal v. United States, 195 F.3d 229, 232 (5th Cir. 1999); Barnett v. IRS, 988 F.2d 1449, 1454 (5th Cir. 1993).

A trust fund penalty may be assessed against any responsible person and is separate from the employer's liability for the unpaid income and employment taxes. Sec. 6672(a); Howard v. United States, 711 F.2d 729, 733 (5th Cir. 1983). While there is no requirement that the Commissioner pursue collection of the taxes from the employer before assessing the penalty against a responsible person, as a matter of policy the Commissioner does not pursue collection of the penalty where the employer pays its liability. Hornsby v. IRS, 588 F.2d 952, 954 (5th Cir. 1979). 13

A. Preliminary Notice

Generally, before a section 6672 penalty may be assessed, the Commissioner must mail a Letter 1153 to the responsible person's last known address advising that a trust fund penalty will be assessed. Sec. 6672(b)(1). 14 While we determined petitioner did not have an opportunity to contest her liability for the penalties because she did not receive the Letter 1153, we arrived at that determination by applying the standard established in section 6330(c)(2)(B). Whether the Government must ensure that a taxpayer actually receives a Letter 1153 or whether it is sufficient for the Government to show it timely mailed the notice to a taxpayer's last known address in order for the assessment to be valid is a question recently addressed by this Court. We concluded that the mailing of section 6672 notification to a taxpayer's "last known address" would be sufficient to advise a responsible officer of the assertion of a trust fund penalty. See Hickey v. Commissioner, T.C. Memo. 2009-2. In Hickey we held that where the notice has been mailed to the taxpayer's last known address, it is not necessary for the taxpayer to receive the notice before the Commissioner can assess the trust fund penalty. A bankruptcy court reached the same conclusion in In re Chabrand, 301 Bankr. 468, 476-477 (Bankr. S.D. Tex. 2003).

The other means of providing notice to a taxpayer pursuant to section 6672(b)(1) is by personal service. This option was added to the statute in 1998 with the enactment of RRA sec. 3307, 112 Stat. 744. A Senate Finance Committee report explains the addition to the statute and states, in a parenthetical to the explanation, that "In some cases, personal delivery may better assure that the recipient actually receives notice." S. Rept. 105-174, at 66 (1998) 1998-3 C.B. 537, 602. The Committee's explanation implies that Congress added personal delivery as an option for the Commissioner that would "better assure" receipt of the notice, thereby acknowledging that mailing notice to the taxpayer's last known address does not guarantee receipt. The delivery methods are alternatives, and the statute permits the Commissioner to choose which method to use; thus, we have concluded that Congress did not require the Commissioner to ensure that a taxpayer actually receive the notice.

Accordingly, proper mailing of a preliminary notice to the last known address is sufficient to comply with section 6672(b)(1). In this case the notice requirement of the statute was satisfied by respondent's certified mailing of a Letter 1153 to petitioner's last known address.

B. Burden of Proof

The parties have not raised the issue of who bears the burden of proof in this proceeding. Generally, the burden of proof is upon the taxpayer. Sec. 7453; Rule 142(a). Section 7491(a), providing for a shift to the Commissioner of the burden of proof in certain circumstances, is inapplicable to trust fund penalty cases. 15 In any event we find on a preponderance of the evidence that employment taxes were not paid, that petitioner was a responsible person, and that she willfully failed to pay over those taxes.

C. Responsible Person

Liability is imposed upon all persons responsible for collecting, accounting for, or paying over employment withholding taxes. 16 The Court of Appeals for the Fifth Circuit, to which this case is appealable, "generally takes a broad view of who" qualifies as a "responsible person under § 6672." Gustin v. United States, 876 F.2d 485, 491 (5th Cir. 1989). It is one's duties, status, and authority that define him as a responsible person. Turnbull v. United States, 929 F.2d 173, 178 (5th Cir. 1991); Gustin v. United States, supra at 491. A delegation of that duty to others does not necessarily change that person's status as a responsible person. Turnbull v. United States, supra at 178. Further, an individual may be a responsible person even though he did not know that withholding taxes were not being paid over to the Government. Barnett v. IRS, 988 F.2d at 1454.

The Court of Appeals for the Fifth Circuit considers the following to be indicia of a responsible person: (i) Holding the position of officer or member of the board of directors; (ii) substantial ownership of the business; (iii) possessing the authority to hire and fire employees; (iv) managing the day-today operations of the business; (v) deciding how to disburse funds and pay creditors; and (vi) possessing the authority to sign checks for the business. Id. at 1455. "No single factor is dispositive." Id. In applying these indicia, there may be, and often are, more than one responsible person within each business. Id. However, for purposes of imposing liability for trust fund penalties, it does not matter how many responsible persons there are, or who is the most responsible, because the statute applies equally to all responsible persons. Id. Therefore, we must determine only whether petitioner is a responsible person.

During the periods at issue petitioner was the president, treasurer, and an employee of New Life. She was also the majority (75 percent) shareholder of the corporation. She admits she had the ability to and did exercise her right to hire and terminate employees. Petitioner was a signatory on New Life's checking account. There is considerable evidence that she signed most of the checks for New Life. There is evidence she was involved in managing the corporation although that responsibility was shared with others. She concedes that she had "overall management" responsibilities for the corporation. Finally, petitioner admits that she had the authority to direct the payment of corporate funds, and there is ample evidence she exercised that authority.

It is clear on the basis of her admissions that petitioner possessed, albeit in varying degrees, all six of the indicia of a responsible person. There is ample evidence to support the conclusion that petitioner was a responsible person, for purposes of section 6672.

D. Willfulness

A responsible person will be held liable for the penalty only where that failure to pay over withholding tax was willful. The Court of Appeals for the Fifth Circuit has determined that "willful", in the context of section 6672, does not mean the responsible person must have a "criminal or other bad motive * * *, but simply a voluntary, conscious and intentional failure to collect, truthfully account for, and pay over the taxes withheld from the employees." Newsome v. United States, 431 F.2d 742, 745 (5th Cir. 1970). To establish willfulness, there is no requirement that the responsible person have intended to deprive the Government of the withholding tax. Id. at 747. However, willfulness is established where the "responsible person acts with a reckless disregard of a known or obvious risk that trust funds may not be remitted to the Government". Mazo v. United States, 591 F.2d 1151, 1154 (5th Cir. 1979). While willfulness is typically proven by evidence that a responsible person paid other creditors when withholding tax was due to the Government, mere negligence is not sufficient to establish willfulness. Gustin v. United States, supra at 492.

Delegation of the responsibility to handle trust fund taxes appropriately is not proof that the responsible person was not willful. Hornsby v. IRS, 588 F.2d at 953. "Responsible persons owe a fiduciary obligation to care properly for the funds that are temporarily entrusted to them for the ultimate use of the United States." Id. A responsible person's fiduciary duty remains with him even where he has delegated responsibility for discharging that duty to a subordinate. Id.

Petitioner admits that as early as March 2002 she became aware that New Life had not been paying over its trust funds to the Government. Petitioner employed a bookkeeper who was responsible for preparing New Life's Form 941, Employer's Quarterly Federal Tax Return, and remitting payment along with these returns. For all periods at issue petitioner signed the quarterly employment tax returns reflecting an unpaid liability for employment taxes. She does not recall whether at the time she signed these returns they were blank or had been completed by the bookkeeper. There is evidence petitioner signed checks paying for the corporation's rent and insurance, as well as an "advance" payable to herself. These payments were made before and after she became aware of the corporation's unpaid employment tax liability.

Petitioner's delegation of the duty to prepare and remit the employment tax returns and payments does not insulate her from liability. Her defense is that she was unaware of the bookkeeper's failure to remit the employment taxes. Petitioner did, however, become aware during March 2002, if not sooner, that the corporation had not been paying over these taxes. Other creditors were paid despite New Life's liability to respondent and its failure to remit employment taxes continued for the quarters ended March 31, June 30, and September 30, 2002, and September 30, 2003. Petitioner's authorization of payment to other New Life creditors after becoming aware that employment taxes were unpaid is indicative that as a responsible person her "conduct was willful as a matter of law." See Mazo v. Commissioner, supra at 1157.

Even though petitioner was distracted and pressured by business problems and responsibilities, her failure to discharge the outstanding obligations to the Government is not thereby excused. We can draw only one conclusion from these facts: Petitioner's failure to pay over employment taxes was "willful".

E. Reasonable Cause

Finally, the Court of Appeals for the Fifth Circuit recognizes that a taxpayer may avoid liability for a trust fund penalty by showing reasonable cause for a failure to collect, account for, or pay over trust fund taxes. Newsome v. United States, supra at 746-747; Frazier v. United States, 304 F.2d 528, 530 (5th Cir. 1962). It is a very limited exception to a finding of willfulness. Logal v. United States, 195 F.3d at 233; Bowen v. United States, 836 F.2d 965 (5th Cir. 1988); Newsome v. United States, supra at 747. While reasonable cause is a defense, conceptually, the Court of Appeals has stated that "no taxpayer has * * * carried that pail up the hill." Id. Further, reasonable cause is not a defense where a responsible person "knew that the withholding taxes were due, but * * * made a conscious decision to use corporate funds to pay creditors other than the government." Logal v. United States, 195 F.3d at 233.

While petitioner does not assert the reasonable cause exception applies to her, we consider its applicability. Petitioner concedes that she knew withholding taxes for New Life were due. Additionally, the record contains considerable evidence she paid other creditors after becoming aware of the corporation's unpaid liability for employment taxes. Thus, we find that a defense of reasonable cause is not available to petitioner.



III. Collection Due Process Appeal
Having found petitioner liable for the trust fund penalties, we turn to other aspects of respondent's notice of determination upholding the filing of the notices of lien against petitioner. A section 6330 hearing is to be conducted by an officer or employee of the Commissioner's Appeals Office who has had no prior involvement with respect to the tax in controversy. Sec. 6330(b)(1), (3). The Appeals officer or employee is required to verify that the requirements of any applicable law or administrative procedure have been met. Sec. 6330(c)(1). At the hearing, the taxpayer may raise "any relevant issue relating to the unpaid tax". Sec. 6330(c)(2)(A). At the conclusion of the hearing, the Appeals officer must determine whether and how to proceed with collection and shall take into account: (i) The verification that the requirements of any applicable law or administrative procedure have been met; (ii) the relevant issues raised by the taxpayer; (iii) challenges to the underlying tax liability by the taxpayer, where permitted; and (iv) 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. Sec. 6330(c)(3).

In regard to matters other than the tax liability, our standard for review of an Appeals officer's determination concerning a collection due process hearing is generally whether there has been an abuse of discretion, a standard which the Court of Appeals for the Fifth Circuit also applies when it reviews such aspects of collection due process cases. Christopher Cross, Inc. v. United States, 461 F.3d 610, 612 (5th Cir. 2006). This Court will find an abuse of discretion has occurred in collection due process cases where the exercise of discretion is without sound basis in fact or law. See Freije v. Commissioner, 125 T.C. 14, 23 (2005); Ansley-Sheppard-Burgess Co. v. Commissioner, 104 T.C. 367, 371 (1995). The Court of Appeals for the Fifth Circuit has adopted a similar test for whether an abuse of discretion has occurred. Christopher Cross, Inc. v. Commissioner, supra at 612 (defining an abuse of discretion as "clear taxpayer abuse and unfairness by the IRS"); see Burnett v. Commissioner, 227 Fed. Appx. 342, 343 (5th Cir. 2007) (citing Cross and stating that the court is "applying the same abuse-of-discretion standard as the Tax Court" (emphasis added). We, therefore, proceed by considering whether respondent's determination, insofar as related to matters other then petitioner's challenge to her underlying liabilities, was an abuse of discretion.

Petitioner challenged the propriety of the Appeals officer's determination on three grounds: (1) Respondent never mailed her the Letter 1153; (2) notification was not sent to New Life advising it had defaulted on an installment agreement with respondent for payment of the employment tax liability; and (3) a notice of lien was filed against petitioner despite an agreement not to file the notice within a certain period and despite petitioner's having informed respondent that the $2,927 payment needed to institute the refund abatement could not be made until 1 week after the agreed time.

We held that petitioner did not receive the Letter 1153, and we reviewed her underlying liability. Our finding that petitioner did not receive the Letter 1153 did not invalidate the trust fund penalty assessment. Petitioner has not raised any other issue with respect to respondent's determination to assess the trust fund penalty, and nothing in the record would cause us to invalidate the assessment.

Petitioner next contends that the decision to proceed with filing a notice of lien was in error because she was not advised that New Life had defaulted on its installment agreement. 17 At her CDP hearing and at trial petitioner also raised her concern that New Life's offers-in-compromise had been inappropriately rejected. As we understand petitioner's argument, she is asserting that respondent's mishandling of these administrative tasks led respondent to pursue trust fund penalties against her. 18

Respondent's handling of the installment agreement default or of the offers-in-compromise with New Life has no direct bearing on petitioner's case. Whether or not New Life was paying a portion of its liability under an offer-in-compromise or installment agreement, respondent had discretion to collect the unpaid trust fund tax by pursuing a penalty against petitioner as a responsible person. 19 Because the pursuit of the trust fund penalties against petitioner was within respondent's discretion, we cannot, on that basis, conclude respondent abused his discretion.

Petitioner's final argument is that respondent should not have filed the liens once she submitted the necessary payment with her Form 843 abatement request. The CAP officer gave petitioner until May 24, 2006, to perfect her Form 843 abatement request and agreed not to file the notice of lien until a decision was reached on her abatement request. Petitioner, however, did not submit the payment to perfect her abatement request until June 2, 2006. Petitioner and respondent disagree as to whether petitioner was given the impression that the lien filing would be held in abeyance even though she missed the May 24 deadline. Whether petitioner was or was not granted additional time to perfect her abatement request has no bearing on the appropriateness of respondent's decision to file notices of tax lien. The Commissioner may proceed with filing a tax lien after a tax has been assessed, notice and demand has been given, and a taxpayer has refused or neglected to pay. Sec. 6321. There is no legal prohibition to filing a notice of Federal tax lien while a taxpayer is seeking administrative review of the underlying liability. 20 Respondent's decision to proceed with filing the lien was well within the bounds of respondent's discretion.

The Appeals officer verified that respondent had complied with all legal and procedural requirements pertaining to the proposed lien. Petitioner did not challenge the appropriateness alternative. Also, petitioner did not raise any other defenses to collection. Finally, as explained in the notice of determination, the Appeals officer took into account whether any proposed collection action balanced the need for the efficient collection of taxes with the legitimate concern of petitioner that the collection action be no more intrusive than necessary. See sec. 6330(c)(3). Consequently, the Appeals officer determined the filing of a notice of lien was legally and procedurally correct.

The Appeals officer's determination to uphold the lien is sustained.

To reflect the foregoing,

Decision will be entered for respondent.

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

2 The notice of determination reflects zero liability for the period ended Sept. 30, 2001. Petitioner paid the liability for this period, and she now seeks a refund. We do not have jurisdiction to review that period. See Greene-Thapedi v. Commissioner, 126 T.C. 1, 11 (2006).

3 The parties' stipulation of facts and the attached exhibits are incorporated herein by this reference.

4 At the time this case was petitioned, petitioner had elected the small tax case procedures. Before the commencement of the trial, with the agreement of the parties, the Court removed this case from small tax case status.

5 Neither party has raised any question concerning the burden or proof or burden of production in this case. See sec. 7491.

6 We recently held that a matter the Appeals officer should have considered under sec. 6330(c)(1) was before us for review regardless of whether the taxpayer raised it with the Appeals officer. Hoyle v. Commissioner, 131 T.C. ___ (2008).

7 In Giamelli v. Commissioner, 129 T.C. 107, 114 n.5 (2007), we noted that we need not address "whether a taxpayer, having raised one issue with respect to his or her underlying liability in a collection review hearing, may then raise new and different issues with respect to the underlying liability for the first time on appeal of respondent's determination before this Court." Because we have found that petitioner raised all the issues before us at her CDP hearing, we need not address this issue.

8 At trial SO Hill attempted to explain how he addressed petitioner's claims simultaneously, yet separately. At best, his testimony was confused and convoluted as to how he denied petitioner the opportunity to raise her underlying liability while, at the same time, reviewing her challenge to the trust fund penalty assessments.

9 This result is compatible with the law involving notices of deficiency. To be effective, a notice of deficiency need not be received by a taxpayer; instead, it must be shown that the Commissioner sent it to a taxpayer's last known address. Sec. 6212(a) and (b); Weber v. Commissioner, 122 T.C. 258, 263 (2004); Pietanza v. Commissioner, 92 T.C. 729, 735-736 (1989), affd. without published opinion 935 F.2d 1282 (3d Cir. 1991). In contrast, when Congress enacted the collection due process statute, it determined that a higher standard should apply and that taxpayers had to receive a notice of deficiency before they would be precluded from raising their underlying liability at their CDP hearing. Sec. 6330(c)(2)(B). Therefore, our conclusion that a taxpayer must receive a Letter 1153 fits within the intent of Congress's collection due process laws.

10 While respondent did not present a U.S. Postal Service Form 3877, there is sufficient evidence in the record that respondent sent a Letter 1153 by certified mail to petitioner's last known address.

11 For instance, petitioner hand-delivered payments to respondent. In her dealings with respondent she attended meetings that either she or respondent scheduled. She never raised frivolous arguments or employed tactics solely for delay.

12 It is clear from the record that petitioner raised her concern that she did not receive the Letter 1153, but that SO White solely focused petitioner's CAP hearing on the propriety of the proposed notice of lien filing.

13 According to the Service's Policy Statement P-5-14, "The withheld income and employment taxes or collected excise taxes will be collected only once, whether from the business, or from one or more of its responsible persons." 1 Administration, Internal Revenue Manual (IRM) (CCH), pt. 1.2.14.1.3(2), at 2404 (June 9, 2003).

14 The exception is where the Commissioner determines that collection of the penalty is in jeopardy. Sec. 6672(b)(4). Respondent does not assert that the penalty was in jeopardy of collection; therefore, this exception does not apply.

15 Sec. 7491(a)(1) provides that the burden of proof may be shifted to the Commissioner, provided that certain requirements are met, for "any tax imposed by subtitle A or B". The sec. 6672 trust fund penalty is imposed by subtit. F of the Internal Revenue Code.

16 The U.S. Supreme Court explained that responsibility for collecting, truthfully accounting for, and paying over employment taxes must be read disjunctively because Congress did not intend to limit liability for trust fund taxes "to those persons in a position to perform all three of the enumerated duties". Slodov v. United States, 436 U.S. 238, 250 (1978).

17 On Mar. 3, 2004, New Life and respondent entered into an installment agreement for payment of its employment tax liabilities. Respondent admits that an employee agreed not to pursue the trust fund penalties against petitioner as long as certain conditions were met, including New Life's timely payment of the amounts agreed to under the installment agreement. Petitioner does not contend that the installment payments were made; instead, she asserts that respondent should have notified her of the default and failed to do so.

18 As previously noted, petitioner was impeded by the fact that respondent had as many as five different employees dealing with her regarding the employment tax and trust fund penalties for the same tax periods. These circumstances do not constitute an abuse of discretion. It is possible, however, that petitioner would have encountered less confusion and there might have been an administrative resolution of this case if she had been able to deal with a single point of contact concerning the employment tax.

19 It is the Service's policy that the amount offered to compromise a liability subject to assertion of the TFRP will represent what can be collected from the employer. If the Service enters into a compromise with an employer for a portion of the trust fund tax liability, the remainder of the trust fund taxes may still be collected from a responsible person pursuant to Section 6672 of the Internal Revenue Code.

1 Administration, IRM (CCH), pt. 5.8.4.13.2(2), at 16.349-11 (Sept. 23, 2008); see also Hult v. Commissioner, T.C. Memo. 2007-302; sec. 301.6159-1(d)(3), Proced. & Admin. Regs. (stating the Commissioner may file a lien while a taxpayer has an installment agreement in place as long as the terms of the agreement do not provide otherwise).

20 Unlike notice of lien filings, the Commissioner is prohibited from pursuing a levy where a taxpayer satisfies the requirements of sec. 6672(c). Included in the list of requirements is that the taxpayer file a refund/abatement request. Sec. 6672(c)(1)(B); 1 Administration, IRM (CCH), pt. 5.7.7.6.2(1), at 16,216 (Apr. 13, 2006).

Mattie Marie Mason v. Commissioner.

Dkt. No. 4908-07 , 132 TC --, No. 14, May 6, 2009.

]
100% penalty for failure to withhold or pay over withholding taxes: Responsible person: Willfulness. --
The majority shareholder of a home health care corporation was liable for trust fund recovery penalties. For purposes of imposing the penalties, the notice requirement was satisfied by a proper mailing of Letter 1153 to the taxpayer's last known address. Actual receipt of the notice was not required. As the majority shareholder, officer and employee of the corporation who had the authority to hire and fire employees, write checks and manage the corporation, the taxpayer possessed six indicia of a responsible person. While initially unaware of the bookkeeper's failure to remit employment taxes, once she became aware of the failure, she continued to authorize payments to other creditors. Accordingly, her failure to pay over employment taxes was willful and the defense of reasonable cause was not available to her. -


P is majority owner and principal officer of C, which failed to pay employment taxes. R mailed a notice of intent to assess sec. 6672, I.R.C., trust fund penalties to P at P's last known address. P did not receive R's notice and the penalties were assessed. R notified P of the intent to file a notice of Federal tax lien with respect to the penalties. P administratively appealed and also filed a request to abate the penalties. After administrative review of R's decision to file a lien, R determined to proceed with the lien filing. P's abatement request was also denied. P appealed both decisions to R's Appeals Office. During the hearing, an Appeals officer simultaneously considered R's intent to file a lien and denial of P's abatement request. The Appeals officer determined that P was not entitled to contest the penalties as part of the hearing as it related to the lien filing. During the same hearing the Appeals officer did consider the merits of the penalties as it related to review of P's abatement request.

The questions presented are: (1) Whether pursuant to sec. 6330(c)(2)(B), I.R.C, a taxpayer has "otherwise [had] an opportunity to dispute" a sec. 6672, I.R.C., penalty and therefore is precluded from challenging the merits of that penalty at a collection due process hearing where the taxpayer never received a notice of intent to assess the penalty; (2) whether at any juncture during the administrative proceedings P "otherwise [had] an opportunity to dispute" the sec. 6672, I.R.C., penalties, thereby precluding P from challenging the merits of the penalties at P's collection due process hearing, and if not, whether P's underlying liabilities are before the Court for de novo review; (3) whether, for purposes of sec. 6672, I.R.C., the validity of R's notice of intent to assess trust fund recovery penalties depends upon a taxpayer's receipt of that notice; (4) whether P is liable for sec. 6672, I.R.C., penalties because P is a "responsible person" who willfully failed to pay over C's employment taxes; and (5) whether R's decision to uphold the lien filing was an abuse of discretion.

1. Held: A taxpayer must receive a sec. 6672, I.R.C., notice of intent to assess a trust fund recovery penalty to have "otherwise [had] an opportunity to dispute" that tax liability under sec. 6330(c)(2)(B), I.R.C. P did not receive R's notice of intent to assess sec. 6672, I.R.C., penalties and did not "otherwise have an opportunity to dispute" the underlying tax liability.

2. Held, further, P did not "otherwise have an opportunity to dispute" P's underlying tax liability at any time during the administrative proceedings. Held, further, P raised P's liability for the sec. 6672, I.R.C., penalties at P's collection due process hearing. P's liability for the trust fund recovery penalties is, therefore, before this Court for de novo review.

3. Held, further, a assess sec. 6672, I.R.C., purposes of assessing the taxpayer does not receive notice of intent to penalties is valid for penalties even where a the notice. Consequently, even though P did not receive R's notice, R validly assessed trust fund penalties.

4. Held, further, P is a "responsible person" who willfully failed to pay over C's withholding taxes and P is liable for the trust fund penalties.

5. Held, further, R's decision to uphold the lien filing was not an abuse of discretion.


OPINION

GERBER, Judge: This case arises from a petition for judicial review filed in response to a Notice of Determination Concerning Collection Actions(s) Under Section 6320 and/or 6330 (notice of determination) issued to petitioner Mattie Marie Mason. 1 The overall question is whether respondent may proceed with the collection action. The answer depends upon whether petitioner is liable for trust fund penalties assessed against her as a responsible person for failure to collect and pay over withholding taxes of New Life Perinatal Health Care Services Inc. (New Life), for tax periods ended December 31, 2001, March 31, June 30, and September 30, 2002, and September 30, 2003. 2


Background 3

Petitioner resided in Texas at the time her petition was filed. 4 She earned a bachelor of science degree in nursing in 1978 and thereupon commenced a 30-year career as a registered nurse. The focus of that career has been on providing services to pregnant and parenting women, especially teenagers. In 1989 petitioner incorporated New Life under the laws of the State of Texas. Corporate shares of New Life have at all relevant times been held 75 percent by petitioner and 25 percent by her husband Phillip Mason (Mr. Mason). Petitioner served as president and treasurer of New Life, while Mr. Mason served as vice president and secretary. New Life elected to be treated as an S corporation for Federal tax purposes.

New Life was licensed in the State of Texas as a home health agency. Through New Life, petitioner engaged in her primary business activities of providing services to pregnant and parenting women, especially teenagers. New Life's mission included, among other things, home health care services, case management services for public and private third-party entities, health care education and consulting services and programs (e.g., programs aimed at prevention of pregnancy, school dropout, and illicit drug use among at-risk youth).

Case management programs accounted for the majority of New Life's business and revenues. In conducting that portion of the business, New Life would enter into contracts with entities such as school districts or hospitals to administer the provision of services to targeted high-risk groups. New Life, in turn, would hire independent contractors with backgrounds as registered nurses or social workers to serve as "case managers" providing care services to the particular patients or "clients" referred through the entities. Because the clients were principally high-risk pregnant and parenting women, especially teenagers, much of the revenue earned by New Life for their care was obtained through the Medicaid programs of the Texas Department of Health.

As New Life grew throughout the 1990s, petitioner assembled an administrative staff of approximately seven employees to manage the business and perform clerical support functions. Petitioner used a team management approach in conducting New Life's day-to-day operations. She delegated substantial authority to staff members so that they could independently handle their administrative portion of New Life's operation.

Key members of that team during the late 1990s to early 2000s included petitioner, Walterene Reed (Ms. Reed), Shelly Morton (Ms. Morton), and Mabel Hatton (Ms. Hatton). Petitioner served as administrator overseeing management and was responsible for hiring and firing staff and establishing and maintaining business contracts. Ms. Reed was employed as New Life's office manager to oversee the activities of case managers, the referrals of patients/clients, and the billing process. Ms. Morton was a billing specialist responsible for handling Medicaid claims.

Ms. Hatton served as New Life's internal accountant. Petitioner delegated to her full authority for the financial, tax, and accounting matters of the business, including oversight of accounts payable and receivable, payment of bills and compensation, bank deposits, and preparation and filing of Federal employment tax returns. Although petitioner and Mr. Mason were the sole signatories on New Life's corporate bank account, it was petitioner's practice to sign blank checks for Ms. Hatton to complete and use in performing her duties. Petitioner likewise relied on Ms. Hatton's expertise in handling financial affairs, and she signed employment tax returns prepared by Ms. Hatton relying completely on Ms. Hatton's expertise.

By late 2000 and early 2001 the business of New Life reached its apex. With approximately 2,000 clients and 10 case managers, the corporation income approached $1 million. During spring 2001 New Life began to experience internal and external problems. In particular, New Life experienced difficulties with respect to the management staff, the independent contractors serving as case managers, and the receipt of payments from Government agencies and from other programs.

During March 2001 Ms. Reed became unable to continue working for New Life because of a serious illness that resulted in her death before the end of the year. A replacement for Ms. Reed was hired but proved to be incapable of handling the office manager's duties. In addition, other departures of administrative staff exacerbated New Life's problems. The loss of Ms. Reed left a significant gap in the operations of New Life and led to problems with, among other things, billing processes. Mounting unbilled or incorrectly billed claims in many instances foreclosed expected payments from Government programs, particularly Medicaid. Compounding these problems, some of the case managers began to use New Life's client base to start their own businesses, effectively taking New Life's clients and corresponding ability to generate revenue.

During this period petitioner was consumed with efforts to save the business; i.e., handling duties formerly covered by Ms. Reed and personally serving clients on account of the reduced number of case managers. Ms. Hatton continued to be responsible for accounting and financial matters, paying creditors to the extent funds allowed and filing Federal employment tax returns without remitting payment. The failure to pay employment taxes began with the tax return for the quarter ending September 30, 2001, and continued into the first three quarters of 2002 and again for the quarter ended September 30, 2003. It was not until March 2002 that petitioner became aware that New Life's Federal employment taxes were not being paid.

On July 8, 2002, the collection of New Life's delinquent taxes was assigned to Revenue Officer Elvina Davis (RO Davis) of the Internal Revenue Service (IRS). RO Davis first contacted New Life by leaving a telephone message on July 16, 2002. On August 8, 2002, RO Davis reached Ms. Hatton and told her that she would need to obtain a power of attorney from petitioner in order for RO Davis to deal directly with Ms. Hatton. Near the end of August RO Davis received the power of attorney and began initial conversations with Ms. Hatton. It was not until November of 2002 that petitioner engaged in personal interaction with RO Davis. She also completed and provided RO Davis with a Form 4180, Report of Interview with Individual Relative to Trust Fund Recovery Penalty or Personal Liability for Excise Tax, signed and dated November 5, 2002. Form 4180 contained details of petitioner's relationship to and oversight of New Life.

Throughout the fall of 2002 and during 2003 investigation and collection activities continued in the form of conversations, meetings, requests for records, lien filing, etc. On February 12, 2003, RO Davis advised petitioner about options to settle New Life's debt and the potential for assessment of trust fund penalties against petitioner personally.

During September 2003, the State of Texas instituted massive changes to the case management program and concomitant Medicaid payment processes, which caused a substantial reduction of New Life's revenue stream. In response, petitioner laid off the New Life administrative staff and worked with volunteers to keep the business afloat and restructure for the new environment. In addition to those reductions, petitioner returned to work as a nurse in a local hospital to generate funds.

On January 23, 2004, petitioner submitted an offer-in-compromise for New Life's employment tax liabilities. That offer, however, could not be processed because New Life was not in compliance with return filing and payment obligations at that time. RO Davis contacted petitioner on that date to so inform her, and the two discussed how to proceed. RO Davis calculated an arrangement under which New Life could pay $1,150 per month through an installment agreement until an offer-in-compromise could be processed, to which petitioner agreed. In addition, RO Davis advised petitioner that if she signed a waiver extending the period of limitations for assessment of trust fund penalties, made timely payments under the installment agreement, filed timely Federal tax returns, and made timely tax deposits, then the IRS would forbear from assessing trust fund penalties against petitioner.

Early in March 2004 an installment agreement was approved for the liabilities of New Life that provided for payments of $1,150 on the 28th of each month. The installment agreement was assigned to Revenue Officer Avis Smith (RO Smith), a case processor who monitors accounts and payments for respondent. Petitioner made installment payments under the agreement on April 27, 2004 ($1,150), May 28, 2004 ($1,150), September 10, 2004 ($1,150), November 19, 2004 ($1,100), December 28, 2004 ($1,150), January 28, 2005 ($1,150), March 4, 2005 ($550), March 10, 2005 ($600), and May 25, 2005 ($1,150), after which payments ceased. Payments made under the agreement were personally delivered by petitioner to respondent's office.

Throughout the entire period, petitioner, on repeated occasions, communicated with RO Smith and/or RO Davis regarding financial problems and difficulty in making payments. Petitioner also raised the possibility of decreasing the monthly payment to $500, but she did not formally pursue a reduction, opting instead to proceed with preparation of a second offer-in-compromise. On December 17, 2004, petitioner submitted the second offer-in-compromise. However, like the first offer, the second was not processed because an employment tax return for New Life had not been filed. Petitioner, however, continued her effort to perfect an offer.

Sometime during March 2005 the installment agreement was deemed in default on account of missed payments. On April 14, 2005, petitioner contacted RO Smith in an attempt to perfect an offer-in-compromise. During that conversation, although petitioner was advised of the installment agreement default, she did not fully comprehend what was being explained. Accordingly, the default was again explained to petitioner when she spoke to respondent's personnel in June. New Life did not receive formal, written notification of the default, apparently because of confusion regarding a change of the corporation's address. After the April 14, 2005, conversation with RO Smith, New Life's case was transferred to RO Davis on account of the default, but petitioner did not learn of the case transfer until some time later. Sometime during June 2005 petitioner's frustrations in her attempts to deal with various IRS personnel led her to contact the Taxpayer Advocate Service, thereby adding an additional layer of complexity to petitioner's involvement and communications with respondent.

On August 8, 2005, petitioner hand-delivered a third offer-in-compromise of New Life's tax debt, along with a $150 filing fee, to RO Davis. RO Davis forwarded the offer materials, first to her manager for approval and then, on August 15, 2005, to the IRS Service Center in Memphis, Tennessee, responsible for processing offers. Thereafter, the offer materials were returned to petitioner, absent the $150 cashier's check, with a form letter dated September 12, 2005, advising, without further explanation, that the "offer is closed". The return of the offer-in-compromise was caused by an error on the part of the IRS when it misapplied the $150 filing fee to payment of outstanding New Life liabilities. Petitioner at that juncture began to make inquiries regarding what had transpired with regard to the offer, and on September 21, 2005, she faxed a copy of the $150 cashier's check to the Memphis Service Center.

It was not until December 2005 that New Life finally received respondent's written notification concerning the earlier return of the August 8, 2005, offer-in-compromise. A brief form letter advised that a Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, had not been included and that the $150 application fee had not been paid.

Meanwhile in early September 2005 a determination was made by the IRS to commence proceedings against petitioner personally with respect to New Life's employment tax liabilities. RO Davis prepared a Letter 1153, Trust Funds Recovery Penalty Letter, proposing assessment of section 6672 trust fund penalties against petitioner as a person required to collect, account for, and pay over withheld taxes of the business for the unpaid liabilities. That letter further informed petitioner that if she did not agree, she could contact the individual identified therein (RO Davis) within 10 days of the date of the letter or could submit a written appeal within 60 days.

The Letter 1153 was mailed on September 2, 2005, hand-addressed to petitioner at what was then her address of record. Although a certified mail label and return receipt were affixed to the envelope, postage was placed thereon with a private postage meter and the letter was posted without being presented to a U.S. Postal Service (USPS) employee. As a result, no USPS postmark was date-stamped on the envelope, nor was the item number on the certified label entered into the USPS certified mail tracking system. Notations made on the envelope by the USPS indicate that delivery was attempted and notice was left for petitioner on September 3, 2005; that a second notice was left on September 8, 2005; and that the document was returned to the IRS marked "UNCLAIMED" on September 18, 2005. The unopened envelope, return receipt still attached, was received by the IRS on September 29, 2005. Petitioner did not receive the Letter 1153 or notification of its attempted delivery.

On December 19, 2005, trust fund penalties were assessed against petitioner for the trust fund portion of New Life's outstanding employment tax liabilities, and notices of balance due were issued to her. Petitioner, surprised by the turn of events, began to investigate by contacting various individuals at the IRS. Her inquiries also led to internal inquiries by several of respondent's offices. It was discovered that the $150 filing fee petitioner submitted with the August 8, 2005, offer-in-compromise had been misapplied as a payment toward New Life's taxes for the period ended September 30, 2001.

A meeting was held on February 16, 2006, among, inter alia, petitioner, RO Davis, and RO Davis's supervisor. The participants discussed the mailing of the Letter 1153 and assessment of the trust fund penalties, petitioner's desire to appeal the assessments, and the procedures for such an appeal and for the continued pursuit of an offer-in-compromise. Shortly thereafter, RO Davis faxed to petitioner a copy of the envelope in which the Letter 1153 had been returned to the IRS. Petitioner took that information to the post office and spoke to USPS employees in an attempt to track the item as a certified letter. Such efforts, however, were unsuccessful on account of the mailing procedures that had been used by respondent's personnel.

During the period March to May 2006, in addition to continuing work to perfect an offer-in-compromise, petitioner submitted various forms and letters in an attempt to forestall the filing of a Federal tax lien against her. To address the assessment of the trust fund penalties, petitioner needed to file a Form 843, Claim for Refund and Request for Abatement, disputing that she was a responsible person within the meaning of the employment tax statutes. Her early attempts to file could not be processed. For example, in March she sent a letter of appeal to RO Davis, rather than submitting a Form 843. Later, her initial Form 843, submitted in April and assigned to Revenue Officer Advisor Ken McNeil (ROA McNeil) in the IRS Technical Services Advisory, was returned to petitioner for failure to submit the requisite payment therewith of the amount of tax attributable to one individual for each tax period included in the claim; i.e., $2,927.

Meanwhile, on April 12, 2006, petitioner was given notice that the IRS was proposing and preparing to file liens against her for the assessed trust fund tax penalties. Petitioner was also advised that in order to dispute that proposal, she needed to file with the IRS a Form 9423, Collection Appeal Request. On April 13, 2006, petitioner submitted a Form 9423, thereby initiating her participation in the IRS Collection Appeal Program (CAP) for prefiling challenge of the lien proposal.

The CAP appeal was assigned to Settlement Officer Liana White (SO White) of the IRS Office of Appeals. SO White held a face-to-face conference with petitioner on April 26, 2006. During that conference and followup telephone calls, petitioner alleged that she had never received the Letter 1153 proposing assessment of the trust fund penalties, and she argued that if the installment agreement for New Life had been renegotiated to an affordable amount, then assessment of the penalties would not have been necessary and no filing of a notice of lien would be needed. SO White explained the distinction between the corporate and individual proceedings and that the trust fund penalties can be assessed and liens filed regardless of whether the underlying corporation is under an installment agreement. SO White also communicated with ROA McNeil regarding the Form 843 abatement request and its rejection for lack of payment, and further explained those issues, and the steps to perfect the Form 843 claim, to petitioner.

SO White concluded the CAP process by means of a closing letter dated May 1, 2006. Because petitioner's Form 843 could not be processed at that time, SO White sustained the proposed lien filing but recommended that the filing be delayed until petitioner had been afforded an opportunity to perfect a Form 843 and then, if perfected, until a decision on the claim, including any attendant appeals, was made by the IRS. Because she was considering only petitioner's challenge to the proposed lien filing, SO White was willing to postpone her recommendations pending the outcome of ROA McNeil's investigation into petitioner's liability for the trust fund penalties. Petitioner was given until May 24, 2006, to perfect the claim for abatement of the penalties by providing ROA McNeil with a proper Form 843 accompanied by a payment. If that was not done, the closing letter directed that the IRS compliance function would file the notice of tax lien. Upon closure of the CAP process with the issuance of the May 1, 2006, letter, petitioner's case was returned to RO Davis for monitoring, and the letter advised that petitioner should contact RO Davis with any questions.

In late May 2006 petitioner telephoned ROA McNeil concerning financial hardship she was encountering in securing payment to perfect her Form 843 claim. She indicated that she could remit payment by June 1, 2006. ROA McNeil responded that petitioner could resubmit the Form 843 abatement request with payment at any time and that there existed no deadline for submission of such a claim. Petitioner believed that ROA McNeil spoke for respondent's organization and that the CAP recommendations would be extended as well, even though ROA McNeil advised she should also speak with other of respondent's employees, because she believed that respondent coordinated all activities concerning New Life's and her trust fund tax liabilities. Petitioner did contact SO White who, because the CAP matter had been closed, informed petitioner that she needed to speak to RO Davis. Petitioner, in her confusion over who had authority over her case, did not do so.

On May 30, 2006, RO Davis inquired of ROA McNeil whether petitioner had submitted a perfected Form 843 claim. ROA McNeil answered in the negative. On June 1, 2006, RO Davis, acting on the CAP recommendations and without further inquiry of petitioner, prepared and filed notices of Federal tax lien against petitioner for the unpaid trust fund penalties. Also on that date, petitioner called ROA McNeil again and told him that she was sending the completed Form 843 and payment. That claim and payment were received by the IRS on June 2, 2006, and handled by ROA McNeil. After receiving petitioner's Form 843 abatement request, ROA McNeil reviewed it, along with information petitioner supplied when she completed the Form 4180, New Life's employment tax returns for the periods at issue, and canceled checks she had signed on behalf of New Life. On June 22, 2006, ROA McNeil issued his decision on petitioner's claim and disallowed petitioner's request for abatement of the trust fund penalties. He also informed her of her right to appeal his determination with the IRS Office of Appeals or file suit in either a U.S. District Court or the U.S. Court of Federal Claims.

While petitioner's Form 843 abatement request was being reviewed and ultimately denied by ROA McNeil, the IRS, on June 7, 2006, mailed petitioner a Letter 3172, Notice of Federal Tax Lien Filing and Your Right to a Hearing under IRC 6320, informing her that notices of Federal tax liens were filed for the unpaid trust fund penalties assessed against her for the tax periods ended September 30 and December 31, 2001, March 31, June 30, and September 30, 2002, and September 30, 2003. The Letter 3172 informed petitioner of her right to appeal the lien filing by submitting a Form 12153, Request for a Collection Due Process Hearing. On July 10, 2006, respondent received petitioner's completed Form 12153 disputing the lien filing. Her collection due process (CDP) lien appeal was assigned to Settlement Officer Bart A. Hill (SO Hill) in the IRS Office of Appeals.

On July 20, 2006, respondent received a letter from petitioner stating she did not agree with ROA McNeil's decision to disallow her Form 843 abatement request for the trust fund penalties and requesting review by IRS Office of Appeals. Her trust fund penalty abatement appeal was also assigned to SO Hill. In a letter dated November 1, 2006, petitioner was instructed that at her CDP hearing she could raise collection alternatives, challenge the appropriateness of the lien filing, challenge the underlying tax liability if she had not otherwise had a prior opportunity to do so, and raise spousal defenses. She was also informed in that letter that SO Hill was responsible for considering her appeal of her denied Form 843 abatement request.

After filing her appeals requests, on August 22, 2006, petitioner filed an amended offer-in-compromise on behalf of New Life for its unpaid employment tax liabilities. The corporation offered to pay $33,660 at a rate of $330 a month over 102 months, which was the period remaining by statute for the IRS to collect. On or around September 20, 2006, the IRS accepted New Life's August 22, 2006, offer-in-compromise. However, respondent also informed petitioner that she was still personally responsible for the trust fund penalties that had been assessed against her.

On December 5, 2006, SO Hill held a telephone conference with petitioner to discuss the appeal of the lien filing. SO Hill notified her that she was not permitted to discuss her liability for the trust fund penalties at her CDP hearing. However, during the CDP conference, petitioner asserted that the trust fund penalty assessment was invalid. She raised other concerns pertaining to the lien filing with SO Hill, specifically that she had reached an agreement with ROA McNeil to extend the time for perfecting her Form 843, and more generally that the IRS did not follow proper procedures when it failed to send New Life a formal default letter and when it improperly returned New Life's August 8, 2005, offer-in-compromise. Finally, she made a general claim that the notice of Federal tax lien for the trust fund penalties should be released.

At the same time, SO Hill also held, concurrent with petitioner's CDP hearing, a conference with petitioner to discuss her Form 843 abatement request appeal. During the conference SO Hill considered the validity of petitioner's liability for the assessed trust fund penalties. His consideration consisted of a full review of her status as a responsible person who willfully failed to pay over employment taxes.

On January 30, 2007, SO Hill issued his determination sustaining the denial of petitioner's Form 843 abatement request for trust fund penalties. He based his determination upon a finding that petitioner was a responsible person who willfully failed to pay over trust fund taxes.

On February 2, 2007, SO Hill issued his determination in which the filing of the Federal tax liens for the trust fund penalties was sustained. Finding that petitioner had had a prior opportunity to dispute her underlying liability for the trust fund penalties, SO Hill declined to consider petitioner's underlying liability as part of that determination. His finding that she had had a prior opportunity to dispute the liability was based on the IRS's attempted delivery of the Letter 1153 and his consideration of her Form 843 Appeal. He also determined through discussions with SO White and ROA McNeil that neither had granted petitioner an extension of the May 24, 2006, deadline to perfect her Form 843 abatement request. In that regard, petitioner provided SO Hill with permission to conduct ex parte communications with ROA McNeil and SO White. SO Hill did not consider petitioner's concerns with the IRS's mishandling of New Life's offer-in-compromise or respondent's failure to provide formal notice when New Life defaulted on its installment agreement, citing his lack of jurisdiction over matters pertaining to the corporation. Instead, he noted that after accepting a long-term payment offer from the corporation it was appropriate for respondent to file trust fund recovery penalty liens because respondent needed to "protect the government's interest in the taxpayer's assets in case the corporate offer defaults." SO Hill also considered whether any reason existed to release the lien but found no reason to do so and recommended against release.

Finally, SO Hill noted that petitioner had neither supplied him with a collection information statement nor proposed any collection alternatives for her trust fund penalties. He reviewed the procedures followed to file the notice of lien and concluded they were proper. He determined that the notice of lien filing "balances the need for efficient collection of taxes with the taxpayer's legitimate concern the action is no more intrusive than necessary."

In response to the notice of determination, petitioner timely filed a petition with this Court challenging the decision to sustain the notice of tax lien filing and the denial of her refund claim.


Discussion 5

Petitioner's corporation incurred an employment tax liability. Petitioner, an educated and intelligent person, had great difficulty navigating the administrative process to arrange for payment. While she was in the process of dealing with the corporate liability, an assessment was made against her for trust fund tax. Notices of lien were filed with respect to the trust fund assessment, though she argues an agreement to delay had been made. One major reason for petitioner's difficulty was that she had to deal with a different person for each type of procedure concerning the employment tax liability. At one point in the process she was dealing with as many as five of respondent's representatives regarding different aspects of the same underlying tax liability; i.e., offers, installment payments, claim for refund, etc. Respondent's balkanized approach to collection procedures was also detrimental to respondent, because important dates and events were not being internally coordinated. For petitioner, it presented Kafkaesque circumstances and confusion. The administrative record in this case is complex and convoluted. Ultimately, we have sorted out the underlying circumstances and we must decide whether petitioner is entitled to relief from the Appeals officer's determination.

Respondent filed notices of Federal tax lien with respect to petitioner's trust fund tax assessments. See secs. 6321, 6322, and 6323. Section 6320 provides that the Secretary shall furnish taxpayers with written notice of the filing of a notice of lien under section 6323. This notice must be provided not more than 5 business days after the date the notice of lien is filed and must advise the taxpayer of the opportunity for administrative review in the form of a hearing. Sec. 6320(a)(2) and (3). Petitioner has not shown or asserted any omission in the procedures with respect to the filing, or notice with respect to the filing, and none is disclosed in the record.

Section 6320(b) provides taxpayers with the right to request a "Fair Hearing" before an "Impartial" Appeals officer. The hearing generally shall be conducted consistent with the procedures set forth in section 6330(c), (d), and (e). Sec. 6320(c). Section 6330(c)(1) requires the Appeals officer to obtain verification that the requirements of any applicable law or administrative procedure have been met. Under section 6330(c)(2)(A) a taxpayer may raise any relevant issue at the hearing including challenges to "the appropriateness of collection actions" and may make "offers of collection alternatives, which may include the posting of a bond, the substitution of other assets, an installment agreement, or an offer-in-compromise." The taxpayer may also challenge the existence and amount of the underlying tax liability if no notice of deficiency was received or the taxpayer did not otherwise have an opportunity to dispute such tax liability. Sec. 6330(c)(2)(B).

Section 6330(c)(3) provides that a determination of the Appeals officer shall take into consideration the verification under section 6330(c)(1), the issues raised by the taxpayer, and whether 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. Section 6330(d)(1) allows the taxpayer to appeal a determination to the Tax Court.

Where the underlying tax liability is properly at issue in the hearing, we review that issue on a de novo basis. Goza v. Commissioner, 114 T.C. 176, 181-182 (2000). However, where the underlying tax liability is not at issue, we review the determination for an abuse of discretion. Nicklaus v. Commissioner, 117 T.C. 117, 120 (2001).



I. Scope and Standard of Review
The Tax Court recently acquired exclusive jurisdiction to review appeals from the Commissioner's lien and levy determinations made after October 16, 2006, irrespective of the type of tax making up the underlying liability. See Ginsberg v. Commissioner, 130 T.C. 88 (2008); Callahan v. Commissioner, 130 T.C. 44 (2008); McClure v. Commissioner, T.C. Memo. 2008-136. A taxpayer's "underlying tax liability" includes all "amounts a taxpayer owes pursuant to the tax laws that are the subject of the Commissioner's collection activities." Callahan v. Commissioner, supra at 49. Because respondent's determination sustaining the filing of notices of Federal tax lien for unpaid trust fund penalties was issued on February 2, 2007, we are authorized to review the trust fund penalties assessed against petitioner unless precluded by section 6330(c)(2)(B).

Generally, a taxpayer must raise an issue at a collection due process hearing to preserve it for this Court's consideration. Perkins v. Commissioner, 129 T.C. 58, 63 (2007) (de novo review); Magana v. Commissioner, 118 T.C. 488, 493 (2002) (abuse of discretion review); sec. 301.6330-1(f)(2), Q&A-F5, Proced. & Admin. Regs. 6 At her hearing, held in conjunction with the conference concerning the trust fund penalties, petitioner disputed that she received the Letter 1153 and also contended that she did not willfully fail to pay over the trust fund taxes. 7 The Appeals officer testified that these conferences were held simultaneously and that petitioner contested her liability for the penalties. In these circumstances there is no reason to draw an invisible curtain between issues that have been administratively merged by respondent. As far as petitioner was concerned, her CDP hearing and Form 843 abatement request were being addressed by the same Appeals officer within one proceeding. Moreover, the Appeals officer's explanation of the hearing at trial reflects that he handled both of petitioner's claims concurrently. 8 Petitioner challenged her liability for the trust fund penalties at her hearing. Accordingly, we may consider the merits of that assessment provided she was not statutorily precluded from raising it during her CDP appeal.

A taxpayer cannot challenge an underlying liability in a CDP hearing, and therefore this Court cannot review that liability, if the taxpayer received a notice of deficiency or otherwise had an opportunity to dispute the underlying liability. Sec. 6330(c)(2)(B). Because the assessments against petitioner were trust fund penalties, respondent would not have issued and mailed a notice of deficiency. See sec. 6212(a). The question is whether petitioner "otherwise [had] an opportunity to dispute" the trust fund penalty assessments. The Appeals officer concluded that petitioner had such an opportunity when respondent mailed a Letter 1153 to her. Similarly, respondent argues that the Letter 1153 was sent by certified mail to petitioner's last known address and that petitioner did not avail herself of her opportunity to contest the proposed assessment within the time prescribed by the letter. On these facts, respondent asserts that petitioner was barred from challenging her underlying liability before the Appeals officer.

A section 6672(b)(1) notice provides a taxpayer with the means for protesting a proposed trust fund penalty assessment administratively with the Commissioner. It follows that where a taxpayer has not received a section 6672(b)(1) notice, then that taxpayer has missed an opportunity to dispute the underlying tax liability. 9 Documentary evidence of mailing may suffice as proof that a notice of deficiency was properly mailed to a taxpayer. Coleman v. Commissioner, 94 T.C. 82, 90-91 (1990). When a Letter 1153 is mailed, the Commissioner must follow the same mailing procedures that are provided for notices of deficiency in section 6212(b). Sec. 6672(b)(1). It follows that the same evidence that establishes that the Commissioner mailed a notice of deficiency to a taxpayer's last known address should be sufficient to establish that the Commissioner properly sent a Letter 1153. See Hickey v. Commissioner, T.C. Memo. 2009-2. Respondent has established that a Letter 1153 was mailed, by certified mail, to petitioner's last known address, as required by section 6672(b)(1). 10

The record also reflects that the letter was returned to respondent undelivered and marked "unclaimed". Petitioner's circumstances are therefore distinguishable from those of the taxpayers in McClure v. Commissioner, T.C. Memo. 2008-136, and Pelliccio v. United States, 253 F. Supp. 2d 258 (D. Conn. 2003). The taxpayer in McClure received a Letter 1153 and contested his liability in response. This Court held that that was his opportunity to dispute the trust fund penalty assessment. Likewise, in Pelliccio the taxpayer received a Letter 1153 before each assessment, and the District Court concluded that the taxpayer had the requisite opportunity. We conclude that a section 6672(b)(1) notice that was not received, but not deliberately refused, by a taxpayer does not constitute an opportunity to dispute that taxpayer's liability.

We note that during the prolonged course of her dealings with respondent, petitioner received numerous notices and documents from respondent, some by certified mail. She not only received them, but unlike the taxpayer in Sego v. Commissioner, 114 T.C. 604 (2000), she responded or took other appropriate action in response to them. 11 The Letter 1153 was the sole instance where petitioner made no response nor took other action. Further, respondent has neither argued nor presented any evidence that petitioner refused delivery of the Letter 1153.

We recently addressed what it means to "otherwise have an opportunity to dispute" a tax liability in the context of section 6330(c)(2)(B). See Perkins v. Commissioner, 129 T.C. 58 (2007); Lewis v. Commissioner, 128 T.C. 48 (2007). Neither the Internal Revenue Service Restructuring and Reform Act of 1998 (RRA), Pub. L. 105-206, sec. 3401, 112 Stat. 746, nor the Internal Revenue Code defines what Congress intended by the phrase "otherwise have an opportunity to dispute" a tax liability. The Commissioner has defined this phrase to some extent by promulgating a regulation indicating that an opportunity "includes a prior opportunity for a conference with Appeals". Sec. 301.6330-1(e)(3), Q&A-E2, Proced. & Admin. Regs. (emphasis added).

The Commissioner's limited definition leaves open the opportunity for deciding what other circumstances do or do not constitute an "opportunity". Lewis v. Commissioner, supra at 55. Regarding this subject, this Court has explained:

As we see it, if Congress had intended to preclude only those taxpayers who previously enjoyed the opportunity for judicial review of the underlying liability from raising the underlying liability again in a collection review proceeding, the statute would have been drafted to clearly so provide. The fact that Congress chose not to use such explicit language leads us to believe that Congress also intended to preclude taxpayers who were previously afforded a conference with the Appeals Office from raising the underlying liabilities again in a collection review hearing and before this Court.

Id. at 61. We concluded our analysis by holding that "A conference with the Appeals Office provides a taxpayer a meaningful opportunity to dispute an underlying tax liability." Id.

In his determination sustaining the filing of the notice of tax liens, the Appeals officer decided that petitioner had had an opportunity to dispute her liability for the trust fund penalties when he reviewed her Form 843 abatement request. We find the Appeals officer's conclusion unsupportable. As explained in Perkins v. Commissioner, supra at 65, section 6330(c)(2)(B) "utilizes the past tense in reference to the opportunity to dispute, indicating that Congress contemplated that the dispute opportunity would have already transpired when the hearing under section 6330 occurred." It was also noted that the Commissioner's regulation specifies that a prior conference with Appeals is an opportunity to dispute a liability. Id. The analysis and reasoning we applied in Perkins is equally applicable to petitioner's situation. Petitioner's concurrent appeal of the denial of her abatement request was not an "opportunity" as contemplated by section 6330(c)(2)(B). To hold otherwise would unduly limit judicial review. Accordingly, a simultaneous collection due process appeal and underlying tax liability appeal is not an "opportunity" to contest the underlying tax liability within the meaning of section 6330(c)(2)(B).

To challenge the propriety of the proposed lien filing, petitioner filed an appeal with respondent's CAP. The CAP Settlement Officer, an Appeals officer, was fully aware of petitioner's pending Form 843 abatement request. The CAP Settlement Officer did not consider petitioner's underlying tax liability and instead focused her review solely on the propriety of the proposed notice of lien filing. 12 Petitioner's CAP prelien filing hearing did not rise to the level of an "opportunity to dispute" her underlying tax liability where the Appeals officer limited her review to the propriety of filing the notice of liens.

Where a taxpayer has not received a notice of deficiency or had an opportunity to contest her liability and raises her underlying liability at her CDP hearing, we review the underlying liability. Sec. 6330(c)(2)(B); see, e.g., Bach v. Commissioner, T.C. Memo. 2008-202, affd. without published opinion 103 AFTR 2d 1340, 2009-1 USTC par. 50,286 (4th Cir. 2009). Where a taxpayer is incorrectly advised at a CDP hearing that she had a prior opportunity to contest her underlying liability, we consider the underlying liability. Petitioner raised the underlying liability, and it was reviewed and considered in her abatement hearing. The Appeals officer conducting petitioner's CDP hearing mistakenly believed she had had a prior opportunity to raise her underlying tax liability. We find that petitioner did not have an opportunity to dispute her liability for the trust fund penalty assessments before her CDP hearing with SO Hill. Petitioner's liability for the trust fund penalties is accordingly before this Court for de novo review.



II. Trust Fund Penalty
Section 6672 imposes a penalty for the willful failure to collect, account for, and pay over income and employment taxes of employees. Income and employment tax withholding is commonly referred to as "trust fund tax" because the Internal Revenue Code characterizes such withholding as a "special fund in trust for the United States." Sec. 7501(a). As set forth in section 6671, penalties for the failure to collect, account for, and pay over trust fund taxes are assessed and collected in the same manner as tax against a person including "an officer or employee of a corporation, or a member or employee of a partnership, who as such officer, employee, or member is under a duty to perform" the duties referred to in section 6672. Sec. 6671(b). Such persons are referred to as "responsible persons" and the term may be broadly applied. See generally Logal v. United States, 195 F.3d 229, 232 (5th Cir. 1999); Barnett v. IRS, 988 F.2d 1449, 1454 (5th Cir. 1993).

A trust fund penalty may be assessed against any responsible person and is separate from the employer's liability for the unpaid income and employment taxes. Sec. 6672(a); Howard v. United States, 711 F.2d 729, 733 (5th Cir. 1983). While there is no requirement that the Commissioner pursue collection of the taxes from the employer before assessing the penalty against a responsible person, as a matter of policy the Commissioner does not pursue collection of the penalty where the employer pays its liability. Hornsby v. IRS, 588 F.2d 952, 954 (5th Cir. 1979). 13

A. Preliminary Notice

Generally, before a section 6672 penalty may be assessed, the Commissioner must mail a Letter 1153 to the responsible person's last known address advising that a trust fund penalty will be assessed. Sec. 6672(b)(1). 14 While we determined petitioner did not have an opportunity to contest her liability for the penalties because she did not receive the Letter 1153, we arrived at that determination by applying the standard established in section 6330(c)(2)(B). Whether the Government must ensure that a taxpayer actually receives a Letter 1153 or whether it is sufficient for the Government to show it timely mailed the notice to a taxpayer's last known address in order for the assessment to be valid is a question recently addressed by this Court. We concluded that the mailing of section 6672 notification to a taxpayer's "last known address" would be sufficient to advise a responsible officer of the assertion of a trust fund penalty. See Hickey v. Commissioner, T.C. Memo. 2009-2. In Hickey we held that where the notice has been mailed to the taxpayer's last known address, it is not necessary for the taxpayer to receive the notice before the Commissioner can assess the trust fund penalty. A bankruptcy court reached the same conclusion in In re Chabrand, 301 Bankr. 468, 476-477 (Bankr. S.D. Tex. 2003).

The other means of providing notice to a taxpayer pursuant to section 6672(b)(1) is by personal service. This option was added to the statute in 1998 with the enactment of RRA sec. 3307, 112 Stat. 744. A Senate Finance Committee report explains the addition to the statute and states, in a parenthetical to the explanation, that "In some cases, personal delivery may better assure that the recipient actually receives notice." S. Rept. 105-174, at 66 (1998) 1998-3 C.B. 537, 602. The Committee's explanation implies that Congress added personal delivery as an option for the Commissioner that would "better assure" receipt of the notice, thereby acknowledging that mailing notice to the taxpayer's last known address does not guarantee receipt. The delivery methods are alternatives, and the statute permits the Commissioner to choose which method to use; thus, we have concluded that Congress did not require the Commissioner to ensure that a taxpayer actually receive the notice.

Accordingly, proper mailing of a preliminary notice to the last known address is sufficient to comply with section 6672(b)(1). In this case the notice requirement of the statute was satisfied by respondent's certified mailing of a Letter 1153 to petitioner's last known address.

B. Burden of Proof

The parties have not raised the issue of who bears the burden of proof in this proceeding. Generally, the burden of proof is upon the taxpayer. Sec. 7453; Rule 142(a). Section 7491(a), providing for a shift to the Commissioner of the burden of proof in certain circumstances, is inapplicable to trust fund penalty cases. 15 In any event we find on a preponderance of the evidence that employment taxes were not paid, that petitioner was a responsible person, and that she willfully failed to pay over those taxes.

C. Responsible Person

Liability is imposed upon all persons responsible for collecting, accounting for, or paying over employment withholding taxes. 16 The Court of Appeals for the Fifth Circuit, to which this case is appealable, "generally takes a broad view of who" qualifies as a "responsible person under § 6672." Gustin v. United States, 876 F.2d 485, 491 (5th Cir. 1989). It is one's duties, status, and authority that define him as a responsible person. Turnbull v. United States, 929 F.2d 173, 178 (5th Cir. 1991); Gustin v. United States, supra at 491. A delegation of that duty to others does not necessarily change that person's status as a responsible person. Turnbull v. United States, supra at 178. Further, an individual may be a responsible person even though he did not know that withholding taxes were not being paid over to the Government. Barnett v. IRS, 988 F.2d at 1454.

The Court of Appeals for the Fifth Circuit considers the following to be indicia of a responsible person: (i) Holding the position of officer or member of the board of directors; (ii) substantial ownership of the business; (iii) possessing the authority to hire and fire employees; (iv) managing the day-today operations of the business; (v) deciding how to disburse funds and pay creditors; and (vi) possessing the authority to sign checks for the business. Id. at 1455. "No single factor is dispositive." Id. In applying these indicia, there may be, and often are, more than one responsible person within each business. Id. However, for purposes of imposing liability for trust fund penalties, it does not matter how many responsible persons there are, or who is the most responsible, because the statute applies equally to all responsible persons. Id. Therefore, we must determine only whether petitioner is a responsible person.

During the periods at issue petitioner was the president, treasurer, and an employee of New Life. She was also the majority (75 percent) shareholder of the corporation. She admits she had the ability to and did exercise her right to hire and terminate employees. Petitioner was a signatory on New Life's checking account. There is considerable evidence that she signed most of the checks for New Life. There is evidence she was involved in managing the corporation although that responsibility was shared with others. She concedes that she had "overall management" responsibilities for the corporation. Finally, petitioner admits that she had the authority to direct the payment of corporate funds, and there is ample evidence she exercised that authority.

It is clear on the basis of her admissions that petitioner possessed, albeit in varying degrees, all six of the indicia of a responsible person. There is ample evidence to support the conclusion that petitioner was a responsible person, for purposes of section 6672.

D. Willfulness

A responsible person will be held liable for the penalty only where that failure to pay over withholding tax was willful. The Court of Appeals for the Fifth Circuit has determined that "willful", in the context of section 6672, does not mean the responsible person must have a "criminal or other bad motive * * *, but simply a voluntary, conscious and intentional failure to collect, truthfully account for, and pay over the taxes withheld from the employees." Newsome v. United States, 431 F.2d 742, 745 (5th Cir. 1970). To establish willfulness, there is no requirement that the responsible person have intended to deprive the Government of the withholding tax. Id. at 747. However, willfulness is established where the "responsible person acts with a reckless disregard of a known or obvious risk that trust funds may not be remitted to the Government". Mazo v. United States, 591 F.2d 1151, 1154 (5th Cir. 1979). While willfulness is typically proven by evidence that a responsible person paid other creditors when withholding tax was due to the Government, mere negligence is not sufficient to establish willfulness. Gustin v. United States, supra at 492.

Delegation of the responsibility to handle trust fund taxes appropriately is not proof that the responsible person was not willful. Hornsby v. IRS, 588 F.2d at 953. "Responsible persons owe a fiduciary obligation to care properly for the funds that are temporarily entrusted to them for the ultimate use of the United States." Id. A responsible person's fiduciary duty remains with him even where he has delegated responsibility for discharging that duty to a subordinate. Id.

Petitioner admits that as early as March 2002 she became aware that New Life had not been paying over its trust funds to the Government. Petitioner employed a bookkeeper who was responsible for preparing New Life's Form 941, Employer's Quarterly Federal Tax Return, and remitting payment along with these returns. For all periods at issue petitioner signed the quarterly employment tax returns reflecting an unpaid liability for employment taxes. She does not recall whether at the time she signed these returns they were blank or had been completed by the bookkeeper. There is evidence petitioner signed checks paying for the corporation's rent and insurance, as well as an "advance" payable to herself. These payments were made before and after she became aware of the corporation's unpaid employment tax liability.

Petitioner's delegation of the duty to prepare and remit the employment tax returns and payments does not insulate her from liability. Her defense is that she was unaware of the bookkeeper's failure to remit the employment taxes. Petitioner did, however, become aware during March 2002, if not sooner, that the corporation had not been paying over these taxes. Other creditors were paid despite New Life's liability to respondent and its failure to remit employment taxes continued for the quarters ended March 31, June 30, and September 30, 2002, and September 30, 2003. Petitioner's authorization of payment to other New Life creditors after becoming aware that employment taxes were unpaid is indicative that as a responsible person her "conduct was willful as a matter of law." See Mazo v. Commissioner, supra at 1157.

Even though petitioner was distracted and pressured by business problems and responsibilities, her failure to discharge the outstanding obligations to the Government is not thereby excused. We can draw only one conclusion from these facts: Petitioner's failure to pay over employment taxes was "willful".

E. Reasonable Cause

Finally, the Court of Appeals for the Fifth Circuit recognizes that a taxpayer may avoid liability for a trust fund penalty by showing reasonable cause for a failure to collect, account for, or pay over trust fund taxes. Newsome v. United States, supra at 746-747; Frazier v. United States, 304 F.2d 528, 530 (5th Cir. 1962). It is a very limited exception to a finding of willfulness. Logal v. United States, 195 F.3d at 233; Bowen v. United States, 836 F.2d 965 (5th Cir. 1988); Newsome v. United States, supra at 747. While reasonable cause is a defense, conceptually, the Court of Appeals has stated that "no taxpayer has * * * carried that pail up the hill." Id. Further, reasonable cause is not a defense where a responsible person "knew that the withholding taxes were due, but * * * made a conscious decision to use corporate funds to pay creditors other than the government." Logal v. United States, 195 F.3d at 233.

While petitioner does not assert the reasonable cause exception applies to her, we consider its applicability. Petitioner concedes that she knew withholding taxes for New Life were due. Additionally, the record contains considerable evidence she paid other creditors after becoming aware of the corporation's unpaid liability for employment taxes. Thus, we find that a defense of reasonable cause is not available to petitioner.



III. Collection Due Process Appeal
Having found petitioner liable for the trust fund penalties, we turn to other aspects of respondent's notice of determination upholding the filing of the notices of lien against petitioner. A section 6330 hearing is to be conducted by an officer or employee of the Commissioner's Appeals Office who has had no prior involvement with respect to the tax in controversy. Sec. 6330(b)(1), (3). The Appeals officer or employee is required to verify that the requirements of any applicable law or administrative procedure have been met. Sec. 6330(c)(1). At the hearing, the taxpayer may raise "any relevant issue relating to the unpaid tax". Sec. 6330(c)(2)(A). At the conclusion of the hearing, the Appeals officer must determine whether and how to proceed with collection and shall take into account: (i) The verification that the requirements of any applicable law or administrative procedure have been met; (ii) the relevant issues raised by the taxpayer; (iii) challenges to the underlying tax liability by the taxpayer, where permitted; and (iv) 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. Sec. 6330(c)(3).

In regard to matters other than the tax liability, our standard for review of an Appeals officer's determination concerning a collection due process hearing is generally whether there has been an abuse of discretion, a standard which the Court of Appeals for the Fifth Circuit also applies when it reviews such aspects of collection due process cases. Christopher Cross, Inc. v. United States, 461 F.3d 610, 612 (5th Cir. 2006). This Court will find an abuse of discretion has occurred in collection due process cases where the exercise of discretion is without sound basis in fact or law. See Freije v. Commissioner, 125 T.C. 14, 23 (2005); Ansley-Sheppard-Burgess Co. v. Commissioner, 104 T.C. 367, 371 (1995). The Court of Appeals for the Fifth Circuit has adopted a similar test for whether an abuse of discretion has occurred. Christopher Cross, Inc. v. Commissioner, supra at 612 (defining an abuse of discretion as "clear taxpayer abuse and unfairness by the IRS"); see Burnett v. Commissioner, 227 Fed. Appx. 342, 343 (5th Cir. 2007) (citing Cross and stating that the court is "applying the same abuse-of-discretion standard as the Tax Court" (emphasis added). We, therefore, proceed by considering whether respondent's determination, insofar as related to matters other then petitioner's challenge to her underlying liabilities, was an abuse of discretion.

Petitioner challenged the propriety of the Appeals officer's determination on three grounds: (1) Respondent never mailed her the Letter 1153; (2) notification was not sent to New Life advising it had defaulted on an installment agreement with respondent for payment of the employment tax liability; and (3) a notice of lien was filed against petitioner despite an agreement not to file the notice within a certain period and despite petitioner's having informed respondent that the $2,927 payment needed to institute the refund abatement could not be made until 1 week after the agreed time.

We held that petitioner did not receive the Letter 1153, and we reviewed her underlying liability. Our finding that petitioner did not receive the Letter 1153 did not invalidate the trust fund penalty assessment. Petitioner has not raised any other issue with respect to respondent's determination to assess the trust fund penalty, and nothing in the record would cause us to invalidate the assessment.

Petitioner next contends that the decision to proceed with filing a notice of lien was in error because she was not advised that New Life had defaulted on its installment agreement. 17 At her CDP hearing and at trial petitioner also raised her concern that New Life's offers-in-compromise had been inappropriately rejected. As we understand petitioner's argument, she is asserting that respondent's mishandling of these administrative tasks led respondent to pursue trust fund penalties against her. 18

Respondent's handling of the installment agreement default or of the offers-in-compromise with New Life has no direct bearing on petitioner's case. Whether or not New Life was paying a portion of its liability under an offer-in-compromise or installment agreement, respondent had discretion to collect the unpaid trust fund tax by pursuing a penalty against petitioner as a responsible person. 19 Because the pursuit of the trust fund penalties against petitioner was within respondent's discretion, we cannot, on that basis, conclude respondent abused his discretion.

Petitioner's final argument is that respondent should not have filed the liens once she submitted the necessary payment with her Form 843 abatement request. The CAP officer gave petitioner until May 24, 2006, to perfect her Form 843 abatement request and agreed not to file the notice of lien until a decision was reached on her abatement request. Petitioner, however, did not submit the payment to perfect her abatement request until June 2, 2006. Petitioner and respondent disagree as to whether petitioner was given the impression that the lien filing would be held in abeyance even though she missed the May 24 deadline. Whether petitioner was or was not granted additional time to perfect her abatement request has no bearing on the appropriateness of respondent's decision to file notices of tax lien. The Commissioner may proceed with filing a tax lien after a tax has been assessed, notice and demand has been given, and a taxpayer has refused or neglected to pay. Sec. 6321. There is no legal prohibition to filing a notice of Federal tax lien while a taxpayer is seeking administrative review of the underlying liability. 20 Respondent's decision to proceed with filing the lien was well within the bounds of respondent's discretion.

The Appeals officer verified that respondent had complied with all legal and procedural requirements pertaining to the proposed lien. Petitioner did not challenge the appropriateness alternative. Also, petitioner did not raise any other defenses to collection. Finally, as explained in the notice of determination, the Appeals officer took into account whether any proposed collection action balanced the need for the efficient collection of taxes with the legitimate concern of petitioner that the collection action be no more intrusive than necessary. See sec. 6330(c)(3). Consequently, the Appeals officer determined the filing of a notice of lien was legally and procedurally correct.

The Appeals officer's determination to uphold the lien is sustained.

To reflect the foregoing,

Decision will be entered for respondent.

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

2 The notice of determination reflects zero liability for the period ended Sept. 30, 2001. Petitioner paid the liability for this period, and she now seeks a refund. We do not have jurisdiction to review that period. See Greene-Thapedi v. Commissioner, 126 T.C. 1, 11 (2006).

3 The parties' stipulation of facts and the attached exhibits are incorporated herein by this reference.

4 At the time this case was petitioned, petitioner had elected the small tax case procedures. Before the commencement of the trial, with the agreement of the parties, the Court removed this case from small tax case status.

5 Neither party has raised any question concerning the burden or proof or burden of production in this case. See sec. 7491.

6 We recently held that a matter the Appeals officer should have considered under sec. 6330(c)(1) was before us for review regardless of whether the taxpayer raised it with the Appeals officer. Hoyle v. Commissioner, 131 T.C. ___ (2008).

7 In Giamelli v. Commissioner, 129 T.C. 107, 114 n.5 (2007), we noted that we need not address "whether a taxpayer, having raised one issue with respect to his or her underlying liability in a collection review hearing, may then raise new and different issues with respect to the underlying liability for the first time on appeal of respondent's determination before this Court." Because we have found that petitioner raised all the issues before us at her CDP hearing, we need not address this issue.

8 At trial SO Hill attempted to explain how he addressed petitioner's claims simultaneously, yet separately. At best, his testimony was confused and convoluted as to how he denied petitioner the opportunity to raise her underlying liability while, at the same time, reviewing her challenge to the trust fund penalty assessments.

9 This result is compatible with the law involving notices of deficiency. To be effective, a notice of deficiency need not be received by a taxpayer; instead, it must be shown that the Commissioner sent it to a taxpayer's last known address. Sec. 6212(a) and (b); Weber v. Commissioner, 122 T.C. 258, 263 (2004); Pietanza v. Commissioner, 92 T.C. 729, 735-736 (1989), affd. without published opinion 935 F.2d 1282 (3d Cir. 1991). In contrast, when Congress enacted the collection due process statute, it determined that a higher standard should apply and that taxpayers had to receive a notice of deficiency before they would be precluded from raising their underlying liability at their CDP hearing. Sec. 6330(c)(2)(B). Therefore, our conclusion that a taxpayer must receive a Letter 1153 fits within the intent of Congress's collection due process laws.

10 While respondent did not present a U.S. Postal Service Form 3877, there is sufficient evidence in the record that respondent sent a Letter 1153 by certified mail to petitioner's last known address.

11 For instance, petitioner hand-delivered payments to respondent. In her dealings with respondent she attended meetings that either she or respondent scheduled. She never raised frivolous arguments or employed tactics solely for delay.

12 It is clear from the record that petitioner raised her concern that she did not receive the Letter 1153, but that SO White solely focused petitioner's CAP hearing on the propriety of the proposed notice of lien filing.

13 According to the Service's Policy Statement P-5-14, "The withheld income and employment taxes or collected excise taxes will be collected only once, whether from the business, or from one or more of its responsible persons." 1 Administration, Internal Revenue Manual (IRM) (CCH), pt. 1.2.14.1.3(2), at 2404 (June 9, 2003).

14 The exception is where the Commissioner determines that collection of the penalty is in jeopardy. Sec. 6672(b)(4). Respondent does not assert that the penalty was in jeopardy of collection; therefore, this exception does not apply.

15 Sec. 7491(a)(1) provides that the burden of proof may be shifted to the Commissioner, provided that certain requirements are met, for "any tax imposed by subtitle A or B". The sec. 6672 trust fund penalty is imposed by subtit. F of the Internal Revenue Code.

16 The U.S. Supreme Court explained that responsibility for collecting, truthfully accounting for, and paying over employment taxes must be read disjunctively because Congress did not intend to limit liability for trust fund taxes "to those persons in a position to perform all three of the enumerated duties". Slodov v. United States, 436 U.S. 238, 250 (1978).

17 On Mar. 3, 2004, New Life and respondent entered into an installment agreement for payment of its employment tax liabilities. Respondent admits that an employee agreed not to pursue the trust fund penalties against petitioner as long as certain conditions were met, including New Life's timely payment of the amounts agreed to under the installment agreement. Petitioner does not contend that the installment payments were made; instead, she asserts that respondent should have notified her of the default and failed to do so.

18 As previously noted, petitioner was impeded by the fact that respondent had as many as five different employees dealing with her regarding the employment tax and trust fund penalties for the same tax periods. These circumstances do not constitute an abuse of discretion. It is possible, however, that petitioner would have encountered less confusion and there might have been an administrative resolution of this case if she had been able to deal with a single point of contact concerning the employment tax.

19 It is the Service's policy that the amount offered to compromise a liability subject to assertion of the TFRP will represent what can be collected from the employer. If the Service enters into a compromise with an employer for a portion of the trust fund tax liability, the remainder of the trust fund taxes may still be collected from a responsible person pursuant to Section 6672 of the Internal Revenue Code.

1 Administration, IRM (CCH), pt. 5.8.4.13.2(2), at 16.349-11 (Sept. 23, 2008); see also Hult v. Commissioner, T.C. Memo. 2007-302; sec. 301.6159-1(d)(3), Proced. & Admin. Regs. (stating the Commissioner may file a lien while a taxpayer has an installment agreement in place as long as the terms of the agreement do not provide otherwise).

20 Unlike notice of lien filings, the Commissioner is prohibited from pursuing a levy where a taxpayer satisfies the requirements of sec. 6672(c). Included in the list of requirements is that the taxpayer file a refund/abatement request. Sec. 6672(c)(1)(B); 1 Administration, IRM (CCH), pt. 5.7.7.6.2(1), at 16,216 (Apr. 13, 2006).

Failure to Collect and Pay Over Tax, or Attempt to Evade or Defeat Tax: Assessment of Penalty: Notice of deficiency required

Penalty for failure to pay over tax may not be assessed without notice except in the case of withheld employment taxes.

Mrizek, DC, 59-2 USTC ¶9678.

Notice, before the IRS transmitted a company's payment to the IRS on to the company's creditor, was not required in order for liability to be imposed (1) upon one officer who made the payment with funds attached under law by the creditor and (2) upon another officer who resigned before the ineffective payment to the IRS was made.

J. Satterlee, DC, 81-2 USTC ¶9815.

The IRS was not entitled to apply a corporation's fourth-quarter employment tax deposits to late payment penalties attributable to the third quarter. The third-quarter penalty did not become payable until the date on which the IRS gave notice and demanded payment of the penalty; therefore, the IRS incorrectly applied payments it received before that date to a penalty that had not yet matured. Nonetheless, the IRS was permitted to retain the funds as payment for the corporation's outstanding fourth-quarter and following first-quarter taxes. The corporation had been dissolved in bankruptcy and the court saw no reason to hold the corporation's former officers personally liable for the 100% employment tax penalty while speculating as to which creditor the corporation would have paid with the funds.

E.F. Elms, DC Mich., 93-1 USTC ¶50,281. Aff'd, CA-6 (unpublished opinion 10/26/94).

The IRS could not levy on funds received as a tax overpayment until it gave the taxpayer notice and demand for payment of the penalty to which it applied the overpayment. The notice and demand requirements of the penalty provisions overrode the general Code Sec. 6402 rule that permitted the IRS to credit overpayments to debts owed to federal agencies. Although the penalty had accrued, it had not matured because the IRS had not issued a notice and demand for payment. On motion to alter a judgment of a District Court decision, 93-1 USTC ¶50,281.

E.F. Elms, DC Mich., 93-2 USTC ¶50,390.

The lack of a notice of deficiency did not invalidate the trust fund recovery penalty that the IRS imposed against a taxpayer because a notice of deficiency was not a precondition to assessment.

N.P. Czajkowski, DC Mich., 95-1 USTC ¶50,176.

A corporate officer received valid notices of assessment and, thus, was properly deemed to be a responsible person liable for the corporation's failure to account for and pay over withheld employment taxes. Although the notices contained information concerning how to pay the penalty if the officer did not wish to contest it, such information was not the equivalent of a demand for payment and were valid under Code Sec. 6672(b).

J.E. Bisbee, CA-8, 2001-1 USTC ¶50,359, 245 F3d 1001, aff'g an unreported District Court decision.

That the IRS sent a notice of deficiency by ordinary mail, rather than by certified or registered mail, to a third-party, responsible person's last known address was insufficient to demonstrate that the notice was invalid. It was reasonable to infer that he received timely notice of the IRS's deficiency claim because his attorney received the notice of deficiency and submitted a protest to the IRS on his behalf.

D.K. Scheingold, DC N.J. (unpublished opinion), 2002-2 USTC ¶50,510.

A certified letter provided to the CEO of a business from the IRS that it "planned" to assess the trust fund recovery penalty against him for unpaid employment taxes met the requirements of providing notice the taxpayer of the proposed assessment. The use of the word "plan," rather than the IRS "shall" assess the penalty against the taxpayer, did not alter the import of the letter.

F.C. Cappetta, DC Ill., 2006-1 USTC ¶50,174.

Failure to Collect and Pay Over Tax, or Attempt to Evade or Defeat Tax: Willfulness: Paying others before IRS

The vice president, secretary and treasurer of a dry-cleaning company was subject to the trust fund recovery penalty for failure to pay over withheld employment taxes. The taxpayer's failure to pay over the taxes was willful as a matter of law because the officer admitted that he was aware that other corporate obligations were being paid while employment tax liabilities were outstanding. Thus, the officer, who had conceded that he was a responsible person, made a conscious decision to prefer other creditors over the government. The court rejected the officer's argument that he should be held to the "personal fault" standard of willfulness used in Slodov (see ¶39,780.726, above), because that case applies only to the situation in which a person becomes responsible after withheld taxes have been spent and other corporate funds have been dissipated. Slodov does not relieve a responsible person of the duty to remit taxes if the taxpayer has been a responsible person throughout the period during which withholding tax liability accrued and thereafter.

M.A. Richner, DC Kan., 93-2 USTC ¶50,668.

A trial judge's determination that, contrary to a jury verdict, as a matter of law, a corporate vice-president was "willful" for purposes of failing to pay over withheld employment taxes for the six quarters in issue was proper. He knew about the unpaid liability but chose to use the corporation's after-acquired unencumbered funds to pay creditors rather than the government.

M.H. Kim, CA-7, 97-1 USTC ¶50,370.

A president and sole shareholder of a company who made a plan to liquidate the company in an effort to secure a payment for the company's unpaid withholding taxes was liable for the trust fund recovery penalty. Although he informed the IRS of his plan, he paid other creditors, as part of the plan, while he knew the withholding taxes were unpaid. Although he was trying to ultimately rescue something for the IRS, the president, who was a continuing responsible person, was the one conducting the rescue operations. Further, even though an IRS revenue officer, whom the president notified of the plan by a letter, did not dissuade him from his course of action, the letter was insufficient to estop the government because it was not accepted in writing.

H.D. Buffalow, Jr., CA-9, 97-1 USTC ¶50,290, 109 F3d 570.

The senior officer of a community action agency, who administered millions of dollars of public funds to provide a variety of programs for low-income persons, was the responsible person accountable for remitting payroll taxes. Her failure to remit the withholding taxes was willful since her agency continued to expend a considerable portion of its funds for other purposes after she undeniably knew of the delinquent taxes. Despite the fact she was unsophisticated in the financial dealings of her agency and her actions were taken solely to improve the lives of the poor citizens of her community, it was not unfair to hold her accountable.

C.B. Stanley, BC-DC N.C., 92-2 USTC ¶50,480, 146 BR 655.

A district court did not clearly err when it determined that the president of a drilling company, although a "responsible person," did not willfully fail to pay over delinquent payroll taxes withheld from employees' wages during a period when a creditor-bank possessed and exerted substantial control over the company's accounts. The bank's withdrawal of funds from such accounts in violation of a written agreement with the company effectively prevented the president from discharging his withholding tax responsibilities. The president's actions did not constitute a voluntary, conscious and intentional preference of other creditors over the government.

S.R. Rykoff, CA-9, 94-2 USTC ¶50,601.

A responsible person willfully failed to pay over taxes when he paid other, nongovernmental creditors in preference to the IRS after he became aware of the tax obligation. The corporation's bankruptcy filing did not absolve the individual of liability for the penalty on wages already paid.

R.C. Kelley, CA-10, 95-2 USTC ¶50,561. Cert. denied, 2/20/96.

A corporate president who admitted he was a responsible person was liable for the trust fund recovery penalty with respect to withheld taxes that were used by the company to pay creditors other than the IRS. As a responsible person, he had a duty to pay over withholding taxes and his decision to forgo paying the government in favor of paying other creditors constituted a willful breach of that duty.

S. Layne, DC Mich., 97-1 USTC ¶50,423.

The trust fund recovery penalty was imposed against a corporate officer who had check-writing authority, was aware of the entity's payroll tax delinquencies, and paid others ahead of the IRS.

G.T. Sheppard, BC-DC S.C., 2000-1 USTC ¶50,362.

An individual who was the majority shareholder and president of a corporation was a responsible person for purposes of the corporation's unpaid withholding tax liabilities. He willfully preferred other creditors over the United States and checking account statements revealed that there were sufficient funds to pay the corporation's withholding taxes for five of the six quarters in issue.

M.W. Newton, BC-DC Ariz., 2000-2 USTC ¶50,681.

The general manager of a manufacturing corporation was liable for the trust fund recovery penalty in connection with unpaid employee withholding taxes because his failure to pay the taxes at issue was willful. He paid other creditors before the IRS although he had knowledge that employment taxes were due, and his claim that he was ordered to do so did not constitute a defense to liability. There was no evidence that he had reasonable cause for his failure to pay the withheld taxes.

J.J. Treacy, BC-DC Pa., 2000-2 USTC ¶50,776.

The president and sole officer of a closely held corporation willfully failed to pay over withheld employment taxes to the IRS. She admitted that she was aware of the corporation's failure to pay over the taxes and that she paid other creditors ahead of the IRS. Thus, she had no reasonable cause for failing to remit the taxes.

J.C. Luce, DC Ohio, 2000-2 USTC ¶50,847, 119 FSupp2d 779.

A vice-president of a defunct corporation qualified as a responsible person and was not entitled to a refund of payments issued in partial satisfaction of a trust fund recovery penalty assessed against him individually in connection with the corporation's failure to pay over withheld employment taxes. The taxpayer had extensive control over the financial affairs of the business including the ability to sign checks and pay bills. Moreover, his conduct was willful in that he knew that the withholding taxes were not being paid and that available funds were being used to pay other creditors in preference to the IRS.

H.W. Fisher, DC Okla., 2001-1 USTC ¶50,159.

A bankrupt corporate officer's objection to the IRS's claim for the trust fund recovery penalty assessed against him was denied because he was properly deemed a responsible person within the meaning of Code Sec. 6672. The debtor had extensive control over the corporation's financial affairs, including check signing authority and the ability to pay bills. Further, his conduct was willful in that he knew the withholding taxes were not being paid and that available funds were being used to pay other creditors, including himself, in preference to the IRS.

W. Karnofsky, BC-DC Fla., 2001-1 USTC ¶50,170.

The president, director and sole shareholder of a bankrupt contracting business who qualified as a responsible person and who willfully failed to remit employee withholding taxes to the government was liable for the trust fund recovery penalty. Although he withheld the taxes from his employees' wages during the 10 quarters at issue and knew that the taxes were due and owing, he failed to remit payment to the IRS. Instead, he used corporate funds to pay wages to such employees as himself, his wife and his son, and he paid a broad array of other creditors ahead of the IRS.

L.B. Breaux, DC La., 2001-1 USTC ¶50,255.

A corporate accountant who was deemed to a responsible person was liable for the trust fund recovery penalty because she had knowledge of the unpaid employment taxes, yet paid off debts to other creditors before the government. That she was directed by the corporation's CEO not to pay the outstanding employment taxes was irrelevant to her knowledge of them.

B. Frey, DC Tex., 2001-1 USTC ¶50,417. Aff'd, per curiam, CA-5 (unpublished opinion), 2002-2 USTC ¶50,690, 34 FedAppx 151.

The conduct of a business owner, who was a responsible person within the meaning of Code Sec. 6672, was willful because he knew that the business had failed to properly account for and pay over withheld employment taxes, but paid other creditors of the business ahead of the IRS.

S. Rocha, DC Ore., 2001-1 USTC ¶50,425, 142 FSupp2d 1277.

The owner and former president of a bankrupt corporation was not liable for the trust fund recovery penalty because he did not willfully fail to pay his company's employment tax delinquency. While the individual conceded he was a responsible person within the meaning of Code Sec. 6672, he had no reason to know that his company was in arrears since he turned over control of his company when it was in good standing. Moreover, he took immediate action when he became aware of its failure to remit payroll taxes to the IRS, retaking control of the company, ensuring that it remained current with its tax obligations and making arrangements for paying past-due taxes. Moreover, he did not favor other creditors above the IRS.

R.D. Nutt, DC Fla., 2003-1 USTC ¶50,395, aff'g BC-DC Fla., 2002-2 USTC ¶50,753.

The trust fund recovery penalty was imposed against married taxpayers who failed to withhold or pay over employment taxes. Both taxpayers, were corporate officers with significant financial interest in the corporation, and were deemed responsible persons under Code Sec. 6672. They shared authority to authorize payroll, sign payroll checks, pay creditors, hire and discharge employees and enter into contracts on behalf of the corporation. Moreover, the taxpayers admitted that they knew about the unpaid withholding taxes and chose to pay creditors and fund payroll for themselves and other employees, rather than ensuring payment of the taxes.

A. Fuscaldo, DC Pa., 2002-1 USTC ¶50,141.

The wife of the owner of a sole proprietorship willfully failed to pay the outstanding employment tax liability of the business. The taxpayer, who was a responsible person, stipulated that she knew the business was delinquent on its withholding obligations during the tax quarters in issue, yet she continued to draft and sign checks to pay other creditors, payroll and personal expenses.

D.M. Keohan, DC Mass., 2002-1 USTC ¶50,279.

The failure of a corporate vice president, who was a responsible person, to withhold or pay over employment taxes was willful. Following his receipt of the notice of deficiency regarding the corporation's unpaid tax liability, he was aware that the corporation was paying creditors other than the government. In addition, he continued to sign payroll checks and he favored payment of the corporation's debts that were owed to him over the payment of the deficient withholding taxes.

B. Crutcher, DC Ala., 2002-1 USTC ¶50,289.

A corporate president was liable for the trust fund recovery penalty in connection with the corporation's failure to pay over its employment tax liability. The taxpayer's failure to pay over the taxes at issue was willful. He knew of the corporation's liability for employment taxes but paid net wages to employees knowing that payroll taxes would not be paid over to the government. The taxpayer unsuccessfully contended that his actions were not willful because he acted on orders of the bankruptcy court to use the company's available funds for environmental cleanup and operating expenses. The bankruptcy court, however, did not compel him to avoid paying the corporation's employment tax obligations.

D.F. Cook, FedCl, 2002-1 USTC ¶50,328.

The chairman of a corporation was liable for the trust fund recovery penalty because he was a responsible person who willfully failed to remit his company's employment taxes. He failed to fulfill his obligation to apply unencumbered corporate funds to pay its tax liabilities despite his knowledge that the taxes were unpaid. His self-serving statements that he lacked such knowledge were insufficient to satisfy his burden of proving that he had not acted willfully. In addition, he devoted corporate funds to purposes other than payment of the withholding taxes.

C.S. Perlman, DC Fla., 2002-1 USTC ¶50,346.

A corporate vice president's failure to pay withholding taxes was willful. The record indicated that he continued to make payments to other creditors after learning of the corporation's failure to pay employment taxes.

D.W. Parr, DC Tex., 2002-1 USTC ¶50,376.

An individual who owned 90 percent of his company's stock acted willfully in failing to collect and pay over the company's withholding taxes. He paid other creditors, including the entity's employees, ahead of the IRS. He was kept informed of the company's financial situation and was provided with financial statements that included lists of its outstanding liabilities. In addition, the shareholder spoke to an IRS agent about the unpaid taxes. In light of the fact that the company received revenues that were sufficient to pay the delinquent taxes, the shareholder's decision to prefer other creditors was conscious and intentional.

F.E. Riley, DC Mo., 2002-2 USTC ¶50,514.

A business owner who contended that adverse business circumstances were reasonable cause for failing to remit the business's employment taxes was liable for the trust fund recovery penalty. In order to continue business operations, he decided to forgo paying the government in favor of other creditors and employee salaries, including his own. Deciding to favor other creditors constitutes willfulness as a matter of law.

J.L. Carlson, DC Iowa, 2003-1 USTC ¶50,265.

A responsible person who willfully paid other creditors of his delinquent corporation ahead of the IRS was liable for the trust fund recovery penalty. The individual, who was a corporate officer who owned stock in the company, acted willfully in failing to remit the company's withholding taxes because he was aware that other parties were being paid ahead of the IRS. His failure to make the payments on orders of the second responsible person and his approval of payments to other creditors in order to keep the company going and to preserve its ability to repay the delinquent taxes did not relieve him of liability for the penalty.

P. Thosteson, CA-11, 2002-2 USTC ¶50,649, 304 F3d 1312.

A president and fifty percent shareholder of an employee leasing company was liable for the trust fund recovery penalty in connection with his company's failure to pay employee withholding taxes. The court determined that the taxpayer was liable for the penalty because he knew of the company's tax deficiency yet increased his salary, paid for personal expenses with corporate funds and paid other creditors.

S. Farkas, FedCl, 2003-2 USTC ¶50,574.

An individual willfully failed to pay over a company's employment taxes and was liable for the trust fund recovery penalty. The taxpayer argued that he had a tenuous and indirect formal connection to the business. However, there was evidence that the taxpayer retained managerial control of the company and had knowledge of nonpayment of the employment taxes. Moreover, he failed to show that he investigated or corrected mismanagement of funds that allowed other creditors to be paid ahead of the IRS. Thus, the district court did not abuse its discretion in denying a new trial.

J.V. Stuart, CA-1, 2003-2 USTC ¶50,585, 337 F3d 31.

A company's sole shareholder knowledge of previously dishonored checks amounted to reckless disregard of a risk of payroll tax delinquencies because he failed to ensure that checks to the IRS were actually honored before making additional payments to non-IRS creditors. However, as to an earlier period, the taxpayer was not obligated, after nearly four years of adequate payments, to double check with the IRS that a payment for that period was not applied to other liabilities.

H.W. Baimbridge, DC Calif., 2004-2 USTC ¶50,344, 335 FSupp2d 1084.

A debtor's objection to the IRS's claim for the trust fund recovery penalty assessed against him was denied because he was determined to be a responsible person who willfully failed to pay over withheld taxes. The debtor stipulated that he was a responsible person and his failure to remit the withheld taxes was willful because he was aware of the company's employment tax deficiency yet chose to pay creditors other than the government.

L. Borman, BC-DC Fla., 2005-1 USTC ¶50,109.

The president of a corporation admitted to causing the corporation to pay creditors other than the IRS making the failure to pay the corporation's trust fund taxes willful.

D.J. Frank, BC-DC N.C., 2005-1 USTC ¶50,222.

The IRS was granted summary judgment against the former president of a non-profit corporation for trust fund recovery penalties under Code Sec. 6672. The taxpayer had significant control of the corporation's finances, had check writing authority, and was responsible for ensuring that the company paid its trust fund taxes. Further, once the taxpayer became aware of the deficiency, he failed to ensure its payment before any other creditors were paid. Such a failure is willful and subjects the responsible person to trust fund recovery penalties.

Reverend R. W. Schlicht, DC Ariz., 2005-2 USTC ¶50,527.

An individual who had control over a corporation's financial affairs willfully failed to collect and pay over unpaid corporate trust fund taxes. He had assumed complete financial control of the corporation and had control over the corporation's unrestricted assets. Although he had actual knowledge of the unpaid withheld taxes, he acted with reckless disregard by using unencumbered funds to pay other creditors of the company before repaying the corporation's tax obligation. A bank held a security interest in the company's assets but the funds in the company's bank account were not encumbered since the bank did not restrict the use of those funds.

F.B.J. Branagan, Jr., BC-DC Pa., 2006-2 USTC ¶50,379.

A debtor's actions with respect to the IRS's claim for unpaid withholding taxes were willful because he was a responsible person who allowed disbursements of funds to creditors other than the IRS although he knew that taxes were owed.

L.R. Mendez, BC-DC Tex., 2006-2 USTC ¶50,547.

A debtor, who was the owner and president of a financial services corporation, was properly determined by the bankruptcy court to be a responsible person who willfully failed to pay over the corporation's withholding taxes. After he became aware of the corporation's delinquent tax obligations, he continued to pay other creditors rather than the IRS. He failed to prove that the corporation's funds were encumbered under state and federal securities law or to establish how the creditors held a superior legal interest in the corporation's funds to the interest of the IRS.

J.L. Paris, DC Fla., 2007-1 USTC ¶50,235, 355 BR 867.

The CEO and board chairman of a motorcycle company was not entitled to a refund of a portion of the trust fund recovery penalty he paid to the IRS in satisfaction of the company's unpaid payroll withholding taxes. Testimony of the CEO and the company's chief operating officer and financial director established that the CEO was a responsible person who willfully failed to pay the company's taxes. He had overall authority, including raising capital and hiring, was involved in the day-to-day management of the company, had the authority to issue checks, and determined which creditors to pay and when to pay them. Further, he instructed the company's financial director that bills pertaining to utilities were to be paid first; thus, checks were issued to other creditors but not to the government.

R.K. Hagen, DC Md., 2007-1 USTC ¶50,510, 485 FSupp2d 622.

An individual who was the president, director, Chief Executive Officer and majority shareholder of a corporation was liable for the trust fund recovery penalty assessed against him in connection with the corporation's unpaid withholding taxes. The individual was a "responsible person" with respect to the corporation and acted willfully because he was aware of the tax debt, yet authorized and made payments to other creditors.

J.C. Tornes, DC Ohio, 2008-2 USTC ¶50,431.

The majority stockholder of two retail optometry companies was not entitled to a refund of the trust fund recovery penalty he paid to the IRS in satisfaction of the companies' unpaid withholding taxes. The inidividual was a responsible person who acted willfully by continuing to sign payroll checks, authorizing payment of wages, rather than ensuring payment of taxes, even after he became aware of the delinquent tax obligations.

L.H. Joel, DC Ky., 2008-2 USTC ¶50,451.

Unpaid employment tax assessments against the president and vice-president of two health care companies were reduced to judgment. The individuals were responsible persons because they had the authority to sign checks, hire and fire employees, determine corporate financial policy, and authorize the payment of bills. Their decision not to pay the payroll taxes was willful because they knew about the companies' unpaid payroll taxes, but they paid employees and other creditors in preference to the IRS.

J.A. Rineer, DC Tex., 2009-1 USTC ¶50,149.
Responsible person determined. --Failure to Collect and Pay Over Tax, or Attempt to Evade or Defeat Tax: Responsible Person: Responsible person determined

The treasurer of a bankrupt corporation was personally liable to the government for withheld taxes that were diverted to pay other creditors. The treasurer breached his duty to hold such collected taxes in trust until they are paid over to the government. Although the treasurer could not sign checks in excess of $1,000 without the signature of another officer, such a limitation on his authority did not protect him from liability as the person responsible for payment of taxes. Further, the government was not bound by a hold-harmless agreement executed in favor of the treasurer by the other corporate officers.

E.A. Cella, DC, 80-1 USTC ¶9369.

Taxpayer was not an officer, director or employee of a toy company financed by her father and therefore was not liable for unpaid employment taxes of the company.

S. Philipson, DC, 55-1 USTC ¶9466.

Although the claimant denied that he was a director, officer or shareholder of the corporation, the weight of the evidence showed that he (1) hired and controlled employees of the corporation, (2) controlled the financial and business aspects of the corporation, (3) signed IRS forms, (4) engaged in other activities tending to show his direction and control over corporate funds, and (5) had the corporation formed.

J. Labowitz, DC, 73-1 USTC ¶9155, 352 FSupp 202.

A district court reversed a bankruptcy court's finding that the chairman of the board of two corporations was not a responsible person with respect to the collection and paying over of withholding and social security taxes. Because the taxpayer had, at all times, the power to see that such taxes were paid, the bankruptcy court's decision was clearly erroneous. The bankruptcy court's finding that the taxpayer did not willfully fail or refuse to pay the taxes in question was also clearly erroneous. After she became aware that the taxes had not been paid, she paid other creditors in preference to the government.

T.L. Woodson, DC Mich, 83-1 USTC ¶9258, rev'g BC- DC, 81-2 USTC ¶9791, 15 BR 185.

The determination of the liability (a corporate officer) for the payment of withheld taxes is an issue to be decided on the facts of the case. Thus, the court was compelled to dismiss both the government's and the taxpayer's motions for summary judgment.

B.H. Hoeniger, DC, 76-1 USTC ¶9296.

A corporate officer who paid the corporate liability for FICA taxes under the mistaken assumption that he was personally liable for their payment was entitled to a refund of the taxes and penalties paid.

E.B. David, DC, 83-1 USTC ¶9259.

After he failed to appear at trial, a district court sustained a 100% penalty against a president and treasurer of a photographic equipment business for his failure to pay over or collect employment taxes. However, an individual who had acted as general manager was not jointly liable for the penalty, since there was not sufficient evidence to suggest that he either preferred other creditors over the government or that he had financial responsibility over corporate affairs beyond that of depositing funds in a corporate account. As a result, the court sustained the penalty assessed against the president, but it dismissed the government's claim against the general manager.

R. Sparkman, DC Calif., 84-2 USTC ¶9983.

In reversing the Claims Court, the court of appeals held that a corporation's chairman of the board was not liable for the 100-percent penalty for failure to collect and pay withholding taxes because (1) he was not a responsible person who had a duty to collect, account for, and pay over taxes, since there was no evidence that he had or exercised control over such functions and (2) he did not act willfully in failing to withhold taxes because there was no evidence that he had actual knowledge of the nonpayment of taxes due after the first two quarters of the year until the eve of the corporation's bankruptcy. Since the taxpayer was not a responsible person and did not fail willfully to execute a duty to collect and pay taxes, the part of the judgment relating to the IRS's allocation of certain tax payments was vacated as moot.

D.J. Godfrey, Jr., CA-FC, 84-2 USTC ¶9974, 748 F2d 1568, rev'g ClsCt, 83-2 USTC ¶9635.

For withholding tax purposes, an individual who acquired a company in bleak financial condition and assumed unpaid liabilities had control over such company and was a responsible person. The facts that (1) the list of liabilities assumed did not include reference to unpaid pre-acquisition withholding tax liabilities and (2) such individual subsequently entered into an agreement with a bank to handle receipts and payments were insufficient to relieve such individual of his status as a responsible party. However, a question of material fact existed regarding whether such individual intentionally failed to pay taxes due.

H. Bonnabel, DC N.J., 90-2 USTC ¶50,481.

Mere titular officers of a corporation were not responsible parties and, even if they were, there was no showing that they willfully failed to pay the taxes due.

R.E. Couture, DC, 74-2 USTC ¶9706.

The son of the president of a restaurant corporation was not liable for the unpaid employee withholding taxes of the corporation because he was not a responsible person obligated to withhold and pay over taxes. Even though he managed some of the company's restaurants and was authorized to sign checks, he could not disburse funds except in emergency situations, and he did not have authority to pay creditors. In addition, although he held the office of Secretary/Treasurer and technically owned 10 percent of the stock of the corporation, he did not control that interest, had no authority to sell the stock, and was completely accountable to his father. Finally, even if it had been determined that he was a responsible person, he lacked authority to pay the taxes and other debts of the corporation and, therefore, could not be found to have willfully failed to carry out that responsibility.

E.D. Goodick, DC La., 92-1 USTC ¶50,279.

Individual financial backers who loaned money and obtained lines of credit for a corporation were responsible persons and, therefore, were liable for penalties for failure to pay over withheld income taxes. The backers had the ability to decide where corporate funds were spent and, in fact, exerted this control at least once. They had check-writing authority and could pull their financial support at any time their wishes were not fulfilled. Moreover, the backers' failure to pay the taxes was willful because they knew of the corporation's obligation to pay the taxes. In addition, the corporate officer, who operated the company on a day-to-day basis, was also liable for the taxes as a responsible person. Even though the officer intended to pay the taxes in the long run, he preferred to use current cash flows to carry on the corporation's operations and not to pay over the withheld taxes.

C.D. Webster, DC Md., 94-1 USTC ¶50,008.

A corporation in bankruptcy that was in the business of providing security guards to its customers was the employer of these guards because it had control over the guards and the funds used to pay them. It was responsible for the payment of employment taxes regarding these employees, and this obligation could not be avoided by delegating that function to another. However, the government's tax claim for the penalty for the failure to pay over withheld taxes was disallowed with leave to file an amended claim, because it failed to identify a particular person as the responsible person liable for the corporation's FICA and FUTA obligations and did not specify whether the unpaid FICA amounts were attributable to the debtor's portion or the employees' share.

Professional Security Services, Inc., BC-DC Fla., 94-1 USTC ¶50,148.

Summary judgment was denied where material issues of fact existed as to whether a corporate officer should be classified as a responsible person. The corporate officer had authority to sign corporation checks and could be deemed a person responsible for paying withholding taxes. Further, there was evidence that the officer was aware that the corporation was delinquent in paying over withholding to the IRS.

J.P. Ladwig, DC Ill., 94-1 USTC ¶50,192.

Married individuals were not responsible persons during the time that a company's tax delinquency accrued and, therefore, were not required to pay over federal income taxes and social security taxes withheld from employees' wages. They lacked control over the decision-making process by which the corporation allocated funds to other creditors instead of paying its withholding tax obligations.

M.L. Michaud, FedCl, 97-2 USTC ¶50,972, 40 FedCl 1.

The president of a bankrupt company who willfully failed to pay over his company's payroll withholding taxes was a responsible person with respect to the trust fund recovery penalty. The president acknowledged that he was a responsible person under the statute. However, whether two other company officers were responsible persons was questionable. Although one of the officers served as chief financial officer and both had check-writing authority, the president exerted such command over the finances of the company that a reasonable fact-finder could conclude that neither officer had significant control over the company's finances.

R.S. Hudson, DC Pa., 99-2 USTC ¶50,914.

A bankrupt attorney who was the president and sole shareholder of his law corporation was liable for the trust fund recovery penalty in connection with the corporation's failure to collect and pay over employment taxes.

D.A. Smith, DC Hawaii, 99-2 USTC ¶50,998. Aff'g 99-1 USTC ¶50,278.

The president and vice president of a corporation who failed to remit withholding taxes to the IRS were determined to be "responsible persons" liable for the trust fund recovery penalty. In addition to being corporate directors and officers, the individuals owned stock in the corporation, were responsible for daily management operations, hired and fired employees, and had the authority to sign checks and pay the corporation's taxes.

D.C. Stull, DC Tex., 2000-1 USTC ¶50,168. Aff'd, per curium, CA-5 (unpublished opinion), 2001-1 USTC ¶50,333, 252 F3d 436.

A corporate director who lacked control over the company's tax deposits and payments did not qualify as a responsible person liable for the trust fund recovery penalty. Although he made deposits and tax payments at a bank under the direction of the corporate president and was aware of the company's payroll tax delinquencies, he had no decision-making authority regarding the payment of creditors.

M.D. McGlaughlin, DC Md., 2000-1 USTC ¶50,183.

Questions of fact precluded summary judgment on the government's claim for the trust fund recovery penalty against the sole owner of a real estate appraisal business who was on maternity leave during the quarters at issue. Because her level of involvement with company during her maternity leave was in dispute, it could not be determined on summary judgment that she was a responsible party.

P. Ranson, DC Wash., 2001-1 USTC ¶50,161.

A federal district court applied improper legal standards to reach its determination that an individual was not a responsible person. The district court erroneously focused its inquiry on whether the taxpayer had knowledge of the unpaid taxes, the taxpayer's functional responsibility, and the fact that another individual had greater control of corporate affairs. That the taxpayer had significant control over the company's affairs was sufficient for him to qualify as a responsible person.

D.M. Chapman, CA-9 (unpublished opinion), 2001-1 USTC ¶50,380, 7 FedAppx 804, rev'g and rem'g and unreported District Court decision.

The former owner of a plumbing business who transferred 80% of the ownership in the business to his children was deemed to be a responsible person for purposes of the trust fund recovery penalty. The individual was still a 20% owner in the business, had check-signing authority, was often asked to co-sign checks for the business and continued to work to determine the bids the company would make. Moreover, he loaned money to the company when it was in financial difficulty and had considerable influence over how his children ran the business.

M.E. Pitts, DC Ariz., 2001-1 USTC ¶50,419.

The president and CEO of two trucking corporations, who was assessed penalties for his failure to turn over withholding taxes, was a responsible person under Code Sec. 6672. The undisputed evidence established that he had the authority to instruct his manager to pay the taxing authorities, had significant control over the finances of the corporations, retained the authority to sign checks on behalf of the corporation, and possessed the authority to hire and discharge employees. The taxpayer's argument that he delegated these duties and did not have day-to-day financial responsibilities was unpersuasive.

R.C. Bolus, Sr., DC Pa., 2001-2 USTC ¶50,644.

An individual who was the sole shareholder of one credit bureau and the president and CEO of a second bureau, both of which failed to pay over withholding taxes, qualified as a responsible person who willfully failed to collect, account for, or remit the funds to the IRS. Thus, he was liable for the assessed trust fund recovery penalties. No triable issues of fact existed as to the individual's liability for the penalties.

W.K. Hankins, DC Ind., 2001-2 USTC ¶50,692.

A third-party defendant's motion for summary judgment in connection with the IRS's assessment of a trust fund recovery penalty against him due to a corporation's failure to pay over employment taxes was denied. He unsuccessfully contended that he was not a responsible person because he was not an employee, officer or shareholder of the corporation. However, he served as corporate counsel and as the entity's chief financial officer. He also directed the president to make payments to various creditors, including tax payments to the IRS, was involved in the preparation and filing of the company's payroll tax returns, prepared corporate tax returns and was responsible for ensuring that the payroll tax deposits were made.

D.K. Scheingold, DC N.J. (unpublished opinion), 2002-2 USTC ¶50,510.

The chairman of a corporation was liable for the trust fund recovery penalty in connection with the corporation's failure to pay over employment taxes. He qualified as a responsible person because he had the authority to sign checks, hire and fire employees, participate in management, determine corporate financial policy, and authorize the payment of bills. He also discussed corporate business with other company officers on a weekly basis and was the corporation's majority shareholder, a member of its board of directors, and a guarantor of corporate loans.

C.S. Perlman, DC Fla., 2002-1 USTC ¶50,346.

The founder and president of a corporation was a responsible person with liability to pay the IRS's assessment of unpaid employment and withholding taxes, plus interest and penalties, for one tax year. He held the position of president of the company and attended its board meetings, he was generally responsible for the operation of the company and possessed the authority to sign checks and approved the check signing of the only other company employee with checking signing authority. Furthermore his decision not to pay over or withhold the employment taxes was willful. He made the decision to pay other creditors in preference to the IRS knowing that taxes were due and he failed to take corrective actions.

G. Sutton,, DC Tex., 2002-2 USTC ¶50,552, 194 FSupp2d 559.

The president of a corporation was considered the responsible person with liability to pay the assessment of unpaid taxes, plus interest and penalties, for two tax years. He was the highest-ranking officer and had substantial authority to direct operations. Moreover, he signed the payroll tax returns and had signature authority on corporate accounts. He paid other creditors in preference to the IRS knowing that taxes were due and failed to take corrective actions. That he resigned from his position of president was meaningless as he exercised control in all relevant areas both before and after the purported resignation.

L.A. Mitchell, DC N.J. (unpublished opinion), 2002-2 USTC ¶50,537. Aff'd, CA-3 (unpublished opinion), 2004-1 USTC ¶50,113, 82 FedAppx 781.

The CFO of a bankrupt airline company was a "responsible person," who willfully failed to file quarterly excise tax returns and pay the accompanying tax to the government. The CFO held a corporate office, possessed control over the financial affairs of the airline company, possessed the authority to disburse corporate funds, and possessed the ability to pay the excise taxes without the approval of the company's Board. There was a material issue of genuine fact, however, as to whether the controller of the company had the requisite corporate decision making authority within the company to be considered a responsible person with regard to the delinquent excise taxes. Although the controller applied for credit on behalf of the company and signed promissory notes that bound the company, he was not in charge of the department that was responsible for tracking the excise taxes and he was not involved in overall day-to-day operations of the company.

D.R. Ferguson, DC Iowa, 2004-1 USTC ¶50,247, 317 FSupp2d 945.

The bankruptcy court erroneously held that the president and sole shareholder was not a responsible person for purposes of the trust fund recovery penalty. Although the taxpayer did not run the day-to-day operations of the corporation, she had sole authority to right checks for the company. The bankruptcy court's conclusion that the taxpayer was not a responsible person was strongly based on the lack of authority or power over daily management of the company. However, the taxpayer's status as president, sole shareholder and her authority to sign checks was sufficient to make her the responsible person.

E.L. Marino, DC Fla., 2004-1 USTC ¶50,262, 311 BR 111, rev'ing BC-DC Fla., 2004-1 USTC ¶50,261.

A president and fifty percent shareholder of an employee leasing company was liable for the trust fund recovery penalty in connection with his company's failure to pay employee withholding taxes. Evidence established that the taxpayer was a responsible person because he had check signing authority, even though he claimed that he did not often exercise such authority, and had the authority to manage and direct the employees of the company. The taxpayer also had the authority to hire and fire all levels of employees, which he displayed when he fired his business partner, who was also a fifty percent shareholder.

S. Farkas, FedCl, 2003-2 USTC ¶50,574.

A debtor who served as vice-president of a general contracting business was a responsible person as a matter of law. He had significant authority over the employees, as well as over the finances of the company during the tax periods in issue. Questions remained regarding whether he willfully failed to pay over the withholding taxes.

V.K. Pugh, BC-DC Nev., 2004-2 USTC ¶50,352, 315 BR 889.

A debtor's objection to the IRS's claim for the trust fund recovery penalty assessed against him was denied because he was determined to be a responsible person who willfully failed to pay over withheld taxes. The debtor stipulated that he was a responsible person and his failure to remit the withheld taxes was willful because he was aware of the company's employment tax deficiency yet chose to pay creditors other than the government. The fact that the debtor was told by the company's owner not to pay the taxes and that he might have been fired had he disobeyed orders did not excuse his liability for nonpayment.

L. Borman, BC-DC Fla., 2005-1 USTC ¶50,109.

An individual was liable for the trust fund recovery penalty, during the time he was no longer president of the corporation. The taxpayer admitted to being the chairman of the board, the sole director, vice president, secretary, and treasurer. Between himself, his spouse and his children, he controlled about 50 percent of all outstanding stock and he has controlling interest in the corporation. At all times, the interim president served at his will. Undoubtedly, the taxpayer was a "responsible person" liable to pay the trust fund taxes.

D.J. Frank, BC-DC N.C., 2005-1 USTC ¶50,222.

The manager of a casino was not a responsible person for purposes of the trust fund recovery penalty since he had no authority over payroll or tax matters. Although he supervised department managers and was otherwise responsible for the day-to-day operations of the casino, the manager did not have significant decision-making authority over the financial affairs of the company to be responsible for payroll taxes. Authority to decide which checks were to be written, and to whom, rested in the sole shareholder, director and corporate officer of the casino.

B.E. Dewing, DC Nev., 2005-1 USTC ¶50,275.

The chief financial officer of a bankrupt company was not a responsible person for purposes of imposition of the trust fund recovery penalty, despite have check-signing authority, because the company president had absolute control over all of the company funds. The company president reviewed the cash flow balance daily, authorized the creditors to be paid and even wired funds to another creditor to prevent the IRS from obtaining the funds after the CFO sent the IRS a check without the president's knowledge.

J.D. Salzillo, FedCl, 2005-1 USTC ¶50,324, 66 FedCl 23.

The sole owner and president of a corporation was a responsible person who willfully failed to pay the corporation's employment tax liabilities for purposes of imposing the trust fund recovery penalty. He signed Form 941 employment tax returns on behalf of the corporation, could independently sign checks on behalf of the corporation and signed a sworn statement that he was solely responsible for all tax debts incurred by the corporation. The taxpayer's failure to pay the taxes was willful because he knew of the tax liabilities, but chose to pay other expenses.

G. Kraljevich, DC Mich., 2005-1 USTC ¶50,372, 364 FSupp2d 655.

An individual was determined to be a responsible person with respect to unpaid employment taxes. The taxpayer, who was involved in the operation of two companies until the time a surety company assumed control, did not present any evidence contradicting that he was a responsible party for tax liability under Code Sec. 6672. Instead, the evidence reflected that the majority of the unpaid employment taxes accrued prior to the time the surety company assumed control. Furthermore, whether the surety was responsible for the unpaid employment taxes had no bearing on whether the taxpayer was a responsible person for purposes of tax liability.

J. Dowdy, DC Tex., 2005-2 USTC ¶50,517.

The IRS was granted summary judgment against the former president of a non-profit corporation for trust fund recovery penalties under Code Sec. 6672. The taxpayer had significant control of the corporation's finances, had check writing authority, and was responsible for ensuring that the company paid its trust fund taxes. Further, once the taxpayer became aware of the deficiency, he failed to ensure its payment before any other creditors were paid. Such a failure is willful and subjects the responsible person to trust fund recovery penalties under Code Sec. 6672.

Reverend R. W. Schlicht, DC Ariz., 2005-2 USTC ¶50,527.

An electrical contractor was liable for penalties under Code Sec. 6672 for failing to pay over federal employment taxes owed by two corporations that he formed. Despite having relinquished his management role to family members, he was a "responsible person" for purposes of Code Sec. 6672 liability because he kept the title of president and retained authority to control the company, even if he did not exercise that authority. Specifically, the taxpayer had full check writing authority, full access to company books and records, and the opportunity to exercise substantial financial control over company affairs.

J.F. Grillo, BC-DC N.J, 2005-2 USTC ¶50,625.

The founder, president and principal stockholder of a company was determined to be a responsible person with respect to unpaid employment taxes. The failure of the taxpayer's accountant and tax specialist to properly designate amounts paid to offset these liabilities did not mean that the IRS should be equitably estopped from collecting under Code Sec. 6672, as the taxpayer mistakenly argued. The trust fund recovery penalty is separate and distinct from the legal obligation imposed on the employer to collect and remit the trust fund taxes. Since the taxpayer did not present any evidence to the contrary, he was found to be a responsible person who willfully failed to pay the owed employment taxes.

J.A. Lencyk, DC Tex., 2005-2 USTC ¶50,630, 384 FSupp2d 1028.

A 100-percent trust fund penalty was reduced to judgment since the taxpayer was the responsible person even though he did not have day-to-day control of the company. Rather his status as CEO, president and sole shareholder gave him sufficient control to be the responsible person for trust fund purposes.

R. Sage, DC N.Y., 2006-1 USTC ¶50,175, 412 FSupp2d 406.

The president of a tax-exempt organization was not entitled to a refund of the federal employment and withholding taxes he paid from his personal funds. As president of the board of directors for almost 20 years, he had check-signing authority and control over the organization's financial affairs. Further, he exhibited a reckless disregard of a known risk that the organization was not making required trust fund payments to the IRS and he made no effort to ascertain the status of the organization's tax payments.

C.E. Jefferson, DC Ill., 2007-1 USTC ¶50,304, 459 FSupp2d 685.

A company's vice president of operations was denied a refund of a trust fund recovery penalty assessed against her for her employer's failure to pay backup withholding taxes. She was a responsible person because her own testimony about her duties and responsibilities and her undisputed check-writing authority established that she could have prevented the company from paying other creditors instead of paying the taxes. She enjoyed exclusive check-writing authority and was responsible for collecting, accounting for, and paying over the withheld taxes. She was in a position to use her ability to prioritize creditors and her check-signing authority to impede the flow of business to the extent necessary to ensure the payment of taxes and nothing in the company's business model prevented her from paying the taxes. In addition, the undisputed evidence clearly established that the willfulness requirement was met.

N.A. Cook, DC Ind., 2007-1 USTC ¶50,333.

A trust fund recovery penalty was correctly assessed against the chief financial officer of a bankrupt airline company because he was a responsible person who willfully failed to pay the company's excise taxes. The individual was authorized to sign checks and disburse corporate funds on behalf of the company and had the authority to pay the company's excise taxes without board or management approval. The board never explicitly instructed him to not pay the excise taxes but he chose not to do so in order to pay other company expenses.

R. Musal, DC Iowa, 2006-1 USTC ¶50,207, 421 FSupp2d 1153. Aff'd sub nom. D.R. Ferguson, CA-8, 2007-1 USTC ¶50,481, 484 F3d 1068.

The CEO and board chairman of a motorcycle company was not entitled to a refund of a portion of the trust fund recovery penalty he paid to the IRS in satisfaction of the company's unpaid payroll withholding taxes. Testimony of the CEO and the company's chief operating officer and financial director established that the CEO was a responsible person who willfully failed to pay the company's taxes. He had overall authority, including raising capital and hiring, was involved in the day-to-day management of the company, had the authority to issue checks, and determined which creditors to pay and when to pay them. Further, he instructed the company's financial director that bills pertaining to utilities were to be paid first; thus, checks were issued to other creditors but not to the government.

R.K. Hagen, DC Md., 2007-1 USTC ¶50,510, 485 FSupp2d 622.

An individual who held no ownership or entrepreneurial stake in debtor corporations was not a responsible person with regard to those corporations' failure to pay over withheld federal taxes. She could not sign checks without the prior authorization of the president and sole shareholder of the corporations and had no power or authority to hire or fire employees. Although she was the secretary of the debtor corporations, the duties that she performed were ministerial and administrative in nature. All of the authority and control over the corporations' administration and finances resided with the president, and the tasks she performed were executed solely upon his instructions.

L.M. Benitez, DC PR, 2006-2 USTC ¶50,598.

The sole corporate officer of a construction company was a responsible person who willfully failed to pay over federal withholding taxes. The officer continued to write checks, sign returns and act on behalf of the corporation after the date he claimed an insurance company took over control under an indemnity agreement. However, the officer's wife was not liable for the unpaid taxes because there was no evidence that she was an officer or director of the construction company. Her involvement was limited to occasional business purchases and as a signatory with her husband on the indemnity agreement.

G. Hartman, BC-DC Pa., 2007-2 USTC ¶50,747, 375 BR 740.

The chairman of a corporation was a responsible person who willfully failed to collect, account for and pay over the withheld income and employment taxes of the corporation. The IRS's evidence showed that he had the ability to sign checks, hire and fire employees, and sign the corporation's tax returns. He owned stock in the corporation, was ultimately responsible for making financial decisions and directed payment to the corporation's creditors despite knowledge of the corporation's unpaid employment taxes. However, a genuine issue of material fact existed as to whether another corporate officer, the CEO, had sufficient authority over the corporation's financial affairs to be considered a responsible person for purposes of the trust fund recovery penalties.

R.C. Savona, DC Calif., 2007-2 USTC ¶50,788.

The CEO and the Chief Financial Officer of a trucking company were both responsible persons who were jointly and severally liable for the trust fund recovery penalties in connection with the company's failure to pay its federal employment tax obligations. Both officers acted willfully when they made numerous voluntary and intentional payments to creditors despite having knowledge that the employment taxes were unpaid. Both exercised significant control over the disbursement of company's funds, had active day-to-day involvement in the business and had full authority to sign checks and Form 941 tax returns.

J.M. Horovitz, DC Pa., 2008-1 USTC ¶50,186, 543 FSupp2d 441.

The founder, shareholder and officer of a corporation was liable for the trust fund recovery penalty because he exercised significant control over the corporation's day-to-day activities and participated in the decision to hire or fire management employees and accountants in charge of the corporation's payroll operations. He also reviewed weekly and monthly financial statements, personally guaranteed payments to vendors and directed checks to be written and expenses to be paid.

C.B. Erwin, DC N.C., 2008-1 USTC ¶50,258.

The owner and the bookkeeper of a limited liability company (LLC) were liable for trust fund recovery penalties in connection with the operation of a restaurant. The owner was a responsible person because she organized the LLC, entered into a lease agreement for the restaurant, obtained a liquor license and failed to make a timely election for the LLC to be taxed as a corporation. Further, the bookkeeper was also a responsible person because he had the authority to sign checks for the restaurant, to make and authorize bank deposits, to identify and calculate the amount to be withheld for federal payroll taxes, to authorize payment of federal tax deposits and to authorize payroll checks. Moreover, he acted willfully because he knew about the delinquent taxes and voluntarily paid other creditors before paying the government.

D.M. Seymour, DC Ky., 2008-2 USTC ¶50,406.

An individual who was the president, director, Chief Executive Officer and majority shareholder of a corporation was liable for the trust fund recovery penalty assessed against him in connection with the corporation's unpaid withholding taxes. The individual was a "responsible person" with respect to the corporation because he had complete authority over every aspect of the corporation's finances, including the sole authority to hire and fire employees, take out loans, sign contracts and checks, withhold income and FICA taxes from wages and pay those taxes to the government.

J.C. Tornes, DC Ohio, 2008-2 USTC ¶50,431.

The majority stockholder of two retail optometry companies was not entitled to a refund of the trust fund recovery penalty he paid to the IRS in satisfaction of the companies' unpaid withholding taxes. The individual was a responsible person because he exercised significant control over the companies' finances, had check-signing authority and the authority to sign the companies' employment tax returns. Furthermore, more than one person can be a responsible person with respect to liability for unpaid taxes.

L.H. Joel, DC Ky., 2008-2 USTC ¶50,451.

The director, shareholder and secretary-treasurer of a closely held corporation was liable for the trust fund recovery penalty assessed against her in connection with the corporation's unpaid withholding taxes. The individual was a responsible person because she was involved in the corporation's business operations, had check signing authority, attended meetings to discuss the corporation's cash-flow problems, had access to the corporation's financial records and books and knew of the corporation's tax problems. Although her responsibilities did not typically include the payment of withholding taxes and she did not believe that it was within her control, she had the power to pay the corporation's withholding taxes.

N. Noronha, DC Ky., 2008-2 USTC ¶50,554.

The president of a company was liable for the trust fund recovery penalties assessed against him. The individual was the responsible person with respect to the company since he had the sole authority to write and sign checks on corporate accounts and to hire and fire personnel.

C.C. Anuforo, DC Minn., 2008-2 USTC ¶50,584.

The owner of a company was liable for the trust fund recovery penalty (TFRP). The individual maintained the company's books, prepared its financial statements, authorized payment of its bills and payroll, reviewed federal income tax returns and prepared and signed federal payroll tax returns. He acted willfully because he had reason to know that the taxes were not being paid and failed to exercise his authority to ensure their payment. Despite knowledge of the tax deficiencies, he regularly directed that payments be made to creditors other than the IRS.

S.O. Johnson, DC Ill., 2008-2 USTC ¶50,585.

The president of the board of directors of a tax-exempt organization was not entitled to a refund of federal employment and withholding taxes he paid from his personal funds. Although his position was voluntary and uncompensated, and although he was not involved in the day-to-day operations of the day care center, the individual had enough involvement in and control over the organization's financial affairs to qualify him as a "responsible person" within the meaning of Code Sec. 6672.

C.E. Jefferson, CA-7, 2008-2 USTC ¶50,587.

The owners of three companies and their employee, a certified public accountant (CPA), serving as the vice president of finance for those companies, were all responsible persons for purposes of the trust fund recovery penalty. The owners were the founders, officers, board members, and equal shareholders of each of the three companies. They had check-signing authority, could hire and fire employees, could exercise control over the companies' finances, including the payment of payroll taxes, and were intimately involved in running the companies. Although the CPA/employee had no check-signing authority, he supervised the accounting department, oversaw the preparation of checks, including payroll and federal tax deposit checks and had the authority to direct the accounting department to draft checks to the IRS instead of to other creditors. Further, the individuals acted willfully when they made payments to other creditors despite knowing that the trust fund taxes remained unpaid.

S.P. Davis, Sr., DC La., 2008-2 USTC ¶50,613.

The secretary and treasurer of a corporation was liable for the trust fund recovery penalty assessed against him in connection with the corporation's unpaid withholding taxes. The individual was a "responsible person" because he exercised significant control over the day-to-day management of the corporation and over the company's payroll, had the power to write checks on behalf of the corporation, had the authority to hire and fire employees, sign corporate income tax and payroll tax returns and to determine which creditors to pay and when.

W.M. Cheatle, DC Va., 2009-1 USTC ¶50,139.

Unpaid employment tax assessments against the president and vice-president of two health care companies were reduced to judgment. The individuals were responsible persons because they had the authority to sign checks, hire and fire employees, determine corporate financial policy, and authorize the payment of bills.

J.A. Rineer, DC Tex., 2009-1 USTC ¶50,149.

An individual who assumed the role of chief executive officer (CEO) of a holding company was a responsible person liable for the unpaid employment tax obligations of a wholly-owned subsidiary for two assessment periods at issue. On becoming a CEO, he also became a "responsible person" within the meaning of the trust fund provisions because he had the authority to control the financial affairs of the subsidiary. He was not relieved of that responsibility even though he took control after the holding company decided to cease paying the subsidiary's trust fund taxes. However, the individual was not responsible with respect to unpaid tax obligations for a period when he was merely a member of the board of directors and had no official role in the subsidiary's operations or any direct control over payment of the subsidiary's taxes.

B.A. Haslett, DC Alas., 2009-1 USTC ¶50,225.

The general manager of a printing company was a responsible person liable for the company's unpaid employment taxes for the two tax years at issue. The individual's power to ensure that the taxes were paid was evidenced by his control over the company's day-to-day operations, accounting and finance functions, independent check-signing authority and his unrestrained authority to electronically pay the payroll taxes. Moreover, the district court correctly refused to instruct the jury that a capital infusion into the business was a necessary indicia of responsibility or that only the owner of a closely held corporation was a responsible person or that the reasonable cause exception to the willfulness requirement applied. The reasonable cause defense was not available because the individual failed to pay the taxes even after he was directly instructed to keep the taxes current and despite his knowledge of the tax deficiencies and that other creditors were being paid. Further, the jury instructions also properly stated that a superior's order to pay other creditors did not negate the individual's status as a responsible person.

R.A. Smith, CA-10, 2009-1 USTC ¶50,263.

Notice 2009-44

May 6, 2009

Code Sec. 42

Low-income housing credit : Utility allowance : Calculation methods .



Part III - Administrative, Procedural and Miscellaneous



Section 42. --Low-Income Housing Credit



Notice 2009-44



PURPOSE

The purpose of this notice is to clarify that, under §1.42-10 of the Income Tax Regulations (the utility allowance regulations), utility costs paid by a tenant based on actual consumption in a sub-metered rent-restricted unit as described herein are treated as paid directly by the tenant for purposes of §42(g)(2)(B)(ii) of the Internal Revenue Code.



BACKGROUND

Section 42 sets forth rules for determining the amount of the low-income housing credit, which is allowed as a credit against income tax pursuant to §38 . Section 42(a) provides that the amount of the low-income housing credit determined under §42 for any taxable year in the credit period is an amount equal to the applicable percentage of the qualified basis of each qualified low-income building. A qualified low-income building is defined in §42(c)(2) as any building that is part of a qualified low-income housing project.

A qualified low-income housing project is defined in §42(g)(1) as any project for residential rental property if the project meets one of the following tests elected by the taxpayer: (A) At least 20 percent of the residential units in the project are rent-restricted and occupied by individuals whose income is 50 percent or less of area median gross income; or (B) at least 40 percent of the residential units in the project are rent-restricted and occupied by individuals whose income is 60 percent or less of area median gross income. Failure to qualify as a rent-restricted unit may result in ineligibility for the section 42 credit, reduction in the amount of the credit, and/or recapture of previously allowed credits. In order to qualify as a rent-restricted unit within the meaning of §42(g)(2) , the gross rent for the unit must not exceed 30 percent of the applicable income limitation. Section 42(g)(2)(B)(ii) provides that gross rent includes a utility allowance determined by the Secretary after taking into account the procedures under section 8 of the United States Housing Act of 1937.

Section 1.42-10 , which was recently amended by Treasury decision 9420 on July 29, 2008 (73 FR 43863), sets forth the circumstances under which gross rent includes a utility allowance and provides rules for determining the applicable utility allowance. Under §1.42-10(a) , if the cost of any utility (other than telephone, cable television, or Internet) for a residential rental unit is paid directly by the tenant(s), and not by or through the owner of the building, the gross rent for that unit includes a utility allowance.

If gross rent includes a utility allowance, §1.42-10(b) provides rules for determining the applicable utility allowance depending upon whether (1) the building receives rental assistance from the Rural Housing Service (RHS) ("RHS-assisted building"), (2) the building has any tenant that receives RHS rental assistance payments ("RHS tenant assistance"), (3) the rents and utility allowances of the building are reviewed by the Department of Housing and Urban Development (HUD) ("HUD-regulated building"), or (4) the building is not described in (1), (2), or (3) ("other building"). Section 1.42-10(b)(1) and (2) provides that, for an RHS-assisted building and a building with RHS tenant assistance, the applicable utility allowance is the applicable RHS utility allowance. Section 1.42-10(b)(3) provides that, for a HUD-regulated building, the applicable utility allowance is the applicable HUD utility allowance. With respect to other buildings, §1.42-10(b)(4)(i) provides that, for all rent-restricted units occupied by tenants receiving HUD tenant assistance, the applicable utility allowance is the applicable Public Housing Authority (PHA) utility allowance established for the Section 8 Existing Housing Program. With respect to all other tenants in other buildings, §1.42-10(b)(4)(ii) provides that the applicable utility allowance is the applicable PHA utility allowance under §1.42-10(b)(4)(ii)(A) , a local utility company estimate under §1.42-10(b)(4)(ii)(B) , an estimate from the State or local housing credit agency that has jurisdiction over the building under §1.42-10(b)(4)(ii)(C) , the HUD Utility Schedule Model under §1.42-10(b)(4)(ii)(D) , or an energy consumption model under §1.42-10(b)(4)(ii)(E) .

Some buildings in qualified low-income housing projects are sub-metered. Sub-metering measures tenants' actual utility consumption, and tenants pay for the utilities they use. A sub-metering system typically includes a master meter, which is owned or controlled by the utility supplying the electricity, gas, or water, with overall utility consumption billed to the building owner. In a sub-metered system, building owners (or their agents) use unit-based meters to measure utility consumption and prepare a bill for each residential unit based on consumption. The building owners (or their agents) retain records of resident utility consumption, and tenants receive documentation of utility costs as specified in the lease.



DISCUSSION

For purposes of §1.42-10(a) of the utility allowance regulations, utility costs paid by a tenant based on actual consumption in a sub-metered rent-restricted unit are treated as paid directly by the tenant, and not by or through the owner of the building. For RHS-assisted buildings under §1.42-10(b)(1) , buildings with RHS tenant assistance under §1.42-10(b)(2) , HUD-regulated buildings under §1.42-10(b)(3) , and rent-restricted units in other buildings occupied by tenants receiving HUD rental assistance under §1.42-10(b)(4)(i) , the applicable RHS or HUD rules apply. For all other tenants in rent-restricted units in other buildings under §1.42-10(b)(4)(ii) :


(1) The utility rates charged to tenants in each sub-metered rent-restricted unit must be limited to the utility company rates incurred by the building owners (or their agents);



(2) If building owners (or their agents) charge tenants a reasonable fee for the administrative costs of sub-metering, then the fee will not be considered gross rent under §42(g)(2) . The fee must not exceed an aggregate amount per unit of 5 dollars per month unless State law provides otherwise; and



(3) If the costs for sewerage are based on the tenants' actual water consumption determined with a sub-metering system and the sewerage costs are on a combined water and sewerage bill, then the tenants' sewerage costs are treated as paid directly by the tenants for purposes of the utility allowances regulations.


The utility allowance regulations will be amended to incorporate the guidance set forth in this notice.



EFFECTIVE DATE

This notice is effective for utility allowances subject to the effective date in §1.42-12(a)(4) . Consistent with §1.42-12(a)(4) , building owners (or their agents) may rely on this notice for any utility allowances effective no earlier than the first day of the building owner's taxable year beginning on or after July 29, 2008.



REQUEST FOR COMMENTS

The Treasury Department and IRS invite taxpayers to submit written comments on issues relating to this notice. Send comments to: CC:PA:LPD:PR ( Notice 2009-44 ), Room 5205, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand-delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR ( Notice 2009-44 ), Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue, NW., Washington, DC. Submissions may also be sent electronically via the Internet to the following e-mail address: Notice.comments@irscounsel.treas.gov . Include the notice number ( Notice 2009-44 ) in the subject line. Comments must be received on or before July 27, 2009. All comments will be available for public inspection and copying.



DRAFTING INFORMATION

The principal author of this notice is David Selig, Office of the Associate Chief Counsel (Passthroughs and Special Industries). For further information regarding this notice, please contact Mr. Selig at (202) 622-3040 (not a toll-free call).


NON: ADC01 NOTICE2009-44 http://tax.cchgroup.com/network&JA=LK&fNoSplash=Y&&LKQ=GUID%3Acf51008d-33b1-3d4a-95eb-c70711374c27&KT=L&fNoLFN=TRUE& ADC01 #3 [ADC01 ]

President Obama Announces International Tax Reform Measures

President Obama on May 4 announced a series of proposals designed to curb off-shore tax havens and remove tax incentives, which he said throughout his presidential campaign encourage corporations to shift jobs overseas. In remarks at an international tax forum, Obama said the administration proposals are "a downpayment on the larger tax reform we need to make our tax system simpler and fairer and more efficient for individuals and corporations." The administration plans to announce additional international tax reform measures as part of the more detailed fiscal year budget plan that will be released later in May, according to a White House release.

Overseas Jobs
The Obama plan would remove tax advantages for investing overseas by reforming deferral rules so that companies cannot claim deductions --with the exception of the research and experimentation (R&E) expenses --on their U.S. tax returns for supporting offshore investments until they pay taxes on offshore profits. The administration would use a portion of the revenue to make permanent the R&E tax credit that is set to expire at the end of 2009.

The plan also would close foreign tax credit loopholes that currently allow U.S. businesses that pay foreign taxes on overseas profits to claim a credit against their U.S. taxes for the foreign taxes paid. These combined proposals would raise $101.3 billion over ten years, according to the White House document.

Overseas Tax Havens
A second component of the plan is designed to crack down on overseas tax havens, raising a total of $95.2 billion over ten years. Under the plan, the administration proposes to reform "check-the-box" rules to require certain foreign subsidiaries to be considered as separate corporations for U.S. tax purposes

The administration plan calls for a comprehensive package of disclosure and enforcement measures to make it more difficult for financial institutions and wealthy individuals to evade taxes. It would require foreign banks doing business with the U.S. to sign an agreement with the IRS to become a qualified intermediary (QI) and share as much information about their U.S. customers as U.S. financial institutions do. Obama also proposes to tighten reporting standards for overseas investments and increase penalties to be imposed on individuals who do not report foreign accounts.

To provide the IRS with the necessary tools to prosecute international tax-evasion schemes, the plan would double penalties for failure to report overseas investments, extend the statute of limitations for international tax enforcement and increase the reporting requirement on international investors, particularly QIs. The president's fiscal year 2010 budget includes IRS funding to hire 800 new staff specifically for international tax enforcement.

White House Press Secretary Robert Gibbs said that Obama's proposals are designed to be passed this year and do not necessarily have to be part of the reconciliation process. In response to widespread opposition by corporations and business groups to the deferral provision, Gibbs noted that businesses would benefit from making the R&E tax credit permanent since it would provide some certainty to business investment. He also maintained that the proposal would not put U.S. corporations at a competitive disadvantage or result in job losses in the U.S.

Many businesses contend that deferrals level the playing field for U.S. companies competing in global markets. One bit of good news for businesses is that the president remains open to lowering corporate tax rates if paid for by loophole closings, Gibbs confirmed.

Senate Reaction
Senate reaction to Obama's proposals was mixed. Senate Finance Committee Chairman Max Baucus, D-Mont., said more study is required to see how American companies will be influenced by the suggested policies. "I want to make certain that our tax policies are fair and support the global competitiveness of U.S. businesses," he said. Finance Committee ranking member Charles E. Grassley, R-Iowa said the proposals have to be vetted carefully, and Congress needs to look at whether the proposals will cause U.S. workers to lose their jobs and if they will lead U.S. companies to fall behind foreign competition and become more vulnerable to foreign acquisition. "To the extent the president continues on the road of cracking down on tax abuse, he can count on my support," said Grassley. "But, if he's using tax shelters as a stalking horse to raise taxes on corporations at the cost of U.S. jobs, he'll lose me," the senator said.

Only Senate Budget Committee Chairman Kent Conrad, D-N.D., expressed full support for the president's initiatives. "Far too many big corporations and wealthy individuals have been using offshore tax havens to evade paying taxes that they owe," said Conrad. "This abuse has to stop."

House Reaction
House Ways and Means Committee ranking member Dave Camp, R-Mich., said Obama's proposal would cause American firms to be taken over by their foreign competitors. Camp said raising taxes on firms like Caterpillar and Cisco during a recession is the wrong action to take. That viewpoint was echoed by National Association of Manufacturers (NAM) President John Engler, who called the Obama plan a disaster. Although Engler said he supports a permanent R&E tax credit, the president's plan will destroy U.S. jobs and undermine the ability of firms to compete overseas.

Meanwhile, House Majority Leader Steny Hoyer, D-Md., said the proposal would prohibit America's wealthiest taxpayers from avoiding their fair share of taxes. Hoyer said that reducing the use of tax havens and providing additional resources to crack down on abuses of international tax laws will save American taxpayers billions of dollars. House Ways and Means Committee Chairman Charles B. Rangel, D-N.Y., added that he supports Obama's effort to reform international tax laws that allow companies to invest overseas and keep their money abroad through the use of tax havens.
White House Press Release --Leveling The Playing Field: Curbing Tax Havens and Removing Tax Incentives for Shifting Jobs Overseas

White House Press Release --Leveling The Playing Field: Curbing Tax Havens and Removing Tax Incentives for Shifting Jobs Overseas

May 5, 2009

Obama administration : Tax havens : International tax reform .


Leveling the Playing Field: Curbing Tax Havens and Removing Tax Incentives For Shifting Jobs Overseas


There is no higher economic priority for President Obama than creating new, well-paying jobs in the United States. Yet today, our tax code actually provides a competitive advantage to companies that invest and create jobs overseas compared to those that invest and create those same jobs in the U.S. In addition, our tax system is rife with opportunities to evade and avoid taxes through offshore tax havens:
o In 2004, the most recent year for which data is available, U.S. multinational corporations paid about $16 billion of U.S. tax on approximately $700 billion of foreign active earnings - an effective U.S. tax rate of about 2.3%.

o A January 2009 GAO report found that of the 100 largest U.S. corporations, 83 have subsidiaries in tax havens.

o In the Cayman Islands, one address alone houses 18,857 corporations, very few of which have a physical presence in the islands.

o Nearly one-third of all foreign profits reported by U.S. corporations in 2003 came from just three small, low-tax countries: Bermuda, the Netherlands, and Ireland.

Today, President Obama and Secretary Geithner are unveiling two components of the Administration's plan to reform our international tax laws and improve their enforcement. First, they are calling for reforms to ensure that our tax code does not stack the deck against job creation here on our shores. Second, they seek to reduce the amount of taxes lost to tax havens - either through unintended loopholes that allow companies to legally avoid paying billions in taxes, or through the illegal use of hidden accounts by well-off individuals. Combined with further international tax reforms that will be unveiled in the Administration's full budget later in May, these initiatives would raise $210 billion over the next 10 years. The Obama Administration hopes to build on proposals by Senate Finance Committee Chairman Max Baucus and House Ways and Means Chairman Charles Rangel - as well as other leaders on this issue like Senator Carl Levin and Congressman Lloyd Doggett - to pass bipartisan legislation over the coming months.
1. Replacing Tax Advantages for Creating Jobs Overseas With Incentives to Create Them at Home: The Administration would raise $103.1 billion by removing tax advantages for investing overseas, and would use a portion of those resources to make permanent a tax credit for investment in research and innovation within the United States.

 Reforming Deferral Rules to Curb A Tax Advantage for Investing and Reinvesting Overseas: Currently, businesses that invest overseas can take immediate deductions on their U.S. tax returns for expenses supporting their overseas investments but nevertheless "defer" paying U.S. taxes on the profits they make from those investments. As a result, U.S. taxpayer dollars are used to provide a significant tax advantage to companies who invest overseas relative to those who invest and create jobs at home. The Obama Administration would reform the rules surrounding deferral so that - with the exception of research and experimentation expenses - companies cannot receive deductions on their U.S. tax returns supporting their offshore investments until they pay taxes on their offshore profits. This provision would take effect in 2011, raising $60.1 billion from 2011 to 2019.

 Closing Foreign Tax Credit Loopholes : Current law allows U.S. businesses that pay foreign taxes on overseas profits to claim a credit against their U.S. taxes for the foreign taxes paid. Some U.S. businesses use loopholes to artificially inflate or accelerate these credits. The Administration would close these loopholes, raising $43.0 billion from 2011 to 2019.

 Using Savings from Ending Unfair Overseas Tax Breaks to Permanently Extend the Research and Experimentation Tax Credit for Investment in the United States: The Research and Experimentation Tax Credit - which provides an incentive for businesses to invest in innovation in the United States - is currently set to expire at the end of 2009. To provide businesses with the certainty they need to make long-term investments in research and innovation, the Administration proposes making the R&E tax credit permanent, providing a tax cut of $74.5 billion over 10 years to businesses that invest in the United States.

2. Getting Tough on Overseas Tax Havens: The Administration's proposal would raise a total of $95.2 billion over the next 10 years through efforts to get tough on overseas tax havens by:

 Eliminating Loopholes for "Disappearing" Offshore Subsidiaries : Traditionally, U.S. companies have been required to report certain income shifted from one foreign subsidiary to another as passive income subject to U.S. tax. But over the past decade, so-called "check-the-box" rules have allowed companies to make their foreign subsidiaries "disappear" for tax purposes - permitting them to legally shift income to tax havens and make the taxes they owe the United States disappear as well. The Obama administration proposes to reform these rules to require certain foreign subsidiaries to be considered as separate corporations for U.S. tax purposes. This provision would take effect in 2011, raising $86.5 billion from 2011 to 2019.

 Cracking Down on the Abuse of Tax Havens by Individuals: Currently, wealthy Americans can evade paying taxes by hiding their money in offshore accounts with little fear that either the financial institution or the country that houses their money will report them to the IRS. In addition to initiatives taken within the G-20 to impose sanctions on countries judged by their peers not to be adequately implementing information exchange standards, the Obama Administration proposes a comprehensive package of disclosure and enforcement measures to make it more difficult for financial institutions and wealthy individuals to evade taxes. The Administration conservatively estimates this package would raise $8.7 billion over 10 years by:

o Withholding Taxes From Accounts At Institutions That Don't Share Information With The United States: This proposal requires foreign financial institutions that have dealings with the United States to sign an agreement with the IRS to become a "Qualified Intermediary" and share as much information about their U.S. customers as U.S. financial institutions do, or else face the presumption that they may be facilitating tax evasion and have taxes withheld on payments to their customers. In addition, it would shut down loopholes that allow QIs to claim they are complying with the law even as they help wealthy U.S. citizens avoid paying their fair share of taxes.

o Shifting the Burden of Proof and Increasing Penalties for Well-Off Individuals Who Seek to Abuse Tax Havens: In addition, the Obama Administration proposes tightening the reporting standards for overseas investments, increasing penalties and imposing negative presumptions on individuals who fail to report foreign accounts, and extending the statute of limitations for enforcement.

 Devoting New Resources for IRS Enforcement to Help Close the International Tax Gap: As part of the Obama Administration's budget, the IRS will hire nearly 800 new employees devoted to international enforcement, increasing its ability to crack down on offshore tax avoidance.


Leveling the Playing Field: Removing Tax Incentives For Moving Jobs Overseas and Curbing Tax Havens



Backgrounder




I. Replacing Tax Advantages to Create Jobs Overseas with Incentives to Create Jobs at Home

As the first plank of its international tax reform package, the Obama Administration intends to repeal the ability of American companies to take deductions against their U.S. taxable income for expenses supporting profits in low-tax jurisdictions on which they defer paying taxes on for years and perhaps indefinitely. Combined with closing loopholes in the foreign tax credit program, the revenues saved will be used to make permanent the tax credit for research and experimentation in the United States. This will be accomplished through:



1. Reforming Deferral Rules to Curb A Tax Advantage for Investing and Reinvesting Overseas



Current Law
 Companies Can Defer Paying Taxes on Overseas Profits Until Later, While Taking Tax Deductions on Their Foreign Expenses Now : Currently, a company that invests in America has to pay immediate U.S. taxes on its profits from that investment. But if the company instead invests and creates jobs overseas through a foreign subsidiary, it does not have to pay U.S. taxes on its overseas profits until those profits are brought back to the United States, if they ever are. Yet even though companies do not have to pay U.S. taxes on their overseas profits today, they still get to take deductions today on their U.S. tax returns for all of the expenses that support their overseas investment.

 Deferral Rules Use U.S. Taxpayer Dollars to Create A Tax Advantage for Companies That Invest Abroad: As a result, this preferential treatment uses U.S. taxpayer dollars to provide companies with an incentive to invest overseas, giving them a tax advantage over competitors who make the same investments to create jobs in the United States.



Example Under Current Law:
 Suppose that two U.S. companies decided to borrow to invest in a new factory. Company A invests that money to build its plant in the U.S., while Company B invests overseas in a jurisdiction with a tax rate of only 10 percent.

 Company A will be able to deduct its interest expense, reducing its overall U.S. tax liability by 35 cents for every dollar it pays in interest. But it will also pay a 35 percent tax rate on its corporate profits.

 Company B will also be able to deduct its interest expense from its U.S. tax liabilities at a 35 percent rate. But it will only face a tax of 10 percent on its profits.

 Thus, our current tax code uses U.S. taxpayer dollars to put companies that invest in the United States at a competitive advantage with companies who invest overseas.



The Administration's Proposal
 Level the Playing Field: The Administration's commonsense proposal, similar to an earlier measure proposed by House Ways and Means Chairman Charles Rangel, would level the playing field by requiring a company to defer any deductions - such as for interest expenses associated with untaxed overseas investment - until the company repatriates its earnings back home. In other words, companies would only be able to take a deduction on their U.S. taxes for foreign expenses when they also pay taxes on their foreign profits in the United States. This proposal makes an exception for deductions for research and experimentation because of the positive spillover impacts of those investments on the U.S. economy.

 Raise $60.1 Billion From 2011 to 2019: This proposal goes into effect in 2011, and would raise $60.1 billion between 2011 and 2019.



2. Closing Foreign Tax Credit Loopholes



Current Law
 Companies Can Take Advantage Of Foreign Tax Credit Loopholes: When a U.S. taxpayer has overseas income, taxes paid to the foreign jurisdiction can generally be credited against U.S. tax liabilities. In general, this "foreign tax credit" is available only for taxes paid on income that is taxable in the U.S. The intended result is that U.S. taxpayers with overseas income should pay no more tax on their U.S. taxable income than they would if it was all from U.S. sources. However, current rules and tax planning strategies make it possible to claim foreign tax credits for taxes paid on foreign income that is not subject to current U.S. tax. As a result, companies are able to use such credits to pay less tax on their U.S. taxable income than they would if it was all from U.S. sources - providing them with a competitive advantage over companies that invest in the United States.


The Administration's Proposal

 Reform the Foreign Tax Credit to Remove Unfair Tax Advantages for Overseas Investment: The Administration's proposal would take two steps to rein in foreign tax credit schemes. First, a taxpayer's foreign tax credit would be determined based on the amount of total foreign tax the taxpayer actually pays on its total foreign earnings. Second, a foreign tax credit would no longer be allowed for foreign taxes paid on income not subject to U.S. tax. These reforms would go into effect in 2011, raising $43.0 billion from 2011 to 2019.

3. Making R&E Tax Credit Permanent to Encourage Investment in Innovation in the United States: The resources saved by curbing tax incentives for jobs overseas and limiting losses to tax havens would be used to strengthen incentives to invest in jobs in the United States by making permanent the R&E tax credit.


Current Law

 R&E Credit Is Set to Expire At End of 2009 : Under current law, companies are eligible for a tax credit equal to 20 percent of qualified research expenses above a base amount. But the research and experimentation tax credit has never been made permanent - instead, it has been extended on a temporary basis 13 times since it was first created in 1981 - and is set to expire on December 31, 2009.



How It Works
 Through the research and experimentation tax credit, companies receive a credit valued at 20 percent of qualified research expenses in the United States above a base amount. Taxpayers can also elect to take an alternative simplified research credit that provides an incentive for increasing research expenses above the level of the previous three years. Taxpayers may also take a credit based on spending on basic research and certain energy research.

 Any uncertainty about whether the R&E credit will be extended reduces its effectiveness in stimulating investments in new innovation, as it becomes more difficult for taxpayers to factor the credit into decisions to invest in research projects that will not be initiated or completed prior to the credit's expiration.



The Administration's Proposal
 Create Certainty to Encourage New Investment and Innovation at Home By Making the Research and Experimentation Tax Credit Permanent: To give companies the certainty they need to make long-term research and experimentation investment in the U.S., the Administration's budget includes the full cost of making the R&E credit permanent in future years. By making this tax credit permanent, businesses would be provided with the greater confidence they need to initiate new research projects that will improve productivity, raise standards of living, and increase our competitiveness. And with over 75 percent of credit dollars attributed to wages, the credit would provide an important incentive for businesses to create new jobs.

 Paid For With Provisions That Make the Tax Code More Efficient and Fair: This change would cost $74.5 billion over 10 years, which will be paid for by reforming the treatment of deferred income and the use of the foreign tax credit.



II. Getting Tough on Overseas Tax Havens

Some countries make it easy for U.S. taxpayers to evade or avoid U.S. taxes by withholding information about U.S.-held accounts or giving favorable tax treatment to shell corporations created just to avoid taxes. In certain cases, companies are taking advantage of currently legal loopholes to avoid paying taxes by shifting their profits to tax havens. In other cases, Americans break the law by hiding their income in hidden overseas accounts, and these tax havens refuse to provide the information the IRS needs to enforce U.S. law. Either way, these tax havens make our tax system less fair and harm the U.S. economy. President Obama proposes to address tax havens by:

1. Eliminating Loopholes that Allow "Disappearing" Offshore Subsidiaries: Current law allows U.S. businesses to establish foreign subsidiary corporations, but then to "check a box" to pretend that the subsidiaries do not exist for U.S. tax purposes. This practice allows taxes that would otherwise be paid in the U.S. on passive income to be avoided, at great cost to U.S. taxpayers.



Current Law
 Disappearing Subsidiaries Allow Corporations to Shift Income Tax-Free: Traditionally, if a U.S. company sets up a foreign subsidiary in a tax haven and one in another country, income shifted between the two subsidiaries (for example, through interest on loans) would be considered "passive income" for the U.S. company and subject to U.S. tax. Over the last decade, so-called "check-the box" rules have allowed U.S. firms to make these subsidiaries disappear for U.S. tax purposes. With the separate subsidiaries disregarded, the firm can shift income among them without reporting any passive income or paying any U.S. tax. As a result, U.S. firms that invest overseas are able to shift their income to tax havens. It is clear that this loophole, while legal, has become a reason to shift billions of dollars in investments from the U.S. to other counties.



Example under Current Law
 Suppose that a U.S. company invests $10 million to build a new factory in Germany. At the same time, it sets up three new corporations. The first is a wholly owned Cayman Islands holding company. The second is a corporation in Germany, which is owned by the holding company and owns the factory. The third is a Cayman Islands subsidiary, also owned by the Cayman Islands holding company.

 The Cayman subsidiary makes a loan to the German subsidiary. The interest on the loan is income to the Cayman subsidiary and a deductible expense for the German subsidiary. In this way, income is shifted from higher-tax Germany to the no-tax Cayman Islands.

 Under traditional U.S. tax law, this income shift would count as passive income for the U.S. parent - which would have to pay taxes on it. But "check the box" rules allow the firm to make the two subsidiaries disappear --and the income shift with them. As a result, the firm is able to avoid both U.S. taxes and German taxes on its profits.



The Administration's Proposal
 Require U.S. Businesses That Establish Certain Foreign Corporations To Treat Them As Corporations For U.S. Tax Purposes: The Administration's proposal seeks to abolish a range of tax-avoidance techniques by requiring U.S. businesses that establish certain corporations overseas to report them as corporations on their U.S. tax returns. As a result, U.S. firms that invest overseas would no longer be able to make their subsidiaries --or their income shifts to tax havens --disappear for tax purposes. This would level the playing field between firms that invest overseas and those that invest at home.

 Raise $86.5 Billion from 2011 to 2019: This loophole would be closed beginning in 2011, raising $86.5 billion from 2011 to 2019.

2. Cracking Down on the Abuse of Tax Havens by Individuals: The IRS is already engaged in significant efforts to track down and collect taxes from individuals illegally hiding income overseas. But to fully follow through on this effort, it will need new legal authorities. Current law makes it difficult for the IRS to collect the information it needs to determine that the holder of a foreign bank account is a U.S. citizen evading taxation. The Obama administration proposes changes that will enhance information reporting, increase tax withholding, strengthen penalties, and shift the burden of proof to make it harder for foreign account-holders to evade U.S. taxes, while also providing the enforcement tools necessary to crack down on tax haven abuse.



Current Law
 A Free Ride for Financial Institutions that Flout Reporting Rules: A centerpiece of the current U.S. regime to combat international tax evasion is the Qualified Intermediary (QI) program, under which financial institutions sign an agreement to share information about their U.S. customers with the IRS. Unfortunately, this regime, while effective, has become subject to abuse:

o At Non-Qualifying Institutions, Withholding Requirements Are Easy to Escape: Currently, an investor can escape withholding requirements by simply attesting to being a non-U.S. person. That leaves it to the IRS to show that the investor is actually a U.S. citizen evading the law.

o Loopholes Allow Qualifying Institutions to Still Serve as Conduits for Evasion: Moreover, financial institutions can qualify as QIs even if they are affiliated with non-QIs. As a result, a financial institution need not give up its business as a conduit for tax evasion in order to enjoy the benefits of being a QI. In addition, QIs are not currently required to report the foreign income of their U.S. customers, so U.S. customers may hide behind foreign entities to evade taxes through QIs.

o Legal Presumptions Favor Tax Evaders Who Conceal Transactions: U.S. investors overseas are required to file the Foreign Bank and Financial Account Report, or FBAR, disclosing ownership of financial accounts in a foreign country containing over $10,000. The FBAR is particularly important in the case of investors who employ non-QIs, because their transactions are less likely to be disclosed otherwise. Unfortunately, current rules make it difficult to catch those who are supposed to file the FBAR but do not. And even when the IRS has evidence that a U.S. taxpayer has a foreign account, legal presumptions currently favor the tax evader --without specific evidence that the U.S person has an account that requires an FBAR, the IRS cannot compel an investor to provide the report or impose penalties for the failure to do so. This specific evidence may be almost impossible for the IRS to get.

 The IRS Lacks the Tools It Needs to Enforce International Tax Laws: In addition to the shortcomings of the QI program, current law features inadequate tools to crack down on wealthy taxpayers who evade taxation. Investors who withhold information about overseas investments face penalties limited to 20 percent of the amount of the understatement. The statute of limitations for enforcement is typically only three years - which is often too short a time period for the IRS to get the information it needs to determine whether a taxpayer with an offshore account paid the right amount of tax. And there are no requirements that U.S. individuals or third parties report transfers to and from foreign accounts, limiting the ability of the IRS to determine whether taxpayers are paying what they owe.



Example Under Current Law
 Through a U.S. broker, a U.S. account-holder at a non-qualified intermediary sells $50 million worth of securities.

 If the seller self-certifies that he is not a U.S. citizen and the non-qualified intermediary simply passes that information along to the U.S. broker, the broker may rely on that statement and does not need to withhold money from the transaction.

 As a result, a U.S. taxpayer who provides a false self-certification can easily avoid paying taxes, since the non-QI has not signed an agreement with the IRS, and the IRS may have limited tools to detect any wrongdoing.



Proposal
In addition to initiatives taken within the G-20 to impose sanctions on countries judged by their peers not to be adequately implementing information exchange standards, the Obama administration proposes to make it more difficult to shelter foreign investments from taxation by cracking down on financial institutions that enable and profit from international tax evasion. These measures - expected to raise $8.7 billion over 10 years - would:

 Strengthen the "Qualified Intermediary" System to Crack Down on Tax Evaders: The core of the Obama Administration's proposals is a tough new stance on investors who use financial institutions that do not agree to be Qualifying Intermediaries. Under this proposal, the assumption will be that these institutions are facilitating tax evasion, and the burden of proof will be shifted to the institutions and their account-holders to prove they are not sheltering income from U.S. taxation. As a result, the Administration proposes to:

 Impose Significant Tax Withholding On Transactions Involving Non-Qualifying Intermediaries: The Administration's plan would require U.S. financial institutions to withhold 20 percent to 30 percent of U.S. payments to individuals who use non-QIs. To get a refund for the amount withheld, investors must disclose their identities and demonstrate that they're obeying the law.

 Create A Legal Presumption Against Users Of Non-Qualifying Intermediaries: The Administration's plan would create rebuttable evidentiary presumptions that any foreign bank, brokerage, or other financial account held by a U.S. citizen at a non-QI contains enough funds to require that an FBAR be filed, and that any failure to file an FBAR is willful if an account at a non-QI has a balance of greater than $200,000 at any point during the calendar year. These presumptions will make it easier for the IRS to demand information and pursue cases against international tax evaders. This shifting of legal presumptions is a key component of the anti-tax haven legislation long championed by Senator Carl Levin.

 Limit QI Affiliations With Non-QIs: The Administration's plan would give the Treasury Department authority to issue regulations requiring that a financial institution may be a QI only if all commonly-controlled financial institutions are also QIs. As a result, financial firms couldn't benefit from siphoning business from their legitimate QI operations to illegitimate non-QI affiliates.

 Provide the IRS With The Legal Tools Necessary to Prosecute International Tax Evasion : The Obama administration proposes to improve the ability of the IRS to successfully prosecute international tax evasion through the following steps:

 Increase Penalties for Failing to Report Overseas Investments : The Administration's plan would double certain penalties when a taxpayer fails to make a required disclosure of foreign financial accounts.

 Extend the Statute of Limitations for International Tax Enforcement: The Administration's plan would set the statute of limitations on international tax enforcement at six years after the taxpayer submits required information.

 Tighten Lax Reporting Requirements : The Administration's plan would increase the reporting requirement on international investors and financial institutions, especially QIs. QIs would be required to report information on their U.S. customers to the same extent that U.S. financial intermediaries must. And U.S. customers at QIs would no longer be allowed to hide behind foreign entities. U.S. investors would be required to report transfers of money or property made to or from non-QI foreign financial institutions on their income tax returns. Financial institutions would face enhanced information reporting requirements for transactions that establish a foreign business entity or transfer assets to and from foreign financial accounts on behalf of U.S. individuals.

3. Hire Nearly 800 New IRS Staff to Increase International Enforcement: As part of the President's budget, the IRS would be provided with funds to support the hiring of nearly 800 new employees devoted specifically to international enforcement. The funding would allow the IRS to hire new agents, economists, lawyers and specialists, increasing the IRS' ability to crack down on offshore tax avoidance and evasion, including through transfer pricing and financial products and transactions such as purported securities loans. According to estimates by the IRS, every additional dollar invested in enforcement in recent years has yielded about four dollars in added tax revenues.

Senate Finance Committee Memorandum: Baucus Statement on President's International Tax Proposals

Senate Finance Committee Memorandum: Baucus Statement on President's International Tax Proposals

May 5, 2009

111th CongressTo: Reporters and editors

From: Dan Virkstis for Senate Finance Committee Chairman Max Baucus (D-Mont.)

Re: Baucus statement on President's international tax proposals

Senate Finance Committee Chairman Max Baucus (D-Mont.) commented today following the Obama Administration's announcement, as part of the President's budget, of several international tax policy proposals that would directly affect American multinational corporations. Baucus said more study is required to see how American companies will be influenced by the suggested policies. Proposals would modify the law surrounding companies' ability to defer tax on foreign earnings, foreign tax credits, classification of foreign businesses, and offshore tax havens.

"The President's proposals highlight an important point --our corporate international tax system needs reforming. There are a number of Finance Committee ideas reflected here, such as the proposal to address offshore tax evasion and making the R&D credit permanent for businesses, but further study is needed to assess the impact of this plan on U.S. businesses," said Baucus. "I want to make certain that our tax policies are fair and support the global competitiveness of U.S. businesses. These policies must be designed to encourage economic growth and create good-paying jobs Americans need right now. The proposals announced by the President today set the table for tax reform, and I look forward to sitting down with the Administration soon to take up these issues. "

House Ways and Means Committee Release: Congress Will Work with Obama Administration to Close Loopholes, Strengthen Investment Opportunities and Job Creation in America

House Ways and Means Committee Release: Congress Will Work with Obama Administration to Close Loopholes, Strengthen Investment Opportunities and Job Creation in America

May 5, 2009

111th Congress

The Honorable Charles B. Rangel, Chairman



FOR IMMEDIATE RELEASE



Contact: Matthew Beck



May 4, 2009


Congress Will Work With Obama Administration to Close Loopholes, Strengthen Investment Opportunities and Job Creation in America


WASHINGTON, DC - Today President Barack Obama joined Treasury Secretary Timothy Geithner to unveil components of the Administration's plan to reform and improve the enforcement of America's international tax laws. In the announcement, President Obama signaled support for the closure of tax loopholes to strengthen investment opportunities and job creation in the United States, as well as an effort to crack-down on the use of illegal tax havens. Many of the proposals outlined by the Administration are similar to legislative proposals that have been introduced and championed by members of the Ways and Means Committee. Chairman Charles B. Rangel (D-NY) authored a tax reform bill in 2007 (H.R. 3970, 110th Congress) that would have closed a number of loopholes encouraging investment overseas and issued the following statement on today's announcement by President Obama and Secretary Geithner:

"Today's announcement by President Obama and Secretary Geithner is another strong step toward fulfilling the Administration's promise to strengthen opportunities for investment and job creation here in the U.S. For too long, our tax laws have rewarded companies that invest and keep their money overseas and turned a blind eye to the use of tax havens by the wealthy. Closing these loopholes and investing the money in American jobs will help millions of American families regain some of the economic security they lost in recent years.

"Our tax code should reward companies that thrive by continuing to invest in America and American workers. I applaud President Obama's commitment to simplifying our tax code and look forward to working with the Administration to close these loopholes."

White House Press Release --Remarks by the President on International Tax Policy Reform

White House Press Release --Remarks by the President on International Tax Policy Reform

May 5, 2009

Obama administration : Tax havens : International tax reform .



THE WHITE HOUSE


Office of the Press Secretary




For Immediate Release



May 4, 2009


REMARKS BY THE PRESIDENT ON INTERNATIONAL TAX POLICY REFORM



Grand Foyer




11:39 A.M. EDT

THE PRESIDENT: All right. Good morning, everybody. Hope you all had a good weekend.

Let's begin with a simple premise: Nobody likes paying taxes, particularly in times of economic stress. But most Americans meet their responsibilities because they understand that it's an obligation of citizenship, necessary to pay the costs of our common defense and our mutual well-being.

And yet, even as most American citizens and businesses meet these responsibilities, there are others who are shirking theirs. And many are aided and abetted by a broken tax system, written by well-connected lobbyists on behalf of well-heeled interests and individuals. It's a tax code full of corporate loopholes that makes it perfectly legal for companies to avoid paying their fair share. It's a tax code that makes it all too easy for a number --a small number of individuals and companies to abuse overseas tax havens to avoid paying any taxes at all. And it's a tax code that says you should pay lower taxes if you create a job in Bangalore, India, than if you create one in Buffalo, New York.

Now, understand, one of the strengths of our economy is the global reach of our businesses. And I want to see our companies remain the most competitive in the world. But the way to make sure that happens is not to reward our companies for moving jobs off our shores or transferring profits to overseas tax havens. This is something that I talked about again and again during the course of the campaign. The way we make our businesses competitive is not to reward American companies operating overseas with a roughly 2 percent tax rate on foreign profits; a rate that costs --that costs taxpayers tens of billions of dollars a year. The way to make American businesses competitive is not to let some citizens and businesses dodge their responsibilities while ordinary Americans pick up the slack.

Unfortunately, that's exactly what we're doing. These problems have been highlighted by Chairmen Charlie Rangel and Max Baucus, by leaders like Senator Carl Levin and Congressman Lloyd Doggett. And now is the time to finally do something about them. And that's why today, I'm announcing a set of proposals to crack down on illegal overseas tax evasion, close loopholes, and make it more profitable for companies to create jobs here in the United States.

For years, we've talked about ending tax breaks for companies that ship jobs overseas and giving tax breaks to companies that create jobs here in America. That's what our budget will finally do. We will stop letting American companies that create jobs overseas take deductions on their expenses when they do not pay any American taxes on their profits. And we will use the savings to give tax cuts to companies that are investing in research and development here at home so that we can jumpstart job creation, foster innovation, and enhance America's competitiveness.

For years, we've talked about shutting down overseas tax havens that let companies set up operations to avoid paying taxes in America. That's what our budget will finally do. On the campaign, I used to talk about the outrage of a building in the Cayman Islands that had over 12,000 business --businesses claim this building as their headquarters. And I've said before, either this is the largest building in the world or the largest tax scam in the world.

And I think the American people know which it is. It's the kind of tax scam that we need to end. That's why we are closing one of our biggest tax loopholes. It's a loophole that lets subsidiaries of some of our largest companies tell the IRS that they're paying taxes abroad, tell foreign governments that they're paying taxes elsewhere --and avoid paying taxes anywhere. And closing this single loophole will save taxpayers tens of billions of dollars --money that can be spent on reinvesting in America --and it will restore fairness to our tax code by helping ensure that all our citizens and all our companies are paying what they should.

Now, for years, we've talked about stopping Americans from illegally hiding their money overseas, and getting tough with the financial institutions that let them get away with it. The Treasury Department and the IRS, under Secretary Geithner's leadership and Commissioner Shulman's, are already taking far-reaching steps to catch overseas tax cheats --but they need more support.

And that's why I'm asking Congress to pass some commonsense measures. One of these measures would let the IRS know how much income Americans are generating in overseas accounts by requiring overseas banks to provide 1099s for their American clients, just like Americans have to do for their bank accounts here in this country. If financial institutions won't cooperate with us, we will assume that they are sheltering money in tax havens, and act accordingly. And to ensure that the IRS has the tools it needs to enforce our laws, we're seeking to hire nearly 800 more IRS agents to detect and pursue American tax evaders abroad.

So all in all, these and other reforms will save American taxpayers $210 billion over the next 10 years --savings we can use to reduce the deficit, cut taxes for American businesses that are playing by the rules, and provide meaningful relief for hardworking families. That's what we're doing. We're putting a middle class tax cut in the pockets of 95 percent of working families, and we're providing a $2,500 annual tax credit to put the dream of a college degree or advanced training within the reach for more students. We're providing a tax credit worth up to $8,000 for first-time home buyers to help more Americans own a piece of the American Dream and to strengthen the housing market.

So the steps I am announcing today will help us deal with some of the most egregious examples of what's wrong with our tax code and will help us strengthen some of these other efforts. It's a down payment on the larger tax reform we need to make our tax system simpler and fairer and more efficient for individuals and corporations.

Now, it will take time to undo the damage of distorted provisions that were slipped into our tax code by lobbyists and special interests, but with the steps I'm announcing today we are beginning to crack down on Americans who are bending or breaking the rules, and we're helping to ensure that all Americans are contributing their fair share.

In other words, we're beginning to restore fairness and balance to our tax code. That's what I promised I would do during the campaign, that's what I'm committed to doing as President, and that is what I will work with members of my administration and members of Congress to accomplish in the months and years to come.

Thanks very much, guys.

The Obama Administration is looking at the flat tax


Senate Budget Committee Majority Staff Overview of the FY 2010 Budget Conference Agreement

April 29, 2009

111th Congress

OVERVIEW



FY 2010 BUDGET



CONFERENCE AGREEMENT



PREPARED BY: MAJORITY STAFF, SENATE BUDGET COMMITTEE



April 27, 2009


Laying a New Foundation for Nation's Economy


The Budget conference agreement for Fiscal Year 2010 is a fiscally responsible budget plan that addresses the fiscal and economic crises inherited by the Obama Administration and lays a new foundation for our nation's economy. It preserves the major priorities in President Obama's budget with strategic investments in energy, education, and health care - investments needed to restore our crumbling economy and put the country in a position to remain globally competitive. It provides significant middle-class tax relief, directed at families with incomes under $250,000. And it begins to put the country back on a more fiscally responsible path by cutting the federal budget deficit in half by 2012 and by two-thirds by 2014 - bringing the deficit down to three percent of GDP.



Inheriting Fiscal and Economic Crises

President Obama and the Democratic Congress have been handed a colossal mess. We are now in the midst of the worst recession since the Great Depression. We face housing and financial market crises that have wiped out home values and weakened our credit markets. We have lost 3.7 million jobs in the last six months. And we have ongoing wars in Iraq and Afghanistan.

Spending nearly doubled under the prior administration and revenues have now fallen to the lowest level as a share of the economy since 1950. Not surprisingly, we have seen record deficits and a doubling of the national debt over the last eight years. Gross debt rose from $5.8 trillion in 2001 to an estimated $12 trillion in 2009. While that $6.2 trillion includes some debt resulting from the economic recovery package, the additional debt load is directly a function of the collapsed economy - a collapse that occurred under the watch of President Bush.

The economic mess left for the Obama administration has made the budgetary outlook even worse than originally believed. The Congressional Budget Office's re-estimate of the President's budget showed the 10-year deficits would be $2.3 trillion more than originally projected. To keep the deficit on a downward trajectory and meet the President's goal of cutting the deficit in half, the conference agreement makes adjustments to the President's budget proposal, while supporting the President's core priorities.



Restoring Economic Growth

President Obama and the Democratic Congress acted swiftly in February to adopt an economic recovery package to jumpstart the economy, create jobs, and begin laying the foundation for long-term economic growth. The package included investments in infrastructure, energy, education, and health. It provided tax cuts for 95 percent of working Americans. The package strengthened the economy by increasing food stamp and unemployment insurance benefits, which have a strong stimulative effect on the economy. The Obama Administration has also taken steps to address both the housing and financial market crises, which are being coordinated with additional actions by the Federal Reserve and other agencies.



Preserving Major Priorities in Obama Budget

The conference agreement includes President Obama's budget proposals that focus on areas that will lay the foundation for our nation's long-term economic security, including: reducing our dependence on foreign energy; striving for excellence in education; and reforming our health care system.

Energy Independence. It has never been more clear that our nation's economic and national security are directly linked to our energy policy. We must address our dangerous addiction to foreign oil and confront the challenges of global climate change. In the process, we can create new "green collar" jobs that will help our nation's economic recovery. To meet these challenges, the conference agreement builds on the energy initiatives in the economic recovery package with continued investments in alternative and clean energy technology, energy efficiency, and modernization of our energy infrastructure. It includes a deficit-neutral reserve fund that could accommodate initiatives to invest in clean energy or address global climate change, such as that proposed by the President.

Education . The conference agreement also recognizes that education is crucial to our nation's future economic strength. For too long, we have been falling behind our competitors in educating our citizens. The conference agreement responds with investments in education and training programs that will help our economic growth and build a highly skilled workforce to compete in the global marketplace. Increasing access to higher education is central to this effort. This is why the conference agreement assumes a Pell grant level of $5,550 in 2010 and includes a deficit-neutral reserve fund to allow for increases in Pell grants in line with those proposed in President Obama's budget. This will make college more affordable and more accessible for millions of Americans.

Health Reform . The conference agreement recognizes that reforming our nation's health care system is essential to ensuring our long-term fiscal stability and economic strength, in addition to the well-being of our citizenry. Soaring health care costs are the biggest source of the projected explosion in federal debt in our long-term budget outlook. Rapidly rising health costs make it harder for our businesses to compete globally, while putting a tremendous strain on family budgets. The conference agreement follows up on the health investments made in the economic recovery package, and includes, as requested by the President, a reserve fund to allow for a major health reform initiative. This deficit-neutral reserve fund is in keeping with President Obama's commitment to paying for the cost of health reform.



Returning to a Sound Fiscal Course

The conference agreement begins to return the nation to a sound fiscal course by cutting the deficit by more than half by 2012, and by two-thirds by 2014. Under the conference agreement, the deficit will be cut to $620 billion in 2012 and to $523 billion in 2014 - bringing the deficit down to three percent of GDP.

Spending as a share of the economy falls under the conference agreement, with domestic discretionary spending declining from 4.4 percent of GDP in 2010 to 3.4 percent in 2014. In nominal terms, non-defense discretionary funding increases at an average annual rate of 2.9 percent.

The conference agreement retains crucial budget enforcement provisions, such as a strong paygo rule and allowing reconciliation for deficit reduction only.

The conference agreement generates valuable savings by expanding oversight activities in large benefit programs, more aggressively pursuing fraud, and increasing tax compliance and enforcement activities to ensure taxpayer dollars are spent wisely.

The conference agreement also includes a two-year placeholder for the cost of possible disaster relief.



Providing Tax Relief for Middle Class

The conference agreement provides significant middle-class tax relief. In total, the conference agreement cuts taxes by $764 billion over the next five years. This tax relief includes:
 $512 billion to extend middle-class tax cuts, such as the 10 percent bracket, the child tax credit, marriage penalty relief, and education incentives, as well as the other 2001 and 2003 tax cuts extended in the President's budget for taxpayers making under $250,000;

 $214 billion for three years of AMT reform;

 $72 billion to match the President's estate tax reform proposal - which would permanently extend the 2009 level of a $7 million exemption for couples and $3.5 million for individuals;

 $54 billion for two years of extenders; and

 $9 billion for other tax cuts.

The conference agreement includes $97 billion in loophole closers and raisers. The specifics of these proposals will be developed by the Finance and Ways and Means Committees.

The conference agreement allows for the extension of the President's Making Work Pay tax credit beyond 2010 through its deficit-neutral reserve funds. This is consistent with the President's commitment to ensuring the extension of this tax credit is paid for.



Supporting Our Troops and Accounting for War Costs

The conference agreement matches President Obama's core defense budget and the President's request for additional war costs. Unlike Bush administration budgets, which repeatedly left out or understated likely war costs, President Obama's budget includes a far more honest accounting of the likely costs of overseas contingency operations including the wars in Iraq and Afghanistan. The conference agreement follows this approach, which will enhance oversight of war funds and save vital defense resources.



Honoring Our Veterans

The conference agreement honors our veterans by providing a $5.6 billion, 11.7 percent, increase over the 2009 level in veterans' health care and other services. It follows the President's budget in ending the Bush administration's ban on enrolling modest-income veterans for Department of Veterans' Affairs (VA) health care. It provides more funding than 2009 for VA to research and treat mental health, post-traumatic stress disorder, and traumatic brain injury. It also assumes VA's current policy of paying for the treatment of veterans' service-connected conditions and billing private insurance companies only for treatment of non-service-connected conditions.



Addressing Long-Term Fiscal Challenge

While the conference agreement takes important steps in the near-term of cutting the deficit in half by 2012 and by two-thirds by 2014, it is clear that more will be needed to address the long-term fiscal imbalance confronting the nation beyond the five-year budget window. The combination of our retiring baby boom generation, soaring health care costs, and an outdated and inefficient revenue system are projected to explode federal debt over the long-term to an unsustainable level. The economic downturn has only worsened that long-term debt outlook.

As noted above, to begin addressing our soaring health care costs - the biggest source of the projected long-term debt explosion - the conference agreement provides for a major health care reform initiative to be done on a deficit-neutral basis. It will be critical for that effort to follow up on the health care investments made in the recently passed economic recovery package, such as funding for health information technology, prevention and wellness interventions, and comparative effectiveness research. Over time, these investments and other steps can help to bend the cost curve on health care and put our health care accounts back on a sustainable course.

President Obama's Fiscal Responsibility Summit - which occurred within roughly the first month of his administration - initiated an open bipartisan dialogue on ways to address the long-term fiscal challenge. That dialogue will hopefully lead to bipartisan action on this challenge in the near future. The administration has also indicated its seriousness about reforming our nation's tax system by appointing former Federal Reserve Chairman Paul Volcker to lead a task force on tax reform this year.

No matter how successful we are in pulling out of the current economic downturn, our long-term economic security will remain in jeopardy until we address this projected long-term fiscal imbalance.

Congressional Research Service Report for Congress --Flat Tax: An Overview of the Hall-Rabushka Proposal, April 22, 2009

April 29, 2009

111th Congress

Flat Tax: An Overview of the Hall-Rabushka Proposal

James M. Bickley
Specialist in Public Finance

April 22, 2009

Congressional Research Service

7-5700

www.crs.gov

98-529



Summary

The concept of replacing the current U.S. income tax system with a flat rate consumption tax is receiving congressional attention. The term "flat tax" is often associated with a proposal formulated by Robert E. Hall and Alvin Rabushka (H-R), two senior fellows at the Hoover Institution. This report analyzes the idea of replacing the U.S. income tax system with this type of consumption tax. Although the current tax structure is referred to as an income tax, it actually contains elements of both an income and a consumption-based tax. A consumption base is neither inherently superior nor inherently inferior to an income base. On March 30, 2009, Senator Arlen Specter introduced S. 741, Flat Tax Act of 2009, which is modeled after the Hall-Rabushka proposal.

The combined individual and business taxes proposed by H-R can be viewed as a modified valueadded tax (VAT). The individual wage tax would be imposed on wages (and salaries) and pension receipts. Part or all of an individual's wage and pension income would be tax-free depending on marital status and number of dependents. The business tax would be a modified subtractionmethod VAT with wages (and salaries) and pension contributions subtracted from the VAT base, in contrast to the usual VAT practice.

The analysis of the flat tax proposal is covered by the following four topics that sometimes overlap: broad economic issues, narrow sectoral economic issues, simplicity, and international comparisons. First , broad economic issues relate to economic effects of the flat tax on the entire economy: equity, efficiency, international trade, price level, interest rates, and revenue. Second , sectoral economic issues deal with specific industries or sectors of the total economy: differential effects on businesses, charitable organizations, housing, financial services, pensions and insurance, health care services, and state and local governments. Third , tax economists, government leaders, and taxpayers are interested in the simplicity of a tax system, and the current income tax system is complex. A positive aspect of the proposed flat tax is the ease with which the individual and corporate tax systems could be integrated. But, the complexity of the current tax code is partially due to attempts to achieve greater equity or to improve economic efficiency, and there are often tradeoffs between simplicity, equity, and efficiency. It can be argued that it may be "unfair" to compare the current income tax system with some form of a "pure" consumption tax; by the time a consumption tax becomes enacted, it may become complicated. Fourth , there are major distinctions between recent consumption tax proposals for the United States and the current tax systems of other developed nations. Numerous aspects of the H-R flat tax proposal have not been fleshed out and many important policy issues have yet to be analyzed.

This report will be updated as issues develop or legislation is introduced.



Contents

Introduction
Income Versus Consumption Taxation

Types of Consumption Taxes

Retail Sales Tax

Value-Added Tax

Consumed-Income Tax

Hall-Rabushka Flat Tax
Justification

Operation

Individual Wage Tax

Business Tax

Selected Policy Issues
Broad Economic Issues

Equity

Efficiency

International Trade

Price Level

Interest Rates

Revenue

Sectoral Issues

Differential Effects on Businesses

Charitable Organizations

Housing

Financial Services

Pensions and Insurance

Health Care

State and Local Governments

Simplicity

Integration and Measuring Capital Income

Simple Returns and Other Simplicity Issues

International Comparisons

Conclusion



Figures

Figure A-1. Individual Wage Tax

Figure A-2. Business Tax



Appendixes

Appendix. Tax Forms under the Flat Tax



Contacts

Author Contact Information



Introduction

Some Members of Congress have indicated interest in the concept of replacing our current federal income tax system with some form of a consumption tax, including proposals with a flat rate. The term "flat tax" is often associated with a proposal formulated by Robert E. Hall and Alvin Rabushka (H-R), two senior fellows at the Hoover Institution at Stanford University. In 1981, they proposed the replacement of the federal individual income tax and the federal corporate income tax with a flat rate consumption tax. In early 1995, Hall and Rabushka published the second edition of their book titled simply The Flat Tax . 1 In 2005, Dr. Hall provided some additional insights into his flat tax proposal. 2 This report explains and evaluates the Hall-Rabushka proposal for three reasons. First, on March 30, 2009, Senator Arlen Specter introduced S. 741, Flat Tax Act of 2009, which is modeled after the Hall-Rabushka proposal. Second, the Hall-Rabushka proposal concerns many issues relevant to other tax reform proposals. Third, unlike a number of other reform plans, the H-R proposal has sufficient detail to permit examination, although numerous aspects of the proposal have yet to be fleshed out. 3

The report begins with discussions of congressional interest in the flat tax, the concept of an income tax base versus a consumption tax base, and three types of broad-based consumption taxes. Next, the justification and operation of the proposed H-R flat tax are explained. Lastly, selected policy issues are examined, including both broad and narrow economic issues, simplicity, and international comparisons. The broad economic issues relate to the economic effects of the flat tax on the entire economy, for example, equity, efficiency, and international trade. The more narrow economic issues deal with specific industries or sectors of the total economy, such as housing or charitable organizations.

In the 111 th Congress (as of April 22, 2009), four bills have been introduced that include proposals for fundamental tax reform; that is, basic changes in what is taxed, in tax rates, in how taxes are collected, or some combination of these reforms. Two of these bills are companion bills and would replace the current income tax system with a national retail sales tax. The third bill would broaden the income tax base ("simplified taxable income") and reduce marginal tax rates. The fourth bill, as previously indicated, would levy a flat tax based on the H-R proposal as a replacement tax for both the current income taxes and the estate and gift taxes.



Income Versus Consumption Taxation

Although our current tax structure is frequently referred to as an income tax in popular discussions, it actually contains elements of both an income and a consumption-based tax. For example, it excludes some income that goes to savings, such as pension and individual retirement account (IRA) contributions, which is consistent with a tax using a consumption base. Overall, however, the return to new investment is taxed, which is consistent with an income tax.

The easiest way to understand the differences between the income and consumption tax bases is to define and understand the economic concept of income. In its broadest sense, income is a measure of the command over resources that an individual acquires during a given time period. Conceptually, an individual can exercise two options with regard to his income: he can consume it or he can save it. This theoretical relationship between income, consumption, and saving allows a very useful accounting identity to be established; income, by definition, must equal consumption plus saving.

Should the tax base be income or consumption? Is one inherently superior to the other? How do they stack up in terms of simplicity, equity, and efficiency? There appears to be insufficient theoretical or empirical evidence to conclude that a consumption-based tax is inherently superior to an income-based tax or vice versa.



Types of Consumption Taxes

The three general types of consumption-based taxes are: a retail sales tax, a value-added tax (VAT), and a consumed-income tax. 4 A broad-based consumption tax, however formulated, is equal to a tax on wages plus a lump sum tax on old capital in existence at the time the tax is imposed.



Retail Sales Tax

A retail sales tax (RST) is a consumption tax collected only at the retail level by vendors. A RST equals a set percentage of the retail price of taxable goods and services. Retail vendors collect the RST and remit tax revenue to the government.



Value-Added Tax

The H-R flat tax can be considered a modified value-added tax. Hence, an examination of specific aspects of a VAT is particularly important in explaining the operation of the proposed flat tax. 5



Concept of a Value-Added Tax 6

A value-added tax is levied at each stage of production on firms' value added. The value added of a firm is the difference between a firm's sales and a firm's purchases of inputs from other firms. In other words, a firm's value added is simply the amount of value a firm contributes to a good or service by applying its factors of production (land, labor, capital, and entrepreneurial ability). 7

The prevailing procedure is to treat the purchase of capital inputs (plant and equipment) the same way as the purchase of any other input; that is, the purchase price is deducted at the time of purchase. This tax treatment of capital purchases is equivalent to expensing.



Methods of Calculating VAT

Three alternative methods of calculating VAT are the credit method, the subtraction method, and the addition method. Under the credit method , the firm calculates the VAT to be remitted to the government by a two-step process. First, the firm multiplies its sales by the tax rate to calculate VAT collected on sales. Second, the firm credits VAT paid on inputs against VAT collected on sales and remits this difference to the government. Under the credit-invoice method , a type of credit method, the firm is required to show VAT separately on all sales invoices and to calculate the VAT credit on inputs by adding all VAT shown on purchase invoices. Under the subtraction method , the firm calculates its value added by subtracting its cost of taxed inputs from its taxable sales. Next, the firm determines its VAT liability by multiplying its value added by the VAT rate. Under the addition method , the firm calculates its value added by adding all payments for untaxed inputs (e.g., wages and profits). Next, the firm multiplies its value added by the VAT rate to calculate VAT to be remitted to the government. 8



Consumed-Income Tax

A consumed-income tax would have a tax base that includes all sources of income but allows deductions for saving. This base would result in the taxation of only consumption. Taxpayers would deduct contributions to qualified savings accounts (equivalent to individual retirement accounts, with unlimited contributions permitted). All withdrawals from qualified savings accounts would be taxable at the time of withdrawal. Policymakers would have the option of applying a progressive rate structure to the level of consumed income. In contrast to a RST or VAT, each individual would be responsible for calculating his level of consumed income and paying his tax obligation. 9



Hall-Rabushka Flat Tax



Justification

Hall and Rabushka argue that replacing the existing individual income tax with their flat tax would be a major improvement for three reasons: the flat tax would be much simpler than the current income tax, consumption is a better tax base than income, and the flat tax would be much more efficient than the current income tax system.

First , Hall and Rabushka maintain that there is a need for tax simplification. They argue that the complexity of the current federal individual and corporate income tax systems results in excessive administrative and compliance costs. 10

Second , Hall and Rabushka argue that a consumption tax is superior to an income tax because "... individuals would be taxed on what they take out of the economy (when they spend money to consume), not on what they produce (reflected in working and saving)." 11 They claim that
By exempting investment from taxation, consumption taxes encourage investment and discourage spending. (Over time, each act of investment traces back to an act of saving; thus exempting investment from the tax base amounts to exempting saving.) 12

Third , Hall and Rabushka assert that the current tax system results in an inefficient use of resources. They argue that their flat tax proposal would improve the allocation of resources, which would result in higher economic growth and a rise in living standards.

As will be discussed in more detail, some economists dispute H-R's justifications for a flat tax.



Operation

With a standard VAT, firms collect the tax and remit it to the Government. The H-R flat tax is essentially a modified VAT . The H-R flat tax proposal breaks the VAT into two parts: "an individual wage tax" (to collect tax on wages and pension receipts) and "a business tax" (to collect tax on old capital). 13 The principal effects of the H-R flat tax are like those of a standard VAT. In 1995, Hall and Rabushka published the second (and most current) edition of their book about their flat tax proposal. Hence, their analysis utilizes data from 1991, and their presentation of their proposal is for 1995. From 1991 through 2008 and from 1995 through 2008, according to the Bureau of Labor Statistics, the consumer price index rose 58.08% and 41.27%, respectively. 14 Thus, these rises in the price level should be considered in examining the data in their proposal.

The proposed bill in the 111 th Congress based on the H-R concept includes much higher "personal allowances" for taxpayers and dependences than proposed by H-R for 1995, as described in the subsequent sections of this report. As previously indicated, on March 30, 2009, Senator Arlen Specter introduced S. 741, the Flat Tax Act of 2009. This bill's individual wage tax includes a "basic standard deductions" (equivalent to H-R's "personal allowances") of $25,000 for a joint return, $25,000 for a surviving spouse, $18,750 for a head of household, $12,500 for a married taxpayer filing separately, and $12,500 for a single taxpayer. The Flat Tax Act of 2009 also includes a deduction for each dependent of the taxpayer of $6,250. The dollar value of these deductions are indexed for inflation.



Individual Wage Tax

The individual wage tax would be imposed on wages (and salaries) and pension receipts at a 19% rate. Part or all of an individual's wage and pension income would be tax free depending on marital status and number of dependents. For tax year 1995, the personal allowance for a married couple filing jointly would be $16,500 and the personal allowance for each dependent would be $4,500. Thus, for a family of four (husband, wife, and two dependents) the first $25,500 in wage and pension income would not be taxed. All current income tax deductions would be eliminated including those for charitable contributions, mortgage interest, and state and local income and property taxes. An individual's Social Security contributions would not be deductible and his Social Security benefits would not be taxable. The current partial taxation of benefits for higherincome taxpayers would be eliminated. 15 H-R estimate that 80% of taxpayers do not run businesses, and consequently, they would only have to file this simple individual wage-tax form. 16



Business Tax

The business tax would be a modified subtraction method VAT at a 19% rate with wages (and salaries) and pension contributions subtracted from the VAT base. (Under a standard subtractionmethod VAT, a firm would not subtract its wages and pension contributions when calculating its tax base.)

Except for pension contributions, all fringe benefits would be included in the firm's tax base. "The employer's [Social Security] contributions would be treated like other fringe benefits --it would not be deductible from the business tax." 17

All purchases of plant and equipment would be immediately expensed (deducted from gross income). There would be no depreciation expenses for previously purchased plant and equipment. There would be no recovery of cost of goods sold (existing inventory) --a firm selling off inventory would not be able to deduct the cost.

A standard subtraction-method VAT would rebate negative amounts of VAT that might occur when a firm's subtractions exceed its revenue --for example, when a firm invests a large amount but has low sales. Under the H-R business tax, any negative tax would be carried forward to the next year with interest paid on the carry-forward.

Self-employed individuals would usually find it advantageous to file both a business tax return and an individual tax return. From their business operations, they would be able to pay themselves a salary, and thus use the personal allowance to exclude some income from taxation. For example, a married couple operating a business could exclude up to $16,500 in salary from taxation.

All owners of rental real estate would be required to file the business tax return. 18 "The purchase price [of rental property] would be deducted at the time of purchase, and the sale price would be taxed at the time of sale." 19



Selected Policy Issues

The H-R tax presented policy issues that fall into four broad categories: broad economic issues, more narrow sectoral economic issues, simplicity and international comparisons.



Broad Economic Issues

Broad economic issues concern the economic effects of the flat tax on the entire national economy. There are six: equity, efficiency, international trade, price level, interest rates, and revenue.



Equity

Policymakers are concerned about the distributional (or equity) effects of taxation; the proposed flat tax is no exception. A tax change has both a horizontal effect and a vertical effect on equity. Horizontal equity concerns the equal treatment of households with the same ability-to-pay. Vertical equity concerns the tax treatment of households with different abilities-to-pay. The most common measure of ability-to-pay is some measure of income, but some prefer a measure of consumption. Tax incidence usually is measured by using a one-year time period although a lifetime period sometimes is considered. 20



Hall-Rabushka Analysis

Hall and Rabushka acknowledged that their proposed flat tax would cause some taxpayers to pay more taxes and some to pay less in the short run, but in the long run, they claimed that a higher rate of economic growth would cause many taxpayers who initially lost to eventually benefit. 21

For 1991, H-R compared taxes on adjusted gross income consisting only of wage income with a hypothetical tax payments from the wage tax for a typical family (a married couple with 1.1 dependents). H-R concluded that currently the typical family with wage income below about $10,000 does not pay significant individual income tax on that income and would pay no flat tax on wages. The typical family with wage income between $10,000 and $30,000 would pay less under the flat wage tax than they currently pay in income tax. But, the flat wage tax would be slightly higher on average for the typical family in the $30,000 to $90,000 range. The typical family with wage income over $100,000 would pay less under the flat wage tax. 22

But, H-R pointed out that there are limits to the preceding comparison.
The individual wage tax component of the flat tax, however, will raise less revenue than the personal income tax, and, correspondingly, the business tax component of the flat tax will raise more revenue than the existing corporate income tax. 23

The comparison above only covered wage income. For 1991, the average tax rate on wage income under the flat tax would have been only 8.5% because personal allowances would have excluded one-half of wage income from taxation. 24 In contrast, for 1991, the average tax rate on wage income under the individual income tax was 10.4%. 25

Because of the substantial data problems in attempting to measure the incidence of the flat tax compared to the current individual tax, H-R conclude that
We can't tell if there are any income groups who would pay significantly higher taxes, including the wage taxes they would pay directly and the business taxes they would pay indirectly. This group could not include the poor, who receive almost no business income. 26



U.S. Treasury's Analysis

The U.S. Treasury analyzed the incidence of the proposed Armey-Shelby flat tax, which is based on the Hall-Rabushka concept. 27 The Treasury used a broad-based income concept called Family Economic Income (FEI): a concept that includes, for example, employer-provided fringe benefits and the imputed rent on owner-occupied housing. 28 In order for the Armey-Shelby flat tax to be revenue neutral, the U.S. Treasury maintained that a 20.8 percentage rate would have to be levied. The Treasury calculated the incidence of the change to the flat tax on eight different FEI classes. The Treasury concluded that only the highest income class (FEI of $200,000 or more) would pay less in taxes; other classes would pay more. 29 These distributional effects are partially the result of assumptions concerning the incidence of different components of the flat tax. 30



Gravelle's Analysis

Jane G. Gravelle, a Senior Specialist at CRS, emphasized that if a flat tax is passed, and the Federal Reserve did not change the money supply, then the flat tax would be shifted backwards onto owners of equities (old capital) and wage earners. Gravelle also assesses the lifetime and intergenerational incidence of a consumption tax:
The consumption tax tends to shift the burden to holders of old assets, who are likely to be old. The young tend to benefit if they are likely to do a significant amount of lifetime saving, but the young who do little lifetime saving can be made worse off if tax rates are much higher. Those who do little lifetime saving are likely to be the lifetime poor. At the same time, very wealthy individuals with accumulated assets who consistently pass on wealth across the generations may also avoid the tax and may find their tax burdens lowered indefinitely compared to an income tax. Thus, these generational shifts probably contribute to a less progressive tax. 31

Gravelle's analysis raises the issue of horizontal equity since the flat tax would shift the tax burden from the young to the old. It should also be noted that old capital and thus the old will bear a consumption tax regardless of whether the money supply is altered. Accommodating the tax with a price change will cause the burden to be shared by debt claimants --the cost of physical assets would rise resulting in the net of tax sales proceeds being fixed, but the purchasing power would fall and cause proceeds of both debt and equity holders to effectively bear the tax. If price is not changed, and there is no reason to believe it will be under the flat tax except for a minor revision to reflect the cost of fringe benefits, prices of goods will not rise, and the net of tax sales proceeds would fall by the amount of this tax. This tax will fall solely on equity since the value of outstanding debt is fixed. This tax could be very high for heavily leveraged assets that are recently purchased.

In summary, the current income tax system is progressive but the incidence of the H-R flat tax is uncertain. There is no general agreement concerning the vertical incidence of the proposed shift to the H-R flat tax --whether it would reduce or increase tax progressivity.



Efficiency

In public finance, the more neutral is a tax, the less the tax affects private economic decisions; and, consequently, the more efficient is the operation of the economy.

For households, two out of three major decisions would not be altered by this hypothetical consumption tax. First, this consumption tax would not alter choices among goods because all would be taxed at the same rate. Thus, relative prices would not change. In contrast, other taxes, such as excise taxes, which change relative prices, would distort household consumer choices by encouraging the substitution of untaxed goods for taxed goods. A hypothetical income tax on all income would be neutral in this respect.

Second, a flat tax does not affect the relative prices of present and future consumption. In contrast, the individual income tax affects the relative prices of present and future consumption because the income tax is levied on income which is saved, and then the returns on saving are taxed.

A household's work-leisure decision, however, would be affected by a flat tax or any other tax on either consumption or income. Since leisure would not be taxed, any tax increase would fall on the returns to work. Hence, under either an consumption or an income tax the price of leisure is reduced relative to the consumption an individual could finance with an extra hour of labor.

For a firm, the flat tax would not affect decisions concerning method of financing (debt or equity), choice among inputs, type of business organization (corporation, partnership, or sole proprietorship), and goods to produce. Other types of taxes may affect one or more of these types of decisions.

Because consumption is a smaller base than income, to raise the same amount of tax revenue, a consumption-based tax would require a larger increase in marginal tax rates than would an income tax. Distortions caused by these higher marginal rates could offset (or even exceed) other neutral advantages of the flat tax. Hence, whether an income tax system or a flat tax system is more efficient is unknown. 32



Savings

H-R argue that taxing only consumption rather than all income (saving and consumption) would increase the savings rate. H-R predict that in consequence, a flat tax would cause an increase in the capital stock that would increase gross domestic product (GDP) by 2% to 4% within seven years. 33

National saving consists of government saving, business saving, and personal saving. 34 Any tax increase or reduction in federal expenditures would be expected to reduce government dissaving, and consequently, raise national saving. 35 Thus, whether a flat tax increases or reduces revenue is relevant to its effect on national saving.

Another issue concerns the personal savings rate. But there is no conclusive theoretical or empirical evidence that a consumption tax will increase the savings rate and consequently the level of national savings. 36 According to economic theory, a rise in the after tax rate of return would have two conflicting effects. First , each dollar saved today results in the possibility of a higher amount of consumption in the future. This relative increase in the return from saving causes a household to want to substitute saving for consumption out of current income (substitution effect). Second , a higher rate of return on savings raises a household's income; consequently, the household has to save less to accumulate some target amount of savings in the future (income effect). Thus, this income effect encourages households to have higher current consumption and lower current saving. These two conflicting effects mean that economic theory cannot determine the effects of the rate of return on the savings rate.

Highly stylized life-cycle models show that a flat tax would cause a substantial increase in the savings rate, but these models are extremely controversial. 37 These stylized models add a third effect for a consumption tax. Unlike a mere exclusion of tax on the return, the consumption tax allows an up-front deduction for savings, but requires the payment of tax on both principal and return when consumption occurs in the future. Thus, individuals need to save today to pay these taxes due in the future; they can do so while still consuming more today because of their large tax cuts. Thus, while the young may consume some part of their tax cut, the old reduce their consumption by much more, and the overall effect is to increase aggregate savings in the economy. But these stylized life-cycle models rely on somewhat idealized assumptions, such as all taxpayers having perfect information and certainty that the tax system will not change during their lifetimes. If these idealized assumptions are relaxed, then the results are not conclusive that switching from an income tax to consumption tax would increase savings. 38



Work Effort

H-R maintain that their flat tax would reduce the marginal tax rate of most taxpayers. Taxpayers would have a marginal rate of either zero or 19%. H-R estimate that as a result, their flat tax would increase total hours of work in the U.S. economy by 4%. 39 Hence, "total annual output of goods and services in the U.S. economy would rise by about 3%, or almost $200 billion." 40

Whether a revenue neutral flat tax increases or reduces a household's marginal tax rate, it would have conflicting effects on the number of hours worked by that household. Households with a lower marginal tax rate would have an incentive to substitute work for leisure because of the relative rise in the value of work to leisure (substitution effect). Conversely, a household would have an incentive to reduce its hours worked because it needs to work fewer hours in order to achieve a given standard of living (income effect). For households with a higher marginal rate, the substitution effect would tend to decrease work effort but the income effect would tend to increase work effort. A household's marginal rate affects its substitution effect but its average tax rate affects its income effect. Thus, as assessed by current economic theory, a flat tax could decrease, increase, or not change a household's hours worked. In any case, many economists believe that, on the basis of theoretical considerations and empirical studies, the current income tax system does not significantly affect the aggregate number of hours worked.



Investment

H-R maintain that taxing all investment at a uniform rate would improve the efficient allocation of capital and raise the return on capital investment. The current system does have major distortions in the taxation of capital income such as the double taxation of corporate income, the preference for debt financing, and the favorable treatment of owner occupied housing. In addition, H-R cite an analysis by Alan J. Auerbach, an economics professor at the University of California at Berkeley, that the current tax system has a bias in investment toward equipment and away from structures, and consequently, eliminating this bias would raise gross national product (GNP) by 0.8%. 41

H-R argue that currently tax-favored entities such as pension funds prefer investing in low risk activities often secured by readily marketable assets. H-R maintain that their flat tax would eliminate tax preferences including the interest deduction, and therefore, redirect investment into innovative enterprises based on new ideas. 42

But in response to all the efficiency arguments, it can be argued that it is not appropriate to compare a perfect consumption tax in concept with an imperfect real income tax system. There are steps that might improve the present system that stop short of a flat tax --for example, the current individual income tax and the corporate income tax could be integrated or, current tax preferences could be eliminated or curtailed, thus producing a more neutral income tax.



Growth

According to H-R,
Tax reform along the lines of our simple tax will influence the American economy profoundly: Improved incentives for work, entrepreneurial activity, and capital formation will substantially raise national output and the standard of living. 43

H-R estimate that their flat tax would raise annual output by 6% after the economy has fully adjusted to the tax change which would be a period of seven years. 44 This 6% increase in output would consist of a 3% rise due to increased work effort and a 3% rise due to a combination of added capital formation and better entrepreneurial incentives. 45

But H-R provide no model on which their estimate is based. As discussed in preceding sections, many tax economists do not believe that changes in the tax code can significantly affect either the savings rate or the work-leisure decision. Also, most capital accumulation models have a much longer period to return to steady state than seven years. For example, to increase net output by 3% through increased savings, the capital stock would have to increase by about 12%. Since the capital stock tends to grow at the growth rate of the economy --say 2% a year --the savings rate would have to nearly double for that seven-year period to increase the capital stock by that much.



International Trade

The Hall-Rabushka flat tax is not border adjustable. That is, unlike a credit-invoice method valueadded tax, for example, the H-R tax is not levied on all imports and rebated on all exports. Popular perception holds that this lack of border adjustability would increase this nation's balance-of-trade deficit. Economic theory, however, holds that border tax adjustments have little current effect on the balance-of-trade because the balance-of-trade is, in part, a function of international capital flows. Any changes in the product prices of traded goods and services brought about by border tax adjustments would usually be offset by exchange rate adjustments. 46



Price Level

The H-R flat tax proposal would not require any change in the price level. Wage income and pension receipts are taxed at the individual level while capital income minus net investment and fringe benefits (except pension contributions) are taxed at the firm level. Thus, the flat tax proposal would not require a change in the price level to prevent an economic contraction (unlike a VAT), except for the small effects due to taxing fringe benefits. 47



Interest Rates

Most economists believe that the H-R flat tax (or a similar proposal) would lower interest rates, but a minority of economists maintain that interest rates could rise. 48



Revenue

Policymakers are concerned about three aspects of a tax's revenue yield: adequacy, stability, and countercyclical effects.



Adequacy

The H-R flat tax would replace the personal income and corporate income taxes. This drastic change raises the issue of the adequacy of the revenue yield. Revenue forecasting is, at best, a necessary but inexact government undertaking. Revenue forecasts of income tax revenues often have been too low or too high. Thus, there is a justifiable concern that in an abrupt transition to a flat tax the initial revenue yield could be far too low or too high compared with the amount forecasted. Any drastic unexpected decline or rise in tax revenue could be destabilizing to the economy.



Stability

Consumption is more stable than personal income since people attempt to maintain their living standards during recessions (save less) and save more during periods of prosperity. Business income (and hence business income taxes) usually rises dramatically during an economic expansion, but usually declines precipitously during a recession. Because the flat tax excludes business income, it would result in more stable total tax revenues over the business cycle than an income tax system.



Countercyclical Effects

The current income tax system is an automatic stabilizer; that is, without any discretionary action by policymakers, the income tax system tends to maintain aggregate demand in the economy (by reducing tax revenues) during recessions and curtailing aggregate demand (by increasing tax revenue) during booms. The countercyclical effects of a flat tax would be much weaker since revenues would be more stable over the business cycle. But the importance of these tax effects are diminished in the modern world of highly mobile capital.



Sectoral Issues

As previously indicated, more narrow economic issues deal with specific industries or sectors of the total economy. Seven are discussed in the subsequent sections: differential effects on businesses, charitable organizations, housing, financial services, pensions and insurance, health care, and state and local governments.



Differential Effects on Businesses

As noted previously, if there is no price accommodation, the general burden of the H-R flat tax will fall on wages and old capital. At a more discrete level, the business tax proposed by H-R would have differential effects among corporations depending on their financial characteristics and their industry. 49 Many large, established, slow-growing corporations with large depreciation expenses and high interest expenses would be collect much higher business taxes than they pay under the current corporate income tax. These corporations would be unable to deduct depreciation for plant and equipment purchased prior to the enactment of the flat tax. Also, they would be unable to deduct interest costs on their outstanding debt. Furthermore, existing inventory costs would not be recovered. Firms selling off inventory or selling assets would face a large tax burden especially if debt financed. 50

In contrast, young, fast growing corporations with little debt and low depreciation expenses would collect less under the business tax than they pay under the current corporate income tax. All new investment in plant and equipment would be immediately expensed. Because of their low level of outstanding debt, the loss of the interest expense would be of little concern to these corporations.

H-R use examples to demonstrate that there would be a dramatic change in the amount of taxes collected by different corporations. According to H-R, in 1993, General Motors (GM) paid about $110 million in corporate income taxes. In 1993, GM's interest expense and depreciation outweighed its new investment: GM had interest expenses of $5.7 billion and depreciation deductions for past investment of $9 billion but only about $6 billion in new investment. Thus, under the H-R flat tax, for 1993, H-R estimate that GM would have remitted taxes of $2.72 billion, over 24 times its actual corporate tax liability. 51

In contrast, H-R examined the corporate income tax return of the Intel Corporation. In 1993, Intel paid $1.2 billion in corporate income taxes. Intel had no debt and thus no interest expenses and invested heavily in new plant and equipment. Thus, under the proposed flat tax, Intel would have remitted only $277 million for 1993, less than one-fourth its actual corporate income tax liability. 52

The elimination of depreciation expenses would create a special transitional problem. Managers of a business would be reluctant to purchase plant and equipment in the year before the flat tax would go into effect because they would be able to write off only one year of depreciation. If managers of this business simply waited a year, the entire investment outlay could be written off, that is, expensed. Hence, the approval of the flat tax could result in a sudden decline and then a sharp rise in investment after the flat tax was operational. Furthermore, managers of many existing businesses may consider it "unfair" to change the rules and deny depreciation expenses for past investment.

H-R offer, as an option, allowing managers of businesses to continue depreciating investments made before the introduction of the flat tax. This would require, however, a higher tax rate to offset the resulting loss in revenue, and there would be a reduction in economic efficiency. 53 But, the higher tax rate would be temporary, since depreciation expenses would diminish over time. 54 Furthermore, the flat tax would be more complicated if depreciation was permitted.

Also, the flat tax would eliminate tax preferences available to specific industries. For instance, oil producers currently receive a tax break on "intangibles" which allows them to write off most of their drilling costs. In addition, oil independents use the percentage depletion allowance to write off a percentage of their receipts. Thus, the oil producing companies probably would collect more under the business tax than they currently pay in corporate income taxes.

Hence, the financial structure and tax preferences of different industries would result in differential shifts in tax liabilities between the current corporate income tax and the proposed business tax.



Charitable Organizations

Currently, taxpayers who itemize can deduct the value of contributions they make to qualifying charitable organizations. 55 The H-R flat tax would eliminate this charitable deduction which would likely cause charitable donations to decline. But H-R claim that the decline in charitable contributions would be small. 56 Their claim, however, is controversial. 57 For example, Professor Charles T. Clotfelter and Richard L. Schmalbeck estimated that the Armey flat tax proposal (which is based on the H-R proposal) would significantly reduce charitable contributions. 58



Housing

The flat tax would eliminate the mortgage interest deduction and the property tax deduction. 59 These deductions are controversial. Supporters argue that they promote home ownership and home improvement, which have positive spillover effects. Opponents argue that these preferences have little effect on the rate of home ownership and primarily benefit higher income families. 60 Furthermore, critics claim that these preferences have led to an overinvestment in housing. For example, the Competitive Policy Council, a bipartisan panel established by Congress, warned that Americans are hurting their competitiveness "by overinvesting in their houses and underinvesting in the kinds of new products and technologies that generate higher wages and salaries." 61

Hall and Rabushka argue that interest rates would decline, and consequently the loss of these tax advantages could be offset by homeowners refinancing their mortgages. H-R predict that their flat tax would reduce interest rates by "at least a fifth." 62 H-R point out that in 1994 interest rates on municipal bonds were about one-sixth less than comparable taxable bonds. But H-R assert that taxable bonds also receive tax preferences; for example, if they are held in pension funds, the tax is deferred on interest income. 63 Hence, H-R assert that "interest rates could easily fall to threequarters of their present levels after tax reform; rates on tax-free securities would then fall a little as well." 64 H-R maintain that their flat tax would encourage new investment which could cause some rise in interest rates, therefore, "as a safe working hypothesis ... [they] assume interest rates [would] fall in the year after tax reform by about a fifth." 65

But their analysis did not incorporate the expanding influence of international movements of capital. Today's capital markets are truly global. Owners of financial capital can quickly transfer their funds among countries in order to maximize their expected returns. Consequently, whether or not the flat tax would lower interest rates is unknown.

Hence, many families with large interest payments and property tax payments might be unable to continue making their mortgage payments. These families might be forced to sell their homes. Furthermore, the sudden elimination of these preferences might cause a sudden drop in the value of the average house. 66 A decline in housing values would be a loss for sellers but a benefit to buyers.

H-R acknowledge that the elimination of interest deductions would result in winners and losers during transition. They state:
If Congress decides that a transition measure to protect interest deductions is needed, we suggest the following. Any borrower may choose to treat interest payments as a tax deduction. If the borrower so chooses, the lender must treat the interest as taxable income. But the borrower's deduction should be only 90% of the actual interest payment, while the lender's taxable income should include 100% of the interest receipts. 67

This transition option would grandfather in existing interest deductions; thus, borrowers would benefit at the expense of lenders. The proposal also would apply to new loans. For the housing industry, many homeowners would be protected from the forced sale of their homes, but mortgage lenders would suffer financially. Furthermore, this transition proposal would add complexity to the flat tax. It is important to recognize that part of the effect of H-R in discouraging demand for housing arises from the opportunities for a higher return from other investments. 68



Financial Services

The primary service of financial institutions (banks, savings & loan associations, credit unions, etc.) is intermediation; that is, aggregating funds of depositors and providing credit to borrowers by making loans or purchasing debt instruments. Core services provided by financial institutions are not identified by explicit fees. Instead these services are implicit in the interest spread between the rates paid depositors and the rates charged on loans to borrowers or received on purchased debt instruments. For an insurance company, the value-added is approximately equal to premiums received from policyholders for risk protection. But life insurance often includes a savings component, which is difficult to separate from risk protection. 69

Hall and Rabushka claim that it would be easy to measure the value-added of financial intermediaries and insurance companies. 70 But, developed nations have found that it is so difficult to measure value-added of financial institutions and insurance companies that they generally exempt these businesses from their VATs. 71



Pensions and Insurance

Pensions are favored under current tax law because they are effectively tax exempt (treated on a consumption-tax basis). While firms would still have reasons to provide pensions, proposals that would extend this treatment to all investments would make pensions relatively less attractive, and might discourage their use. If some individuals now save more through a pension plan than they would on their own, overall savings could be adversely affected as well. 72 Currently tax-favored insurance policies (e.g., whole life insurance) would also become relatively less attractive. 73



Health Care

Under current law, there are numerous tax preferences for health care spending. The most significant is that "an individual is entitled to an itemized deduction for expenses paid during the tax year for the medical care of the individual, the individual's spouse, or a dependent to the extent that such expenses exceed 7.5% of adjusted gross income." 74 Under the H-R flat tax, all tax preferences for health care would be eliminated including the itemized deduction.

Under the H-R flat tax, firms would have less of an incentive to provide compensation in the form of health care for employees. Furthermore, individuals with catastrophic health care needs (in excess of 7.5% of adjusted gross income) would not receive a tax preference.

Hence, the H-R flat tax would tend to reduce the rate of growth in the demand for health care which in turn would lower the rate of inflation of health care services from what would otherwise occur.



State and Local Governments

State and local governments would be affected by the proposed H-R flat tax. These effects fall into three categories: municipal bonds, deductibility of state and local taxes, and states' tax structures. 75



Municipal Bonds

Currently, interest on municipal (state and local) bonds is exempt from federal corporate and individual income taxes. This tax exemption has raised the market value of municipal bonds. As noted above, the effect of the H-R proposal on interest rates is disputed. But, if interest rates decline only slightly, or not at all, the H-R proposal would cause outstanding municipal bonds to decline sharply in value because of the elimination of the tax exemption.

The mere possibility of passage of the Armey flat tax plan, which was similar to the H-R proposal, reduced the value of outstanding municipal bonds at that time. 76 Many managers of municipal bond funds blamed discussions about flat taxes for the negative cash flow which "plagued municipal bond funds throughout 1995." 77 Thus, if the H-R flat tax becomes law, individuals owning municipal bonds may experience large capital losses. Furthermore, state and local governments may have to pay higher interest rates on new debt issues because municipal securities would no longer have a tax advantage over other debt issues.

Some economists dispute the wisdom of providing a tax subsidy to municipal bonds. Thus, the flat tax's removal of the subsidy may be beneficial.



Deductibility of State and Local Taxes

Currently, individuals who itemize can deduct most state and local taxes. This is a form of revenue sharing. For example, if a state raises its income tax, individuals who itemize save on their federal income taxes an amount equal to their marginal federal income tax rate multiplied by the increase in their state income tax payments. The H-G flat tax would eliminate this tax preference. This tax preference is particularly valuable to high income individuals in high tax states such as New York. This tax preference has been controversial, and some tax economists have recommended that it be curtailed or eliminated. 78



States' Tax Structures

Since the flat tax is a consumption tax, the federal government would be competing directly with states' sales taxes, their primary revenue source. But most states also levy an income tax which is their second main source of revenue. States with income taxes generally base their tax bases on the federal income tax base, with slight variations. If the federal government replaces its income taxes then the continuation of current state income taxes would impose high compliance costs on individuals and businesses since these taxpayers would have to continue to calculate their income tax liabilities. States would also have high administrative costs. But states probably would react by dropping their taxes on net income and adopting a consumption-based tax that would piggyback on the new federal consumption tax base, thereby retaining the administrative and compliance benefits that flow from conforming to the federal tax base. 79



Simplicity

H-R argue that their flat tax proposal would reduce drastically the current complexity of the U.S. tax system. Tax preferences would be eliminated. Tax integration and simple returns would result from their consumption tax.



Integration and Measuring Capital Income

Since new investment would no longer be taxed, the flat tax would also eliminate problems the current system encounters with measuring capital income: capital gains, attempts to distinguish between real and nominal income, depreciation procedures, and debt versus equity financing. A positive aspect of the proposed flat tax is the ease with which the individual and corporate tax systems could be integrated. Thus, a change that economists have long advocated for its economic efficiency could be accomplished in a simple way.

But it would be possible to levy a flat tax with an income base, simply by retaining depreciation and inventory accounting. The corporate and individual income tax systems could be integrated while retaining an income base --what makes integration simple is the flat rate.



Simple Returns and Other Simplicity Issues

H-R emphasize that, because their flat tax system is simple, the two tax forms "can fit on postcards." 80 The flat tax returns require little information and only a few simple calculations, but critics argue that there are numerous underlying complications.

Six additional issues are relevant to the complexity of the proposed flat rate tax. First , the current income tax system is complex. The federal tax code and the federal tax regulation are lengthy and continue to expand. Many taxpayers spend much time, money, and effort complying with the current income tax system. The complexity of the tax code and the fear of the Internal Revenue Service (IRS) have caused many taxpayers to pay for professional assistance.

For tax year 2000, a microsimulation model developed jointly by IBM and the IRS estimated the amount of time and money that individuals spend on federal tax compliance. 81 The authors found that "in tax year 2000, 125.9 million individual taxpayers experienced a total compliance burden of 3.21 billion hours and $18.8 billion." 82 This translates into an average burden of 25.5 hours and $149 per taxpayer. 83 Furthermore, for tax year 2003, 78.75 million individuals paid for the preparation of their returns. 84

The complexity of the income tax, however, should not be overstated. For example, for tax year 2006, the Internal Revenue Service reported that only 49.12 million returns out of 138.39 million returns were filed by individuals who itemized their deductions." 85 Also, the complexity of the current tax code is partially due to attempts to achieve greater equity or improve economic efficiency, and there are often tradeoffs between simplicity, equity, and efficiency.

Second , complexity may contribute to the gross income "tax gap" --the difference between income taxes owed and the amount voluntarily paid in a timely manner --which the Internal Revenue Service estimated is $350 billion for 2001. 86 In addition, widespread tax avoidance reduces tax revenues which, in turn, necessitates higher tax rates to raise a given amount of revenue. But, enforcement efforts and late payments reduced the gross tax gap by $55 billion for 2001. Furthermore, it can be argued that, in comparison to other developed nations, current U.S. tax compliance is satisfactory. Finally, a tax gap of unknown magnitude would occur under the flat tax.

Third , in comparison to the current income tax, a flat rate does little to reduce complexity because most taxpayers simply look up their tax liability in a table.

Fourth , it can be argued that it may be "unfair" to compare the current income tax system with some form of a "pure" consumption tax. By the time a consumption tax becomes enacted, it may become complicated, in part, because of lobbying by special interest groups. Furthermore, an initially simple tax may become complicated over time as it is revised.

Fifth , as an alternative to the flat tax, the current income tax system could be simplified by expanding the tax base which would require eliminating tax preferences and reducing marginal rates.

Sixth , the flat tax can, in some instances, be more complicated (rather than simpler) than the tax it replaces. For example, federal government employees and employees of non-profits would have to add to their wage base the imputed value of their fringe benefits. 87 Hence, a separate individual wage tax form would be necessary for these employees. The actual calculation of the imputed value of fringe benefits would be complicated. Another example is that H-R have not discussed tax issues concerning multinational corporations.



International Comparisons

There are three major distinctions between recent consumption tax proposals for the United States and the current tax systems of other developed nations. First , although the United States is the only developed nation without a broad-based consumption tax at the national level, other developed nations adopted broad-based consumption taxes as adjuncts rather than as replacements for their income based taxes. Congressional proposals would replace our current income taxes with consumption taxes, rather than use consumption taxes as adjuncts to our current income based system. Despite what is sometimes claimed, the United States would thus be moving into unchartered waters.

Second , all developed nations with VATs, except Japan, calculate their VATs using the creditinvoice method. The H-R flat tax proposal, however, would use the subtraction method of calculation for the business tax. The General Agreement on Tariffs and Trade (GATT Agreement) requires that for a consumption tax (including a VAT) to be rebated on exports, the tax must be levied on an item by item basis. Furthermore, the business tax is not levied on wage income. In contrast to most VATs, the business tax would not be border adjustable. Consequently, domestic firms would collect the business tax on their products sold domestically or exported but the business tax would not be collected on imported products. But, as previously discussed, economic theory has long recognized that border tax adjustments have no effect on the balance-of-trade because the balance-of-trade is a function of international capital flows.

Third , most other developed nations have much larger public sectors (government spending as a percentage of gross domestic product) than the United States. These countries offer a wider range of social benefits (such as national health care) in order to reduce inequality and lessen economic insecurity. Hence, these nations need greater tax revenues, and consequently, levy both broadbased consumption taxes and income taxes.



Conclusion

The concept of replacing our current federal income tax system with a flat rate consumption tax is receiving congressional interest. The term "flat tax" is often associated with a consumption tax proposal formulated by Robert E. Hall and Alvin Rabushka, two senior fellows at the Hoover Institution.

This report discusses the idea of replacing the current U.S. income tax system --which is a hybrid of an income and a consumption tax --with a pure consumption tax formulated by H-R.

The combined individual and business taxes proposed by H-R can be viewed as a modified valueadded tax (VAT). The individual wage tax would be imposed on wages (and salaries) and pension receipts. Part or all of an individual's wage and pension income would be tax free depending on marital status and number of dependents. The business tax would be a modified subtraction method VAT with wages (and salaries) and pension contributions subtracted from the VAT base. (Under a standard subtraction-method VAT, a firm would not subtract its wages and pension contributions when calculating its tax base.)

Hall and Rabushka argue that replacing the existing individual income tax with their flat tax would be a major improvement for three reasons: the flat tax would be much simpler than the current complex income tax, consumption is a better tax base than income, and the flat tax would be much more efficient than the current income tax system.

This report's examination of the H-R flat tax proposal and their arguments supporting it looked at four topics: broad economic issues, narrow sectoral economic issues, simplicity, and international comparisons.

The broad economic issues concern the economic effects of the flat tax on the entire national economy. The flat tax would be shifted backwards onto owners of equities (old capital) and wage earners. The current income tax system is progressive but the incidence of the H-R flat tax proposal across income classes is unknown. The flat tax would reduce the tax burden on the young but increase it on the old.

Whether the proposed flat tax would be more or less efficient than the current income tax system is unknown. There is no conclusive theoretical or empirical evidence that the flat tax proposal would significantly affect savings, work effort, investment, or growth. A consumption base is neither inherently superior nor inferior to an income base.

The H-R flat tax would not be border adjustable. Current economic theory holds that border tax adjustments have little effect on the balance-of-trade because the balance-of-trade is largely a function of international capital flows.

The H-R flat tax proposal would not require any change in the price level. Most economists believe that the H-R flat tax would lower interest rates, but a minority of economists maintain that interest rates could rise.

Revenue forecasting is an inexact, if necessary, science; hence, there is a considerable concern that the initial revenue yield from the flat tax could be far too low or too high. Over the business cycle, total tax revenues would be more stable under a flat tax than under an income tax system.

Narrow sectoral economic issues concern specific industries or sectors of the total economy. The six microeconomic issues discussed were differential effects on businesses, charitable organizations, housing, financial services, health care, and state and local governments. Most of these discussions related to the elimination of an existing income tax preference.

The simplicity of the proposed flat tax is emphasized by Hall and Rabushka. A positive aspect of the proposed flat tax is the ease with which the individual and corporate tax systems could be integrated.

The complexity of the current tax code is partially due to attempts by policymakers to achieve greater equity or improve economic efficiency. In comparison to the current income tax, a flat rate, per se, does little to reduce complexity because most taxpayers simply look up their tax liability in a table. It can also be argued that it may be "unfair" to compare the current income tax system with some form of a "pure" consumption tax. By the time a consumption tax can be enacted it may become complicated. As an option to the flat tax, some observers maintain that the current income tax system could be simplified by expanding the tax base.

International comparisons of tax systems indicate that there are major distinctions between recent consumption tax proposals for the United States and the current tax systems of other developed nations. Although the United States is the only developed nation without a broad-based consumption tax at the national level, other developed nations adopted broad-based consumption taxes as adjuncts rather than as replacements for their income based taxes. Notably, all developed nations with VATs, except Japan, calculate their VATs using the credit-invoice method. The H-R flat tax proposal, however, would use the subtraction method of calculation for the business tax. Finally, most other developed nations have much larger public sectors (government spending as a percentage of gross domestic product) than the United States. These nations need greater tax revenues, and consequently, levy both broad-based consumption taxes and income taxes.

It is worth noting that numerous aspects of the H-R flat tax proposal have not been fleshed out and important policy issues have yet to be analyzed.



Appendix. Tax Forms under the Flat Tax

Figure A-1. Individual Wage Tax




Figure A-2. Business Tax





Author Contact Information

James M. Bickley
Specialist in Public Finance
jbickley@crs.loc.gov, 7-7794

1 The complete citation of this book is Robert E. Hall and Alvin Rabushka, The Flat Tax, Second Edition (Stanford, California: Hoover Institution Press, 1995), 152 p. (The first edition of this book was published in 1985.)

2 Robert E. Hall, "Guidelines for Tax Reform: The Simple, Progressive Value-Added Tax," in Alan J. Auerbach and Kevin A. Hassett, eds., Toward Fundamental Tax Reform (Washington, DC: The AEI Press, 2005), pp. 70-80.

3 For a description of current tax reform proposals, see CRS Report R40414, Tax Reform: An Overview of Proposals in the 111th Congress , by James M. Bickley.

4 For a comparison of the flat tax concept with other consumption tax concepts, see Joel Slemrod and Jon Bakija, Taxing Ourselves: A Citizen's Guide to the Great Debate over Tax Reform , 3rd ed. (Cambridge, MA: The MIT Press, 2004), pp. 233-271.

5 Robert E. Hall refers to his flat tax as "the simple, progressive value-added consumption tax."

6 For a comprehensive examination of the value-added tax, see CRS Report RL33619, Value-Added Tax: A New U.S. Revenue Source? , by James M. Bickley.

7 These factors of production have specific meanings to an economist. Labor consists of all employees hired by the firm. Land consists of all natural resources including raw land, water, and mineral wealth. Capital is anything used in the production process, which has been made by man. The entrepreneur is the decision maker who operates the firm.

8 For a comparison of the credit-invoice method and the subtraction method, see CRS General Distribution Memorandum, Value-Added Tax: Methods of Calculation , by James M. Bickley; available from the author.

9 An analysis of the concept of a consumed income tax is presented in CRS Report 98-248, A Federal Tax On Consumed Income: Background and Analysis , by Gregg A. Esenwein. (Non-distributable report available from CRS on request.)

10 For an examination of the administrative and compliance costs of the current income tax system and the flat tax, see William G. Gale and Janet Holtzblatt, "Measuring the Impact of Administrative Factors under Tax Reform," Proceedings of the 1998 Annual Conference of the National Tax Association , pp. 341-349.

11 Hall and Rabushka, p. 40.

12 Ibid., p. 41.

13 Copies of tax forms for the individual wage tax and the business tax are shown in Appendix .

14 Bureau of Labor Statistics, CPI Inflation Calculator , available at http://www.bls.gov/data/inflation_calculator.htm, visited Apr. 22, 2009.

15 Hall and Rabushka, p. 77.

16 Ibid., p. 59.

17 Ibid., p. 77.

18 Ibid., p. 72.

19 Ibid.

20 For a brief discussion of these equity issues, see CRS Report RL33619, Value-Added Tax: A New U.S. Revenue Source? , by James M. Bickley.

21 Hall and Rabushka, p. 93.

22 Ibid., p. 91.

23 Ibid.

24 Ibid., p. 92.

25 Ibid.

26 Ibid., p. 93.

27 The flat tax proposal of former House Majority Leader Richard K. Armey would have repealed the earned income tax credit (EITC), thus the Treasury's study includes a repeal of the EITC. If the earned income tax credit (EITC) were repealed, there would have been an increase in taxes (loss in negative tax) for those who had an EITC in excess of their tax liability. Hall and Rabushka did not mention the EITC in their book, and consequently, whether or not their proposal included a repeal of the EITC is not known.

28 For a definition of Family Economic Income, see U.S. Treasury, Office of Tax Analysis, "New Armey-Shelby Flat Tax Would Still Lose Money, Treasury Finds," Tax Notes , v. 70, no. 4, Jan. 22, 1996, p. 454.

29 Ibid., pp. 453-455.

30 For a presentation of these assumptions about incidence, see U.S. Treasury, Office of Tax Analysis, "New Armey-Shelby Flat Tax Would Still Lose Money, Treasury Finds," p. 453.

31 CRS Report 95-1141, The Flat Tax and Other Proposals: Who Will Bear the Tax Burden? , by Jane G. Gravelle.

32 For an analysis of the efficiency of a pure consumption tax versus a pure income tax, see Jane G. Gravelle, "Income, Consumption, and Wage Taxation in a Life-Cycle Model: Separating Efficiency from Redistribution," American Economic Review , v. 81, no. 4, Sept. 1991, pp. 985-995.

33 Hall and Rabushka, p. 87.

34 For an explanation of the components of national saving, see CRS Report RL32119, Can Public Policy Raise the Saving Rate? , by Brian W. Cashell.

35 For a comprehensive analysis of the U.S. saving rate, see CRS Report RS21480, Saving Rates in the United States: Calculation and Comparison , by Brian W. Cashell.

36 For an examination of this issue, see CRS Report RS22367, Federal Tax Reform and Its Potential Effects on Saving , by Gregg A. Esenwein.

37 For example, see Don Fullerton and Diane Lim Rogers, "Lifetime Effects of Fundamental Tax Reform," in Economic Effects of Fundamental Tax Reform , Henry J. Aaron and William G. Gale, eds. (Washington: Brookings Institution Press, 1996), p. 321-352; and David Altig, Alan J. Auerbach, Laurence J. Kotlikoff, Kent A. Smetters, and Jan Walliser, "Simulating Fundamental Tax Reform in the United States," American Economic Review , v. 91, no. 3, June 2001, pp. 574-595.

38 CRS Report RL32603, The Flat Tax, Value-Added Tax, and National Retail Sales Tax: Overview of the Issues , by Jane G. Gravelle.

39 Hall and Rabushka, p. 84.

40 Ibid., p. 86.

41 Ibid., p. 87.

42 Ibid., p. 88.

43 Ibid., p. 83.

44 Ibid., p. 89.

45 Ibid.

46 For an further explanation of this issue, see CRS Report RL32603, The Flat Tax, Value-Added Tax, and National Retail Sales Tax: Overview of the Issues , by Jane G. Gravelle.

47 For a comprehensive analysis of this topic, see CRS Report 95-1141, The Flat Tax and Other Proposals: Who Will Bear the Tax Burden? , by Jane G. Gravelle.

48 For opposing views on the effect of a flat tax on interest rates, see John E. Golob, "How Would Tax Reform Affect Financial Markets?," Federal Reserve Bank of Kansas City Economic Review , v. 80, no. 4, Fourth Quarter, 1995, pp. 19-39; and, Martin Feldstein, "The Effect of a Consumption Tax on the Rate of Interest," Working Paper No. 5,397, National Bureau of Economic Research, Cambridge, Massachusetts, Dec. 1995, 31 p. An analysis of various factors affecting interest rate changes is presented in CRS Report 96-379, The Flat Tax and Other Proposals: Effects on Housing , by Jane G. Gravelle. (Non-distributable report available from CRS on request.)

49 For a comprehensive analysis of this issue, see Martin A. Sullivan, Flat Taxes and Consumption Taxes: A Guide to the Debate (New York: American Institute of Certified Public Accountants, 1995), pp. 125-149.

50 This could be a quite a problem not only for many mature large corporations but also for many small businesses, farmers, and owners of rental properties.

51 Hall and Rabushka, pp. 64-65.

52 Ibid., pp. 65-66.

53 Ibid., pp. 78-79.

54 Ibid., p. 79.

55 For an examination of this tax preference, see U.S. Congressional Budget Office, Budget Options (Washington, U.S. Govt. Print. Off., Feb. 2007), pp. 272-274.

56 Hall and Rabushka, The Flat Tax , pp. 99-101.

57 For an article on this issue, see William C. Randolph, "Dynamic Income, Progressive Taxes, and the Timing of Charitable Contributions," Journal of Political Economy , v. 103, no. 4, Aug. 1995, pp. 709-738.

58 Charles T. Clotfelter, and Richard L. Schmalbeck, "The Impact of Fundamental Tax Reform on Nonprofit Organizations," in Economic Effects of Fundamental Tax Reform , edited by Henry J. Aaron and William G. Gale (Washington, Brookings Institution Press, 1996), pp. 211-246.

59 For an analysis of possible policy changes under fundamental tax reform concerning the mortgage interest deduction, see CRS Report RL33025, Fundamental Tax Reform: Options for the Mortgage Interest Deduction , by Pamela J. Jackson.

60 U.S. Congressional Budget Office, Budget Options , pp. 267-268.

61 Steven Pearlstein, "Americans' Investing Focus Faulted," Washington Post , no. 284, Sept. 15, 1995, p. F3.

62 Hall and Rabushka, p. 94.

63 Ibid., p. 95.

64 Ibid.

65 Ibid.

66 For a view that argues that there will be serious effects, see Roger E. Brinner, Mark Lasky, and David Wyss, "Residential Real Estate: Impacts of Flat Tax Legislation," DRI Analysis, Summary Prepared for the National Association of Realtors, Lexington, Massachusetts, May 1995, 19 p. Also, for a critical view of this DRI study, see Rebecca S. Schaefer, "Ganging Up Again at 'Gucci Gulch': A Look at the DRI Flat Tax Study," Issues and Answers , Citizens for a Sound Economy, Aug. 15, 1995, 3 p.

67 Hall and Rabushka, p. 79.

68 An analysis of this issue is presented in CRS Report 96-379, The Flat Tax and Other Proposals: Effects on Housing , by Jane G. Gravelle. (Non-distributable report available from CRS on request.)

69 Charles E. McLure, Jr., The Value-Added Tax, Key to Deficit Reduction? (Washington: American Enterprise Institute, 1987), p. 135.

70 Hall and Rabushka, pp. 74-75.

71 McLure, pp. 135-138.

72 CRS Report RL32603, The Flat Tax, Value-Added Tax, and National Retail Sales Tax: Overview of the Issues , by Jane G. Gravelle.

73 For an overview of the taxation of life insurance products and life insurance companies, see CRS Report RL32000, Taxation of Life Insurance Products: Background and Issues , by Andrew D. Pike and CRS Report RL32180, Taxation of Life Insurance Companies , by Andrew D. Pike.

74 For a comprehensive discussion of this tax preference, see Internal Revenue Service, Publication 502 --Medical and Dental Expenses, 2007.

75 An overview of the effects on the states of flat tax proposals is presented in CRS Report 95-1150, Consumption Taxes and State-Local Tax Systems , by Dennis Zimmerman (Non-distributable report available on request), and Robert P. Strauss, Administrative and Revenue Implications of Alternative Federal Consumption Taxes for the State and Local Sector (Washington: American Tax Policy Institute, July 6, 1997), 78 p.

76 Michael Stanton, "Correction for Possible Tax Reform Has Run Its Course, Managers Say," The Bond Buyer , v. 313, no. 29,686, July 7, 1995, p. 7.

77 Jon Birger, "Tax Reform Won't Do Much for State Funds, Moles Says," The Bond Buyer , v. 313, no. 29,717, Aug. 21, 1995, p. 6.

78 For an examination of this tax preference, see U.S. Congressional Budget Office, Budget Options , p. 269.

79 CRS Report 95-1150, Consumption Taxes and State-Local Tax Systems , by Dennis Zimmerman (Non-distributable report available from CRS on request).

80 Hall and Rabushka, The Flat Tax , p. 52.

81 John L. Guyton, John F. O'Hare, Michael P. Stavrianos, and Eric J. Toder, "Estimating the Compliance Cost of the U.S. Individual Income Tax," National Tax Journal , v. 66, no. 3, Sept. 2003, pp. 673-688.

82 Ibid., p. 682.

83 Ibid.

84 Internal Revenue Service, Statistics of Income Bulletin , v. 25, no. 3, winter 2005-2006, p. 208.

85 Internal Revenue Service, Statistics of Income Bulletin , v. 27, no. 4, spring 2008, available at http://www.irs.gov/tax_stats, visited Mar. 16, 2009.

86 For an analysis of the tax gap, see CRS Report R40414, Tax Reform: An Overview of Proposals in the 111th Congress , by James M. Bickley.

87 As already discussed, private businesses would pay the business tax on the fringe benefits of their employees except for pension contributions, which would be taxed at the individual level.

Section 162 - when does a business begin? An individual was not entitled to deductions he claimed as trade or business expenses because he was not actively engaged in the real estate investment and rental business at the time he incurred the expenses. He did not purchase business property until December 30, which was one day before the end of the year in issue and did not secure a tenant until the following year. The expenses he incurred throughout the year in issue for travel, training, supplies, computers, etc., were actually business start-up expenses under Code Sec. 195.


Thomas J. Woody v. Commissioner.TC Memo. 2009-93, April 30, 2009.



P alleges that during tax year 2004 he had a real estate investment and rental business. P deducted expenses associated with this activity as business expenses under I.R.C. sec. 162. R disallowed the business expense deductions. On the basis of this disallowance, R determined a deficiency in P's Federal income tax for 2004. P petitioned this Court for redetermination of that deficiency.



Held: P was not actively engaged in a real estate investment and rental business when he incurred and paid the expenses he deducted as Schedule C business expenses in 2004. Therefore, the costs P deducted are pre-operational start-up expenditures and may not be deducted as business expenses under I.R.C. sec. 162.





MEMORANDUM FINDINGS OF FACT AND OPINION



GUSTAFSON, Judge: This case is before the Court on petitioner Thomas J. Woody's petition for redetermination of his Federal income tax deficiency for 2004 which the Internal Revenue Service (IRS) determined to be $4,955. The issue for decision is whether Mr. Woody is entitled under section 162 1 to deductions claimed on his 2004 Schedule C, Profit or Loss From Business. As a threshold matter, we must decide whether Mr. Woody was actively engaged in the trade or business of real estate investment and rental at the time he incurred and paid the expenses that he reported as business expenses. We find that he was not.





FINDINGS OF FACT



Some of the facts have been stipulated and are so found. The stipulation of facts filed October 16, 2008, and the attached exhibits are incorporated herein by this reference. At the time Mr. Woody filed his petition, he resided in Washington, D.C.



On or about February 15, 2004, Mr. Woody started investigating the real estate market so he could acquire real estate for investment or rental. Throughout 2004 Mr. Woody looked at many properties he was interested in buying for this real estate investment and rental business. He made multiple offers to purchase properties but was out-bid on most of his offers. In May 2004 Mr. Woody entered into a contract to purchase a property on Bradley Avenue in Camden, New Jersey. However, after a home inspection revealed many defects in the property, Mr. Woody canceled the contract because the seller was not willing to make the needed repairs.



Mr. Woody did not purchase any investment or rental property until he purchased the property on Randolph Street in Camden, New Jersey, on December 30, 2004, i.e., the next to last day of the year at issue. At that time, there was no tenant in the property, and he did not secure a tenant until sometime after 2004. Furthermore, there is nothing in the record to indicate that Mr. Woody held the property out for rent in 2004.



Throughout 2004 Mr. Woody performed many other tasks in conjunction with his alleged business. He created a name for his endeavor --Value Property Investments --and began marketing his services via business cards, flyers, and word of mouth. In May 2004 Mr. Woody completed a business outline with "buying, remodeling, and renting property" being the stated purpose of Value Property Investments. On October 17, 2004, Mr. Woody paid $21,490 to the Wealth Intelligence Academy for certain training classes, which he subsequently attended to acquire real estate investment skills. After Mr. Woody took the Wealth Intelligence Academy courses, his business plan shifted from merely buying, remodeling, and renting to also include what Mr. Woody referred to as "flipping" or "wholesaling". 2 However, he never consummated this type of transaction during 2004.



In November 2004 Mr. Woody applied, and was approved, for a loan from the U.S. Small Business Administration, and he obtained an employer identification number from the IRS. In December 2004 Mr. Woody obtained a credit card in the name of "Thomas J. Woody Value Property Invest" and opened a checking account in the name of "Mr. Thomas J. Woody D/B/A Value Property Investments".



Despite all of the foregoing activity, Mr. Woody did not purchase any investment property until December 30, 2004, and he did not buy or sell any other property, rent out any property, or hold any property out for rent, nor did he engage in "flipping" or "wholesaling" during tax year 2004.



For tax year 2004 Mr. Woody filed a Form 1040, U.S. Individual Income Tax Return, with an attached Schedule C. On that Schedule C Mr. Woody reported no gross receipts or sales but reported total expenses of $23,373, which consisted of:





Car and truck expenses $144

Supplies 153

Meals and entertainment 41

Workshops and training 21,515

Computer and software 1,451

Misc. 69





Respondent now concedes that Mr. Woody incurred and paid all of the expenses set forth in his Schedule C (as listed above), and the parties stipulate that they were incurred and paid before December 29, 2004. 3 However, upon examination of Mr. Woody's 2004 tax return, the IRS disallowed Mr. Woody's Schedule C expenses on the grounds that he had failed to substantiate his expenses or to prove that they were "ordinary and necessary" to his business.



In the statutory notice of deficiency issued to Mr. Woody on October 9, 2007, the IRS determined an income tax deficiency of $4,955. Mr. Woody timely petitioned the Tax Court on December 27, 2007, for a redetermination of that deficiency. In response to Mr. Woody's petition, respondent answered:



respondent determined that petitioner was not engaged in the active conduct of a real estate investment business as alleged. Further alleges, in any event, that petitioner has not substantiated the amount of, payment of, or the specifics of any such expenses.



Therefore, respondent's justification of his disallowance of Mr. Woody's expenses was in fact two-fold: (1) lack of substantiation of the expenses, and (2) the determination that Mr. Woody was not actively engaged in a trade or business as required by section 162.



A trial in this case was held on October 16, 2008, in Washington, D.C.





OPINION




I. The Parties' Contentions


Mr. Woody does not dispute that his initial investigation of properties (and the failed bids thereon) and his research into the real estate investment and rental business from February to April 2004 occurred before the commencement of his business. However, Mr. Woody contends that he commenced his real estate investment and rental business on May 1, 2004, when he entered into a contract of sale on the Bradley Avenue property in Camden, New Jersey (i.e., the contract he ultimately canceled). 4 As a result, Mr. Woody maintains that all the expenses associated with his business that were incurred after May 1, 2004, should be deductible as business expenses under section 162.



Respondent asserts that Mr. Woody was not actively engaged in the real estate investment and rental business at any time during 2004, because Mr. Woody did not become actively engaged in business, i.e., by buying, selling, renting, or offering to rent property, until he held the Randolph Street property out for rent some time after 2004. As a result, since all of the Schedule C expenses were incurred and paid before December 30, 2004, i.e., before the acquisition of any potential rental property, respondent contends that none of Mr. Woody's Schedule C expenses are deductible under section 162.




II. Burden of Proof


At trial and on brief, Mr. Woody argued that the burden of proof on the question whether he was actively engaged in a trade or business when he incurred the expenses has shifted to respondent because respondent raised that issue as a "new matter" in his answer. 5 See Rule 142(a)(1). The IRS's notice of deficiency stated that Mr. Woody "did not establish * * * that the expense was ordinary and necessary to your business". Mr. Woody contends that this language did not raise the issue of whether he was engaged in the business.



However, in this case the allocation of the burden of proof does not affect the outcome, because the facts found here are essentially undisputed, and the parties disagree only on how to characterize them. "[E]xcept for extraordinary burdens (e.g., in fraud cases), the burden of proof is merely a 'tie-breaker' * * * [and] is irrelevant unless the evidence is in equipoise." Steiner v. Commissioner, T.C. Memo. 1995-122, 69 T.C.M. (CCH) 2176, 2198 (1995), 1995 T.C.M. (RIA) par. 95,122. On the basis of the stipulated facts and the evidence presented at trial, we do not find the evidence with respect to whether Mr. Woody was actively engaged in business to be in equipoise. As a result, the question of who bears the burden of proof is one we need not reach.




III. Business Expense Deductions


Section 162 generally allows a deduction for all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. Such expenses must be directly connected with or pertain to the taxpayer's trade or business that is functioning as a business at the time the expenses were incurred. Hardy v. Commissioner, 93 T.C. 684 (1989), affd. in part and remanded in part per order (10th Cir., Oct. 29, 1990); Glotov v. Commissioner, T.C. Memo. 2007-147; sec. 1.162-1(a), Income Tax Regs. (26 C.F.R.). Whether an expenditure satisfies the requirements of section 162 is a question of fact. Commissioner v. Heininger, 320 U.S. 467, 475 (1943). And whether a taxpayer's activities constitute the carrying on of a trade or business requires an examination of the facts and circumstances of each case. Commissioner v. Groetzinger, 480 U.S. 23, 36 (1987); Higgins v. Commissioner, 312 U.S. 212 (1941); O'Donnell v. Commissioner, 62 T.C. 781 (1974), affd. without published opinion 519 F.2d 1406 (7th Cir. 1975).



However, "A taxpayer is not carrying on a trade or business under section 162(a) until the business is functioning as a going concern and performing the activities for which it was organized." Glotov v. Commissioner, supra. Until that time, expenses related to that activity are not "ordinary and necessary" expenses currently deductible under section 162 (nor are they deductible under section 212) but rather are "start-up" or "pre-opening" expenses. Hardy v. Commissioner, supra at 687-688. "Start-up expenditures" --i.e., expenses incurred "before the day on which the active trade or business begins," 6 sec. 195(c)(1)(A)(iii) (emphasis added) --may be deducted only over time under section 195. 7



While all of Mr. Woody's 2004 expenditures at issue have been substantiated, the question for decision before the Court is whether they qualify as section 162 business expenses. It is respondent's position that even though Mr. Woody incurred these expenses, they are, at best, start-up expenditures, as opposed to section 162 business expenses. In determining whether these expenses are in fact section 162 business expenses, the threshold question is when Mr. Woody completed his start-up phase and became actively engaged in his business.



Whether a taxpayer is engaged in a trade or business is determined using a facts and circumstances test under which courts have focused on the following three factors that indicate the existence of a trade or business: (1) whether the taxpayer undertook the activity intending to earn a profit; (2) whether the taxpayer is regularly and actively involved in the activity; and (3) whether the taxpayer's activity has actually commenced. See McManus v. Commissioner, T.C. Memo. 1987-457, affd. without published opinion 865 F.2d 255 (4th Cir. 1988). On the basis of Mr. Woody's testimony, we may assume that he undertook this activity to make a profit and that he regularly and actively engaged in it. 8 However, it is the third factor --whether Mr. Woody's business had actually commenced --that is determinative here.



In Mr. Woody's business outline, dated May 10, 2004, he indicated that he was starting Value Property Investments "for the purpose of buying, remodeling and renting property." Therefore, until Mr. Woody began to buy, remodel, or rent --i.e., to perform the activities for which Value Property Investments was organized --he was not carrying on a trade or business as contemplated by section 162.



We find that Mr. Woody's activities did not rise to the level of a trade or business until, at the earliest, the time he purchased the Randolph Street property on December 30 of the year in suit. More likely, Mr. Woody's activities did not rise to the level of a trade or business until he held the Randolph Street property out for rent sometime after the close of the year in suit. See Charlton v. Commissioner, 114 T.C. 333, 338 (2000) (holding that the mere purchase of property did not constitute an active trade or business since the property was not rented or held out for rent until a subsequent year).



Nonetheless, in order to resolve the matter before us, we do not need to decide whether Mr. Woody's business started at the time he purchased the Randolph Street property or at the time he held it out for rent, because, in any event, the expenses in question here all occurred before the purchase date, i.e., before December 30, 2004. 9 If the earliest possible date Mr. Woody was actively carrying on a trade or business was December 30, 2004, then any expenses incurred in that year but incurred "before the day on which the active trade or business" began, sec. 195(c)(1)(A)(iii) --i.e., all the expenses incurred from January 1 through December 29, 2004 --would be, by definition, start-up expenses whose deductibility, and possible amortization, is expressly dealt with by section 195. Since all the expenses at issue here were incurred between January 1 and December 29, 2004, 10 they would not be deductible for 2004 under section 162 because their timing makes them subject to the provisions of section 195, and section 195 start-up expenditures are not deductible under section 162. See Hardy v. Commissioner, 93 T.C. 684 (1989). Mr. Woody's largest expenditure in 2004 --$21,515 for workshops and training --was an educational expense incurred to prepare for a new career, i.e., real estate investor and renter, rather than to maintain or improve skills in an ongoing business or career. It was therefore not deductible under section 162. See sec. 1.162-5, Income Tax Regs.





Conclusion



Although we found Mr. Woody's testimony to be credible, it established that he was not actively carrying on a trade or business at the time that the expenses at issue were incurred. Mr. Woody's activities in 2004 were, at most, start-up activities, because he had not yet commenced the activities for which Value Property Investments was organized, i.e., buying, selling, renting, or offering to rent property, or even "flipping" or "wholesaling". Accordingly, we hold that the IRS's disallowance of Mr. Woody's 2004 Schedule C deductions was proper.



To reflect the foregoing,



Decision will be entered for respondent.


1 Unless otherwise indicated, all citations to sections refer to the Internal Revenue Code of 1986 (26 U.S.C.), as amended, and all citations to Rules refer to the Tax Court Rules of Practice and Procedure.

2 "Wholesaling" or "flipping" is entering into a contract for the purchase of a property and then, before the sale goes to closing, assigning to a third-party buyer (in return for a fee) the right to buy the property.

3 For most of these listed expenses, the record shows expressly that they were incurred before October 22, 2004, and there is no indication that any of them was incurred after that date. (For the relevance of that date, see infra note 7). At trial Mr. Woody presented additional evidence to establish that he paid an additional $1,887.82 in expenses that should have been included on his 2004 Schedule C. Three of those additional expenditures (a loan application fee of $475; an advertising expense of $114; and settlement charges of $874, totaling $1,463) were incurred after October 22, 2004. However, the $874 in settlement charges incurred with respect to the purchase of the Randolph Street property is a capital expenditure which is non-deductible in 2004. See sec. 263; sec. 1.263(a)-2(a), Income Tax Regs.

4 Mr. Woody also makes much of the fact that since the contractual rights in relation to the existing tenant at the Bradley Avenue property would belong to him in the event that he acquired the property, that implies he offered that property for rent. However, because Mr. Woody never acquired the property, we cannot find that he ever had any legal ability to offer that property for rent. In any event, such activity is not sufficient to rise to the level of carrying on a trade or business. See Johnsen v. Commissioner, 83 T.C. 103 (1984) (looking for or securing a tenant before the taxpayer actually owns the property and could actually rent the property was not sufficient to indicate the start of a business), revd. on other grounds 794 F.2d 1157 (6th Cir. 1986), overruled on other grounds Hardy v. Commissioner, 93 T.C. 684 (1989), affd. in part and remanded in part per order (10th Cir., Oct. 29, 1990).

5 A new theory that is presented to sustain a deficiency is treated as a new matter when it increases the amount of the original deficiency or requires the presentation of different evidence. Shea v. Commissioner, 112 T.C. 183, 191 (1999) (and cases cited thereat). A new theory which merely clarifies or develops the original determination is not a new matter in respect of which the Commissioner bears the burden of proof. Id.

6 Where expenses are incurred in the same taxable year in which a business begins to function but before the day on which it begins to function, the disallowance of the deduction of such an expense under section 162 arguably constitutes an exception to the generality that our tax system is annualized. Nonetheless, the deductibility of an expense under section 162 --or its relegation to treatment under section 195 --does depend on the date on which the expense was incurred in relation to the date on which the business began operating; and the expense is not deductible under section 162 unless the business was functioning on the day the expense was incurred.

7 In his post-trial briefs, Mr. Woody acknowledges that he would be precluded from the special treatment afforded under section 195 because he failed to make the requisite election required by section 195(b). Even without such an election, a taxpayer might be entitled to section 195 amortization of expenses that were incurred after October 22, 2004, see sec. 1.195-1T(b), (d), Temporary Income Tax Regs., 73 Fed. Reg. 38913 (July 8, 2008); but only $1,463 of the expenses at issue here was incurred after that date, see supra note 3, and Mr. Woody has made no claim for section 195 treatment, so we do not here make any determination as to section 195 treatment.

8 Mr. Woody cites Dreicer v. Commissioner, 78 T.C. 642, 645 (1982), affd. without published opinion 702 F.2d 1205 (D.C. Cir. 1983), for the proposition that because Mr. Woody engaged in his activity for profit, he must have been actively engaged in business. Mr. Woody's reliance on Dreicer is misplaced. Dreicer deals exclusively with determining whether a taxpayer is engaged in an activity for profit. However, whether a taxpayer is engaged in an activity for profit is not the decisive factor in determining whether he is actively engaged in a trade or business; rather it is just one of the three factors that needs to be satisfied. See McManus v. Commissioner, T.C. Memo. 1987-457, affd. without published opinion 865 F.2d 255 (4th Cir. 1988).

9 If Mr. Woody argued for section 195 treatment for the $1,463 portion of his 2004 expenses that was incurred after October 22, then it might be necessary to resolve the precise date on which he commenced his business (i.e., December 30, 1994, versus a later date in 2005). However, as stated supra note 7, Mr. Woody has made no claim for section 195 treatment.

10 The settlement expenses associated with the purchase of the Randolph Street property were incurred on December 30, 2004. However, as stated supra note 3, the settlement charges are not deductible business expenses, but rather are capital expenditures. See sec. 1.263(a)-2(a), Income Tax Regs.