Friday, July 31, 2009

[ Code Sec. 7122] Offer in compromise (OIC): Bankruptcy distribution. -- The IRS Appeals office acted within its discretion in rejecting a married couple's offer-in-compromise (OIC). Appeals had a legitimate concern that it could forfeit its right to the couple's bankruptcy distribution.

Claude E. Salazar, Dana L. Salazar, Petitioners-Appellants v. Commissioner of Internal Revenue, Respondent-Appellee.

U.S. Court of Appeals, 2nd Circuit; 08-2670-ag(L), 08-3842-ag(CON), July 23, 2009.

Unpublished opinion affirming the Tax Court, 95 TCM 1149, Dec. 57,342(M), TC Memo. 2008-38, and 91 TCM 659, Dec. 56,410(M), TC Memo. 2006-7.

[ Code Sec. 6404]



Before: Calabresi and Katzmann, Circuit Judges, and Eaton, Judge.
GUIDO CALABRESI, ROBERT A. KATZMANN, Circuit Judges,

RICHARD K. EATON, Judge. 1


SUMMARY ORDER


UPON DUE CONSIDERATION of the appeals from the United States Tax Court (Goeke, J.), it is hereby ORDERED, ADJUDGED and DECREED that the decisions of the Tax Court are AFFIRMED.

Appellants Claude E. Salazar and Dana L. Salazar (collectively, "Taxpayers") appeal pro se from the Tax Court's decisions entered on February 25, 2008 and June 2, 2008, sustaining the collection by levy of unpaid employment taxes for the calendar quarters ending December 31, 1998, through June 30, 2001, and unpaid personal income taxes for the years 1997, 1998, and 1999. We assume the parties' familiarity with the underlying facts, the procedural history, and the issues on appeal.

Taxpayers jointly operated an art gallery in Nevada that was organized in Mr. Salazar's name as a sole proprietorship. Certain of the gallery's employment taxes were not paid from 1998 to 2001, and the Taxpayers failed to pay their personal income taxes for the years 1997, 1998, and 1999. In January 2001, Taxpayers filed for Chapter 13 protection, which was later converted to a Chapter 7 proceeding. The Internal Revenue Service ("IRS") filed a proof of claim, later amended, in the bankruptcy proceeding covering these tax liabilities, to which Taxpayers did not object. Taxpayers received a discharge in July 2002, however, their tax liabilities were non-dischargeable. See 11 U.S.C. § 523(a)(1)(A). In August 2005, the bankruptcy trustee disbursed some funds to the IRS, which it applied solely to the employment tax liability.

On October 27, 2003, during the course of the bankruptcy proceeding, the IRS issued a notice of intent to levy for Taxpayers' unpaid income taxes. This notice informed Taxpayers that they had the right to a collection due process ("CDP") hearing with the IRS Appeals Office. Taxpayers asked for a hearing, during which they submitted an offer-in-compromise ("OIC") to the Appeals Office seeking to resolve all outstanding income tax liabilities. Thereafter, having reviewed the IRS Internal Revenue Manual ("IRM"), the Appeals Office rejected Taxpayers' OIC, explaining that accepting it could jeopardize the IRS's ability to collect an additional $20,000 from the Taxpayers' bankruptcy distribution, and noting that Taxpayers had declined to increase their offer by that amount.

On February 22, 2006, the IRS issued an additional notice of intent to levy Mr. Salazar's assets to satisfy the employment tax liability. He likewise asked for a CDP hearing, during which he indicated that he wished the Appeals Office to reconsider its decision not to accept the first OIC. He further objected to the accrual of post-petition interest and to the IRS's decision to apply Taxpayers' joint bankruptcy distribution solely to the employment tax liability. Mr. Salazar then submitted a second OIC in an effort to settle all of Taxpayers' liabilities. After a hearing, the Appeals Office rejected the second OIC, finding that the IRS's reasonable collection potential far exceeded the amount offered. The Appeals Office then issued a notice of determination sustaining the levy.

Taxpayers filed separate petitions in the Tax Court, 2 which were consolidated. The Tax Court then issued a single Memorandum Findings of Fact and Opinion, although it later entered separate decisions on each petition. In doing so, the Tax Court sustained both levies.

Three primary arguments 3 are raised on appeal: (1) that the Appeals Office erred in rejecting Taxpayers' first OIC; (2) that post-petition interest should not have accrued on tax liabilities that were paid by the distribution of funds from the bankruptcy; and (3) that the Tax Court erred in permitting the IRS to apply the August 2005 bankruptcy distribution solely to the employment tax liability.

We review the Tax Court's decisions de novo, and therefore we stand in the shoes of the Tax Court and review the Appeals Office's determinations for abuse of discretion where the underlying liability is not at issue and de novo when it is. See Robinette v. Comm'r, 439 F.3d 455, 462 (8th Cir. 2006); see also Living Care Alternatives of Utica, Inc. v. United States, 411 F.3d 621, 625, 628-31 (6th Cir. 2005).

Taxpayers insist that the Appeals Office's rejection of their OIC, (1) based on Taxpayers' refusal to increase their offer to account for the IRS's possible recovery in bankruptcy; and (2) based on the IRS's reliance on the IRM, was unlawful. These contentions are without merit. As the Tax Court observed, the record reveals that the Appeals Office had a legitimate concern about forfeiting the IRS's right to Taxpayers' bankruptcy distribution and there was nothing improper about it consulting the IRM. See Salazar v. Comm'r, T.C. Memo 2008-38, 2008 WL 495313, at *9 ("[The Appeal's Office] was simply applying respondent's guidelines on evaluating offers-in-compromise, including the reasonable collection potential, to the specifics of petitioners' offer."). Further, Taxpayers have made no serious argument as to why the Appeals Office should not consult the IRM. See Christopher Cross, Inc. v. United States, 461 F.3d 610, 613 (5th Cir. 2006) ("Taxpayer has offered no viable support for its contention that the Officer cannot utilize the guidelines set forth in the Manual when making the discretionary decision to return a submitted offer in compromise."). Thus, because the Appeals Office acted within its discretion and, in fact, consistent with the relevant Treasury regulation, the Tax Court's decision must be affirmed. See 26 C.F.R. § 301.7122-1(c)(1) ("[T]he decision to accept or reject an offer to compromise ... is left to the discretion of the Secretary."); see also 26 U.S.C. § 7122(a) ("The Secretary may compromise any civil or criminal case arising under the internal revenue laws ....") (emphasis added)); Murphy v. Comm'r, 469 F.3d 27, 32 (1st Cir. 2006) ("We will only disturb the rejection of [an] offer-in-compromise if it represents a clear abuse of discretion in the sense of clear taxpayer abuse and unfairness by the IRS.") (internal quotation marks omitted)).

Taxpayers next argue for abatement of interest on their tax liabilities because of an alleged delay in distribution of funds by the bankruptcy trustee. As to this claim, the Tax Court noted that the IRS "was no more in control over the distribution of the bankruptcy proceeds than were [Taxpayers]" and held that the IRS was not prohibited from seeking interest for the time period that Taxpayers' bankruptcy proceeding was pending. See Salazar, T.C. Memo 2008-38, 2008 WL 495313, at *12 (citations omitted). In reaching its conclusion, the Tax Court relied in part upon Woodward v. United States, 113 B.R. 680, 684 (Bankr. D. Or. 1990), in which the court explained that most courts that have considered the issue of whether a debtor remains liable for post-petition interest have found the Supreme Court's decision in Bruning v. United States, 376 U.S. 358 (1964), controlling.

We, too, believe that Bruning v. United States, whatever its full scope may be, precludes these Taxpayers from arguing that post-petition interest could not accrue on non-dischargeable tax liability. See 376 U.S. at 360 (explaining that "logic and reason indicate that post-petition interest on a tax claim excepted from discharge ... should be recoverable in a later action against the debtor personally"); see also In re Johnson Elec. Corp., 442 F.2d 281, 284 (2d Cir. 1971). Moreover, Taxpayers would have remained liable on their non-dischargeable liability --including interest --even had the IRS not filed a proof of claim in their bankruptcy proceeding. See 11 U.S.C. § 523(a)(1)(A). Therefore, we find Taxpayers' claim that the IRS is not entitled to collect post-petition interest to be without merit.

Finally, Taxpayers argue that the Tax Court erred in permitting the IRS to apply Taxpayers' bankruptcy distribution to the employment tax liability. Here, we review the Tax Court's conclusion of law de novo. See Sunik v. Comm'r, 321 F.3d 335, 337 (2d Cir. 2003); 26 U.S.C. § 7482(c)(1). Taxpayers claim that the application of the distribution to what they insist is Mr. Salazar's liability alone is unfair. Notwithstanding Taxpayers' fairness concerns, this claim must fail. The payments from Taxpayers' bankruptcy estate were involuntary, and, therefore, Taxpayers had no entitlement to designate where those payments were to be applied. See United States v. Pepperman, 976 F.2d 123, 127 (3d Cir. 1992) ("Under ... long-standing IRS policy, taxpayers may designate the application of tax payments that are voluntarily made, but may not designate the application of involuntary payments."); In re Kaplan, 104 F.3d 589, 596 n.16 (3d Cir. 1997) ("[A] tax payment has been considered 'involuntary' when it is made to agents of the United States as a result of ... levy or from a legal proceeding in which the Government is seeking to collect its delinquent taxes or file a claim therefor.") (internal quotation marks omitted)). Accordingly, the IRS was free to allocate the funds to Taxpayers' tax liabilities as it saw fit, and it cannot be said to have acted improperly given that the Taxpayers operated the art gallery jointly. See Davis v. United States, 961 F.2d 867, 879 (9th Cir. 1992) ("Involuntary payments, like undesignated [voluntary] payments, may be credited as the IRS desires."); see also Rev. Proc. 2002-26, 2002-1 C.B. 746, at § 3.02 (stating that IRS will apply non-designated payments in a manner that will "serve its best interest").

We have considered Taxpayers' remaining arguments and find them to be without merit. Accordingly, the decisions of the Tax Court are hereby AFFIRMED.

1 The Honorable Richard K. Eaton of the United States Court of International Trade, sitting by designation.

2 Taxpayers originally filed a single joint petition in the Tax Court challenging the Appeals Office's rejection of their first OIC. However, because the employment tax liability was not part of the initial levy, that portion of the petition was dismissed for lack of jurisdiction.

3 An additional argument, concerning the IRS's ability to assess statutory penalties during the pendency of Taxpayers' bankruptcy case, has been resolved by the parties.

Bankruptcy. --Compromises: Bankruptcy

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

1900 M Restaurant Associates, Inc., 2007-1 USTC ¶50,116; aff'g, BC-DC D.C., 2005-1 USTC ¶50,313, 319 BR 302.

The IRS was not required to process an offer-in-compromise submitted by debtors in bankruptcy. That type of requirement would be a remedy in the nature of mandamus and that remedy was not appropriate. The IRS owed no clear duty to the debtors and its decision to not process offers-in-compromise submitted by debtors in bankruptcy was solely within its discretion. The plan confirmation process was an adequate alternative remedy to obtain a compromised tax liability from the IRS. Requiring the IRS to negotiate with the debtors outside of the plan confirmation process would not further the provisions of the Internal Revenue Code nor would it foster the ultimate goal of achieving a confirmed plan. The reasoning of 1900 M Restaurant Associates, Inc., BC-DC D.C., 2005-1 USTC ¶50,313, was adopted.

W. Uzialko, BC-DC Pa., 2006-1 USTC ¶50,297.

The District Court affirmed a Bankruptcy Court order requiring the IRS to consider an offer in compromise made by an individual in bankruptcy. The Bankruptcy Court had jurisdiction to make such an order under 11 U.S.C. §105, which states that a bankruptcy court can issue any order necessary to carry out the provisions of the Bankruptcy Code.

W.K. Holmes, DC Ga., 2005-1 USTC ¶50,230.

The IRS was ordered to process and consider an offer in compromise submitted by a debtor despite the agency's published policy of not considering offers in compromise from taxpayers who have filed for bankruptcy. The IRS position of not accepting less than what is required to be paid by a Chapter 13 reorganization plan, as set forth in Rev. Proc. 2003-71, was not required by the Tax Code or Treasury Regulations and did not carry the force and effect of law. Also, the IRS determination not to entertain offers in compromise from those in bankruptcy was not exempt from judicial review as an "agency action."

C. Peterson, BC-DC Neb., 2005-1 USTC ¶50,142, 317 BR 532.

A federal district court upheld a bankruptcy court order compelling the IRS to consider an individual debtor's offer in compromise. The bankruptcy court properly reasoned that the IRS could not dismiss the debtor's offer without processing and considering it, as the IRS does with non-debtor offers. The court reasoned that the offer was not submitted as a request for a discharge of taxes, but rather as a reflection of what the debtor was able to pay. The IRS's policy of mechanically disregarding the debtor's offer in compromise did not allow a "fresh start", as generally promoted by the Bankruptcy laws. Moreover, the rejection of such offers contradicted the IRS's general practice of being flexible in negotiating with debtors. The court rejected the government's claim that the order exceeded the bankruptcy court's jurisdiction pursuant to Bankruptcy Code sections 1129(a)(9) and 1129(a)(7). It was determined that Congress only intended to bar consideration of offers during Chapter 11 proceedings where a debtor did not agree to different treatment of his claim. Finally, the court was not persuaded that the order violated the Anti-Injunction Act.

R.H. Macher, DC Va., 2004-1 USTC ¶50,114, aff'g BC-DC Va., 2003-2 USTC ¶50,537.

The IRS has announced its nonacquiescence with respect to In re Macher, in which a federal district court upheld a bankruptcy court's order compelling the IRS to consider an individual debtor's offer in compromise. The district court found that the IRS's policy of mechanically rejecting a debtor's offer in compromise did not allow the "fresh start," generally promoted by the bankruptcy laws. The district court also found that the IRS's rejection of such offers contradicted the IRS's general practice of being flexible in negotiating with debtors.

Nonacquiescence Announcement, I.R.B. 2004-32, August 9, 2004.

The Chief Counsel has recommended nonacquiescence with respect to In re Macher. In Macher a federal district court upheld a bankruptcy court's order compelling the IRS to consider an individual debtor's offer in compromise. The district court found that the IRS's policy of mechanically rejecting a debtor's offer in compromise did not allow the "fresh start," generally promoted by the bankruptcy laws. The district court also found that the IRS's rejection of such offers contradicted the IRS's general practice of being flexible in negotiating with debtors.

AOD 2004-03, August 5, 2004.

An individual failed to prove that he entered into a contract with the IRS to release a federal tax lien on his real property. Since an IRS agent lacked statutory authority to release the lien prior to the taxpayer's discharge in bankruptcy, he could not accept the taxpayer's offer to release the lien for payment and, thus, there was no mutual assent to a settlement agreement. Moreover, even if a contract had been formed, the existence of a material misrepresentation on the part of the taxpayer would have made the contract voidable.

G.J. Buesing, FedCl, 2000-2 USTC ¶50,724, 228 FSupp2d 908.

An IRS policy not to consider offers in compromise from taxpayers who had filed for bankruptcy was impermissibly discriminatory because it was based solely on the bankruptcy status of the taxpayer and not on the merits of the offer. Failure to consider offers in compromise made by bankruptcy debtors denied the debtors access to procedures set forth in Code Sec. 7122 that were available to all other taxpayers. Further, investigation of offers in compromise did not violate the automatic stay. It was also irrelevant that a bankruptcy filing might transfer the IRS's authority to accept a compromise offer to the Department of Justice. Therefore, married taxpayers who had filed for bankruptcy were entitled to have their offer in compromise considered by the IRS under the same standards as non-debtor taxpayers.

G.E. Chapman, BC-DC W.Va., 99-2 USTC ¶50,690.

Similarly.

D.A. Mills, BC-DC W.Va., 2000-1 USTC ¶50,103, 240 BR 689.

The IRS's rejection of married taxpayers' two offers-in-compromise with respect to both income and employment taxes was not an abuse of discretion. The taxpayers had already filed for bankruptcy when they submitted their first offer-in-compromise (OIC) and the Appeals officer rejected the offer because it was less than what the IRS expected to receive from the bankruptcy distribution and because accepting the offer would risk, if not extinguish, all claims the IRS had to the bankruptcy estate's assets. The IRS also did not abuse its discretion when rejecting the taxpayers' second OIC with respect to the husband's employment tax liabilities because the taxpayers' financial situation had improved by the time the second OIC was submitted and the IRS determined that the taxpayers could pay their liabilities in their entirety. In addition, the taxpayers did not present any argument or evidence to suggest that the rejection of the second OIC was an abuse of discretion.

C.E. Salazar, 95 TCM 1149, Dec. 57,342(M) , TC Memo. 2008-38.

The IRS did not abuse its discretion in rejecting a taxpayer's offer-in-compromise of his outstanding tax liabilities. In evaluating his reasonable collection potential, the taxpayer argued that the IRS failed to make an allowance for his basis living expenses greater than provided in published guidance and that the IRS failed to take into consideration his option to file for bankruptcy and potentially discharge some of the tax liabilities. However, the taxpayer had not disclosed any special circumstances that would warrant allowing him a standard of living more lavish that the standard for the area where he lived. The evidence also indicated that the IRS did consider the possibility that the taxpayer might file for bankruptcy; however, in light of the changes to the bankruptcy law, the IRS believed that the taxpayer would not be able to avoid paying the total tax liability by filing for bankruptcy.

C. Klein, 94 TCM 423, Dec. 57,156(M), TC Memo. 2007-325.

The IRS has issued the 2007 allowable living expense standards. Allowable living expense standards, also known as collection financial standards, are used to determine the ability of a taxpayer to pay a delinquent tax liability. The standards are effective October 1, 2007. For bankruptcy purposes, the effective date for the standards will be January 1, 2008.

IRS News Release, IR-2007-163, October 1, 2007.

An individual's offer-in-compromise, which was based on doubt as to collectibility, was properly rejected because the individual had a reasonable collection potential in excess of $1,000 and he was not in compliance with federal income tax laws. The individual's contention that he was protected under a state law (California) bankruptcy exemption was rejected because it was not properly raised before the IRS Appeals Office. Even if the issue had been properly raised, a federal tax lien would survive a subsequent bankruptcy filing, regardless of any state statute.

A.M. Kun, Dec. 57,513(M), TC Memo. 2008-192.

Labels:

Thursday, July 30, 2009

IR-2009-69

July 30, 2009

Internal Revenue Service : Fraud prosecution : First-time homebuyer credit .


IRS Warns Taxpayers to Beware of First-Time Homebuyer Credit Fraud


IR-2009-69, July 29, 2009

WASHINGTON --The Internal Revenue Service today announced its first successful prosecution related to fraud involving the first-time homebuyer credit and warned taxpayers to beware of this type of scheme.

On Thursday July 23, 2009, a Jacksonville, Fla.-tax preparer, James Otto Price III, pled guilty to falsely claiming the first-time homebuyer credit on a client's federal tax return. Price faces the possibility of up to three years in jail, a fine of as much as $250,000, or both.

To date, the IRS has executed seven search warrants and currently has 24 open criminal investigations in pursuit of potential instances of fraud involving the credit. The agency has a number of sophisticated computer screening tools to quickly identify returns that may contain fraudulent claims for the first-time homebuyer credit.

"We will vigorously pursue anyone who falsely tries to claim this or any other tax credit or deduction," said Eileen Mayer, Chief, IRS Criminal Investigation. "The penalties for tax fraud are steep. Taxpayers should be wary of anyone who promises to get them a big refund."

Whether a taxpayer prepares his or her own return or uses the services of a paid preparer, it is the taxpayer who is ultimately responsible for the accuracy of the return. Fraudulent returns may result not only in the required payment of back taxes but also in penalties and interest.



First-Time Homebuyer Credit

The First-Time Homebuyer Credit, originally passed in 2008 and modified in 2009, provides up to $8,000 for first-time homebuyers. The purchaser, however, must qualify as a first-time homebuyer, which for purposes of this credit means someone who has not owned a primary residence in the past three years. If the taxpayer is married, this requirement also applies to the taxpayer's spouse. The home purchase must close before Dec. 1, 2009, to qualify, and the credit may not be claimed on the purchaser's tax return until after the taxpayer closes and has purchased the home.

Different rules apply for homes bought in 2008.

Full details and instructions are available on the official IRS Web site, IRS.gov .


.O. Price III Plea Agreement

July 30, 2009

Internal Revenue Service : Fraud prosecution : First-time homebuyer credit : Plea agreement .


UNITED STATES DISTRICT COURT MIDDLE DISTRICT OF FLORIDA JACKSONVILLE DIVISION


UNITED STATES OF AMERICA v. JAMES OTTO PRICE, III

CASE NO. 3:09-cr-132-J-25HTS


PLEA AGREEMENT


Pursuant to Fed. R. Crim. P. 11(c), the United States of America, by A. Brian Albritton, United States Attorney for the Middle District of Florida, and the defendant, James Otto Price, III, and the attorney for the defendant, Donald Mairs, mutually agree as follows:



A. Particularized Terms



1. Count(s) Pleading To

The defendant shall enter a plea of guilty to Count One of the Indictment, which charges the defendant with knowingly and willfully aiding and assisting in the preparation and filing of a Federal income tax return knowing it to be false or fraudulent in some material way, in violation of 26 U.S.C. § 7206(2).



2. Maximum Penalties

Count One is punishable by up to three (3) years' imprisonment, a fine of up to $250,000, or both a fine and imprisonment, a term of supervised release of up to one (1) year, and a special assessment of $100. In addition, if the defendant were to violate any of the terms of supervised release upon release from imprisonment, the defendant could be sentenced to an additional term of imprisonment of up to one (1) year and could face an additional period of supervised release. With respect to certain offenses, the Court shall order the defendant to make restitution to any victim of the offense(s), and with respect to other offenses, the Court may order the defendant to make restitution to any victim of the offense(s), or to the community, as set forth below. Additionally, the defendant may be assessed the costs of prosecution.



3. Counts Dismissed

At the time of sentencing, the remaining counts against the defendant, Counts Two through Thirty-Five of the Indictment, will be dismissed pursuant to Fed. R. Crim. P. 11(c)(1)(A).



4. Elements of the Offense(s)

The defendant acknowledges understanding the nature and elements of the offense(s) with which defendant has been charged and to which defendant is pleading guilty. The elements of Count One are:
First : That the Defendant aided or assisted in the preparation and filing of an income tax return which was false in a material way, as charged in the Indictment; and

Second : That the Defendant did so knowingly and willfully.



5. No Further Charges

If the Court accepts this plea agreement, the United States Attorney's Office for the Middle District of Florida agrees not to charge the defendant with committing any other federal criminal offenses known to the United States Attorney's Office at the time of the execution of this agreement, related to the conduct giving rise to this plea agreement.



6. Joirt Stipulation - Loss Amount

The United States and the defendant stipulate and agree that, for purposes of determining the defendant's offense level under USSG §2T4.1. the tax loss attributable to the defendant is more than $200.000 but not more than S400.000. which equates to a base offense level of 18. The parties understand and agree that this stipulation is not binding on the Court, and if not accepted by the Court the parties will not be allowed to withdraw from the plea agreement, and the defendant will not be allowed to withdraw from the plea of guilty. The defendant further understands and agrees that this stipulation and agreement is for criminal sentencing purposes only, and is in exchange for the United States' agreements contained in this plea agreement. including the United States' agreement not to pursue federal charges for relevant conduct against the defendant. The stipulated amount is not binding on the Internal Revenue Service for purposes of determining any restitution amounts or the defendant's civil tax liability. Such liability may be greater than the tax loss amount specified above, and may include interest and penalties .



7. Acceptance of Responsibility - Three Levels

At the time of sentencing, and in the event that no adverse information is received suggesting such a recommendation to be unwarranted, the United States will recommend to the Court that the defendant receive a two-level downward adjustment for acceptance of responsibility, pursuant to USSG §3E1.1(a). The defendant understands that this recommendation or request is not binding on the Court, and if not accepted by the Court, the defendant will not be allowed to withdraw from the plea.

Further, at the time of sentencing, if the defendant's offense level prior to operation of USSG §3E1.1(a) is level 16 or greater, and if the defendant complies with the provisions of USSG §3E1.1(b), the United States agrees to move, pursuant to USSG §3E1.1(b) for a downward adjustment of one additional level. The defendant understands that the determination as to whether the defendant has qualified for a downward adjustment of a third level for acceptance of responsibility rests solely with the United States Attorney for the Middle District of Florida, and the defendant agrees that the defendant cannot and will not challenge that determination, whether by appeal, collateral attack, or otherwise.



8. Cooperation - Substantial Assistance to be Considered

Defendant agrees to cooperate fully with the United States in the investigation and prosecution of other persons, and to testify, subject to a prosecution for perjury or making a false statement, fully and truthfully before any federal court proceeding or feceral grand jury in connection with the charges in this case and other matters, such cooperation to further include a full and complete disclosure of all relevant information, including production of any and all books, papers, documents, and other objects in defendant's possession or control, and to be reasonably available for interviews which the United States may require. If the cooperation is completed prior to sentencing, the government agrees to consider whether such cooperation qualifies as "substantial assistance" in accordance with the policy of the United States Attorney for the Middle District of Florida, warranting the filing of a motion at the time of sentencing recommending (1) a downward departure from the applicable guideline range pursuant to USSG §5K1.1, or (2) the imposition of a sentence below a statutory minimum, if any, pursuant to 18 U.S.C. § 3553(e), or (3) both. If the cooperation is completed subsequent to sentencing, the government agrees to consider whether such cooperation qualifies as "substantial assistance" in accordance with the policy of the United States Attorney for the Middle District of Florida, warranting the filing of a motion for a reduction of sentence pursuant to Fed. R. Crim. P. 35(b). In any case, the defendant understands that the determination as to whether "substantial assistance" has been provided or what type of motion related thereto will be filed, if any, rests solely with the United States Attorney for the Middle District of Florida, and the defendant agrees that defendant cannot and will not challenge that determination, whether by appeal, collateral attack, or otherwise.



9. Use of Information - Section 1B1.8

Pursuant to USSG §1B1.8(a), the United States agrees that no self-incriminating information which the defendant may provide during the course of defendant's cooperation and pursuant to this agreement shall be used in determining the applicable sentencing guideline range, subject to the restrictions and limitations set forth in USSG §1B1.8(b).



10. Cooperation - Responsibilities of the Parties

a. The government will make known to the Court and other relevant authorities the nature and extent of defendant's cooperation and any other mitigating circumstances indicative of the defendant's rehabilitative intent by assuming the fundamental civic duty of reporting crime. However, the defendant understands that the government can make no representation that the Court will impose a lesser sentence solely on account of, or in consideration of, such cooperation.

b. It is understood that should the defendant knowingly provide incomplete or untruthful testimony, statements, or information pursuant to this agreement, or should the defendant falsely implicate or incriminate any person, or should the defendant fail to voluntarily and unreservedly disclose and provide full. complete, truthful, and honest knowledge, information, and cooperation regarding any of the matters noted herein, the following conditions shall apply:

(1) The defendant may be prosecuted for any perjury or false declarations, if any, committed while testifying pursuant to this agreement, or for obstruction of justice.

(2) The United States may prosecute the defendant for the charges which are to be dismissed pursuant to this agreement, if any, and may either seek reinstatement of or refile such charges and prosecute the defendant thereon in the event such charges have been dismissed pursuant to this agreement. With regard to such charges, if any, which have been dismissed, the defendant, being fully aware of the nature of all such charges now pending in the instant case, and being further aware of defendant's rights, as to all felony charges pending in such cases (those offenses punishable by imprisonment for a term of over one year), to not be held to answer to said felony charges unless on a presentment or indictment of a grand jury, and further being aware that all such felony charges in the instant case have heretofore properly been returned by the indictment of a grand jury, does hereby agree to reinstatement of such charges by recision of any order dismissing them or, alternatively, does hereby waive, in open court, prosecution by indictment and consents that the United States may proceed by information instead of by indictment with regard to any felony charges which may be dismissed in the instant case, pursuant to this plea agreement, and the defendant further agrees to waive the statute of limitations and any speedy trial claims on such charges.

(3) The United States may prosecute the defendant for any offenses set forth herein, if any, the prosecution of which in accordance with this agreement, the United States agrees to forego, and the defendant agrees to waive the statute of [imitations and any speedy trial claims as to any such offenses.

(4) The government may use against the defendant the defendant's own admissions and statements and the information and books, papers, documents, and objects that the defendant has furnished in the course of the defendant's cooperation with the government.

(5) The defendant will not be permitted to withdraw the guilty pleas to those counts to which defendant hereby agrees to plead in the instant case but, in that event, defendant will be entitled to the sentencing limitations, if any, set forth in this plea agreement, with regard to those counts to which the defendant has pled: or in the alternative, at the option of the United States, the United States may move the Court to declare this entire plea agreement null and void.



11. Cooperation with Internal Revenue Service

The defendant agrees to fully cooperate with the Internal Revenue Service in the determination and payment of the defendant's civil tax liability for all years for which the defendant has not filed a tax return, or for which the defendant has filed an incorrect tax return. Such cooperation shall include, but is not limited to: (1) providing the Internal Revenue Service with all relevant books, records, and documents in the defendant's possession, under the defendant's control, or otherwise available to the defendant for all such years; (2) filing complete and correct income tax returns for all such years; and (3) paying, or making arrangements acceptable to the Internal Revenue Service to pay over time, the defendant's civil tax liability for all such years. The defendant understands and agrees that the defendant's tax liability for purposes of this paragraph (i.e., the defendant's civil tax liability) may include interest and penalties. The defendant agrees not to file any claim for refund of taxes, interest, or penalties for amounts attributable to any tax returns filed incident to this plea agreement. The defendant agrees to provide the defendant's Probation Officer with such verification as the Probation Officer may deem necessary that the defendant's income tax obligations (under this paragraph and otherwise) are being met.



B. Standard Terms and Conditions



1. Restitution, Special Assessment, and Fine

The defendant understands and agrees that the Court, in addition to or in lieu of any other penalty, shall order the defendant to make restitution to any victim of the offense(s), pursuant to 18 U.S.C. § 3663A, for all offenses described in 18 U.S.C. § 3663A(c)(1) (limited to offenses committed on or after April 24, 1996); and the Court may order the defendant to make restitution to any victim of the offense(s), pursuant to 18 U.S.C. § 3663 (limited to offenses committed on or after November 1, 1987) or § 3579, including restitution as to all counts charged, whether or not the defendant enters a plea of guilty to such counts, and whether or not such counts are dismissed pursuant to this agreement. On each count to which a plea of guilty is entered, the Court shall impose a special assessment, to be payable to the Clerk's Office, United States District Court, and due on date of sentencing. The defendant understands that this agreement imposes no limitation as to fine.



2. Supervised Release

The defendant understands that the offense(s) to which the defendant is pleading provide(s) for imposition of a term of supervised release upon release from imprisonment, and that, if the defendant should violate the conditions of release, the defendant would be subject to a further term of imprisonment.



3. Sentencing Information

The United States reserves its right and obligation to report to the Court and the United States Probation Office all information concerning the background, character, and conduct of the defendant, to provide relevant factual information, including the totality of the defendant's criminal activities, if any, not limited to the count(s) to which defendant pleads, to respond to comments made by the defendant or defendant's counsel, and to correct any misstatements or inaccuracies. The United States further reserves its right to make any recommendations it deems appropriate regarding the disposition of this case, subject to any limitations set forth herein, if any.

Pursuant to 18 U.S.C. § 3664(d)(3) and Fed. R. Crim. P. 32(d)(2)(A)(ii), the defendant agrees to complete and submit, upon execution of this plea agreement, an affidavit reflecting the defendant's financial condition. The defendant further agrees. and by the execution of this plea agreement, authorizes the United States Attorney's Office to provide to, and obtain from, the United States Probation Office or any victim named in an order of restitution, or any other source, the financial affidavit, any of the defendant's federal, state, and local tax returns, bank records and any other financial information concerning the defendant, for the purpose of making any recommendations to the Court and for collecting any assessments, fines, restitution, or forfeiture ordered by the Court.



4. Sentencing Recommendations

It is understood by the parties that the Court is neither a party to nor bound by this agreement. The Court may accept or reject the agreement, or defer a decision until it has had an opportunity to consider the presentence report prepared by the United States Probation Office. The defendant understands and acknowledges that, although the parties are permitted to make recommendations and present arguments to the Court, the sentence will be determined solely by the Court, with the assistance of the United States Probation Office. Defendant further understands and acknowledges that any discussions between defendant or defendant's attorney and the attorney or other agents for the government regarding any recommendations by the government are not binding on the Court and that, should any recommendations be rejected, defendant will not be permitted to withdraw defendant's plea pursuant to this plea agreement. The government expressly reserves the right to support and defend any decision that the Court may make with regard to the defendant's sentence, whether or not such decision is consistent with the government's recommendations contained herein.



5. Defendant's Waiver of Right to Appeal and Right to Collaterally Challenge the Sentence

The defendant agrees that this Court has jurisdiction and authority to impose any sentence up to the statutory maximum and expressly waives the right to appeal defendant's sentence or to challenge it collaterally on any ground, including the ground that the Court erred in determining the applicable guidelines range pursuant to the United States Sentencing Guidelines, except (a) the ground that the sentence exceeds the defendant's applicable guidelines range as determined by the Court pursuant to the United States Sentencing Guidelines; (b) the ground that the sentence exceeds the statutory maximum penalty; or (c) the ground that the sentence violates the Eighth Amendment to the Constitution; provided, however, that if the government exercises its right to appeal the sentence imposed, as authorized by Title 18 United States Code, Section 3742(b), then the defendant is released from his waiver and may appeal the sentence as authorized by Title 18, United States Code, Section 3742(a).



6. Middle District of Florida Agreement

It is further understood that this agreement is limited to the Office of the United States Attorney for the Middle District of Florida and cannot bind other federal, state, or local prosecuting authorities, although this office will bring defendant's cooperation, if any, to the attention of other prosecuting officers or others, if requested.



7. Filing of Agreement

This agreement shall be presented to the Court, in open court or in camera , in whole or in part, upon a showing of good cause, and filed in this cause, at the time of defendant's entry of a plea of guilty pursuant hereto.



8. Voluntariness

The defendant acknowledges that defendant is entering into this agreement and is pleading guilty freely and voluntarily without reliance upon any discussions between the attorney for the government and the defendant and defendant's attorney and without promise of benefit of any kind (other than the concessions contained herein), and without threats, force, intimidation, or coercion of any kind. The defendant further acknowledges defendant's understanding of the nature of the offense or offenses to which defendant is pleading guilty and the elements thereof, including the penalties provided by law. and defendant's complete satisfaction with the representation and advice received from defendant's undersigned counsel (if any). The defendant also understands that defendant has the right to plead not guilty or to persist in that plea if it has already been made, and that defendant has the right to be tried by a jury with the assistance of counsel, the right to confront and cross-examine the witnesses against defendant, the right against compulsory self-incrimination, and the right to compulsory process for the attendance of witnesses to testify in defendant's defense; but, by pleading guilty, defendant waives or gives up those rights and there will be no trial. The defendant further understands that if defendant pleads guilty, the Court may ask defendant questions about the offense or offenses to which defendant pleaded, and if defendant answers those questions under oath, on the record, and in the presence of counsel (if any), defendant's answers may later be used against defendant in a prosecution for perjury or false statement. The defendant also understands that defendant will be adjudicated guilty of the offenses to which defendant has pleaded and, if any of such offenses are felonies, may thereby be deprived of certain rights, such as the right to vote, to hold public office, to serve on a jury, or to have possession of firearms.



9. Factual Basis

Defendant is pleading guilty because defendant is in fact guilty. The defendant certifies that defendant does hereby admit that the facts set forth in the attached "Factual Basis," which is incorporated herein by reference, are true, and were this case to go to trial, the United States would be able to prove those specific facts and others beyond a reasonable doubt.



10. Entire Agreement

This plea agreement constitutes the entire agreement between the government and the defendant with respect to the aforementioned guilty plea and no other promises, agreements, or representations exist or have been made to the defendant or defendant's attorney with regard to such guilty plea.



11. Certification

The defendant and defendant's counsel certify that this plea agreement has been read in its entirety by (or has been read to) the defendant and that defendant fully understands its terms.

DATED this 22 day of July, 2009.
A. BRIAN ALBRITTON

United States Attorney

______________________________

JAMES OTTO PRICE, III

Defendant
By: ______________________________

NICHOLAS A. PILGRIM

Assistant United States Attorney

______________________________

DONALD MAIRS

Attorney for Defendant
______________________________

MAC D. HEAVENER, III

Assistant United States Attorney

Deputy Chief, Jacksonville Division


UNITED STATES DISTRICT COURT MIDDLE DISTRICT OF FLORIDA JACKSONVILLE DIVISION


UNITED STATES OF AMERICA v. JAMES OTTO PRICE, III

CASE NO. 3:09-cr-132-J-25HTS


PERSONALIZATION OF ELEMENTS


1. Do you admit that on or about February 23, 2009, in Duval County, in the Middle District of Florida, you aided or assisted in the preparation and filing of an income tax return which was false in a material way. as charged in Count One of the Indictment?

2. Do you admit that you did so knowingly and willfully?


UNITED STATES DISTRICT COURT MIDDLE DISTRICT OF FLORIDA JACKSONVILLE DIVISION


UNITED STATES OF AMERICA v. JAMES OTTO PRICE, III

CASE NO. 3:09-cr-132-J-25HTS


FACTUAL BASIS 1


James Otto Price, III, has prepared numerous fraudulent tax returns. The first fifteen tax returns described in Counts One through Fifteen of the Indictment involve tax year 2008. In these tax returns prepared by Price, Price falsely claimed that the taxpayers were eligible to receive the First-Time Home Buyer Credit made available by Congress pursuant to the Housing and Economic Recovery Act of 2008. (The First-Time Home Buyer Credit can be claimed by using a Form 5405, which is filed with the 2008 or 2009 federal tax return presented or filed by. or on behalf of. a taxpayer. The credit operates like an interest-free loan for the 2008 filing year because it must be repaid over a 15-year period. To qualify for the credit, a buyer must purchase a home within a relevant time period, i.e., April 2008 through December 2009.)

A number of the taxpayers who Price claimed were eligible for the home buyer credit were not even aware that Price had claimed a First-Time Home Buyer Credit on their returns. Other clients were erroneously advised by Price that if they merely contemplated buying a house in the upcoming months, they were eligible for the credit. Price knew when he prepared the fifteen tax returns claiming the First-Time Home Buyer Credit in 2008 that the taxpayers whose returns he prepared had not purchased a home to qualify for the credit. Price also knew that his false representations were material to the IRS' determination of whether the taxpayer would receive the home buyer credit.

For example, with respect to Count One of the Indictment, on or about February 23. 2009. Price met with a client, Charde Hampton, to prepare her tax return. Although Ms. Hampton advised Price that she did not have a house and was not planning on purchasing a house, Price told Ms. Hampton that she qualified for the First-Time Home Buyer Credit by virtue of the fact that she had two jobs. Price then claimed the credit on the tax return that he prepared for Ms. Hampton, and he inputted the address of a home unknown to Ms. Hampton as the house that allegedly qualified for the credit. Price also falsely claimed that the qualifying home had been purchased by Ms. Hampton on January 5, 2009, when, as he well knew, Ms. Hampton had not purchased a home, much less a home on January 5, 2009, to qualify for the home buyer tax credit.

Price's other fraudulent 2008 tax year returns conform to the same pattern. In other words, in addition to fraudulently claiming the First-Time Home Buyer Credit for the 2008 tax returns for his clients whom he knew had not purchased a qualifying home. Price made up a date upon which the taxpayer(s) allegedly purchased the house qualifying for the tax credit. Price knew that the dates that he inputted on the tax returns as the dates for when the qualifying house was purchased were false when he filed the tax returns for his clients. As a result of the fraudulent returns, Price was able to pay himself fees of approximately $1,000 per fraudulent tax return by electronically debiting this amount from the $7,500 home buyer credit and tax refund proceeds wrongly received by his clients.

The remaining twenty tax returns prepared by Price charged in the Indictment involve tax years 2004 and 2005. In these returns. Price intentionally overstated or made up charitable contribution deductions and unreimbursed employee expenses on the Schedule A and/or Form 2106-EZ for the taxpayers. Price also intentionally made up false businesses and business expenses on the Schedule C forms incorporated with the tax returns in order to increase the amount of the tax refund that his clients would receive. Price profited from preparing these false returns by getting his clients to return to him as clients and to refer new business to him. It should be noted that many of the taxpayers did not even know that Price had claimed on their tax return that they owned a for-profit business until they were subsequently contacted by the IRS for an audit. Price knew that the fictitious figures he inputted onto the tax returns of his clients would have the effect of increasing the tax refund paid out to his clients beyond the amount that the taxpayers would have received from the IRS in the absence of Price's false representations. Price prepared the thirty-five tax returns identified in the Indictment in Duval County, in the Middle District of Florida, on or about the dates specified in the Indictment for each tax return. The tax loss attributable to Price as a result of the thirty-five fraudulent tax returns that he prepared is $216,454.00.

1 The factual basis is prepared by the United States and does not include all of the facts relevant to the defendant's involvement in the crime to which the defendant is pleading guilty.

Labels:

Wednesday, July 29, 2009

Jess Willard Canterbury v. Commissioner.

Docket No. 17393-06S . Filed July 28, 2009.


An barge operator who was employed by the same New York company in excess of one year was denied a deduction for travel expenses from his residence in Florida to New York because his tax home was determined to be the location of his principal place of employment in New York. The barge operator worked two weeks and then returned to Florida for his two off weeks so that he could be near his daughter. Most of the barge operator's work assignments originated in New York and, for those that did not, his employer reimbursed him for travel expenses from New York to other northern ports, but not for his expenses from Florida to New York. He testified that he took the New York job because it paid twice what he could make in Florida and he got an extra week off between assignments; therefore, it was his personal choice to maintain a Florida residence and commute to New York and his commuting expenses were not deductible.



ARMEN, Special Trial Judge: This case was heard pursuant to the provisions of section 7463 of the Internal Revenue Code in effect at the time that the petition was filed. 1 Pursuant to section 7463(b), the decision to be entered is not reviewable by any other court, and this opinion shall not be treated as precedent for any other case.



Respondent determined a deficiency of $2,768 in petitioner's Federal income tax for 2003.



After the parties' concessions, the issue for decision is whether petitioner is entitled to a deduction of $4,866 for travel expenses under section 162(a)(2). The resolution of this issue turns on whether petitioner's "tax home" was in the New York City metropolitan area (hereinafter, New York) or in or around Jacksonville, Florida (hereinafter, Jacksonville). We hold that petitioner's tax home was in New York and, therefore, that he is not entitled to the deduction in issue.





Background



Some of the facts have been stipulated, and they are so found. We incorporate by reference the parties' stipulation of facts and accompanying exhibits.



When the petition was filed, petitioner resided in the State of Florida.



In 2003 petitioner began working as a barge mate with Reinauer Transportation Cos., L.L.C. (Reinauer). At that time, and at all relevant times thereafter, petitioner resided in Jacksonville.



As a barge mate, petitioner was responsible for the operation and safety of the barge, including assuring that the barge was transported in water deep enough to support the barge's draft.



After being offered a job with Reinauer, petitioner reported to New York on January 20, 2003, and proceeded to Reinauer's barge in Brooklyn, where he filled out paperwork for Reinauer and began his first assignment. Petitioner remained employed with Reinauer until sometime in 2005. Petitioner was not required by Reinauer to reside in New York. Throughout 2003, petitioner lived in Jacksonville, where his daughter also lived.



Following petitioner's initial assignment, Reinauer's dispatcher called petitioner to tell him when and where to report to his next assignment. Once notified of his assignment, petitioner reported directly to the barge whether stationed in New York Harbor; Boston, Massachusetts; Portland, Maine; Providence, Rhode Island; or Yorktown, Virginia. When assigned to a barge stationed in New York Harbor, which was the case for most of his assignments, 2 petitioner usually flew to Newark, New Jersey, and took a cab to the barge. The one occasion on which the barge was stationed in Virginia, petitioner drove from Florida to the barge. When petitioner was assigned to a barge stationed in Maine, Massachusetts, or Rhode Island, Reinauer arranged for petitioner to fly out of Newark; thus, petitioner flew from Jacksonville to Newark in order to board the flight to the barge location.



When the barge was stationed outside New York Harbor, Reinauer made arrangements for or reimbursed petitioner for the cost of his travel from New York to the other port. On the one occasion when petitioner drove directly to the barge from his residence in Florida, Reinauer did not reimburse him for his transportation expenses. Reinauer also did not reimburse petitioner for his expenses in traveling between Jacksonville and New York.



In traveling from his residence in Jacksonville to New York to report to his barge assignments, petitioner incurred airline fares, cab expenses, and tolls of $4,866.



Before working for Reinauer, petitioner worked in Jacksonville as well as in other locations around the country. During 2003 he chose to work for Reinauer in New York because the pay was twice the rate for the same work in Jacksonville. In addition, in New York, a barge mate worked 2 weeks on and 2 weeks off, whereas in Jacksonville a barge mate worked 2 weeks on and only 1 week off.





Discussion



Generally, expenditures for transportation to and from a taxpayer's workplace are considered personal expenses and are not deductible. Sec. 262; secs. 1.162-2(e), 1.262-1(b)(5), Income Tax Regs. However, travel expenses may be deducted under section 162(a)(2) if they are: (1) Ordinary and necessary; (2) incurred while "away from home"; and (3) incurred in pursuit of a trade or business. Commissioner v. Flowers, 326 U.S. 465, 470 (1946). The reference to "home" in section 162(a)(2) means the taxpayer's "tax home". 3 Mitchell v. Commissioner, 74 T.C. 578, 581 (1980); Foote v. Commissioner, 67 T.C. 1, 4 (1976); Kroll v. Commissioner, 49 T.C. 557, 561-562 (1968).



As a general rule, a taxpayer's principal place of employment is his tax home, not where his personal residence is located, if different from his principal place of employment. Mitchell v. Commissioner, supra at 581; Kroll v. Commissioner, supra at 561-562. An exception to the general rule exists where a taxpayer accepts temporary, rather than indefinite, employment away from his personal residence; in that case, the taxpayer's personal residence may be his tax home. Peurifoy v. Commissioner, 358 U.S. 59, 60 (1958). Section 162(a) provides that the taxpayer shall not be treated as being temporarily away from home during any period of employment if such period exceeds 1 year. Similarly, if a taxpayer does not have a principal place of employment, the courts have determined that his residence may be his tax home. Johnson v. Commissioner, 115 T.C. 210, 221 (2000).



A taxpayer whose employer does not require him to travel may not deduct transportation expenses, as they are more in the nature of nondeductible personal commuting expenses. Commissioner v. Flowers, supra at 473. "The exigencies of business rather than the personal conveniences and necessities of the traveler must be the motivating factors." Id. at 474.



This Court has differentiated between deductible and nondeductible transportation expenses, holding that a riverboat pilot's transportation expenses between his residence and points of assignment and return were nondeductible commuting expenses, whereas transportation expenses attributable to traveling directly from one assignment to another were deductible. Heuer v. Commissioner, 32 T.C. 947, 953 (1959) (taxpayer commuted from his residence to more than 100 points of assignment and from one assignment to another), affd. 283 F.2d 865 (5th Cir. 1960). The distance a taxpayer commutes to work, no matter how far, still represents nondeductible commuting expenses under section 262. Commissioner v. Flowers, supra at 473.



Although the subjective intent of the taxpayer is a factor to be considered in determining tax home for purposes of 162(a)(2), this Court and others have consistently focused on more objective criteria. Foote v. Commissioner, supra at 3-4.



Petitioner contends that his tax home was in Jacksonville, as that was where he maintained a home and resided while he was not working on Reinauer's barges. Respondent argues that petitioner's tax home was not his residence in Jacksonville, but rather in New York at his principal place of employment. We agree with respondent.



In January 2003 petitioner began employment as a barge mate with Reinauer and reported to New York, where he completed paperwork and received his first assignment. Although each assignment typically lasted a fortnight, petitioner remained employed by Reinauer until 2005. Thus, his employment with Reinauer was not temporary within the meaning of section 162(a) in that he was employed for a period in excess of 1 year.



There is ample evidence in the record to support the conclusion that New York was petitioner's principal place of employment. For each assignment, Reinauer's dispatcher called petitioner directly to inform him when and where to report to the barge for his next assignment, and petitioner reported directly to the designated location. Most of petitioner's assignments originated in New York. If the barge was stationed in New York Harbor, petitioner flew to Newark from Jacksonville to catch the barge. If the barge was north of New York, in Maine, Massachusetts, or Rhode Island, petitioner flew to Newark, boarded another plane, and flew to the location of the barge. Reinauer reimbursed petitioner for his transportation expenses between New York and the northern locations but did not reimburse him for travel between Florida and New York. For the one assignment south of New York, in Virginia, petitioner drove his personal vehicle to the barge at Yorktown and was not reimbursed for such travel. This pattern of reimbursement indicates that petitioner's travel from Florida to New York was regarded by his employer as a home-to-work commute.



Petitioner testified at trial that he took the job with Reinauer because he received more pay for less work. Indeed, he earned twice as much working as a barge mate in New York compared with working in Jacksonville; moreover, following a 2-week work period, petitioner received 2 weeks off rather than only 1 week. Petitioner's daughter also lived in Jacksonville. The rate of pay, the time off, and the proximity to his daughter suggest that it was personal choice and not business exigencies that dictated the decision by petitioner to maintain his residence in Jacksonville and commute to New York. See Commissioner v. Flowers, supra at 474.



Consequently, because petitioner's position with Reinauer lasted more than 1 year, and further because most of his assignments originated in New York, his principal place of employment, and therefore his tax home, was in New York for the relevant period.



In conclusion, because petitioner was not "away from home" within the meaning of section 162(a)(2), he is not entitled to a deduction for expenses incurred for traveling between Florida and New York. Instead, his costs were in the nature of personal expenses for commuting. We thus sustain respondent's determination on this issue.





Conclusion



We have considered all of the other arguments made by petitioner and, to the extent that we have not specifically addressed them, we conclude that they are without merit.



To reflect our disposition of the disputed issue, as well as the parties' concessions,



Decision will be entered under Rule 155.


1 Unless otherwise indicated, all subsequent section references are to the Internal Revenue Code in effect for 2003, the taxable year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

2 Petitioner had 13 assignments during 2003. Six of the assignments originated in New York Harbor; three in Portland, Maine; two in Boston, Massachusetts; one in Yorktown, Virginia; and one assignment, beginning Oct. 10, 2003, did not designate an origin, but the barge floated through the Erie basin en route to Albany, and thus that assignment most likely originated in New York Harbor.

3 The vocational "tax home" concept was first construed by this Court in Bixler v. Commissioner, 5 B.T.A. 1181, 1184 (1927), and has been steadfastly upheld by this Court. See, e.g., Horton v. Commissioner, 86 T.C. 589 (1986); Leamy v. Commissioner, 85 T.C. 798 (1985); Foote v. Commissioner, 67 T.C. 1 (1976); Kroll v. Commissioner, 49 T.C. 557 (1968).

Labels:

Tuesday, July 28, 2009

tax lien invalid

Dorothy Smith-Irving v. Commissioner.

Docket No. 18234-07S . Filed July 27, 2009.


The IRS could not proceed with collection against a delinquent taxpayer because her assessment was untimely. Although she had signed a Form 4945-CG, Income Tax Examination Changes, that included a consent to the assessment and a waiver of her right to a deficiency notice, the form was invalid. Her cover letter that accompanied the form made it clear that she misunderstood the proposed changes; the IRS was therefore aware of her confusion; and, under state (California) contract law, one party's unilateral mistake invalidated an agreement if the other party knew or had reason to know of the error. The taxpayer's subsequent deficiency notice was also invalid because the IRS did not mail it to her last known address, and there was no evidence she had actually received it. However, since the taxpayer had an opportunity to contest the assessment after she received a notice of intent to levy, she could not dispute her underlying tax liability at her Collection Due Process (CDP) hearing, and the IRS determination was reviewed for abuse of discretion. Finally, since the assessment was invalid, the IRS Appeals officer who conducted the hearing abused his discretion when he concluded that the IRS had satisfied all legal and administrative requirements before it issued the taxpayer's tax lien.
Gerber, Judge: This case was heard pursuant to the provisions of section 7463 of the Internal Revenue Code in effect when the petition was filed. 1 Pursuant to section 7463(b), the decision to be entered is not reviewable by any other court, and this opinion shall not be treated as precedent for any other case.

Respondent determined to proceed to collect petitioner's unpaid tax liabilities for tax year 1997 by filing a notice of Federal tax lien (NFTL). Petitioner seeks review of that determination under sections 6320(c) and 6330(d).

The issue for consideration is whether respondent's determination to proceed with collection was an abuse of discretion.


Background

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. Petitioner resided in California when she filed her petition.

Petitioner began a prolonged and complex journey when she filed her 1997 Form 1040, U.S. Individual Income Tax Return, on April 19, 1999. On that return she reported a $27,411 tax liability (original liability). Petitioner did not remit payment with her 1997 return. Respondent assessed the reported liability (original assessment) and also applied a $1,396 withholding tax credit. Additionally, respondent determined additions to tax of $458.15 for failure to pay estimated tax, $5,853.37 for failure to file timely the return, and $1,690.97 for failure to pay the tax shown on the return. On July 26, 1999, respondent notified petitioner of his intent to levy, but petitioner did not request a collection due process (CDP) hearing.

On December 20, 1999, petitioner filed a Form 1040X, Amended U.S. Individual Income Tax Return, for 1997 showing reduced taxable income because of a reduction in the amount reported as an early withdrawal distribution from her individual retirement account (IRA). She claimed a $74,012 reduction of her adjusted gross income and, in turn, a $13,910 reduction of her tax liability. On December 23, 1999, petitioner submitted an offer to compromise her outstanding tax liability (first OIC). On March 26, 2002, respondent rejected petitioner's first OIC.

On March 8, 2000, respondent notified petitioner that her 1997 return had been selected for examination. On January 18, 2001, respondent notified petitioner that the claimed reduction in adjusted gross income had been disallowed and that additional tax was due. The letter was accompanied by a Form 2297, Waiver of Statutory Notification of Claim Disallowance, with respondent's request that petitioner sign and return it if she agreed with the examination results. In a February 21, 2001, letter, respondent asked petitioner to sign a Form 4549-CG, Income Tax Examination Changes, with the request that petitioner sign and return it if she agreed with respondent's determination of $59,301 of additional taxable income. The increase was mostly due to the disallowance of petitioner's charitable contribution deduction for lack of substantiation. Respondent's determination obviated the $13,910 reduction in tax liability petitioner claimed on her amended return and resulted in a $17,038 tax increase (audit liability). Respondent also determined an additional late filing addition to tax of $4,909.88.

By cover letter dated March 5, 2001, petitioner signed and returned the Forms 4549-CG and 2297. However, she did so under the mistaken belief that respondent was proposing to reduce her outstanding tax liability to $17,038 rather than increasing it by that amount. Petitioner's cover letter revealed the misunderstanding and provided respondent with petitioner's new address as of April 13, 2001.

Because it appeared to respondent that petitioner did not understand the Form 4549-CG, petitioner was issued a notice of deficiency on May 31, 2001. The notice of deficiency, however, was mailed to petitioner's old address. There is no indication that she received the notice, and she did not file a petition with this Court. On September 3, 2001, respondent assessed the deficiency and the addition to tax (audit assessment).

On December 5, 2001, petitioner filed a chapter 7 bankruptcy petition. On March 18, 2002, the bankruptcy court granted a partial discharge of her 1997 tax liability, abating the $21,447.83 remaining on the original liability and all associated penalties and interest. The audit liability was not abated because the audit assessment had been made within 240 days before the bankruptcy petition's filing date.

Pursuant to the bankruptcy court's order, respondent adjusted petitioner's account to reflect the abatement of the additions to tax for estimated tax, late filing, and failure to pay. Respondent, however, did not reduce the original assessment and the associated interest in accordance with the amounts abated.

On August 24, 2005, respondent sent petitioner a second notice of intent to levy concerning petitioner's outstanding 1997 tax liability. Because respondent had not applied the abatement of the tax liability from the original assessment and its associated interest, the notice erroneously stated petitioner's unpaid tax liability as $35,534.95. Petitioner did not request a CDP hearing.

On January 9, 2006, petitioner offered to compromise her outstanding tax liabilities 2 for $31,500 (second OIC) on the basis of doubt as to liability and doubt as to collectibility. On April 19, 2006, respondent rejected the second OIC and filed an NFTL with respect to petitioner's unpaid tax liabilities. On April 21, 2006, respondent notified petitioner of the NFTL filing. On May 22, 2006, petitioner made a timely request for a CDP hearing.

On June 20, 2007, Settlement Officer Nathan August (Mr. August) conducted a telephone CDP hearing with petitioner. He told petitioner that she could not contest the underlying tax liability because she had had a prior opportunity to do so. He also informed her that the abatement of the original liability had not been posted to her account. He estimated that she would have a remaining liability of approximately $20,000 to $25,000 after the abatement was applied because the audit liability had not been discharged.

Mr. August also reviewed respondent's decision to reject petitioner's second OIC. He stated that there was no doubt as to liability because she had consented to the audit assessment by signing the Form 4549-CG. He also stated that there was no doubt as to collectibility because she had sufficient assets and/or monthly income to fully pay the liability. Because Mr. August believed there was no doubt as to liability or collectibility, he informed petitioner that he would be sustaining the rejection of the second OIC.

Petitioner argued that the NFTL was invalid because the amount of the 1997 liability reflected on the NFTL was incorrect. Mr. August explained that an incorrect amount did not provide a basis to amend the NFTL. He therefore indicated that he would be sustaining the filing of the NFTL.

Petitioner also requested abatement of interest and additions to tax, stating that she had not been aware of the nondischargeability of the audit liability. Mr. August advised her that the interest and addition to tax accruals resulted from petitioner's failure to pay rather than from any errors or delays by respondent. As a result, Mr. August did not find cause for abatement.

On July 16, 2007, respondent sent petitioner a notice of determination sustaining the NFTL filing. Respondent also sent petitioner a letter informing her of the rejection of her request for abatement of interest for the period from September 3, 2001, to June 20, 2007. On August 14, 2007, petitioner filed a petition with the Court for review of the notice of determination.


Discussion

If a taxpayer neglects or refuses to pay a tax owed after demand for payment, the unpaid tax will be a lien in favor of the United States upon all property and rights to property belonging to that person. Sec. 6321.

Upon request, the taxpayer is entitled to an administrative review hearing before an impartial officer or employee of the Appeals Office. Sec. 6320(b). The hearing is conducted according to the procedures under section 6330(c), (d), and (e). Sec. 6320(c). At the hearing, the taxpayer may raise any issue relevant to the unpaid tax or the Commissioner's collection activities. Sec. 6330(c)(2)(A). However, if a taxpayer received a statutory notice of deficiency for the year in issue or otherwise had a prior opportunity to dispute the underlying tax liability, the taxpayer is precluded from challenging the existence or amount of the liability. Sec. 6330(c)(2)(B). A taxpayer who has signed a Form 4549-CG is deemed to have had an opportunity to dispute the underlying tax liability. Zapara v. Commissioner, 124 T.C. 223, 228 (2005); see Aguirre v. Commissioner, 117 T.C. 324, 327 (2001). A taxpayer who previously received a notice under section 6330 for the same tax and tax periods and did not request a hearing has already received an opportunity to challenge the existence and amount of the underlying liability. Sec. 301.6320-1(e)(3), Q&A-E7, Proced. & Admin. Regs.

Following the hearing, the Appeals officer must determine whether the collection action is to proceed, taking into account the verification the Appeals officer has made, the issues the taxpayer raised at the hearing, and whether the collection action balances the need for the efficient collection of taxes with the legitimate concern of the taxpayer that any collection action be no more intrusive than necessary. Sec. 6330(c)(3).

For determinations made after October 16, 2006, this Court has jurisdiction to review the determination irrespective of the type of tax liability involved. Pension Protection Act of 2006, Pub. L. 109-280, sec. 855, 120 Stat. 1019; Callahan v. Commissioner, 130 T.C. 44 (2008). When the validity of the underlying tax liability is properly at issue, we review the determination de novo. Goza v. Commissioner, 114 T.C. 176, 181-182 (2000). When the underlying tax liability is not in issue, we review for abuse of discretion. Id. at 182. Under the abuse of discretion standard, the taxpayer is required to show that the Commissioner's actions were arbitrary, capricious, or without sound basis in fact. See Knorr v. Commissioner, T.C. Memo. 2004-212.

Respondent contends that petitioner was not entitled to dispute her underlying tax liability at the CDP hearing because she: (1) Signed the Form 4549-CG; (2) was sent a notice of deficiency and did not petition the Court; and (3) received the second notice of intent to levy and did not request a CDP hearing.

Petitioner argues that the Form 4549-CG was invalid because she signed it under the mistaken belief that her tax liability had been reduced to $17,038 rather than increased. Petitioner further contends that the notice of deficiency was also invalid because it was not sent to her last known address.

Though the Form 4549-CG and the notice of deficiency were invalid (discussed infra), petitioner did have an opportunity to dispute her underlying tax liability when she received the second notice of intent to levy. Accordingly, we will review respondent's determination for abuse of discretion.

Section 6330(c)(1) and (3) requires the Appeals officer to obtain verification that the requirements of any applicable law or administrative procedure have been met. In order to collect a tax owed by the taxpayer, the Commissioner generally must assess the liability within 3 years after the return is filed. Secs. 6303(a), 6501(a). Section 6503(h) extends that 3-year period of limitations for the time the Commissioner is precluded from assessing the tax because of the filing of a bankruptcy petition, plus 60 days. The Commissioner is generally precluded from assessing a deficiency until after the mailing of a notice of deficiency, unless the taxpayer waives that restriction. Sec. 6213(a), (d).

The audit assessment was made after petitioner had submitted a signed Form 4549-CG and after respondent had issued her a notice of deficiency. Petitioner claims the Form 4549-CG and the notice of deficiency were invalid.

Form 4549-CG includes a waiver under which a taxpayer consents to immediate assessment and collection and waives the right to receive a notice of deficiency. We apply contract principles in determining the enforceability of waiver documents. Horn v. Commissioner, T.C. Memo. 2002-207. In California a party's unilateral mistake is ground for relief where the other party knew or had reason to know of the mistake. Libby, McNeil & Libby, Cal. Canners & Growers v. United Steelworkers of Am., 809 F.2d 1432, 1434 (9th Cir. 1987); 1 Restatement, Contracts 2d, sec. 153(b) (1981).

When petitioner signed the Form 4549-CG, she believed that the audit examiner had told her that her tax liability would be reduced. The accompanying cover letter communicated her confusion as to the amount of her tax liability: "I am a little skeptic [sic] in signing this because it looks like $27,000 is the amount due instead of $17,000." (Emphasis added.) The cover letter put respondent on notice that petitioner did not understand she was consenting to the assessment of an additional tax liability, and respondent accordingly issued petitioner a notice of deficiency. Because respondent was aware of petitioner's unilateral mistake, there was no meeting of the minds and the Form 4549-CG waiver is invalid.

Petitioner also claims the notice of deficiency is invalid because it was sent to the wrong address. A notice of deficiency is sufficient if mailed to the taxpayer's last known address. Sec. 6212(b); Frieling v. Commissioner, 81 T.C. 42, 52 (1983). A taxpayer's last known address is the address shown on the taxpayer's most recently filed return, absent clear and concise notice of a change of address. Sec. 301.6212-2(a), Proced. & Admin. Regs.

Petitioner's March 5, 2001, cover letter provided respondent with such notice of her change of address. The letter informed the audit examiner that she would be moving to her new address on April 13, 2001. Respondent issued the notice of deficiency after that date on May 31, 2001, but nevertheless mailed it to petitioner's old address. Because the notice of deficiency was not sent to petitioner's last known address and there is no evidence she actually received it, the notice is invalid.

Because the Form 4549-CG and the notice of deficiency were invalid, the September 3, 2001, assessment was improper. Respondent did not make a valid assessment of the audit liability before the period for assessment, as extended by the bankruptcy filing, expired. Because respondent's assessment was invalid on account of the expiration of the assessment period, Mr. August's verification that the requirements of applicable law had been met was incorrect. Respondent's determination to sustain the NFTL filing was therefore in error as a matter of law and was an abuse of discretion.

Accordingly, respondent cannot proceed with collection.

To reflect the foregoing,

Decision will be entered for petitioner.

1 Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for period under consideration.

Labels:

Monday, July 27, 2009

TAO regulations have been proposed

Assistance Order ., (July 27, 2009)
Proposed Regulations, NPRM REG-152166-05

July 27, 2009

Code Sec. 7811

IRS Organization : National Taxpayer Advocate : Taxpayer Assistance Order .



DEPARTMENT OF THE TREASURY



Internal Revenue Service

26 CFR Part 301

[REG-152166-05]

RIN 1545-BF33

Taxpayer Assistance Orders

AGENCY: Internal Revenue Service (IRS), Treasury

ACTION: Withdrawal of notice of proposed rulemaking and notice of proposed rulemaking.

SUMMARY: This document withdraws the notice of proposed rulemaking published on April 19, 1996, in the Federal Register and contains proposed regulations relating to the issuance of Taxpayer Assistance Orders (TAOs). The IRS is issuing these proposed regulations to provide guidance relating to the issuance of a TAO. These proposed regulations are necessary because the existing regulations do not reflect changes to the law made by the Taxpayer Bill of Rights II (TBOR 2), the Internal Revenue Service Restructuring and Reform Act of 1998 (RRA 98), the Community Renewal Tax Relief Act of 2000, and the American Jobs Creation Act of 2004 (AJCA). The action taken in these proposed regulations will affect IRS employees in cases where a TAO is being considered or issued.

DATES: Written or electronic comments and requests for a public hearing must be received by [ INSERT DATE 90 DAYS AFTER DATE OF PUBLICATION OF THIS DOCUMENT IN THE FEDERAL REGISTER ].

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-152166-05), room 5205, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20224. Submissions may be hand delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-152166-05), Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW, Washington, DC 20044, or sent electronically via the Federal eRulemaking Portal at http://www.regulations.gov/ (IRS REG-152166-05).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, Janice R. Feldman, (202) 622-8488; concerning submissions of comments, Richard.A.Hurst@irscounsel.treas.gov (202)622-7180(not toll-free numbers).

SUPPLEMENTARY INFORMATION:



Background

Section 7811 of the Internal Revenue Code (Code) authorizes the NTA to issue a TAO when a taxpayer is suffering or is about to suffer a significant hardship as a result of the manner in which the internal revenue laws are being administered by the IRS and the law and the facts support relief. A TAO may be issued to direct that the operating division or function take a specific action, cease a specific action, or refrain from taking a specific action or to order the IRS to review at a higher level, expedite consideration of, or reconsider a taxpayer's case. The IRS will comply with a TAO unless it is appealed and then modified or rescinded by the Commissioner, the Deputy Commissioner, or the NTA. Appeal procedures are provided in the Internal Revenue Manual (IRM).

Proposed regulations were published on April 19, 1996, in the Federal Register (61 FR 17265). The proposed regulations limited the authority to modify or rescind TAOs to the Ombudsman, the Commissioner, and the Deputy Commissioner, and, with the written authorization of one of these officials, a district director, a service center director, a compliance center director, a regional director of appeals (director), or the superiors of a director. Following the publication of the proposed regulations, Congress enacted TBOR 2, Public Law 104-168, 110 Stat. 1452 (1996), which, among other things, authorized only the Taxpayer Advocate, the Commissioner, or the Deputy Commissioner to modify or rescind a TAO. In light of the enactment of TBOR 2, this document withdraws the proposed regulations published in the Federal Register on April 19, 1996.

This document also contains proposed amendments to the Procedure and Administration Regulations (26 CFR part 301) relating to TAOs under section 7811 . Temporary regulations ( TD 8246 ) were published on March 22, 1989, in the Federal Register (54 FR 11699). Final regulations ( TD 8403 ) were published on March 23, 1992, in the Federal Register (57 FR 9975). After the final regulations were published, sections 101 and 102 of TBOR 2, Public Law 104-168, 110 Stat. 1452 (1996), amended section 7811 by changing the name of the Ombudsman to the Taxpayer Advocate, providing that TAOs may order the IRS to take certain affirmative actions, and restricting who may modify or rescind a TAO. Section 1102 of RRA 98, Public Law 105-206, 112 Stat. 685 (1998), further amended section 7811 , by providing examples of significant hardship and replacing "Taxpayer Advocate" with "National Taxpayer Advocate." Section 881(c) of AJCA, Public Law 108-357, 118 Stat. 1418 (2004) clarified that a TAO applies to personnel performing services under a qualified tax collection contract to the same extent as it applies to IRS personnel. Thus, this document contains a new notice of proposed rulemaking implementing the amendments under section 7811 pursuant to the enactment of TBOR 2, RRA 98, the Community Renewal Tax Relief Act of 2000, and AJCA and also to provide guidance on issues that have arisen in the administration of section 7811 . Section 301.7811-1(e) of the existing regulations, which concerns the suspension of statutes of limitations, is not being revised as part of this proposed rulemaking as changes to that section may involve changes to IRS computer processing systems and will be dealt with at a later date.



Explanation of Provision



1. Significant Hardship

Under Section 301.7811-1(a)(4)(ii) of the existing regulations, significant hardship means "serious privation caused or about to be caused to the taxpayer as the result of the particular manner in which the internal revenue laws are being administered by the Internal Revenue Service." RRA 98 clarified the meaning of the term significant hardship by providing a nonexclusive list of types. Section 7811(a)(2) provides that significant hardship includes: (1) an immediate threat of adverse action;(2) a delay of more than 30 days in resolving taxpayer account problems;(3) the incurring by the taxpayer of significant costs (including fees for professional representation) if relief is not granted; or (4) irreparable injury to, or a long-term adverse impact on, the taxpayer if relief is not granted. Thus, the proposed regulations list the statutory types and also provide guidance with regard to what constitutes significant hardship under the delay standard and other criteria. Significant hardship under the 30-day delay standard is met when a taxpayer does not receive a response by the date promised by the IRS, or when the IRS has established a normal processing time for taking an action and the taxpayer experiences a delay of more than 30 days beyond the normal processing time.



2. Distinction Between Significant Hardship and Issuance of TAO

The proposed regulations discuss the distinction between a finding of "significant hardship" and "the issuance of a TAO." The proposed regulations are designed to clarify that a finding by the NTA that a taxpayer is suffering or about to suffer a significant hardship as a result of the manner in which the internal revenue laws are being administered by the IRS will not automatically result in the issuance of a TAO. After making a determination of significant hardship, the NTA must determine whether the facts and the law support relief.



3. Compliance with the TAO

The proposed regulations explain that a TAO is an order by the NTA to the IRS and that the IRS will comply with the terms of the TAO unless it is appealed and then modified or rescinded by the Commissioner, the Deputy Commissioner, or the NTA. If a TAO is modified or rescinded by the Commissioner or Deputy Commissioner, a written explanation of the reasons for the modification or rescission must be provided to the NTA. Furthermore, the proposed regulations clarify that a TAO is not intended to be a substitute for an established administrative or judicial review procedure, but rather is intended to supplement these procedures if a taxpayer is about to suffer or is suffering a significant hardship. Thus, a taxpayer's right to administrative or judicial review will not be diminished or expanded in any way as a result of the taxpayer's seeking assistance from the Taxpayer Advocate Service (TAS).



4. Form of Request

The proposed regulations provide that a request for a TAO shall be made on a Form 911, "Request for Taxpayer Advocate Service Assistance (And Application for Taxpayer Assistance Order)" (or other specified form) or in a written statement that provides sufficient information for TAS to determine the nature of the harm or the need for assistance.



5. Scope of the TAO

The proposed regulations provide that the NTA can issue a TAO directing an action in the circumstances outlined in section 7811(b) . Section 7811(b) provides that the NTA may issue a TAO ordering the IRS within a specified time to (i) release levied property, or (ii) cease any action, take any action as permitted by law, or refrain from taking any action with respect to a taxpayer under: (A) chapter 64 (relating to collection); (B) chapter 70, subchapter B (relating to bankruptcy and receiverships); (C) chapter 78 (relating to discovery of liability and enforcement of title); or (D) any other provision of law specifically described by the NTA in the TAO. Consistent with the list of specific subchapter and chapters of the Code in section 7811(b) , the proposed regulations provide that the phrase "any provision of law" refers to other provisions of the internal revenue laws similar to the provisions enumerated in the statute.

The proposed regulations further provide that in circumstances where the statute does not authorize the issuance of a TAO to order a specific action, if the NTA determines that the taxpayer is suffering or about to suffer a significant hardship and that the issuance of a TAO is appropriate, the NTA may issue a TAO seeking to expedite, review, or reconsider an action at a higher level. Although the statute does not expressly state that a TAO may be issued to request that the IRS expedite, review, or reconsider at a higher level an action, the statute and the legislative history support this interpretation.

As initially enacted, section 7811(b) did not grant the Ombudsman (the predecessor to the NTA) the authority to order affirmative actions. At that time, section 7811(b) provided that a TAO could order either the release of levy or could order the IRS to cease or refrain from taking an action under the three enumerated chapters of the Code listed in the statute. Thus, under the initial version of section 7811(b)(2) , except for releasing levies, TAOs could not be issued to take affirmative actions. For example, a TAO could order the IRS to refrain from filing a Notice of Federal Tax Lien (NFTL), but it could not require the IRS to release an NFTL. Delegation Order (DO) 239 (01-31-92) remedied this problem by delegating to the Ombudsman the authority to order affirmative acts. Congress also recognized the deficiency in the law and amended section 7811(b) as part of TBOR 2 to allow TAOs to be issued with respect to affirmative acts by inserting the words "take any action as permitted by law" into the statute. The Committee Report to TBOR 2, H. Rep. No. 104-506, 104 th Cong., 2 nd Sess., at 1148 (1996), explains how the existing law was deficient in that, for example, it did not allow a TAO to be issued to expedite a refund or review the validity of a tax deficiency. The report explains that the reason for amendment to section 7811(b) was to allow a TAO to be issued "for a review of the appropriateness of the proposed action." Thus, consistent with the legislative history and the statutory amendments, the proposed regulations provide that where the statute does not authorize the issuance of a TAO to order a specific action, if the NTA determines that a taxpayer is suffering or about to suffer a significant hardship and that relief is appropriate, the NTA may issue a TAO seeking to expedite, review, or reconsider an action at a higher level.



6. Who is Subject to a TAO

The proposed regulations provide rules regarding who is subject to a TAO. Generally, a TAO can be issued to any operating division or function of the IRS. Due to the sensitivity and importance of criminal investigations, the proposed regulations provide that a TAO may not be issued if the action ordered in the TAO could reasonably be expected to impede a criminal investigation. The IRS Criminal Investigation division (CI) will determine whether the action ordered in the TAO could reasonably be expected to impede an investigation. Procedures for handling cases where the NTA questions CI's initial determination will be added to the IRM.

The rule for issuing a TAO to the Office of Chief Counsel has been updated to reflect the reorganization of the IRS as well as statutory changes. The existing regulations provide that: "[a] taxpayer assistance order may generally not be issued ... to enjoin an act of the Office of Chief Counsel (with the exception of Appeals)." Due to a reorganization of the Office of Chief Counsel, effective October 1, 1995, Appeals is no longer a component of the Office of Chief Counsel. Accordingly, the proposed regulations eliminate the parenthetical reference to Appeals in §301.7811-1(c)(3) . The NTA continues to have the authority to issue TAOs to Appeals. Additionally, at the time that the existing regulations were finalized, the Ombudsman could not issue a TAO to order an affirmative act, other than a release of levy. As discussed in this preamble, under the current version of the statute, the NTA has much broader authority regarding the ability to order an affirmative act. Thus, the term "enjoin" has also been eliminated, and the rule under the proposed regulations is that: "[g]enerally a TAO may not be issued to the Office of Chief Counsel."



Special Analyses

This notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. Pursuant to the Regulatory Flexibility Act (5 U.S.C. chapter 6), it is hereby certified that these regulations will not have a significant economic impact on a substantial number of small entities. The information required under these proposed regulations is already required by the current regulations and the Form 911, "Request for Taxpayer Advocate Service Assistance (And Application for Taxpayer Assistance order)." In addition, the Form 911 takes minimal time and expense to prepare, and the filing of a Form 911 is optional. Therefore, preparing the Form 911 does not significantly increase the burden on taxpayers. Based on these facts, the Treasury Department and the IRS have determined that these proposed regulations will not have a significant economic impact on a substantial number of small entities. Furthermore, the substance of the regulations does not concern the Form 911, but the procedures the Taxpayer Advocate Service (TAS) or the Internal Revenue Service (IRS) must follow with respect to taxpayer assistance orders. Therefore, any burden created by these regulations is on the TAS or IRS, not taxpayers. Pursuant to section 7805(f) of the Code, this notice of proposed rulemaking has been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.



Comments and Requests for a Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any written or electronic comments that are submitted timely to the IRS. All comments will be available for public inspection and copying. A public hearing may be scheduled if requested in writing by any person who timely submits written comments. If a public hearing is scheduled, notice of the date, time, and place for the public hearing will be published in the Federal Register .



Drafting Information

The principal author of these regulations is Janice R. Feldman, Office of the Special Counsel (National Taxpayer Advocate Program)(CC:NTA).



List of Subjects in 26 CFR Part 301

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



Withdrawal of Proposed Regulations

Accordingly, under the authority of 26 U.S.C. 7805, the notice of proposed rulemaking that was published in the Federal Register on April 19, 1996 (61 FR 17265) is withdrawn.



Proposed Amendments to the Regulations

Accordingly, 26 CFR part 301 is proposed to be amended as follows:



PART 301 --PROCEDURE AND ADMINISTRATION

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

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

Par. 2. Section 301.7811-1 is amended by revising paragraphs (a), (b), (c) and (d), removing paragraphs (f),(g), (h) and redesignating paragraph (h) as (f) and revising newly designated paragraph (f) to read as follows:



§301.7811-1 Taxpayer Assistance Orders

(a) Authority to issue --(1) In general . When an application for a Taxpayer Assistance Order (TAO) is filed by the taxpayer or the taxpayer's authorized representative in the form, manner and time specified in paragraph (b) of this section, the National Taxpayer Advocate (NTA) may issue a TAO if, in the determination of the NTA, the taxpayer is suffering or is about to suffer a significant hardship as a result of the manner in which the internal revenue laws are being administered by the Internal Revenue Service (IRS), including action or inaction on the part of the IRS.

(2) The National Taxpayer Advocate defined . The term National Taxpayer Advocate includes any designee of the NTA, such as a Local Taxpayer Advocate.

(3) Issuance without a written application . The NTA may issue a TAO in the absence of a written application by the taxpayer under section 7811(a) .

(4) Significant hardship --(i) Determination required . Before a TAO may be issued, the NTA is required to make a determination regarding significant hardship.

(ii) Term Defined . The term significant hardship means a serious privation caused or about to be caused to the taxpayer as the result of the particular manner in which the revenue laws are being administered by the IRS. Significant hardship includes situations in which a system or procedure fails to operate as intended or fails to resolve the taxpayer's problem or dispute with the IRS. A significant hardship also includes, but is not limited to:

(A) An immediate threat of adverse action;

(B) A delay of more than 30 days in resolving taxpayer account problems;

(C) The incurring by the taxpayer of significant costs (including fees for professional representation) if relief is not granted; or

(D) Irreparable injury to, or a long-term adverse impact on, the taxpayer if relief is not granted.

(iii) A delay of more than 30 days in resolving taxpayer account problems is further defined . A delay of more than 30 days in resolving taxpayer account problems exists under the following conditions:

(A) When a taxpayer does not receive a response by the date promised by the IRS; or

(B) When the IRS has established a normal processing time for taking an action and the taxpayer experiences a delay of more than 30 days beyond the normal processing time.

(iv) Examples of significant hardship . The provisions of this section are illustrated by the following examples:

Example 1 . Immediate threat of adverse action . The IRS serves a levy on A's bank account. A needs the bank funds to pay for a medically necessary surgical procedure that is scheduled to take place in one week. If the levy is not released, A will lack the funds necessary to have the procedure. A is experiencing an immediate threat of adverse action.

Example 2 . Delay of more than 30 days . B files a Form 4506, "Request for a Copy of Tax Return." B does not receive the photocopy of the tax return after waiting more than 30 days beyond the normal time for processing. B is experiencing a delay of more than 30 days.

Example 3 . Significant costs . The IRS sends XYZ, Inc. several notices requesting payment of the outstanding employment taxes owed by XYZ, Inc. and four of its subsidiaries. The IRS contends that XYZ, Inc. and the four subsidiaries have small employment tax balances with respect to 12 employment tax quarters totaling $10X. XYZ, Inc. provides documentation to the IRS which it contends shows that if all payments were applied to each entity correctly, there would be no balance due. The IRS requests additional records and documentation. Because there are 60 tax periods (12 quarters for each of the five entities) involved, to comply with this request XYZ, Inc. will need to hire an accountant, who estimates he will charge at least $5X to organize all the records and provide a detailed analysis of the how the payments should have been applied. XYZ, Inc. is facing significant costs.

Example 4 . Irreparable injury . D has arranged with a bank to refinance his mortgage to lower his monthly payment. D is unable to make the current monthly payment. Unless the monthly payment amount is lowered, D will lose his residence to foreclosure. The IRS refuses to subordinate the federal tax lien, as permitted by IRC section 6325(d) , or discharge the property subject to the lien, as permitted by IRC section 6325(b) . As a result, the bank will not allow D to refinance. D is facing an irreparable injury if relief is not granted.

(5) Distinction Between Significant Hardship and the Issuance of a TAO . A finding that a taxpayer is suffering or about to suffer a significant hardship as a result of the manner in which the internal revenue laws are being administered by the IRS will not automatically result in the issuance of a TAO. After making a determination of significant hardship, the NTA must determine whether the facts and the law support relief for the taxpayer. In cases where any IRS employee is not following applicable published administrative guidance (including the Internal Revenue Manual), the NTA shall construe the factors taken into account in determining whether to issue a TAO in the manner most favorable to the taxpayer.

(b) Generally . A TAO is an order by the NTA to the IRS. The IRS will comply with a TAO unless it is appealed and then modified or rescinded by the NTA, Commissioner or the Deputy Commissioner. If a TAO is modified or rescinded by the Commissioner or Deputy Commissioner, a written explanation of the reasons for the modification or rescission must be provided to the NTA. The NTA may not make a substantive determination of any tax liability. A TAO is also not intended to be a substitute for an established administrative or judicial review procedure, but rather is intended to supplement existing procedures if a taxpayer is about to suffer or is suffering a significant hardship. A request for a TAO shall be made on a Form 911, "Request for Taxpayer Advocate Service Assistance (And Application for Taxpayer Assistance Order)" (or other specified form) or in a written statement that provides sufficient information for TAS to determine the nature of the harm or the need for assistance. A taxpayer's right to administrative or judicial review will not be diminished or expanded in any way as a result of the taxpayer's seeking assistance from TAS.

(c) Contents of Taxpayer Assistance Orders . After establishing that the taxpayer is facing significant hardship and determining that the facts and law support relief to the taxpayer, the NTA may issue a TAO ordering the IRS within a specified time to --

(1) Release a Levy . Release levied property (to the extent that the IRS may by law release such property); or

(2) Take Certain Other Actions . Cease any action, take any action as permitted by law, or refrain from taking any action with respect to a taxpayer pursuant to --

(i) Chapter 64 (relating to collection);

(ii) Chapter 70, subchapter B (relating to bankruptcy and receiverships);

(iii) Chapter 78 (relating to discovery of liability and enforcement of title); or

(iv) Any other provision of the internal revenue laws specifically described by the NTA in the TAO.

(3) Expedite, Review or Reconsider an Action at a Higher Level . Although the NTA may not make the substantive determination, a TAO may be issued to require the IRS to expedite, reconsider, or review at a higher level an action taken with respect to a determination or collection of a tax liability.

(4) Examples . The following examples assume the existence of significant hardship:

Example 1 . J contacts a local taxpayer advocate because a wage levy is causing financial difficulties. The NTA determines that the levy should be released as it is causing economic hardship (within the meaning of section 6343(a) and Treas. Reg. §301.6343-1(b)(4)) . The NTA may issue a TAO ordering the IRS to release the levy in whole or in part by a specified date.

Example 2 . The IRS rejects K's offer in compromise. K files a Form 911, "Request for Taxpayer Advocate Service Assistance (and Application for Taxpayer Assistance Order)." The NTA discovers facts that support acceptance of the offer in compromise. The NTA may issue a TAO ordering the IRS to reconsider its rejection of the offer or to review the rejection of the offer at a higher level. The TAO may include NTA analysis of and recommendation for resolving the case.

Example 3 . L files a protest requesting Appeals consideration of IRS's proposed denial of L's request for innocent spouse relief. Appeals advises L that it is going to issue a Final Determination denying the request for innocent spouse relief. L files a Form 911, "Request for Taxpayer Advocate Service Assistance (and Application for Taxpayer Assistance Order)." The NTA reviews the administrative record and concludes that the facts support granting innocent spouse relief. The NTA may issue a TAO ordering Appeals to refrain from issuing a Final Determination and reconsider or review at a higher level its decision to deny innocent spouse relief. The TAO may include TAS analysis of and recommendation for resolving the case.

(d) Issuance . A TAO may be issued to any office, operating division, or function of the IRS. A TAO shall apply to persons performing services under a qualified tax collection contract (as defined in section 6306(b) ) to the same extent and in the same manner as the order applies to IRS employees. A TAO will not be issued to IRS Criminal Investigation division (CI), or any successor IRS division responsible for the criminal investigation function, if the action ordered in the TAO could reasonably be expected to impede a criminal investigation. CI will determine whether the action ordered in the TAO could reasonably be expected to impede an investigation. Generally, a TAO may not be issued to the Office of Chief Counsel.

* * * * *

(f) Effective applicability date . These regulations are applicable for TAOs issued on or after the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register, except that paragraph (e) is applicable beginning March 20, 1992.

Linda E. Stiff

Deputy Commissioner for Services and Enforcement

Labels:

Monday, July 20, 2009

The government was enjoined from proceeding with a collection action against an individual during the pendency of the individual's refund proceeding and its request for a stay with repect to the refund proceedings was denied. The individual filed a refund action to recover trust fund recovery penalty taxes he had paid; subsequently, the government brought suit in a different district court to collect the unpaid portion of the trust fund recovery penalty from the individual and another responsible person. Code Sec. 6331(i)(4)(A) prohibits the government from filing a collection action against a refund claimant for any unpaid divisible tax while a refund suit is pending with respect to that individual and that tax. The government could not rely on the exception to Code Sec. 6331(i)(4)(A), which states that the statute does not apply to any "proceeding relating to" the refund proceeding. A collection action will always have some connection, relation and reference to a refund proceeding involving the same taxes and taxpayer; however, taking into consideration the language of the statute, its legislative history and subsequent decisions, the exception was not meant to apply in a collection action against the same taxpayer to recover the same tax at issue in the refund proceeding.

Jerry D. Nickell, Sr., Plainitff v. United States of America, Defendant..

U.S. District Court, East. Dist. Tex., Sherman Div.; 4:08CV319, June 5, 2009.

[ Code Secs. 6331 and 6672]






MEMORANDUM ADOPTING REPORT AND RECOMMENDATION OF THE UNITED STATES MAGISTRATE JUDGE


SCHELL, United States District Judge: Came on for consideration the report of the United States Magistrate Judge in this action, this matter having been heretofore referred to the United States Magistrate Judge pursuant to 28 U.S.C. § 636. On April 2, 2009, the report of the Magistrate Judge was entered containing proposed findings of fact and recommendations that Jerry D. Nickell, Sr.'s Motion to Enjoin Proceedings in Collection Case Filed by Defendant in Western District of Texas, Midland Division (Dkt. 22) should be GRANTED and the United States of America's Motion to Stay (Dkt. 18) should be DENIED as MOOT.

The court, having made a de novo review of the objections raised by the United States, is of the opinion that the findings and conclusions of the Magistrate Judge are correct, and the objections of the United States are without merit as to the ultimate conclusion and recommendation of the Magistrate Judge. Therefore, the court hereby adopts the findings and conclusions of the Magistrate Judge as the findings and conclusions of this court, and Jerry D. Nickell, Sr.'s Motion to Enjoin Proceedings in Collection Case Filed by Defendant in Western District of Texas, Midland Division (Dkt. 22) is GRANTED and the United States of America's Motion to Stay (Dkt. 18) is DENIED as MOOT.

IT IS SO ORDERED.

SIGNED this 5th day of June, 2009.


REPORT AND RECOMMENDATION OF UNITED STATES MAGISTRATE JUDGE


BUSH, United States Magistrate Judge: On March 30, 2009, the Court conducted a hearing on the United States of America's Motion to Stay (Dkt. 18) and Jerry D. Nickell, Sr.'s Motion to Enjoin Proceedings in Collection Case Filed by Defendant in Western District of Texas, Midland Division (Dkt. 22). As stated on the record at the hearing, the Court finds that the Motion to Enjoin (Dkt. 22) should be GRANTED and the Motion to Stay (Dkt. 18) should be DENIED as MOOT.


Background


Nickell commenced the above captioned suit (the "First Suit") on August 26, 2008. At issue in the First Suit are trust fund recovery penalty taxes ("TFRP") assessed against Nickell in accordance with 26 U.S.C. § 6672. On January 16, 2009, the United States filed suit against Nickell and another individual, Thomas Alvey, in the United States District Court for the Western District of Texas - Midland Division, Case No. MO-09-CV 005 (the "Second Suit"). In the Second Suit, the United States alleges Nickell and Alvey are responsible persons for the failure to pay withholding and employment taxes and seeks to collect from Nickell the unpaid portion of the same TFRP at issue in the First Suit.

On January 20, 2009, the government filed a motion to stay seeking to stay the proceedings in the First Suit to allow the Second Suit to continue. Shortly thereafter, Nickell filed a motion to enjoin the proceedings against him in the Second Suit.

Both parties agree that Nickell first filed a refund action to recover his TFRP payment in this District. The parties further agree that after Nickell filed suit here, the Government filed a separate action against Nickell and Alvey in the Western District of Texas to collect the unpaid portion of the TFRP.

In his motion to enjoin, Nickell asserts that the plain language of Section 6331(i)(4)(A) of the Internal Revenue Code prohibits the United States from bringing the Second Suit against him. The United States argues that the "related to" exception in Section 6331(i)(4)(A)(ii) permits it to pursue the Second Suit against Nickell because the Second Suit is "related to" the first and seeks a stay of these proceedings in the interests of judicial economy. As set forth below, the Court is not persuaded by the Government's argument.


Analysis


All parties agree that 26 U.S.C. § 6331(i)(1) is applicable to this case and that the unpaid taxes at issue are divisible. Under Section 6331(i):

(i) No levy during pendency of proceedings for refund of divisible tax. --
(1) In general. --No levy may be made under subsection (a) on the property or rights to property of any person with respect to any unpaid divisible tax during the pendency of any proceeding brought by such person in a proper Federal trial court for the recovery of any portion of such divisible tax which was paid by such person if-

(A) the decision in such proceeding would be res judicata with respect to such unpaid tax; or

(B) such person would be collaterally estopped from contesting such unpaid tax by reason of such proceeding.... .

Further, Section 6331(i)(4) states:

(4) Limitation on collection activity; authority to enjoin collection. --
(A) Limitation on collection. --No proceeding in court for the collection of any unpaid tax to which paragraph (1) applies shall be begun by the Secretary during the pendency of a proceeding under such paragraph. This subparagraph shall not apply to --

(i) any counterclaim in a proceeding under such paragraph; or

(ii) any proceeding relating to a proceeding under such paragraph.

(B) Authority to enjoin. --Notwithstanding section 7421(a), a levy or collection proceeding prohibited by this subsection may be enjoined (during the period such prohibition is in force) by the court in which the proceeding under paragraph (1) is brought.

As part of the Taxpayer Bill of Rights 3, Congress added I.R.C. § 6331(i). As noted above, in accordance with that provision, the Secretary of the Treasury may not file a collection action against a taxpayer for any unpaid divisible tax during the pendency of a taxpayer refund proceeding for the recovery of any portion of such divisible tax if the decision in the collection action would be res judicata or the taxpayer would be collaterally estopped from contesting such unpaid tax by reason of the collection action. See 26 U.S.C. § 6331(i)(4)(A).

The United States contends that the Western District collection action is not prohibited under Section 6331(i)(4)(A) because the case falls within the exception outlined in the statute that states that Section § 6331(i)(4)(A) does not apply to any "proceeding relating to" the refund proceeding. The United States argues that the refund action relates to Nickell's refund proceeding because both proceedings involve the same legal issues arising out of the same set of facts. The United States further argues that it cannot bring its claims against Alvey as counterclaims here because this Court has no personal jurisdiction over Alvey, a Texas resident who apparently resides in the Western, not Eastern, District of Texas. The United States has not provided the Court with any statutory authority in support of its personal jurisdiction argument.

Not only is the Court presently unconvinced by the Government's jurisdictional arguments as to Alvey, the Court finds that the statute - as it is currently written - specifically prohibits the case from proceeding in the Western District as to the claims against Nickell. As this Court has recently found in another case pending before it, Congress did not define "proceeding related to" in the body of the statute, and it is therefore ambiguous. The United States seeks to define "proceeding related to" as any proceeding that has a connection, relation, or reference to the refund proceeding. As argued by the United States, any collection action that has a connection, relation, or reference to the refund proceeding is exempt from the rule.

The Court agrees with Nickell that, using the United States' definition of related proceedings, the exception would swallow the rule. A subsequent collection action will always have some connection, relation, and reference to the preceding refund proceeding involving the same taxes and taxpayer. It is a basic rule of statutory construction that courts "should act under the assumption that Congress intended its enactment to have meaningful effect and must, accordingly, construe [the enactment] so as to give it such effect." Sutton v. United States, 819 F.2d 1289, 1295 (5th Cir. 1987). Accordingly, the Court rejects the United States' definition and finds that the exception set out in Section § 6331(i)(4)(A)(ii) does not apply to a collection action against the same taxpayer to recover the same tax at issue in the refund proceeding.

This conclusion is consistent with the statute's congressional history and interpretation by other courts. See, e.g., Enax v. United States, 243 Fed. Appx. 449, 451 (11th Cir. 2007) (finding that 26 U.S.C. § 6331(i)(4)(B) "grants a district court overseeing a taxpayer's claim for recovery of a portion of taxes already paid the authority to enjoin a collection proceeding on the unpaid portion of those taxes until the taxpayer's recovery suit is resolved."); Rineer v. United States, 79 Fed. Cl. 765 (2007) (finding that 26 U.S.C. § 6331(i)(4) prevents the government from filling a collection action against a refund claimant while the refund suit is still pending, even at the cost of judicial economy); Swinford v. United States, No. 5:05-cv-234, 2007 WL 496376 (W.D. Ky. Feb. 9, 2007), vacated as moot, No. 5:05-cv-234, 2008 WL 4682273 (W.D. Ky. Jun. 20, 2008) (holding that "an exception that would allow the Government to bring a collection action against the plaintiffs in a properly filed tax refund suit for the same unpaid taxes at issue in the refund suit...would be inconsistent with Congress's intent and contrary to the principle's of statutory construction."). Indeed, in the legislative history of the statute, the Committee notes that the change in the law was based on the belief that "taxpayers who are litigating a refund action over divisible taxes should be protected from collection of the full assessed amount, because the court considering the refund suit may ultimately determine that the taxpayer is not liable." S. Rep. No. 105-174, at 80 (1998). The Court finds that Nickell, in filing his refund action first, has sought and is entitled to such protection here.

Therefore, having reviewed the language of the statute, the legislative history, and the authorities relying on it, the Court finds that the Western District collection action is not a "proceeding relating to" the refund proceeding, and that Section 6331(i)(4)(A) prohibited the Government from filing the Western District action against Nickell.

Moreover, the Court finds that enjoining the Western District case is warranted. The I.R.C. provides that if the United States initiates a prohibited collection action, the collection action may be enjoined by the court in which the refund proceeding is pending. See 26 U.S.C. § 6331(i)(4)(B). Because the United States filed a counterclaim in this action requesting the same relief against Nickell as in the Western District proceeding, this Court will ultimately determine the underlying issue in the Western District proceeding - whether Nickell is liable for the unpaid taxes. Accordingly, in the interest of judicial economy and to promote respect for the law, the Court finds that the Secretary of the Treasury should be enjoined from continuing to prosecute the Western District action against Nickell during the pendency of the refund proceeding.


Recommendation


For the reasons previously stated, the Court recommends that Jerry D. Nickell, Sr.'s Motion to Enjoin Proceedings in Collection Case Filed by Defendant in Western District of Texas, Midland Division (Dkt. 22) be GRANTED and the Secretary of the Treasury be enjoined from continuing to prosecute the Western District action against Nickell during the pendency of the refund proceeding. Further, the Court recommends that the United States of America's Motion to Stay (Dkt. 18) be DENIED as MOOT.

Within ten (10) days after service of the magistrates judge's report, any party may serve and file written objections to the findings and recommendations of the magistrate judge. 28 U.S.C. § 636(b)(1)(c). Failure to file written objections to the proposed findings and recommendations contained in this report within ten days after service shall bar an aggrieved party from de novo review by the district court of the proposed findings and recommendations and from appellate review of factual findings accepted or adopted by the district court except on grounds of plain error or manifest injustice. Thomas v. Arn, 474 U.S. 140, 148 (1985); Rodriguez v. Bowen, 857 F.2d 275, 276-77 (5th Cir. 1988).

SIGNED this 2nd day of April, 2009.

Levy and Distraint: Levy prohibited during pendency of divisible tax refund suit

The IRS may not assess a tax deficiency or take any collection action if the taxpayer has filed a timely petition with the Tax Court with respect to the deficiency ( Code Sec. 6213(a)). This rule is necessary because a taxpayer does not need to pay the deficiency in order to obtain Tax Court jurisdiction.

The Tax Court generally has no jurisdiction over "divisible taxes" such as employment taxes and the trust fund penalty tax ( Code Sec. 6672). Although a taxpayer is generally required to pay the full amount of a deficiency in order to obtain Federal District Court or Claims Court jurisdiction in a refund suit, an exception applies in the case of a divisible tax. Under the exception, these courts have jurisdiction if a taxpayer pays only a portion of the divisible tax (usually the tax due for a single payment period). For example, in the case of trust fund penalty tax, an employer will commonly pay the amount of tax due for one employee for one period and then file a refund claim with a request for abatement of the remaining penalty. Although IRS Policy 5-16, which has been in effect since March 1, 1984, prohibits collection activities during the pendency of a divisible tax refund suit, the IRS occasionally disregarded this policy. The IRS Restructuring and Reform Act of 1998 ( P.L. 105-206), however, codified the policy by prohibiting the IRS from levying on the property or property rights of a taxpayer for the payment of an unpaid divisible tax during the pendency of a Federal trial court proceeding for the refund of a portion of the divisible tax which has been paid ( Code Sec. 6331(i)). The provision applies to unpaid tax attributable to tax periods beginning after December 31, 1998 (Act Sec. 3433(b) of P.L. 105-206).

The prohibition against levy actions applies only if a decision in the proceeding will be res judicata (i.e., binding) with respect to the unpaid tax, or will collaterally estop the taxpayer from contesting the unpaid tax ( Code Sec. 6331(i)(1)).

Pending suit defined. The IRS is prohibited from collecting by levy any unpaid divisible tax while a refund proceeding in a proper federal trial court for the paid portion of such tax is pending. A proceeding is considered pending until a final judgment or order from which an appeal may be taken is entered ( Code Sec. 6331(i)(6)).

Divisible taxes. Divisible taxes are employment taxes imposed by subtitle C of the Internal Revenue Code and the penalty imposed by Code Sec. 6672 with respect to any such employment tax for failure to collect and pay over tax or attempt to evade or defeat tax ( Code Sec. 6331(i)(2)).

Exceptions to levy. The prohibition against IRS collection by levy does not apply if the taxpayer files a written waiver with the IRS (for example, because the taxpayer wants to stop the running of interest or penalties) or the IRS finds that collection of the unpaid tax is in jeopardy. This prohibition also does not apply to a levy that carries out an offset under Code Sec. 6402 or to a levy made before the proceeding began ( Code Sec. 6331(i)(3)).

IRS prohibited from beginning collection proceedings in court during pendency of refund suit. The IRS may not begin a court proceeding to collect any unpaid divisible tax while a refund proceeding for the paid portion of such tax is pending. If the IRS does begin such a collection proceeding, the anti-injunction provisions of Code Sec. 7421 do not apply and the court with jurisdiction over the refund proceeding may enjoin the collection proceeding.

This prohibition does not apply to a proceeding that is a counterclaim or to a proceeding related to the refund proceeding ( Code Sec. 6331(i)(4)). The Conference Report to P.L. 105-206 (see ¶38,185.0172) states that a proceeding related to a refund proceeding includes, but is not limited to, civil actions brought by the United States or another person with respect to the same type of tax (or related taxes or penalties) for the same (or overlapping) tax periods. Thus, the IRS may counterclaim against the taxpayer for the balance of the unpaid tax or may initiate an action against other persons assessed for trust fund recovery penalties for the same employment taxes.

Further, the levy prohibition only applies to tax periods that are the subject of the tax refund suit. In Unico Services, Inc., FedCl, 2006-1 USTC ¶50,321, at ¶38,187.221, a corporation was not entitled to an injunction to prevent collection for tax periods that were not the subject of the refund claim. The tax periods for which the corporation claimed a refund were different from the tax periods for which the IRS issued a notice of intent to levy. Since the tax liabilities of the non-suit tax periods were not the subject of the corporation's refund claim, the IRS was not prohibited under Code Sec. 6331(i)(1) from collecting by levy the corporation's unpaid employment tax liabilities for those periods.

Statute of limitations on collections suspended. The 10-year period of limitations on collection of delinquent taxes after assessment ( Code Sec. 6502) is suspended during the pendency of a refund proceeding during which the IRS is prohibited from collecting by levy ( Code Sec. 6331(i)(5)).

Notice of Federal Tax Lien. Code Sec. 6331(i) does not prevent the IRS from filing a Notice of Federal Tax Lien, according to the Conference Committee Report to P.L. 105-206 (see ¶38,185.017

Stay of collection. --Failure to Collect and Pay Over Tax, or Attempt to Evade or Defeat Tax: Stay of collection

An individual's appeal of the stay of his refund claim was properly suspended pending the resolution of a later-filed action by the government. Although the taxpayer properly invoked the refund jurisdiction of the U.S. Court of Federal Claims, the court exercised its discretion to suspend the case in the interest of efficient case management because the later-filed action would resolve the entire matter for all parties. Furthermore, the taxpayer's motion to enjoin the IRS from its administrative collection proceeding was dismissed because he had failed to post a bond. Also, the exception to the Anti-Injunction Act that restricts IRS collection procedures did not apply.

R. Klein, CA-FC (unpublished opinion), 95-2 USTC ¶50,376.

The bond and sureties requirements of Reg. §301.7101-1 will apply to stay the collection of unpaid employment and excise taxes and relief is available from the 100% penalty if such a bond is furnished within 30 days after the date of notice and demand for payment of the penalty.

Rev. Rul. 79-170, 1979-1 CB 437.

An individual's motion for a stay on a levy imposed by the IRS on his wages to collect outstanding trust fund recovery penalties was prohibited by the Anti-Injunction Act. He either failed to invoke any of the statutory exceptions to the Act or the exceptions did not cover the penalties at issue. Moreover, the IRS was not prohibited from imposing a levy to collect the penalties because the individual had not paid any amount and did not post any bond within thirty days of receiving the notice that penalties were assessed against him.

Q. Bullard, DC Md., 2007-1 USTC ¶50,245, 486 FSupp2d 512.

An individual's action seeking refund of money paid in partial satisfaction of a trust fund recovery penalty was not suspended pending completion of a collection action subsequently filed by the government in the U.S. district court against the individual and another responsible person. The government's request to suspend the refund proceedings on the grounds of judicial efficiency was rejected in light of the individual's theory of non-liability and her right to choose the forum in which to litigate the refund claim. The nature of the individual's claim was such that if she succeeded, she would have demonstrated that the failure to pay the withheld taxes was not willful and arose at the firm level.

J.A. Rineer, FedCl, 2008-1 USTC ¶50,119.

Labels:

Friday, July 17, 2009

This taxpayer would not go to gail if he voluntarily filed tax returns and will not make any false statements in his tax return. Unfortunately, this person did not seek competent tax advice.

United States of America v. Leroy M. Bennett, Appellant.

U.S. Court of Appeals, 3rd Circuit; 08-1849, July 8, 2009.

. --
An individual was properly convicted and sentenced for willfully failing to file federal income tax returns. The government's calculation of the tax loss caused by his violations was consistent with the sentencing guidelines. Contrary to the individual's argument, forms containing withholding information that were submitted to the IRS by the individual's employers did not make filing income tax returns voluntary. The forms could not be considered to be returns since the information on the forms was insufficient for tax-computation purposes. The government was not required to prove that the individual had actual knowledge of the specific provision of the Tax Code he was violating. The individual was aware of his duty to pay taxes and file proper returns because he had paid taxes for nearly two decades before he stopped filing. The individual's contention that the Paperwork Reduction Act (PRA) of 1980 provides a good faith defense to a charge of willful failure to file tax returns was without merit. The PRA has no effect on the IRS's ability to penalize taxpayers for failing to provide a complete and transparent report of their income, and did not prevent the individual from being prosecuted for failure to file tax returns. s.


OPINION


AMBRO, Circuit Judge: Leroy M. Bennett appeals his conviction for five counts of willfully failing to file federal income tax returns for tax years 2000 through 2004, in violation of 26 U.S.C. § 7203. 1 For the following reasons, we affirm the District Court's judgment.

Because we write solely for the parties, we recount only the facts relevant to our analysis. In 1995, Bennett, a Pennsylvania resident, stopped filing federal income taxes on various grounds, including that taxes were voluntary, could not apply to his income, and could not be collected by the Internal Revenue Service ("IRS"). The IRS began calculating Bennett's tax liability using the withholding information reported on W-2 forms submitted by his employers (General Electric Company through 2002, and Wal-Mart Stores Inc. beginning in 2004). Despite the withholdings, Bennett owed the IRS money each year. The IRS told Bennett that it would begin levying against assets if he refused to pay his taxes. He responded by filing bankruptcy when the IRS tried to garnish his wages and, to reduce withholdings, claiming many more exemptions than applied to him. The IRS eventually threatened Bennett with criminal sanctions, and in 2006 and 2007 he finally filed 12 years of tax returns for tax years 1995 through 2006. In them, Bennett claimed that the IRS owed him almost $350,000, even though his employers withheld much less than that over those years.

In August 2007, Bennett was indicted by a grand jury in the Western District of Pennsylvania on five counts of § 7203 violations, and in December 2007 a jury found him guilty of all five counts. Bennett was sentenced to 21 months' imprisonment and one year supervised release, which was the lower end of the advisory Sentencing Guidelines range, U.S.S.G. §§ 2T1.1 & 2T4.1, calculated by taking into account Bennett's $80,000 owed in back taxes to the IRS.

On appeal, Bennett argues that: (1) because his employers filed W-2 forms with the IRS on his behalf, his filing of income tax returns was voluntary and therefore the District Court lacked subject matter jurisdiction over the charges; (2) the Paper Reduction Act of 1995 ("PRA") provides a complete or "good faith" defense to a charge of willfully failing to file an income tax Form 1040; (3) the Government was required to show that he had knowledge of the specific provision he was alleged to have violated to meet its burden of proof; and (4) it was error to include tax years 2000 through 2004 in calculating the amount of tax loss caused by his crime for sentencing purposes. 2

The crime charged here has three elements: (1) the duty or requirement to file a tax return; (2) failure to file the return; and (3) willfulness. See United States v. McKee, 506 F.3d 225, 244 (3d Cir. 2007) (citing United States v. Foster, 789 F.2d 457, 460 (7th Cir. 1986)). Bennett's first claim --that the W-4 forms he completed for his employers, and the W-2 forms that his employers submitted to the IRS, made filing income tax returns voluntary --goes to the "duty" element of the offense. This argument has been rejected by us and other courts of appeals. In Bachner v. Commissioner, 81 F.3d 1274, 1280 (3d Cir. 1996), we held that information on the W-2 form is not independently sufficient for tax-computation purposes, as it "fail[s] to provide facts addressed to or determinative of other potential liabilities and therefore [is] not sufficient to be considered a 'return.'" See also Kartrude v. Commissioner, 925 F.2d 1379, 1384 (11th Cir. 1991); United States v. Birkenstock, 823 F.2d 1026, 1030 (7th Cir. 1987); United States v. Rickman, 638 F.2d 182 (10th Cir.1980). Bennett cites United States v. Patridge, 507 F.3d 1092 (7th Cir. 2007), as support for this contention. However, the portion of the decision he cites relates to his PRA claim, not to whether he had an independent duty to file. We therefore turn to Bennett's PRA argument.

The Court in Patridge stated that "the obligation to file a tax return stems from 26 U.S.C. § 7203," and the PRA does not "change any substantive obligation" or repeal § 7203. Id. at 1094-95. Bennett claims that, despite this, the PRA provides a complete or "good faith" defense to a charge of willfully failing to file income tax returns because Form 1040 does not comply with the PRA requirements. The Government points out that this argument was soundly rejected in Miller-Wagenknecht v. Commissioner, 285 F. App'x 956 (3d Cir. 2008), and in Barzeski v. Commissioner, 173 F. App'x 175 (3d Cir. 2006). Because these decisions are not precedential, we do not rely on them. That does not mean we come out any differently, however. The obligation to file federal income tax returns stems from a Congressional statute, while the PRA applies to agency regulations, and thus the PRA has no effect on the IRS's ability to penalize taxpayers for failing to provide a complete and candid report of their income. See Patridge, 507 F.3d at 1095; United States v. Hicks, 947 F.2d 1356, 1359 (9th Cir. 1991). Additionally, it is well established that Form 1040 bears the necessary control number and expiration date to be in compliance with the PRA. See Patridge, 507 F.3d at 1095; United States v. Dawes, 951 F.2d 1189, 1193 (10th Cir. 1991).

Bennett also contends that the Tenth Circuit's decisions in United States v. Chisum, 502 F.3d 1092 (10th Cir. 2007), and Pond v. Commissioner, 211 F. App'x 749 (10th Cir. 2007), support his claim that the PRA provides a defense to failure to file income taxes. There the Court held that the PRA was not implicated where a taxpayer had filed false returns because it "protects a person only for failing to file information," Chisum, 502 F.3d at 1243-44, and that tax forms are collection requests within the meaning of the PRA, see Pond, 211 F. App'x at 752. The problem at the outset for Bennett is that the most recent Tenth Circuit decision on this issue is Lewis v. Commissioner, 523 F.3d 1272 (10th Cir. 2008). It clarified Chisum and Pond; Chisum "should not be read to support an argument that the PRA ultimately protects individuals who fail to file tax information," and Pond simply "declined to address the argument that [Form 1040] violated the PRA because the defendant had not included any of the forms in the record," and "even affirmed the district court's dismissal of the PRA claims as frivolous." Id. at 1275 nn.4-5. After reviewing Lewis' arguments, which were comparable to those Bennett presents on appeal, the Tenth Circuit's decision confirmed that they lacked sufficient merit and held that Form 1040 satisfies the PRA requirements. Id. at 1277.

Bennett next claims that, to satisfy its burden of proof regarding the "willfulness" element of his crime, the Government was required to prove that he had actual knowledge of the specific provision of the Tax Code he was violating. He cites Bryan v. United States, 524 U.S. 184 (1998), arguing that it requires the Government to prove he was aware of the "specific provision of the Tax Code he was charged with violating." Id. at 194. But Bennett fails to acknowledge that (1) Bryan involved a firearms violation, and thus the Court's statement regarding the Tax Code could not possibly have been its holding; 3 (2) the Bryan Court specifically noted that the reason for requiring actual knowledge was that certain tax cases involve "highly technical statutes that present ... the danger of ensnaring individuals engaged in apparently innocent conduct"; and (3) the Court further noted that, "[e]ven in tax cases, we have not always required this heightened mens rea." Id. at 194 & n.17. A heightened mens rea was not required here. Bennett paid taxes for at least 20 years before he stopped filing. That he did so makes plain he knew of his duty to pay taxes and file proper tax returns, and no technical "ensnaring" appears even remotely plausible.

Finally, Bennett challenges the District Court's inclusion of tax years 2000 through 2004 in its calculation of the amount of tax loss caused by his violations. This argument is an extension of his first claim, as he asserts that because his employers timely and accurately filed W-2s on his behalf for these years, his income was therefore "reported" and should not be used to enhance his sentence under tax loss. Just as Bennett's underlying claim fails, so too does its sentencing corollary. The Government's calculation of the tax loss caused by Bennett's violations was consistent with the Sentencing Guidelines set out in U.S.S.G. §§ 2T1.1 & 2T4.1. Indeed, its conclusion that Bennett owed approximately $80,000 in back taxes was actually a conservative estimate. 4 We note that Bennett was sentenced to 21 months' imprisonment and one year supervised release, a sentence at the bottom of the advisory Guidelines range of 21 to 27 months for Bennett's offense level of 16 (his criminal history category is I). 5

* * * * *

For these reasons we affirm the judgment of the District Court.

1 The District Court had jurisdiction under 18 U.S.C. § 3231. We have appellate jurisdiction under 18 U.S.C. § 3742(a) and 28 U.S.C. § 1291.

2 Our review of a district court's subject matter jurisdiction is de novo. See Pontarelli v. U.S. Dep't of the Treas., 285 F.3d 216, 219 (3d Cir. 2002) (citing In re Phar-Mor, Inc. Sec. Litig., 172 F.3d 270, 273 (3d Cir. 1999)). We exercise plenary review over the legal findings of a district court, including its interpretation of federal income tax statutes, see In re CM Holdings, Inc., 301 F.3d 96, 101 n.3 (3d Cir. 2002) (citing ACM Partnership v. Commissioner, 157 F.3d 231, 245 (3d Cir. 1998)), and we apply a plain error standard to alleged sentencing errors raised for the first time on appeal. See United States v. Russell, 564 F.3d 200, 203 (3d Cir. 2009) (citing United States v. Lloyd, 469 F.3d 319, 320 (3d Cir. 2006)).

3 See United States v. Cavins, 543 F.3d 456, 458-59 (8th Cir. 2008) (characterizing the language from Bryan regarding the Tax Code as dictum).

4 The Government gave Bennett the standard deductions he could have claimed had he actually filed his tax returns, but the majority of the courts of appeals do not require this. See, e.g., United States v. Delfino, 510 F.3d 468, 473 (4th Cir. 2007) (holding that the Government is not required to include a taxpayer's deductions in its calculation of the amount of tax loss under U.S.S.G. § 2T1.1); United States v. Chavin, 316 F.3d 666, 679 (7th Cir. 2002) (rejecting the inclusion of deductions); United States v. Spencer, 178 F.3d 1365, 1368 (10th Cir. 1999) (rejecting the interpretation of the statute as "giving taxpayers a second opportunity to claim deductions after having been convicted of tax fraud"). But see United States v. Gordon, 291 F.3d 181, 187 (2d Cir. 2002) (concluding that § 2T1.1(c)(1)(A) requires the calculation of deductions).

5 We note that, while we agree with the Government that Bennett's arguments on appeal are unpersuasive, the language used in its brief to us is often too cute for cricket. Whatever the legal merit of his claims, Bennett takes them seriously enough to go to jail for nearly two years. The Government should be equally serious.

Labels:

Wednesday, July 15, 2009

Business expense deductions claimed by a married couple were denied for combination business and pleasure travel because the taxpayers failed to show how much time was spent on each trip for business and for pleasure and, therefore, did not establish that a trip's primary purpose was for business. The taxpayers also failed to show which expenses were properly allocable to business-related activities. The couple's business expense deductions for rent paid by the wife's business for office space in the couple's home were improper because there was no proof of a bona fide rental agreement and the purported rental was not at arm's length.


A married couple was denied deductions for cash contributions made in amounts less than $250.00, because they provided no canceled checks or other reliable evidence of the amount paid or the recipient of the donations.



A married couple was denied deductions for business expenses and charitable contributions, which resulted in a substantial underpayment of income tax. The accuracy-related penalty under Code Sec. 6662(a) was properly imposed because the IRS met its burden of production by showing there was a substantial understatement of income tax and the couple failed to show that they acted with reasonable cause and in good faith. At trial, they admitted to incorrectly deducting personal items as business expenses, such as travel with relatives and personal use of business products, and they deducted rental expenses for a home office, even though there was no written rental agreement and the area was used to watch TV and relax.


Leland B. and Brenda J. Bruns v. Commissioner.

Dkt. No. 6881-07 , TC Memo. 2009-168, July 14, 2009.



[ Code Sec. 162]



MEMORANDUM FINDINGS OF FACT AND OPINION



VASQUEZ, Judge: Respondent determined a $10,695 deficiency in and a $2,139 section 6662(a) 1 penalty on petitioners' 2003 Federal income tax. The issues for decision are: (1) Whether petitioners are entitled to deductions claimed; and (2) whether petitioners are liable for the accuracy-related penalty under section 6662(a).





FINDINGS OF FACT



Some of the facts have been stipulated and are so found. The stipulation of facts, the supplemental stipulation of facts, and the attached exhibits are incorporated herein by this reference. At the time they filed the petition, petitioners resided in South Dakota.



Petitioner Brenda Bruns (Mrs. Bruns), Joetta Swanhorst (Mrs. Bruns's mother), and Heather Mitzel (petitioners' daughter) are the partners of ABS Associates (ABS). 2 Mrs. Bruns is entitled to 100 percent of the profits and losses of ABS. Petitioner Leland Bruns (Mr. Bruns) is not a partner of ABS.



ABS is an independent distributor of Shaklee Corp. (Shaklee), which produces nutritional and cleaning products. The Shaklee business model allows distributors of products to earn income in three ways: (1) Distributors earn income from purchasing Shaklee products at a wholesale price and reselling them at a higher price; (2) distributors are paid commissions on the purchases of distributors in their group; 3 and (3) distributors receive bonuses on the purchases of leaders they develop. Leaders are distributors who generate sales of $2,000 per month or more. ABS is a leader, has developed 12 leaders, and has approximately 500 to 600 customers, not counting the customers of other distributors or leaders that ABS trained.



ABS holds customer meetings to look for potential distributors. In the lower level of petitioners' personal residence, petitioners keep a small inventory of Shaklee products, equipment, and sales aides used in training and development. Customers and distributors come to the lower level of petitioners' home to get products and receive coaching.



During 2003 ABS earned $77,547 from its activities related to the distribution of Shaklee products. 4 On Form 1065, U.S. Return of Partnership Income, ABS reported gross income of $78,570 and net income of $60,570 after taking an $18,000 deduction for rent paid. All income from ABS was distributed to Mrs. Bruns, and she reported this income on petitioners' 2003 Form 1040, U.S. Individual Income Tax Return.




Schedule C Expenses


On petitioners' Schedule C, Profit or Loss From Business, attached to their 2003 Form 1040, petitioners claimed expenses of $44,975 paid during 2003, which resulted from Mrs. Bruns' work for ABS in the distribution and sale of Shaklee products. Petitioners were issued a notice of deficiency that disallowed some of the expenses claimed on that Schedule C. The following is a table of reported expenses, the amount of each expense allowed after examination, and the amount disallowed:





Amount
Item Claimed Allowed Disallowed

Advertising $4,854 $1,361 $3,493

Car and truck
expenses 2,238 798 1,440

Commissions and fees 495 495 --

Contract labor 1,490 -- 1,490

Depreciation 1,500 1,500 --

Insurance 47 47 --

Other interest 101 101 --

Legal and
professional services 679 679 --

Business (office)
expenses 9,545 1,331 8,214

Rent or lease
--vehicle, machinery,
and equipment 5,968 3,647 2,321

Taxes and licenses 635 635 --

Travel 4,253 2,526 1,727

Meals and
entertainment 2,582 1,192 1,390

Other expenses 1 10,588 8,588 2 2,000

Total 44,975 22,900 22,075

1 This amount is the total of the following claimed business
expenses: Freight postage expenses of $988, business phone
expenses of $4,684, cleaning expenses of $175, books/publications
subscription expenses of $304, meeting expenses of $952, sales
aids expenses of $1,390, bank charge expenses of $95, and image
expense of $2,000.

2 This disallowed amount is the complete disallowance of
petitioners' claimed "image" expense of $2,000.






1. Advertising Expenses


Petitioners claimed deductions for advertising expenses of $4,854; respondent allowed $1,361 and disallowed $3,493. The $1,361 deduction allowed includes $500 respondent determined petitioners were entitled to for advertising-related gifts worth $25 apiece to 20 individuals.



Shaklee leaves advertising up to distributors and does not advertise or market its products. ABS does not advertise in the phonebook or on the Internet; instead, Mrs. Bruns goes out and meets customers' families and friends to sell Shaklee products. She then rewards customers who go out and talk up the product, who have provided consistent business or increased their volume of products sold, and who have been willing to introduce her to their families and friends. As a reward Mrs. Bruns will give books, movies, cards, jewelry, flowers, and food. Mrs. Bruns' reward criteria are that the person be a good referral source, love the products, and be a consistent customer. Petitioners provided photocopies of receipts for gifts purchased by Mrs. Bruns and substantiated gifts to 26 individuals.



Additionally, ABS paid to have newsletters, flyers, and pictures printed. Mrs. Bruns took pictures at Shaklee-related meetings and when she met with different groups of Shaklee customers, distributors, and leaders. She then sent the photos over the Internet and used them in presentations to show sales leaders' achievements with their group members. Petitioners submitted photocopies of receipts and invoices from Harold's Photo Centers, Office Max, Vista Print, and Express Copy & Printing for copies, a Nikon camera with accessories, photo development costs, and shipping labels. The receipts total $699.13. The camera purchased by ABS is used only for taking pictures of customers and has never been used by petitioners for personal purposes.




2. Car and Truck Expenses


Mrs. Bruns drove a passenger vehicle to and from activities related to the distribution and sale of Shaklee products. Petitioners claimed deductions for car-related expenses of $2,238; respondent allowed $798 and disallowed $1,440.



Petitioners submitted photocopies of gasoline receipts, carwash receipts, and car repair/maintenance invoices and receipts. The gasoline receipts total $1,132.49, the carwash receipts total $115.20, and the car repair/maintenance invoices and receipts total $102.84.




3. Contract Labor Expenses


Petitioners claimed deductions for contract labor expenses of $1,490, and respondent disallowed the full amount. At trial petitioners conceded they are entitled only to a $910 deduction for contract labor.



To substantiate the expenses for contract labor, petitioners submitted a Quicken printout that showed payments totaling $1,489.66 made to Robin Berg on numerous occasions, Cournie Gunderson on 1/14/03, Michelle Bruns on 2/1/03, Robin Ramsey on 3/21/03, Richie Clary on 4/16/03, and Brandon Carpet Cleaning on 11/15/03. Petitioners hired Robin Berg to clean their office and living space. No invoices or canceled checks were submitted to prove payment of contract labor expenses.




4. Business Expenses


Petitioners claimed deductions for business expenses of $9,545 incurred by Mrs. Bruns in distributing and selling Shaklee products; respondent allowed $1,331 and disallowed $8,214.



Petitioners submitted photocopies of receipts totaling $7,619.17 to substantiate their claimed business expenses of $9,545. Petitioners submitted receipts for furniture, a portable CD player with speakers, supplies, refreshments, and decorations used by Mrs. Bruns in her role as a Shaklee salesperson. The furniture receipts were for display cases, storage and file cabinets, a table, a rubber floor cover, and a chair. There was a receipt for a portable CD player with speakers Mrs. Bruns used for training herself and others about Shaklee products when at home and when traveling. The supplies receipts were for pens, paper, tape, printing costs, and various other items. Petitioners also submitted receipts for refreshments, such as coffee and candy that Mrs. Bruns offered to customers, and receipts for seasonal decorations Mrs. Bruns put up in the space she devoted to meeting with customers and displaying Shaklee products.



Although Mrs. Bruns often delivers Shaklee products to customers and meets with Shaklee distributors and leaders at restaurants, she does have customers, distributors, and leaders stop by her home. She maintains and displays a small inventory of Shaklee products in her home, and she receives and stores Shaklee products ordered by customers. Further, Mrs. Bruns keeps a desk and file cabinets which store Shaklee distribution and sales information. In another cabinet she stores Shaklee training tapes, CDs, and sales aids. Adjacent to that cabinet is a table used for customer appointments and business planning with distributors and leaders.




5. Rent or Lease --Vehicle, Machinery, and Equipment


Petitioners claimed and deducted vehicle leasing expenses of $5,968; respondent allowed $3,647 and disallowed $2,321. As a result of ABS' high volume of sales in 2003, ABS qualified for and participated in a car bonus program where ABS selected a car from Shaklee's lease program.



Petitioners submitted monthly statements issued by Shaklee to ABS from December 2002 through November 2003. On each statement ABS earned a monthly $400 car bonus credit and incurred a monthly lease charge of $702.21 and a monthly insurance charge of $88.20. ABS paid these charges in advance (i.e., in December 2002, ABS made lease payments for January 2003).



ABS' participation in the Shaklee bonus program resulted in a monthly car lease and insurance cost of $790.41 to ABS at a yearly cost of $9,484.92. This amount was subtracted from the direct deposit to ABS from Shaklee each month after the $400 car bonus was added as earnings. If ABS had not participated in Shaklee's car leasing program, ABS would have received $400 per month in cash.



Petitioners drove two other vehicles in addition to the ABS car and reported having occasionally driven the ABS car for unrelated business matters. The ABS car was driven a total of 23,550 miles in 2003 and the total number of business miles petitioners claimed the car was driven in 2003 was 18,755. Mrs. Bruns calculated 79 percent business use for the car.



Petitioners submitted a 2003 mileage log, a 2003 daily planner, and a list of abbreviations used in the mileage log and the daily planner. The mileage log lists the destination to which Mrs. Bruns drove, the person Mrs. Bruns met with, the miles driven to arrive at the location, and an abbreviation of the business purpose for the meeting. The business purposes stated included leaving information (such as literature or CDs), conducting a demonstration of products, delivering products, orienting new members, and conducting an overview of business with distributors and sales leaders. The mileage log reported 18,242 miles traveled for 2003 but failed to list the business purpose for 1,266 of the reported miles traveled.




6. Travel Expenses


Petitioners claimed deductions for travel expenses of $4,253; respondent allowed $2,526 and disallowed $1,727. Petitioners' Quicken printout reported travel expenses of $2,770.16. To substantiate the travel expenses, petitioners provided photocopies of receipts from hotel stays and a receipt from a travel agency. Because ABS has no territorial limitations, many of its customers are in States other than South Dakota. Petitioners wrote on the top of each photocopied receipt the purpose for the trip. The total of the photocopied receipts is $2,464.60. However, some of the receipts were missing a date, and one receipt was in Mr. Bruns' name.



Respondent disallowed expense deductions for a trip for petitioners to see Kim and Mike Bruns, relatives and distributors for ABS. Respondent disallowed expense deductions for a trip to see Mrs. Bruns' mother, Joetta Swanhorst, a "bonus earner" for ABS who lives in a retirement community in Aberdeen, South Dakota. Petitioners seek to deduct the cost of a three-night hotel stay in Aberdeen, South Dakota. Respondent disallowed expense deductions for a trip to meet with Lori Kimball, a "bonus earner" for ABS who lives in Minnesota. Petitioners stayed in a hotel near her to spend time with her while they were in Minneapolis and provided a photocopy of a hotel receipt for $168.36 for two nights. Respondent disallowed expenses incurred in petitioners' overnight stay at the Radisson Encore Hotel on December 26, 2003. It was an "award bonus weekend" where petitioners stayed with six other persons, including petitioners' daughter, and shared with them the possible business opportunities in distributing Shaklee products. ABS paid for petitioners' and their daughter's rooms. Petitioners provided photocopies of their receipts for two rooms at the rate of $80.66 per night for staying overnight on December 26, 2003.



Petitioners claimed a deduction of $144.15 for luggage used to carry Shaklee samples and supplies and submitted as substantiation a receipt that was missing the date of purchase and had no description of the item.



Petitioners claimed a deduction of $201.40 for a handbag and a coin purse used to carry sales cards, name tags, and business cards. Petitioners provided photocopies of two receipts for $71.02 and $130.38; neither receipt contained a description of the items purchased.




7. Meals and Entertainment Expenses


Petitioners claimed a deduction of $2,582 5 for meals and entertainment expenses in 2003; respondent allowed $1,192 and disallowed $1,390. At trial Mrs. Bruns conceded that petitioners were entitled to a deduction of only $2,195 because she had realized her husband was not a partner of ABS and his meals were not deductible.



To substantiate the meals and entertainment expense deductions, petitioners submitted photocopies of receipts from restaurants and grocery stores and a list of abbreviations used by Mrs. Bruns to reference the purpose of the meal. At the top of most of the receipts, Mrs. Bruns wrote a specific business purpose for incurring the expense. The business purposes included trips into Sioux Falls for Shaklee sales-related errands, nutrition talks, catalog presentations, leaving literature, business meetings with other Shaklee groups or leaders, product delivery or exchanges, bookkeeping, Shaklee products opportunity meetings (to attract new distributors), member orientations, appreciation of members, and delivering voice CDs about Shaklee products and about becoming a Shaklee distributor.



The receipts petitioners submitted total $3,429.58. However, many of the receipts did not show proof of payment, lacked the date, or did not have a specific business purpose listed for the expense.



Some of the receipts from restaurants were for meals costing less than $10. Mrs. Bruns admitted one of the receipts for a meal costing $9.60 was only for her meal although she did have the meal with a customer.




8. Other Expenses


Petitioners claimed deductions for other expenses of $10,588. Respondent disallowed an expense of $2,000 that petitioners incurred for "image". 6 Mrs. Bruns explained that the expense for product promotion reflected the cost of various products that she took from the inventory of ABS after it purchased them from Shaklee and that Mrs. Bruns personally tried, let others try, or gave away at gatherings. Mrs. Bruns personally tried new products to see whether she believed in the product and to figure out a way to promote it. Mrs. Bruns admitted some of the products were used for her personal care.



In substantiating the claimed product promotion expense, petitioners submitted two invoices listing the product, the quantity, and the price of the item used for product promotion. The invoices showed that petitioners had used $6,822.24 in products. However, Mrs. Bruns asked the Court to disregard $1,124.76 worth of products listed on the invoice because they had been used for personal care. Petitioners claimed a deduction for product promotion after taking certain numbers from the two invoices and rounding the number to $2,000. In picking which items were used for personal care and which were used as demo products, Mrs. Bruns made an educated guess.




Schedule E Expenses


On Schedule E, Supplemental Income and Loss, petitioners reported $18,000 of alleged rents received from ABS and related expenses of $3,471. The notice of deficiency disregarded the alleged rental agreement, decreased rents received by $18,000, and disallowed expenses claimed of $3,471. The notice of deficiency increased petitioners' other income by $18,000 to reflect the disregarded rental agreement. In disregarding the alleged rental of petitioners' home to ABS, the income of the partnership was increased by $18,000. Since Mrs. Bruns was entitled to 100 percent of the partnership's income and expenses, her income from the partnership was increased by $18,000 in 2003.



ABS allegedly leased premises owned by petitioners for $1,500 a month. Petitioners and ABS had a month-to-month oral agreement in 2003, and ABS allegedly had leased space from petitioners for 13 or 14 years. ABS wrote monthly rent checks to Mr. Bruns. To substantiate this expense, petitioners submitted photocopies of checks written to Leland Bruns on or around the 15th of every month for the year 2003.



On the Schedule E for 2003, petitioners claimed expenses of $3,471 arising from the leasing arrangement. The expenses were as follows: Insurance $358, taxes $1,092, utilities $1,150, and depreciation $871. The insurance, taxes, and utilities expenses were calculated by multiplying the annual amount for the house by 40 percent, the approximate percentage of the lease space ABS occupied in the house.



Petitioners established the monthly rent charged to ABS by visiting spaces in the community that were smaller than the space ABS rented from petitioners. The rents of the smaller spaces were approximately $9 to $13 per square foot. Petitioners measured the area ABS leased to be approximately 1,400 square feet and charged a little over $1 per square foot.



In the space ABS allegedly rented there is a meeting space and a working area. In the meeting area there is a TV for presentations, and it is connected to cable. There is no door or lock which separates the area used by ABS from the other part of the house. ABS allegedly uses the space for Mrs. Bruns to meet with clients, hold meetings, and sell products. However, Mr. Bruns and Mrs. Bruns occasionally watch entertainment shows, sports, and news on the television in the meeting area. Mr. Bruns has access to the meeting area.




Schedule A Deductions


On Schedule A, Itemized Deductions, petitioners claimed itemized deductions totaling $9,793 for taxes paid, gifts to charity, tax preparation fees, and safe deposit expenses. Petitioners claimed a deduction of $7,353 for alleged gifts to charity. The notice of deficiency disallowed $945 of the claimed gifts to charity. After a concession by petitioners of $51.02, $893.98 of claimed gifts to charity remains in dispute.



The standard deduction for petitioners in 2003 was $9,500. The itemized deductions allowed in the notice of deficiency do not exceed the standard deduction to which petitioners are entitled. Accordingly, the notice of deficiency allowed the standard deduction.



To substantiate the disallowed gifts to charity, petitioners submitted a letter from their church, Abiding Savior Free Lutheran Church, stating that they had donated a baking rack in November of 2003 and an invoice from Furniture Discounters stating they had paid $423.98 for a new baking rack to be delivered to their church.



Petitioners also claimed cash gifts of $470 made in 2003. Petitioners allegedly made these donations in amounts of $20 or $30 at miscellaneous events that occurred throughout the year to various organizations that asked Mr. or Mrs. Bruns for a donation. Petitioners did not provide any substantiation for the additional $470 cash donations claimed.





OPINION




I. Burden of Proof


In pertinent part, Rule 142(a)(1) provides, as a general rule: "The burden of proof shall be upon the petitioner". However, section 7491(a) places the burden of proof on the Commissioner with regard to certain factual issues. Petitioners have alleged section 7491(a) applies, and respondent bears the burden of proof. However, the burden of proof is inconsequential to the outcome of this case.




II. Deficiency


The Commissioner's determinations are generally presumed correct, and the taxpayer bears the burden of proving the determinations erroneous. Rule 142(a). The taxpayer bears the burden of proving that he is entitled to the deduction claimed, and this includes the burden of substantiation. Id.; Hradesky v. Commissioner, 65 T.C. 87, 90 (1975), affd. per curiam 540 F.2d 821 (5th Cir. 1976). A taxpayer must substantiate amounts claimed as deductions by maintaining the records necessary to establish he or she is entitled to the deductions. Sec. 6001.



Section 162(a) provides a deduction for certain business-related expenses. In order to qualify for the deduction under section 162(a), "an item must (1) be 'paid or incurred during the taxable year,' (2) be for 'carrying on any trade or business,' (3) be an 'expense,' (4) be a 'necessary' expense, and (5) be an 'ordinary' expense." Commissioner v. Lincoln Sav. & Loan Association, 403 U.S. 345, 352 (1971); see also Commissioner v. Tellier, 383 U.S. 687, 689 (1966) (the term "necessary" imposes "only the minimal requirement that the expense be 'appropriate and helpful' for 'the development of the [taxpayer's] business" (quoting Welch v. Helvering, 290 U.S. 111, 113 (1933))); Deputy v. du Pont, 308 U.S. 488, 495 (1940) (to qualify as "ordinary", the expense must relate to a transaction "of common or frequent occurrence in the type of the business involved"). Whether an expense is ordinary is determined by time, place, and circumstance. Welch v. Helvering, supra at 113-114. Respondent has not challenged the existence of ABS' Shaklee distributorship as a business and Mrs. Bruns' related activities in distributing and selling Shaklee products.



If a taxpayer establishes that he or she paid or incurred a deductible business expense but does not establish the amount of the expense, we may approximate the amount of the allowable deduction, bearing heavily against the taxpayer whose inexactitude is of his or her own making. Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930). However, for the Cohan rule to apply, there must be sufficient evidence in the record to provide a basis for the estimate. Vanicek v. Commissioner, 85 T.C. 731, 743 (1985). Certain expenses may not be estimated because of the strict substantiation requirements of section 274(d). See sec. 280F(d)(4)(A); Sanford v. Commissioner, 50 T.C. 823, 827 (1968), affd. per curiam 412 F.2d 201 (2d Cir. 1969).



A. Schedule C Expenses



1. Advertising Expenses



In general, advertising expenses to promote a taxpayer's trade or business are deductible pursuant to section 162(a). Brallier v. Commissioner, T.C. Memo. 1986-42; sec. 1.162-1(a), Income Tax Regs. Petitioners claimed advertising expenses of purchasing gifts for selected customers, printing a newsletter, and the purchase of a camera.



a. Gift Expenses



The cost of gifts may be an ordinary and necessary business expense if the gifts are connected with the taxpayer's opportunity to generate business income. Brown v. Commissioner, T.C. Memo. 1984-120 (finding similarly gifts not connected with taxpayer's opportunity to generate business income where taxpayer, physician employed by hospital, gave out Parker pens as promotional gifts because physician did not depend upon referrals for business); cf. Eder v. Commissioner, a Memorandum Opinion of this Court dated Feb. 10, 1950 (finding gifts were not connected with taxpayer's opportunity to generate business income where taxpayer gave cosmetic sets to office workers employed by someone else and to telephone operators employed by someone else and paid monthly by taxpayer to put through calls and deliver messages). Mrs. Bruns has the burden of proving to what extent the gift items contributed to her income. See Sutter v. Commissioner, 21 T.C. 170, 173-174 (1953).



Business gift deductions pursuant to section 162 are restricted to $25 per donee per taxable year. Sec. 274(b)(1).



Further, section 274(d) requires adequate substantiation. A taxpayer claiming a deduction for a business gift is required to substantiate the gift with adequate records or sufficient evidence corroborating his own testimony as to (1) the cost of the gift; (2) the date and description of the gift; (3) the business purpose of the gift; and (4) the business relationship of the person receiving the gift. Sec. 1.274-5T(b)(5), Temporary Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6, 1985). Respondent allowed petitioners to deduct $25 per donee for gifts to 20 individuals.



Unlike the gifts in the situations in Eder and Brown, the gifts given were connected with opportunities for Mrs. Bruns to generate business. Gifts were given only to customers who were good referral sources, loved the products, and were consistent customers. The referrals and introductions Mrs. Bruns received from the gift recipients were to individuals who were not Shaklee customers. Because of the dependence Mrs. Bruns placed on personal connections and interactions in distributing Shaklee products, these introductions were an important part of building the Shaklee customer base. Accordingly, the gifts given were an ordinary and necessary advertising expense of Mrs. Bruns in selling Shaklee products.



However, petitioners have failed to adequately substantiate every gift expense. Petitioners provided photocopies of receipts for items purchased for the purpose of making gifts, but many of the receipts were illegible as to the amount spent, the date of the purchase, or the item purchased. On the receipts which did contain such information, petitioners consistently failed to note the person to whom the gift was given, and many of the gifts exceeded the $25 restriction imposed by section 274(b). Petitioners have adequately substantiated advertising business gift expenses to 26 individuals and are entitled to a deduction of $650. This exceeds the amount allowed by respondent by $150 as we have allowed a deduction for gifts of $25 to 6 recipients in addition to the 20 recipients previously allowed by respondent.



b. Newsletter and Camera Expenses



Petitioners have not provided the content of the newsletters or information as to how the printing of the newsletters is an ordinary and necessary expense. Accordingly, we cannot allow a deduction for these printing expenses.



Mrs. Bruns received income (as allocated by ABS) in 2003 from the sales of Shaklee distributors and leaders under ABS. Mrs. Bruns stated she was constantly looking for new distributors and coaching distributors on becoming leaders. The photos taken by Mrs. Bruns of Shaklee sales gatherings and distributed among distributors and leaders in her group were a part of this coaching. The camera purchased by Mrs. Bruns was used exclusively for this business purpose. However, the useful life of the camera is greater than 1 year. Accordingly, she must capitalize the cost. See Best Lock Corp. v. Commissioner, 31 T.C. 1217, 1234-1235 (1959) (cost of catalogs with useful life of more than 1 year must be capitalized); Ala. Coca-Cola Bottling Co. v. Commissioner, T.C. Memo. 1969-123 (cost of signs, clocks, and scoreboards with useful lives of more than 1 year must be capitalized). Petitioners are entitled to a $62.15 deduction for the substantiated costs of printing photos and an allowable camera depreciation deduction. These are in addition to the amount respondent allowed.



2. Car and Truck Expenses



Petitioners claimed a deduction for car and truck expenses incurred in 2003 for gasoline, car washes, repairs, and maintenance on the vehicle leased and used for business purposes. Petitioners claimed $2,238; respondent allowed $798 and disallowed $1,440.



Section 162(a) allows a deduction for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. Under that provision, an employee or a self-employed individual may deduct the cost of operating an automobile to the extent that it is used in a trade or business. However, under section 262 no portion of the cost of operating an automobile that is attributable to personal use is deductible.



A passenger vehicle is listed property under section 280F(d)(4). Section 274(d) disallows any deduction with respect to listed property unless the taxpayer adequately substantiates: (1) The amount of the expense, (2) the time and place of the travel or the use of the property, (3) the business purpose of the expense, and (4) the business relationship of the persons using the property.



Mrs. Bruns provided a mileage log that listed the date of travel, the length of the travel, and the business purpose of the travel in a majority of the entries. After totaling the miles recorded for 2003, Mrs. Bruns calculated that she used the car 79 percent of the time for business purposes. 7 Upon recalculation of the business percentage use, we conclude the business percentage use is 72 percent. 8



Petitioners submitted gasoline receipts listing the amount of gasoline purchased, method of payment, and date. The dates on the receipts are consistent with the reported travel in the mileage log; i.e., there are increased gas purchases when the mileage log reports more miles traveled. The gasoline receipts total $1,132.49. Petitioners submitted carwash receipts of $115.20 listing the service provided, the amount, and the date rendered. The car washes are spaced throughout 2003 and are reasonable in amount and frequency. Petitioners submitted receipts of payment totaling $102.84 for repairs and maintenance on the passenger vehicle. The receipts, which are for oil changes, specify Mrs. Bruns' car and are spaced throughout 2003 as the car mileage increased. We conclude petitioners have met their burden of substantiating these actual expenses of operating a vehicle for business purposes and are entitled to a deduction of $972.38 9 in addition to the amount respondent allowed.



3. Contract Labor Expenses



In general, payments made or incurred by a trade or business for personal services rendered are ordinary and necessary business expenses and may be deducted under section 162. Sec. 1.162-7(a), Income Tax Regs. Petitioners failed to provide any proof of payment and did not provide sufficient substantiation to permit a reasonable estimate of contract labor expenses. Accordingly, respondent's complete disallowance of a deduction is sustained.



4. Office Expenses



The cost of materials and supplies consumed and used in operations during a taxable year is generally considered an ordinary and necessary expense of conducting a business or for-profit activity. Sec. 162; sec. 1.162-3, Income Tax Regs. Petitioners submitted photocopies of receipts for business furniture which total $5,106.83 and photocopies of receipts for business supplies, refreshments, and decorations which total $2,512.34.



Petitioners introduced into the record photographs showing the use of the furniture whose costs are claimed as a business expense. The furniture stored business information and Shaklee products kept as inventory or orders and displayed Shaklee products. Although Mrs. Bruns delivered Shaklee products to customers, customers would also stop by her home to pick up products. This required her to devote an area to storing a small inventory of products for sale and those ordered by customers and to displaying Shaklee products for sales. Because leaders and distributors would also stop by her home, Mrs. Bruns had to provide a meeting place and store Shaklee informational tapes, CDs, and sales aids. An area for Mrs. Bruns to coach distributors and leaders was frequently used and helpful to increasing revenue. Further, sales aids and training materials to refer to was helpful to Mrs. Bruns in selling Shaklee products and coaching others on how to successfully sell Shaklee products. Accordingly, the business furniture was an ordinary and necessary business expense of Mrs. Bruns in selling Shaklee products.



Petitioners also claimed an office expense deduction for the purchase of a portable CD player with speakers. Because much of the training Mrs. Bruns received as a Shaklee distributor was done through CDs that she could listen to on a portable CD player while at home or while traveling, the CD player was necessary to sell Shaklee products. However, the receipt petitioners submitted included the purchase of two radios unrelated to the business; we disallow a deduction for those radios.



Mrs. Bruns used the supplies in her business of selling Shaklee products. The total amount spent on business supplies, decorations, and refreshments is not excessive in consideration of her business. The cost of pens, paper, and other office supplies to keep track of products, customer orders, and sales was an ordinary and necessary business expense she incurred selling Shaklee products. Further, offering coffee and candy to customers was helpful to Mrs. Bruns in promoting the sale of Shaklee products when customers visited her. Putting up seasonal decorations in the area of her home where Shaklee customers visited was also helpful to Mrs. Bruns in selling Shaklee products.



Petitioners' business expense receipts for purchases of furniture, supplies, refreshments, and decorations adequately substantiated those purchases. Each receipt was dated and provided the amount spent, a description of the item purchased, and the reason for the purchase. However, because the furniture and the portable CD player with speakers have an expected useful life exceeding 1 year, petitioners may not deduct the full amounts paid as ordinary and necessary business expenses. The costs of the business furniture and the portable CD player with speakers are capital expenses, and petitioners must properly depreciate the property. They are entitled to an allowable depreciation deduction. See sec. 263(a)(1); sec. 1.263(a)-2(a), Income Tax Regs. Petitioners are entitled to an ordinary and necessary business expense deduction of $2,512.34 10 for business supplies, decorations, and refreshments purchased in 2003. The business supplies deduction and the depreciation deductions for the furniture and the CD player are allowed in addition to the amounts respondent already allowed.



5. Rent or Lease --Vehicle, Machinery, and Equipment



Petitioners claimed a deduction of $5,968 for leasing expenses associated with the business vehicle leased by ABS and used by Mrs. Bruns in 2003. Respondent allowed a deduction of $3,647, and $2,321 remains at issue. Car leasing expenses are subject to the section 274(d) strict substantiation requirements (explained supra) because a car is listed property. Sec. 280F(d)(4).



We found that Mrs. Bruns used the leased passenger car 72 percent of the time for business purposes in 2003. The direct deposit reports issued to ABS from Shaklee show a monthly car charge of $790.41. Petitioners have substantiated ABS' car leasing expense of $6,829.14. 11 Accordingly, petitioners are entitled to a deduction for the full amount claimed on their 2003 tax return.



6. Travel Expenses



A deduction is allowed for ordinary and necessary traveling expenses incurred while away from home in the pursuit of a trade or business. Sec. 162(a)(2). If a taxpayer travels to a destination at which he engages in both business and personal activities, the traveling expenses to and from the destination are deductible only if the trip is related primarily to the taxpayer's trade or business. Sec. 1.162-2(b)(1), Income Tax Regs. If the trip is primarily personal, the traveling expenses to and from the destination are not deductible; however, expenses at the location properly allocable to the taxpayer's trade or business are deductible. Id.



Whether a trip is related primarily to the taxpayer's trade or business depends on the facts and circumstances in each case. Sec. 1.162-2(b)(2), Income Tax Regs. An important factor is the amount of time during the trip spent on personal activity compared to the amount of time spent on activities directly relating to the taxpayer's trade or business. Id. If a member of the taxpayer's family accompanies him on a business trip, expenses attributable to the family member are not deductible unless it can be adequately shown that the presence of the family member on the trip has a bona fide business purpose. Sec. 1.162-2(c), Income Tax Regs.



Of the $4,253 petitioners claimed as travel expenses, respondent allowed $2,526 and disallowed $1,727. Respondent disallowed deductions for expenses of trips to see relatives, to visit a friend in Minnesota, and to spend a weekend with petitioners' daughter and with others. Respondent also disallowed deductions for costs of luggage, a handbag, and a coin purse.



Petitioners submitted photocopies of receipts for travel expenses incurred in 2003. The disallowed deductions are for trips having a mixed business and pleasure motivation. Petitioners saw friends and relatives who were customers and distributors of ABS and who earned bonuses for ABS in 2003. Updating these earners about the new Shaklee products and providing coaching on business leadership was business related. Visiting with friends and relatives about matters not related to ABS was for pleasure.



Where a trip has mixed motivations of business and pleasure, the costs of traveling to and from the location are deductible only if the primary purpose of the trip is business. Sec. 1.162-2(b)(1), Income Tax Regs. Petitioners have failed to prove how much time was spent on each trip for business and for pleasure. Without this information we cannot conclude that these trips were primarily for business and must disallow the costs of traveling to and from these locations. Petitioners would be entitled to a deduction for expenses incurred at the location properly allocable to business activities. However, petitioners have failed to provide sufficient information to allow any of the disallowed travel expenses. Petitioners have not shown which expenses are properly allocable to business-related activities.



Petitioners also claimed travel expense deductions for amounts incurred to purchase business luggage. Petitioners failed to provide receipts adequately substantiating these expenses. Accordingly, petitioners are not entitled to a deduction for travel expenses above that allowed by respondent.



7. Meals and Entertainment Expenses



Section 162 permits the deduction of food and beverage expenses incurred by a taxpayer if they are ordinary, necessary, and reasonable expenses incurred by the taxpayer in his business. No deduction is allowed with respect to personal, living, or family expenses. Sec. 262. However, section 162(a) permits the deduction of amounts expended for meals (not lavish or extravagant under the circumstances) when away from home in the pursuit of a trade or business. In the context of section 162(a)(2), a taxpayer's home generally refers to the area of a taxpayer's principal place of employment, whether or not in the vicinity of the taxpayer's personal residence. Daly v. Commissioner, 72 T.C. 190, 195 (1979), affd. 662 F.2d 253 (4th Cir. 1981); Kroll v. Commissioner, 49 T.C. 557, 561-562 (1968). "[I]n the pursuit of a trade or business" has been read to mean: "The exigencies of business rather than the personal conveniences and necessities of the traveler must be the motivating factors." Commissioner v. Flowers, 326 U.S. 465, 474 (1946).



Section 274(a) further restricts the deduction of business food and beverage expenses. Such expenditures must be directly related to the conduct of the taxpayer's trade or business, or associated with the active conduct of the taxpayer's trade or business, to be deductible. Id.



An expenditure is considered associated with the active conduct of the taxpayer's trade or business if the taxpayer establishes that she had a clear business purpose in making the expenditure, such as to obtain new business or to encourage the continuation of an existing business relationship. Sec. 1.274-2(d)(2), Income Tax Regs.



In order to establish a substantial and bona fide business discussion, the taxpayer must show that he actively engaged in a business meeting, negotiation discussion, or other bona fide business transaction, other than entertainment, for the purpose of obtaining income or other specific trade or business benefit. Sec. 1.274-2(d)(3)(i)(A), Income Tax Regs. Additionally, the taxpayer must establish that this business meeting, negotiation, discussion, or transaction was substantial in relation to the entertainment. Id. Entertainment which occurs on the same day as a substantial and bona fide business discussion will be considered to directly precede or follow the discussion. Sec. 1.274-2(d)(3)(ii), Income Tax Regs.



Food and beverage expense deductions are further limited by section 274(k) and (n). No deduction is permitted for food and beverage expenses unless the expense is not lavish or extravagant under the circumstances and the taxpayer is present at the furnishing of such food or beverages. Sec. 274(k). Further, the amount of the deduction that would otherwise be allowed for food and beverage expenses is generally reduced by 50 percent. Sec. 274(n)(1).



Finally, in order to deduct food and beverage expenses, a taxpayer must meet the strict substantiation requirements of section 274(d). To substantiate these expenditures the taxpayer must prove: (a) The amount; (b) the time and date; (c) the place; (d) the business purpose; and (e) the business relationship. Sec. 1.274-5T(b)(3), Temporary Income Tax Regs., 50 Fed. Reg. 46015 (Nov. 6, 1985). The majority of the photocopied receipts and accompanying information petitioners submitted either did not have a sufficient business purpose, were for a personal expense, or otherwise failed to meet the strict substantiation requirements.



Petitioners submitted numerous grocery store receipts as food and beverage expenses with a notation that they were for guests. Petitioners failed to specify the time and date of the entertainment of the guests, the place where they entertained the guests, the business purpose of buying the groceries for the guests, and the business relationship of the guests. Because petitioners have failed to meet the strict substantiation requirements of section 274(d), we cannot allow a deduction for these expenses.



Petitioners submitted receipts for personal meals of both Mr. and Mrs. Bruns. Mr. Bruns was not an employee or partner of ABS or a participant in Mrs. Bruns' activities in distributing Shaklee products. Mrs. Bruns conceded at trial that petitioners were not entitled to a deduction for these expenses.



Many of the receipts for food and beverage expenses were for an amount under $10 and for a single serving of food. Mrs. Bruns admitted a particular receipt for a single serving of food in the amount of $9.60 was only for her meal, but she said she ate with a customer. Expenses for meals are personal and as such nondeductible unless a business purpose can be shown for incurring the expenses, as in the case of expenses incurred away from home in the pursuit of business and not lavish or extravagant under the circumstances. Secs. 262(a), 162(a)(2); Drill v. Commissioner, 8 T.C. 902, 903 (1947); sec. 1.262-1(b)(5), Income Tax Regs.



We conclude petitioners' home, for purposes of section 162(a)(2), was in the Sioux Falls area of South Dakota. Petitioners claimed multiple deductions under $10 in amount for meal expenses Mrs. Bruns incurred when she was not away from home. These are personal expenses and are not deductible. See Drill v. Commissioner, supra. The meal expenses Mrs. Bruns incurred while she was away from home were not lavish or extravagant under the circumstances, were incurred in the pursuit of business, and are deductible. At the top of each receipt submitted to substantiate meal expenses incurred while away from home was a notation explaining Mrs. Bruns' business purpose in being away from home. The majority of the notations referenced a Shaklee convention, and we are persuaded that the exigencies of business prompted Mrs. Bruns to travel away from home and incur these expenses.



After eliminating the aforementioned nondeductible food and beverage expenses petitioners claimed, expenses totaling $1,409.83 remain. These expenses meet the strict substantiation requirements of section 274(d) and are for meals where Mrs. Bruns met with a customer to conduct some form of business for ABS.



A majority of these receipts are for amounts in the range of $15 to $30. Treating customers, distributors, and leaders to a meal is a strategy Mrs. Bruns employed to increase the sale of Shaklee products. Mrs. Bruns used the meals as an opportunity to deliver products to customers, spend time with customers to encourage them to buy more Shaklee products, and discuss potentially starting their own distributorships. She used the meals with distributors and leaders as opportunities to review business strategy in their Shaklee distributorships. These business meals occurred consistently throughout 2003 and were helpful in promoting the sale of Shaklee products by distributors and leaders Mrs. Bruns supervised. Accordingly, we conclude the costs of meals for specific customers, distributors, and leaders were incurred by Mrs. Bruns to increase the sale of Shaklee products by Mrs. Bruns, her distributors, and leaders and were ordinary and necessary business expenses of Mrs. Bruns in selling Shaklee products.



Further, we conclude these meals were associated with the active conduct of Mrs. Bruns' business of distributing Shaklee products and the meals directly preceded or followed a substantial and bona fide business discussion. The meals purchased were associated with the active conduct of Mrs. Bruns in distributing and selling Shaklee products because there was a clear business purpose in purchasing the meals for customers, distributors, and leaders. Mrs. Bruns had an existing business relationship with these individuals, and meals were used to facilitate sales of Shaklee products to customers and to encourage and increase the distribution of Shaklee products by distributors and leaders. Further, at each meal, substantial and bona fide business discussions occurred. At the top of each receipt, petitioners listed what sort of business discussion and transactions occurred at the meal. Accordingly, petitioners are entitled to a deduction of $704.92 12 for the meals and entertainment expenses incurred in 2003. This is in addition to the $1,192 deduction respondent allowed.



8. Other Expenses



The products used by Mrs. Bruns and claimed as a product promotion expense of petitioners were not specified. Rather Mrs. Bruns admitted personal use of products and guessed at the amount of alleged non-personal-use products. Without more specificity as to which products Mrs. Bruns used for product promotion, we cannot conclude that any portion of the $2,000 product promotion expense she claimed as a deduction is allowable as an ordinary and necessary business expense.



B. Schedule E Expenses



Petitioners assert that ABS rented basement space in petitioners' residence during 2003. ABS subtracted $18,000 in rental expenses from its gross income on its Form 1065. The alleged rental was month to month, and there was no written rental agreement. There is lack of proof of a bona fide rental. The purported rental was not at arm's length, and we disregard it for lack of economic substance. Accordingly, we disallow deductions petitioners claimed on Schedule E of their return for insurance, taxes, utilities, and depreciation attributed to the rental.



C. Schedule A Deductions: Charitable Contributions



In general, a taxpayer is entitled to deduct charitable contributions made during the taxable year to or for the use of certain types of organizations. Sec. 170(a)(1), (c). A taxpayer is required to substantiate charitable contributions; records must be maintained. Sec. 6001; sec. 1.6001-1(a), Income Tax Regs. Petitioners claim to have made charitable contributions of $893.98 in 2003: Approximately $470 in cash contributions of $20 to $30 increments to undisclosed charitable organizations and $423.98 by delivery of a new baking rack to their church.



A contribution of cash in an amount less than $250 made in a tax year beginning before August 17, 2006, may be substantiated with a canceled check, a receipt, or other reliable evidence showing the name of the donee, the date of the contribution, and the amount of the contribution. Sec. 1.170A-13(a)(1), Income Tax Regs. Petitioners have provided no substantiation of the cash contributions, nor have they adequately identified the recipients of these contributions. Accordingly, petitioners are not entitled to deduct these claimed cash charitable contributions.



Contributions of cash or property in excess of $250 require the donor to obtain contemporaneous written acknowledgment of the donation from the donee. Sec. 170(f)(8). At a minimum, the contemporaneous written acknowledgment must contain a description of any property contributed, a statement as to whether any goods or services were provided in consideration, and a description and good-faith estimate of the value of any goods or services referred to. Sec. 170(f)(8)(B). Petitioners claim to have contributed a baking rack to their church. The receipt they provided establishes they paid $423.98 for a new baking rack to be delivered to their church. The invoice establishes the fair market value of the baking rack as $423.98. Petitioners have provided a letter of acknowledgment from their church which meets the statutory requirements of a contemporaneous written acknowledgment. Accordingly, petitioners are entitled to a $423.98 charitable contribution deduction.




III. Section 6662(a) Penalty


Section 7491(c) provides that the Commissioner bears the burden of production with respect to the liability of any individual for additions to tax and penalties. "The Commissioner's burden of production under section 7491(c) is to produce evidence that it is appropriate to impose the relevant penalty, addition to tax, or additional amount". Swain v. Commissioner, 118 T.C. 358, 363 (2002); see also Higbee v. Commissioner, 116 T.C. 438, 446 (2001). The Commissioner, however, does not have the obligation to introduce evidence regarding reasonable cause or substantial authority. Higbee v. Commissioner, supra at 446-447.



Respondent determined that petitioners are liable for the section 6662(a) penalty for 2003. Pursuant to section 6662(a) and (b)(1) and (2), a taxpayer may be liable for a penalty of 20 percent on the portion of an underpayment of tax due to negligence or disregard of rules or regulations or a substantial understatement of income tax. An "understatement" is the difference between the amount of tax required to be shown on the return and the amount of tax actually shown on the return. Sec. 6662(d)(2)(A). A "substantial understatement" exists if the understatement exceeds the greater of (1) 10 percent of the tax required to be shown on the return for a taxable year or (2) $5,000. See sec. 6662(d)(1)(A). Respondent met his burden of production as there was a substantial understatement of income tax.



The accuracy-related penalty is not imposed with respect to any portion of the underpayment as to which the taxpayer acted with reasonable cause and in good faith. Sec. 6664(c)(1). The decision as to whether the taxpayer acted with reasonable cause and in good faith depends upon all the pertinent facts and circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs.



Petitioners deducted as business expenses personal items such as travel with relatives and personal use of Shaklee products. At trial petitioners conceded some of these personal items and claimed inadvertent error. However, petitioners should have discovered these inadvertent errors well in advance of trial. Further, petitioners deducted rent when no written rental agreement existed and the alleged rent was for an area where petitioners watched TV and relaxed. Petitioners have failed to show they acted with reasonable care and in good faith. Accordingly, we sustain the section 6662(a) penalty.



To reflect the foregoing,



Decision will be entered under Rule 155.


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

2 ABS is not subject to the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) partnership audit and litigation rules. See sec. 6231(a)(1)(B) (the partnership ABS had 10 or fewer partners and all partners were natural persons and U.S. citizens).

3 Each distributor has a group of customers. A customer may get discount buying privileges by paying a fee to become a member or distributor. Once the customer becomes a distributor, the customer-distributor is in the group of his original distributor and starts a group of his own.

4 Respondent does not dispute the income to Mrs. Bruns from ABS.

5 The $2,582 deduction is 50 percent of claimed meals and entertainment expenses of $5,164.

6 We take "image" to mean product promotion and shall refer to it as such.

7 Mrs. Bruns arrived at 79 percent by dividing business miles of 18,755 by total miles of 23,550.

8 Some of the entries in petitioners' mileage log did not contain a purpose. The total of the entries containing the miles traveled, the date, and the purpose of the trip is 16,976 miles.

9 The total of gas expenses of $1,132.49 plus carwash expenses of $115.20 plus repairs and maintenance expenses of $102.84 times business use of 72 percent equals $972.38.

10 This is the total of the substantiated business supplies, decorations, and refreshment purchases in 2003.

11 This number results from multiplying $790.41 ´ 12 months ´ 72 percent of business use.

12 This is 50 percent of the total expenses of $1,409.83 which met the requirements of secs. 162 and 274(a) and (d). A 50-percent reduction of the allowed deduction is required by sec 274(n).

Tuesday, July 14, 2009

Civil fraud case under section 6663

[T.C. Summary Opinion 2009-107]
Jerome Francis Schmitt v. Commissioner.

Docket No. 7249-06S . Filed July 13, 2009.

[ Code Sec. 6663]

An individual who improperly claimed deductions for employee business expenses and submitted false documents at trial was liable for the fraud penalty. The false documents were ostensibly from the taxpayer's employer and stated that the employer did not have an expense reimbursement policy for employees. However, the IRS established that the employer did have a reimbursement policy and that the taxpayer had received reimbursement for his expenses. Thus, the IRS provided clear and convincing evidence that part of the taxpayer's underpayments for the years at issue was due to fraud and the taxpayer failed to establish that any portion of the underpayments was not due to fraud.

DEAN, Special Trial Judge: This case was heard pursuant to the provisions of section 7463 of the Internal Revenue Code in effect when the petition was filed. Pursuant to section 7463(b), the decision to be entered is not reviewable by any other court, and this opinion shall not be treated as precedent for any other case. Unless otherwise indicated, subsequent section references are to the Internal Revenue Code in effect for the years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.



Respondent determined for 2001 a deficiency in petitioner's Federal income tax of $4,456, a fraud penalty under section 6663 of $2,815, and in the alternative an accuracy-related penalty under section 6662 of $128. Respondent determined for 2002 a deficiency in petitioner's Federal income tax of $5,192, a fraud penalty under section 6663 of $2,714, and in the alternative an accuracy-related penalty under section 6662 of $315.



Petitioner presented no argument or evidence with respect to any of the adjustments that result in the deficiencies for either year. He is deemed to have conceded those items. See Bradley v. Commissioner, 100 T.C. 367, 370 (1993); Sundstrand Corp. & Subs. v. Commissioner, 96 T.C. 226, 344 (1991); Rybak v. Commissioner, 91 T.C. 524, 566 n.19 (1988).



The issue remaining for decision is whether petitioner is liable for the fraud penalty, or in the alternative the accuracy-related penalty, for 2001 or 2002.





Background



None of the facts have been stipulated. The exhibits received in evidence are incorporated herein by reference. When the petition was filed, petitioner was living in New York.



Petitioner timely filed his Federal income tax returns for 2001 and 2002. Petitioner marketed telecommunication services in the New York City area during the years at issue. On his income tax returns petitioner itemized his deductions and filed Forms 2106, Employee Business Expenses, claiming, before the application of the 2-percent floor of section 67(a), employee business expenses of $15,008 for 2001 and $14,778 for 2002. On line 7 of the forms, "reimbursements received from your employer", petitioner indicated zero.



Respondent selected petitioner's tax return for examination. Revenue Agent Richard Lebrando (Lebrando) sent an appointment letter to petitioner to begin the examination.



Petitioner appeared for the initial examination meeting accompanied by his return preparer. Lebrando asked petitioner for substantiation of his employee business expenses and charitable contributions as shown on his Schedule A, Itemized Deductions. Petitioner provided to Lebrando a typewritten statement asserting that petitioner marketed telecommunications services and that "My company didn't have [sic] reimbursement policy." Upon receipt of petitioner's statement, Lebrando asked petitioner to supply him with a letter or other documentation from his employer to corroborate the written statement.



Petitioner provided Lebrando with an undated document bearing an apparent letterhead with the name "Primus Telecommunications Group, Inc." (Primus), in response to the agent's document request. The document states that petitioner was employed as a "Senior Account Executive" with the company in 2001 1 and that Primus "had no stated reimbursement policy for their expenses at that time." The document is signed by a Steve Garcia, "Sales Manager". Lebrando thought the document appeared suspect because the letterhead looked just like the top of the Web site of Primus.



Lebrando contacted Primus and solicited a copy of its reimbursement policy. Primus forwarded to Lebrando a copy of its "Financial Policy And Procedure Manual" dated February 1, 2001. The first paragraph of the manual states: "Employees will be reimbursed for actual and reasonable expenses incurred while traveling or conducting business on behalf of the Company or attending mandatory Company meetings." Primus's human resources (HR) department informed Lebrando by letter 2 that Steven Garcia was an account executive whose manager was Richard Cadiz. The HR department enclosed copies of petitioner's signed reimbursement requests for travel expenses for 2001.



Lebrando expanded his examination to include 2002. Petitioner informed Lebrando that his employer in 2002 was not the same as in 2001. Petitioner provided Lebrando with a document indicating that it was from "Broadview Networks" (Broadview). 3 The undated document states that Broadview employed petitioner as an account executive in 2002 and that "Broadview Networks, Inc, had no stated reimbursement policy for their expenses at that time." The document bears the signature of a William Cory, "Sales Director".



Lebrando contacted Broadview and obtained from the company's comptroller a copy of its 30-page expense reimbursement policy effective for 2002. The comptroller reported to Lebrando by letter that the statement in petitioner's document that Broadview had no reimbursement policy "is completely untrue." The comptroller also reported that Broadview "has never employed a Sales Director named William Cory."



Petitioner attempted to substantiate his mileage with documents entitled "Log of Miles Driven" for 2001 and 2002. The document for 2001 purports to cover the period from January 4 through April 12, 2001. The document for 2002 lists dates from January 7 through October 28, 2002. The documents show the categories of "Contact Name & Address", miles driven "Per Mapquest", and "Tolls/Parking".



Petitioner provided a similar document as substantiation for his entertainment and meals expenses for 2001. Lebrando attempted to match the dates and locations on the mileage log with those on the entertainment and meals expense log to no avail. No similar log was provided for 2002, but petitioner did submit copies of American Express card statements, with certain amounts circled for the period April 9 through December 6, 2002. He did not explain the significance of the circled items. There were charges on the statements for both petitioner and Alice E. Schmitt. For May 5, 2002, petitioner circled charges for food and beverages purchased in both Springfield, Virginia, and New York.



At trial petitioner was disruptive and refused to cooperate with either respondent or the Court.





Discussion




Addition to Tax for Fraud


The Commissioner has the burden of proving fraud by clear and convincing evidence. Sec. 7454(a); Rule 142(b); Parks v. Commissioner, 94 T.C. 654 (1990).



As part of his burden in the trial of a fraud case, the Commissioner must first prove an underpayment of some amount of tax. Sec. 6663(a); 4 Hebrank v. Commissioner, 81 T.C. 640, 642 (1983). To do this, the Commissioner may not merely rely on a taxpayer's failure to disprove the deficiency determination. Parks v. Commissioner, supra at 660-661.



Second, the Commissioner must show that at least some part of the underpayment of tax was due to fraud. Sec. 6663(a); Rule 142(b); DiLeo v. Commissioner, 96 T.C. 858, 873 (1991), affd. 959 F.2d 16 (2d Cir. 1992); Parks v. Commissioner, supra at 664; Hebrank v. Commissioner, supra. If the Commissioner establishes that some portion of the underpayment is attributable to fraud, the entire underpayment shall be treated as attributable to fraud, except with respect to any portion of the underpayment that the taxpayer establishes is not attributable to fraud. Sec. 6663(b).



The Commissioner will meet his burden of proof if it is shown that the taxpayer intended to evade a tax known to be due and owing by conduct intended to conceal, mislead, or otherwise prevent tax collection. Stoltzfus v. United States, 398 F.2d 1002, 1004-1005 (3d Cir. 1968); Parks v. Commissioner, supra at 661; Rowlee v. Commissioner, 80 T.C. 1111, 1123 (1983). The existence of fraud is a question of fact to be resolved upon consideration of the entire record. DiLeo v. Commissioner, supra at 874. The Commissioner may prove fraud by circumstantial evidence because direct evidence of the taxpayer's intent is rarely available. Stephenson v. Commissioner, 79 T.C. 995, 1005-1006 (1982), affd. per curiam 748 F.2d 331 (6th Cir. 1984).



Intent to mislead or conceal may be inferred from a pattern of conduct. Spies v. United States, 317 U.S. 492, 499 (1943). A pattern of consistent underreporting of income for several years, especially when accompanied by other circumstances showing intent to conceal, is strong evidence of fraud. Holland v. United States, 348 U.S. 121 (1954); Parks v. Commissioner, supra at 664. An implausible explanation of behavior is also a "badge of fraud". Bradford v. Commissioner, 796 F.2d 303, 307 (9th Cir. 1986), affg. T.C. Memo. 1984-601.



The Court, however, will not sustain a determination of fraud based only on circumstances that at most create only the suspicion of fraudulent intent. Katz v. Commissioner, 90 T.C. 1130, 1144 (1988); Green v. Commissioner, 66 T.C. 538, 550 (1976); Ross Glove Co. v. Commissioner, 60 T.C. 569, 608 (1973).



Respondent has shown that petitioner failed to report the receipt of $2,639.73 of income reported on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit Sharing Plans, IRAs, Insurance Contracts, etc., in 2002 and claimed deductions for unreimbursed employee business for which he lacked proper substantiation for both 2001 and 2002. Respondent has shown that petitioner underpaid his taxes for both years.



For both years petitioner deducted relatively large amounts of employee business expenses for which he failed to produce appropriate substantiation. Petitioner, on his tax returns, stated that he had received no reimbursements from his employers for his employee business expenses. Respondent, however, obtained records from one of his employers that show that petitioner in fact received reimbursement for expenses in 2001 pursuant to his employer's written reimbursement policy. During the examination of both his 2001 and 2002 returns, petitioner submitted false documents to Lebrando concerning his employers' reimbursement policies. Petitioner's submission of the false documents is evidence of guilty knowledge that he could have received or did receive expense reimbursements and falsified his tax returns to wrongfully obtain tax deductions.



The Court holds that respondent has produced clear and convincing evidence that part of each underpayment of tax for 2001 and 2002 was due to fraud under section 6663. Since petitioner has not shown that any portion of the underpayment for each year is not due to fraud, the entire underpayment shall be treated as attributable to fraud. 5 Sec. 6663(b).



To reflect the foregoing,



Decision will be entered for respondent.


1 Petitioner attached to his 2001 Federal income tax return a Form W-2, Wage and Tax Statement, from Primus showing wages of $31,337.54.

2 The letterhead on the human resources letter differed from that of the document that petitioner had supplied to Lebrando.

3 Petitioner attached to his 2002 Federal income tax return a Form W-2 from Broadview Network reporting wages of $61,359.93.

4 Former sec. 6653 was repealed and replaced in part by sec. 6663. See Omnibus Budget Reconciliation Act of 1989, Pub. L. 101-239, sec. 7721(a), (c)(1), 103 Stat. 2395, 2399.

5 The accuracy-related penalty under sec. 6662(a) does not apply to any portion of an underpayment on which the fraud penalty under sec. 6663 applies. Sec. 6662(b).


NON: TCS01 TCSO2009-107 http://tax.cchgroup.com/network&JA=LK&fNoSplash=Y&&LKQ=GUID%3Af328a007-efd6-3a84-9ecb-448cc6d008c1&KT=L&fNoLFN=TRUE& TCS01 #4 [TCS01 ]

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Monday, July 13, 2009

Notice 2009-58 , I.R.B. 2009-30, July 10, 2009.


The IRS has issued interim guidance on the procedures that manufacturers must use to certify a vehicle as eligible for the new specified qualified plug-in electric vehicle credit under Code Sec. 30. Guidance is also provided to purchasers of qualified vehicles regarding reliance on the manufacturer's certification in claiming the credit.


SECTION 1. PURPOSE

This notice sets forth interim guidance, pending the issuance of regulations, relating to the qualified plug-in electric vehicle credit under § 30 of the Internal Revenue Code. Specifically, this notice provides procedures for a vehicle manufacturer (or, in the case of a foreign vehicle manufacturer, its domestic distributor) to certify to the Internal Revenue Service ("Service") that a vehicle of a particular make, model, and model year meets the requirements that must be satisfied to claim the new specified plug-in electric vehicle credit under § 30.

This notice also provides guidance to taxpayers who purchase vehicles regarding the conditions under which they may rely on the vehicle manufacturer's (or, in the case of a foreign vehicle manufacturer, its domestic distributor's) certification in determining whether a credit is allowable with respect to the vehicle. The Service and the Treasury Department expect that the regulations will incorporate the rules set forth in this notice.



SECTION 2. BACKGROUND

Section 30 provides for a credit for qualified plug-in electric vehicles. The credit is an amount equal to 10 percent of the cost of a qualified plug-in electric vehicle placed in service by the taxpayer during the taxable year. Section 30(b) limits the amount of the credit allowed for a vehicle to $2,500.



SECTION. SCOPE OF NOTICE

The qualified plug-in electric vehicle credit applies to new specified plug-in electric vehicles that are acquired after February 17, 2009, and before January 1, 2012, and that otherwise meet the requirements of § 30. No credit is allowed under § 30 for a vehicle that is acquired after February 17, 2009, and before January 1, 2010, if the credit for qualified plug-in electric drive motor vehicles under § 30D is allowable for that vehicle. The credit for qualified plug-in electric drive motor vehicles applies for vehicles placed in service in taxable years beginning after December 31, 2008. Guidance regarding the credit under § 30D for qualified plug-in electric drive motor vehicles that are acquired before January 1, 2010, is provided in Notice 2009-54, I.R.B. 2009-26. Guidance regarding the credit under § 30D for qualified plug-in electric drive motor vehicles that are acquired after December 31, 2009 will be provided in a separate notice.



SECTION 4. MEANING OF TERMS

The following definitions apply for purposes of this notice:

.01 In General. Terms used in this notice and not defined in this section 4 have the same meaning as when used in § 30.

.02 Battery Capacity. The term "battery capacity" means the quantity of electricity that the battery is capable of storing, expressed in kilowatt hours, as measured from a 100 percent state of charge to a zero percent state of charge.

.03 Specified Vehicle. The term "specified vehicle" means any vehicle that:

(a) Is a low-speed vehicle as defined in section 4.04 of this notice, or

(b) Has two or three wheels.

.04 Low Speed Vehicle. The term "low speed vehicle" means a vehicle:

(1) That has at least four wheels;

(2) That is manufactured primarily for use on public streets, roads and highways (not including a vehicle operated exclusively on a rail or rails);

(3) That is not manufactured primarily for off-road use, such as primarily for use on a golf course;

(4) Whose speed attainable in one mile is more than 20 miles per hour and not more than 25 miles per hour on a paved level surface; and

(5) Whose gross vehicle weight rating is less than 3,000 pounds.

.05 Model Year. The term "model year" means the model year determined under the Clean Air Act regulations (see 40 CFR § 86-082-2).



Section 5. MANUFACTURER'S CERTIFICATION

.01 When Certification Permitted. A vehicle manufacturer (or, in the case of a foreign vehicle manufacturer, its domestic distributor) may certify to purchasers that a vehicle of a particular make, model, and (if applicable) model year meets all requirements (other than those listed in section 5.02 of this notice) that must be satisfied to claim the qualified plug-in electric vehicle credit allowable under § 30 with respect to the vehicle, if the following requirements are met:

(1) The manufacturer (or, in the case of a foreign vehicle manufacturer, its domestic distributor) has submitted to the Service, in accordance with this section 5, a certification with respect to the vehicle and the certification satisfies the requirements of section 5.03 of this notice; and

(2) The manufacturer (or, in the case of a foreign vehicle manufacturer, its domestic distributor) has received an acknowledgment of the certification from the Service.

.02 Purchaser's Reliance. Except as provided in section 5.05 of this notice, a purchaser of a vehicle may rely on the manufacturer's (or, in the case of a foreign vehicle manufacturer, its domestic distributor's) certification concerning the vehicle (including cases in which the certification is received after the purchase of the vehicle). The purchaser may claim a credit with respect to a vehicle if the following requirements are satisfied:

(1) The vehicle is acquired after February 17, 2009, and on or before December 31, 2011;

(2) The original use of the vehicle commences with the taxpayer;

(3) The vehicle is acquired for use or lease by the taxpayer, and not for resale;

(4) The vehicle is used predominantly in the United States.

.03 Content of Certification. The certification must contain the information required in section 5.03(1) of this notice and any applicable additional information required in section 5.03(2) of this notice.

(1) All Vehicles. For all vehicles, the certification must contain the following information:


(a) The name, address, and taxpayer identification number of the certifying entity;



(b) The make, model and (if applicable) model year, and any other appropriate identifiers of the vehicle;



(c) A statement that the vehicle is made by a manufacturer;



(d) The gross vehicle weight rating of the vehicle;



(e) A statement that the vehicle is propelled to a significant extent by an electric motor which draws electricity from a battery;



(f) The number of wheels that the vehicle has;



(g) The kilowatt hour capacity of the battery;



(h) A statement that the battery is capable of being recharged from an external source of electricity;


(i) A statement that the vehicle is manufactured primarily for use on public streets, roads, and highways, and is not manufactured primarily for off-road use;

(j) A description of the motor vehicle safety provisions of 49 C.F.R. Part 571 applicable to the vehicle and a statement that the vehicle complies with those provisions; and

(k) A declaration, applicable to the certification, statements, and any accompanying documents, signed by a person currently authorized to bind the manufacturer (or, in the case of a foreign vehicle manufacturer, its domestic distributor) in these matters, in the following form: "Under penalties of perjury, I declare that I have examined this certification, including accompanying documents, and to the best of my knowledge and belief, the facts presented in support of this certification are true, correct, and complete."

(2) Low Speed Vehicles. A certification with respect to a low speed vehicle as defined in section 4.04 of this notice must also contain the following:

(a) A statement that the vehicle is a low speed vehicle within the meaning of section 571.3 of Title 49 of the Code of Federal Regulations (as in effect on February 17, 2009), and

(b) A specific statement that the maximum speed attainable by the vehicle in 1 mile is more than 20 miles per hour but not more than 25 miles per hour on a paved level surface.

.04 Acknowledgement of Certification. The Service will review the original signed certification and issue an acknowledgment letter to the vehicle manufacturer (or, in the case of a foreign vehicle manufacturer, its domestic distributor) within 30 days of receipt of the request for certification. This acknowledgment letter will state whether purchasers may rely on the certification.

.05 Effect of Erroneous Certification. The acknowledgment that the Service provides for a certification is not a determination that a vehicle qualifies for the credit. If the Service, upon examination (and after any appropriate consultation with the Department of Transportation or the Environmental Protection Agency), determines that the vehicle is not a qualified plug-in electric vehicle, the manufacturer's (or, in the case of a foreign vehicle manufacturer, its domestic distributor's) right to provide a certification to future purchasers of plug-in electric vehicles will be withdrawn. Purchasers who acquire vehicles after the date on which the Service publishes an announcement of the withdrawal may not rely on the certification. Purchasers may continue to rely on the certification for vehicles they acquired on or before the date on which the announcement of the withdrawal is published (including in cases in which the vehicle is not placed in service and the credit is not claimed until after that date), and the Service will not attempt to collect any understatement of tax liability attributable to such reliance. Manufacturers (or, in the case of foreign vehicle manufacturers, their domestic distributors) are reminded that an erroneous certification may result in the imposition of penalties, including, but not limited to, the following:

(1) Under § 7206 for fraud and making false statements; and

(2) Under § 6701 for aiding and abetting an understatement of tax liability in the amount of $1,000 ($10,000 in the case of understatements by corporations) per return on which a credit is claimed in reliance on the certification.



Section 6. TIME AND ADDRESS FOR FILING CERTIFICATION

.01 Time for Filing Certification. In order for a certification under section 5 of this notice to be effective for qualified plug-in electric vehicles placed in service during a calendar year, the certification must be received by the Service not later than December 31 of that calendar year.

.02 Address for Filing. Certifications under section 5 of this notice must be sent to:

Internal Revenue Service

Industry Director, LMSB, Heavy Manufacturing & Transportation

Metro Park Office Complex - LMSB

111 Wood Avenue, South

Iselin, New Jersey 08830



Section 7. PAPERWORK REDUCTION ACT

The collection of information contained in this notice has been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under control number 1545-2150.

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

The collections of information in this notice are in sections 5 and 6. This information is required to be collected and retained in order to ensure that vehicles meet the requirements for the qualified plug-in electric vehicle credit under § 30. This information will be used to determine whether the vehicle for which the credit is claimed by a taxpayer is property that qualifies for the credit. The collection of information is voluntary to obtain a benefit. The likely respondents are corporations and partnerships.

The estimated total annual reporting burden is 250 hours.

The estimated annual burden per respondent varies from 6 hours to 12 hours, depending on individual circumstances, with an estimated average burden of 10 hours to complete the certification required under this notice. The estimated number of respondents is 25.

The estimated annual frequency of responses is on occasion.

Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103.



SECTION 8. DRAFTING INFORMATION

The principal author of this notice is Patrick S. Kirwan of the Office of Associate Chief Counsel (Passthroughs & Special Industries). For further information regarding this notice contact Mr. Kirwan at (202) 622-3110 (not a toll-free call).

Thursday, July 9, 2009

Congressional Research Service Report for Congress --Tax Benefits for Health Insurance and Expenses: Overview of Current Law and Legislation, June 29, 2009

July 9, 2009

111th Congress

Tax Benefits for Health Insurance and Expenses: Overview of Current Law and Legislation

Bob Lyke

Julie M. Whittaker

Specialist in Income Security

June 29, 2009

Congressional Research Service

7-5700

www.crs.gov

RL33505



Summary

How tax policy affects health insurance and health care spending is a perennial subject of discussion in Washington. The issue is prompted by the size of the tax benefits, by their effect on the cost and allocation of health care resources, and by interest in comprehensive tax and health care reform. Health care reform proposals currently being considered could make important tax changes.

Current law contains significant tax benefits for health insurance and expenses. By far the largest is the exclusion for employer-paid coverage, which employees may omit from their individual income taxes. The exclusion also applies to employment taxes and to health benefits in cafeteria plans. (The exclusion should be distinguished from the deduction employers may take for the payments they make and other costs they incur.) Some see ending or capping the exclusion as a way to raise revenue that might be used to pay for health care reform. Other important tax benefits include the following:


Ÿ Self-employed taxpayers may deduct 100% of their health insurance, even if they do not itemize deductions,



Ÿ Taxpayers who itemize may deduct insurance payments and other unreimbursed medical expenses to the extent they exceed 7.5% of adjusted gross income,



Ÿ Some workers eligible for Trade Adjustment Assistance or receiving a pension paid by the Pension Benefit Guarantee Corporation can receive the Health Coverage Tax Credit (HCTC) to purchase certain types of insurance,



Ÿ Four tax-advantaged accounts are available to help taxpayers pay their health care expenses: Flexible Spending Accounts, Health Reimbursement Accounts, Health Savings Accounts, and Medical Savings Accounts,



Ÿ Voluntary Employees' Beneficiary Association plans (VEBAs), are vehicles for prefunding retiree health benefits on a tax-advantaged basis for certain groups of workers, particularly unionized workers,



Ÿ Coverage under Medicare, Medicaid, CHIP, and military and veterans health care programs is not considered taxable income, and



Ÿ A temporary COBRA premium subsidy was included in the American Recovery and Reinvestment Act of 2009.


By lowering the after-tax cost of insurance, these tax benefits generally help extend coverage to more people; they also lead some people to obtain more coverage than they otherwise would. The incentives influence how coverage is acquired: the uncapped exclusion for employer-paid insurance, which can benefit nearly all workers and is easy to administer, is partly responsible for the predominance of employment-based insurance in the United States. In addition, the tax benefits increase the demand for health care by enabling insured people to obtain services at discounted prices; this in turn contributes to rising health care costs. Because many people would likely obtain insurance without tax benefits, they can be an inefficient use of public dollars. When insurance is viewed as a form of personal consumption, most tax benefits appear to be inequitable because taxpayers' savings depend on marginal tax rates. When viewed as spreading catastrophic economic risk over multiple years, however, basing those savings on marginal rates might be justified as the proper treatment for losses under a progressive tax system.



Contents

Most Recent Developments

Tax Benefits in Current Law


Employer-Paid Insurance



COBRA Continuation Coverage



Unreimbursed Medical Expenses



Individual Market Policies



Self-Employed Individuals



Cafeteria Plans



Premium Conversion



Flexible Spending Accounts



Health Reimbursement Accounts



Health Savings Accounts



Medical Savings Accounts



Health Coverage Tax Credit



Military Health Care



Veterans Health Care



Medicare



Medicaid



CHIP



VEBAs


Some Consequences of the Tax Benefits


Increases in Coverage



Sources of Insurance Coverage



Increases in Health Care Use and Cost



Equity


Current Proposals


Comprehensive Reform Proposals



Exclusion for Employer-Provided Insurance



Definition of Medical Care



Expanded Tax Deduction



Self-Employed Deduction



Cafeteria Plans



Premium Conversion



Flexible Spending Accounts



Health Savings Accounts



Health Coverage Tax Credit



Individual Tax Credit



Employer Tax Credit


For Additional Reading

Appendixes

Appendix. General Formula For Calculating Federal Income Taxes

Contacts

Author Contact Information

Additional Author Information



Most Recent Developments

The congressional committees with principal jurisdiction for health care are working on comprehensive reform proposals. The Senate HELP Committee released a draft on June 9, while a coordinated measure by three House committees (Education and Labor, Energy and Commerce, and Ways and Means) was released on June 19. The Senate Finance Committee has not yet released a public draft. The HELP Committee draft does not include tax provisions related to health care aside from a penalty tax to enforce an individual mandate. 1 The House committees' draft also has a penalty tax for people without coverage, a requirement that employers either offer acceptable coverage or pay 8% of payroll into a health exchange trust fund, and a small business health insurance tax credit.



Tax Benefits in Current Law

Current law provides significant tax benefits for health insurance and expenses. The tax subsidies (mostly federal income tax exclusions and deductions) are widely available, though not everyone can take advantage of them. They reward some people more than others, raising questions of equity. They influence the amount and type of coverage that people obtain, which affects their ability to choose doctors and other providers. In addition, the tax benefits affect the distribution and cost of health care.

This section of the report summarizes the current tax treatment of the principal ways that people obtain health insurance and pay their health care expenses. It describes general rules but does not discuss all limitations, qualifications, or exceptions. To understand possible effects on tax liability, readers may want to refer to the Appendix for an outline of the federal income tax formula. For example, exclusions are omitted from gross income, whereas deductions are subtracted from gross income in order to arrive at taxable income. Section number references are to the Internal Revenue Code of 1986, as amended.

This section also includes Joint Committee on Taxation (JCT) estimates of tax expenditures, where available. Tax expenditures measure the difference in tax liabilities for individuals and corporations due to provisions that are exceptions to a normative comprehensive income tax. Tax expenditures are not the same as revenue losses to the government, the measurement of which reflects assumed behavioral responses, timing considerations, and changes in employment tax receipts. 2

Most of the tax rules discussed here have also been adopted by states that have income taxes.



Employer-Paid Insurance

Over 60% of the noninstitutionalized population under age 65 is insured under an employment-based plan. In the average plan, employers pay about 85% of the cost of single coverage and 74% of the cost of family coverage, though some pay all and others pay none. 3

Health insurance paid by employers generally is excluded from employees' gross income in determining their income tax liability; it also is not considered for either the employees' or the employer's share of employment taxes (i.e., Social Security, Medicare, and unemployment taxes). 4 The income and employment tax exclusions apply to both single and family coverage, which includes the employee's spouse and dependents. Premiums paid by employees may be subject to a premium conversion arrangement under a cafeteria plan or counted towards the itemized medical expense deduction (both of which are discussed below). 5

The exclusion for employer-paid insurance should be distinguished from the tax deduction employers are allowed for the payments they make and other costs they incur. For income taxes, the exclusion applies to employees as individual taxpayers, while the deduction applies to employers. The employer deduction is not a tax benefit but a calculation necessary for the proper measurement of the net income that is subject to taxation. Revenue loss attributable to this deduction is not considered a tax expenditure.

Insurance benefits paid from employment-based plans are excluded from gross income if they are reimbursements for medical expenses or payments for permanent physical injuries. Benefits not meeting these tests are taxable in proportion to the share of the insurance costs paid by the employer that were previously excluded from gross income. 6 Benefits are also taxable to the extent that taxpayers received a tax benefit from deducting expenses in a prior year (e.g., if taxpayers claimed a deduction for medical expenditures in 2007 and then received an insurance reimbursement for them in 2008). In addition, benefits received by highly compensated employees under discriminatory self-insured plans are partly taxable. A self-insured plan is one in which the employer assumes the risk for a health care plan and does not shift it to a third party. 7

The Joint Committee on Taxation (JCT) estimates that the FY2009 tax expenditure attributable to the exclusion for employer payments for health insurance premiums, health care, and long-term care insurance premiums will be $127.4 billion. The estimate does not include the effect of the exclusion on employment taxes. 8



COBRA Continuation Coverage

COBRA refers to the Consolidated Omnibus Budget Reconciliation Act of 1985 (P.L. 99-272), which in general allows separated employees and their family members the right to continue employer-sponsored coverage for a limited time (generally 18 to 36 months, depending on the qualifying event). Private-sector firms with 20 or more employees are subject to COBRA, as are state and local governments; the federal government must provide continuation rights under other legislation. 9

The American Recovery and Reinvestment Act of 2009 (ARRA) authorized temporary premium subsidies of 65% for 9 months to help unemployed workers afford COBRA coverage from their former employer. The subsidy is provided in the form of a credit that employers can use to offset payroll taxes (e.g., Social Security and Medicare taxes) they would otherwise pay; the unemployed workers would then pay the employer the other 35% of the cost. To qualify, workers must be involuntarily unemployed between September 1, 2008, and December 31, 2009. Workers who were involuntarily terminated between September 1, 2008, and February 17, 2009 (the date of enactment) but failed to initially elect COBRA are to be notified by their former employer that they are entitled to elect COBRA and receive the subsidy. The subsidy is phased out for workers whose annual household adjusted gross income exceeds $125,000 for single filers and $250,000 for joint filers. The temporary subsidy applies to coverage under other continuation laws as well, including state laws that may affect employers with fewer than 20 employees. 10



Unreimbursed Medical Expenses

Taxpayers who itemize their deductions may deduct unreimbursed medical expenses that exceed 7.5% of adjusted gross income (AGI). 11 Medical expenses include health insurance premiums paid by the taxpayer, principally premiums for individual market policies and the employee's share of premiums for employment-based coverage (aside from those subject to a premium conversion arrangement). More generally, medical expenses include amounts paid for the "diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body." 12 They also include certain transportation and lodging expenditures, qualified long-term care costs, and long-term care insurance premiums that do not exceed certain amounts.

The deduction is intended to help only people with catastrophic expenses, so by design it is not widely used. For most taxpayers, the standard deduction is larger than the sum of their itemized deductions; moreover, most do not have unreimbursed expenses that exceed 7.5% AGI. In 2005, about 35% of all returns had itemized deductions, and of these, less than 21% (about 7% of all returns) claimed the medical expense deduction.

The JCT estimates that the FY2009 tax expenditure attributable to the medical expense deduction (including long-term care expenses) will be about $10.6 billion.



Individual Market Policies

About 6% of the noninstitutionalized population under age 65 is insured through private individual market policies. Likely purchasers include early retirees, young adults, employees without access to employment-based insurance, and the self-employed. All of these people can claim the medical expense deduction just described, provided they qualify (i.e., they must itemize and then can deduct only unreimbursed expenses that exceed 7.5% AGI). Many self-employed taxpayers can claim a more generous deduction described below.

Premiums for certain types of individual market insurance are not deductible, including policies for loss of life, limb, and sight; policies that pay guaranteed amounts each week for a stated number of weeks for hospitalization; policies to provide payment for loss of earnings; and the part of car insurance that provides medical coverage for persons injured in or by the policyholder's car.

Benefits paid under accident and health insurance policies purchased by individuals are excluded from gross income, even if they exceed medical expenses.



Self-Employed Individuals

Self-employed individuals include sole proprietors (single owners of unincorporated businesses), general partners, limited partners who receive guaranteed payments, and individuals who receive wages from S-corporations in which they are more than 2% shareholders. 13

Self-employed taxpayers may deduct payments for health insurance in determining their AGI (i.e., as an "above-the-line" deduction). 14 The "above-the-line" deduction for the self-employed is not restricted to itemizers or subject to a floor, as is the medical expense deduction described above. Currently, 100% of the insurance cost may be taken into consideration. However, the deduction cannot exceed the net profit and any other earned income from the business under which the plan is established, less deductions taken for certain retirement plans and for one-half the self-employment tax. It is not available for any month in which the taxpayer or the taxpayer's spouse is eligible to participate in a subsidized employment-based health plan (i.e., one in which the employer pays part of the cost). These restrictions prevent taxpayers with little net income from their business (which is not uncommon for a new business) from deducting much if any of their insurance payments. The portion not deductible under these rules may be treated as an itemized medical expense deduction.

Self-employed individuals may not deduct their health insurance costs in determining the employment taxes they pay (the self-employment tax).

In 2006, about 3.8 million tax returns (about 3% of all returns) claimed the self-employed health insurance deduction. For FY2009, the JCT estimates that the tax expenditure attributable to the deduction (including the self-employed deduction for long-term care insurance) will be $4.8 billion.



Cafeteria Plans

Cafeteria plans are employer-established benefit plans under which employees may choose between receiving cash (typically additional take-home pay) and certain normally nontaxable benefits (such as employer-paid health insurance) without being taxed on the value of the benefits if they select the latter. A general rule of taxation is that taxpayers given these options will be taxed on whichever they choose because they are deemed to be in constructive receipt of the cash. The cafeteria plan provisions of the Code provide an express exception to this rule when the plan meets various reporting and nondiscrimination requirements. 15 Nontaxable benefits received under a cafeteria plan are exempt from both income and employment taxes.

Cafeteria plans may be simple or complex. Simple plans might allow employees to choose between cash and one nontaxable benefit, such as additional health insurance. Complex plans might give employees a "pot of money" to allocate among health insurance and reimbursement accounts, dependent care assistance, group term life insurance, commuter benefits, and cash as they see fit.



Premium Conversion

Under a cafeteria plan option known as premium conversion, employees may elect to reduce their taxable wages in exchange for having their share of health insurance premiums paid on a pretax basis. The arrangement reduces both income and employment taxes. Federal employees who participate in the Federal Employees Health Benefits Program (FEHBP) have been able to elect this option since October 2000. Private sector and state or local government employees may also elect premium conversion if their employers permit.

In general, premium conversion is not available to retirees. The barrier is not the cafeteria plan rules but an Internal Revenue Service (IRS) determination that distributions from qualified retirement plans are always subject to taxes, aside from several minor exceptions. 16 The IRS ruling precludes former employees from recasting pension payments as pretax income, as active workers can recast their wages. However, employer payments for retiree health insurance are excluded from taxes, just as they are for active workers. For many retirees, the employer pays much of the premium.

The Pension Protection Act of 2006 (P.L. 109-280) allows certain retired public safety officers to pay up to $3,000 of qualified health insurance premiums from their pensions on a pretax basis each year. Technically, the amount is excluded from the retirees' gross income. The premiums do not have to be for a plan sponsored by the former employer; however, the exclusion does not apply to premiums paid by the retiree and then reimbursed with pension distributions.

For FY2009, the JCT estimates that the tax expenditure attributable to cafeteria plans will be $36.8 billion. The estimate includes the tax expenditures attributable to dependent care flexible spending accounts, though this is a minor portion. 17



Flexible Spending Accounts

Flexible spending accounts (FSAs) are employer-established benefit plans that reimburse employees for specified expenses as they are incurred. 18 Accounts may be used for dependent care or for medical and dental expenses, though there must be separate accounts for these two purposes. FSAs and cafeteria plans are closely related, but not all cafeteria plans have FSAs and not all FSAs are part of cafeteria plans. FSA reimbursements funded through salary reduction agreements (the most common arrangement) are exempt from income and employment taxes under cafeteria plan provisions because employees have a choice between cash (their regular salary) and a nontaxable benefit. In contrast, FSA reimbursements funded by nonelective employer contributions are exempt from taxation directly under provisions applying to employer-paid dependent care or health insurance. 19

Health care FSAs must exhibit some of the risk-shifting and risk-distribution characteristics of insurance. Among other things, participants must elect a specific benefit amount prior to the start of a plan year; this election cannot be revoked except for changes in family status. The full benefit amount (less any benefits paid) must be made available throughout the entire year, even if employees spread their contributions throughout the year. Amounts unused at the end of the year must be forfeited to the employer (the "use it or lose it" rule), though employers may allow a 2 1/2 -month grace period. 20 FSAs cannot be used to purchase insurance; however, they can be combined with premium conversion arrangements under cafeteria plans to achieve the same tax effect. Employers are permitted, but not required, to allow military reservists called to active duty to receive some or all of the remaining funds in their account. 21

In 2006, about 21% of private-sector establishments offered a health care FSA to their workers. 22 They are more common in larger firms: 70% of establishments with 50 or more workers offered them, but only 9% of smaller establishments. Similarly, more employees had access to an FSA if they worked in larger firms: 68% of workers did in firms with 50 or more workers, but only 11% did in smaller firms. Overall, 53% of private-sector employees could establish a health care FSA.

Most people with access to an FSA do not use them. A 2006 survey by Mercer Human Resources Consulting showed that an average of 36% of eligible employees participated in health care FSAs offered by employers with 10 or more employees. The average amount contributed was $1,208.

Federal employees have had the opportunity to use FSAs since July 2003. In September 2008, there were 240,000 federal health care FSAs.



Health Reimbursement Accounts

Health Reimbursement Accounts (HRAs) are employer-established arrangements to reimburse employees for medical and dental expenses not covered by insurance or otherwise reimbursable. As with FSAs, reimbursements are not subject to either income or employment taxes. In contrast, however, contributions cannot be made through salary reduction agreements; only employers may contribute. Employers need not actually fund HRAs until employees draw on them; the accounts may be simply notional. Also unlike FSAs, reimbursements can be limited to amounts previously contributed. Unused balances may be carried over indefinitely, though employers may limit the aggregate carryovers.

HRAs are governed by the Code provisions discussed above for the exclusion of benefits paid from employment-based plans and various IRS guidance. 23



Health Savings Accounts

Health Savings Accounts (HSAs) are one way that people can pay on a tax-advantaged basis for unreimbursed medical expenses (deductibles, copayments, and services not covered by insurance). 24 Eligible individuals can establish and fund accounts when they have a qualifying high deductible health plan and no other health plan, with some exceptions. The high deductible plan may be through an employer-provided option or purchased individually. For 2009, the deductible for self-only coverage must be at least $1,150 with an annual out-of-pocket limit not exceeding $5,800; the deductible for family coverage must be at least $2,300 with an annual out-of-pocket limit not exceeding $11,600.

The annual HSA contribution limit in 2009 for individuals with self-only coverage is $3,000; for family coverage, it is $5,950. Individuals who are at least 55 years of age but not yet enrolled in Medicare may contribute an additional $1,000. Contributions may be made by employers, individuals, or both. 25

HSA contributions are deductible as an above-the line deduction if made by individuals, and they are exempt from both income and employment taxes if made by employers. Contributions may be made through salary reduction agreements, in which case they are treated as if made by employers. Withdrawals are not taxed if used for qualified medical expenses; however, they are taxable and usually subject to a penalty if used for other expenses or to purchase health insurance, with some exceptions. Account earnings are tax-exempt. Unused balances may accumulate without limit.

In January 2009, there were about 8 million people covered by qualifying high deductible insurance plans ; the number includes both policyholders and their family members. The number of people covered by HSAs is smaller because it is not necessary to establish an account along with the insurance. Moreover, some accounts may not be funded. The number of HSAs grew rapidly after they were first allowed, but it is not clear what growth will occur in the future. 26

For FY2009, the JCT estimates that the tax expenditure attributable to HSAs will be about $700 million.



Medical Savings Accounts

Medical Savings Accounts (MSAs) are an older, more-restrictive version of HSAs. Begun as a demonstration program in 1997, they are limited to people who either are self-employed or are employees covered by a high deductible insurance plan established by a small employer (50 or fewer employees). Like HSAs, annual contributions are limited and can be made only when account owners have qualifying high deductible insurance, though the specific rules are different. Unlike HSAs, contributions can be made by individuals or employers, not both, and they cannot occur through salary-reduction agreements. The official name of MSAs is now Archer MSAs. 27

MSA contributions are deductible (as an above-the-line deduction) if made by individuals, and they are exempt from both income and employment taxes if made by employers. Withdrawals are not taxed if used for qualified medical expenses under rules similar to those for HSAs. Account earnings are tax-exempt. Unused balances may accumulate without limit.

The legislative upper limit on the number of MSAs is 750,000 (not counting accounts of owners who previously were uninsured, among others), though there never has been close to that many established. For tax year 2003 (just before HSAs were authorized), the IRS estimated that there were fewer than 80,000 accounts in total. Many of these have subsequently been rolled into HSAs. The IRS estimated that 20,361 MSAs had contributions in 2005. 28

MSAs should be distinguished from Medicare MSAs, which are discussed below under "Medicare."



Health Coverage Tax Credit

Three groups of taxpayers are potentially eligible for the health coverage tax credit (HCTC):


Ÿ individuals receiving a Trade Readjustment Assistance allowance, including those eligible for but not yet receiving the allowance because they have not yet exhausted their state unemployment benefits;



Ÿ individuals receiving an Alternative Trade Adjustment Assistance allowance; and



Ÿ individuals aged 55 and older receiving a Pension Benefit Guaranty Corporation pension payment, including those who received a lump sum payment after August 5, 2002.


Recipients cannot be enrolled in certain other health insurance, including Medicaid or employment-based insurance for which the employer pays at least half the cost, nor can they be entitled to Medicare. 29

The HCTC equals 80% of the premiums the taxpayer pays for qualifying insurance for themselves and for their family. (The credit rate was raised from 65% by the ARRA until December 31, 2010.) Up to 11 types of coverage are specified in the statute, though most require state action to become effective. The credit is payable in advance to insurers, allowing workers to benefit before they file their tax returns. It is also refundable: workers can receive the full credit even if they have no regular tax liability.

The Internal Revenue Services reports that approximately 28,000 taxpayers claimed the HCTC in tax year 2005. The average monthly premium for this group was $600, for an average credit of $429. Approximately 17,000 family members were covered under these plans; in total, 45,000 persons received some type of health insurance subsidized by the HCTC. 30

For FY2009, the JCT estimates that the tax expenditure attributable to the HCTC will be about $100 million.



Military Health Care

The U.S. Department of Defense (DOD) provides health care to active duty military personnel, military retirees, and their dependents. In general, active duty personnel receive care without cost (aside from small per diem charges), while the others may have deductibles, copayments, and premiums depending on where they are served and the particular insurance plan they are in. Military insurance plans currently are called Tricare plans. About 9 million people are eligible for services and coverage by these arrangements. 31

Coverage under military health care programs and the benefits they provide are not considered taxable. 32

For FY2009, the JCT estimates that the tax expenditure attributable to medical care and Tricare insurance for military dependents, retirees, and dependents of retirees will be approximately $2.2 billion.



Veterans Health Care

The U.S. Department of Veterans Affairs provides health care directly to veterans through hospitals, nursing homes, residential rehabilitation treatment centers, and community-based outpatient clinics. In some cases, it pays for care provided by independent doctors and other health care professionals. Veterans health care is not an entitlement (unlike Medicare Part A, for example), and eligibility for services is prioritized according to several factors, including the severity of disabilities, whether disabilities occurred during or after military service, certain military events (e.g., having been a prisoner of war), the period of service, and means testing. Just over 5 million veterans receive services. 33

Coverage under veterans health care programs and the benefits they provide are not considered taxable. 34



Medicare

Medicare is a national health insurance program for people aged 65 and older or who meet certain disability tests. Nearly 42 million people are covered by one or more of its parts. Coverage under Medicare and the benefits it pays for qualifying expenses are not considered taxable. 35

Medicare Part A (insurance for hospitalization, skilled nursing facilities, post-hospitalization home health, and hospice care) is financed largely by employment taxes that workers and their employers both pay, currently 1.45% of covered wages. Individuals cannot take these tax payments into account for the itemized deduction for medical expenses. 36 However, employers may deduct what they pay as a business expense.

Workers and their spouses become entitled to Part A once the workers have paid employment taxes on covered wages for certain periods of time. They pay no additional premium to be enrolled. People aged 65 and older who are not entitled to Part A may voluntarily enroll by paying a monthly premium. This premium may be taken into account for the itemized deduction for medical expenses, as may the deductibles and copayments associated with Part A.

Medicare Part B (insurance for doctors' fees, hospital outpatient services, most home health, and other medical services) is financed by general tax revenues and monthly premiums paid by those who enroll. Usually the premiums are withheld from Social Security benefits. These premiums may be taken into account for the itemized deduction for medical expenses, as may the deductibles and copayments associated with Part B. 37

Medicare Part D (insurance for prescription drugs) is also financed by general tax revenues and monthly premiums paid by those who enroll. Deductibles and copayments associated with Medicare Part D may be taken into account for the itemized deduction for medical care, as may the Part D premiums themselves. 38

Medicare Part C authorizes a number of alternative Medicare health plans, now called Medicare Advantage plans. Participants must be enrolled in both Medicare Part A and Part B. Some of these plans may charge an additional premium, which can be taken into account for the itemized deduction for medical expenses. In 2007, for the first time there are Medicare Medical Savings Account plans offered under Part C. The tax treatment of these plans is similar to that of Health Savings Accounts; contributions and account earnings are exempt from taxes, as are withdrawals used to pay medical expenses. 39 However, other specifications differ depending on the plan. Contributions to Medicare MSA plans are made by the Centers for Medicare and Medicaid Services (CMS) of the U.S. Department of Health and Human Services.

For FY2009, the JCT estimates that the tax expenditure attributable to the exclusion of Medicare Part A benefits will be $23.7 billion. The tax expenditures attributable to Part B and Part D are estimated to be $16 billion and $5.3 billion, respectively. 40



Medicaid

Medicaid provides health care services for the elderly, people who have disabilities, pregnant women, families with dependent children, and children who have low income and few assets. It also pays for long-term care for people meeting similar needs tests. As each state designs and administers its own program, there is variation within broad federal guidelines with respect to who is served, benefits and delivery systems, and cost-sharing and other patient requirements. Medicaid waivers allow states even more flexibility for certain populations. Nearly 63 million people are covered by Medicaid each year. 41

Coverage under Medicaid and the benefits it pays for qualifying expenses are not considered taxable. 42



CHIP

The State Children's Health Insurance Program (CHIP) provides health insurance to children in families without coverage and with income above Medicaid eligibility levels. Some states expand their Medicaid programs to cover these children, whereas others have separate programs or a combination of both. CHIP waivers allow states to cover adults as well. More than 7 million children were covered by CHIP in FY2007, as were about 587,000 adults. 43

As with Medicaid, coverage under CHIP and the benefits it pays for qualifying expenses are not considered taxable.



VEBAs

Voluntary Employees' Beneficiary Association (VEBA) plans provide life insurance, medical, disability, accident and other welfare benefits to employee members and their dependents. 44 Most are organized as trusts to be legally separate from employers, which is important if the latter become bankrupt. Provided certain conditions are met, the investment earnings of VEBAs are exempt from taxation, as are the benefits paid out if the benefit would normally be exempt. For example, VEBA medical benefits would be tax exempt, but severance pay would not be.

VEBAs can be funded by employers or employees. Employer contributions are tax deductible as a business expense, but the deductions generally are limited to the sum of qualified direct costs (amounts employers could have deducted for the employee benefit for the year if they followed cash basis accounting) and additions to qualified asset account s (reserves for unpaid claims, some administrative costs, and certain post-retirement benefits), minus VEBA after-tax net income. Reserves for retiree health benefits normally must be funded over the working lives of covered individuals on a level basis, using actuarial assumptions incorporating current, but not projected, medical costs. These limitations reduce the utility of VEBAs for retiree health plans, but they do not apply to collectively-bargained plans or to multiple employer welfare arrangements (MEWAs) of ten or more employers. 45 The American Recovery and Reinvestment Act of 2009 allows VEBAs in the case of certain bankruptcies to be considered qualified insurance for purposes of the Health Coverage Tax Credit.

According to the 2005 Mercer National Survey of Employer-Sponsored Plans, 9% of employers with 500 or more employees use VEBAs for prefunding retiree health benefits. VEBAs are more common in heavy manufacturing, communication, transportation, and utility industries.



Some Consequences of the Tax Benefits 46



Increases in Coverage

By lowering the after-tax cost of insurance, some of the tax benefits described above help extend coverage to more people. This is, of course, the intention: Congress has long been concerned about whether people have access to health care. The public subsidy implicit in the incentives (the foregone tax revenue) usually is justified on grounds that people would otherwise under-insure; that is, they would delay purchasing coverage in the hope that they will not become ill or have an accident. Uninsured people are an indication of what economists call market failure; they impose spill-over costs on society in the form of public health risks and uncompensated charity care. If insurance were purchased only by people who most need health care, its cost would become prohibitive for others.

Tax benefits also lead some people to obtain more coverage than they might otherwise choose. They purchase insurance that covers more than hospitalization and other catastrophic expenses, such as routine doctor visits, prescription drugs, and dental care. They obtain coverage with smaller deductibles and copayments than are necessary. However, many people are risk-averse with respect to health care, so the tax benefits are only one factor influencing the amount of insurance purchased. Some people contend that comprehensive coverage and lower cost-sharing lead to better preventive care and possibly long-term savings for certain medical conditions.

Tax benefits associated with Heath Savings Accounts are an attempt to encourage people to purchase less coverage by having higher deductibles. In this respect, they appear to differ from the tax benefits usually associated with health insurance. However, the accounts themselves might be viewed as a form of insurance, particularly as they grow in size, so it is not clear what their impact will be in reducing overall coverage.



Sources of Insurance Coverage

Tax benefits influence the way in which insurance coverage is acquired. The uncapped exclusion for employer-paid insurance, which can benefit nearly all workers and is easy to administer, is partly responsible for the predominance of employment-based insurance in the United States. In contrast, restrictions on the itemized deduction allowed for individual private market insurance may be one reason this insurance covers only about 6% of the noninstitutionalized population under age 65.

Employment-based insurance carries both advantages and disadvantages for the typical worker. The principal advantage is that coverage is based on larger and often more stable risk pools; this generally lowers the cost for people who need more care. Usually, employee premiums do not vary by age or risk. Although young and healthy workers sometimes pay more than they would for identical individual market coverage, they are protected from cost increases as they get older or need additional care. However, plans chosen by employers may not meet individual workers' needs, particularly if there is only one available health plan, and changing jobs may require both new insurance and doctors.



Increases in Health Care Use and Cost

Tax benefits increase the demand for health care by enabling insured people to obtain services at discounted prices. This induced demand can be beneficial to the extent that it reflects needed health care (that which society deems everyone should have) that financial constraints otherwise would have prevented. It can be wasteful to the extent it results in less essential or ineffective care. In any case, increasing use of health care contributes to rising health care costs.

Whether insurance coverage could be encouraged without increasing the cost of health care has long been a matter of debate. Comprehensive reforms that might accomplish this goal include capping the exclusion for employer-paid insurance and replacing both the exclusion and the deduction with a limited tax credit. But substantial changes along these lines could be difficult to implement and might create serious inequities. Consumer-driven health care (most commonly associated with high deductible insurance plans coupled with Health Reimbursement Accounts and Health Savings Accounts) is a recent attempt to help people obtain coverage without driving up costs as much. The Congressional Budget Office analyzed this approach in a December 2006 publication, Consumer-Directed Health Plans: Potential Effects on Health Care and Spending Outcomes.

Many people probably would obtain some health insurance even without the tax benefits. The cost of subsidizing people for what they would otherwise do is an inefficient use of public dollars. One important goal of the tax incentives is for insurance to be purchased only to the extent it results in better health care for society as a whole. But how the incentives could be revised to accomplish this goal is a difficult question given the different ways insurance is provided, the various ways it is regulated, and the voluntary nature of decisions to purchase it.



Equity

Questions might be raised about the distribution of the tax incentives. Because as a practical matter they are not available to everyone, problems of horizontal equity arise. 47 Workers without employment-based insurance generally cannot benefit from them, nor can many early retirees (people under 65, the age of Medicare eligibility). Even if these individuals itemize their deductions, they may deduct health insurance premiums only to the extent that they (and other health care expenditures) exceed 7.5% of AGI. In contrast, the exclusion for employer-paid insurance is unlimited.

Even if everyone could benefit from the tax incentives, there would be questions of vertical equity. 48 Tax savings from the exclusions and deductions described above generally are determined by taxpayers' marginal tax rate. Thus, taxpayers in the 15% tax bracket would save $600 in income taxes from a $4,000 exclusion (i.e., $4,000 x 0.15) for an employer-paid premium, whereas taxpayers in the 35% bracket would save $1,400 (i.e., $4,000 x 0.35). If health insurance is considered a form of personal consumption like food or clothing, this pattern of benefits would strike many people as unfair. It is unlikely that a government grant program would be designed in this manner. However, to the extent that health insurance is considered a way of spreading an individual's catastrophic economic risk over multiple years, basing tax savings on marginal tax rates might be justified. Under a progressive income tax system, economic losses ought to be deducted at applicable marginal rates, just as economic gains are taxed at those rates.

Assessing the equity of tax incentives for health insurance is complicated by uncertainty as to who pays for employer subsidies. In the long run, the cost of these subsidies presumably is passed on to the workers in the form of reductions to wages and other benefits. But whether these reductions are shared equally by all workers is unclear given differences in their preferences for insurance, their attachment to particular employers, and broader labor market forces.



Current Proposals

This section focuses on bills that have received committee or floor action or that otherwise are the subject of discussion. It identifies other relevant bills that have been introduced but may not include all of them. In a typical Congress, there may be several hundred tax measures pertaining to health insurance and expenses, not all of which are easily tracked. In addition, the Legislative Information System (LIS), the principal source of information for this section, sometimes does not include bills for a number of days after their introduction.

A list of all bills on a particular topic (e.g., tax credits for health insurance) is available to congressional staff through the LIS. The Advanced Search link in the middle of the screen enables users to search for terms such as "'Internal Revenue Code' AND 'health insurance' AND 'credit.'" Often it is helpful to restrict searches to terms that are likely to be in close proximity to each other in the bills. For example, the previous search might be modified to "'Internal Revenue Code' AND 'health insurance' adj/7 'credit'." Whatever the search terms, it is not unusual to miss relevant bills and turn up others that are irrelevant. For assistance, call the CRS inquiry number at 7-5700.

In considering bills on a particular topic, it is important to take account of whether the legislation would also make other changes to health care financing (e.g., by authorizing the sale of insurance across state lines) or to the tax system (e.g., by changing the definition of dependents or reducing tax rates). The effect of one provision could differ substantially depending on the scope of these other changes.

Some changes might occur through legislation that ostensibly has little to do with a particular topic. For example, a tax credit for health insurance could increase the number of health savings accounts by enabling currently uninsured people to purchase qualifying high deductible insurance. Similarly, capping the exclusion for employer-paid insurance could increase the number of people who claim the medical expense deduction because they would have more unreimbursed expenses.



Comprehensive Reform Proposals

The 111 th Congress is considering comprehensive health care reform. A number of comprehensive reform bills have been introduced so far, some of which include significant tax provisions:


Ÿ H.R. 15 (Dingell) would establish national health insurance that is financed by a value added tax (a consumption tax levied at each stage of the production of a product or service).



Ÿ H.R. 193 (Stark) would establish nationally available insurance that is financed in part by employer contributions for their workers.



Ÿ H.R. 676 (Conyers) would establish a national system of health care that is financed in part by increasing income taxes on high income earners, a payroll tax on employers, and taxes on stock and bond transactions.



Ÿ H.R. 1200 (McDermott)/S. 703 (Sanders) would establish a state-based health system that is financed in part by a payroll tax on employers and an individual income tax surcharge.



Ÿ H.R. 1321 (Eshoo)/S. 391 (Wyden) would establish state-based private insurance that is financed in part by employer contributions, repeal on the tax exclusion on employer-paid coverage and the employer's deduction for that coverage (with some exceptions), and modifications of other tax benefit provisions. H.R. 1321 would also authorize a refundable tax credit for individuals' health insurance payments, while S. 391 would authorize a standard above-the-line deduction for those payments.



Ÿ H.R. 2399 (Langevin) would provide universal health insurance through a new program for everyone not eligible for employer coverage or certain public plans. The new program, for which there would be a refundable tax credit, would be financed in part by an excise tax on employers not offering coverage.



Ÿ H.R. 2520 (Ryan of Wisconsin)/S. 1099 (Coburn) would rely upon a less-restricted private market to make health insurance more affordable. It would repeal the tax exclusion for employer-provided coverage and authorize a new refundable tax credit.



Ÿ H.R. 3000 (Lee) would establish a national health insurance program for all individuals financed by a tax surcharge.



Ÿ S. 1240 (DeMint) would allow insurance regulated in a primary state to be sold elsewhere in the country and would authorize association health plans for small businesses. It would authorize a refundable individual tax credit.



Ÿ S. 1278 (Rockefeller) would establish a public health insurance plan available to all individuals.


Some of these bills would eliminate existing tax subsidies for health insurance, such as the exclusion for employer provided coverage.

The committees of principal jurisdiction for health care are working on comprehensive reform proposals. The Senate HELP Committee released a draft on June 9, while a coordinated measure by three House committees (Education and Labor, Energy and Commerce, and Ways and Means) was released on June 19. The Senate Finance Committee has not yet released a public draft. The HELP Committee draft did not include tax provisions related to health care aside from a penalty tax to enforce an individual mandate. 49 The House committees' draft also has a penalty tax for people without coverage, a requirement that employers either offer acceptable coverage or pay 8% of payroll into a health exchange trust fund, and a small business health insurance tax credit.

Comprehensive reform is likely to be expensive, with initial 10-year estimates for the three committee proposals ranging from $1 trillion to more than $1.5 trillion, depending on their scope and details. More recent versions are said to be less expensive. Some of the cost may be offset by reductions in future Medicare and Medicaid spending, though unspecified tax increases are also being considered. The Senate Finance Committee released some policy options for tax changes on May 20. 50 For an analysis of some of these options, see CRS Report R40648, Tax Options for Financing Health Care Reform , by Jane G. Gravelle.



Exclusion for Employer-Provided Insurance

The federal income tax exclusion is criticized for several reasons. Since it reduces the after-tax cost of insurance, usually in ways that are not transparent, it likely encourages people to obtain more coverage than they otherwise would. Not being explicitly capped or limited, it does little to restrict the generosity of the insurance or annual premium increases. These attributes contribute to what some economists argue is a welfare (or efficiency) loss from excess health insurance for those with coverage; they also contribute to rising health care costs and spending. In addition, the exclusion often is criticized for giving greater tax savings to higher income individuals and families, an outcome that strikes many observers as wasteful and inequitable.

However, these arguments involve complex issues, and other points and perspectives might be taken into account. The welfare loss may be difficult to gauge considering how consumers react to higher cost-sharing. Determining alternative tax benefits to replace the exclusion that would not share its faults or adversely affect people with high costs could be challenging. The larger tax savings to higher income people might not be inequitable but only a consequence of the proper treatment of losses under a progressive income tax. (For more discussion of these points, see CRS Report RL34767, The Tax Exclusion for Employer-Provided Health Insurance: Policy Issues Regarding the Repeal Debate , by Bob Lyke.)

In the 111 th Congress, the exclusion is being targeted as a way to finance health care reform. Completely eliminating the federal income tax exclusion would increase tax revenue by more than $130 billion a year, and more than $90 billion could be raised by eliminating the exclusion for employment taxes as well. 51 Bills that would eliminate the tax exclusion (with some exceptions) include H.R. 1321 (Eshoo), H.R. 2520 (Ryan of Wisconsin), H.R. 3000 (Lee), S. 391 (Wyden), S. 1099 (Coburn), and S. 1240 (DeMint), all of which are comprehensive reform proposals. Most of these bills would eliminate other health tax benefits as well.

There are also proposals to cap the exclusion rather than eliminate it, though currently no bills have been introduced for this purpose. Capping the exclusion might be less controversial than elimination, though it would also raise less money for reform. Proposals to cap the exclusion often are aimed at coverage with generous or excessive benefits, thought these can be difficult to define. One complication in setting a cap is that the cost of insurance varies with geographic differences in the cost of health care and the health status and risk of the people who are insured. See CRS Report R40673, Limiting the Exclusion for Employer-Provided Health Insurance: Background and Issues , by Bob Lyke and Chris L. Peterson.



Definition of Medical Care

H.R. 2105 (Kind) would allow up to $1,000 a year ($2,000 for married couples filing jointly) in qualified sports and fitness expenses to be considered medical care. This would affect deductions and credits for health care expenses, as well as the exclusion that applies to health insurance benefits.

Expanding the definition of medical care would alter the line between what has generally been considered to be medical care under the Code (defined as amounts paid "for the diagnosis, cure, mitigation, or prevention of disease, or for the purpose of affecting any structure or function of the body") 52 and what simply contributes to healthy living. Some health care reform proposals include provisions to encourage better health, and there is something to be said for providing tax subsidies for activities that are generally thought to do this. However, it sometimes can be difficult to justify including certain expenditures (exercise in this instance) without including others (diet foods and nutritional supplements, for example).



Expanded Tax Deduction

In the 111 th Congress, several bills have been introduced that would expand the deduction allowed for health insurance and other unreimbursed expenses, which currently is available only to those who itemize and to the extent the expenses exceed 7.5% of adjusted gross income (AGI).

H.R. 502 (Bachman) and H.R. 1495 (Paul) would remove the AGI floor from the itemized deduction for health insurance and unreimbursed medical care costs. H.R. 99 (Dreier) would remove the floor only for those ages 65 and over who are not covered by an employer plan.

S. 207 (Boxer) and H.R. 198 (Stearns) would allow an above-the-line deduction (that is, one not limited to itemizers) for health insurance expenses. The Stearns bill would also allow this deduction for unreimbursed prescription drug costs.

S. 391 (Wyden) would establish a standard above-the-line deduction for health insurance, that is, a set amount (depending on filing status) that all taxpayers could claim. The standard deduction is part of the Senator's comprehensive reform proposal.

H.R. 1203 (Van Hollen) and S. 491 (Webb) would allow an above-the-line deduction of Tricare supplemental premiums.

The principal argument for expanding the tax deduction for health insurance is equity; it would allow people who purchase individual market insurance to receive tax savings roughly equivalent (in the case of an above-the-line deduction) to those of workers who exclude employer-provided coverage. (The deduction would not offset employment taxes that people with individual market insurance must pay on the income they use to pay the premiums.) However, an expended deduction would provide little or no savings to lower income taxpayers since they either have no taxable income (due to the standard deduction and personal exemptions) or it is taxed at low marginal rates.



Self-Employed Deduction

H.R. 533 (Neuberger), H.R. 1470 (Kind), H.R. 1763 (Latta), and S. 725 (Bingaman) would allow self-employed taxpayers to subtract their health insurance costs in determining their selfemployment taxes. Under current law, self-employed taxpayers may deduct these costs on their income taxes, but not self-employment taxes for Social Security and Medicare. H.R. 1763 would also allow Health Savings Account contributions to be deducted in determining self-employment taxes.

The principal argument for allowing this deduction is that taxpayers who have employer-provided coverage can exclude employer contributions from their Social Security and Medicare taxes. The different treatment seems inequitable. However, most self-employed taxpayers can choose health insurance plans that are to their advantage, which employees generally cannot, and self-employed taxpayers sometimes could be classified as employees (and thus eligible for the exclusion) if they organized their business under a different legal form.



Cafeteria Plans

S. 988 (Snowe) would make it easier for small businesses to establish cafeteria plans by modifying the nondiscrimination requirements for firms with 100 or fewer employees and allowing self-employed people to be considered employees for purposes of participating.



Premium Conversion

Several bills have been introduced in the 111 th Congress to allow federal retirees to pay for their share of Federal Employees Health Benefits Program (FEHBP) premiums on a pretax basis: H.R. 1203 (Van Hollen) and S. 491 (Webb).

The principal argument for premium conversion for federal retirees is that it is allowed for active federal workers, who in addition generally have higher incomes. On the other hand, it would seem difficult to justify extending premium conversion to federal retirees and not retirees with private sector or state or local government retiree health insurance. Extending premium conversion to other retiree groups would greatly increase the revenue loss of this proposal.

H.R. 1413 (Crowley) would allow retired public employees in general to pay up to $3,000 of qualified health insurance premiums from their pensions on a pretax basis each year, similar to what is now allowed for certain retired public safety officers. In addition, the bill would convert the exclusion that is available under current law to an above-the-line deduction and also index the allowable amount for inflation.



Flexible Spending Accounts

Several 111 th Congress bills allow limited unused amounts in FSAs to be carried over to the following year, contributed to an HSA, or contributed to a qualified retirement account (depending on the particular bill): H.R. 544 (Royce), H.R. 1495 (Paul), and S. 988 (Snowe). S. 988 would modify FSA rules in other respects as well, and it would impose a ceiling on the amount that individuals could put into the accounts (for example, $7,500 in the case of one individual).

The principal argument for allowing carryovers and rollovers is that taxpayers might be more willing to participate in FSAs if unused balances at the end of the year were not lost. Allowing carryovers or rollovers might also discourage participants from spending remaining balances carelessly, just to use them up.

However, FSAs provide tax benefits for the first dollars of health care spending, which is just the opposite of the restriction limiting the medical expense deduction to catastrophic expenses (i.e., those exceeding 7.5% of AGI). FSAs also conflict with the rationale for high deductible insurance, which is not to provide third-party assistance for expenditures that are customary and routine. Some argue that expansion of FSAs may inhibit the spread of health savings accounts. Allowing unused balances to be carried or rolled over would also contribute to the revenue losses associated with FSAs.



Health Savings Accounts

A number of bills have been introduced in the 111 th Congress regarding HSAs:

H.R. 1118 (Blackburn) would authorize a Medicare Alternative Voucher program for individuals entitled to Medicare Part A. For individuals who elect this alternative, the Secretary of Health and Human Services (HHS) would issue a monthly voucher that could be used for high deductible insurance or deposited into an HSA. The allowable deduction for an HSA would be increased by the amount of the voucher deposit.

H.R. 1311 (Paul) would allow distributions from HSAs (and other tax-qualified accounts) used for certain living and education expenses to be excluded from income during periods of unemployment.

H.R. 1495 (Paul) would allow contributions to HSAs even though the taxpayer does not have high deductible insurance. Contributions would be limited to $8,000 a year ($16,000 in the case of joint returns).

H.R. 2520 (Ryan) and S. 1099 (Coburn) would among other things increase the contribution limits for HSAs, allow premiums paid for individual market high deductible insurance to be considered qualified distributions, allow qualifying high deductible insurance to cover chronic disease maintenance without a deductible, and allow employers to make payments for chronically ill employees or their family members without violating the requirement to make comparable contributions to employees' accounts.

H.R. 2974 (Campbell) would allow individuals to contribute to HSAs even though they receive periodic hospital care or medical services for veterans.



Health Coverage Tax Credit

In the 111 th Congress, the American Recovery and Reinvestment Act of 2009 (ARRA, P.L. 111-5) made a number of modifications to the HCTC and eligibility for it. Among the more important are the following, all of which expire at the end of 2010:


Ÿ increases the credit rate to 80%;



Ÿ allows retroactive credit payments for costs incurred before certification of eligibility;



Ÿ allows the credit to apply to VEBAs in the case of certain bankruptcies;



Ÿ allows certain family members to continue to receive the credit after the qualified taxpayer becomes eligible for Medicare, divorces, or dies; and



Ÿ broadens eligibility for TAA assistance (and thus eligibility for the credit) to include service sector and public agency workers.


S. 29 (Brown) would increase the HCTC rate to 85% and add COBRA enrollees to the list of taxpayers eligible for the credit.



Individual Tax Credit

In recent years, there has been much discussion of an individual income tax credit for health insurance, usually as part of comprehensive health care reform. If the credit were refundable, it would allow taxpayers to receive the full amount of the credit even if that exceeds their regular tax liability. 53 If the credit were also available in advance, it could be paid directly to the insurer or health plan, and taxpayers would not have to wait until they filed their returns to benefit. The HCTC described above is an example of a credit that is both refundable and advanceable.

In the 111 th Congress, several bills have been introduced that would authorize a tax credit for health insurance, sometimes limited to particular types of insurance (such as individual market insurance) or to taxpayers with certain incomes. These bills include H.R. 879 (Granger), H.R. 956 (Kaptur), H.R. 1321 (Eshoo), H.R. 1495 (Paul), H.R. 2399 (Langevin), H.R. 2520 (Ryan of Wisconsin), S. 1099 (Coburn), and S. 1240 (DeMint). Some of these bills would also terminate other tax benefits for individuals who are eligible for their credit.

A refundable tax credit for health insurance could be attractive. If it were generally available, a credit could aid taxpayers who do not have access to employment-based insurance but cannot claim the medical expense deduction (usually because they do not itemize their deductions). A credit could provide all taxpayers with the same dollar reduction in final tax liability, avoiding the vertical equity limitations associated with exclusions and deductions. A credit could also provide lower-income taxpayers with sufficient resources to purchase insurance, likely reducing the number of uninsured.

The effects of tax credits, however, can vary widely depending on the legislation. One important question is whether a credit would supplement or replace existing tax benefits, particularly the exclusion for employer-paid insurance. If the credit replaced the exclusion, it probably would have to be made available to people with high as well as low income (though the credit could be phased out for incomes above a certain level). A generous credit may lead employers to drop coverage (or not start it in the first place), possibly increasing the number of the uninsured. A credit that is not generous would not enable lower-income individuals and families to purchase insurance. Advance payments would be essential for many families (since they could not wait until filing their returns to get the credit for their insurance) but would add administrative complexity.

The most difficult questions about tax credits may have to do with health policy. If a credit were generous enough to provide meaningful help to lower-income people, it is likely that the legislation would have to specify what is qualifying insurance. Otherwise, there would be no assurance that public funds would be used efficiently and effectively. Defining qualifying insurance would involve decisions about minimum benefits, deductible and copayment limits, guaranteed issue and pre-existing condition exclusions, and other contentious issues.

Other tax credit bills with more limited focus have been introduced in the 111 th Congress, as listed below.

H.R. 163 (Paul) would authorize a tax credit for prescription drugs purchased by individuals who have attained Social Security retirement age.

H.R. 194 (Stark) would authorize a refundable tax credit for catastrophic expenses as part of his comprehensive health insurance for children.

H.R. 237 (Emerson) would authorize a refundable tax credit for Medicare Part B premiums for military retirees.

H.R. 1496 (Paul) would authorize a nonrefundable credit for dependents' unreimbursed medical expenses.

S. 142 (Kerry) would authorize a refundable tax credit for health insurance coverage for children.

S. 958 (Rockefeller) would authorize a refundable tax credit for taxpayers whose cost-sharing expenses for children covered by the MediKids program (to be authorized by the bill) exceed 5% of AGI.

S. 960 (Rockefeller) would allow individuals ages 55 through 64 to buy into Medicare and provides a 75% refundable tax credit for the premiums they would be charged.



Employer Tax Credit

Under current law, employers may deduct the expenses they incur for employees' health insurance and health care and the contributions they make to their tax-advantaged health care savings accounts. Depending on the employer's marginal tax rate, a tax credit might result in greater tax savings, thereby providing an additional incentive to start and maintain health insurance plans. Tax credits could also be useful for government and nonprofit employers that are not subject to income taxes; the credits would offset some of the employment taxes they pay.

Employer tax credits are sometimes proposed as part of comprehensive health care reform. One advantage of employer credits is that they can be easier to administer than individual tax credits; there are far fewer employers than individual taxpayers, and employers already must submit employment taxes and withheld income taxes on a regular basis. On the other hand, it is difficult to target employer tax credits to low income workers. Employers do not know the income of their employees, only their wages; many employees have an employed spouse or a second job.

In the 111 th Congress, the American Recovery and Reinvestment Act of 2009 (ARRA) included a COBRA premium subsidy to help the unemployed afford health insurance coverage from their former employer. The subsidy, which takes the form of an employer credit for payroll taxes, is described above on page 3. 54 Aside from covering additional administrative costs, employers do not have to spend money of their own to get this credit.

H.R. 850 (Velazquez) would provide small employers (not more than 500 employees) a tax credit for employees who are covered by a health insurance cooperative the bill would authorize.

H.R. 2360 (Kind) and S. 979 (Durbin) would provide small employers (not more than 50 employees) a tax credit for paying certain percentages of the premiums for small group health insurance meeting specified standards or the small business health insurance program that the bill would authorize.

The coordinated reform draft released June 19 by the three House committees with principal jurisdiction for health care (Education and Labor, Energy and Commerce, and Ways and Means) includes a credit for small business employers (the full credit is available only if the number of employees does not exceed 10).



For Additional Reading

Feldman, Roger and Bryan Dowd. A New Estimate of the Welfare Loss of Excess Health Insurance. American Economic Review . vol. 81 (March 1991), pp. 297-301.

Gruber, Jonathan. Tax Policy for Health Insurance . NBER Working Paper 10977 National Bureau of Economic Research. December 2004. 35 p.

Hubbard, R. Glenn, John F. Cogan, and Daniel P. Kessler. Healthy, Wealthy, and Wise: Five Steps to a Better Health Care System . AEI Press/The Hoover Institution. November 2005.

Kaplow, Louis. The Income Tax as Insurance: The Casualty Loss and Medical Expense Deductions and the Exclusion of Medical Insurance Premiums. California Law Review , vol. 79 (1991), pp. 1485-1510.

Kahn, Charles N. and Ronald F. Pollack. Building a Consensus for Expanding Health Coverage. Health Affairs , vol. 20 (January/February 2001), pp. 40-48.

Smart, Michael and Mark Stabile. Tax Credits and the Use of Medical Care . NBER Working Paper 9855. National Bureau of Economic Research. July 2003. 35 p.

Pauly, Mark. Taxation, Health Insurance, and Market Failure in the Medical Economy. Journal of Economic Literature , vol. 24 (1986), pp. 629-675.

Pauly, Mark and Bradley Herring. Expanding Coverage via Tax Credits: Trade-Offs and Outcomes. Health Affairs , vol. 20 (January/February, 2001), pp. 9-26.

The President's Advisory Panel on Federal Tax Reform. Simple, Fair, and Pro-Growth: Proposals to Fix America's Tax System . November 2005.

Sheils, John and Randall Haught. The Cost of Tax-Exempt Health Benefits in 2004. Health Affairs , Web exclusive (January - June 2004), pp. W106-W112.

U.S. Congressional Budget Office. Consumer-Directed Health Plans: Potential Effects on Health Care Spending and Outcomes . December 2006.

----- The Tax Treatment of Employment-Based Health Insurance . March 1994.



Appendix. General Formula For Calculating Federal Income Taxes

The general formula for calculating federal income taxes appears below. The list omits some steps, such as prepayments (from withholding and estimated payments) and the alternative minimum tax.


1. Gross income (everything counted for tax purposes)



2. Minus deductions (or adjustments) for determining adjusted gross income (AGI) --"above the line deductions"



3. Equals AGI



4. Minus greater of standard or itemized deductions



5. Minus personal and dependency exemptions



6. Equals taxable income



7. Times tax rate



8. Equals tax on taxable income (i.e., "regular tax liability")



9. Minus credits



10. Equals final tax liability.




Author Contact Information

Bob Lyke


Julie M. Whittaker

Specialist in Income Security
jwhittaker@crs.loc.gov, 7-2587



Additional Author Information

This report was co-authored by Bob Lyke, who currently is working as a contractor for CRS. He can be reached at rlyke@crs.loc.gov, 7-7355. Julie Whittaker is on maternity leave until August 2009.

1 The draft includes some tax benefits for long-term care. It also includes individual and employer credits payable through program funding; these might be converted to tax credits in subsequent legislation.

2 All JCT estimates are from Estimates of Federal Tax Expenditures for Fiscal Years 2008-2012 , JCS-2-08 (October 31, 2008). Current estimates the JCT makes may be somewhat different. Tax expenditures should not be added together since they do not take account of interaction effects among provisions.

3 CRS Report 96-891, Health Insurance Coverage: Characteristics of the Insured and Uninsured Populations in 2007 , by Chris L. Peterson and April Grady, and Employer Health Benefits: 2008 Summary of Findings , by the Kaiser Family Foundation and the Health Research and Educational Trust. Much of the employers' cost for this insurance is probably passed on to employees through reductions in wages and other forms of compensation.

4 Sections 106 and 3121, respectively.

5 For more information about tax exclusion, see CRS Report RL34767, The Tax Exclusion for Employer-Provided Health Insurance: Policy Issues Regarding the Repeal Debate , by Bob Lyke.

6 Sections 104 and 105.

7 About 70% of these employers purchase stop-loss insurance to cover major liabilities.

8 The JCT estimate includes payments of premiums through cafeteria plans.

9 COBRA eligibility rules are complex. For additional information about basic COBRA rules, see CRS Report R40142, Health Insurance Continuation Coverage Under COBRA , by Janet Kinzer.

10 The Joint Committee on Taxation estimates that the COBRA subsidy provision in the ARRA will cost $24.7 billion over FY2009-FY2013 (mostly in FY2009 and FY2010). JCX-19-09.

11 Section 213. If the taxpayer is subject to the Alternative Minimum Tax (AMT), the deduction is limited to expenses that exceed 10% of AGI. Section 56(b)1)(B).

12 Section 213(d)(1)(A).

13 Corporations may elect S-corporation status if they meet a number of Internal Revenue Code requirements. Among other things, they cannot have more than 100 shareholders or more than one class of stock. S-corporations are tax-reporting rather than tax-paying entities, in contrast to C-corporations, which are subject to the corporate income tax.

14 Section 162(l).

15 Section 125. "Cash" in this context includes any taxable benefit.

16 Rev. Rul. 2003-62.

17 The JCT estimate for health insurance received through cafeteria plans is also included in the exclusion for employer-paid insurance (discussed above).

18 Some FSAs are linked to employers' health insurance plans so provider payments can be made directly from the accounts. These arrangements avoid the need for employees to pay first and then seek reimbursement.

19 For additional information, see CRS Report RL32656, Health Care Flexible Spending Accounts , by Bob Lyke and Janemarie Mulvey.

20 The Tax Relief and Health Care Act of 2006 (P.L. 109-432) allows individuals to make limited, one-time rollovers from balances in their health care FSAs to Health Savings Accounts. See IRS Notice 2007-22 for details.

21 The Heroes Earnings Assistance and Tax Relief Act (P.L. 110-245).

22 Data in this paragraph are from the 2006 Medical Expenditure Panel Survey.

23 Section 105, Rev. Rul. 2002-41, and IRS Notice 2002-45.

24 For an overview of HSAs and three other types of tax-advantaged accounts (Flexible Spending Accounts, Health Reimbursement Accounts, and Medical Savings Accounts) see CRS Report RS21573, Tax-Advantaged Accounts for Health Care Expenses: Side-by-Side Comparison , by Bob Lyke and Chris L. Peterson.

25 Section 223. For more information, see CRS Report RL33257, Health Savings Accounts: Overview of Rules for 2009 , by Bob Lyke.

26 January 2009 Census Shows 8 Million People Covered by HSA/High Deductible Health Plans . America's Health Insurance Plans (AHIP) Center for Policy and Research (May 2009). http://www.ahipresearch.org/pdfs/2009hsacensus.pdf

27 Section 220.

28 Announcement 2007-44.

29 For additional information of the eligibility rules, see CRS Report RL32620, Health Coverage Tax Credit , by Bernadette Fernandez.

30 David R. Williams, Director of Electronic Tax Administration and Refundable Credits, Internal Revenue Service, Testimony Before the House Committee on Ways and Means, June 14, 2007, http://waysandmeans.house.gov/hearings.asp?formmode=view&id=6131.

31 For more information, see CRS Report RL33537, Military Medical Care: Questions and Answers , by Don J. Jansen.

32 Section 134. The exemption of certain combat zone compensation under Section 112 might also apply, as might employer-provided health care and coverage under Sections 105 and 106.

33 For additional information, see CRS Report RL34598, Veterans Medical Care: FY2009 Appropriations , by Sidath Viranga Panangala.

34 Section 134 of the Internal Revenue Code and 38 USC § 5301.

35 Rev. Rul. 70-341. The ruling states that benefits received under Part A are not legally distinguishable from certain Social Security benefits and thus are excluded from taxation as disbursements made to further a social welfare function of the government. In contrast, benefits received under Part B are excluded from taxation as medical insurance proceeds under Section 104.

36 Rev. Rul. 66-216.

37 Rev. Rul 66-216.

38 IRS Publication 502, Medical and Dental Expenses , p. 9.

39 Section 138.

40 JCS-2-06.

41 For an overview, see CRS Report RL33202, Medicaid: A Primer , by Elicia J. Herz.

42 There apparently is no statutory provision or revenue ruling that Medicaid coverage and benefits are exempt from taxation. The question would not often arise because Medicaid usually is for individuals and families with low income.

43 CRS Report RL30473, State Children's Health Insurance Program (SCHIP): A Brief Overview , by Elicia J. Herz, Chris L. Peterson, and Evelyne P. Baumrucker.

44 Sections 501(a) and 501(c)(9). For a comprehensive summary of the tax treatment of VEBAs, see Tax Expenditures: Compendium of Background Material on Individual Provisions , U.S. Senate Committee on the Budget, December 2008 (S. Prt. 110-667, p. 663-671.

45 Sections 419 and 419A.

46 The issues in this section are discussed in more detail in CRS Report RL34767, The Tax Exclusion for Employer-Provided Health Insurance: Policy Issues Regarding the Repeal Debate , by Bob Lyke.

47 Horizontal equity is a tax principle which in the case of an income tax holds that people who have essentially equal economic income should be treated the same.

48 Vertical equity is a tax principle which in the case of an income tax holds that people who have higher economic income should have higher tax liabilities.

49 The draft includes tax subsidies for long-term care. It also includes individual and employer credits payable through program funding; these might be converted to tax credits in subsequent legislation.

50 Financing Comprehensive Health Care Reform: Proposed Health System Savings and Revenue Options , http://www.finance.senate.gov/sitepages/leg/LEG%202009/051809%20Health%20Care%20Description%20of%20Policy%20Options.pdf.

51 Joint Committee on Taxation, Background Materials for Senate Committee on Finance Roundtable on Health Care Financing (JCX-27-09), May 8, 2009.

52 Section 213(d)(1)A).

53 It is also possible to place limits on refundability. For example, the credit might be limited to the taxpayer's regular tax liability plus payments for Social Security taxes. A credit might be refundable for purposes of the regular income tax but not the alternative minimum tax.

54 For analysis of this subsidy, see CRS Report R40165, Unemployment and Health Insurance: Current Legislation and Issues , by Bob Lyke and Janemarie Mulvey, and CRS Report R40420, Health Insurance Premium Assistance for the Unemployed: The American Recovery and Reinvestment Act of 2009 , coordinated by Janemarie Mulvey.

Labels:

Wednesday, July 8, 2009

Step transaction doctrine -

William A. Linton and Stacy A. Linton, Plaintiffs v. United States of America, Defendant.

U.S. District Court. Dist. Wash.; C08-227Z, July 1, 2009.

[ Code Sec. 2511]

Gift tax: Transfers in general: Indirect gifts: Transfers to partnerships. --
A husband's transfer of property and securities to a limited liability company (LLC) was an indirect gift to his children for purposes of Code Sec. 2511. The husband formed the LLC in November of 2002. On January 22, 2003, the husband transferred half of his interest to his wife and contributed property and securities to the LLC. The couple then executed trusts for each of their four children and gifted a percentage of their interest in the LLC to the trusts. The gifts were discounted by 47 percent for lack of control and lack of marketability. Although, the trust agreements and the transfers to the trust were originally undated, the language in both documents indicated the trusts were signed and funded on January 23, 2003. Furthermore, the couple's attempts to reform the documents to indicate that the trusts' creation and funding occurred on January 31, 2003, were denied. Accordingly, the court held that the gifts to the trust were indirect because they lacked the proper sequence of transactions. Instead, the funding of the trusts and the funding of the partnership occurred simultaneously. Moreover, even if the reformation of the trust agreement and the gift documents had been permitted, the court found that the step transaction doctrine applied. Because the couple failed to show any volatility in the LLC assets which would demonstrate that they a bore a real economic risk of a change in value from January 23 to January 31, the case was distinguishable from T.H. Holman, Jr., Dec. 57,455, 130 TC --, No. 12 and B. Gross, 96 TCM 187, Dec. 57,544(M), TC Memo. 2008-221. J. Shepherd, Dec. 54,098, 115 TC 376, aff'd CA-11, 2002-1 USTC ¶60,431, 283 F3d 1258 and M. Senda, 88 TCM 8, Dec. 55,685(M), TC Memo. 2004-160, aff'd CA-8, 2006-1 USTC ¶60,515, 433 F3d 1044


Before: Thomas S. Zilly, United States District Judge.


ORDER


ZILLY, United States District Judge: THIS MATTER comes before the Court on cross-motions for summary judgment. Having reviewed all papers filed in support of and in opposition to each motion, and having heard the arguments of counsel, the Court GRANTS the Government's motion for summary judgment, docket no. 19, DENIES plaintiffs' cross-motion for partial summary judgment, docket no. 21, and DIRECTS the Clerk to enter judgment consistent with this Order.



Background

Plaintiffs William and Stacy Linton seek a partial refund of gift taxes paid for the year 2003. For that year, William Linton reported taxable gifts of $725,548, while Stacy Linton reported taxable gifts of $724,000. See Exh. I to Linton Decl. (docket no. 23-10). The Internal Revenue Service ("IRS") examined both gift tax returns and concluded that, during the year 2003, William and Stacy Linton actually made taxable gifts of $1,587,988 and $1,520,440, respectively. See Exhs. A & B to Complaint (docket no. 1-2 at 29 & docket no. 1-3 at 29). The Lintons timely paid the additional gift taxes computed by the IRS, in the aggregate amount of $518,331.41, including interest, and in this action, they seek a refund of this additional amount, together with costs and attorney fees.

The gift taxes at issue relate to interests in a limited liability company given by William and Stacy Linton to trusts established for the benefit of their children. In November 2002, William Linton formed WLFB Investments, LLC ("WLFB LLC"). Certification of Formation, Exh. A to Linton Decl. (docket no. 23-2 at 20); see Limited Liability Company Agreement dated Nov. 7, 2002 [hereinafter "LLC Agreement"] at 1, 18, Exh. A to Linton Decl. (docket no. 23-2 at 2, 19). At the time of formation, WLFB LLC had only one member, namely William Linton. LLC Agreement at 18, Exh. A to Linton Decl. (docket no. 23-2 at 19).

On January 22, 2003, William Linton gave to his wife Stacy Linton 50% of his percentage interests in WLFB LLC. Gift of Percentage Interest in WLFB Investments, LLC (docket no. 42). 1 Also on January 22, 2003, William and/or Stacy Linton executed and dated the following documents, which contributed property to WLFB LLC:
 A Quit Claim Deed signed by William Linton, conveying undeveloped real property in Snohomish County, which was his separate property, to WLFB LLC; see Exh. D to Linton Decl. (docket no. 23-5);

 Letters signed by William Linton, authorizing transfers of securities, including municipal bonds, and cash to WLFB LLC; see Exh. D to Auchterlonie Decl. (docket no. 20-5); Exh. E to Linton Decl. (docket no. 23-6); and

 An Assignment of Assets signed by William Linton as Assignor and by both William and Stacy Linton as Managers of Assignee WLFB LLC; see Exh. F to Linton Decl. (docket no. 23-7); see also LLC Agreement at ¶ 6 (identifying William and Stacy Linton as Managers of WLFB LLC).

In addition, on January 22, 2003, William and Stacy Linton, as well as James Linton, William Linton's brother, signed a number of other documents, which they left undated. These executed, but contemporaneously undated, documents consist of:
 Four separate Trust Agreements signed by both William and Stacy Linton as Grantors, and by James Linton as Trustee, one Trust Agreement for each of the Lintons' four children, who are identified by initials as J.M.L., J.R.L., S.J.L., and T.W.L.; see Exh. E to Auchterlonie Decl. (docket no. 20-6);

 Four separate documents titled "Gift of Percentage Interest in WLFB Investments, LLC" signed by William Linton as Assignor and James Linton, Trustee, on behalf of Assignee, one document for each of the four Trusts; see Exh. G to Linton Decl. (docket no. 23-8); and

 Four separate documents titled "Gift of Percentage Interest in WLFB Investments, LLC" signed by Stacy Linton as Assignor and James Linton, Trustee, on behalf of Assignee, one document for each of the four Trusts; see Exh. G to Linton Decl. (docket no. 23-8).

Each of the Trust Agreements indicates that the Trust is irrevocable and that the Trust Agreement is "entered into effective upon contribution of property to the Trust." Exh. E to Auchterlonie Decl. (docket no. 20-6). The Trust Agreements further state that "[a]t the time of signing of this Agreement, the Grantors have transferred percentage interests in the WLFB Investments, LLC ... to the Trustee of the Trust for the benefit of the Grantor's [sic] child." Id. Finally, the Trust Agreements reflect that the Trustee, James Linton, "acknowledges receipt of such property and agrees to administer all contributed property pursuant to the terms" of the Agreements. Id.

The documents titled "Gift of Percentage Interest in WLFB Investments, LLC" (the "Gift Documents") contain the following language: Assignor "hereby gifts to the ... Trust, dated the same date hereof, (the "Assignee") a total of 11.25 of the percentage interests in WLFB Investments, LLC ... standing in his respective name on the books of the Company." Exh. G to Linton Decl. (docket no. 23-8). Based on this language, each of the four Trusts received 11.25% from each parent, for a total of 22.5 of the percentage interests in WLFB LLC for each Trust.

According to Richard Hack, the attorney who prepared the various documents, a few months after the transactions at issue, when he was preparing the minute book for WLFB LLC, he filled in the missing dates on the Trust Agreements and Gift Documents. Hack Dep. at 13:12-17:1, Exh. B to Colvin Decl. (docket no. 22-3 at 4-8). He put the date of January 22, 2003, on these documents, but he now believes that he made a "mistake" in doing so and that the intended date for the creation of the Trusts and the transfers of percentage interests in WLFB LLC to the Trusts was January 31, 2003. Hack Dep. at 20:18- 23:12, Exh. B to Colvin Decl. (docket no. 22-3 at 9-12).

Mr. Hack's deposition testimony is consistent with that of Caryl Thorp, who provided estate planning and tax compliance services for the Lintons. See Thorp Dep. at 18:23-19:5, Exh. C to Colvin Decl. (docket no. 22-4 at 6-7). According to Ms. Thorp, the intended order of the transactions was as follows: "To form the LLC, transfer the assets into the LLC, and then determine the amount of any gifts they wanted to make of LLC units for the benefit of their children and do those after that." Thorp Dep. at 20:6-9, Exh. C to Colvin Decl. (docket no. 22-4 at 8). Ms. Thorp explained that this sequence was required "[b]ecause you have to get the assets into the LLC first so it's the owner of the assets before you start making transfers of units in the LLC." Thorp Dep. at 20:12-14, Exh. C to Colvin Decl. (docket no. 22-4 at 8).

When asked in his deposition how he decided on the amount of assets he would transfer to WLFB LLC, William Linton testified as follows:
Well, it started out Stacy and I were using our lifetime exemptions, and somewhere along the way, with my team of experts, they came up with this thing that people do in my situation and they discount it because as managers, we control it, and what a willing buyer will pay to a willing seller, who is going to buy a hundred percent of someone's share if they can't touch it or feel it or control it, so there's some proven way that they go out and they discount this stuff. Well, it was news to me... . They said somewhere between 40 and 49 percent discounting based on the blend of assets that you're proposing. So, based on that, I just did some back math to figure out how much money to put into the LLC.

Linton Dep. at 26:6-23, Exh. B to Auchterlonie Decl. (docket no. 20-3).

The tax return filed on behalf of WLFB LLC for the calendar year 2003 provided the following information about the capital accounts of the LLC members:


capital
member contributed income withdrawals capital balance

1 $1,792,386 $5,793 $1,613,148 $185,031

2 $1,792,386 $5,793 $1,613,148 $185,031

3 $806,574 $26,070 $832,644

4 $806,574 $26,071 $832,645

5 $806,574 $26,067 $832,641

6 $806,574 $26,070 $832,644



See Schedule L to Form 1065 for 2003, Exh. J-1 to Linton Decl. (docket no. 23-11 at 15). Members 1 and 2 are William and Stacy Linton, while Members 3, 4, 5, and 6 are the Trusts for the Linton children. Schedule L reflects contributions of assets in the aggregate amount of $3,584,772, and transfers of capital in the aggregate amount of $3,226,296, divided evenly among the four Trusts, with each Trust receiving $806,574. The capital account balances shown in Schedule L appear consistent with the percentage interests held by each member after the gifts at issue, namely 5% for William Linton, 5% for Stacy Linton, and 22.5% for each of the Trusts. 2

The LLC Agreement places certain restrictions on the transfer of percentage interests to persons who are not family members, and it limits the involvement of members in the dayto-day business of the LLC, reserving to the Managers (William and Stacy Linton) all "authority or power to act" for WLFB LLC. LLC Agreement at ¶¶ 6.5, 9.1, 9.2, 9.2.1., 9.2.2., & 9.2.3 (docket no. 23-2 at 4-5, 8-10). In light of these provisions, in computing their gift taxes for the year 2003, plaintiffs applied a discount of 47% based on the theory that the limitations on alienability and non-controlling status rendered the percentage interests in WLFB LLC unmarketable. See Exh. 5 to Moss Adams Advisory Services Appraisal Report for WLFB LLC, Exh. H to Linton Decl. (docket no. 23-9 at 39) [hereinafter "Moss Adams Report"]. The Government contends that any discounting is improper.



Discussion



A. Standard for Summary Judgment

The Court should grant summary judgment if no genuine issue of material fact exists and the moving party is entitled to judgment as a matter of law. Fed. R. Civ. P. 56(c). The moving party bears the initial burden of demonstrating the absence of a genuine issue of material fact. Celotex Corp. v. Catrett, 477 U.S. 317, 323 (1986). A fact is material if it might affect the outcome of the suit under the governing law. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986). When a properly supported motion for summary judgment has been presented, the adverse party "may not rely merely on allegations or denials in its own pleading." Fed. R. Civ. P. 56(e). Rather, the non-moving party must set forth "specific facts" demonstrating the existence of a genuine issue for trial. Id.; Anderson, 477 U.S. at 256. All "justifiable inferences" are to be drawn in favor of the non-moving party. Anderson, 477 U.S. at 255. When the record, however, taken as a whole, could not lead a rational trier of fact to find for the non-moving party, summary judgment is warranted. See Miller v. Glenn Miller Prod., Inc., 454 F.3d 975, 988 (9th Cir. 2006).



B. Federal Gift Tax Analysis

A tax is imposed "for each calendar year on the transfer of property by gift during such calendar year by any individual." 26 U.S.C. § 2501(a)(1). If property is transferred for less than adequate and full consideration, then "the amount by which the value of the property exceeded the value of the consideration shall be deemed a gift." 26 U.S.C. § 2512(b). The value of gifted property is determined as of the date of the gift. 26 U.S.C. § 2512(a). A gift is measured "by the value of the property passing from the donor, rather than by the [value of the] property received by the donee," and the amount of a gift is generally an issue of fact. Shepherd v. Comm'r, 115 T.C. 376, 383 (2000). A gift is complete when the donor "has so parted with dominion and control as to leave in him no power to change its disposition." 26 C.F.R. § 25.2511-2(b). Although federal revenue acts identify the property interests and rights that are taxed, state law governs the creation of those property interests and rights. Morgan v. Comm'r, 309 U.S. 78, 80 (1940).

The gift tax applies "whether the transfer is in trust or otherwise" and "whether the gift is direct or indirect." 26 U.S.C. § 2511(a). An example of an indirect gift is a transfer of property for less than adequate consideration to a corporation, which constitutes an indirect gift of the property to each shareholder of the corporation to the extent of his or her proportionate interest in the corporation. Shepherd, 115 T.C. at 388 (citing 26 C.F.R. § 25.2511-1(h)(1)). Because the corporate structure differs from a partnership relationship, the question whether a contribution of property to a partnership is an indirect gift to the partners requires further analysis. In situations in which property has been transferred for less than adequate consideration to a partnership, the distinguishing factor for gift tax purposes is whether the donating partner's contribution of property was apportioned among the other partners or was attributed only to the donor's own capital account. In the former circumstance, the contribution of property has been deemed an indirect gift to the other partners, see Shepherd, 115 T.C. at 388-89, while in the latter situation, the transfer has been held not to constitute an indirect gift, see Estate of Jones v. Comm'r, 116 T.C. 121 (2001) (citing Estate of Strangi v. Comm'r, 115 T.C. 478 (2000)); see also Gross v. Comm'r, 96 T.C.M. (CCH) 187, 2008 WL 4388277 (2008).



1. Indirect Gift to Partners (Shepherd)

In Shepherd, the taxpayer and his wife executed deeds purporting to transfer certain leased land to a partnership, the partnership agreement for which the taxpayer signed on the same day. 115 T.C. at 379, 382. The following day, the taxpayer's two adult sons executed the partnership agreement. Id. at 379. The Tax Court concluded that, under the law of the state in which the partnership was created, the partnership came into existence on the second day, when the sons signed the partnership agreement. Id. at 384-85. As a result, the Tax Court held that the conveyance of land occurred on the second day, not on the first day. Id. at 385 (on the first day, "there was no completed gift, because there was no donee, and petitioner had not parted with dominion and control over the property"). On a subsequent day, the taxpayer contributed bank stock to the partnership. Id. at 381. The Tax Court ultimately held that the taxpayer's transfers of both land and bank stock represented indirect gifts to each of his sons to the extent of their respective percentage interests in the partnership. Id. at 389. The Tax Court reasoned that, because the contributions of property were allocated, pursuant to the partnership agreement, to the taxpayer's and his sons' capital accounts according to their respective partnership shares, and because each son would be entitled upon dissolution of the partnership to receive payment of the balance in his capital account, the taxpayer had made indirect gifts to the sons. Id.



2. Contributions to Own Capital Account (Jones and Gross)

In contrast, in both Estate of Jones and Gross, one partner's contributions were not treated as indirect gifts to the other partners. In Estate of Jones, the decedent formed two different partnerships under Texas law. 116 T.C. at 123-24. The first partnership, Jones Borregos Limited Partnership ("JBLP"), was with his son, and the second partnership, Alta Vista Limited Partnership ("AVLP"), was with his four daughters. Id. Both decedent and his son transferred certain property to JBLP, with the contributions reflected in their respective capital accounts. Id. at 123. Decedent and each of his daughters transferred certain property to AVLP, with the contributions reflected in their respective capital accounts. Id. at 124.

On the same day the partnerships were formed and property was contributed, decedent gave his son an 83.08% limited interest in JBLP, and he gave each of his daughters a 16.915% limited interest in AVLP. Id. at 123-25. Decedent filed a federal gift tax return in which he applied a 66% percent discount to the limited interests in JBLP and a 58% discount to the limited interests in AVLP, pursuant to a "minority interest, nonmarketable" theory. Id. at 127. The Tax Court concluded that, in making contributions to each of the partnerships, decedent had not made indirect gifts to his children because he had received continuing limited partnership interests in exchange for the property at issue, his contributions had been properly reflected in his respective capital accounts, and the value of the other partners' interests had not been enhanced by his contributions. Id. at 128.

In Gross, the Tax Court found that the contributions of property were "similar in form to the contributions in Estate of Jones" and were "distinguishable in form from the gifts in Shepherd." 2008 WL 4388277 at *7. The Tax Court concluded that the taxpayer, who had formed a partnership with her two daughters, "made a series of contributions of securities to Dimar [Holdings L.P.] and received increasing partnership interests in return. All of the contributions were reflected in her capital account, and the value of her daughters' capital accounts was not enhanced because of her contributions. After she contributed the ... securities to the partnership, she made gifts of [additional] interests in the partnership to her daughters... . [The taxpayer] made gifts of interests in Dimar to her daughters and did not make indirect gifts of portions of the ... securities that she had contributed to the partnership." Id.



3. Uncertain Sequence of Events (Senda)

Two important facts distinguish Shepherd from both Estate of Jones and Gross. First, in Shepherd, when property was contributed to the partnership, it was allocated among the partners according to their share of the partnership, whereas in Estate of Jones and Gross, the transferred property was attributed solely to the donor's capital account. Second, in Shepherd, no subsequent gift of partnership interests was involved, whereas in Estate of Jones and Gross, after the contributed property had been reflected in the donor's account, the donor gave interests in the partnership to the other partners. This sequence of activities, namely first creating the partnership, then contributing property to the partnership (and ascribing it to the taxpayer's own capital account), and finally making a gift of partnership interests, has been described as "critical" in evaluating the tax consequences of the transactions. See Senda v. Comm'r, 433 F.3d 1044, 1046 (8th Cir. 2006). In Senda, however, the taxpayers did not present "reliable evidence that they contributed the stock to the partnerships before they transferred the partnership interests to the children." Id. Absent adequate proof of the chronology of events, the transactions in Senda were deemed to mirror those in Shepherd; the taxpayers were treated as having gifted partnership interests to their children before transferring property to the partnership, and the contributed property was therefore held to have enhanced the children's partnership interests and constituted an indirect gift to each child. See Senda v. Comm'r, T.C.M. (RIA) 2004-160, 2004 WL 1551275, aff'd, 433 F.3d 1044 (8th Cir. 2006).



4. Oral Testimony Is Insufficient

In this case, the Government relies heavily on Senda and contends that the sequence of events here was equally uncertain. The various documents, contributing property to WLFB LLC, creating Trusts for each child, and giving each Trust percentage interests in the LLC, were all signed on the same day, January 22, 2003. Although the Trust Agreements and Gift Documents were not dated when executed, they were eventually given the date of January 22, 2003. The Membership Interest Ledger for the LLC shows the transfers of percentage interests from William to Stacy Linton, and from William and Stacy Linton to each of the four Trusts; however, the Ledger does not indicate the dates of these transfers. See Exh. K to Linton Decl. (docket no. 23-13); compare Senda, 2004 WL 1551275 at *6 (noting that the taxpayers "did not maintain any books or records for the partnerships other than brokerage account statements and partnership tax returns"). In addition, although the letters directing US Bancorp Piper Jaffray 3 to transfer securities to WLFB LLC were signed and dated on January 22, 2003, they were not received by US Bancorp Piper Jaffray until January 24, 2003, and the instructions were not followed until after the date of receipt. See Exh. D to Auchterlonie Decl. (docket no. 20-5); see also Exhs. M - Q to Auchterlonie Decl. (docket nos. 20-14, 20-15, 20-16, 20-17, & 20-18) (indicating that Mr. Linton's requested inter-account transfers did not occur until January 24, 2003, at the earliest, and as late as January 31, 2003). The Quit Claim Deed conveying real property in Snohomish County to WLFB LLC was dated and delivered to the Lintons' attorney on January 22, 2003, but it was not recorded until February 13, 2003. The parties, however, agree that this transfer was effective on the date the deed was executed and delivered, not on the date it was recorded. Plaintiffs' Response at 12 (docket no. 25); Government's Reply at 5 (docket no. 29).

In connection with their attempt to establish a chronology of transfers having favorable tax consequences, plaintiffs ask the Court to consider transcripts from the depositions of William Linton, Richard Hack, and Caryl Thorp. The Government contends that this oral testimony is either inadmissible or insufficient, citing an unpublished decision of the Ninth Circuit for the proposition that a taxpayer's claim for refund "must be substantiated by something other than tax returns, uncorroborated oral testimony, or selfserving statements." Lovelace v. United States, 1991 WL 275375 at *1 (9th Cir.) (quoting Mays v. United States, 763 F.2d 1295, 1297 (11th Cir. 1985)). The Government also references a tax regulation indicating that the applicability of the gift tax should be "based on the objective facts of the transfer and the circumstances under which it is made, rather than on the subjective motives of the donor." 26 C.F.R. § 25.2511-1(g)(1).

The Court is persuaded that plaintiffs may offer parol evidence concerning the Trust Agreements and Gift Documents, but concludes that such testimony does not aid plaintiffs in their efforts to obtain a tax refund. The Court is aware of no authority that would preclude the Lintons from testifying they did not place the dates on the Trust Agreements and Gift Documents, or that would bar their attorney from indicating he filled in those dates. Moreover, no evidentiary or tax rule has been cited that would prohibit plaintiffs from proffering evidence about their intent or "state of mind" in connection with these transactions. See Trucks, Inc. v. United States, 234 F.3d 1340, 1342 (11th Cir. 2000) ("evidence about the state of mind of the [taxpayer] ... is considered direct evidence as to the reasonableness of her decisions, and will not be seen as merely self-serving statements"). Finally, because plaintiffs, as the non-moving party, are entitled to have all reasonable inferences drawn in their favor, for purposes of the Government's summary judgment motion, the Court will treat the deposition testimony at issue as admissible evidence. See Fed. R. Civ. P. 56(e)(1) (affidavits supporting or opposing a summary judgment motion must "set out facts that would be admissible in evidence").

Plaintiffs' parol evidence, however, does not prove the sequence of events that they assert in this litigation, and thus, whether or not the Court considers the parol evidence, the result is the same. 4 Each Trust Agreement indicates that it is effective upon contribution of property to the Trust, and that, at the time of its signing, property consisting of interests in WLFB LLC had been transferred to the Trustee. See Exh. E to Auchterlonie Decl. (docket no. 20-6). In turn, in executing each Trust Agreement, the Trustee "acknowledge[d] receipt of such property." Id. In addition, the Gift Documents each recite that the respective Trusts are "dated the same date hereof." Exh. G to Linton Decl. (docket no. 23-8). Thus, the express language of these documents establishes that the Trusts were created and the gifts were made on January 22, 2003; on that date, when the Trust Agreements were signed, percentage interests in WLFB LLC had already been or were contemporaneously gifted to the Trusts, thereby making the Trusts effective.

Plaintiffs seek to reform the Trust Agreements and Gift Documents to reflect that both the creation of the Trusts and the gifting to the Trusts occurred on January 31, 2003. They cite to Washington cases describing the circumstances under which a written instrument may be reformed, including to correct a scrivener's error, due to mutual mistake, or as a result of unilateral mistake caused by fraud or other inequitable conduct. See Wilhelm v. Beyersdorf, 100 Wn. App. 836, 843-44, 99 P.2d 54 (2000); Reynolds v. Farmers Ins. Co., 90 Wn. App. 880, 884-85, 960 P.2d 432 (1998); Snyder v. Peterson, 62 Wn. App. 522, 526-29, 814 P.2d 1204 (1991). Plaintiffs, however, fail to present any evidence to justify the reformation they desire. The proffered testimony proves only that the Lintons did not date the Trust Agreements or the Gift Documents and that the dates on those documents are in Mr. Hack's handwriting. At most, this evidence establishes only a scrivener's error with respect to the date; it does not demonstrate any scrivener's error 5 in the written terms of the documents. Those terms explicitly indicate that the gifting to the Trusts occurred before or with the signing of the Trust Agreements, which undisputedly took place on January 22, 2003. Plaintiffs cannot via parol evidence contradict or modify the express language of the Trust Agreements or the Gift Documents. Hearst Commc'ns, Inc. v. Seattle Times Co., 154 Wn.2d 493, 504, 115 P.3d 262 (2005) (Washington courts "do not interpret what was intended to be written but what was written" (clarifying the holding of Berg v. Hudesman, 115 Wn.2d 657, 801 P.2d 222 (1990))).

Moreover, plaintiffs have offered no theory under which the Trust Agreements and Gift Documents would have been rendered void or voidable had they never been dated. At oral argument, however, counsel for plaintiffs suggested that the Trusts could not have been effective on January 22, 2003, because no trust res existed on that date. This contention is flawed. Although a voluntary trust requires "subject matter" or res to be valid, e.g., Laughlin v. March, 19 Wn.2d 874, 878, 145 P.2d 549 (1944), any type of property may be held in trust, including undivided, reversionary, executory, or contingent future interests, remainders (whether contingent, vested, or vested subject to being divested), and choses in action, see Restatement (Third) of Trusts § 40 cmt. b (2003). In this case, the res consisted of percentage interests in WLFB LLC, which existed and were contributed to the Trusts at or before the signing of the Trust Agreements on January 22, 2003.

In addition, the percentage interests had value because, as of January 22, 2003, WLFB LLC had both real and personal property. The parties agree that the conveyance of undeveloped real estate in Snohomish County was effective on January 22, 2003, when Mr. Linton signed the Quit Claim Deed. Plaintiffs also contend that the transfer of securities was effective on January 22, 2003, when Mr. Linton executed the Assignment of Assets in favor of WLFB LLC. Although plaintiffs make this argument for another reason, namely in an effort to show that the contribution of securities to the LLC occurred prior to the gifts of LLC interests to the Trusts, having advanced this position, plaintiffs will not be heard to challenge whether WLFB LLC had assets, or whether percentage interests in WLFB LLC constituted adequate trust res, on January 22, 2003.

On their claim for tax refund, plaintiffs bear the burden of proof. 6 See Helvering v. Taylor, 293 U.S. 507, 515 (1935). They have not met this burden. They have not demonstrated the existence of any genuine issue for trial, and they have not refuted the appropriateness of treating the transactions in question as indirect gifts to the children's Trusts of the assets of WLFB LLC. The Court concludes, as a matter of law, that the Trusts were valid and irrevocable on January 22, 2003, regardless of what date, if any, was placed on the Trust Agreements. The Court also concludes that the gifts of percentage interests in WLFB LLC were made on January 22, 2003, regardless of what date, if any, was placed on the Gift Documents. In addition, the Court is satisfied that the percentage interests in WLFB LLC constituted sufficient trust res. Because the Trusts were created, and gifts of LLC interests were made to the Trusts, on January 22, 2003, either before or simultaneously with the contribution of property to WLFB LLC, the Court holds that this case is analogous to both Shepherd and Senda, and that the Lintons' transfers of real estate, cash, and securities enhanced the LLC interests held by the children's Trusts, thereby constituting indirect gifts to the Trusts of pro rata shares of the assets conveyed to the LLC.



5. Step Transaction Doctrine

The Court also finds persuasive the Government's alternative theory that, even if plaintiffs could establish the proper sequence of events, namely funding the LLC before gifting interests in it, they nevertheless made indirect gifts to their children's Trusts under the step transaction doctrine. The step transaction doctrine "treats a series of formally separate 'steps' as a single transaction if such steps are in substance integrated, interdependent, and focused toward a particular result." Penrod v. Comm'r, 88 T.C. 1415, 1428 (1987). Taxation is concerned more with the substance of a transaction than with its mere form. Cal-Maine Foods, Inc. v. Comm'r, 93 T.C. 181, 197 (1989). Although a taxpayer has the right to minimize taxes as far as the law will allow, a taxpayer may not "through form alone achieve tax advantages which substantively are without the intent of the statute." Id.; see also id. at 197-98 ("A given result at the end of a straight path is not made a different result because reached by following a devious path." (quoting Minn. Tea Co. v. Helvering, 302 U.S. 609, 613 (1938))). Accordingly, when "a taxpayer has embarked on a series of transactions that are in substance a single, unitary, or indivisible transaction, the courts have disregarded the intermediary steps and have given credence only to the completed transaction." Id. at 198.

Whether a series of transactions should be "stepped" together and treated as a single transaction generally constitutes a question of fact. Senda, 433 F.3d at 1048; Cal-Maine Foods, 93 T.C. at 198. The proper characterization of a transaction for tax purposes, however, is an issue of law. Senda, 433 F.3d at 1048. No specific standard has been universally applied in assessing whether a number of separate steps or activities should be viewed as comprising one transaction; however, courts have generally used one of three alternative tests: (i) the "binding commitment" test; (ii) the "end result" test; and (iii) the "interdependence" test. Holman v. Comm'r, 130 T.C. 170, 187-88 (2008); see Cal-Maine Foods, 93 T.C. at 198-99; see also Santa Monica Pictures, LLC v. Comm'r, 89 T.C.M. (CCH) 1157, 2005 WL 1111792 at *80-*81 (2005).

The binding commitment test, which is the narrowest alternative, collapses a series of transactions into one "if, at the time the first step is entered into, there was a binding commitment to undertake the later step." Penrod, 88 T.C. at 1429. The end result test stands at the other extreme and is the most flexible standard, asking whether the "series of formally separate steps are really pre-arranged parts of a single transaction intended from the outset to reach the ultimate result." Id. The interdependence test inquires whether, "on a reasonable interpretation of objective facts," the steps were "so interdependent that the legal relations created by one transaction would have been fruitless without a completion of the series" of transactions. Cal-Maine Foods, 93 T.C. at 199; Penrod, 88 T.C. at 1430. The interdependence test focuses on the relationships between the steps, rather than on their end result. Penrod, 88 T.C. at 1430. The question is whether "any one step would have been undertaken except in contemplation of the other integrating acts." Cal-Maine Foods, 93 T.C. at 199.

Regardless of which of these three alternative tests is applied, plaintiffs made "stepped" indirect gifts to their children's Trusts of the assets they contributed to WLFB LLC. The binding commitment test is met because plaintiffs executed binding Trust Agreements and Gift Documents at the same time they took the first step of contributing property to the LLC; as counsel for plaintiffs conceded during oral argument, these documents would have been valid after signing had they never been dated. The end result test is likewise satisfied because plaintiffs undisputedly had a subjective intent to convey as much property as possible to their children while minimizing their gift tax liability, pursuant to which they crafted, with the aid of an attorney and a tax advisor, a scheme consisting of "pre-arranged parts of a single transaction." Penrod, 88 T.C. at 1429. The pre-arrangement is most apparent in Mr. Linton's explanation for why he did not date the Gift Documents, namely in an effort to ensure, for tax purposes, that US Bancorp Piper Jaffray completed the transfers of securities before the gifts became effective. See Linton Dep. at 37:13-38:16, Exh. A to Colvin Decl. (docket no. 22-2). In addition, the interdependence test is met because the undisputed evidence demonstrates that plaintiffs would not have undertaken one or more of the steps at issue absent their "contemplation of the other integrating acts." Cal-Maine Foods, 93 T.C. at 199. But for the anticipated 40% to 49% discount in calculating gift taxes, premised on the low market appeal of WLFB LLC's structure, plaintiffs would not have contributed assets to the LLC. Indeed, the quantum of property transferred to WLFB LLC was determined solely on the basis of maximizing the tax advantages of the transaction. See Linton Dep. at 26:6-23, Exh. B to Auchterlonie Decl. (docket no. 20-3). Because the events here satisfy all three of the step transaction tests, the Court need not choose among the different standards, and the Court holds as a matter of law that, under the step transaction doctrine, plaintiffs made gifts to their children's Trusts of pro rata shares of the assets they contributed to WLFB LLC. Although the applicability of the step transaction doctrine has been described as generally an issue of fact, in this case, no purpose would be served by deferring to trial the legal analysis of the undisputed evidence.

This case is distinguishable from two recent cases in which the Tax Court concluded that the step transaction doctrine did not apply. See Holman v. Comm'r, 130 T.C. 170 (2008); see also Gross v. Comm'r, 96 T.C.M. (CCH) 187, 2008 WL 4388277 (2008). In Holman, the taxpayers, husband and wife, on the sixth day after the formation and funding of a limited partnership, made gifts of limited partnership shares ("LP units") to a trust for the benefit of their children. 130 T.C. at 174-79. The partnership had been funded with stock in Dell Computer Corporation ("Dell"). Id. at 172, 175. The Tax Court, observing that "the passage of time may be indicative of a change in circumstances that gives independent significance to a partner's transfer of property to a partnership and the subsequent gift of an interest in that partnership to another," id. at 189, examined the historical prices of Dell stock and concluded that the value of an LP unit changed over time due to its correlation with the worth of Dell stock, which dropped 1.316% during the six days at issue. Id. at 189-91. The Tax Court found that, during the six days between funding the partnership and gifting the LP units, the taxpayers bore a "real economic risk" that the value of an LP unit could change, and thus, the Tax Court refused to disregard the passage of time or to treat the contributions to the partnership and the subsequent gifts as occurring simultaneously pursuant to the step transaction doctrine. Id.

The facts of Gross are similar to those of Holman. In Gross, the taxpayer and her daughters formed a limited partnership into which they each contributed a small amount of cash, which was reflected in their respective capital accounts. 2008 WL 4388277 at *1-*2. Over the course of three months following the formation of the partnership, the taxpayer transferred various securities to the partnership, each time receiving credit for the contributions on her capital account. Id. at *2, *7. The last of these transfers occurred eleven days before the taxpayer gave each daughter, by way of a "Deed of Gift," a 22.25% limited interest in the partnership. Id. In Gross, the Tax Court cited to Holman as support for its decision that the step transaction doctrine did not apply, focusing on the passage of eleven days between the last transfer of securities and the gifts of partnership interests, as well as on the status of the securities at issue as "common shares of well-known companies." Id. at *7-*8. The Tax Court in Gross concluded that "[t]he form of the transactions ... accords with their substance." Id. at *8.

The case before this Court bears little resemblance to either Holman or Gross. In contrast to the taxpayers in Holman and Gross, plaintiffs here did not make affirmative decisions to delay the gifts for some period of time after funding. Rather, with the benefit of hindsight, knowing the date on which US Bancorp Piper Jaffray completed the last transfer of assets to WLFB LLC, plaintiffs devised the passage of time between funding and gifting that would have favorable tax consequences. Moreover, unlike in Holman, in this case, plaintiffs have submitted no data concerning the fluctuations, if any, in the prices of the various securities at issue on a daily basis during the period in question. On this subject, the Government contends that, with regard to the bulk of the assets in question, consisting of real property worth approximately $650,000, cash in the amount of $843,724, and municipal bonds valued at roughly $1.54 million, plaintiffs cannot show the volatility necessary to establish a real economic risk associated with the passage of less than ten days. See Exh. 1 to Moss Adams Report (docket no. 23-9 at 35); Exh. E to Linton Decl. (docket no. 23-6); Exh. M to Auchterlonie Decl. (docket no. 20-14). Given the nature of the assets and the dearth of evidence in the record to suggest any real economic risk during the alleged interim between funding the LLC and gifting interests in it, the Court is satisfied that neither Holman nor Gross raise any doubt concerning the applicability of the step transaction doctrine in this case.



Conclusion

Plaintiffs have raised no genuine issue of material fact concerning their subjective intent, the contemplated sequence of transactions, or the way in which events actually unfolded. On January 22, 2003, plaintiffs executed documents and transferred property in a manner that, as a matter of law, constituted indirect gifts to their children. See Senda v. Comm'r, 433 F.3d 1044 (8th Cir. 2006). These actions also, as a matter of law, satisfy the step transaction doctrine. See Penrod v. Comm'r, 88 T.C. 1415 (1987). The Court therefore GRANTS summary judgment in favor of the Government and DISMISSES plaintiffs' complaint with prejudice.

IT IS SO ORDERED.

The Clerk is directed to enter judgment consistent with this Order and to send a copy of this Order to all counsel of record.

DATED this 1st day of July, 2009.

1 This gift had no gift tax implications. See 26 U.S.C. § 2523(a).

2 The tax return for WLFB LLC indicates that the business started on January 31, 2003. See Exh. J-1 to Linton Decl. (docket no. 23-11). This date is inconsistent with the Certificate of Formation for WLFB LLC, which was filed by the Washington Secretary of State on November 7, 2002, see Exh. A to Linton Decl. (docket no. 23-2 at 21); see also RCW 25.15.070(2)(a) ( "a limited liability company is formed when its certificate of formation is filed by the secretary of state"), as well as with the Assignment of Assets signed by William Linton and Stacy Linton as Managers of WLFB LLC, which is dated January 22, 2003, and thereby manifests the conducting of business before the date indicated on the tax return, see Exh. F to Linton Decl. (docket no. 23-7). The tax return itself, which was prepared by Moss Adams LLP, is dated March 29, 2004, and it does not constitute contemporaneously prepared evidence as to the sequence of the transactions resulting in the capital account balances disclosed in Schedule L.

3 In his declaration, William Linton describes letters also directing RBC Dain Rauscher to transfer certain assets to WLFB LLC, but the record contains no such documents. See Linton Decl. at ¶¶ 12 & 15 and Exh. E.

4 To be clear, the various subsequently prepared documents in this case do not serve as reliable evidence of plaintiffs' intent. See Senda, 433 F.3d at 1047 (the tax returns and certificates of ownership generated months or weeks later were "unreliable in deciding whether petitioners transferred the partnership interest to the children before or after they contributed the stock to the partnerships" (quoting Senda, 2004 WL 1551275 at *6)). For example, the Membership Interest Ledger for WLFB LLC, which was prepared a few months after the transactions at issue, contains no dates and offers no information concerning the sequence of events. See Exh. K to Linton Decl. (docket no. 23-13). Likewise, the Moss Adams Report provides no useful data, but rather makes assumptions about the transactions that occurred approximately six months before the report was generated. See Exh. H to Linton Decl. (docket no. 23-9). Finally, the tax return for WLFB LLC was filed over a year after events, see Exh. J-1 to Linton Decl. (docket no. 23-11), and it does not constitute contemporaneous evidence of plaintiffs' intent.

5 Plaintiffs do not appear to challenge the Trust Agreements or Gift Documents on the basis of any unilateral mistake generated by fraudulent conduct. At oral argument, counsel for plaintiffs clarified that the mutual mistake doctrine is likewise not alleged as a ground for reformation because the documents at issue convey a gift. In response or perhaps as an addendum, the Government asserted that the failure to join Trustee James Linton as a party was fatal to plaintiffs' request for reformation and that the Court lacks subject matter jurisdiction to grant such relief because it would only flow from state law claims beyond the scope of the Government's waiver of sovereign immunity. In light of its ruling in this matter, the Court need not address either of these contentions.

6 Plaintiffs incorrectly suggest that the burden of proof has shifted to the Government pursuant to 26 U.S.C. § 7491(a), which provides that, "[i]f ... a taxpayer introduces credible evidence with respect to any factual issue ..., the Secretary shall have the burden of proof with respect to such issue" so long as the taxpayer has satisfied certain prerequisites, including cooperation with the IRS. Plaintiffs have not identified any factual issue on which the Government should bear the burden of proof. Indeed, at oral argument, counsel for plaintiffs conceded that the matter before the Court involves only questions of law. Thus, the burden-shifting provision of the tax code has no relevance to this case. See Calvert v. Comm'r, T.C. Summ. Op. 2007-7, 2007 WL 105129 at *1 n.1 ( "Since this case involves only a question of law, sec. 7491 is not applicable here."); see also Ayres v. Comm'r, T.C. Summ. Op. 2007-4, 2007 WL 54098 at *1 n.1 ( "The facts are not in dispute, and the issue is a question of law; therefore, with respect to the burden of proof, the Court need not address the applicability of sec. 7491." (citing Higbee v. Comm'r, 116 T.C. 438 (2001))).

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