On July 31, President Obama signed into law H.R. 3236, the “Surface Transportation and Veterans Health Care Choice Improvement Act of 2015[1],” which, among other issues, modifies the due dates for several common tax returns, overrules the Supreme Court’s Home Concrete decision, requires that additional information be reported on mortgage information statements, and requires consistent basis reporting between estates and beneficiaries.

NEW FBAR FILING DUE DATES – For returns for taxable years beginning after December 31, 2015, the due date for FinCEN Form 114 is changed from June 30 to April 15, and taxpayers will be allowed a six-month extension to October 15. For any taxpayer required to file an FBAR for the first time, any penalty for failure to timely request for, or file, an extension, may be waived by the IRS.

PARTNERSHIP RETURN DUE DATES – Returns of partnerships under Code section 6031 and returns of S corporations under Code §§ 6012 and 6037 made on the basis of the calendar year shall be filed on or before the 15th day of March following the close of the calendar year, and such returns made on the basis of a fiscal year shall be filed on or before the 15th day of the third month following the close of the fiscal year. Accordingly, for partnership returns, the new due date is March 15 (for calendar-year partnerships) and the 15th day of the third month following the close of the fiscal year (for fiscal-year partnerships). Currently, these returns are due on April 15, for calendar-year partnerships. The act directs the IRS to allow a maximum filing extension of six months for Forms 1065, U.S. Return of Partnership Income.

C CORPORATION RETURN DUE DATES – For C corporations, the new return due date is the 15th day of the fourth month following the close of the corporation’s year (April 15 for calendar-year corporations) – these returns are currently due on the 15th day of the third month following the close of the corporation’s year.[2]

C corporations will be allowed an automatic 6-month extension to file, except that calendar-year corporations would get a five-month extension until 2026 and corporations with a June 30 year end would get a seven-month extension until 2026. The new filing due dates will apply to returns for tax years beginning after December 31, 2015. However, for C corporations with fiscal years ending on June 30, the new filing due dates will not apply until tax years beginning after December 31, 2025 (yes, 2025).

VARIOUS EXTENSIONS OF TIME TO FILE – For returns for taxable years beginning after December 31, 2015, the IRS is to modify its regulations to allow a maximum extension of:

  • 5 1/2 months ending on September 30 for calendar year taxpayers on Form 1041, U.S. Income Tax Return for Estates and Trusts;
  • 3 1/2 months ending on November 15 for calendar year plans on Form 5500, Annual Return/Report of Employee Benefit Plan;
  • 6 months ending on November 15 for calendar year filers on Form 990, Return of Organization Exempt From Income Tax;
  • an automatic 6-month period beginning on the due date for filing the return (without regard to any extensions) on Form 4720, Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code;
  • an automatic 6-month period beginning on the due date for filing the return (without regard to any extensions) Form 5227, Split-Interest Trust Information Return;
  • an automatic 6-month period beginning on the due date for filing the return (without regard to any extensions) on Form 6069, Return of Excise Tax on Excess Contributions to Black Lung Benefit Trust Under Section 4953 and Computation of Section 192 Deduction; and
  • an automatic 6-month period beginning on the due date for filing the return (without regard to any extensions) on Form 8870, Information Return for Transfers Associated With Certain Personal Benefit Contracts; and
  • the due date for Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, will be April 15 for calendar-year filers, with a maximum six-month extension. The due date of Form 3520–A, Annual Information Return of a Foreign Trust with a United States Owner, shall be the 15th day of the 3d month after the close of the trust’s taxable year, with a maximum six-month extension.

STATE CONFORMITY – California and various other states will not automatically conform to any of these due date changes, so separate legislation will be required if they are going to change and conform to the due dates for these returns.

MODIFICATION OF MORTGAGE REPORTING REQUIREMENTS ON RETURNS RELATING TO MORTGAGE INTEREST RECEIVED IN TRADE OR BUSINESS FROM INDIVIDUALS- Code § 6050H(b)(2) is amended to require new information on the mortgage information statements that are required to be sent to individuals who pay more than $600 in mortgage interest in a year. These statements will now be required to report the outstanding principal on the mortgage at the beginning of the calendar year, the address of the property securing the mortgage, and the mortgage origination date. This change applies to returns required to be made, and statements required to be furnished, after December 31, 2016.

CONSISTENT BASIS REPORTING BETWEEN ESTATE AND BENEFICIARIES – Code § 1014 is amended to provide that anyone inheriting property from a decedent cannot treat the property as having a higher basis than the basis reported by the estate for estate tax purposes.

New Code § 6035 requires executors of estates that are required to file an estate tax return to furnish statement identifying the value of each interest in such property as reported on the estate tax return to the IRS and to each person acquiring any interest in property included in the decedent’s gross estate for Federal estate tax purposes. These statements will identify the value of each interest in property acquired from the estate as reported on the estate tax return.

These statements must be filed on or before than the earlier of (i) the date which is 30 days after the date on which the return under Code § 6018 was required to be filed (including extensions, if any), or (ii) the date which is 30 days after the date such return is filed. These new reporting provisions apply to property with respect to which an estate tax return is filed after the date of enactment (July 31, 2015).

CLARIFICATION OF 6-YEAR STATUTE OF LIMITATIONS IN CASE OF OVERSTATEMENT OF BASIS – OVERRULING HOME CONCRETE – In Home Concrete & Supply, LLC, 132 S. Ct. 1836 (2012), the Supreme Court held that the extended six-year statute of limitation under Code § 6501(e)(1)(A), which applies when a taxpayer “omits from gross income an amount properly includible” in excess of 25% of gross income, does not apply when a taxpayer overstates its basis in property it has sold. In response to Home Concrete, Code § 6501(e)(1)(B) has been amended to add: “An understatement of gross income by reason of an overstatement of unrecovered cost or other basis is an omission from gross income.” The change applies to returns filed after the date of enactment (July 31, 2015) as well as previously filed returns for which the applicable statute of limitations remains open under Code § 6501.

[1] “Surface Transportation and Veterans Health Care Choice Improvement Act of 2015,” H.R.3236 (enacted July 31, 2015). See https://www.congress.gov/bill/114th-congress/house-bill/3236/text#toc-HCFC1B5C758A944DE807AC0FC688A702A

[2] S corporation returns will continue to be due on the 15 day of the third month following the close of the taxable year (March 15 for calendar-year S corporations)

Posted by: Taxlitigator.com | July 29, 2015

Determining “Reasonable Cause” for Non-Willful FBAR Violations

Taxpayers who do not need to use the OVDP or the Streamlined Filing Compliance Procedures to file delinquent or amended tax returns to report and pay additional tax, but who:

  • have not filed one or more required international information returns,
  • have reasonable cause for not timely filing the information returns,
  • are not under a civil examination or a criminal investigation by the IRS, and
  • have not already been contacted by the IRS about the delinquent information returns

should file the delinquent information returns with a statement of all facts establishing reasonable cause for the failure to file.

Describe your situation in the reasonable cause statement

As part of the reasonable cause statement, taxpayers must also certify that any entity for which the information returns are being filed was not engaged in tax evasion.  If a reasonable cause statement is not attached to each delinquent information return filed, penalties may be assessed in accordance with existing procedures.

  • All delinquent international information returns other than Forms 3520 and 3520-A should be attached to an amended return and filed according to the applicable instructions for the amended return.
  • All delinquent Forms 3520 and 3520-A should be filed according to the applicable instructions for those forms.
  • A reasonable cause statement must be attached to each delinquent information return filed for which reasonable cause is being requested.

Information returns filed with amended returns will not be automatically subject to audit but may be selected for audit through the existing audit selection processes that are in place for any tax or information returns.

http://www.irs.gov/Individuals/International-Taxpayers/Delinquent-International-Information-Return-Submission-Procedures

Posted by: Taxlitigator.com | July 18, 2015

IRS Advises re Delinquent FBAR Submission Procedures

Taxpayers who do not need to use either the OVDP or the Streamlined Filing Compliance Procedures to file delinquent or amended tax returns to report and pay additional tax, but who:

  • have not filed a required Report of Foreign Bank and Financial Accounts (FBAR) (FinCEN Form 114, previously Form TD F 90-22.1),
  • are not under a civil examination or a criminal investigation by the IRS, and
  • have not already been contacted by the IRS about the delinquent FBARs

should file the delinquent FBARs according to the FBAR instructions.

Follow these steps to resolve delinquent FBARS

  • Review the instructions
  • Include a statement explaining why you are filing the FBARs late
  • File all FBARs electronically at FinCEN
  • On the cover page of the electronic form, select a reason for filing late
  • If you are unable to file electronically, contact FinCEN’s Regulatory Help line at 1-800-949-2732 or 1-703-905-3975 (if calling from outside the United States) to determine possible alternatives to electronic filing.

The IRS will not impose a penalty for the failure to file the delinquent FBARs if you properly reported on your U.S. tax returns, and paid all tax on, the income from the foreign financial accounts reported on the delinquent FBARs, and you have not previously been contacted regarding an income tax examination or a request for delinquent returns for the years for which the delinquent FBARs are submitted.

FBARs will not be automatically subject to audit but may be selected for audit through the existing audit selection processes that are in place for any tax or information returns.

http://www.irs.gov/Individuals/International-Taxpayers/Delinquent-FBAR-Submission-Procedures

Posted by: Taxlitigator.com | July 15, 2015

PRACTICAL ADVICE FOR AN IRS EXAMINATION

    • Maintain timely, clear communications with the examining agent and the client – confirm statements in writing.
    • Know your case and your client – verify information provided by your client. Establish relevant facts, evaluate reasonableness of assumptions or representations, apply relevant legal authorities in arriving at a conclusion supported by the law and the facts.
    • Advise the taxpayer re potential penalties.
    • As a general rule, taxpayers should not meet directly with agents.
    • Maintain copies of all documents provided.
    • Do your due diligence – reasonably verify factual statements by the taxpayer, especially those claims that upon reflection seem too good to be true.
    • Be aware of the benefits afforded by filing a Qualified Amended Return – see Treas. Reg. § 6664-2(c)(3). Timely filed amended return may reduce or eliminate accuracy-related penalties – but no automatic impact on civil fraud penalty.
    • Remain professional with the appearance of cooperation at all times. An audit need not be an adversarial process.
    • Be aware of relevant privileges, especially the accountant-client privilege (IRC Section 7525). Avoid inadvertent waivers of any privilege.
    • Be cautious but reasonable in extending the statute of limitations.
    • Never file original returns with the examining agent.
    • Taxpayer & return preparer interviews – Can you obtain written questions in advance? Timing – if the interview must occur, attempt to coordinate it near end of the audit. Place – request a location where the taxpayer is most comfortable.
    • Maintain notes of all calls and contacts with the examining agent. When possible, confirm statements in writing. Definitely confirm commitments to provide information by a certain date in writing and meet the commitment.
    • Control client expectations – Maintain an objective view of the relevant facts.
    • Conclude the examination ASAP.
    • Prepare, prepare, and then prepare some more . . .

Posted by: Taxlitigator.com | June 12, 2015

NEW IRS Guidance Limits FBAR Penalties!

U.S. persons having a financial interest in or signature authority over one or more foreign financial accounts – including a bank account, brokerage account, mutual fund, trust, or other type of foreign financial account – having an aggregate value exceeding $10,000 at any time during 2014 is generally required by the Bank Secrecy Act to report their interest in the account by electronically filing by June 30, 2015, a “Report of Foreign Bank and Financial Accounts” (FBAR).[i]

Note that, by statute, these FBAR provisions apply to all U.S. persons and are not limited by the residency of the person since the laws of the U.S. are applicable to all U.S. citizens; U.S. residents; entities, including but not limited to, domestic corporations, partnerships, or limited liability companies created or organized in the U.S. or under the laws of the U. S.; and trusts or estates formed under the laws of the United States. Many non-U.S. residents feel that the FBAR requirements should be limited to U.S. persons residing in the U.S. since the “foreign account” of a non-resident U.S. person is typically located in their country of residence and, as such, is not “foreign” in the common sense of the term. This article merely addresses the statutory requirements without opining on the practical aspects associated with non-resident U.S. persons.

FAILURE TO FILE THE FBAR. The failure to timely file the FBAR can be subject to civil penalties and possibly criminal sanctions (i.e., imprisonment). The statutory civil penalties might be $10,000 per year for a non-willful failure but a willful failure to file could, by statute, be subject to civil penalties equivalent to the greater of $100,000 or 50% of the balance in an unreported foreign account, per year, for up to six tax years.[ii] Non-willful penalties might be avoided if there is “reasonable cause” for the failure to timely file the FBAR.

NEW INTERIM GUIDANCE LIMITING FBAR PENALTIES. The IRS recently issued interim guidance to implement procedures to improve the administration of the Service’s FBAR other than determinations arising from participation in the ongoing IRS Offshore Voluntary Disclosure Program or the Streamlined Filing Compliance Procedures.[iii] The statutory FBAR penalty provisions only establish maximum penalty amounts, leaving the IRS to determine the appropriate FBAR penalty amount below that threshold based on the facts and circumstances of each case. In this regard, IRS examiners are instructed to use their best judgment when proposing FBAR penalties, taking into account all the available facts and circumstances of a case.[iv]

(a). Willful FBAR Violations. For cases involving willful violations over multiple years, IRS examiners will recommend a penalty for each year for which the FBAR violation was willful. In most cases, the total penalty amount for all years under examination will be limited to 50 percent of the highest aggregate balance of all unreported foreign financial accounts during the years under examination. In such cases, the penalty for each year will be determined by allocating the total penalty amount to all years for which the FBAR violations were willful based upon the ratio of the highest aggregate balance for each year to the total of the highest aggregate balances for all years combined, subject to the maximum penalty limitation in 31 U.S.C. § 5321(a)(5)(C) for each year.

Examiners may recommend a penalty that is higher or lower than 50 percent of the highest aggregate account balance of all unreported foreign financial accounts based on the facts and circumstances. The IRS guidance provides that in no event will the total willful penalty amount exceed 100 percent of the highest aggregate balance of all unreported foreign financial accounts during the years under examination.

(b). Nonwillful Violations. For most cases involving multiple nonwillful violations, examiners are told to recommend one penalty for each open year, regardless of the number of unreported foreign financial accounts. In those cases, the penalty for each year will be determined based on the aggregate balance of all unreported foreign financial accounts, and the penalty for each year will be limited to $10,000.

For some cases, the facts and circumstances (considering the conduct of the person required to file and the aggregate balance of the unreported foreign financial accounts) may indicate that asserting nonwillful penalties for each year is not warranted. In those cases, examiners, with the group manager’s approval, may assert a single penalty, not to exceed $10,000, for one year only.

For other cases, the facts and circumstances (considering the conduct of the person required to file and the aggregate balance of the unreported foreign financial accounts) may indicate that asserting a separate nonwillful penalty for each unreported foreign financial account, and for each year, is warranted. In those cases, examiners, with the group manager’s approval, may assert a separate penalty for each account and for each year.

The IRS guidance provides that in no event will the total amount of the penalties for nonwillful violations exceed 50 percent of the highest aggregate balance of all unreported foreign financial accounts for the years under examination. A nonwillful penalty will not be recommended if the examiner determines that the FBAR violations were due to reasonable cause and the person failing to timely file correct and complete FBARs later files correct and complete FBARs.

(c). IRS Mitigation Guidelines. In determining the appropriate penalty, IRS examiners are to first determine whether the mitigation threshold conditions in Internal Revenue Manual[v] are satisfied. If the mitigation threshold conditions are met, examiners are to make a preliminary penalty calculation based upon the mitigation guidelines in IRM,[vi] except that the penalty for each year will be limited to $10,000. Unless the facts and circumstances of a case warrant a different penalty amount, this is the penalty amount to be asserted.

If the IRM mitigation threshold conditions are not met, the mitigation guidelines do not apply and examiners are told to not make a preliminary penalty calculation based upon the guidelines. Examiners, with the group manager’s approval, are told to assert a separate penalty for each account and for each year. However, the IRS guidance provides that in no event will the total amount of the nonwillful penalties exceed 50 percent of the highest aggregate balance of all unreported foreign financial accounts for the years under examination.

(d). Co-Owned Accounts. Where there are multiple owners of an unreported foreign financial account, the IRS guidance provides that examiners must make a separate determination with respect to each co-owner of the foreign financial account as to whether there was a violation and, if so, whether the violation was willful or non-willful. For each co-owner against whom a penalty is determined, the penalty will be based on the co-owner’s percentage ownership of the highest balance of the foreign financial account. If examiners are unable to determine a co-owner’s percentage ownership, the penalty will be based on the amount determined by dividing the highest account balance equally among the co-owners.

NO EXTENSION OF TIME TO FILE FBAR. There is no extension of time available for filing an FBAR beyond June 30. Extensions of time to file federal tax returns do NOT extend the time for filing an FBAR. If a delinquent FBAR is filed, attach a statement explaining the reason for the late filing.

NEED FBAR FILING HELP? Assistance regarding the electronic filing of an FBAR is available at BSAEFilingHelp@fincen.gov or through the BSA E-Filing Help Desk at 866-346-9478. The E-Filing Help Desk is available Monday through Friday from 8 a.m. to 6 p.m (Eastern Time).

Help in completing an FBAR is available by telephone at 866-270-0733 (toll-free within the U.S.) or 313-234-6146 (from outside the U.S., not toll-free) from 8 a.m.—4:30 p.m. Eastern time, or by sending an e-mail to FBARquestions@irs.gov.

Additional information, including Frequently Asked Questions, is available at http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/FAQs-Regarding-Report-of-Foreign-Bank-and-Financial-Accounts-(FBAR)—Filing-Requirements#FR5

[i] Financial Crimes Enforcement Network (FinCEN) Form 114.

[ii] 31 U.S.C. § 5321(a)(5) establishes civil penalties for violations of the FBAR reporting and recordkeeping requirements. 31 U.S.C. § 5321(b) sets forth the 6-year statute of limitations, determined whether the FBAR is filed or not; 31 U.S.C. § 5321(d) confirms that civil penalties and criminal sanctions may be imposed with respect to the same FBAR violation.

[iii] See Interim Guidance for Report of Foreign Bank and Financial Accounts (FBAR) Penalties, (May 13, 2015),  Control Number: SBSE-04-0515-0025; http://www.irs.gov/pub/foia/ig/spder/SBSE-04-0515-0025%5B1%5D.pdf

[iv] See IRM 4.26.16.4.7, FBAR Penalties – Examiner Discretion.

[v] Internal Revenue Manual (IRM) 4.26.16.4.6.1 and IRM 4.26.16.4.6.2

Posted by: Taxlitigator.com | June 9, 2015

Reminder FBAR Electronic Filing Due by June 30, 2015

In Riggs v. Commissioner,[i] issued May 26, 2015, the Tax Court held that an Appeals officer did not abuse its discretion in denying the petitioner currently not collectible (CNC) status, for the amount the petitioner owed under IRC section 6672, the trust fund recovery penalty.  The Petitioner had timely requested a collection due process hearing when the IRS issued a final notice of intent to levy on petitioner’s personal assets and filed a federal tax lien.  The petitioner was liable for the trust fund recovery penalty relating to the petitioner’s failure to collect and remit payroll taxes on behalf of Amber Construction, Co., a corporation of which she was the owner and president.  The IRS had already filed a lien against the petitioner as the corporation’s nominee for the corporation’s employment tax liability, which attached to an office building the petitioner owned.

In the collection due process hearing, the petitioner argued to the Appeals officer that her account should be placed in CNC status, which is a collection alternative that suspends IRS collection efforts when the taxpayer has no apparent ability to make payments on the outstanding tax liability based on the taxpayer’ s assets, equity, income and expenses.[ii]  In Riggs, the taxpayer’s salary had been cut by the bankruptcy court, after the successor-in-interest corporation to Amber Construction had filed for bankruptcy.  The petitioner argued that her salary had been limited by the bankruptcy court to the minimum necessary to cover her basic expenses, leaving her with no disposable income with which to make payments on the trust fund recovery penalty.

The Appeals officer denied the petitioner’s request, on the grounds that although the petitioner’s income may have been limited, she had sufficient equity in assets she owned to be able to make payments on the liability.  In particular, the petitioner owned a boat (with her husband) and an office building.  In determining a taxpayer’s ability to pay, the IRS will consider assets that can be liquidated or borrowed against to satisfy the liability.[iii]

On appeal to the Tax Court, the Tax Court reviewed the Appeals officer’s denial of CNC status for abuse of discretion.  The petitioner argued that the Appeals officer erred in denying her CNC status, on the basis that although she had equity in her assets, the lien that had been filed by the IRS against her as a corporate nominee prevented her from being able to sell or borrow against these assets to satisfy the liability, and therefore they should not be considered in determining whether the petitioner’s liability was noncollectible.

The Tax Court rejected this argument, agreeing with the IRS that pursuant to the Internal Revenue Manual, federal tax liens do not decrease the value of a taxpayer’s equity in an asset for purposes of determining whether a liability is currently not collectible.   The court explained that collection potential and eligibility for collection alternatives should be based on the net realizable equity (“NRE”) in the petitioner’s assets, which takes into consideration only certain nontax liens under IRS policies.  Only liens that have a priority over a federal tax lien may be taken into consideration in determining what the “quick sale” price of the taxpayer’s asset would be in an NRE determination.[iv]   Because of the equity in the taxpayer’s assets, the Tax Court held that the Appeals officer’s denial of CNC status was not an abuse of discretion.

The Tax Court also rejected the taxpayer’s argument that other collection alternatives should be available to her, because the taxpayer had failed to argue for any other collection alternatives before the Appeals officer.  Under IRC section 6330(c)(2), a taxpayer may raise various collection alternatives in a collection due process proceeding.[v]  However, because the petitioner had not first raised the issue of other collection alternatives with the Appeals officer, the Tax Court would not consider them on appeal.

LACEY STRACHAN – For more information please contact Lacey Strachan at Strachan@taxlitigator.com. Ms. Strachan is a tax lawyer at Hochman, Salkin, Rettig, Toscher & Perez, P.C. and represents clients throughout the United States and elsewhere involving federal and state, civil and criminal tax controversies and tax litigation. Additional information is available at http://www.taxlitigator.com.

[i] Riggs v. Comm’r, TC Memo 2015-98 (05/26/2015).

[ii] Id. (citing Wright v. Comm’r, T.C. Memo. 2012-24 & Fangonilo v. Comm’r, T.C. Memo. 2008-75).

[iii] See Internal Revenue Manual 5.16.1.2.9 (08-25-2014) (“An account should not be reported as CNC if the taxpayer has income or equity in assets, and enforced collection of the income or assets would not cause hardship.”).

[iv] The Tax Court relies on Internal Revenue Manual 5.8.5.4.1(1) (Oct. 22, 2010).

[v] Other collection alternatives include the posting of a bond, the substitution of other assets, an installment agreement, or an offer-in-compromise.  IRC § 6330(c)(2)(A)(iii).

We recently posted an article regarding the Tax Court’s recent decision in Eaton Corp v. Comm’r, No. 5576-12, where the Tax Court found the taxpayer waived attorney client privilege and work product doctrine protections when it asserted a reasonable cause/good faith penalty defense. More recently, in United States v. Sanmina Corp., No. 5:15-cv-00092 (2015 U.S. Dist. LEXIS 66123), a District Court in California refused to enforce an IRS summons finding the requested documents—two memoranda prepared by the taxpayer’s tax department lawyers—protected by the attorney-client privilege and work product doctrine.

The taxpayer took a worthless stock deduction of $503 million.  One of the documents the taxpayer submitted to the IRS to substantiate the deduction was a 102-page valuation report prepared by outside counsel. A footnote in the report referenced the memoranda at issue: “Guarantee and Capital Contribution Agreement Concerning Sanmima International AG” and “Stock and Debt Losses on Swiss-3600,” both of which were prepared by the taxpayer’s tax department lawyers. The IRS issued a summons and the taxpayer refused to comply, claiming the memoranda were protected by attorney client privilege and the work product doctrine.

Section 7602 of the Internal Revenue Code authorizes the IRS to examine records, issue summonses and take testimony for the purposes of ascertaining the correctness of any return, making a return where none has been made, determining the liability of any person for any internal revenue tax, or inquiring into any offense connected with the administration or enforcement of the internal revenue laws. The court stated the four-part Powell rule for enforcing an IRS summons:

“To enforce a summons, the IRS need only make a prima facie showing that (1) an investigation is being conducted for a legitimate purpose; (2) the information sought may be relevant to that purpose; (3) the information sought is not already within the IRS’ possession and (4) the administrative steps required by the Internal Revenue Code have been followed.”

The court noted that taxpayers challenging a summons have a “heavy” burden to negate the good faith purpose of the investigation or show that the enforcement would amount to an abuse of the court’s process, but that the IRS’s power to obtain information by summons is not absolute and is limited by attorney client privilege and work product doctrine. If the IRS claims the privilege was waived, it bears the burden of production on the issue of waiver. If the IRS meets its burden on the waiver issue, the burden shifts back to the taxpayer to prove the privilege was not waived.

The court stated that for privilege purposes, there is no difference between legal advice and tax advice on compliance, so long as the advice goes beyond mere tax preparation and calculations. A document does not lose protection merely because it is created to assist with a business decision.  The court reasoned that a tax analysis prepared in anticipation of a possible IRS audit may constitute work product, even if that material also assisted in making a business decision.

Both of the memoranda at issue in Sanmina were prepared by the taxpayer’s in-house tax lawyers and distributed to the taxpayer’s internal tax team and outside accountants. The court discussed the content of the memoranda in determining whether they were protected, but declined to conduct an in camera review of their content.  The memorandum entitled “Guarantee and Capital Contribution Agreement Concerning Sanmina International AG” discussed legal analysis supporting the execution of certain agreements among the taxpayer and its subsidiaries, including the tax treatment of the agreements. It included citations to and analysis of IRS letter rulings and Tax Court decisions. The memorandum entitled “Stock and Debt Losses on Swiss-3600,” analyzed the tax effect of the liquidation of Sanmina International AG, containing a short factual discussion and lengthy legal analysis of the liquidation. It included citations to revenue rulings, tax code provisions, tax court decisions and one U.S. Supreme Court decision.

The court concluded that although the IRS made the required four-part Powell showing for enforcement of the summons, the attorney client privilege and work product doctrine protections attached and were not waived. The court found that the attorney client privilege attached because the taxpayer showed “the memoranda constituted tax advice from lawyers to Sanmina—not merely preparation of tax returns or number crunching…Both memos contain legal analysis, were prepared by Sanmina’s tax department lawyers, and were provided confidentially to company personnel who had a need for legal advice.” The court found that the taxpayer did not waive privilege by producing the valuation report that cited the memoranda even though the valuation report relied on the memoranda and the outside counsel preparing the valuation report sometimes provided non-legal services to the taxpayer.

The court applied a “because of” standard in determining that the memoranda were protected by the work product doctrine. Although the memoranda were not prepared during an audit or litigation, the analysis supported the worthless stock deduction, the size of which made it reasonable for the taxpayer to anticipate an IRS challenge to the deduction.   The court also concluded that the taxpayer did not waive its work product doctrine protection by disclosing the memoranda to its outside counsel because the valuation report merely referenced the memoranda, rather than summarizing them.

The court held the memoranda were protected by the attorney client privilege and work product doctrine and denied the IRS’s petition to enforce its summons. Although the Tax Court has held that raising the reasonable cause/good faith defense waives attorney-client privilege and work product doctrine, a full analysis of waiver is still required in the context of summons enforcement.

KRISTA HARTWELL – For more information please contact Krista Hartwell at Hartwell@taxlitigator.com or 310.281.3200. Ms. Hartwell is a tax lawyer at Hochman, Salkin, Rettig, Toscher & Perez, P.C. and represents clients throughout the United States and elsewhere involving federal and state, civil and criminal tax controversies and tax litigation. Additional information is available at http://www.taxlitigator.com.

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