On December 16, 2020, the Eighth Circuit issued its opinion in Coffey v. Commissioner, holding that a tax return filed with the U.S. Virgin Islands Bureau of Internal Revenue (“VIBIR”) was not a filing with the IRS and, thus, the three year statute of limitations on assessment was not triggered. See https://www.taxlitigator.com/a-return-by-any-other-name-by-robert-s-horwitz/.  On February 10, 2021, the Eighth Circuit granted a petition for rehearing before the three-judge panel that wrote the December 16 opinion.  On February 12, the Eighth Circuit issued its new opinion, which reached the same result as its earlier opinion: filing a return with VIBIR was not the same as filing it with the IRS.

The result was the same and the reasoning of the Eighth Circuit in its new opinion in Coffey was similar.  The Coffeys claimed to be residents of the U.S.V.I.  They filed a Form 1040 with the VIBIR, which sent the first two pages of the return to the IRS.  More than three years after receipt of the two pages, the IRS determined that the Coffeys were not residents of the U.S. Virgin Islands and issued a notice of deficiency.  The Coffeys petitioned the Tax Court, which held that since the IRS received the first two pages of the return, it had been “filed” with the IRS, thus starting the statute of limitations on assessment.  Since the notice of deficiency was issued more than three years after filing, it was time barred.

After reciting briefly the facts, the new opinion stated that the U.S. Virgin Islands non-resident must “file” their “return” with both VIBIR and the United States under IRC sec. 932(a)(2).  For purposes of the appeal, the Court assumed that the Coffeys were not U.S.V.I. residents.

The taxpayers’ first argument was that the document sent by the VIBIR to the IRS was “filed” for purposes of both secs. 932(a)(2) and 6501(a).  The Tax Court had agreed with this argument since the first two pages of the Coffeys’ return wound up at the IRS.  According to the Eighth Circuit, this was not enough: returns are filed “if delivered, in the appropriate form, to the specific individual or individuals identified in the Code or Regulations.”  A taxpayer must show “meticulous compliance” with the Code and Regulations.  The Court noted that the Coffeys did not intend to file tax returns with the IRS, but only with the VIBIR.  That the IRS had actual knowledge of the taxpayers’ tax liability was not a filing and without a filing, the statute of limitations on assessment did not begin to run.  The Coffeys had not complied with the federal tax return filing requirements, the VIBIR did not file the Coffeys’ returns with the IRS and the Coffeys had never authorized the VIBIR to do so.

The taxpayers’ second argument was that filing a return with the VIBIR began the statute of limitations under sec. 6501(a) because they intended to comply with all filing requirements under the belief that they qualified as U.S.V.I. residents.  The Court held that the taxpayers’ intent was irrelevant to whether they filed an honest and genuine return.  To be an honest and genuine return, it must be filed with the correct individual.  The U.S.V.I. is a separate taxing entity from the United States.  That the Coffeys may have made an honest attempt to satisfy the tax law is irrelevant, since the filing requirements do not contain an exception for a mistaken belief about residency.  The mistake does not create a “filing.”  While the VIBIR uses the same tax forms as the IRS, filing a return with the VIBIR is not filing it with the IRS.  Thus, the Tax Court was reversed.

Same facts, same legal arguments, slightly different route to get to the same result. Does the Eighth Circuit’s emphasis on “meticulous compliance” indicate that the Beard test for determining what is a return may come under attack?  Only time will tell.

Robert S. Horwitz is a Principal at Hochman Salkin Toscher & Perez P.C., former Chair of the Taxation Section, California Lawyers’ Association, a Fellow of the American College of Tax Counsel, a former Assistant United States Attorney and a former Trial Attorney, United States Department of Justice Tax Division.  He represents clients throughout the United States and elsewhere involving federal and state administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.

In Soboyede v. Comm’r, T.C., T.C. Summary Opinion 2021-3, the Tax Court addressed whether the taxpayer’s travel expenses while performing legal work in Washington were incurred “while away from home” such that they could be deducted as ordinary and necessary travel expenses under IRC Section 162.   While this is a non-precedential opinion, it is a helpful preview of the many issues return preparers will face in filing 2020 and 2021 tax returns as taxpayers work remotely in the post-COVID world.

In Soboyede, the taxpayer performed document review work as an attorney.  Aside from traveling to Nigeria for almost two months, he spent at least 161 days in Washington D.C. and 115 days in Minnesota during 2015.  Soboyede earned over twice as much revenues conducting work in Washington D.C. than he did in Minnesota during the year at issue.  For purposes of section 162(a)(2), “tax home” generally “means the vicinity of the taxpayer’s principal place of employment [or business] and not where his or her personal residence is located.”  There is also an exception to this rule if the working location is “temporary” in a particular year.  The taxpayer introduced several exhibits in trying to establish that he had a greater presence in Minnesota, but his documentation contained “materials gaps in time that ranged from days to weeks.”  Ultimately, the Tax Court determined that Washington D.C. was his tax home and he could not deduct rent or hotel expenses while staying there.  The Tax Court reached this conclusion, even though he also paid “office rent” in Minneapolis and resided there when he filed his Petition with the Tax Court.

Separate from the issue of business expenses paid for “away from home travel,” several other federal and state tax provisions may be implicated as people adjust to COVID circumstances by remote working, working (and schooling your children) from a vacation home (or Airbnb residence), living with family, or other unique COVID working arrangements.

States are already fighting over how they may tax workers within and without their states during COVID. For instance, New Hampshire recently filed a Petition to the Supreme Court for leave to file an action challenging Massachusetts’s taxation of New Hampshire residents who work remotely from their homes for Massachusetts businesses.  Several other states have also filed  amicus curiae briefs urging the court to grant the motion.   As described by Counsel for New Hampshire,

In the middle of a global pandemic, Massachusetts has taken deliberate aim at the New Hampshire Advantage by purporting to impose Massachusetts income tax on New Hampshire residents for income earned while working within New Hampshire. Upending decades of consistent practice, Massachusetts now taxes income earned entirely outside its borders. Through its unprecedented action, Massachusetts has unilaterally imposed an income tax within New Hampshire that New Hampshire, in its sovereign discretion, has deliberately chosen not to impose.

This blog does not address the consequences of Massachusetts’s tax regime, or “sourcing” regimes in other states, but states will certainly evaluate how they should tax persons working in their states.

Finally, the “Big One” is how tax agencies in high-tax states will evaluate COVID-related habitations when conducting state residency audits.  A growing list of significant taxpayers and their businesses are moving from high income tax states to states with low or no income tax.  While taxpayers from California, for instance, may have intended to permanently change their domicile to a different state in 2020, the facts and circumstances may make it appear that the stay is temporary or transitory.  Perhaps a taxpayer visited with family in another state for a temporary childcare purpose, or they sought to put their kids in full time school for a school year, or some other temporary reason.  Normally, moving to a different state and putting your children in school or daycare in the state where you move to is a factor that supports a taxpayer claim to have permanently left California and taken up residence elsewhere.  Unique COVID-related facts may result in these facts being reviewed with a different perspective.  Similarly, taxpayers may experience a split year, as was the case in Soboyede, where they lived with family or a loved one in California for a significant part of the year, even though they did not plan for California to be their residence for the year.  Unlike the “tax home” requirements under IRC Section 162, California places significant weight on the  number of days stayed in California, as well as several other facts and circumstances, in determining the taxpayer’s subjective intent for being in, or moving out of, California.

As the taxpayer learned in Soboyede, record keeping can be critical when it comes to proving residency or “tax home” during an audit or subsequent litigation.  Taxpayers should carefully retain records to document where they spend time during years when residency may become an issue.  COVID poses additional challenges.  For instance, it may be difficult to sell a residence when establishing a new domicile, or to complete a remodel of a home.  Even getting a new Driver’s License could present difficulties in 2020 or 2021.  While many people are figuring out which way is up in these unique times, in the future tax agencies will have the benefit of hindsight when applying residency rules.  Representatives may need to distinguish facts unique to the pandemic in order to get a fair result for their clients. 

As returns are prepared for these tax years, taxpayers should provide all available information to their advisors and consult with them early.  They should also consider disclosing positions on their tax returns, and consider filing non-resident tax returns with disclosures, even if the taxpayer arguably had no income sourced to the state, so that the taxing agencies can see the basis for the positions, and also so that the statute of limitations can begin on those returns.

CORY STIGILE – For more information please contact Cory Stigile – stigile@taxlitigator.com  Mr. Stigile is a principal at Hochman Salkin Toscher Perez P.C., a CPA licensed in California, the past-President of the Los Angeles Chapter of CalCPA and a Certified Specialist in Taxation Law by The State Bar of California, Board of Legal Specialization.  His representation includes Federal and state controversy matters and tax litigation, including sensitive tax-related examinations and investigations for individuals, business enterprises, partnerships, limited liability companies, and corporations. His practice also includes complex civil tax examinations. Additional information is available at www.taxlitigator.com.

Historically, most—if not all—states in the U.S. have not required the disclosure of the beneficial owners of corporations, LLCs, or similar entities formed under the laws of the State.[i]  However, with the enactment of the Corporate Transparency Act (CTA)[ii], as part of the 2021 National Defense Authorization Act, the non-disclosure approach has come to an end.

The CTA adds section 5336 to Title 31, which will require “a corporation, limited liability company or other similar entity” that are under the laws of any State or Indian Tribe or formed under the laws of a foreign country and registered to do business in the United States[iii] (Reporting Companies) to disclose to the Financial Crimes Enforcement Network (FinCEN)[iv] specific information on those Beneficial Owners from the company.  The preamble to the CTA, states that the purpose and rationale for the CTA is to, among other things, better enable law enforcement to counter illegality, including “serious tax fraud.”[v]  More specifically, the CTA is an effort to address foreign government concerns and join a growing international trend to require more disclosure of beneficial ownership.  This effort seemingly targets the identity of “malign actors”[vi] who seek to conceal their ownership behind U.S. shell companies that try to hide illicit funds[vii] and facilitate illicit activity.

By January 1, 2022 (at the latest), the Secretary of the Treasury is required to promulgate regulations consistent with CTA and FinCEN will set up a registry to store information on Beneficial Owners of Reporting Companies.[viii]

CTA defines a Reporting Company as any corporation, limited liability company, or other similar entity that is created under the laws of any State or Indian Tribe or a foreign company that is registered to do business in the United States[ix] with the following exclusions: companies with more than 20 full-time employees, gross receipts or sales of more than $5 million and a physical presence in the United States (for example an office).[x]  Various entities that are already subject to supervision or otherwise highly regulated by the Federal government are also excluded.[xi]  These exclusions include: banks, credit unions, registered brokers or dealers, registered exchange or clearing agencies, registered investment companies, insurance companies, public accounting firms, public utility companies and Internal Revenue Code Section 501(c)(3) organizations.[xii]

The definition of Beneficial Owner of a Reporting Company, which is identified as someone who either (1) exercises substantial control over the company; or (2) owns or controls 25% or more of the ownership interest of the company,[xiii] is arguably imprecise as the CTA does not define “substantial control” or clarify how to measure “25% or more ownership.”[xiv]  The CTA, however, is clear as to who is excluded: minor children, acting nominees, intermediaries, custodians, creditors, agents, those acting solely as an employee, and those whose interest in a “privately held company”[xv] is only through a right of inheritance.[xvi]

The Reporting Company must file an “acceptable identification document”[xvii] when it is formed or, for those formed prior to CTA, in a timely manner.  A timely manner is within two years after the effective date of the Treasury Department’s final regulations on CTA.[xviii]  An acceptable identification document must include the full legal name, date of birth, current residential or business address, and unique identifying number (such as driver’s license or passport number)[xix] of all Beneficial Owners.  If there is any change with respect to the “Beneficial Owner”[xx] of the company an updated must be provided as to that change and identification information no later than one year after the change.

The information reported to FinCEN will be made available, under protocols prescribed by the Treasury, to financial institutions and regulatory agencies.  The information is also to be accessible to Treasury employees under procedures and safeguards to be prescribed by Treasury and, of course, to the IRS “for tax administration purposes….”[xxi]  

The CTA will also make it illegal for a Reporting Company formed under the laws of any State or Indian Tribe to issue a certificate in bearer form evidencing an interest in the entity.[xxii] And the CTA imposes civil and criminal penalties on any person who willfully files a false or fraudulent report or makes an unauthorized use or disclosure of information.[xxiii] With the rationale for the CTA being, in large part, to target “malign actors,” such as money launderers, narcotics traffickers, financers of terrorism and people engaged in “serious tax fraud,” to the extent that there is a lack of clarity or complete answers, such as exactly which Beneficial Owners must be disclosed to FinCEN, one can expect that as Treasury fills in the blanks through regulations and procedures, one message will remain clear: the Federal government wants information about beneficial ownership in the U.S., and it is on the path to ensuring that companies provide the information.

SANDRA R. BROWN – Ms. Brown has been a principal at Hochman Salkin Toscher Perez P.C. since March 2018.  Prior to joining the firm, Ms. Brown spent more than 26 years as a federal trial attorney, including serving as the Acting United States Attorney, the First Assistant United States Attorney, and the Chief of the Tax Division of the Office of the U.S. Attorney (C.D. Cal).  Ms. Brown’s broad range of experience in complex civil tax controversies and criminal tax investigations and litigation includes having handled over 2,000 cases on behalf of the United States before the United States District Court, the Ninth Circuit Court of Appeals, the United States Bankruptcy Appellate Panel, and the California Superior Court.  Ms. Brown represents individuals and entities on a national and local level in complex federal criminal investigations and litigation as well as sensitive civil tax controversy examinations and litigation matters.  Ms. Brown obtained her LL.M. in Taxation from the University of Denver, is a fellow of the American College of Tax Counsel, co-chair of the NYU Tax Controversy Section, and a member of the Women’s White Collar Defense Association. Ms. Brown may be reached at brown@taxlitigator.com or 310.281.3217.

MICHAEL GREENWADE – Mr. Greenwade is an Associate at Hochman Salkin Toscher Perez P.C.  Mr. Greenwade concentrates his practice in tax audits and examinations, deductibility of business expenses, and substantiation of cost basis.  Mr. Greenwade is a former law clerk in the Major Crimes Division at the L.A. County District Attorney’s Office, a former tax policy Research Assistant at USC Gould School of Law, where he earned his J.D., and was a Teacher’s Assistant at USC Leventhal School of Accounting.  He graduated Cum Laude from USC Marshall School of Business, earning his Bachelor of Science.  Contact Michael Greenwade at mg@taxlitigator.com


[i] WILLIAM M. (MAC) THORNBERRY NATIONAL DEFENSE AUTHORIZATION ACT FOR FISCAL YEAR 2021, PL 116-283, 134 Stat 3388 (2021).

[ii] Sec. 6401.

[iii] 31 U.S.C. § 5336(a)(11); Senate and House Override Veto and Pass 2021 National Defense Authorization Act With Significant AML Updates, Practical Law Legal Update w-028-9579.

[iv] The FinCEN is a bureau of the U.S. Department of the Treasury that uses strategic efforts to collect and analyze information about financial transactions to combat money laundering, terrorist financing and other financial crimes.  https://www.fincen.gov/about/mission.

[v] Sec. 6402(3) of the WILLIAM M. (MAC) THORNBERRY NATIONAL DEFENSE AUTHORIZATION ACT FOR FISCAL YEAR 2021, PL 116-283, 134 Stat 3388 (2021).

[vi] Id.

[vii] https://www.wealthmanagement.com/high-net-worth/new-law-requires-disclosure-beneficial-owners-companies.

[viii] Senate and House Override Veto and Pass 2021 National Defense Authorization Act With Significant AML Updates, Practical Law Legal Update w-028-9579.

[ix] Id.

[x] https://www.wealthmanagement.com/high-net-worth/new-law-requires-disclosure-beneficial-owners-companies.

[xi] Senate and House Override Veto and Pass 2021 National Defense Authorization Act With Significant AML Updates, Practical Law Legal Update w-028-9579.

[xii] https://www.wealthmanagement.com/high-net-worth/new-law-requires-disclosure-beneficial-owners-companies.

[xiii] 31 U.S.C. § 5336(a)(3).

[xiv] https://www.wealthmanagement.com/high-net-worth/new-law-requires-disclosure-beneficial-owners-companies.

[xv] Id.

[xvi] Senate and House Override Veto and Pass 2021 National Defense Authorization Act With Significant AML Updates, Practical Law Legal Update w-028-9579.

[xvii] 31 U.S.C. § 5336(a)(1).

[xviii] https://www.wealthmanagement.com/high-net-worth/new-law-requires-disclosure-beneficial-owners-companies.

[xix] Id.

[xx] Id.

[xxi] 31 U.S.C. § 5336(c)(5)(B).

[xxii] 31 U.S.C. § 5336(f).

[xxiii] 31 U.S.C. § 5336(h).


Many businesses either have closed or will be forced to close due to the lockdowns imposed during the COVID-19 pandemic, Closing a business can result in the loss of jobs, a loss of the business owner’s livelihood and the destruction of the business owner’s credit rating.  It can also have adverse tax consequences in the form of Cancellation of Debt (“COD”) income.   This was brought home by the recent Tax Court case of Hohl v. Commissioner, T.C. Memo. 2021-5 where the Court held that the partners of a defunct partnership owed tax from the cancellation of debt.

COD income is recognized as gross income under Internal Revenue Code §61(a)(12), but Congress has created many exceptions to the recognition of COD income.  Discharge of a debt occurs when it becomes clear that the debt will not be repaid or when the creditor forgives all or part of the debt.  Whether there was in fact a debt and, if so, when the debt became discharged are determined by the facts and circumstances of the case.

The partnership in the Hohl case, Echo Mobile Marketing Solutions, LLC, was formed in 2009 and ceased operations in 2012, having sustained losses in each year of operation.  It had four partners, three of whom, Michael Hohl, Braden Blake, and James Bowles, operated the business and a fourth, Eduardo Rodriguez, who funded the business. Although Mr. Rodriguez was the only one who provided funds for the business, the three operating partners each had a 30 percent ownership interest in the partnership while Mr. Rodriguez had a 10 percent ownership interest.  

The IRS audited the individual partners’ 2012 tax returns and determined that each of the three operating partners had $178,210 of COD income.  The three operating partners filed petitions with the Tax Court to challenge the IRS’s determination.  The taxpayers claimed that funds provided by Mr. Rodriquez were capital contributions. They pointed to Echo’s operating agreement, which termed Mr. Rodriquez’s initial infusion of funds ($265,000) as a capital contribution, to the lack of any written loan agreement, and to the lack of any collection or repayment activity. 

The Tax Court found the taxpayer’s argument unconvincing because Echo’s tax returns treated the funds provided by Mr. Rodriguez as loans. These loans were allocated among the partners, giving the three operating partners basis in the partnership.  Consistent with the advances being loans, Mr. Rodriquez’s capital account was not credited with any of the funds he advanced to Echo.  Additionally Echo never gave written notice to the partners that it needed additional capital contributions, as required by the operating agreement.  Thus, the Court held that all the funds advanced by Mr. Rodriguez were loans and not capital contributions and that the partnership had COD income when it ceased operation.

This led to the next issue: the allocation of the COD income among the partners.  Under IRC §704(a), a partner’s distributive share of income is determined by the partnership agreement.  If the partnership agreement does not provide for the partner’s share, or if the allocation made by the agreement does not have substantial economic effect, IRC §704(b) provides that the partner’s distributive share of income is determined “in accordance with the partner’s interest in the partnership (determined by taking into account all facts and circumstances).”  To have substantial economic effect, allocations must be consistent with the underlying economic arrangement of the partners.  Treas. Reg. §1.704-1(b)(2)(ii)(a).

Echo’s operating agreement allocated distributive shares of income and losses to its partners according to a formula based on the partner’s capital accounts.  Echo, however, had never followed the formula in allocating its losses among the partners.  Instead, on each year’s tax return it allocated to each of the operating partners 30% of the losses and to Mr. Rodriquez 10% of the losses.  The Court held that the allocations made by Echo’s operating agreement thus did not have substantial economic effect.  The Court therefore upheld the IRS’s allocation of 30% of the COD income to each of the operating partners.

The taxpayers made several additional arguments that aren’t germane to the cautionary tale of this blog:   First, when a business closes due to financial losses, the owners may discover unexpectedly that they had income due to unpaid debts owed by the business.  Second, the failure of a partnership to follow the partnership agreement for the treatment of advances by partners and for the allocation of partnership items can lead to the IRS challenging the way the partnership allocated income, losses, gain and credits during an audit. 

Of course, what would have happened had Echo treated Mr. Rodriguez’s advances as capital contributions and followed the terms of the partnership agreement for allocating profits and losses?  First, the three operating partners would have had zero basis in the partnership, instead of basis from treating the advances as loans allocated among the partners on a 30-30-30-10 basis.  Second, the operating partners would not have been able to deduct the losses (if any) that should have been allocated to them had they followed the partnership agreement, since a partner cannot deduct losses in excess of basis.  So the net tax effect of the case was the same as it would have been had the partnership treated the advances as capital contributions with the operating partners being unable to deduct losses but not having COD income.

Robert S. Horwitz is a Principal at Hochman Salkin Toscher & Perez P.C., former Chair of the Taxation Section, California Lawyers’ Association, a Fellow of the American College of Tax Counsel, a former Assistant United States Attorney and a former Trial Attorney, United States Department of Justice Tax Division.  He represents clients throughout the United States and elsewhere involving federal and state administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.

Tenzing Tunden is a Tax Associate at Hochman Salkin Toscher Perez P.C.

Posted by: Cory Stigile | January 31, 2021

Journal of Accountancy – Enlist an Ally in TAS by Cory Stigile

When the IRS’s processes are not working as they should, the Taxpayer Advocate Service (TAS) may be able to help. Sec. 7811 authorizes TAS to issue a taxpayer assistance order if the taxpayer is suffering, or about to suffer, a significant hardship as a result of the way the internal revenue laws are being administered.

Click Here to read more.

The intersection of virtual currency with Bank Secrecy Act (BSA) and tax laws frequently results in a square peg, round hole problem.  All too often, regulators try to solve the problem as would a toddler, by pounding as hard as possible to make the square peg fit in the round hole.  Witness the IRS treating virtual currency as property, not currency, resulting in buying a latte at Starbuck with bitcoin as a taxable event requiring the computation of basis because the IRS hasn’t seen fit to establish “de minimis” transaction exclusions.  Unlike the IRS, FinCEN (another arm of the Treasury Department) treats virtual currency as currency and regulates it accordingly, at least most of the time.  And don’t get me started about how the SEC and CFTC apply securities and commodities regulations to virtual currency. The agencies’ conflicting regulations prove the adage: If you’re a hammer, everything looks like a nail.  It’s small wonder so few taxpayers have complied with tax laws surrounding virtual currency when the IRS’s rules make routine transactions using virtual currency into events that require the user to scurry home and input the transaction into an Excel spreadsheet before she forgets to log her basis and sale price.

Regarding the Foreign Bank Account Report (FBAR) form, practitioners have been wondering for years whether certain virtual currency holdings need to be reported.  Keep in mind that FinCEN has treated “exchangers and administrators of convertible virtual currency” as subject to the money transmitter rules under the BSA since 2013.  The BSA is designed in large part to require reporting of transactions that may be associated with illegal activity, resulting in law enforcement being able to identify the illegal activity through the BSA reports.  The purported anonymity of virtual currencies (some more than others) is attractive to those who want to remain off of the government’s radar screen, whether for illegal or other reasons.  Those who violate the BSA are subject to stiff civil and criminal penalties.  Essentially, FinCEN recognizes that people use virtual currencies as a cash alternative and that persons playing intermediary roles in virtual currency transactions should be treated like fiat currency intermediaries.  Despite making this clear pronouncement, it took seven years for FinCEN to clarify that virtual currency is not reportable on current FBAR forms in Notice 2020-2.   Filing Requirement for Virtual Currency (fincen.gov)

This conclusion was far from obvious.  Cryptocurrency exchanges are based both inside and outside the United States, and even US-based exchanges may have servers overseas.  It may even be impossible for an accountholder to know where precisely their cryptocurrency is being held by an exchange.  Perhaps an easier example from an FBAR perspective is “cold storage,” where the private keys giving access to the virtual currency are held in a device not attached to the Internet for security purposes.  If the cold storage device (which is normally portable) is overseas, then arguably the owner should be worried about filing an FBAR.

As nice as it is to hear that virtual currency holders have one less thing to worry about, FinCEN delivered this good news wrapped in bad news.  FinCEN announced that it intended to propose amending FBAR regulations to require reporting of virtual currency “as a type of reportable account.”  FinCEN offered no additional information, and the unanswered questions abound. how is “virtual currency” an “account”?  What factors demonstrate whether a virtual currency holding is foreign or domestic? 

At the same time, FinCEN proposed another rule to require money services businesses to report and keep records on certain transactions with “unhosted wallets.”  2020-28437.pdf (federalregister.gov)  The upshot of the “proposed” regulation – proposed in name only as FinCEN noted that the regulation is not subject to notice-and-comment rulemaking – is that any entity that qualifies as an MSB will have to conduct “know your customer” validation on the wallet owner and retain records for production to FinCEN. 

The effect of these two changes will be to substantially reduce anonymity vis a vis the US government as well as substantially increase the chance that owners of large crypto holdings will be targets for hackers, extortionists, and other miscreants.  It’s unclear whether additional regulation will make virtual currencies less attractive or, as some have argued, will bolster the legitimacy and lead to more widespread adoption.  The one certainty is that more regulation will lead to more work for lawyers and accountants.   

EVAN J. DAVIS – For more information please contact Evan Davis – davis@taxlitigator.com or 310.281.3288. Mr. Davis has been a principal at Hochman Salkin Toscher Perez P.C. since November 2016.  He spent 11 years as an AUSA in the Office of the U.S. Attorney (C.D. Cal), spending three years in the Tax Division where he handed civil and criminal tax cases and eight years in the Major Frauds Section of the Criminal Division where he handled white-collar, tax, and other fraud cases through jury trial and appeal.  As an AUSA, he served as the Bankruptcy Fraud coordinator, Financial Institution Fraud coordinator, and Securities Fraud coordinator.  Among other awards as a prosecutor, he received an award from the CDCA Bankruptcy Judges for combatting Bankruptcy Fraud and the U.S. Attorney General awarded him the Distinguished Service Award (DOJ’s highest litigation award) for his work on the $16 Billion RMBS settlement with Bank of America.  Before becoming an AUSA, Mr. Davis was a civil trial attorney in the Department of Justice’s Tax Division in Washington, D.C. for nearly 8 years, the last three of which he was recognized with Outstanding Attorney awards.  He is a magna cum laude and Order of the Coif graduate of Cornell Law School and cum laude graduate of Colgate University.

Mr. Davis represents individuals and closely held entities in federal and state criminal tax (including foreign-account and cryptocurrency) investigations and prosecutions, civil tax controversy and litigation, sensitive issue or complex civil tax examinations and administrative tax appeals, and white-collar criminal investigations including campaign finance, FARA, money laundering, and health care fraud.

Last week, the Commissioner issued the Taxpayer First Act (TFA) report to Congress. The report will establish the framework of the IRS for the next 20 year, with a goal of improved employee training, increased taxpayer accessibility and making the IRS a more technology-driven organization. 

So what is the TFA and why is there a report?  The TFA was enacted in 2019 with the goal of changing the IRS’s structure, improving taxpayer service, improving enforcement procedures, and increasing IRS use of information technology and electronic systems.  The TFA had four Titles, “Putting Taxpayer’s First,” “21st Century IRS,” “Miscellaneous Provisions” and “Budgetary Effects.”  These Titles included subtitles, for an Independent Office of Appeals, Improved Services, Organizational Modernization, Cybersecurity and Identity Theft, Expanded Use of Information Technology and Electronic Systems, and Reform of Laws Governing IRS Employees.  One of the provisions, TFA sec. 1203, dealt with innocent spouse relief.  As several writers have pointed out, one of the subsections of sec. 1203 reduced the Tax Court’s scope of review in innocent spouse cases rather than putting the taxpayer first. 

The TFA report focuses on three provisions of the TFA:  Sec. 1101, Taxpayer Services, Sec. 2402, Employee Training, and Sec. 1302, Organizational Structure.  The main focus of this blog will be the future organizational structure of the IRS.

But before turning to the IRS’s new organization, the IRS hopes to modernize taxpayer services, by making online access easier, reducing call wait times and the use of data analytics to “analyze behavioral research and other data to better identify and separate taxpayers who are intentionally violating our tax laws, minimizing compliance contacts where direct enforcement activity would not be necessary.”  Employee training will include “IRS University” to centralize training, TFA training for all IRS employees and continuing education for all employees.

Now, about organizational change:  Presently, there seven people in the IRS who report directly to the Commissioner: a chief of staff, Chief of Appeals, National Taxpayer Advocate, Chief Counsel, Chief of Communications & Liaison, Deputy Commissioner for Operations Support and Deputy Commissioner for Services & Enforcement.  Under the Deputy Commissioner for Operations Support are things like Human Resources, CFO, procurement, diversity, etc.  Under the Deputy Commissioner for Services & Enforcement are the operating divisions, including CI, LB&I, SB/SE, Wage & Investment.  That structure will be gone under the IRS’s new organizational plan.

In the future there will be one Deputy Commissioner, who will fulfill such roles as assigned by the Commissioner and a Chief of Staff.  Added to Appeals, NTA, Chief Counsel and Chief Communications will be a new position, Chief Taxpayer Experience Officer, since the focus of the IRS will be to give taxpayers a better experience.  Also reporting directly to the Commissioner will be five Assistant Commissioners: (a) Relationships and Services; (b) Compliance; (c) Enterprise Change and Innovation; (d) Operations Management; and (e) Chief Information Officer.  The people who directly report to the Commissioner will be the “Senior Leadership Team,” which will set the overall strategic direction of the IRS and manage the executives who oversee the IRS’s day-to-day operations.

The Relationships and Services Division is completely new and will oversee the groups that deliver services and information to taxpayers, including Outreach & Education, Digital Services, Submission Processing (which I assume is processing returns), Identity Theft, etc.  The Report states that this division will put “all taxpayer-facing service channels under one division” and will integrate “digital, telephone, virtual and face-to-face channels seamlessly.”   The report details what each sub part of the division will focus on, such as the Assisted Services Office, which will oversee walk-in centers and toll—free phone lines, online text and video chat.

The Compliance Division will be reorganized.  LB&I, SB/SE, Wage & Investment, Exempt Organization will all be gone.  Instead, there will be Criminal Investigation, Whistleblower, Exam and Collection.   Exam will consolidate all exam operations that are currently spread among several units and Collection will be responsible for collection activities from all types of taxpayers (or as the report puts it, “all taxpayer segments”).  This is a similar structure to the one that existed for over 40 years before the 1998 restructuring act, i.e., an Examination Division, a Collection Division and a Criminal Investigation Division.  

Enterprise Change and Innovation Division:  Like the Relationships and Services Division, this division is completely new.  According to the Report this Division will “serve as the strategic planning and integration role across the agency, utilizing data management, analytics and business process improvement best practices to identify and implement enterprise-wide initiatives that would enable IRS to be more efficient and effective in serving taxpayers and administering the tax code.” 

The last two Divisions, Operations Management and Information Technology, will. take over the functions currently performed by the Operations Support Division.  Operations Management will take over functions such as Human Resources, Financial, Security, Procurement and Information Technology will take over cybersecurity, computing centers, networks service and similar IT functions.

According to the IRS website, the reorganization will mean for taxpayers more “seamless services,” quicker resolution of issues and more tools for interacting with the IRS.  For tax professionals it will  supposedly mean “a more seamless and consistent experience for tax professionals and their clients,” provide tax professionals with the “latest tools for communicating with the IRS,” and through the “Third—Party Relationships organization … facilitate collaborative networking with partners across tax administration and beyond.”  For IRS employees it will mean “an organization without silos” that can adapt quickly with less duplication of effort and the ability to deliver “a seamless experience for taxpayers.” 

While the new reorganization addresses some of the problems facing the IRS today how this will work out in practice is unknown, but the effort needs to be made and the goals of providing taxpayers with a more efficient and responsive IRS and improving the overall professionalism and knowledge of IRS personnel are worthy ones. 

IRS management should be applauded for recognizing that the organization  should strive to improve its performance and deliver on its mission of providing “America’s taxpayers top quality service by helping them understand and meet their tax responsibilities and enforce the law with integrity and fairness to all.” The TFA report is a step in that direction.

Contact Steve Toscher at toscher@taxlitigator.com.  Mr. Toscher specializes in civil and criminal tax controversy and litigation.  He is a Certified Tax Specialist in Taxation, the State Bar of California Board of Legal Specialization, a Fellow of the American College of Tax Counsel and has received an “AV” rating from Martindale Hubbell. In addition to his law practice, Mr. Toscher has served as an Adjunct Professor at the USC Marshall School of Business since 1995, where he teaches tax procedure.  Mr. Toscher is past-Chair of the Taxation Section of the Los Angeles County Bar Association, a member of the Accounting and Tax Advisory Board of California State University, Los Angeles, Office of Continuing Education and was the 2018 recipient of the Joanne M. Garvey Award, which is given annually to recognize lifetime achievement and outstanding contributions to the field of tax law by a senior member of the California tax bar.

Contact Robert S. Horwitz at horwitz@taxlitigator.com or 310.281.3200   Mr. Horwitz is a principal at Hochman Salkin Toscher Perez P.C., former Chair of the Taxation Section, California Lawyers’ Association, a Fellow of the American College of Tax Counsel, a former Assistant United States Attorney and a former Trial Attorney, United States Department of Justice Tax Division.  He represents clients throughout the United States and elsewhere involving federal and state administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.

Occasionally I feel sorry for the attorneys in IRS National Office who have to write regulations for the tax laws enacted by Congress.  Gone are the days when Congress had members who could write simple, logical statutes, like the original sec. 162(f), enacted in 1969:

No deduction shall be allowed under subsection (a) for any fine or similar penalty paid to a government for the violation of any law.

That’s it.  Under 25 words and it said all that needed to be said.  In 1975, the IRS promulgated regulations under sec. 162(f) that defined what was a “fine or similar penalty,” what was “a government” and what constituted a “violation of any law”, all in under 1000 words. 

So things stood for 48 years, until late 2017, when Congress got it into its head to amend sec. 162(f) as part of the Tax Cut and Jobs Act (TCJA).  Gone was the simple, elegant language of subsection (f), replaced by a 410-word subsection with exceptions with multi-prong tests and exceptions to the exception.  The main provision of sec. 162(f), carving out the prohibition on the deduction of fines or similar penalties, now reads:

(1) In general-Except as provided in the following paragraphs of this subsection, no deduction otherwise allowable shall be allowed under this chapter for any amount paid or incurred (whether by suit, agreement, or otherwise) to, or at the direction of, a government or governmental entity in relation to the violation of any law or the investigation or inquiry by such government or entity into the potential violation of any law.

The exception to this general rule are for (a) payments of restitution (determined by application of a multi-prong test and which has an exception for reimbursement to the government for the costs of any investigation or litigation), (b) payments ordered by a court in a suit in which the government is not a party, and (c) payments for “taxes due.”  And then there is a subparagraph under which certain nongovernmental entities are treated as governmental entities. 

TCJA also added sec. 6050X to the Code, which imposes a reporting requirement on any government or governmental entity for any suit or agreement concerning the violation of a law within the government or governmental entity’s authority or any investigation or inquiry concerning such a violation if the amount involved with respect to the violation or any investigation or inquiry is over $600.

The final regulations under the NEW! IMPROVED! subsection 162(f) were released on January 12, 2021.  A few of the highlights of the final regulations are discussed below.

Under the general rule of non-deductibility, 26 CFR sec. 162-21(a), the regulation makes it clear that (i) a fine or penalty is “an amount paid or incurred in relation to the violation of any civil or criminal law”  and (ii) a routine investigation or inquiry, such as an audit or inspection, of a regulated business that is not related to evidence of wrongdoing or suspected wrongdoing is not “an investigation or inquiry … into the potential violation of any law.” 

The second part of the regulation, 26 CFR sec. 162-21(b), deals with amounts that will be treated as deductible as restitution, remediation or “to come into compliance with a law.”  First the taxpayer must meet an “identification requirement, which requires a court order or agreement that

(i) States that a payment is restitution, remediation or to comply with a law

(ii) States the purpose for which the restitution or remediation will be paid or the law with which the taxpayer must comply

This part is met if the order or agreement describes (i) the damage done, harm suffered or manner in which the taxpayer failed to comply with the law and (ii) the action required by the taxpayer.  The order or agreement need not identify the amount the taxpayer must pay or incur in order to be treated as a restitution, remediation or for the taxpayer to come into compliance with a law. 

The regulations further provide that to deduct an amount paid as restitution, remediation or for compliance with a law, the taxpayer must provide documentary evidence to prove that it was obligated by an order or agreement to pay the amount identified as restitution, remediation or to come into compliance with the law, the amounts paid or incurred and the dates; and that “based on the origin of the liability and the nature and purpose of the amount paid or incurred,” the amount was paid or incurred for restitution, remediation or to come into compliance with a law.  A taxpayer must meet both this test and the identification test to come within the exception to the disallowance of a deduction for the payment of an amount in relation to the violation of a civil or criminal law of sec. 162(f)(1). 

The third part of the regulation, 26 CFR sec. 162-21(c), deals with “other exceptions” and makes it clear that the prohibition on deducting amounts paid in relation to a violation of a law does not apply to a suit in which a government or governmental entity is not a party or a suit in which a government or governmental entity “enforces its rights as a private party.”  It also clarifies that it does not apply to amounts paid as tax or interest on tax, but it does apply to penalties imposed relating to tax and interest on the penalties.  Amounts paid or incurred as restitution for taxes under the Internal Revenue Code are deductible if the tax itself would otherwise be deductible, such as the payment of employment or excise taxes.

The fourth part of the regulation, 26 CFR sec. 162-21(d) concerns accounting for deductible payments, such as restitution.  The timing of the deduction is determined under sec. 461 (general rules for the taxable year of deduction) and related sections and regulations under those provisions.  And the tax benefit rule applies.

The fifth part of the regulation, 26 CFR sec. 162-21(e), contains definitions: government, nongovernmental entity treated as a governmental entity, remediation, disgorgement, amounts to come into compliance with a law, etc.  a whole smorgasbord of words and terms used in sec. 162(f) and the regulations are defined, including “Amounts not included,” which is reimbursement of a governmental entity for investigatory or litigation costs concerning the violation or potential violation of any law and amounts paid, at the taxpayer’s election, in lieu of a fine or penalty.  The sixth and final part, 26 CFR sec. 162-21(f), is a baker’s dozen of examples of how the regulations are to be applied.

What is to be learned from all of this, other than the fact that the regulations are reasonably to the point and intelligible?  If a client is involved in an administrative proceeding or litigation with the federal or a state government, a governmental entity, a foreign government or a securities exchange or board of trade, the client’s attorney should make sure that any settlement agreement, order or judgment clearly imposing a financial or other obligation on the client sets out what the nature of the obligation is (i.e., remediation, restitution, compliance with law), why the obligation is imposed and that the client keeps documentation establishing the amounts expended and the dates.  Otherwise, the client may not be able to deduct the amount paid or incurred under the agreement, order or judgment.

Contact Robert S. Horwitz at horwitz@taxlitigator.com or 310.281.3200   Mr. Horwitz is a principal at Hochman Salkin Toscher Perez P.C., former Chair of the Taxation Section, California Lawyers’ Association, a Fellow of the American College of Tax Counsel, a former Assistant United States Attorney and a former Trial Attorney, United States Department of Justice Tax Division.  He represents clients throughout the United States and elsewhere involving federal and state administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.

Posted by: Robert Horwitz | January 19, 2021

A Return by Any Other Name by Robert S. Horwitz

You’d think deciding whether something is a federal tax return would be easy: if it’s on a return form put out by the IRS, containing information sufficient to determine the taxpayer’s tax liability and signed under penalty of perjury by the taxpayer it’s a valid tax return.[1]  If only it were that simple.  Whether a specific document qualifies as a tax return is a question that has sometimes perplexed taxpayers, the IRS, and the Courts.  To address the question, the Tax Court in Beard v. Commissioner, 82 T.C. 766, 777 (1984), aff’d per curiam, 793 F.2d 139 (6th Cir. 1986), came up with a four-part test that has been adopted by many of the Courts of Appeals:

First, there must be sufficient data to calculate tax liability; second, the document must purport to be a return; third, there must be an honest and reasonable attempt to satisfy the requirements of the tax law; and fourth, the taxpayer must execute the return under penalties of perjury.

Two recent appeals court decisions, Quezada v. IRS, __ F.3d __, 982 F.3d 931 (December 11, 2020), and Coffey v. Commissioner, 982 F.3d 1127 (8th Cir. December 15, 2020), address the question of whether the taxpayer had filed a valid return and reached potentially contradictory conclusions.

First Quezada.  Mr. Quezada was a stone mason who performed masonry services for general contractors.  He hired independent contractors to do the work.  He issued Forms 1099 to each independent contractor, reporting the total compensation he paid to them.  Most of the Forms 1099 did not have tax identification numbers for the independent contractors.  Under IRC sec. 3406(a), Mr. Quezada was required to withhold from payments to these independent contractors a tax, calculated at a flat rate, and pay it over to the IRS.  When required by regulation, any person liable for any tax, is to “make a return or statement according to the forms and regulations prescribed by the Secretary… [and] include therein such information required by such forms or regulations.”  IRC sec. 6011(a).  A person subject to backup withholding is supposed to pay the amount owed and file a Form 945.  Treas. Reg. sec. 31.6011(a)-(4)(b).  For the years 2005 through 2008 Mr. Quezada didn’t file Forms 945 or pay backup withholding.  In 2014, the IRS assessed over $1.2 million in backup withholding, interest and penalties against him.

Mr. Quezada filed in bankruptcy and sought a determination that the assessments were time-barred.  He lost in bankruptcy court and district court but prevailed on appeal to the Fifth Circuit on his argument that his Forms 1099 and Form 1040, when combined, contained sufficient information to calculate his backup withholding liability and the filing of these forms started the statute of limitations for assessing backup withholding. 

The IRS argued that Treasury Regulations require the filing of Form 945 to report backup withholding and since Mr. Quezada did not file the form, he did not file the return and the statute of limitations never began to run.  The IRS relied on Commissioner v. Lane-Wells, 321 U.S. 217 (1944), where the Court held that a corporate tax return was not a personal holding company return and thus did not start the running of the statute of limitations.  Rejecting the IRS’s argument, the Fifth Circuit seized on language in Lane-Wells that the form filed by the taxpayer “did not show the facts on which liability could be predicated” and noted that some of the Supreme Court’s statements indicated that “the wrong form can be ‘the return’ so long as the form shows the facts on which liability could be predicated.”  Here, the Forms 1099 and 1040, taken together, contained sufficient data on which liability could be predicated, with the Forms 1099 showing the names and amount paid each independent contractor.

According to the Fifth Circuit “the better reading of Lane-Wells is that the taxpayer is not required to file the precise return prescribed by Treasury Regulations in order to start the limitations clock.  Instead, ‘the return’ is filed, and the limitations clock began to tick, when the taxpayer files a return that contains data sufficient (1) to show that the taxpayer is liable for the tax at issue and (2) to calculate the extent of that liability.”  Since Mr. Quezada’s returns contained sufficient data to show the liability for backup withholding, the Forms 1040 and 1099 he filed constituted the return.  Since the assessments were made more than three years after these forms were filed, they were time-barred.

Notes:        

(1) The Court failed to consider the effect of Mayo Foundation v. United States, 562 U.S. 44 (2011), which held that Chevron deference applies to Treasury Regulations.  Maybe I’m wrong, but under Chevron, since the backup withholding statute states that the “Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purpose of this section” and the regulation was not contrary to existing Supreme Court precedent, under Chevron it should have been accorded deference.

(2) The IRS based its assessments entirely on the information contained in the Forms 1099s and 1040s.  The 1099s revealed that many of the independent contractors did not provide Mr. Quezada with their SSNs, which the IRS should have realized when it processed the 1099s, which were apparently filed timely.  There does not seem to be any reason why the IRS took several years after the filing of the 1099s for 2008 to wake up to this fact and make the assessments against him. 

(3) Assume a taxpayer files a Form 8938 that lists foreign bank accounts, but not FBARs.  Would the filing of the Form 8938 be a defense against the FBAR penalty? Or the filing of an FBAR be a defense against the penalty for failing to file Form 8938? 

Which takes us to Coffey.  This is a case where the taxpayers claimed to be residents of the U.S. Virgin Islands.  They filed income tax returns for 2003 and 2004 with the U.S.V.I. but not with the IRS.  The IRS determined the taxpayers weren’t bona fide U.S.V.I. residents and issued a notice of deficiency.  The taxpayers petitioned the Tax Court.

Bona fide U.S.V.I. residents file returns with the U.S.V.I. And pay a reduced tax rate on U.S.V.I.-related income.  A person who is not a bona fide U.S.V.I. resident who has U.S.V.I. source income files returns with both the U.S.V.I. and the IRS. 

The U.S.V.I. sent the IRS the first two pages of the taxpayers’ U.S.V.I. returns shortly after they were filed.  The IRS processed the returns and then remitted the taxpayers’ prepayments to the U.S.V.I., which refunded overpayments to the taxpayers.  The IRS issued the notice of deficiency to the taxpayers in 2009, more than three years after it received the taxpayers’ returns from the U.S.V.I.  In Tax Court, the taxpayers moved for summary judgment on the ground that the deficiency notices were barred by the statute of limitations.  The Tax Court agreed, finding that the taxpayers’ returns were filed with the IRS more than three years before the notices were issued.  The Eighth Circuit reversed.

IRC section 932(a)(2) requires persons who are nonresidents of the U.S.V.I. with U.S.V.I. related income to file returns with “both the United States and the Virgin Islands.”  The Eighth Circuit treated the taxpayers as nonresidents for purposes of the appeal and noted that statutes of limitation are strictly construed in favor of the Government.

The taxpayers claimed (a) that the U.S.V.I. sending their tax documents to the IRS was filing with the United States and (b) that filing their returns with the U.S.V.I.  met their nonresident filing requirement.  The Tax Court had agreed with the first argument, even though the taxpayers did not know or explicitly approve of the U.S.V.I. sending their returns to the IRS.

According to the Eighth Circuit, the taxpayers were required to show “meticulous compliance” with all filing requirements contained in the IRC and Treasury Regulations.  (This of course was something that Mr. Quezada had failed to do.)  “Returns are ‘filed’ if ‘delivered, in the appropriate form, to the specific individual or individuals identified in the Code or Regulations.”  Furthermore, “the three year statute of limitations begins only after the taxpayer’s ‘returns were filed.’  [citation omitted]. The IRS’s actual knowledge is not a filing ….  Without a filing, the statute of limitations in section 6501(a) does not begin when the IRS received the information.”

The Eighth Circuit held that the U.S.V.I.’s sending the first two pages of the return was not a “filing.”  It was undisputed that the Coffeys did not intend to file returns with the IRS, but only with the U.S.V.I.  The U.S.V.I. did not file any returns with the IRS, the Coffeys did not authorize it to file returns and did not even know that the U.S.V.I. sent the tax documents to the IRS.  Thus, the IRS’s processing of the documents did not “create a filing.”

That the Coffeys’ returns were honest and genuine does not affect whether they were filed with the IRS.  That the IRS receives and processes returns from the U.S.V.I. does not satisfy the filing requirement, since the U.S.V.I. is a separate taxing entity and the IRC doesn’t “create an exception for a taxpayer’s mistaken position about residency.”  It was also irrelevant that the returns filed with the U.S.V.I. are identical to federal tax returns since the returns were not filed with the IRS.

The Eighth Circuit ended its analysis that “without a filing, the documents are not an honest and genuine attempt to satisfy the tax laws and are not filed returns.  The Coffeys did not file returns with the IRS, but only returns with the” U.S.V.I.”  Thus, the statute of limitations on assessment for the years in issue had never started to run.

As noted in the Tax Court’s opinion, the IRS transcripts of account for the Coffeys had entries for a return received date and a return processed date for the returns the U.S.V.I. transmitted to the IRS.  If the IRS’s internal records treated the tax documents as returns that were received and processed in the same manner as returns a taxpayer “files,” why weren’t the Coffeys’ returns “filed” with the IRS?  The Tax Court’s decision focused on whether the returns received from the U.S.V.I. met the Beard test and determined that they did.  It seemed apparent to the Tax Court that the documents were filed with the IRS.   One thing the Tax Court found troubling was that the IRS began audits of the Coffeys within two years after it received the returns but dawdled, did not seek statute extensions, and waited several years before issuing the notices of deficiency.

So what do we make of this?  If the Fifth Circuit required “meticulous compliance” with the requirements of the Code and Regulations, it would have affirmed and not reversed the bankruptcy and district court.  But would the Eighth Circuit have affirmed the Tax Court if it applied the Fifth Circuit’s reasoning?  Not necessarily.  First, unlike Mr. Quezada, the Coffeys did not file their returns with the IRS; they were sent to the IRS by the U.S.V.I.  Second, while there was no claim that the Coffeys’ returns understated income or overstated deductions and credits, the tax documents sent to the IRS did not contain all the information needed to determine their liability because the Coffeys’ claimed they were bona fide residents of the U.S.V.I. Their returns thus did not have all the information needed to determine their liability.   But while Mr. Quezada’s Forms 1099 and 1040 contained sufficient information to determine his liability, did he intend for them to meet his backup withholding filing obligation? 

Contact Robert S. Horwitz at horwitz@taxlitigator.com or 310.281.3200   Mr. Horwitz is a principal at Hochman Salkin Toscher Perez P.C., former Chair of the Taxation Section, California Lawyers’ Association, a Fellow of the American College of Tax Counsel, a former Assistant United States Attorney and a former Trial Attorney, United States Department of Justice Tax Division.  He represents clients throughout the United States and elsewhere involving federal and state administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.


[1]We won’t even discuss the potential problems with “tax returns” electronically filed by a paid return preparer, where the taxpayer does not sign the return but instead signs Form 8879, IRS e-file Signature Authorization, and the return preparer’s PIN is treated as the taxpayer’s signature.  That will be reserved for another day or another blog.

Posted by: Robert Horwitz | January 14, 2021

IRS Loses Another Non-Willful FBAR Case by ROBERT S. HORWITZ

In December I had an FBAR roundup, where I wrote about three recent FBAR cases, two willful cases the IRS won (the Fourth Circuit’s decision in US v. Horwitz and the district court’s decision on remand in Bedrosian v. US) and the IRS loss in a non-willful case (US v. Bittner).  This week a district court in Connecticut handed the IRS a loss in another non-willful FBAR case, U.S. v. Kaufman, 18-cv-00787 (Jan. 11, 2021).  As in Bittner, the parties filed cross motions for summary judgment and presented the court with two issues: a) whether the maximum $10,000 non-willful penalty was per account or per annual filing and b) whether the defendant had “reasonable cause” for not filing an FBAR form.  The result was the same as in Bittner: the defendant did not have reasonable cause, but the non-willful penalty was per annual form not per account.

A little background:  Mr. Kaufman is a U.S. citizen who has resided in Israel since 1979.  He had multiple financial accounts in Israel.  In 2008 he had a beneficial interest in or signatory authority over 13 Israeli accounts, in 2009 there were 12 accounts and in 2010 there were 17 accounts.  Mr. Kaufman’s U.S. tax returns were prepared by an American accounting firm.  Each year, the accountants would ask if he had any foreign accounts and would advise him that if he did, he may need to file FBAR forms.  Each year he told his accountants he did not have any foreign accounts.  When asked how he paid his bills, he claimed it was out of a U.S. brokerage account, so they checked the “no” box to the question on the return whether he had foreign accounts.  Notwithstanding this evidence, Mr. Kaufman claimed he did not learn of the FBAR filing requirement until September 2011.  He also claimed that he suffered a heart attack in late 2010 and was involved in an auto accident in 2011 and that these affected his cognitive abilities.

The first issue the Court addressed was the reasonable cause defense.  To escape liability for the non-willful penalty a person must show “reasonable cause” and that the amount in the account was accurately reported.  The Court focused on the “reasonable cause” prong.  Since “reasonable cause” is not defined in the FBAR statute, the Court looked to the reasonable cause defense to penalties in Internal Revenue Code sections 6651 and 6664, noting that under US v. Boyle, 469 U.S. 241 (1985), failure to timely file a return is not excused by reliance on an agent.  Given the facts, including the taxpayer being told by his CPAs that he did not have foreign accounts and used a U.S. brokerage account to pay his bills, the Court found there was no reasonable cause.  Thus, he was liable for the non-willful penalty. 

Now the Court had to decide whether the maximum penalty was $10,000 per year, or whether the IRS could assess the non-willful penalty on an account by account basis, with the maximum penalty per account being $10,000.  This was a question of interpreting the statute, the starting point for which is the “plain meaning” rule, i.e., the language in a statute is given its plain meaning.    The problem was that the language in the statute was not clear on whether the maximum non-willful penalty was to be applied on an annual basis or an account-by-account basis.  The Government pointed to the language in the willful penalty provisions of the statute, which refer to “balance in the account” and “existence of an account” as requiring the non-willful penalty to apply on an account by account basis.  Mr. Kaufman argued that this language “reveals exactly the opposite.  The Court agrees with Kaufman.”  The Court followed the logic of the Bittner court.

The Court, relying on Bittner, reasoned that the language in the willful penalty provision shows that Congress knew how to make penalties account specific.  It drew a negative inference from the exclusion of language in the non-willful provision of language that was in the willful provision of the statute that Congress did not intend for the non-willful penalty to apply per account.  To buttress its determination, the Court found it significant that the regulations provide as the threshold for filing the FBAR form an aggregate balance in all accounts of over $10,000 since it makes no sense to assess a non-willful penalty per account when the reporting obligation is based on the aggregate balance and not on the number of accounts. 

Under both willful and non-willful penalties “the violation flows from the failure to file a timely and accurate FBAR.  The only difference is that the manner for calculating the statutory cap for penalties for willful violations involves an analysis that includes consideration of the balance in the accounts, while no such analysis is required for non-willful violations.”  (Slip. Op. at 18-10.)

The Government’s interpretation “could readily result in disparate outcomes among similarly situated people” based solely on the number of accounts and a person who had several accounts who  was non-willful “could be exposed to a significantly higher penalty than a willful violator.”  The Court found as conjecture the Government’s argument that limiting the penalty for non-willful violations to $10,000 per year would decrease the penalties deterrence value.  The Court noted that for the first three decades of the statutes existence there was only a willful penalty and when Congress added the non-willful penalty it was aware that the willful penalty used the account balance as a cap, something the Court found persuasive evidence that Congress did not want the non-willful penalty to be applied on a per account basis.  The Court found unpersuasive the district court’s decision in US v. Boyd.

Boyd is currently on appeal to the Ninth Circuit, which heard oral argument last summer.  Counsel for Ms. Boyd has already sent a copy of the Kaufman decision to the Ninth Circuit.  We can only wait to see whether the Ninth Circuit finds the reasoning in Kaufman and Bittner persuasive.

Contact Robert S. Horwitz at horwitz@taxlitigator.com or 310.281.3200   Mr. Horwitz is a principal at Hochman Salkin Toscher Perez P.C., former Chair of the Taxation Section, California Lawyers’ Association, a Fellow of the American College of Tax Counsel, a former Assistant United States Attorney and a former Trial Attorney, United States Department of Justice Tax Division.  He represents clients throughout the United States and elsewhere involving federal and state administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.

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