Jeremy and Margaret Jacobs, owners of the Boston Bruins through three entities, checked the IRS into the boards and walked out of Tax Court with no deficiency.[i]  The only issue in the case was whether the entity that owns the Bruins could deduct 100% of meal expenses for away games.  The IRS argued the 50% haircut under IRC §274(n)(2) applied.  The taxpayer claimed the de minimis exception, which allows the entire deduction applied.

The opinion goes into seemingly obvious detail about the requirement that the Bruins play half their regular season games at home and half on the road, that its goal is to win hockey games, and that failing to show up for a game leads to a forfeit.   The Collective Bargaining Agreement (CBA) between the league and the players also contains specific travel requirements such as arrival and departure times relative to game time and location.  But, in the context of the de minimis exception, these facts are crucial in the outcome as meals play an essential role.  Once the NHL schedule is released, the Bruins negotiate with away hotels to provide hotel rooms, conference rooms, and of course meals.  The Bruins staff goes to great lengths to select the specifics of the meals and enters into a banquet event order (BEO) with the hotel.

Meals are mandatory for players, and are provided to all Bruins traveling staff, not just players and coaches. Players and coaches will meet during meals to review strategy, watch film, and the PR staff will go over media inquiries.  During the years at issue the Bruins deducted $255,754, and $286,446 for away game meals.

To qualify for the de minimis exception, as a preliminary matter, access to the eating facility must be available on substantially the same terms to each member of a group of employees. Basically, you cannot discriminate in favor of highly compensated employees.  In this case, meals were provided to all traveling employees, so the Bruins play on.

Employee meals provided in a nondiscriminatory manner satisfy the de minimis exception if they meet 5 requirements: (1) the eating facility is owned or leased by the employer; (2) the facility is operated by the employer; (3) the facility is located on or near the business premises of the employer; (4) meals are provided during, or immediately before or after the employee’s workday; and (5) the annual revenue derived from the facility normally equals or exceeds the direct operating costs of the facility.

At first blush, it would seem like that IRS had a winning argument, but an analysis of each factor and the specifics of the Bruins business illustrate why the Bruins ultimately prevailed. The Bruins do not enter into a formal lease agreement with hotels, but the Court held the BEO and hotel contract function as a lease because the Bruins pay for the right to use and occupy hotel meal rooms.

Under the regulations, operation by the employer includes contracting with another to operate the eating facility. The negotiations between the Bruins and the hotel over the specific meal room requirement met this requirement.

The third requirement, that meals be provided on or near the business premises of the employer, would appear to be too much to overcome. The Tax Court had previously held, however, that a rented hotel suite could constitute a company’s business premises.[ii]  The requirement is functional, not spatial, and not limited by geography.  Here the Court relied heavily on the nature of the Bruins business, namely, a hockey team that travels across the US and Canada to play games with the goal of winning as many as possible.  Players need to be properly housed and fed in order to accomplish that goal.  Hotels are therefore, essential to the Bruins business.

The fourth requirement, the revenue/operating cost test, is met if the meals are excludable from the employees income under IRC §119, which means the meals must be furnished for the convenience of the employer and furnished on the employer’s business premises. Meals are for the convenience of the employer if it is furnished for substantial noncompensatory business reasons.  In this case the players get meals to maximize performance, and the rest of the traveling team receives meals to make sure everything runs smoothly for the players.

The fifth and final requirement, that meals be provided during, before or after the workday is obvious and needs to analysis.

The deficiency in the case was rather small, certainly compared to the overall wealth of Mr. and Mrs. Jacobs, and the expenses to bring this case to trial was likely many multiples greater than the amount at stake. The issue, however, not only repeats itself every year for the Bruins, but for every professional sports team.  This is a substantial win for team owners.

Outside the professional sports world, the case illustrates the specific requirements needed to deduct 100% of meals. Many companies may deduct meals without much thought to what is actually needed to properly claim the deduction.  Similarly, companies might subject themselves to the 50% haircut, without taking advantage of the de minimis exception.

Jonathan Kalinski specializes in both civil and criminal tax controversies as well as sensitive tax matters including disclosures of previously undeclared interests in foreign financial accounts and assets and provides tax advice to taxpayers and their advisors throughout the world.  He handles both Federal and state tax matters involving individuals, corporations, partnerships, limited liability companies, and trusts and estates.

Mr. Kalinski has considerable experience handling complex civil tax examinations, administrative appeals, and tax collection matters.  Prior to joining the firm, he served as a trial attorney with the IRS Office of Chief Counsel litigating Tax Court cases and advising Revenue Agents and Revenue Officers on a variety of complex tax matters.  Jonathan Kalinski also previously served as an Attorney-Adviser to the Honorable Juan F. Vasquez of the United States Tax Court.

 

[i] Jacobs v. Commissioner, 148 T.C. No. 24 (2017).

[ii] Mabley v. Commissioner, T.C. Memo. 1965-323

 

 

Category: Tax Court

 

Tags: Tax Court, Meals and Entertainment, IRC §274, de minimis, deductions

 

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A dual-national (U.S. and Canadian) citizen who lives in Canada found a warm reception in federal district court in Seattle, in the person of Judge James Robart. In the process, taxpayer Jeffrey Pomerantz demonstrated that the Department of Justice can’t rely on assumptions and innuendo to show that a taxpayer willfully failed to file IRS forms disclosing foreign bank accounts.

Many but not all taxpayers know that, if they have foreign bank accounts that together contain more than $10,000, then they have to: (1) check the “yes” box in response to the foreign-accounts question on their tax return; and (2) file the Treasury Department’s foreign bank account reporting form (“FBAR form”).

The Department of Justice (“DOJ”) filed a civil complaint in federal district court in Seattle to collect civil FBAR penalties for Pomerantz’s supposedly willful failure to file an FBAR form.  The difference between willful and non-willful FBAR penalties can be massive: willful violations usually result in a penalty of 50% of the highest balance in the unreported accounts; non-willful violations are penalized at up to $10,000 per occurrence.

In its complaint, the government alleged that Pomerantz had set up a shell company in the Turks and Caicos, failed to report interest on his Forms 1040 from Canadian and Swiss bank accounts that held more than $ 1 million, and failed to file FBAR forms for the same accounts. To make matters worse, Pomerantz would not agree to service of the complaint by mail and refused to disclose his home address to the DOJ lawyer, leading Judge Robart to authorize DOJ to serve Pomerantz by international mail.  Looking like you are dodging service tends to annoy judges, which is particularly bad when the judge is later called on to rule on your motion to dismiss.

Pomerantz represented himself, and argued in his motion to dismiss that DOJ made a handful of false allegations and had failed to allege enough facts in its complaint to show that his failure to file an FBAR form was willful instead of merely inadvertent. The government argued, in response, that Pomerantz’s course of conduct – setting up a Turks and Caicos company, opening bank accounts in that company’s name, and not reporting his foreign interest income on his tax return – was, according to case law, sufficient to assume Pomerantz’s related failure to file an FBAR was willful instead of a mistake.

Judge Robert didn’t buy the government’s argument. Instead, the judge dissected the government’s allegations and found they didn’t support the government’s conclusions.  In particular, Judge Robart noted that the Canadian bank accounts were in Pomerantz’s own name, not the Turks and Caicos company, and the accounts pre-dated the company, so his setting up the company wasn’t evidence that Pomerantz was trying to hide his pre-existing accounts.  Judge Robert also rejected the government’s vague “willful blindness” argument – that acts such as checking the foreign-accounts box “no” on a tax return is sufficient to show the taxpayer knew or deliberately avoided knowing about FBAR filing – by pointing out the government didn’t allege Pomerantz checked the box “no” or alleged any similar facts.  The fact that Pomerantz failed to report his income is a far cry from his having checked “no” on a tax form, and Judge Robart recognized this distinction and found for Pomerantz on this point as well.   The judge granted the motion to dismiss the FBAR penalties for the Canadian accounts, a major win for Pomerantz.

The decision wasn’t all good news for Pomerantz, at least for now. Judge Robart did agree with the government that it was permissible to assume, giving the government the benefit of the doubt in a motion to dismiss, that Pomerantz’s setting up Swiss accounts in the name of the Turks and Caicos shell company was evidence that Pomerantz intended to evade the FBAR filing requirement. (However, Pomerantz’s motion to dismiss suggests the government may have difficulty proving it was a shell company.)  The judge denied the motion to dismiss the FBAR penalty on the Swiss account.

In sum, the judge wanted to dismiss just the FBAR penalty associated with the Canadian accounts and allow the Swiss accounts penalty to proceed. However, because the FBAR penalty assessed did not distinguish between the Canadian and Swiss accounts, the judge dismissed the entire case and invited the government to re-assess the FBAR penalty related just to the Swiss accounts and come back another day.

Having just learned from a government attorney that the IRS appears to be sending more civil FBAR penalty collection cases to DOJ to file suits against the taxpayers, this case will be useful to remind both DOJ and judges that merely having a foreign account isn’t sufficient proof of willful failure to file an FBAR. The government can’t rely on innuendo and logical leaps to make its case, and it’s worth fighting back when they try to do so.

EVAN J. DAVIS – For more information please contact Evan Davis – davis@taxlitigator.com or 310.281.3288. Mr. Davis is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a former AUSA of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) handling civil and criminal tax cases and, subsequently, of the Major Frauds Section of the Criminal Division of the Office of the U.S. Attorney (C.D. Cal) handling white-collar, tax, and other fraud cases through jury trial and appeal. He has served as the Bankruptcy Fraud coordinator, Financial Institution Fraud Coordinator, and Securities Fraud coordinator for the USAO’s Criminal Division, and the U.S. Attorney General awarded him the Distinguished Service Award for his work on the $16 Billion RMBS settlement with Bank of America.

Mr. Davis represents individuals and closely held entities in criminal tax investigations and prosecutions, civil tax controversy and litigation, sensitive issue or complex civil tax examinations and administrative tax appeals, and federal and state white collar criminal investigations. He is significantly involved in the representation of taxpayers throughout the world in matters involving the ongoing, extensive efforts of the U.S. government to identify undeclared interests in foreign financial accounts and assets and the coordination of effective and efficient voluntary disclosures (OVDP, Streamlined Procedures and otherwise).

As part of the Internal Revenue Service’s (“IRS”) continuing  international enforcement effort,  it recently released training materials on  what it means to be “substantially complete”  for an  international information return.  The training is significant because the failure to file a “substantially complete” foreign information return can subject the filer to substantial penalties and the failure to file a “substantially complete” form could also leave open the statute of limitations on  the  assessment of  additional taxes and penalties.

The training of  IRS agents on the topic of “substantially compete” and substantial compliance reflects the evolution of the seriousness of the Service’s commitment to enforce international reporting obligations.  Historically, the IRS was quite forgiving of a taxpayer’s failure to file required information reporting forms.  The forgiving  attitude has been evolving over the last ten (10) years and the IRS, absent the demonstration of “reasonable cause,” is not as forgiving.  Moreover, historically most IRS agents were not familiar with the numerous international reporting forms which lent itself to a more accommodating position with taxpayers.  If IRS agents do not know the requirements, how can a taxpayer be  held to a higher standard?

The  IRS is more closely focusing on the requirements for filing the international reporting forms.  Not only must they be filed to avoid the potential penalties and statute of limitations issue, they must be “substantially complete.”

There are numerous international reporting forms (beyond the scope of this blog), but the more important ones are:

Form 5471 – relating to a controlled foreign corporation; Form 5472 – relating to foreign ownership of a U.S. corporation;  Form 8865- return of U.S. persons with respect to certain foreign partnerships; Form 8858- information return of U.S. persons with respect to certain foreign disregarded entities; Form 926 – return for U.S. transfer of property to a foreign corporation; and Forms 3520 and 3520-A – the annual returns to report transactions with foreign trusts or the receipt of certain foreign gifts.  Each of the forms carries with it substantial penalties for a failure to comply.

While the focus of the completeness of the information reporting forms is a new development of the IRS international enforcement effort, there is a long common law history of what is “substantial compliance.”  The Court precedent relates primarily to non-foreign information reporting, but will provide guidance to the IRS, taxpayers and the Courts as to whether there has been “substantial compliance.”

The IRS’ position is that in determining whether a tax return satisfies a reporting requirement or whether a taxpayer has complied with a statutory or regulatory requirement, two different standards that may apply.  The first requires “strict compliance” with the statute or regulatory requirement; the second requires “substantial compliance.”  In analyzing the statue or regulatory requirement, the first step is to determine which standard applies – – and that may not be clear.  The Service has indicated the Courts may consider the following:

– – if the particular information requirement be relates to the “substance or essence” of the statute or regulation, strict compliance is necessary. On the other hand, if the requirement is seen as “procedural or directory” then substantial compliance can apply.

If an IRS agent raises an error or an omission in a form, the taxpayer will want to try to fit the issue within the “substantial compliance” doctrine.

The leading case cited by the IRS is an old Board of Tax Appeals case (the predecessor to the Tax Court)  by the name of Indiana Rolling Mills Co. v. Commissioner, 13 B.T.A. 1141 (1928) – – yes, in 2017 in connection with the international enforcement effort, we are looking back to guidance in the 1920’s.

The Indiana Rolling Mills Co. v. Commissioner  case deals with the required signatures on a domestic corporate tax return.  The statute required that the corporate tax return be sworn to by the President and the Treasurer of the company.  In Indiana Rolling Mills, the corporate return was sworn to by the Vice-President and Secretary.  The IRS argued that the return was not valid for purposes of the statute of limitations.  A  harsh position indeed.

The Court stated the general rule of statutory construction is that provisions that relate to the “essence of the thing to be done are mandatory,” those that do not relate to the essence of the thing to be done are “directory.”  Here, the essence of the statute was making an honest return.  If the return represented information fairly and honestly given and sworn to by officers of the corporation who are familiar with its affairs,  the Court determined the taxpayer “substantially complied” with the statute.  The fact that the Treasurer or Assistant Treasurer did not swear the return did not go the essence of the statute.

There are a number of cases in the area and it should be kept in mind that the “substantial compliance” doctrine is taxpayer favorable.  Taxpayers do not need to be perfect, but they need to be in good faith and substantially comply with what the statute or regulations require.

The IRS has issued some internal guidance in connection with the application of the substantial compliance doctrine for international information reporting penalties.  The leading internal guidance is Chief Counsel Advice (“CCA”) 20429007 entitled “Whether Form 5472 was Substantially Complete.”  CCA 20429007 concerns the meaning of the term “substantially incomplete” in regard to a Form 5472, relating to an information return of a 25% foreign owned U.S. corporation as that term is used in Regulation Section 1.6038A-4(a)(i).  The CCA considered whether a taxpayer’s return would be considered incomplete and therefore subject to penalty under a variety of factual scenarios.  The CCA identifies two approaches that could be used to determine whether a return is substantially complete.  The first is “strict compliance,” an interpretation of the rules under which virtually any substantive inaccuracy could render the return substantially incomplete.  The second is the facts and circumstances approach.  The CCA provides a list of seven (7) factors that should be considered in a facts and circumstances analysis.  These factors deal with the proportionality and magnitude of the errors and its impact on the IRS to be able to efficiently examine the information required by the statute and regulations.

It is indeed a new world.  Not many years ago, failures or inaccuracies in international reporting were often forgiven by the IRS; now, with the IRS’ new focus on international enforcement, not only must  the information returns be filed, they will be scrutinized for completeness and at a minimum meet the substantial compliance standard.

This new IRS  scrutiny has significant consequences.  We are familiar with situations where the IRS solicits information reporting forms and not only are there initial penalties for failure to file the form, there are what is referred to as “continuation” penalties for the continued failure to file the form.  These can become very significant.  We have seen situations where the information forms have been filed, but the Service has taken the position that they were not “substantially complete” and sought to impose continuation penalties.  It is dangerous out there.  Get it right the first time but if the examining agent  raises the issue, think “substantial compliance.”

STEVEN TOSCHER – For more information please contact Steven Toscher – toscher@taxlitigator.com  Mr. Toscher is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., specializing in civil and criminal tax litigation. Mr. Toscher is a Certified Tax Specialist in Taxation, the State Bar of California Board of Legal Specialization 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 www.taxlitigator.com

 

On June 15, 2017, the California state Legislature voted to pass a comprehensive reform of the State Board of Equalization (BOE), known as the Taxpayer Transparency and Fairness Act of 2017 (AB 102).[i]  As passed by both the Assembly and Senate, this legislation was signed by Governor Jerry Brown on June 27, 2017 as part of the 2017-18 budget trailer package.

The Taxpayer Transparency and Fairness Act of 2017 strips the BOE, which currently administers over thirty tax and fee programs, of most of its powers and instead establishes a new agency: the California Department of Tax and Fee Administration (DOT).   The new DOT will be under the control of a director appointed by the Governor and subject to Senate confirmation.  This is a change from the BOE, which is governed by five elected Board members and is the nation’s only elected tax commission.[ii]

The enactment of this new legislation comes on the heels of a March 2017 report by the Department of Finance, which performed an evaluation of the BOE, including its sales and use tax resource utilization, outreach activities, and sales and use tax reporting.[iii]  The Department of Finance’s evaluation found that “certain board member practices have intervened in administrative activities and created inconsistencies in operations, breakdowns in centralized processes, and in certain instances result in activities contrary to state law and budgetary and legislative directives.”[iv]  State Controller Betty T. Yee stated on Thursday that the “sweeping reform passed today takes the duties of BOE down to the studs and structurally remodels to ensure more consistent, fair, transparent, and efficient administration of California’s tax laws and appeals.”[v]

Beginning July 1, 2017, the BOE will remain responsible for only (1) the review, equalization, or adjustment of property tax assessments; (2) the measurement of county assessment levels and adjustment of secured local assessment rolls; (3) the assessment of certain pipelines and related responsibilities; (4) the assessment of taxes on insurers; and (5) the assessment and collection of excise taxes on alcohol.

The Taxpayer Transparency and Fairness Act of 2017 also establishes a new Office of Tax Appeals, which will create tax appeal panels, each consisting of three administrative law judges, with offices in Sacramento, Fresno and Los Angeles. Each administrative law judge is required by statute to have been an active member in the State Bar of California for at least five years immediately preceding his or her designation to a tax appeals panel, and possess knowledge and experience with regard to the administration and operation of the tax and fee laws of the United States and of California. As such, the administrative law judges must be active, experienced tax lawyers in the state of California.

The Office of Tax Appeals will handle all appeals currently handled by the BOE (other than those relating to the responsibilities retained by the BOE), including petitions for redetermination, administrative protests, claims for refund, and appeals from an action of the Franchise Tax Board. The new Office of Tax Appeals will begin conducting appeals on or after January 1, 2018.

The tax appeals panels are required to publish a written opinion for each appeal decided by each tax appeals panel within 100 days after the date upon which a tax appeals panel’s decision becomes final. Taxpayers may be represented on an appeal by any authorized person or persons, at least 18 years of age, of the person’s choosing, including, but not limited to, an attorney, appraiser, accountant, bookkeeper, employee, business associate, or other person.

Decisions of the tax appeals panel are appealable to the California Superior Court subject to a de novo standard of review. In most California tax disputes (other than for determinations regarding a taxpayers residency status), the underlying liabilities are required to be paid and matters proceed to Superior Court litigation on the basis of a complaint for refund.

Internally, the BOE has a Settlement Section and the FTB has a Settlement Bureau, that were created to provide an administrative resolution of tax disputes on a “hazards of litigation” basis in a manner somewhat similar to the IRS Office of Appeals. Most experienced practitioners would likely conclude that these settlement procedures led to a realistic resolution of an administrative tax dispute often overcoming the need to present a matter to the members of the BOE.

It remains to be seen how this transition will impact taxpayers with cases currently pending before the BOE. Procedurally, although transfer of the administrative duties of the BOE is to occur by July 1, those duties will mostly be handled by the current administrative personnel of the BOE. As such, one might anticipate some, but not much, of an interruption in the examination and collection of taxes from California taxpayers.

Whether six months is a sufficient amount of time for the selection and training of qualified administrative law judges for the Office of Tax Appeals will remain to be seen. However, the requirement for published decisions should be helpful in the administration of future tax disputes within the settlement functions of the DOT (assuming the BOE Settlement Section is to continue) and the FTB. Historically, practitioners were disadvantaged by the inability to determine how other similarly situated tax disputes were resolved and how similar, or not, certain decisions of the BOE may be to an underlying dispute. Transparency in the administration of tax law is, from every perspective, is good for all.

LACEY STRACHAN – For more information please contact Lacey Strachan at Strachan@taxlitigator.com. Ms. Strachan is a senior tax attorney at Hochman, Salkin, Rettig, Toscher & Perez, P.C. and represents clients throughout the United States and elsewhere in complex civil tax litigation and criminal tax prosecutions (jury and non-jury). She represents U.S. taxpayers in litigation before both federal and state courts, including the federal district courts, the U.S. Tax Court, the U.S. Court of Federal Claims, and the Ninth Circuit Court of Appeals. Ms. Strachan has experience in a wide range of complex tax cases, including cases involving technical valuation issues. She routinely represents and advises U.S. taxpayers in foreign and domestic voluntary disclosures, sensitive issue civil tax examinations where substantial civil penalty issues or possible assertions of fraudulent conduct may arise, and in defending criminal tax fraud investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.

[i] AB-102 The Taxpayer Transparency and Fairness Act of 2017: California Department of Tax and Fee Administration: Office of Tax Appeals: State Board of Equalization.(2017-2018), available at https://leginfo.legislature.ca.gov/faces/billCompareClient.xhtml?bill_id=201720180AB102.

[ii] http://www.boe.ca.gov/info/about.htm.

[iii] http://www.dof.ca.gov/Programs/Osae/documents/Board_of_Equalization_Evaluation_March-2017.pdf

[iv] Evaluation, California State Board of Equalization Sales and Use Tax Reporting Retail Sales Tax Fund Adjustment, prepared by Office of State Audits and Evaluations, California Department of Finance, March 2017 at iv.

[v] Press Release, “CA Controller Cheers Passage of Tax Board Overhaul,” 6/15/2017, available at http://sco.ca.gov/eo_pressrel_18545.html.

Plea agreements in criminal tax cases normally have a section containing the calculation of the agreed Sentencing Guideline Range. The plea agreement also typically recites that the Government will recommend a guideline range sentence as long as the defendant meets his obligations under the plea agreement, but that the court is not required to accept the Government’s sentencing recommendations or the parties’ agreements as to facts and sentencing factors.  Most defendants probably assume that in fact the Government’s recommendation is the maximum sentence that they will receive and that if the court sentences outside the Guideline range it will impose a lesser sentence.  This is not always the case, as the defendant learned in United States v. Avan Nguyen, 2016 U.S. App. LEXIS 6390 (5th Cir., April 13, 2017).

Nguyen owned a wholesale salon equipment business. He pled guilty to aiding and abetting the filing of a false and fraudulent corporate tax return.  The plea agreement recited that the Guideline range, after acceptance of responsibility was a level 13, which translates to a 12-18 month term of imprisonment, and that he would forfeit $1.1 million in seized funds.  The district court imposed a sentence of 36 months imprisonment followed by 1 year supervised release and a fine of $250,000.  The reason: the district court disagreed with the Government and Nguyen’s interpretation of certain facts.

During the investigation, the IRS determined that third parties had made almost $5 million in structured deposits into Nguyen’s business accounts. A raid on his house yielded over $3.2 million in cash, most of it wrapped in bundles of $10,000. The Presentence Report discussed the apparent structuring conduct and recommended an upward departure based on either Guidelines § 4A1.3 (underrepresented criminal history) or Guidelines § 5K2.21 (uncharged conduct).  The district court did not accept the recommendation, but did consider the apparent structuring conduct in exercising its discretion under Booker v United States to make an upward variance to the maximum allowable sentence.

Although the Government took the position that there was insufficient evidence that Nguyen was involved in criminal structuring, the district court determined that Nguyen had in fact engaged in criminal structuring. The district court based its finding on several facts beyond the seizure of cash and the structured deposits.  These included that Chase Bank wrote to Nguyen that it believed that structured deposits were made to his bank account, after which he changed the name of his business and opened up a new account under the new business name.  A number of structured deposits were made to the new account.  The district court held that these facts supported a finding that Nguyen knew of the reporting obligations for deposits over $10,000 and knowingly and intentionally had structured deposits made to avoid the reporting requirements.

The court of appeals reviewed the district court’s sentence under an abuse of discretion standard. Finding that there were no procedural errors committed by the district court, that there was sufficient evidence to support its conclusion that Nguyen was engaged in criminal structuring and that the district court articulated a number of factors supporting its sentence, the court of appeals affirmed the sentence.

Criminal tax cases often involve defendants who may have engaged in other financial or tax-related offenses that are not charged. Because plea agreements in criminal tax cases often contain a litany of the defendant’s “bad acts,” this could include facts suggesting that there was uncharged criminal conduct.  From time to time an overzealous special agent may provide the probation officer with evidence about such conduct.  The decision in Nguyen is an object lesson in criminal tax cases: the district court is not bound by the plea agreement.  If presented with evidence detrimental to the defendant, a sentence about the Guideline range may be imposed.

ROBERT S. HORWITZ – For more information please contact Robert S. Horwitz – horwitz@taxlitigator.com or 310.281.3200   Mr. Horwitz is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a former Assistant United States Attorney of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) and 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

 

Large multinational corporations have historically been the focus of IRS transfer pricing examinations, such as the dispute between Amazon and the IRS over the amounts Amazon charged its European subsidiary for certain intangible assets that were transferred.[i]  However, IRS efforts to address potential income shifting between related entities have expanded to include smaller companies in the middle market.

Section 482. These examinations arise as a result of the IRS’s power under Section 482, which provides that in the case of two or more businesses “owned or controlled directly or indirectly by the same interests, the Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any such organizations, trades, or businesses.”  This Section gives the IRS broad discretion to reallocate income so that the income reported by a taxpayer is consistent with the economics and substance of the transactions between the related entities.

The standard under Section 482 is whether a transaction is arm’s length, which is shown by comparing the results of the related party transaction to what the results of the same transaction would be if entered into by unrelated taxpayers.[ii]  The regulations under Section 482 set forth extensive rules and guidance that must be followed in determining whether a controlled transaction satisfies the arm’s length standard.

LB&I Compliance Campaigns. The IRS recently announced that one of LB&I’s new compliance campaigns is the “Related Party Transactions Campaign,” which will be implemented through issue-based examinations.[iii]  The IRS explained in the rollout of the campaign that it will focus on “transactions between commonly controlled entities that provide taxpayers a means to transfer funds from the corporation to related pass through entities or shareholders.”  The IRS specified that it is allocating resources to this issue “to determine the level of compliance in related party transactions of taxpayers in the mid-market segment.  The IRS does not state whether its focus will be on transactions involving foreign entities or whether its focus will include transactions between related domestic entities.  While one of the prime concerns for the IRS in this area is taxpayers shifting income from the U.S. to a jurisdiction with a lower tax rate using non arm’s length transactions, situations arise where taxpayers have an incentive to shift income from one domestic entity to another.  The IRS’s powers under Section 482 apply equally to transactions with a domestic entity as to transactions with a foreign entity.

The IRS also rolled out another campaign targeting specifically one type of cross-border transaction between commonly controlled entities.   The IRS’s “Inbound Distributor Campaign” focuses on U.S. distributors of goods sourced from foreign-related parties, where the U.S. distributor has incurred losses or small profits that are not commensurate with the functions performed and risks assumed by the domestic entity—in such cases, the IRS believes the taxpayer would be entitled to higher returns in arm’s-length transactions.[iv]  For this compliance campaign, which will also be implemented by issue-based examinations, the IRS has “developed a comprehensive training strategy…that will aid revenue agents as they examine this IRC Section 482 issue.”[v]

Transfer Pricing Studies. With the IRS’s expanded focus on related party transactions, it is important for taxpayers who have commonly controlled or related entities to revisit their transfer pricing policies and consider obtaining a transfer pricing study.  In addition to potential substantial or gross valuation misstatement penalties if the IRS makes a transfer pricing adjustment, taxpayers may also be subject to a strict liability penalty depending on the net amount of the adjustment if the taxpayer did not obtain a transfer pricing policy prior to filing its tax return.[vi]  In order to be in the best position in the event of a transfer pricing audit and in order to help avoid the risk of a strict liability penalty in the event of a significant adjustment, taxpayers should have documentation prior to filing their tax returns setting forth the taxpayer’s determination of the price and establishing that the method the taxpayer used was reasonable and consistent with the Section 482 regulations.[vii]

Transfer Pricing Examinations. In an examination, the IRS advises revenue agents to issue a “§6662(e) mandatory Information Documentation Request” at the beginning of an audit, which will request the taxpayer’s documentation regarding its transfer pricing determinations.[viii]  While best practice is to ensure that all related party transactions are done at arm’s length, taxpayers facing a transfer pricing examination should be aware that the regulations under Section 482 allow for a “setoff” of an IRS transfer pricing adjustment, if the taxpayer can establish that the effect of multiple transactions between the related parties, when considered together, reflect an arm’s length arrangement between the entities.[ix]  The procedures that a taxpayer must follow to claim a setoff are set forth in Revenue Procedure 2005-46.

LACEY STRACHAN – For more information please contact Lacey Strachan at Strachan@taxlitigator.com. Ms. Strachan is a senior tax attorney at Hochman, Salkin, Rettig, Toscher & Perez, P.C. and represents clients throughout the United States and elsewhere in complex civil tax litigation and criminal tax prosecutions (jury and non-jury). She represents U.S. taxpayers in litigation before both federal and state courts, including the federal district courts, the U.S. Tax Court, the U.S. Court of Federal Claims, and the Ninth Circuit Court of Appeals. Ms. Strachan has experience in a wide range of complex tax cases, including cases involving technical valuation issues. She routinely represents and advises U.S. taxpayers in foreign and domestic voluntary disclosures, sensitive issue civil tax examinations where substantial civil penalty issues or possible assertions of fraudulent conduct may arise, and in defending criminal tax fraud investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.

[i] Amazon.com, Inc. v. Comm’r, 148 T.C. No. 8, Docket No. 31197-12, 2017 (Mar. 23, 2017).

[ii] Treas. Reg. § 1.482-1(b).

[iii] https://www.irs.gov/businesses/large-business-and-international-launches-compliance-campaigns.

[iv] Id.

[v] Id.

[vi] IRC §6662(e)(1)(B); IRC §6662(h)(2)(A)(ii)(I).

[vii] IRC §6662(e)(3)(B).

[viii] IRS Transfer Pricing Audit Roadmap, available at https://www.irs.gov/pub/irs-utl/FinalTrfPrcRoadMap.pdf.

[ix] Treas. Reg. § 1.482-1(g)(4)(i).

The IRS may soon adopt a variation on Southwest Airlines’ slogan “you are now free to move about the country.” The IRS variant “you are now not free to move about the world.”  We previously blogged about enactment of Internal Revenue Code sec. 7345, which authorizes the State Department to deny a revoke a passport of an individual if the IRS certifies that the individual owes over $50,000 in tax, penalties and interest.  See, http://www.taxlitigator.com/if-you-dont-pay-your-taxes-you-not-be-able-to-travel-by-robert-s-horwitz/.

For a passport to be revoked, the IRS must certify that the taxpayer owes $50,000 in tax, penalties and interest that have been assessed and that either 1) a notice of federal tax lien has been filed and all administrative remedies under IRC § 6320 have lapsed or been exhausted or b) levy has been issued.  Recently, the IRS posted on its website that it will soon begin to certify tax debts to the State Department.  As of early May, 2017, certifications have not been sent, but taxpayers who owe more than $50,000 in tax, penalties and interest can expect in the near future to have their passports revoked or applications for passport denied.  A taxpayer who is making payments under on an installment agreement or has not entered into an offer in compromise or settlement agreement with the IRS is not subject to certification.  Similarly, the IRS will not certify a taxpayer who has requested a collection due process hearing with respect to a notice of intent to levy or a taxpayer who has requested innocent spouse relief.

A taxpayer whose passport has been revoked or who has had a passport application denied because of past due taxes, is not without a remedy: sec. 7345(e) provides that a person who has been notified by the IRS of certification “may bring a civil action against the United States in a district court of the United States or the Tax Court to determine whether the certification was erroneous or whether the Commissioner has failed to reverse the certification.”

Aside from the wisdom of allowing the IRS to strip a citizen of his or her right to travel outside the US, the statute has a number of holes. The statute requires the IRS to notify the individual “contemporaneously” of certification and the right to bring a civil action but does provide how notice is to be given. This is in contrast with other IRC sections requiring notice, such as notices of deficiency (IRC 6212), collection due process notices (IRC 6320 & 6330), summonses (IRC 7603 & 7609) and worker classification notices (IRC 7436), which require at a minimum written notice by certified or registered mail. The IRS website states it will send taxpayers notice by regular mail on Notice CP 508C.  This may not be as good a way as certified mail to ensure that the taxpayer receives notice and pays attention to it, but it is probably sufficient to pass Constitutional muster. Although many people consider the right to travel outside the U.S. as fundamental, the Supreme Court views it as “no more than an aspect of the ‘liberty’ protected by the Due Process Clause of the Fifth Amendment.” Califano v. Gautier Torres, 435 U.S. 1, 5 n.6 (1978) (per curiam).

There are other holes in the statute.   The statute does not provide whether the taxpayer or the Government has the burden of proof. It does not indicate what issues can be considered: can the merits of the assessment be contested or only whether the IRS correctly calculated the amount owed. It does not indicate whether a taxpayer is entitled to a trial on the merits or just summary review by the court. Whether failure to pay tax justifies restricting a citizen’s right to foreign travel has not been decided, but given that several appeals courts have upheld the statute authorizing denial of a passport for unpaid child support, Eunique v Powell, 371 F.3d 971 (9the Cir. 2002); Weinstein v. Albright, 261 F.3d 127 (2nd Cir. 2001), courts will probably uphold the constitutionality of sec. 7345.   It may be several years before we know the answers, however, since these issues will need to be decided in litigation

ROBERT S. HORWITZ – For more information please contact Robert S. Horwitz – horwitz@taxlitigator.com or 310.281.3200   Mr. Horwitz is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a former Assistant United States Attorney of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) and 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 Keller Tank Services II Inc. v. Commissioner, 848 F.3d 1251 (10th Cir. 2017), the Tenth Circuit affirmed the Tax Court’s holding that a taxpayer could not challenge a Section 6707A penalty during a collection due process hearing or in a subsequent Tax Court proceeding because it already challenged the penalty with the IRS Appeals Office.

This holding illustrates how challenges to IRS liabilities that are not subject to the familiar tax deficiency procedures may have multiple pathways to IRS Appeals, but not all of those pathways allow for the Appeals determination to be further appealed to the Tax Court. Two liabilities that present this issue are assessable penalties (i.e. Section 6707A in Heller) and interest.

As set forth in Keller, after the IRS proposes a Section 6707A penalty, the taxpayer has 30 days to agree to or protest the penalty to the Appeals Office. Keller filed such a protest with IRS Appeals to seek rescission of the penalty under Section 6707(d).  Keller received a telephonic conference with an Appeals Officer, but the penalty was ultimately sustained and the Appeals Officer closed the case.  Congress did not provide for this type of determination in appeals be further appealed by filing a Petition the Tax Court.  While there could be benefits to this type of appeal, namely a pre-collection opportunity to have a second independent IRS employee review the same issue, this may be the end of the road for disputing the substantive liability.  Contrast this with the taxpayer in Yari v. Commissioner, Yari, were the taxpayer first appealed an IRC Section 6707A Penalty in the context of a CDP proceeding instead of through an administrative appeal.  See Yari v. Comm’r, 143 TC 157 (2014), affd without discussion of this issue, 118 AFTR 2d 2016-6096 (9th Cir. 2016).  In Yari, unlike in Keller, the Tax Court had jurisdiction to review the dispute of the underlying liability.

Similarly, after the IRS assesses interest, if the taxpayer wishes to seek interest abatement for IRS delays in the audit or the IRS improperly computes interest suspension, a statutory right to appeal exists in IRC Section 6404. Despite this appeal right being present, the taxpayer should still consider waiting to dispute the liability in a CDP Appeal so that they are not faced with a dead end appeal if they exceed the net worth limitations set forth in IRC Section 6404.

In practice, presenting arguments to or negotiating with a final decision maker presents a different dynamic than making an argument to someone who can be overruled as a matter of law (or for abusing their discretion in collection situations). As such, a taxpayer should be well informed so that the taxpayer does not take an appeal pathway that results in a dead end with no further pre-collection appeal rights to the Tax Court.

CORY STIGILE – For more information please contact Cory Stigile – stigile@taxlitigator.com  Mr. Stigile is a principal at Hochman, Salkin, Rettig, 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. Mr. Stigile specializes in tax controversies as well as tax, business, and international tax. His representation includes Federal and state civil and criminal tax 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

Large multinational corporations have historically been the focus of IRS transfer pricing examinations, such as the dispute between Amazon and the IRS over the amounts Amazon charged its European subsidiary for certain intangible assets that were transferred.[i]  However, IRS efforts to address potential income shifting between related entities have expanded to include smaller companies in the middle market.

Section 482. These examinations arise as a result of the IRS’s power under Section 482, which provides that in the case of two or more businesses “owned or controlled directly or indirectly by the same interests, the Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any such organizations, trades, or businesses.”  This Section gives the IRS broad discretion to reallocate income so that the income reported by a taxpayer is consistent with the economics and substance of the transactions between the related entities.

The standard under Section 482 is whether a transaction is arm’s length, which is shown by comparing the results of the related party transaction to what the results of the same transaction would be if entered into by unrelated taxpayers.[ii]  The regulations under Section 482 set forth extensive rules and guidance that must be followed in determining whether a controlled transaction satisfies the arm’s length standard.

LB&I Compliance Campaigns. The IRS recently announced that one of LB&I’s new compliance campaigns is the “Related Party Transactions Campaign,” which will be implemented through issue-based examinations.[iii]  The IRS explained in the rollout of the campaign that it will focus on “transactions between commonly controlled entities that provide taxpayers a means to transfer funds from the corporation to related pass through entities or shareholders.”  The IRS specified that it is allocating resources to this issue “to determine the level of compliance in related party transactions of taxpayers in the mid-market segment.  The IRS does not state whether its focus will be on transactions involving foreign entities or whether its focus will include transactions between related domestic entities.  While one of the prime concerns for the IRS in this area is taxpayers shifting income from the U.S. to a jurisdiction with a lower tax rate using non arm’s length transactions, situations arise where taxpayers have an incentive to shift income from one domestic entity to another.  The IRS’s powers under Section 482 apply equally to transactions with a domestic entity as to transactions with a foreign entity.

The IRS also rolled out another campaign targeting specifically one type of cross-border transaction between commonly controlled entities.   The IRS’s “Inbound Distributor Campaign” focuses on U.S. distributors of goods sourced from foreign-related parties, where the U.S. distributor has incurred losses or small profits that are not commensurate with the functions performed and risks assumed by the domestic entity—in such cases, the IRS believes the taxpayer would be entitled to higher returns in arm’s-length transactions.[iv]  For this compliance campaign, which will also be implemented by issue-based examinations, the IRS has “developed a comprehensive training strategy…that will aid revenue agents as they examine this IRC Section 482 issue.”[v]

Transfer Pricing Studies. With the IRS’s expanded focus on related party transactions, it is important for taxpayers who have commonly controlled or related entities to revisit their transfer pricing policies and consider obtaining a transfer pricing study.  In addition to potential substantial or gross valuation misstatement penalties if the IRS makes a transfer pricing adjustment, taxpayers may also be subject to a strict liability penalty depending on the net amount of the adjustment if the taxpayer did not obtain a transfer pricing policy prior to filing its tax return.[vi]  In order to be in the best position in the event of a transfer pricing audit and in order to help avoid the risk of a strict liability penalty in the event of a significant adjustment, taxpayers should have documentation prior to filing their tax returns setting forth the taxpayer’s determination of the price and establishing that the method the taxpayer used was reasonable and consistent with the Section 482 regulations.[vii]

Transfer Pricing Examinations. In an examination, the IRS advises revenue agents to issue a “§6662(e) mandatory Information Documentation Request” at the beginning of an audit, which will request the taxpayer’s documentation regarding its transfer pricing determinations.[viii]  While best practice is to ensure that all related party transactions are done at arm’s length, taxpayers facing a transfer pricing examination should be aware that the regulations under Section 482 allow for a “setoff” of an IRS transfer pricing adjustment, if the taxpayer can establish that the effect of multiple transactions between the related parties, when considered together, reflect an arm’s length arrangement between the entities.[ix]  The procedures that a taxpayer must follow to claim a setoff are set forth in Revenue Procedure 2005-46.

LACEY STRACHAN – For more information please contact Lacey Strachan at Strachan@taxlitigator.com. Ms. Strachan is a senior tax attorney at Hochman, Salkin, Rettig, Toscher & Perez, P.C. and represents clients throughout the United States and elsewhere in complex civil tax litigation and criminal tax prosecutions (jury and non-jury). She represents U.S. taxpayers in litigation before both federal and state courts, including the federal district courts, the U.S. Tax Court, the U.S. Court of Federal Claims, and the Ninth Circuit Court of Appeals. Ms. Strachan has experience in a wide range of complex tax cases, including cases involving technical valuation issues. She routinely represents and advises U.S. taxpayers in foreign and domestic voluntary disclosures, sensitive issue civil tax examinations where substantial civil penalty issues or possible assertions of fraudulent conduct may arise, and in defending criminal tax fraud investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.

[i] Amazon.com, Inc. v. Comm’r, 148 T.C. No. 8, Docket No. 31197-12, 2017 (Mar. 23, 2017).

[ii] Treas. Reg. § 1.482-1(b).

[iii] https://www.irs.gov/businesses/large-business-and-international-launches-compliance-campaigns.

[iv] Id.

[v] Id.

[vi] IRC §6662(e)(1)(B); IRC §6662(h)(2)(A)(ii)(I).

[vii] IRC §6662(e)(3)(B).

[viii] IRS Transfer Pricing Audit Roadmap, available at https://www.irs.gov/pub/irs-utl/FinalTrfPrcRoadMap.pdf.

[ix] Treas. Reg. § 1.482-1(g)(4)(i).

A Court of Appeals recently decided that an innocent spouse who relied on the IRS’s bad advice and filed suit in Tax Court too late, couldn’t get “equitable tolling” of the filing deadline.

Tax law allows spouses and former spouses to escape liability for joint tax debts in certain situations, including when it would be “inequitable to hold the individual liable for any . . . deficiency.” If the IRS denies so-called “innocent spouse” relief, then the taxpayer can petition the United States Tax Court to get a judge to rule on the requested relief.    Taxpayers don’t have to pay the tax first and sue for a refund in Tax Court, as they would in U.S. District Court, so missing out on Tax Court could mean the end of the case, particularly for taxpayers who don’t have the money to pay the tax and sue for a refund.  Like most lawsuits, there’s a deadline to file suit in Tax Court; in this case, it’s 90 days after the IRS denies a claim for relief.

In the unfortunate case of Nancy Rubel, the IRS failed to accurately count to 90 days. In denying her claims for innocent spouse relief, the IRS helpfully told Ms. Rubel that she had a right to appeal to Tax Court.  Instead of telling her that she had 90 days to file the petition – which presumably would have led her to pull out a calendar and accurately figure out the filing deadline – the IRS unhelpfully told her an exact deadline for filing in Tax Court.  The 90-day period according to the IRS’s calendar actually was 105 days on the calendar that everyone else, including the Tax Court, uses.  Ms. Rubel filed after 90 days had expired but before the incorrect deadline told to her by the IRS.  When she got to Tax Court, the IRS moved to dismiss her appeal as untimely.  She appealed, arguing that the IRS was “equitably estopped” from arguing she was late, because all she did was rely on the IRS’s incorrect calculation of the filing deadline.  It was unfair, she argued, for the IRS to tell her she had 105 days to file and then move to dismiss because she didn’t’ file within 90 days.

The Third Circuit Court of Appeals upheld the Tax Court in Rubel v. Commissioner, finding that the statute setting the 90-day deadline was “jurisdictional.”  That means, if the taxpayer doesn’t file within 90 days, the Tax Court isn’t authorized by Congress to hear the case.  That also means, the deadline can’t be ignored through arguments such as equitable tolling that otherwise might allow a court to overlook a late filing.  Interestingly, the Third Circuit didn’t comment on the harsh result from Ms. Rubel’s decision to trust the IRS.  The court also didn’t comment on the perverse incentives resulting from its decision – that the IRS has no incentive to tell taxpayers the right filing deadline and in fact will greatly improve its position by “miscalculating” the appeal period and slipping out of Tax Court jurisdiction if the taxpayer relies on the IRS.  Hopefully the IRS will start telling taxpayers that the deadline is 90 days instead of trying to calculate 90 days for the taxpayer, as they’ve shown that they can’t even read a calendar and taxpayers suffer the consequences.

EVAN J. DAVIS – For more information please contact Evan Davis – davis@taxlitigator.com or 310.281.3288. Mr. Davis is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a former AUSA of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) handling civil and criminal tax cases and, subsequently, of the Major Frauds Section of the Criminal Division of the Office of the U.S. Attorney (C.D. Cal) handling white-collar, tax, and other fraud cases through jury trial and appeal. He has served as the Bankruptcy Fraud coordinator, Financial Institution Fraud Coordinator, and Securities Fraud coordinator for the USAO’s Criminal Division.

Mr. Davis represents individuals and closely held entities in criminal tax investigations and prosecutions, civil tax controversy and litigation, sensitive issue or complex civil tax examinations and administrative tax appeals, and federal and state white collar criminal investigations. He is significantly involved in the representation of taxpayers throughout the world in matters involving the ongoing, extensive efforts of the U.S. government to identify undeclared interests in foreign financial accounts and assets and the coordination of effective and efficient voluntary disclosures (OVDP, Streamlined Procedures and otherwise).

 

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