Posted by: Lacey Strachan | April 17, 2017

LB&I’s New Compliance Campaigns by LACEY STRACHAN

As part of a move toward issue-based examinations, the IRS’s Large Business and International division has rolled out a compliance campaign process in which the IRS decides which issues representing a risk of non-compliance require one or multiple “treatment streams” to achieve the IRS’s compliance objectives.[i]  The IRS has explained that its potential “treatment streams” include “soft letters” (warnings that inform a taxpayer that the position on its return is inconsistent with the IRS’s position and give the taxpayer an opportunity to amend), changes in forms, examinations, and published guidance.

The IRS’s focus on issue-based examinations is intended to improve return selection, identify issues representing a risk of non-compliance and make the greatest use of limited resources, as part of an effort to redefine large business compliance work and to build a supportive infrastructure inside LB&I. Previously, IRS examinations were centered around selecting the returns of large corporate taxpayers to review in order to uncover issues.  With these efforts, the IRS is reorganizing its resources to focus on specific areas of concern.

Announced on January 31, 2017, the IRS has identified and selected 13 compliance campaigns in its first wave of LB&I’s issue-based compliance work, based on the IRS’s internal data analysis, suggestions from IRS compliance employees, and feedback from the tax community.[ii]  These campaigns reflect areas where the IRS has identified significant compliance issues and are an indication of areas LB&I will be focusing on in future examinations.  The following are the initial 13 campaigns:

  1. IRC 48C Energy Credit Campaign
  2. OVDP Declines-Withdrawals Campaign
  3. Domestic Production Activities Deduction, Multi-Channel Video Program Distributors (MVPD’s) and TV Broadcasters
  4. Micro-Captive Insurance Campaign
  5. Related Party Transactions Campaign
  6. Deferred Variable Annuity reserves & Life Insurance Reserves IIR Campaign
  7. Basket Transactions Campaign
  8. Land Developers – Completed Contract Method (CMM) Campaign
  9. TEFRA Linkage Plan Strategy Campaign
  10. S Corporation Losses Claimed in Excess of Basis Campaign
  11. Repatriation Campaign
  12. Form 1120-F Non-Filer Campaign
  13. Inbound Distributor Campaign

Although no materials relating to these campaigns have been released yet, the IRS has been holding a series of webinars to inform the tax community about these new campaigns. Two webinars have already taken place, on March 7, 2017 and on March 28, 2017.  These initial webinars focused generally on the campaign process, including how the campaigns are being implemented and how they will impact taxpayers.  Future webinars will discuss more fully the 13 compliance campaigns that have been launched.  These webinars are free to the public.  Although dates of these upcoming webinars have not yet been announced, information about upcoming webinars can be found on the IRS’s Large Business and International Compliance Campaigns website:  http://www.irs.gov/businesses/large-business-and-international-compliance-campaigns.

The IRS will be announcing and launching more campaigns in the coming months.

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] Information about LB&I’s Compliance Campaigns is available here: https://www.irs.gov/businesses/large-business-and-international-compliance-campaigns

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

On March 20, 2017, the IRS issued a “Fast Track Settlement Program” to speed up settlements with individuals and small businesses through its Small Business/Self-Employed Division (“SB/SE”). Although this reform was likely to happen regardless, it does come on the heels of the new administration’s criticism — echoed by the IRS Taxpayer Advocate —that the IRS operates with a “gotcha” mentality and should shift to helping taxpayers avoid errors in the first place and resolve cases quickly and cheaply.

In Rev. Proc. 2017-25, the IRS noted that large business taxpayers already have a successful fast-track resolution procedure, and that the IRS had been operating a SB/SE fast-track pilot program since 2003. The IRS is now rolling out a permanent version of the pilot program, and the permanent version contains many of the best features of that pilot program.  It takes effect immediately.

Before Rev. Proc. 2017-25, if a taxpayer couldn’t resolve an issue with an SB/SE agent who was auditing the taxpayer, then the taxpayer would have to wait until the agent finalized the audit and issued a notice. That notice would trigger the taxpayer’s right to seek review of the agent’s decisions by the IRS’s Office of Appeals.  In this normal (non-fast-track) mode, Appeals takes a second look at the IRS agent’s position and offers to settle with the taxpayer on the same or more-generous terms than were offered by the case agent.  Appeals thereby provides an off-ramp for cases that are easily resolved and should not go through the even-more-expensive Tax Court and U.S. District Court routes.  The downside of the current approach of only bringing in Appeals after the examination ends, is that the IRS and taxpayers spend time and money while the agent pushes the audit over the finish line.

The new fast-track procedure is designed to allow for even earlier dispute resolution, which saves money for both the IRS — the agent can move on to another case instead of completing the present audit — and the taxpayer, who can limit legal and accounting bills through early intervention.

Now, the taxpayer can get two bites at the apple. If there’s a disputed “fully developed” factual or legal issue in an examination — meaning the IRS agent has all necessary legal advice and documentation — then the taxpayer can invoke the fast-track process and the Appeals office will try to resolve the issue in no more than 60 days. Even if this fast-track process is unsuccessful, the taxpayer can still take the case through the “traditional Appeals process” after the IRS has finished the examination, permitting a second bite at the apple.

Of course, what would an IRS procedure be without a large helping of red tape? The final fast-track procedure differs from the pilot program in that: the IRS added a “good faith” requirement that taxpayers be fully cooperative – in the IRS’s exclusive opinion – during the audit; the IRS Group Manager must have tried and failed to resolve the issue; and the IRS added a catch-all provision that the fast-track procedure is inapplicable where employing it “would not be in the interest of sound tax administration” (aka, if the IRS doesn’t want to do it).

The bottom line: this is great news for taxpayers, particularly those who are represented in audits. There is no downside for the taxpayer of bringing in an Appeals officer to help resolve an issue, because at worst the Appeals officer will agree with SB/SE.  On the upside, Appeals officers frequently disagree with SB/SE agents, and they can be a powerful ally for the taxpayer and her representatives in trying to resolve disputed legal or factual issues.  This isn’t a cure-all for dealing with unreasonable IRS revenue agents, but it will provide a cost-effective way to challenge agents, particularly when they appear to be taking an unreasonable position during the audit.

EVAN J. DAVIS – For more information please contact Evan Davis – davis@taxlitigator.com or 310.281.3200. 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 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, 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).

Over the last five years, enforcement of employment tax violations has become a priority to the Internal Revenue Service and the Department of Justice, Tax Division.  Notwithstanding the increase in enforcement, the increasing cost to the Treasury indicates the increased attention to employment tax violations has not been enough – – and the Treasury Inspector General for Tax Administration (TIGTA) has just issued a report noting that criminal enforcement must increase.  Interestingly, the report refers to employment tax violations as “employment tax embezzlement, a felony punishable by up to five years in prison.”

On March 21, 2017, TIGTA issued a report to the Commissioner for Small Business/Self-Employed Division and the Chief for Criminal Investigation (CI) Divisions(Report No. 2017-IE-R004).  TIGTA recommended that the Commissioner and the Chief of CI should consider a strategy to address “egregious employment tax cases.”  Importantly, they recommended that the Collection function should expand the criteria used to refer potential criminal cases to CI, to include cases such as those over $1 million or individuals involved in ten or more companies that fail to remit payroll taxes.  The Collection Division indicated that they did not want to expand the criteria to refer cases to CI, given the balancing factors and importantly “limited resources.”  TIGTA however, indicated that additional “egregious” cases should be referred for criminal investigation and prosecution.

The report found that employment tax noncompliance is a growing problem.  As of December 2015, 1.4 million employers owed approximately $45.6 billion unpaid employment taxes, interest and penalties.  It noted that in fiscal year 2015, the IRS asserted trust fund recovery penalties against approximately 27,000 responsible persons, 38% fewer than just five years before.  They attribute this to a diminished resources to the Internal Revenue Service.  On the other hand, the number of employers with employment tax compliance for 20 or more quarters has been steadily growing – – more than tripling in a 17-year period.

Importantly, the Report found that even the use of the trust fund recovery penalty did not stop the abuse, finding that a review of a number of taxpayers who had been assessed the trust fund recovery penalty who had ten or more entities involved, only 8.5% of the individuals had been investigated by the Criminal Investigation Division.

The Report also noted that of approximately the 700 individuals who were assessed in excess of $1 million during the years 2010 to 2015, CI opened investigation on fewer than fifty of these individuals, or approximately 7%.

TIGTA concluded that given the small number of criminal investigations for employment tax violations, the criminal sanction and its goal of general deterrence was not having its intended positive impact on tax compliance.

While we are in a period of limited government resources, employment taxes have become a bigger source of revenue and a larger tax compliance problem.   Expect to see an increase in employment criminal investigations and prosecutions in light of TIGTA’s Report.

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

EVAN J. DAVIS – For more information please contact Evan Davis – davis@taxlitigator.com or 310.281.3200. 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 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, 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).

It is time for a little change of pace from substantive tax discussions.

In tax controversy cases you occasionally must cross examine someone. Whether in litigation, or just sitting in an office interviewing witnesses or clients, it is comforting knowing how to expose a lying witness.

If you have an objective piece of evidence showing the witness is lying, say a contradictory statement in writing or otherwise, it takes no great skill to demonstrate the witness’s lie. (Note it is still possible to botch this cross examination with an inept questioning technique, but that is a topic for another day.)  For an example of a Master using this basic technique see Wellman, The Art of Cross Examination, pp 57-59 (paperback).

What you will learn in this essay is how to cross examine the lying witness when you have only your belief that the witness is lying.  Here is the outline I use when I teach this technique.

Ladies and gentlemen, while this may come as a shock to some of you, there exists something out there in the world we call “objective reality.” (Use finger quotes while saying “objective reality”).  This “objective reality” comprises things we call “facts” (finger quotes).  None of these “facts” exist in isolation; they are all connected to other “facts” making up “objective reality.”

The problem with a lie is that, although it pretends to be a “fact,” it is not. The lie connects to nothing.  The lie is just floating out there unconnected to “objective reality.”

To learn how to attack the lie, we must go back to eighth grade geometry, where we were taught basic logic. (At least that was taught to me in eighth grade in 1963).  Recall the basic formula:

True Formula #1: A ⇒ B. Or translated:  If A is true, then B is true.

Example: If I fall unclothed into the ocean, then I get wet.

One we establish the truth of Formula #1, Formula #2 follows as true:

True Formula #2 follows (this is the important one): ∼ B ⇒ ∼A. Or translated:  If not B is true, then not A is true.

Continuing example: If I am not wet, then I have not fallen unclothed into the ocean.

Apply this to the lie we are trying to attack. The attack on the lie comes from multiple directions.  Hence the name of this essay.

STEP 1: Assume that the lie is true.  Call it “A.”

STEP 2: If the lie is true, what “facts” might we reasonably expect to see connecting the lie to objective reality. Call them “B.”  Recall A ⇒ B.

Pick five connecting “facts.” (You can pick more, you can pick fewer.  Suit your taste).

A ⇒ B1;  A ⇒ B2;  A ⇒ B3;  A ⇒ B4;  A ⇒ B5.

Get the witness to agree that the five connecting “facts” are false. The witness agrees ∼B1;  ∼B2;  ∼B3;  ∼B4;  ∼B5.

Therefore:

∼ B1 ⇒ ∼A: A is false.  The lie is proven false.

∼ B2 ⇒ ∼A: A is false.  The lie is proven false.

∼ B3 ⇒ ∼A: A is false.  The lie is proven false.

∼ B4 ⇒ ∼A: A is false.  The lie is proven false.

∼ B5 ⇒ ∼A: A is false.  The lie is proven false.

Or at least, you argue that.

Let’s use this technique in an easy example. You are prosecuting a young man for robbing a bank.  At the last minute, his mom takes the witness stand and says her son was with her the entire day of the bank robbery.

The basic cross examination, if you have the evidence, is easy. If you have a prior contradictory statement she gave to a neighbor or the police, if you have her employment records showing she worked all that day; if you have a film of what is obviously her son with a gun in his hand inside the bank during the robbery, the cross examination is easy.  But what if you have none of those things?  All you have is your belief she is lying.

Use the Five Different Directions Technique of Cross Examination. It goes like this:

Assume that mom is telling the truth. What would follow, if her son was with her during the day of the bank robbery?

Direction 1: She would have told the investigating detectives that story when she was first interviewed about the bank robbery.  She didn’t.

A ⇒ B1:  If her son was with her, then she would have told the police in her interview.∼ B1 ⇒ ∼A: She did not tell the police in her interview; therefore her son was not with her.  A is false.  The lie is proven false.

The questioning is simple:

Question: Mam, you were interviewed by two police officers after the bank robbery, right?

Answer: Yes.

Question: The police officer asked you questions about the bank robbery?

Answer: Yes.

Question: The police officers asked you questions about your son, didn’t they?

Answer: Yes.

Question: Never during this interview did you tell them your son was with you all day?

Answer: I didn’t, but I was afraid to talk to them.

Direction 2: If she were too frightened initially, she would have told the police or the prosecutors eventually. She didn’t. 

A ⇒ B2:  If her son was with her, then she would have eventually told the police.

∼ B2 ⇒ ∼A: She never told the police; therefore her son was not with her.  A is false.  The lie is proven false.

Question: You have a telephone in your home, right?

Answer: Yes.

Question: And since your interview with the police and until today, your phone has worked properly, hasn’t it.

Answer: Yes.

Question: Never since your interview did you call the police and inform them they had arrested the wrong man, that your son was with you all day, right?

Answer: Right.

Alternative Question Form: Of course, after your interview you called the police and informed them they had arrested the wrong man, that your son was with you all day, right?

Answer: No.

Direction 3: If she were too frightened initially, she would have written the police or the prosecutors eventually.  She didn’t.

A ⇒ B3:  If her son was with her, then she would have eventually written the police.

∼ B3 ⇒ ∼A: She never wrote the police; therefore her son was not with her.  A is false.  The lie is proven false.

Question: You know how to find the address of the police, don’t you?

Answer: Yes.

Question: Mam, you have 34¢ to buy a postcard, don’t you?

Answer: Yes.

Question: Despite knowing the address of the police and despite have 34¢ you did not write a postcard to the police and tell them they had arrested the wrong man, that your son was with you all day, right?

Answer: No answer.

Direction 4: If her son misses school and stays home all day, either she calls the school or the school calls her to make sure her son is OK.  Neither call happened.

A ⇒ B4:  If her son was with her, then she would have called the school or they would have called her.

∼ B4 ⇒ ∼A: No such call occurred; therefore her son was not with her.  A is false.  The lie is proven false.

Question: On the day of the bank robbery, a school day, you never called the school to tell them you son was with you at home, did you?

Answer: No.

Question: On the day of the bank robbery the school did not call you and ask about your son, did they?

Answer: No.

Direction 5: Your turn, dream one up.

You can also use the Five Different Directions Technique on your friends, your spouse, your children, and your co-workers to expose all sorts of lies. Of course you will end up divorced, unemployed and friendless, but no matter, you will have exposed the truth.

Seriously, this is a very aggressive and effective technique. Use it carefully.

EDWARD M. ROBBINS, Jr. – For more information please contact Edward M. Robbins, Jr. -EdR@taxlitigator.com  Mr. Robbins is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., the former Chief 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, civil and criminal tax controversies and tax litigation. Additional information is available at http://www.taxlitigator.com

 

 

The IRS has announced new rules regarding an Offer-In-Compromise (OIC). Beginning with OIC applications received on or after March 27, 2017, the IRS will return any newly filed OIC applications if the taxpayer has not filed all required tax returns.  Additionally, any application fee included with the OIC will also be returned.  Any initial payment required with the returned application, however, will be applied to reduce the taxpayer’s balance due. The new rules do not apply to 2016 tax returns with a valid extension.

Prior to this new policy, the return of an OIC was not mandatory. An OIC can be a great alternative if you owe taxes and cannot fully pay your liability, but the approval process can be lengthy, and you will generally have to make a payment with your offer.  If you aren’t eligible or if the IRS ultimately rejects your OIC, your payment will not be return and will be applied to your tax liability.  If you aren’t sure whether you have filed all required returns, request account transcripts before making assumptions and losing your initial payment.

Several years ago the IRS liberalized the OIC rules under its Fresh Start initiative. Before your offer can be considered, you must: (1) file all tax returns you are legally required to file, (2) have received a bill for at least one tax debt included on your offer, (3) make all required estimated tax payments for the current year, and (4) make all required federal tax deposits for the current quarter if you are a business owner with employees.  If you or your business are in bankruptcy, you are not eligible for an OIC.

The two basic payment methods for an OIC are the lump sum cash and the periodic payment. Lump sum cash option requires 20% of the total offer amount to be paid with the offer and the remaining balance paid in 5 or fewer payments within 5 or fewer months of the date your offer is accepted.  Under the periodic payment option you must make the first payment with the offer and pay the remaining balance within 6 to 24 months, in accordance with your proposed offer terms.

Before submitting an OIC make sure you are eligible. The IRS has a helpful online OIC Pre-Qualifier that can be found at https://irs.treasury.gov/oic_pre_qualifier/. After answering eligibility questions, you will be asked to input your assets, income, and expenses.  At the end the calculator will tell you what your OIC should be under the two payment options.

If an OIC is not the best option for you, consider an installment agreement, which is generally much easier to obtain because in most circumstances you will pay the entire amount of the liability.

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.

The Third Circuit released an unpublished decision on March 13, 2017,,[i] United States v. Chabot, that is the latest development in a series of decisions upholding the constitutionality of IRS summons for documents concerning a taxpayer’s foreign bank account under the authority of the Bank Secrecy Act of 1970 (“BSA”), even if production of those documents may incriminate the taxpayer.  Although taxpayers have argued that the records are protected by the Fifth Amendment act of production doctrine, the IRS has taken the position that the required records doctrine, an exception to the act of production doctrine under the Fifth Amendment, applies to such documents, because the BSA requires the documents to be maintained by the taxpayer in accordance with the regulations under the BSA, including under 31. C.F.R. section 1010.420.  In 2015, the Third Circuit joined the Second, Fourth, Fifth, Seventh, Ninth, and Eleventh Circuits as the seventh Circuit holding that the documents sought in a summons for information required by the BSA falls within the required records doctrine.[ii]

Background. After receiving information from the French competent authority pursuant to the United States-France income tax treaty, the IRS learned that the taxpayer husband was the beneficial owner of an undisclosed foreign bank account held at HSBC.  The IRS requested a summons interview, which the taxpayers appears for but asserted their Fifth Amendment privilege with respect to the foreign bank accounts.  The government followed with an administrative summons for documents, and after some back and forth between parties, the IRS amended its summons to narrow the scope of the summons to only those required to be maintained by the regulations. However the taxpayers refused to produce the requested documents.

In response to a petition the IRS filed to enforce the summons, the district court entered an Order to Show Cause directing the taxpayers to present any defense or opposition to the petition to enforce the summons. In response, the taxpayers argued that the Fifth Amendment Act of production doctrine applied and that the Required Records Doctrine did not apply.

Fifth Amendment Act of Production Doctrine. The Firth Amendment states that no person “shall be compelled in any criminal case to be a witness against himself.”[iii]  The Supreme Court has clarified that the privilege extends to the act of producing potentially incriminating documents, known as the act of production doctrine.[iv]  The rationale behind the Act of Production doctrine is that the act of producing documents requested in a subpoena has communicative aspects to it, wholly aside from the contents of the papers produced.[v]

Required Records Doctrine:  The Required Records Doctrine is an exception to the Act of Production doctrine, which originated in Shapiro v. United States, 335 U.S. 1 (1948).  The Court has subsequently articulated three factors or premises to analyze in determining whether the Required Records Doctrine Applies: First, the purpose of the United States’ inquiry must be essentially regulatory; second, information is to be obtained by requiring the preservation of records of a kind which the regulated party has customarily kept; and third, the records themselves must have assumed “public aspects  which render them at least analogous to a public document.”[vi]

District Court Holding. The district court found the Taxpayer’s arguments against the require records doctrine unpersuasive, because responding to the IRS’s summons does not necessarily result in admitting an FBAR violation or an element of a crime – holding a foreign bank account is not in and of itself illegal, so admitting to having a foreign bank account does not carry the risk of admitting to an inherently criminal activity.[vii]  The district court explained that “That the information contained in the required record may ultimately lead to criminal charges does not convert an essentially regulatory regulation into a criminal one.”[viii]  For the information to lead to a criminal charge, the government would have to prove that that the taxpayer acted willfully. Although the taxpayers also tried to distinguish their case on the basis that they at that time were just undergoing a civil audit and not a grand just investigation; however, the district court held this factor weighed against the taxpayer because the taxpayer arguably faces less of a risk of criminal prosecution.  The district court similarly rejected the taxpayer’s arguments that the records are not “customarily kept” based on the secrecy inherent in international banking or “publicly kept” because they are more analogous to general taxpayer records, with the district court finding that bank customers do customarily keep records of their bank accounts and the regulation requires that the records be kept at all times available for inspection as required by law.[ix]

The district court quoted In re Special February 11-1 Grand Jury Subpoena Dated Sep. 12, 2011, 691 F.3d 300, 309 (7th Cir. 2012), which explained that the “voluntary choice to engage in an activity that imposes record-keeping requirements under a civil regulatory scheme carries consequences, perhaps the most significant of which, is the possibility that those records might have to be turned over upon demand, notwithstanding any Fifth Amendment privilege.”  Accordingly, the district court granted the government’s petition to enforce the summons served on the taxpayers.  The district court’s decision was affirmed by the Third Circuit in United States v. Chabot, 793 F.3d 338 (3d Cir. 2015).

Contempt Hearing. When Mr. Chabot refused to comply with the court’s order enforcing the summons, the government moved to have the Chabots held in civil contempt for disobeying the enforcement order, and the District Court issued an order to show cause.  The civil contempt hearing focused on the Chabots’ argument that no responsive documents existed, because they lacked the requisite interest in any foreign bank accounts during the relevant period, and that Mr. Chabot had suffered a stroke which may have affected his ability to proceed.  The Chabots were able to introduce sufficient evidence that Mrs. Chabot did not have the requisite connection to any foreign financial accounts necessary for her to maintain documents under the BSA and the government withdrew its motion to hold Mrs. Chabot In contempt; however, the court found that Mr. Chabot was unable to establish his inability to comply with the order and was held in civil contempt.

Third Circuit Appeal of Contempt order. On appeal, the Third Circuit affirmed the district court’s decision, holding that Mr. Chabot failed to demonstrate his inability to comply with the summons or that he was being punished for asserting his Fifth Amendment right against self-incrimination.[x]  On appeal, Mr. Chabot argued that after he denied the existence of the documents, the government had the burden of proving their existence by clear and convincing evidence and that by failing to do so, the district court was punishing him for asserting his privilege against self- incrimination.

Rejecting Mr. Chabot’s arguments and affirming the district court, the Third Circuit held that under Supreme Court precedent[xi], once a party has shown that (1) a valid order existed; (2) the other party had knowledge of the order; and (3) disobeyed the order, the burden is then on the party who disobeyed the order to establish his inability to comply with the order.  Because Mr. Chabot failed to establish he was unable to comply with the court’s order, the Third Circuit sustained the finding of contempt. The Third Circuit held that the court’s determination that Mr. Chabot failed to demonstrate his inability to comply with the Court’s enforcement order was not dictated by his prior assertion of the privilege against self-incrimination.[xii]

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 complex tax 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] United States v. Chabot, Docket No. 16-3873 (3rd Cir. March 13, 2017).

[ii] United States v. Chabot, 793 F.3d 338 (3d Cir. 2015).

[iii] U.S. Const. Amend. 5.

[iv] Fisher v.United States, 425 U.S. 391 (1975).

[v] Id.

[vi] Grosso v. United States, 390 U.S. 62, 67-68 (1968).

[vii] United States v. Chabot, No. 14-3055 (FLW), 2014 U.S. Dist. LEXIS 140656 (D.N.J. Oct. 3, 2014).

[viii] Id. (citing M.H. v. United States (In re Grand Jury Investigation M.H.), 648 F.3d 1067, 1075-75 (9th Cir. 2011).

[ix] United States v. Chabot, No. 14-3055 (FLW), 2014 U.S. Dist. LEXIS 140656 (D.N.J. Oct. 3, 2014).

[x] United States v. Chabot, Docket No. 16-3873 (3rd Cir. March 13, 2017).

[xi] United States v. Rylaner, 460 U.S. 752 (1983).

[xii] Id.

JONATHAN KALINSKI is a panelist with U.S. Tax Court Judge Juan Vasquez and IRS Deputy Area Counsel Catherine Chang re Anatomy of a Tax Court Case: Litigation Tips From the Experts – “Everything you need to know about navigating the complex world of Tax Court litigation. The discussion by an esteemed panel of experts includes all aspects of a Tax Court case, from beginning to end. Panel will cover filing a case, discovery, settlement strategies, motions, trial, experts, briefing, and everything else you need to know to litigate in Tax Court.”

Thursday, March 23 at noon (program 12:30 p.m. – 1:30 p.m.) at the Beverly Hills Bar Association, 9420 Wilshire Blvd., Second Floor, Beverly Hills, CA 90212. (Parking at 241 No. Canon Drive). Taxation Law Legal Specialization Credit.

EVERYONE IS INVITED – We look forward to seeing you ad appreciate your support for the Taxation Section of the Beverly Hills Bar Association. 

REGISTRATION: https://www.bhba.org/intus/event3/signup.asp?event_id=4056

CORY STIGILE will be speaking on Section: Settlements with the State Board of Equalization at a San Fernando Valley Bar Tax Section presentation on March 21, 2017 from noon to 1:00 PM at the SFVBA, 5567 Reseda Blvd., Ste 200, Tarzana.

EVERYONE IS INVITED – We look forward to seeing you and appreciate your support of the SFVBA Tax Section. 

REGISTRATION INFO: https://members.sfvba.org/calendar/signup/MTg5Mw==

 

An opinion that begins “Caligula posted the tax laws in such fine print and so high that his subjects could not read them” has to end well for the taxpayer. In Summa Holdings, Inc. v. Commissioner, No. 16-1712 (6th Cir. Feb. 16, 2017), the appellate court reversed the Tax Court and rejected the IRS’s invocation of a “substance over form” argument that sought to disregard a transaction set up in compliance with two Internal Revenue Code provisions that were designed to reduce taxes.

As the Sixth Circuit noted, it takes time, patience and money to learn how complex provisions of the Internal Revenue Code work. The Benenson family, with the assistance of its tax attorneys, used the “domestic international sales corporation” (“DISC”) and the Roth IRA provisions of the Code to avoid tax.

DISCs are an innovation of the Code designed to incentivize domestic corporations to export goods by allowing them to lower tax on export income. A corporation sets up a DISC to which it pays a commission of up to 4% of gross receipts or 50% of net income from qualified exports.  The DISC pays no corporate income tax on its commission income and can pay dividends to shareholders, who are often shareholders of the export corporation.  If the shareholder is a non-taxable entity or a corporation, it pays tax on the dividends at a 33% rate.

A taxpayer who sets up a Roth IRA pays tax on contributions but not on withdrawals, including accrued gains. A taxpayer cannot make contributions to an IRS if his income exceeds a certain level.

Summa Holdings is a manufacturing corporation. James Benenson, Jr., and trusts he formed for his two sons owned over 99% of the corporation’s stock.  In 2001, each of his sons set up a Roth IRA.  Each son contributed $3,500 to his Roth IRA.  Summa Holdings formed JC Export.  Each Roth IRA purchased 50% of the stock of JC Export for $1,500.  The Roth IRAs were the sole shareholders of JC Holdings, to which they transferred the JC Export stock.

JC Export acted as the DISC for Summa Holdings, which paid it commissions. JC Export distributed the commissions as dividends to JC Holdings, which paid tax on the dividends at a 33% rate.  The net dividend income was distributed to the two Roth IRAs as dividends.  Between 2002 and 2008 (the year in issue) JC Holdings distributed over $5.1 million to the Roth IRAs, each of which had accumulated over $3 million.

The IRS issued notices of deficiency. Determining that the substance of the transaction was to distribute Summa Holdings income to the sons without paying tax at the individual level, the IRS invoked the substance over form doctrine.  It disallowed the deductions taken by Summa Holdings as commissions and determined that the commissions were dividends to its shareholders.  It therefore asserted deficiencies against the corporation, Mr. Benenson and his two sons.  It gave a credit to JC Holdings for the 33% tax it paid.  Because each of the Benenson sons earned more than the allowable amount for making contributions to a Roth IRA, the IRS imposed a 6% excise tax on the contributions.  It also imposed accuracy penalties.  The Tax Court upheld the deficiencies but not the penalties and the taxpayers appealed.

The Sixth Circuit reversed. The crux of the Court’s decision was that since Roth IRAs and DISCs were designed by statute to reduce tax, there was nothing improper about a taxpayer using them to do just that.  The Court noted that under any other title of the United States Code this would end the matter:

But when it comes to the Internal Revenue Code, the Commissioner claims a right to reclassify Code-compliant transactions under the “substance-over-form doctrine” in order to respect “overarching . . . principles of federal taxation.” Appellee’s Br. 39, 41. Overarching indeed. As he sees it, the doctrine allows him to nullify the DISC commissions and dividends to the Roth IRAs on the ground that the purpose of the transactions was to sidestep the contribution limits on Roth IRAs and lower the tax obligations of the Benenson sons in the process. That is a step too far. It’s one thing to permit the Commissioner to recharacterize the economic substance of a transaction—to honor the fiscal realities of what taxpayers have done over the form in which they have done it. But it’s quite another to permit the Commissioner to recharacterize the meaning of statutes—to ignore their form, their words, in favor of his perception of their substance.

As originally conceived and as traditionally used, the substance-over-form doctrine has something to it. In writing the tax laws, Congress uses many general terms—“income,” “indebtedness,” “corporate reorganization”—that refer to real-world economic activities, and it assigns tax consequences to those activities. When the courts decide how to classify a transaction, they focus, quite appropriately, on the transaction’s workaday realities, not the labels used by the taxpayers. Take “income.” If a taxpayer receives something of value, 26 U.S.C. § 61(a), he can call it whatever he wants—this, that, or something else. What the taxpayer cannot do is claim that the label he affixes on the transaction precludes it from being “income” under the Code or prevents the courts from treating it as “income” under the Code. Slip op. at 6-7.

As the Court noted, the sham transaction doctrine also disregards labels put on a transaction in order to look at economic reality. But the substance over form and the sham transaction doctrines do not “give the Commissioner purchasing power here.”  Both DISC and Roth IRAs are creatures of Congress designed to help taxpayers reduce taxes.  The Court therefore found it odd for the IRS to reject the transactions at issue “in the service of general concerns about tax avoidance.  It chided the IRS Commissioner for using these doctrines to “avoid tax consequences he doesn’t like”:

The substance-over-form doctrine, it seems to us, makes sense only when it holds true to its roots—when the taxpayer’s formal characterization of a transaction fails to capture economic reality and would distort the meaning of the Code in the process. But who is to say that a low- tax means of achieving a legitimate business end is any less “substantive” than the higher-taxed alternative? There is no “patriotic duty to increase one’s taxes,” as Judge Learned Hand memorably told us in the case that gave rise to the economic-substance doctrine.Slip op. at 10.

This decision will hearten taxpayers who try to utilize the Code in order to minimize their tax in ways that Congress mandated. It will also undoubtedly be used to justify abusive transactions.

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

Son-of-BOSS is one of the more infamous tax shelter scams of the late 1990s, early 2000s. The BASR Partnership engaged in a Son-of-BOSS tax shelter to save its partners millions in taxes.  The IRS proposed adjustments to BASR’s partnership return.  If the adjustments were sustained, BASR’s partners would have owed tax on $6.6 million of gain, plus penalties and interest.  BASR beat the government on procedural grounds.  It then got an award of attorney fees and costs against the government.

The IRS did not issue a Final Partnership Administrative Adjustment (FPAA) until after the normal period of limitations had expired. The government argued that the fraud of the return preparer extended the period of limitations.  The “return preparer” was an attorney at Jenkins & Gilchrist and not the accountant who actually prepared the returns.  The Court of Federal Claims rejected the government’s argument.  The Court of Appeals for the Federal Circuit affirmed.

While the case was pending in the claims court, BASR made a written offer to settle by paying $1 to the IRS. After the claims court was affirmed, BASR moved for an award of attorney fees and costs under Internal Revenue Code §7430, which allows a prevailing party to recover attorney fees from the government in a tax case.  The court granted the motion and awarded BASR attorney fees and costs of $314,710.69.  https://ecf.cofc.uscourts.gov/cgi-bin/show_public_doc?2010cv0244-76-0.

Under §7430, a court may award “litigation costs,” including attorney fees, to a taxpayer who is a “prevailing party” if the government’s position in a case involving the “determination, collection or refund” of any tax is not “substantially justified” and the taxpayer’s net worth does not exceed a statutory amount ($2 million for an individual and $7 million for an entity) on the date the case is filed.  A taxpayer who makes a “qualified offer” during the “qualified offer period” (i.e., from the date that the IRS issues the first notice of proposed deficiency for which administrative review is available until 30 days before the case is first set for trial) can be awarded litigation costs if the amount of the offer is equal to or less than the amount of the taxpayer’s liability as determined by the court.  Where there is a qualified offer, the taxpayer does not have to show that it was the “prevailing party” or that the government’s position was not substantially justified in order to be awarded litigation costs.  The litigation costs that can be awarded are those incurred after the offer is made.

In reaching its decision, the court rejected each of the government’s arguments: that BASR Partnership was not a party (a position that was contrary to IRS regulations); that a tax liability was not an issue (while the partnership is not taxable, its partners are); that the offer was not a “qualified offer” and was a sham; and that BASR did not incur costs, since the fees were paid by its partners.

The court awarded attorney fees incurred from the date of the $1 offer, including those incurred in preparing and defending the motion for fees. The court awarded fees in an amount above the statutory rate because of the complexity of the issues raised at both the trial and appellate court levels.

The moral of the story: if you are in a dispute with the IRS and the IRS has issued a thirty-day letter, make a qualified offer.

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

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