Former IRS Commissioners File Brief Supporting IRS's Position on Regulating Return Preparers

In an unusual move, five former IRS commissioners, appointed by Democratic and Republican Presidents, came together to file an amicus brief (2013 PTC 64) before the D.C. Court of Appeals. In that brief, the commissioners strongly disagreed with the D.C. district court's decision in Loving v. IRS, 2013 PTC 10 (D. D.C. 1/18/13). The district court had ruled that Congress had not empowered the Department of Treasury to regulate tax return preparers. Since the lower court's ruling against the IRS, the IRS's regulation of tax return preparers, other than CPAs, enrolled agents, and certain other licensed professionals subject to Circular 230, has been put on hold.

Observation: The National Consumer Law Center and National Community Tax Coalition have also filed an amicus brief in the Loving case (2013 PTC 65, April 5, 2013).

Background

On January 18, 2013, in Loving v. IRS, 2013 PTC 10 (D. D.C. 1/18/13), the U.S. District Court for the District of Columbia agreed with three independent tax return preparers that the registered tax return preparer (RTRP) rules under Reg. Sec. 1.6109-2 were invalid - and that the IRS could not enforce them. The IRS subsequently said that, in accordance with the district court order, tax return preparers covered by the PTIN program would not be required to register with the IRS, complete competency testing, or secure continuing education. On January 23, the IRS filed a motion to suspend the district court's injunction pending its appeal of the court's decision to the U.S. Court of Appeals for the D.C. Circuit. The IRS also shut down the RTRP exam testing system as of January 23, 2013, thus cancelling all exams from that date forward. On February 1, 2013, in Loving v. IRS, 2013 PTC 13 (D. D.C. 2/1/13), the D.C. district court rejected the IRS's request to stay the injunction but did modify the injunction to make clear that the IRS is not required to suspend it PTIN program, nor is it required to shut down all of its testing and continuing-education centers; instead, they may remain, but no tax-return preparer may be required to pay testing or continuing-education fees or to complete any testing or continuing education unless and until the injunction is stayed or vacated by the D.C. Circuit Court of Appeals. On March 27, 2013, in Loving v. IRS, 2013 PTC 37 (2013), the D.C. Court of Appeals rejected the IRS's motion for a stay pending appeal. The IRS now must wait for the D.C. Circuit Court to hear its appeal

Friend of the Court Brief Filed by Former IRS Commissioners

On April 5, 2013, five former IRS commissioners banded together to support the IRS position on the RTRP rules. In a friend of the court (i.e., an amicus curiae) brief, the former commissioners cited Supreme Court decisions, other court decisions, and statutory and regulatory materials that supported their opinions that the IRS was well within its authority to regulate tax return preparers.

Observation: An amicus curiae informs the court on points of law that are in doubt, gathers or organizes information, or raises awareness about some aspect of the case that the court might otherwise miss. The person is usually, but not necessarily, an attorney, and is usually not paid for her or his expertise. An amicus curiae cannot be a party to the case, nor an attorney in the case, but must have some knowledge or perspective that makes her or his views valuable to the court.

Commissioners' Arguments

Tax Return Preparers Are Representative of the Taxpayers and Thus Subject to Regulation

The commissioners noted that the district court equated representation of persons (which may be regulated by the Treasury Department under Circular 230) with advising and assisting in presenting a case. The district court then concluded that the filing of a tax return would never, in normal usage, be described as presenting a case. According to the commissioners, the district court erred in reaching this conclusion. Preparing and filing a tax return is indeed, the commissioners said, the presentation of a case, in which taxpayers pursue a wide variety of financial claims against the U.S. Treasury. Most significantly, Congress has decided to administer an increasingly wide variety of governmental assistance programs through the federal income tax system, including assistance for low-income families, health care, education, and homebuyers. In each instance, the commissioners stated, preparing and filing a tax return is the sole means by which taxpayers are able to present to the Treasury their qualification for these programs and to obtain the financial assistance intended by Congress.

Congress's willingness to use its taxing power to effectuate public policies in areas such as health care, the commissioners argued, has fundamentally changed the roles of the tax return and tax return preparers. Tax return preparers now find themselves on the front line of administering these programs. For example, the commissioners said, return preparers must counsel taxpayers about issues such as the decision to buy health insurance, explain to taxpayers how those decisions affect their claims against or liabilities to the government, and then represent taxpayers by asserting these claims through the taxpayers' tax returns.

Perhaps the most important manifestation of Congress's use of the Internal Revenue Code to administer public policy programs, the commissioners noted, is the increasingly frequent enactment of refundable tax credits. A refundable tax credit is treated as an overpayment of tax by the taxpayer. Thus, if the taxpayer owes no tax, the taxpayer receives a cash paymentin the form of a tax refund equal to the amount of the creditas if the taxpayer had paid tax when none was owed. In this way, refundable tax credits delink the financial assistance Congress intended to provide from the taxpayer's actual tax liability, but permit the intended financial assistance to be administered by the tax system through the preparation and filing of tax returns. The taxpayers thus must present their qualifications for the assistance by preparing and filing tax returns. As a result, the commissioners argued, the tax return preparer is not merely calculating tax liability; he or she is very often representing the taxpayer by preparing the return establishing the taxpayer's eligibility to receive the benefits provided by these public policy programs.

Approximately 120 million claims for refund are filed each year. Although only a tiny fraction of those claims will result in any sort of contested administrative or judicial proceeding, the IRS nevertheless must review and act on each of them. A vigorous annual IRS audit of every return would be prohibitively expensive to the fisc, and inconsistent with a democratic system. But, the commissioners argued, the absence of a contested tax proceeding for every taxpayer for every year does not change the critical fact that a tax return makes a case for the taxpayer's financial claim against the government.

Complex Tax Laws Result in Complexity in Self-Assessment

The process of self-assessment and self-reporting requires much more than taxpayers identifying themselves so that the government can determine their eligibility for certain programs. The commissioners cited the Supreme Court's analysis in Comm'r v. Lane-Wells Co., in which the Court said that the purpose of a system of self-assessment is not just to get tax information in some form but also to get it with such uniformity, completeness, and arrangement that the physical task of handling and verifying returns may be readily accomplished.

Consistent with this principle, the complexity and scope of information required to complete a federal income tax return have increased as the number and scope of the policies and programs being administered through the tax system have expanded. The commissioners cited the rules relating to the earned income tax credit (EITC) and noted that most tax professionals cannot understand the statutory provisions relating to the EITC without detailed and focused study. And the IRS website dealing with the EITC, the commissioners noted, repeatedly encourages taxpayers to seek assistance from a tax professional in determining their eligibility for this refundable credit.

Lamenting the complexity of the Internal Revenue Code is easy sport, the commissioners observed. However, they said, that complexity is the key to understanding the important role tax return preparers perform in helping taxpayers prepare and file their tax returns to present and establish their eligibility for the benefits distributed through the tax system.

In addition, the commissioners said, scrupulous tax return preparers help guard against fraud against both taxpayers and the government. By way of example, they cited a 2010 report by the Treasury Inspector General for Tax Administration (TIGTA), which highlighted potential fraud related to the first-time homebuyer tax credit. In that report, TIGTA identified 4,608 incarcerated individuals who had attempted to claim the first-time homebuyer credit. TIGTA analyzed a sample of 715 prisoners from that group, and found that 174 of the claims had been prepared by paid tax return preparers, and 241 of the claims had been paid, totaling more than $1.7 million. Stopping bad tax return preparers from striking, the commissioners argued, is wholly consistent with the Treasury Department's authority to regulate commercial tax return preparers in ways reasonably designed to prevent these bad acts from happening in the first instance.

According to the commissioners, the manner in which tax return preparers assist taxpayers in pursuing their claims aligns with the history giving rise to Treasury's authority to regulate representatives under 31 U.S.C. Section 330 (i.e., Circular 230). That section was enacted on July 4, 1884, to address the disreputable conduct of claims agents assisting soldiers seeking pensions, back pay, and various other government benefits. The modern counterpart, the commissioners said, is that benefit claims are pursued through a submission of a tax return to the IRS.

Conclusion

The commissioners concluded that, in deciding that filing a tax return would never, in normal usage, be described as presenting a case, the district court ignored the real workings of the United States' modern federal income tax system. Far from being a mere bookkeeper, a tax return preparer who advises and assists in preparing a tax return may be solely responsible for presenting the case for the taxpayer's eligibility for the benefits provided by crucial government programs administered through the tax systemgovernment programs that result in hundreds of billions of dollars in Treasury disbursements each year based almost exclusively on self-reporting through a tax return. In 1884, Congress empowered the Treasury to regulate the conduct of claims agents pursuing financial benefits from the government; and in 2013, the commissioners concluded, Treasury retains that authority to regulate the conduct of tax return preparers who similarly assist in preparing and filing tax returns that present to the Treasury millions of claims worth billions of dollars each year.

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IRS to Furlough Employees on Five Days; Operations Will Shut Down Entirely

The IRS will be closed for business on five days falling between May 24 and August 30. NTEU Press Release (4/19/13).

Late last week, the National Treasury Employees Union (NTEU) announced that the IRS is sending out furlough notices this week to the entire IRS workforce, identifying the five following furlough days where the agency will shut down entirely: May 24, June 14, July 5, July 22, and Aug. 30. The 30-day notices to employees also leave open the possibility of another two unpaid furlough days.

On those furlough days, all public operations of the IRS will be shut down, leaving taxpayers without access to information and assistance from frontline workers. According to the president of the NTEU, on those days, phone calls to the IRS will go unanswered and Taxpayer Assistance Centers across the country will have closed' signs in their windows. The furloughs are being driven by the ongoing sequestration that is forcing federal agencies, including the IRS, to severely slash their budgets.

NTEU is the largest independent federal union, representing 150,000 employees in 31 agencies and departments.

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IRS Announces Three-Month Filing, Payment Extension Following Boston Marathon Explosions

The IRS announced a three-month tax filing and payment extension to Boston area taxpayers and others affected by Monday's explosions. IR-2013-43 (4/17/13).

Last week, the IRS announced a three-month tax filing and payment extension to Boston area taxpayers and others affected by Monday's explosions. This relief applies to all individual taxpayers who live in Suffolk County, Massachusetts, including the city of Boston. It also includes victims, their families, first responders, others impacted by this tragedy who live outside Suffolk County, and taxpayers whose tax preparers were adversely affected.

Under the relief announced today, the IRS will issue a notice giving eligible taxpayers until July 15, 2013, to file their 2012 returns and pay any taxes normally due April 15. No filing and payment penalties will be due as long as returns are filed and payments are made by July 15, 2013. By law, interest, currently at the annual rate of 3 percent compounded daily, will still apply to any payments made after the April deadline.

The IRS will automatically provide this extension to anyone living in Suffolk County. If taxpayers live in Suffolk County, no further action is necessary by taxpayers to obtain this relief. However, eligible taxpayers living outside Suffolk County can claim this relief by calling 1-866-562-5227 starting Tuesday, April 23, and identifying themselves to the IRS before filing a return or making a payment. Eligible taxpayers who receive penalty notices from the IRS can also call this number to have these penalties abated.

Eligible taxpayers who need more time to file their returns may receive an additional extension to Oct. 15, 2013, by filing Form 4868 by July 15, 2013.

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White House Releases Tax Proposals as Part of Fiscal Year 2014 Budget Plan

President Obama's budget for fiscal year 2014, released earlier this month, includes numerous tax proposals affecting, among others, individuals, small businesses, and partnerships. The proposals are described in the General Explanations of the Administration's Revenue Proposals for FY14, also known as the Greenbook.

Not surprisingly, some Republicans have declared the budget dead on arrival. However, if a comprise should be reached, some of these proposals may actually become law before the end of the year. The following is a summary of some of the more important budget proposals.

Proposals Affecting Individuals

(1) The proposal would permanently extend increased refundability of the child tax credit by reducing the earned income threshold that makes additional credits available.

(2) The proposal would make permanent the temporary expansion of the earned income tax credit that increased the EITC for families with three or more children and increased the phase-out range for all married couples filing a joint return.

(3) The proposal would make the American Opportunity Tax Credit a permanent replacement for the Hope Scholarship credit.

(4) The proposal would permanently increase from $15,000 to $75,000 the AGI level at which the child and dependent care credit begins to phase down.

(5) The proposal would permanently extend the exclusion for income from the discharge of qualified principal residence indebtedness to amounts that are discharged before January 1, 2016, and to amounts that are discharged pursuant to an arrangement entered before that date.

(6) The proposal would limit the tax value of specified deductions or exclusions from AGI and all itemized deductions. This limitation would reduce the value to 28 percent of the specified exclusions and deductions that would otherwise reduce taxable income in the 33-percent, 35-percent, or 39.6-percent tax brackets. A similar limitation also would apply under the alternative minimum tax.

(7) The proposal would impose a new minimum tax, called the Fair Share Tax (FST) (i.e., the Buffet Rule), on high-income taxpayers. The tentative FST would equal 30 percent of AGI less a credit for charitable contributions. The charitable credit would equal 28 percent of itemized charitable contributions allowed after the overall limitation on itemized deductions (i.e., the so called Pease limitation). The final FST would be the excess, if any, of the tentative FST over regular income tax (after certain credits, the alternative minimum tax and the 3.8 percent surtax on investment income) and the employee portion of payroll taxes. The set of certain credits subtracted from regular income tax would exclude the foreign tax credit, the credit for tax withheld on wages, and the credit for certain uses of gasoline and special fuels.

Business-Related Provisions

(1) The proposal would permanently extend the 2013 Code Sec. 179 expensing and investment limitations. Further, the deduction limit of $500,000 and the $2 million level for beginning the phaseout would be indexed for inflation for all tax years beginning after 2013, as would the dollar limitation on the expensing of sport utility vehicles. Qualifying property would permanently include off-the-shelf computer software, but would not include real property.

(2) The proposal would permanently extend the 100-percent exclusion for qualified small business stock.

(3) The proposal would permanently double, from $5,000 to $10,000, the maximum amount of start-up expenditures a taxpayer may deduct (in addition to amortized amounts) in the tax year in which a trade or business begins. This maximum amount of expensed startup expenditures would be reduced (but not below zero) by the amount by which start-up expenditures with respect to the active trade or business exceed $60,000.

(4) The proposal would permanently extend the work opportunity tax credit to apply to wages paid to qualified individuals who begin work for the employer after December 31, 2013.

(5) The proposal would provide qualified employers a tax credit for increases in wage expense, whether driven by new hires, increased wages, or both. The credit would be equal to 10 percent of the increase in the employer's eligible wages paid during the credit period over the employer's eligible wages paid during the base period.

(6) The proposal would provide a new allocated tax credit to support investments in communities that have suffered a major job loss event.

(7) The proposal would provide a new general business credit against income tax equal to 20 percent of the eligible expenses paid or incurred in connection with insourcing a U.S. trade or business.

(8) The proposal would expand eligibility for the health insurance tax credit for small employers and simplify its operation in an effort to increase the utilization of the tax credit, and encourage more small employers to provide health benefits to employees and their families.

(9) The proposal would repeal the deduction for dividends paid with respect to stock held by an ESOP that is sponsored by a C corporation (subject to an exception for C corporations with annual receipts of $5 million or less).

Provisions Relating to International Taxes

(1) The proposal would defer the deduction of interest expense that is properly allocated and apportioned to stock of a foreign corporation that exceeds an amount proportionate to the taxpayer's pro rata share of income from such subsidiaries that is currently subject to U.S. tax. Under the proposal, foreign-source income earned by a taxpayer through a branch would be considered currently subject to U.S. tax; thus, the proposal would not apply to interest expense properly allocated and apportioned to such income. Other directly earned foreign source income (for example, royalty income) would be similarly treated.

(2) The proposal would require a U.S. taxpayer to determine its deemed paid foreign tax credit on a consolidated basis taking into account the aggregate foreign taxes and earnings and profits of all of the foreign subsidiaries with respect to which the U.S. taxpayer can claim a deemed paid foreign tax credit (including lower-tier subsidiaries described in Code Sec. 902(b)). The deemed paid foreign tax credit for a tax year would be limited to an amount proportionate to the taxpayer's pro rata share of the consolidated earnings and profits of the foreign subsidiaries repatriated to the U.S. taxpayer in that tax year that are currently subject to U.S. tax.

Accounting and Depreciation Proposals

(1) The proposal would repeal the use of the LIFO inventory accounting method for federal income tax purposes. Taxpayers that currently use the LIFO method would be required to change their method of inventory accounting, resulting in the inclusion in income of prior-years' LIFO inventory reserves (the amount of income deferred under the LIFO method). The resulting Code Sec. 481(a) adjustment, which is a one-time increase in gross income, would be taken into account ratably over 10 years, beginning with the year of change.

(2) The proposal would statutorily prohibit the use of the lower of cost or market (LCM) and subnormal goods methods for valuing inventory. Appropriate wash-sale rules also would be included to prevent taxpayers from circumventing the prohibition. The proposal would result in a change in the method of accounting for inventories for taxpayers currently using the LCM and subnormal goods methods, and any resulting Code Sec. 481(a) adjustment generally would be included in income ratably over a four-year period beginning with the year of change.

(3) The proposal would increase the recovery period for depreciating general aviation passenger aircraft from five years to seven years. Correspondingly, for taxpayers using the alternative depreciation system, the recovery period for general aviation passenger aircraft would be extended to 12 years.

Partnership Proposals

(1) The proposal would amend Code Sec. 743(d) to also measure a substantial built-in loss by reference to whether the transferee would be allocated a net loss in excess of $250,000 upon a hypothetical disposition by the partnership of all of the partnership's assets, immediately after the transfer of the partnership interest, in a full taxable transaction for cash equal to the fair market value of the assets.

(2) The proposal would amend Code Sec. 704(d) to allow a partner's distributive share of expenditures not deductible in computing the partnership's taxable income and not properly chargeable to capital account only to the extent of the partner's adjusted basis in its partnership interest at the end of the partnership year in which the expenditures occurred.

(3) The proposal would amend Code Sec. 267(d) to provide that the principles of Code Sec. 267(d) do not apply to the extent gain or loss with respect to the property is not subject to federal income tax in the hands of the transferor immediately before the transfer but any gain or loss with respect to the property is subject to federal income tax in the hands of the transferee immediately after the transfer.

Proposals Relating to the Elimination of Fossil Fuel Preferences

(1) The proposal would repeal the investment tax credit for enhanced oil recovery projects.

(2) The proposal would repeal the production tax credit for oil and gas from marginal wells.

(3) The proposal would repeal expensing of intangible drilling costs (IDCs) and 60-month amortization of capitalized IDCs. IDCs would be capitalized as depreciable or depletable property, depending on the nature of the cost incurred, in accordance with the generally applicable rules.

(4) The proposal would repeal the exception from the passive loss rules for working interests in oil and gas properties.

(5) The proposal would repeal percentage depletion with respect to oil and gas wells. Taxpayers would be permitted to claim cost depletion on their adjusted basis, if any, in oil and gas wells.

(6) The proposal would retain the overall manufacturing deduction, but exclude from the definition of domestic production gross receipts all gross receipts derived from the sale, exchange, or other disposition of oil, natural gas, or a primary product thereof. There is a parallel proposal to repeal the domestic manufacturing deduction for coal and other hard mineral fossil fuels.

(7) The proposal would increase the amortization period from two years to seven years for geological and geophysical expenditures incurred by independent producers in connection with all oil and gas exploration in the United States. Seven-year amortization would apply even if the property is abandoned and any remaining basis of the abandoned property would be recovered over the remainder of the seven-year period.

(8) The proposal would repeal expensing, 60-month amortization, and 10-year amortization of exploration and development costs with respect to coal and other hard-mineral fossil fuels. The costs would be capitalized as depreciable or depletable property, depending on the nature of the cost incurred, in accordance with the generally applicable rules. The other hard-mineral fossil fuels for which expensing, 60-month amortization, and 10-year amortization would not be allowed include lignite and oil shale to which a 15-percent depletion rate applies.

(9) The proposal would repeal percentage depletion with respect to coal and other hard-mineral fossil fuels. The other hard-mineral fossil fuels for which no percentage depletion would be allowed include lignite and oil shale to which a 15-percent depletion rate applies. Taxpayers would be permitted to claim cost depletion on their adjusted basis, if any, in coal and other hard mineral fossil-fuel properties.

(10) The proposal would repeal capital gains treatment of coal and lignite royalties and would tax those royalties as ordinary income.

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Employee Partially Escapes Tax Due on Loan Forgiven by Prior Employer

Because the taxpayer was partially insolvent when a loan he received from a former employer was cancelled, he was not taxable on the entire amount of the cancelled debt. McAllister v. Comm'r, T.C. Memo. 2013-96 (4/8/13).

In 2005, Suncoast Roofers loaned its employee, John McAllister, almost $78,849. By August 2007, John was no longer an employee of Suncoast. Suncoast experienced financial difficulties during 2007, leading to its eventual sale to Suncoast Acquisition Corp. The company that acquired Suncoast never contacted John about paying back the loan. John timely filed Form 1040, U.S. Individual Income Tax Return, for 2007 in March 2008. In May 2008, Suncoast Acquisition Corp. issued John a Form 1099-MISC, Miscellaneous Income, showing the amount of the loan and characterizing it as nonemployee compensation paid in 2007. John never reported that amount on his Form 1040.

In 2009, the IRS issued John a deficiency notice. According to the IRS, in 2007, Suncoast constructively awarded John a bonus of $78,849 that he used to repay the $78,849 in loans. Thus, the IRS contended, John had to include $78,849 in income as compensation for 2007. John argued that he did not receive a constructive bonus in 2007 and that either (1) the loans were not canceled because he still intended to pay them back, or (2) alternatively, even if the loans were canceled in 2007, he was insolvent. As evidence of his insolvency, John submitted that the value of his property, which included real estate in Florida and North Carolina, was approximately $332,000, while his debts, which included mortgages of $363,000, totaled $389,000.

Code Sec. 108(a)(1)(B) excludes discharge-of-indebtedness income from gross income if the discharge occurs when the taxpayer is insolvent. The amount of income excluded cannot exceed the amount by which the taxpayer is insolvent. Under Code Sec. 108(d)(3), the amount by which the taxpayer is insolvent is defined as the excess of the taxpayer's liabilities over the fair market value of the taxpayer's assets. Whether a taxpayer is insolvent and by what amount is determined on the basis of the taxpayer's assets and liabilities immediately before the discharge.

The Tax Court rejected the IRS's contention that John earned a $78,849 constructive bonus in 2007. However, it did find that the loan was canceled in 2007 when the Form 1099-MISC was sent. The court noted that Suncoast Acquisition Corp. never contacted John about paying back the loans. The Form 1099-MISC, the court stated, improperly classified the amount of the forgiven debt as nonemployee compensation income and was a bookkeeping error rather than a reflection that John had been awarded a bonus. The court analyzed the values of the real estate reported by John and adjusted the values upward. However, the court still concluded that John was insolvent to the tune of $22,600. Thus the court allowed him to exclude that amount from income. The remaining amount of approximately $56,000 was includible in John's income. The court rejected the IRS's assessment of the accuracy related penalty under Code Sec. 6662, finding that John had reasonable cause for, and acted in good faith with respect to the underpayment.

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Signature of LLC's CFO on Power of Attorney Didn't Meet Requirements

Although partners generally have the authority to bind partnerships, the question of who has the authority to bind an LLC is more complex, and the signature of an LLC's chief financial officer on Form 2848 did not meet the applicable regulation requirements. CCA 201316018.

In CCA 201316018, the Office of Chief Counsel was asked to review an LLC document and opine on the appropriate signatures required for someone to act as a power of attorney for the LLC. The LLC is taxed as a partnership for federal tax purposes.

The Chief Counsel's Office began by noting that Reg. Sec. 601.503(c)(5) generally provides that a power of attorney for a partnership must be signed by all partners, or if signed in the name of the partnership, by the partner or partners duly authorized to act for the partnership, who must certify that he or she has such authority. However, that regulation does not indicate who must sign a power of attorney for an LLC. A person signing a power of attorney must also have the power to bind an entity on behalf of which the person is signing, the Chief Counsel's Office stated. State law determines who has the authority to act on behalf of an LLC. The tax matters partner (TMP) acts as a liaison between the LLC members and the IRS in a TEFRA proceeding, which is an audit of the partners/LLC members with respect to partnership items. The TMP has the authority to bind the LLC members with respect to extensions of the statute of limitations on assessment.

In the instant situation, the Chief Counsel's Office noted that the president and manager of the LLC was also the TMP. Unless any provision of state law or the LLC agreement warrants a different result, the Chief Counsel's Office noted, a Form 2848, Power of Attorney and Declaration of Representative, signed by the TMP in the name of the LLC is sufficient to bind both the LLC and the LLC members.

The Chief Counsel's Office also stated that the signature of the LLC's Chief Financial Officer on the LLC's Form 2848 did not meet the requirements of Reg. Sec. 601.503(c)(5). Although partners generally have the authority to bind partnerships, the question of who has the authority to bind an LLC is more complex. Most states allow members to designate either members or managers to act for the LLC; and where no such designation has been made, most state laws provide that whoever has the authority to manage the LLC (either members if member managed or managers if manager managed) has the authority to bind the LLC. In some cases, the Chief Counsel's Office noted, the requirements in the regulations do not match up with state law provisions as to who has the authority to act for an LLC.

In conclusion, the Chief Counsel's Office stated that the LLC's TMP appeared to have the authority to act generally for the LLC. Although the CFO may have authority to act in certain capacities on behalf of the LLC, the Chief Counsel's Office said that the LLC agreement did not appear to give him authority to enter into agreements or other written instruments on behalf of the LLC, such as the authority to act as a power of attorney.

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No Reduction in Prison Term for Mother Who Involved Children in Filing False Returns

The 24-month prison sentence for a mother of four who drew her children into a scheme involving the filing of false refund claims was upheld. U.S. v. Townsend, 2013 PTC 63 (7th Cir. 4/9/13).

Linda Townsend and Roshunda Smith collected the names and identifying information of acquaintances and family members, including Linda's two incarcerated sons. Then, using W-2 information from one of Roshunda's former employers, the two electronically filed tax returns misrepresenting these individuals' income and withholdings and falsely claiming certain tax credits. Linda and Roshunda directed that the refunds be mailed to Linda's address or electronically deposited in their own bank accounts or the accounts of other participants in the scheme. All told, the two attempted to bilk the IRS of about $1.5 million. The IRS, however, detected problems with many of the returns and paid out only $450,000.

Linda and Roshunda each pleaded guilty to conspiracy to defraud the United States and received sentences at the low end of their guidelines ranges. The district court sentenced Linda to 46 months in prison. Linda appealed to the Seventh Circuit, arguing that the district court erred by failing adequately to address her argument that her relatively minor role in the tax fraud warranted a below-guidelines sentence. According to Linda, she worked for Roshunda and her role in the scheme was limited to allowing Roshunda to use her bank accounts and collecting the names of people Roshunda could use to file false returns.

The Seventh Circuit upheld the district court's sentence. The Seventh Circuit noted that, although the district court did not explicitly respond to Linda's contention that her reduced culpability warranted a below-guidelines sentence, it made several observations, which, taken together, substantiated the lower court's ruling. First, in response to Linda's attorney's comments at sentencing that Linda was not a ringleader, the district court pointed out that she (unlike Roshunda) had received no enhancement for her role in the offense. And during its pronouncement of sentence, the Seventh Circuit observed, the district court highlighted Linda's role in the conspiracy, noting that you weren't just filing returns, you were encouraging the filing of false returns and recruiting people to assist in this effort. Particularly troubling, in the district court's view, was that Linda had involved her four adult children in the crime. These remarks, the Seventh Circuit concluded, which directly addressed Townsend's culpability, made clear why the district court considered her role in the offense significant enough to merit a within-guidelines sentence.

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Third Circuit Reverses Lower Court; Couple with Large Gains Owed Tax to Virgin Islands, Not the IRS

A couple that realized substantial capital gains in 2001 successfully established that they were bona fide residents of the Virgin Islands at the end of the year and thus owed their taxes to the Virgin Islands and not the IRS; but their daughters did not similarly establish VI residency and thus owed their taxes on the capital gains to the IRS. Vento v. Director of Virgin Islands Bureau of Internal Revenue, 2013 PTC 71 (3d Cir. 4/17/13).

Richard and Lana Vento filed a joint 2001 tax return. From 1995 through 2000, the Ventos lived in Incline Village, Nevada, on the north shore of Lake Tahoe. In 2000 and 2001, the Ventos also owned two homes in Hawaii, two homes on the south shore of Lake Tahoe in California, and a condominium in Utah. The Ventos kept approximately 20 automobiles in Nevada and California. The Ventos have three daughters, all of whom were adults in 2001. In early 2001, the eldest daughter, Nicole, lived in a separate home in Incline Village with her husband and three children. The Ventos' second child, Gail, lived in Boulder, Colorado, while their youngest daughter, Renee, lived in San Diego, California. The Ventos also maintained a family office in Incline Village.

Richard co-founded a technology company called Objective Systems Integrators, Inc. (OSI). When OSI was sold, the Ventos, their daughters, and various Vento-controlled entities realized $180 million in capital gains for the 2001 tax year. After the sale of OSI, the Ventos and their daughters took a family vacation in March 2001 during which they chartered a yacht and visited approximately 10 of the British and U.S. Virgin Islands. Before this trip, no member of the Vento family had ever been to the Virgin Islands or considered moving there.

In May 2001, the Ventos (through a limited liability company they controlled) contracted to buy Estate Frydendahl, a residential property on St. Thomas, for $7.2 million. The Ventos ultimately spent more than $20 million over and above the original purchase price in renovating Estate Frydendahl. In addition to purchasing Estate Frydendahl, Richard became interested in participating in the Virgin Islandss Economic Development Program (EDP), which offers very favorable tax treatment to certain approved Virgin Islands companies. He founded three companies in the Virgin Islands, but ultimately only one was approved to receive EDP benefits, and that approval did not occur until 2002. The Ventos obtained Virgin Islands driver's licenses and registered to vote there in the fall of 2001. However, they moved none of the valuable art collection they owned in Nevada and very little of their personal property to St. Thomas.

The Ventos filed a joint 2001 income tax return with the Virgin Islands Bureau of Internal Revenue (VIBIR). Their three daughters also filed their 2001 income tax returns with the VIBIR. In 2005, the VIBIR issued Notices of Deficiency and Final Partnership Administrative Adjustments (FPAAs) to the Ventos and their children, and partnerships they controlled, assessing a deficiency and penalties of over $31 million against the Ventos and approximately $6.3 million against each of their three daughters. That same year, the IRS issued FPAAs to the Ventos and their children that were nearly identical to those issued by the VIBIR. However, the IRS also issued FPAAs to two other Vento-controlled partnerships. Consequently, the IRS assessed deficiencies and penalties against the Ventos and their children that totaled over $9 million more than those assessed by the VIBIR.

The Ventos challenged the VIBIR's and IRS's deficiency notices and FPAAs in several separate proceedings in the District Court of the Virgin Islands. The United States moved to intervene in the cases between the Ventos and the VIBIR, arguing that the taxpayers should have filed and paid their 2001 taxes to the IRS instead of the VIBIR because, under Code Sec. 932, they were not bona fide residents of the Virgin Islands at the close of the tax year. Ultimately, the district court concluded that Ventos and their children were not bona fide residents of the Virgin Islands as of December 31, 2001. The Ventos, their children, and the VIBIR appealed.

Observation: In 2004, Code Sec. 932 was amended to provide that a taxpayer had to be a bona fide resident of the Virgin Islands during the entire tax year rather than on the last day of the tax year to qualify for tax treatment as a Virgin Islands resident.

The Third Circuit reversed the district courts judgment with respect to Richard and Lana Vento and held that they were bona fide residents of the Virgin Islands on December 31, 2001. However, the court affirmed the district court's judgment that the Ventos's children were not bona fide residents of the Virgin Islands on December 31, 2001.

The Third Circuit agreed with the district court's application of the factors in Sochurek v. Comm'r, 300 F.2d 34 (7th Cir. 1962), in determining whether the taxpayers were bona fide residents of the Virgin Islands on December 31, 2001. Courts applying Sochurek consider the following factors to determine whether a taxpayer's claimed residency is bona fide: (1) intention of the taxpayer; (2) establishment of his home temporarily in the foreign country for an indefinite period; (3) participation in the activities of his chosen community on social and cultural levels, identification with the daily lives of the people and, in general, assimilation into the foreign environment; (4) physical presence in the foreign country consistent with his employment; (5) nature, extent, and reasons for temporary absences from his temporary foreign home; (6) assumption of economic burdens and payment of taxes to the foreign country; (7) status of resident contrasted to that of transient or sojourner; (8) treatment accorded his income tax status by his employer; (9) marital status and residence of his family; (10) nature and duration of his employment (whether his assignment abroad could be promptly accomplished within a definite or specified time); and (11) good faith in making his trip abroad (whether it was for the purpose of tax evasion).

The court noted that, consistent with Code Sec. 932, the Ventos and their children did not have to prove that they were residents of the Virgin Islands for all of 2001 or that they had their tax home in the Virgin Islands. Nonetheless, they still had to prove that they were bona fide residents of the Virgin Islands on December 31, 2001. Citing the First Circuit's decision in Bergersen v. Comm'r, 109 F.3d 56 (1st Cir. 1997), the court noted that a taxpayer's intent to remain in a place for an indefinite or at least substantial period of time will support a finding of residency in that place. This intent can be evidenced by the establishment of a long-term home, a long-term employment assignment, or other evidence indicating an intent to become more than a mere transient or sojourner.

Taken as a whole, the Third Circuit said, the Sochurek factors indicated that the Ventos were bona fide residents of the Virgin Islands. The court cited the fact that, by the summer of 2001, the Ventos had developed the intention to live in the Virgin Islands indefinitely, or at least for a substantial period, as evidenced by their purchase of and renovation of a home and establishment of business interests.

The court rejected, however, the Ventos argument that the residency of the Vento daughters followed that of their parents. Code Sec. 932(c), the court noted, requires that each individual taking advantage of the statute either be a bona fide resident of the Virgin Islands or file a joint return with a bona fide Virgin Islands resident. Because all three adult daughters filed their own tax returns, were not dependents of their parents, and were not themselves bona fide residents of the Virgin Islands at the end of 2001, their 2001 taxes were due to the United States.

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Penalty Relief Available to Some Storm Victims Unable to File on Time

The IRS will provide penalty relief to anyone unable to file on time due to severe storms in parts of the South and Midwest over the days before April 15. IR-2013-42 (4/15/13).

Power outages and transportation problems in some cases made it difficult or impossible for some taxpayers and tax professionals to meet the regular April 15 filing deadline. As a result, taxpayers directly impacted by these storms will qualify for penalty relief, based on reasonable cause, if, due to these storms, they were unable to file their returns or pay tax due until after the regular deadline.

The penalty relief applies to the late-filing penalty, normally 5 percent per month, and the late-payment penalty, normally 0.5 percent per month, provided taxpayers file the return or pay the tax within a reasonable time after the power outages and transportation problems have been resolved.

Affected taxpayers may receive penalty notices from the IRS. If so, the IRS will abate these penalties if they request reasonable cause relief, based on the April storms. By law, the IRS cannot abate interest.

For a discussion of the late-filing penalty, see Parker Tax ¶262,105.

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Final Regs Address Broker Reporting of Debt Instruments' and Options' Bases

The IRS has issued final regulations relating to reporting by brokers for transactions involving debt instruments and options. T.D. 9616 (4/18/13).

In 2011, the IRS issued proposed regulations relating to information reporting by brokers, transferors, and issuers of securities under Code Secs. 6045, 6045A, and 6045B for debt instruments and options. The proposed regulations had a proposed effective date for both debt instruments and options of January 1, 2013. After receiving numerous requests to delay the proposed effective dates for both debt instruments and options, the IRS issued Notice 2012-34, which announced that the effective dates in the final regulations would be postponed to January 1, 2014.

The IRS has now finalized those regulations. For a debt instrument with less complex features, the final regulations require basis reporting by a broker if the debt instrument is acquired on or after January 1, 2014. This category of less complex debt instruments includes a debt instrument that provides for a single fixed payment schedule for which a yield and maturity can be determined for the instrument under Reg. Sec. 1.1272-1(b); a debt instrument that provides for alternate payment schedules for which a yield and maturity can be determined for the instrument under Reg. Sec. 1.1272-1(c) (such as a debt instrument with an embedded put or call option); and a demand loan for which a yield can be determined under Reg. Sec. 1.1272-1(d).

The IRS noted, however, that some debt instruments with a fixed yield and a fixed maturity date nevertheless pose challenges for information reporting. For these debt instruments and for more complex debt instruments that do not have a fixed yield and a fixed maturity date, the final regulations require basis reporting for debt instruments acquired on or after January 1, 2016.

T.D. 9616 also contains final regulations relating to the filing of Form 8281, Information Return for Publicly Offered Original Issue Discount Instruments, for certain debt instruments with original issue discount and temporary regulations relating to information reporting for premium.