Federal Tax Bulletin - Issue 141 - June 1, 2017

Property Transferred to Family Limited Partnership Was Included in Decedent's Gross Estate

The Tax Court held that a decedent's gross estate included the excess of the fair market value of cash and securities contributed to a family limited partnership over the value of the partnership interest received. Because a purported gift of the decedent's partnership interest was held void or revocable under state law, the value of the partnership interest was also included in the gross estate; however, gift tax did not apply. Estate of Powell.v. Comm'r, 148 T.C. No. 18 (2017).

Background

Nancy Powell died on August 15, 2008. Her son, Jeffrey, was the executor of her estate. On August 8, 2008, cash and securities worth approximately $10 million were transferred from a revocable trust owned by Mrs. Powell to a limited partnership, NHP, in exchange for a 99 percent limited partnership interest. NHP had been formed two days earlier by Mr. Powell, who was the general partner of NHP. The limited partnership agreement gave Mr. Powell sole discretion to determine the amount and timing of distributions and allowed for the partnership's dissolution with the written consent of all partners.

On August 8, 2008, Mr. Powell, purportedly acting on his mother's behalf under a power of attorney (POA), assigned Mrs. Powell's interest in NHP to a charitable lead annuity trust (CLAT). The POA authorized Mr. Powell to take specified actions on his mother's behalf in the event of her incapacitation. On August 7, 2008, two doctors expressed their opinion that Mrs. Powell was incapacitated and could not act on her own behalf. The terms of the CLAT gave an annuity to the Nancy H. Powell Foundation, a nonprofit corporation, of a specified amount for the remainder of Mrs. Powell's life. On her death, the remaining assets in the CLAT were to be divided equally between two trusts for the benefit of Mr. Powell and his brother. The POA granted Mr. Powell the ability to deal in all property owned by Mrs. Powell. It also authorized him to make gifts on Mrs. Powell's behalf up to the annual federal gift tax exclusion amount. A ratification provision stated that Mrs. Powell ratified and confirmed all actions by Mr. Powell under the POA.

Mrs. Powell's 2008 gift tax return reported a taxable gift of approximately $1,600,000 as a result of the purported transfer to the CLAT of her 99 percent limited partner interest in NHP. The value of the gift - specifically, the remainder interest in the CLAT given to Mrs. Powell's sons - was computed based on an appraised value of the interest in NHP of approximately $7.5 million. That value reflected a 25 percent discount for lack of control and lack of marketability to the approximate value of $10 million for the interest in NHP.

The IRS issued notices of deficiency for both estate and gift tax. In the gift tax notice, the IRS determined that Mrs. Powell's interest in NHP was worth approximately $8.5 million on August 8, 2008, and that her sons' remainder interests in the CLAT were worth approximately $8.3 million. The IRS valued the remainder interests based on the fact that Mrs. Powell was terminally ill when the gift was made. The estate tax notice increased the value of Mrs. Powell's estate by approximately $12.9 million; approximately $10 million of that was for the value of the cash and securities transferred to NHP. The remaining increase of approximately $2.9 million resulted from a gift tax deficiency for the purported transfer of Mrs. Powell's interest in NHP to the CLAT.

Under Code Sec. 2036(a), the value of a decedent's gross estate includes the value of transferred property if the decedent retained, either for life or for a time not ascertainable without reference to the decedent's death or for any period which does not in fact end before the decedent's death, the possession, enjoyment or right to the income from the property or the right to designate the beneficiaries of the property. An exception for bona fide sales applies, in which case the property is not included in the estate if the decedent transferred the property for full and adequate consideration. When property is included in an estate under Code Sec. 2036 and it was transferred for less than full consideration, its value under Code Sec. 2043 is the excess of its fair market value at the time of death over the value of the consideration at the time of the transfer. Under Code Sec. 2038, the value of a gift made by a decedent is included in the gross estate if the gift is subject to the decedent's power to amend or revoke it.

IRS's Position

The IRS argued that the cash and securities Mrs. Powell transferred to NHP should be included in her gross estate under Code Sec. 2036 for two reasons. First, the IRS asserted that the transfer was subject to an implied agreement under which Mrs. Powell retained the possession or enjoyment of the transferred property. Second, according to the IRS, Mrs. Powell, acting with her sons, had the power to dissolve NHP and then decide who would take possession of the property. The IRS argued that the bona fide sale exception did not apply because there was no significant nontax purpose for the creation of NHP and, due to the estate's claimed valuation discount of the partnership interest, the transfer was not made for full and adequate consideration.

Regarding the purported gift of Mrs. Powell's interest in NHP to the CLAT, the IRS argued that the gift was revocable because it was invalid under California law. That is, Mr. Powell's authority under the POA allowed him to make gifts only up to the federal gift tax exclusion amount, and the gift of the partnership interest to the CLAT exceeded that authority. Because the gift was invalid, the IRS argued that value of the partnership interest therefore had to be included in Mrs. Powell's estate under Code Sec. 2038(a).

Estate's Position

The estate did not deny that Mrs. Powell's ability to dissolve NHP with the consent of her sons constituted a right, in conjunction with others, to designate the persons who could possess or enjoy the property she transferred to the partnership or the income therefrom within the meaning of Code Sec. 2036(a)(2). However, the estate argued that Code Sec. 2036 did not apply to the transfer of cash and securities to NHP because Mrs. Powell did not retain the right to designate beneficiaries of the assets for the remainder of her life, and that the brief period for which she held the right was not ascertainable without reference to her death. Regarding the gift of Mrs. Powell's interest in NHP to the CLAT, the estate argued that Mr. Powell's authority to make the gift derived not from any specific provision in the POA but from a general grant of authority to deal in Mrs. Powell's property. According to the estate, the gift was consistent with Mrs. Powell's history of charitable giving and with the provisions of her estate planning documents.

The estate also asserted that, even if the POA did not provide the authority to make gifts in excess of the gift tax exclusion amount, the gift was nonetheless valid under the POA's ratification provision.

Tax Court's Decision

The Tax Court held that the excess of the fair market value of the cash and securities over the value of the partnership interest Mrs. Powell received in exchange for the cash and securities was includible in the gross estate. First, the court found that the purported gift of Mrs. Powell's interest in NHP to the CLAT was either void or revocable because Mr. Powell did not have the authority under the POA to make a gift in excess of the gift tax exclusion amount. The transfer of the partnership interest to the CLAT was therefore disregarded. Second, the court found that Code Sec. 2036(a)(2) applied because Mrs. Powell's ability to dissolve NHP with the cooperation of her sons constituted a right in conjunction with others to designate the beneficiaries of the cash and securities transferred to NHP or the income from them.

The Tax Court distinguished the Supreme Court's decision in U.S. v. Byrum, 408 U.S. 125 (1972), which held that a decedent's right to vote shares he placed in a trust for his children did not cause them to be included in his estate under Code Sec. 2036(a)(2) because, as the controlling shareholder, his fiduciary duties to minority shareholders limited his influence over the company's dividends. The Tax Court, following its previous decision in Estate of Strangi, T.C. Memo. 2003-145, aff'd, 417 F.3d 468 (5th Cir. 2005), found that the fiduciary duties applicable to a family limited partnership are not equivalent to those implicated in Byrum. The Tax Court noted that in addition to his duties as general partner, Mr. Powell owed duties to Mrs. Powell that he assumed either before he created the partnership or at about the same time. The Tax Court saw no reason to believe that Mr. Powell would have exercised his power as the general partner in ways that would have prejudiced Mrs. Powell's interests. Further, because Mrs. Powell owned 99 percent of NHP, any fiduciary duties Mr. Powell owed would be almost exclusively to Mrs. Powell. Finally, the court saw no evidence that NHP conducted any meaningful business operations; it was simply an investment vehicle for Mrs. Powell and her sons. Any fiduciary duties that might limit Mr. Powell's power over NHP's distributions were, in the Tax Court's view, illusory.

Having held that Code Sec. 2036(a) required the inclusion of the cash and securities in Mrs. Powell's estate, the Tax Court then determined that the amount of the inclusion had to be reduced by the value of the partnership interest received by Mrs. Powell. Under Code Sec. 2043(a), the value of the property included in the estate is the excess of the value of the transferred assets on the date of death over the value of the consideration received in exchange, as of the date of the transfer. The court said that the inclusion must take into account any discounts applied in valuing the partnership interest and any increase or decrease in the value of the transferred assets between the date of transfer and the date of death.

On the issue of the purported gift of Mrs. Powell's interest in NHP to the CLAT, the Tax Court held that under California law, general grants of authority to convey property do not provide the power to make gifts, and that an express grant of authority is required. Further, the estate's ratification argument was rejected. The court found that the ratification provision in the POA only ratified acts done by virtue of the POA, and not acts done outside the authority granted by the POA. Interpreting the ratification provision to authorize a gift in excess of the gift tax exclusion amount would conflict with the California rule that the power to make gifts must be expressly granted. Because the Tax Court found that the gift was either void or revocable, the gross estate included the value of the partnership interest, including any applicable discount for lack of marketability. However, the estate was not liable for any gift tax deficiency on the purported gift

Observation: In a concurring opinion, seven judges disagreed with the court's application of Code Sec. 2043(a), which in their view was an untried new theory that could invite overly aggressive tax planning. Rather, the concurring judges would have disregarded the purported transfer of the cash and securities to the partnership under Code Sec. 2036(a)(2) and held that their full value was included in the gross estate. Under this approach, Mrs. Powell's partnership interest would have been treated as an alter ego with no value other than the cash and securities, so there would be no double inclusion problem as a result of including both the cash and securities and the partnership interest in the gross estate.

For a discussion of the inclusion in a gross estate of transfers with a retained life interest, see Parker Tax ¶225,510. For a discussion of inclusions of revocable transfers, see Parker Tax ¶225,910.

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Failure to Disclose Listed Transaction on Form 8886 Prevented Statute from Running

The Ninth Circuit reversed a district court and held that a taxpayer was not entitled to a refund of a penalty because the statute of limitations had not expired on his failure to disclose a listed transaction to the IRS. The court found that because the taxpayer never provided the required information on a completed Form 8886, the statute of limitations had not yet begun to run. U.S. v. May, 2017 PTC 241 (9th Cir. 2017).

Background

Steven May filed his federal income tax return for 2004 on July 22, 2005. May eventually acknowledged to the IRS on September 26, 2011, that he had neglected to include in that return $165,000 of pass-through income from a corporation with which he was affiliated. Specifically, May did not file an IRS Form 8886, Reportable Transaction Disclosure Statement, disclosing the transaction as a listed transaction as defined in Code Sec. 6707A. The IRS attempted over the course of several years to collect various penalties and assessments from May, including a Code Sec. 6707A penalty for failing to disclose the listed transaction on his 2004 return.

On February 6, 2012, the IRS assessed an $18,563 penalty under Code Sec. 6707A for May's failure to disclose his participation in the listed transaction. The IRS acknowledged that by March 2010, it had sufficient information from which to determine that May had engaged in a listed transaction. On March 10, 2010, the IRS sent May a "30-day letter" informing him that it would assess a Code Sec. 6707A penalty relating to the listed transaction if he did not object in writing within 30 days. The IRS also conceded that "there was no information necessary to assess a penalty pursuant to Code Sec. 6707A that the IRS did not have in its possession before February 6, 2011. Nevertheless, it did not assess the penalty until a year later.

May paid the penalty in full, including accrued interest, and submitted a refund claim to the IRS, which the IRS rejected. He subsequently filed suit in a district court seeking a refund on the grounds that the Code Sec. 6707A penalty for 2004 was improperly assessed and was barred by the applicable statute of limitations.

Analysis

Ordinarily, under Code Sec. 6501(a), the IRS may only assess a tax within three years after a tax return is filed (whether or not such return was filed on or after the date prescribed). However, a different statute of limitations, found in Code Sec. 6501(c)(10), governs listed transactions. Under that provision, if a taxpayer fails to include on any return or statement for any tax year any information with respect to a listed transaction which is required under Code Sec. 6011 to be included with such return or statement, the time for assessment of any tax with respect to such transaction does not expire before the date which is one year after the earlier of -

(i) the date on which the IRS is furnished the information so required; or

(ii) the date that a material advisor meets the requirements of Code Sec. 6112 with respect to a request by the IRS under Code Sec. 6112(b) relating to such transaction with respect to such taxpayer.

The IRS maintained that the statute of limitations never even began to run because neither of the two conditions was ever met. The IRS argued that the first condition had still not been satisfied because May did not disclose the required information to the IRS on a Form 8886. May countered that the IRS's collection of the needed information through means other than a Form 8886 put the IRS on constructive notice and started the running of Code Sec. 6501(c)(10)'s one-year limitations period.

The district court agreed with May and ordered the IRS to refund May's payment. According to the court, because no valid extension had been agreed to by March 10, 2011 (i.e., one year after the mailing of the 30-day letter), the statute of limitations had expired before the IRS assessed a Sec. 6707A penalty on February 6, 2012. The parties' overt acts, the district court said, established definitively that there was no mutual assent to extend the Code Sec. 6707A limitations period for tax year 2004. The IRS appealed.

The Ninth Circuit reversed the district court's decision. According to the court, Code Sec. 6501(c)(10)(A), read in isolation, is unclear to the extent it does not define or explain the term "the information so required," and "is furnished." That subparagraph, the court said, must be read in the context of the rest of Code Sec. 6501(c)(10) and in conjunction with Code Sec. 6011, to which it expressly refers.

The Ninth Circuit said that the meaning of the phrase "the information so required" is made clear by referring back to the introductory paragraph of Code Sec. 6501(c)(10), which in turn refers to Code Sec. 6011 explaining that what must be filed to begin the running of the limitations period is that "which is required under section 6011 to be included with [a] return or statement." Code Sec. 6011, the court noted, instructs that taxpayers "shall make a return or statement according to the forms and regulations prescribed by the Secretary" and that "[e]very person required to make a return or statement shall include therein the information required by such forms or regulations." Thus, in Code Sec. 6501(c)(10) and Code Sec. 6011(a), Congress expressly required taxpayer compliance with the IRS's determination of how listed transactions are to be reported. The court looked to Reg. Sec. 1.6011-4(d) which clarifies that the passive phrase "is furnished" means that the taxpayer must provide the information and that a completed Form 8886 is "the information so required."

For a discussion of the statute of limitations for listed transactions, see Parker Tax ¶260,130.

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IRS Not Bound by Offer in Compromise with Modified Terms Even Though It Cashed Taxpayer's Check

The Tax Court held that the statute of limitations had not expired with respect to assessing tax on a married couple's income from three S corporations because the relevant return was the couple's individual return, not the returns of the S corporations. The Tax Court also held that no valid settlement with the IRS arose when the couple sent a check for payment of their liabilities along with a Form 656-L, Offer in Compromise (Doubt as to Liability), which the couple heavily modified, even though the IRS deposited (but later refunded) the check that accompanied the Form 656-L. Whitesell v. Comm'r, T.C. Memo. 2017-84 (2017).

Background

Neil and Tracy Whitesell filed their 2011 and 2012 Forms 1040 on October 12, 2012, and October 15, 2013, respectively. The IRS issued a notice of deficiency relating to both returns on July 27, 2015. The adjustments included amounts that flowed through from Mr. Whitesell's three wholly owned S corporations, Whitesell International Corp. (WIC), NLW Holdings, LLC (NLW), and Whitesell Corp. WIC and NLW filed their Forms 1120S for 2011 on September 17, 2012. NLW filed its Form 1120S for 2012 on September 16, 2013. The IRS did not issue a notice of deficiency to any of the S corporations.

With respect to the deficiency notices, the Whitesells filed a petition with the Tax Court in December 2015. Around that time, the couple sent to the IRS a modified Form 656-L, Offer in Compromise (Doubt as to Liability), (OIC) for their tax liabilities for 2006 through 2012, which included liabilities resulting from the pass-through of income from their S corporations. The Whitesells substantially modified the Form 656-L by crossing out sentences in some subsections as well as crossing out other entire subsections. The Whitesells sent a check for $3 million along with their OIC as satisfaction of their 2006 through 2012 tax liabilities. The Whitesells did not request from the IRS an amount to pay off their outstanding tax liabilities.

The IRS received the OIC and deposited the $3 million check. In January 2016, the IRS sent a letter informing the Whitesells that it was returning their OIC. In February, another IRS letter confirmed that the Whitesells' OIC file had been closed and that the IRS was in the process of refunding the $3 million because of the modified terms and conditions. The Whitesells deposited the refund in April 2016.

Taxpayer and IRS Arguments

The IRS filed a motion for summary judgment on two issues: (1) whether the expiration of the statute of limitation for assessing deficiencies attributable to the S corporations' income barred the IRS from assessing deficiencies relating to the flow-through income for Mr. Whitesell from his S corporations, and (2) whether the Whitesells and the IRS entered into a contract to settle the Whitesells' income tax liabilities as a result of the IRS depositing the $3 million check.

Regarding the statute of limitations, the Whitesells argued that the relevant returns were not the Whitesells' individual returns but rather the returns of the S corporations from which the flowthrough income was allocated to Mr. Whitesell. The Whitesells' argument was based on a split among the circuit courts that arose in the 1990s and relied on a Ninth Circuit decision holding that the filing of the passthrough entity's return controlled. On the issue of the purported settlement with the IRS, the Whitesells argued that under the Uniform Commercial Code (UCC), their OIC was accepted when the IRS deposited their check and did not reject the OIC within 90 days of receipt. The IRS's response was that negotiation of a check does not constitute accord and satisfaction, and that the UCC does not govern the IRS's power to administer the federal income tax system.

The Tax Court held that under Code Sec. 6501(a), the relevant return for determining whether the statute of limitations has expired is the return of the taxpayer to whom the IRS is seeking to determine a deficiency. The court noted that Code Sec. 6501 was amended in 1997 with the specific purpose of clarifying this issue with respect to S corporations. According to the Tax Court, the legislative intent behind the amendment was to clarify that the relevant return is the return of the taxpayer, not the return of another person from whom the taxpayer received an item of income, gain, loss, deduction or credit. Therefore, the controlling returns in this case were the Whitesells' Forms 1040. The notice of deficiency, issued on July 27, 2015, was within the three year statute of limitations period for the Whitesells' 2011 and 2012 returns, which were filed on October 12, 2012 and October 15, 2013, respectively. Therefore, the statute of limitations had not expired.

On the issue of whether a valid settlement was executed, the Tax Court held that no document memorializing settlement of the issues was filed, nor did the parties manifest mutual assent through offer and acceptance. The Tax Court rejected the Whitesells' argument that their submission of a check and the IRS's negotiation of it constituted accord and satisfaction under the UCC. First, the Tax Court reasoned that the U.S. government is not bound by state statutes. Further, the Whitesells' submission of the OIC did not mean that the IRS had assented. The IRS notified the Whitesells by letter in January 2016 that their OIC would be returned along with their $3 million deposit. A second letter stated that the reason the OIC was rejected was that the Whitesells had modified the terms and conditions. The Tax Court found that the IRS had rejected the Whitesells' offer and there was no therefore no settlement.

The Tax Court was also not persuaded that by cashing the Whitesells' check, the IRS accepted their OIC. In the court's view, cashing the check did not necessarily mean that the IRS had accepted the offer. Further, the Whitesells understood at the time they submitted their OIC that their payment could be returned because that possibility was expressly stated on the Form 656-L. The Tax Court also looked to IRS guidelines for OICs, which state that OIC payments or deposits are placed in a non-interest bearing account, stamped nonnegotiable and returned, or posted to a taxpayer's account. The payment is either applied against the taxpayer's liability or returned only after a determination has been made on the OIC. The Tax Court found that the IRS had rejected the OIC and subsequently returned their check in accordance with these guidelines.

The Tax also rejected the Whitesells' argument that under the UCC, the IRS accepted their offer by not rejecting it within 90 days. In the court's view, the facts surrounding the OIC and the IRS's response clearly showed that the IRS had timely rejected the OIC and returned the couple's $3 million deposit.

For a discussion of the statute of limitations, see Parker Tax ¶260,130. For a discussion of offers in compromise, see Parker Tax ¶263,165.

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Complaint Filed After Phone Call With IRS Agent Is Broadcast Live on Popular Radio Show

A taxpayer, who called the IRS to discuss a tax matter, had her phone conversation with an IRS agent broadcast for more than 45 minutes over the Howard Stern Show radio program. She filed suit in a district court alleging violations of Code Sec. 7431 and 6103 and seeking damages for the disclosure of confidential information. Barrigas v. U.S., 2017 PTC 210 (D. Mass. 2017)

Howard Stern is public figure radio personality and the host of a popular radio show which airs on SiriusXM satellite radio. The Howard Stern Show has approximately 1,200,000 regular listeners each day.

On the morning of May 19, 2015, Judith Barrigas called the IRS's service center to discuss the possible misapplication of her 2014 tax refund. The IRS had applied her refund to a 2011 and 2012 tax liability which had already been the subject of a repayment agreement. When Barrigas called the IRS that morning, she was connected with Agent Jimmy Forsythe. Barrigas spent nearly 45 minutes discussing the case with Agent Forsythe. The discussion between Barrigas and Agent Forsythe included, but was not limited to, mention of Barrigas's phone number, the tax return and refund issues, and the details of the repayment plan for the 2011 and 2012 tax liability due.

While on the phone with Agent Forsythe, Barrigas suddenly began to receive a barrage of text messages and phone calls from unknown individuals. The text messages were informing Barrigas that her personal information and phone number was being aired live on the Howard Stern Show.

Unbeknownst to Barrigas, Agent Forsythe had called in to the Howard Stern Show as a listener. Agent Forsythe had been on hold with the show using another phone line during his call with Barrigas. While Agent Forsythe discussed Barrigas's private tax matter with her, Howard Stern and other agents of the Howard Stern Show picked up Agent Forsythe's call and aired the discussion between Agent Forsythe and Barrigas live on satellite radio. The IRS, Howard Stern, and the Howard Stern Show, therefore, broadcast Barrigas's private tax return information and her identity to approximately 1,200,000 listeners.

Barrigas filed a complaint against the IRS, Howard Stern, and the Howard Stern Show (the defendants) in a Massachusetts district court seeking compensatory damages, punitive damages, reasonable attorneys' fees, statutory interest, and the costs of the lawsuit, as well as other such relief as the court deems just and proper. According to the complaint, the defendants conduct was a clear violation of Code Sec. 7431, relating to the unauthorized disclosure of returns information, and Code Sec. 6103, which provides that return information must be kept confidential.

The complaint alleges that the defendants owed Barrigas a duty of reasonable care and had a duty to refrain from publicly disseminating private tax and identity information of a private citizen. According to the compliant, the defendants engaged in reckless and negligent publication of Barrigas's personal identification, tax liability, and return information by airing the information publicly on the Howard Stern Show.

The complaint goes on to say that Howard Stern stated expressly on the air that the conversation involved a tax collector and was of a personal nature and was not what the caller had intended, yet failed to take any action to stop the broadcast. According to the complaint, Howard Stern and the Howard Stern Show joked about the publication and broadcast of Barrigas's tax and personal information and conversation with the IRS's Agent Forsythe and used the broadcast and the humiliation of Barrigas as a source of amusement for their listeners. To this day, the complaint alleges, Barrigas's phone call with Agent Forsythe may be accessed on the internet in full or in part and thus continues to be publicly broadcast.

For a discussion of penalties relating to the unauthorized disclosure of tax return information, see Parker Tax ¶265,153.

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Sixth Circuit Finds CEO Took Reasonable Steps to Ensure Payment of Payroll Taxes

The Sixth Circuit, in a case of first impression, rejected a district court's judgment and held that two corporate officers were not liable for unpaid payroll taxes under Code Sec. 6672 because they did not willfully fail to pay the taxes. The court applied a reasonable cause exception in finding that the officers believed the taxes were in fact being paid, and their belief was reasonable under the circumstances. Byrne v. U.S., 2017 PTC 239 (6th Cir. 2017).

Background

In 1988, Roger Byrne and Eric Kus were among a group of investors who formed Eagle Trim, Inc., an automotive trim business. Kus was named the chairman and CEO and Byrne the president. Another investor, Bernard Fuller, became the controller. The business was financed by General Motors Acceptance Corporation Business Credit LLC (GMAC) with a revolving line of credit. The financing agreement gave GMAC the right to have an accounting firm periodically examine Eagle Trim's business records. GMAC used Lender Services to conduct these examinations. The agreement also required Eagle Trim to provide GMAC with annual financial statements audited by an independent accounting firm. Eagle Trim hired Weber, Curtin & Drake (WCD) to conduct these year-end audits. WCD's engagement letter stated that although its services would provide reasonable assurance of detecting errors or fraud that would have a material effect on the financial statements, an audit was not a guarantee of the accuracy of the financial statements and that there was a risk that material errors or fraud might go undetected.

As controller, Fuller was responsible for ensuring that Eagle Trim's tax liabilities, including payroll taxes, remained current. WCD provided Fuller with guidance on how to make the payroll tax payments. Despite this guidance, Fuller made biweekly instead of semiweekly payments, resulting in a large penalty assessed against Eagle Trim in early 1999. By the end of 1999, Byrne and Kus had determined that Fuller was not adequately performing his duties and provided him with a handwritten list of tasks that he needed to start completing accurately and timely.

In March 2000, Lender Services notified GMAC that Eagle Trim had provided inadequate supporting documentation for Lender Services' collateral reviews. Lender Services recommended that Eagle Trim implement procedures to ensure timely tax payments and appropriate recordkeeping. GMAC forwarded the letter to Eagle Trim and Kus reviewed it. Fuller responded to the letter stating that two payroll tax payments were missed in the course of moving Eagle Trim's accounts to a new bank. Fuller's letter, on which Byrne and Kus were copied, said that Eagle Trim was current with all of its payroll taxes at that time.

In April 2000, on WCD's recommendation, Eagle Trim hired an accountant to assist Fuller with his duties. In July 2000, Eagle Trim hired Andrew Jones as CFO, reporting to Byrne and Kus. Fuller reported to Jones and provided monthly financial statements to him.

In October 2000, the IRS notified Eagle Trim of a penalty for approximately $98,000 for unpaid payroll taxes for the first quarter of 2000. In a meeting between Fuller and David Drake, a WCD partner, Fuller said the payment was late because of the company's switch to a new bank. Fuller also said an IRS representative informed him that all of Eagle Trim's payroll taxes had been paid in full and on time since June 2000. Drake sent the IRS a letter repeating Fuller's explanation and requesting a waiver of the penalty. In November 2000, Fuller sent a letter to Kus and Byrne describing the IRS penalty, his meeting with Drake, and Drake's waiver request.

WCD issued an audit in December 2000 stating that Eagle Trim was current on its payroll taxes. In January 2001, WCD sent a letter to Kus, copying Byrne, Jones and Fuller, identifying flaws in Eagle Trim's accounting practices that WCD found during its 2000 audit. The letter discussed Eagle Trim's failure to timely pay its payroll taxes and recounted the penalties assessed in 1999 and the first quarter of 2000. The letter stated that WCD had been informed that the payroll taxes for the second quarter of 2000 had also not been paid, although no penalty had yet been assessed. WCD recommended measures to ensure the timely payment of payroll taxes and offered its assistance. WCD stated, however, that it did not see any material weaknesses in Eagle Trim's internal control structure.

Lender Services discovered in January 2001 that Eagle Trim's financial statements were fraudulently overstated. According to the review, Fuller had falsified certain receivables by adding digits to the invoices. At this time, Kus and Byrne were unaware that Eagle Trim was delinquent on its payroll taxes for the second, third and fourth quarters of 2000. GMAC hired a crisis management firm, BBK, Ltd, and both GMAC and BBK took complete control over Eagle Trim's finances.

BBK informed Byrne and Kus in February 2001 that Eagle Trim had not made its payroll tax payments for the last three quarters of 2000. Fuller was then fired. In March 2001, WCD notified Byrne and Kus that, because of the discovery of improper accounting resulting in material misstatements, Eagle Trim should no longer rely on WCD's audit reports for 1999 and 2000. Drake also notified Byrne that WCD was recalling its audit reports due to the discovery that Fuller had been making false entries. Drake said that there was a significant effort on Fuller's part to disguise these activities and to prevent their discovery in the course of WCD's audits.

In April 2001, Eagle Trim filed for Chapter 11 bankruptcy and ultimately liquidated. The IRS received payment for the unpaid payroll taxes for the second quarter of 2000 in the liquidation. In July 2005, the IRS assessed a trust fund recovery penalty under Code Sec. 6672 against Byrne and Kus of approximately $855,000 for Eagle Trim's outstanding payroll tax liability for the year 2000. Byrne paid $1,000 to the IRS and then filed for a refund and an abatement of the penalty and of the entire assessment. The IRS denied Byrne's claim and Byrne filed suit in a district court. The IRS's counterclaim seeking a judgment for assessed balance included a claim against Kus.

Under Code Sec. 6672(a), a person who is responsible for collecting and paying payroll taxes who willfully fails to do so is personally liable for the unpaid taxes. A responsible person willfully fails to pay the taxes if the person either has actual knowledge that the taxes were not paid or recklessly disregards known risks that the taxes were not paid.

District Court's Judgment

The district court entered summary judgment in favor of the IRS. Byrne and Kus appealed, arguing that they were not responsible for paying Eagle Trim's payroll taxes and if they were, they did not willfully fail to pay the taxes. On appeal, the Sixth Circuit held that Byrne and Kus were responsible persons under Code Sec. 6672 but reversed the district court's grant of summary judgment, finding that there was a genuine dispute whether Byrne and Kus should have known that the payroll taxes were not being paid. On remand, the district court found that Byrne and Kus willfully failed to file Eagle Trim's payroll taxes for the third and fourth quarters of 2000. The district court entered judgments of approximately $533,000 each against Byrne and Kus, which they appealed.

Sixth Circuit's Decision

The Sixth Circuit held that Byrne and Kus did not willfully fail to pay Eagle Trim's payroll taxes and thus vacated the district court's judgment. The court noted that what constitutes reckless disregard with respect to the nonpayment of payroll taxes was an issue of first impression for the Sixth Circuit. The court cited its holding in Calderone v. U.S., 799 F.2d 254 (6th Cir. 1986) that a responsible person is reckless and therefore willful under Code Sec. 6672(a) when he or she disregards obvious or known risks that payroll taxes are not being paid and fails to investigate. However, to balance the IRS's right to recover taxes it is owed with limiting liability for that recovery to those who are personally at fault, the Sixth Circuit adopted a reasonable cause exception which the Second Circuit articulated in Winter v. U.S., 196 F.3d 339 (2d Cir. 1999). A responsible person is not liable if he or she can demonstrate a reasonable belief under the circumstances that the payroll taxes were being paid on time. The Sixth Circuit characterized this rule as a narrow exception which limits liability to those who fail to take reasonable steps to ensure payment after receiving notice that the taxes have not been paid.

The Sixth Circuit agreed with the district court that Byrne and Kus did not have actual knowledge that the payroll taxes were not being paid until after GMAC and BBK assumed control of Eagle Trim's finances. However, the Sixth Circuit did not agree that Byrne and Kus recklessly disregarded the risk that the taxes were not being paid in the third and fourth quarters of 2000. The court said that it would not impose liability on Byrne and Kus simply because they did not independently verify WCD's reports or Fuller's account of the status of Eagle Trim's tax position. Rather, under the circumstances, the Sixth Circuit held that Byrne and Kus took reasonable steps to ensure the timely payment of the payroll taxes and reasonably believed they were being paid.

The court thought that the hiring of an accountant to assist Fuller and the hiring of a CFO to oversee him were important considerations in determining whether Byrne and Kus reasonably believed Eagle Trim was making timely payroll tax payments. The court also pointed to the hiring of WCD, which demonstrated to the court that Byrne and Kus took reasonable steps to comply with Eagle Trim's tax obligations. The court found that Byrne and Kus reasonably relied on WCD's representations because there were no prior indications of errors or inaccuracies in WCD's auditing. The Sixth Circuit also cited WCD's December 2000 audit report, which concluded that there had been no fraud involving management and that Eagle Trim had accurately disclosed its pending or anticipated tax assessments. Although that audit was withdrawn in March 2001 following the discovery of Fuller's wrongdoing, it was significant to the court that WCD's auditors, who had spent several weeks at Eagle Trim, missed Fuller's inaccurate accounting entries. The court reasoned that if WCD did not detect Fuller's misconduct, and that it took several months for BBK to determine the exact amount of Eagle Trim's tax liability, then Byrne and Kus did not act unreasonably in believing that Fuller was paying the payroll taxes on time. The court said that it was not clear what additional measures Byrne and Kus could have taken short of personally contacting the IRS to verify Eagle Trim's tax liabilities or firing Fuller after the first or second notice of his irresponsible actions.

For a discussion of the Code Sec. 6672 penalty for failure to collect, account for, and pay over payroll taxes, see Parker Tax ¶210,108.

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No Relief Available Where IRS Letter Gave Wrong Date for Filing Tax Court Petition

A taxpayer could not rely on an IRS letter which incorrectly stated the date for filing a petition with the Tax Court to contest the denial of innocent spouse relief. According to the court, the 90-day deadline in Code Sec. 6015(e)(1)(A) for filing a petition with the Tax Court is a jurisdictional requirement and a taxpayer's failure to comply with it deprives the Tax Court of the authority to hear the case, even if equitable considerations would support extending the prescribed time period. Rubel v. Comm'r, 2017 PTC 230 (3d Cir. 2017).

Background

Nancy Rubel and her ex-husband filed joint income tax returns from 2005 through 2008. They had an unpaid tax liability for each year. In 2015, Rubel asked the IRS to relieve her from this liability under the innocent spouse provisions of Code Sec. 6015.

On January 4, 2016, the IRS sent Rubel three identical notices of its final determination denying her requests for relief for tax years 2006 through 2008. On January 13, 2016, the IRS sent Rubel a similar denial for the 2005 tax year. The determinations notified Rubel that, if she disagreed with the IRS's decision, she could file a petition with the Tax Court to review the denial for relief within 90 days from the date of the determination. Accordingly, Rubel needed to file a petition with the Tax Court by April 4, 2016 for the 2006 through 2008 tax years and by April 12, 2016 for the 2005 tax year.

Before filing a petition with the Tax Court, Rubel submitted additional information to the IRS. In a March 3, 2016 letter, the IRS informed Rubel that it considered the information and still proposed to deny relief in full. The IRS also notified Rubel that the correspondence didn't extend the time to file a petition with the Tax Court and that the time to petition the Tax Court began to run when the IRS issued its final determination to Rubel on January 4, 2016 and would end on April 19, 2016. This letter contained incorrect information because the deadlines for Rubel to petition the Tax Court regarding the final determinations were April 4 and 12, 2016, not April 19, 2016.

Taxpayer and IRS Arguments

Rubel mailed a petition challenging the IRS's determinations to the Tax Court on April 19, 2016. The IRS moved to dismiss the petition, arguing that because Rubel failed to file the petition within 90 days of the date of the notices of final determination, the Tax Court lacked jurisdiction to review the petition under Code Sec. 6015(e)(1)(A).

Rubel opposed the motion and argued that the March 3, 2016, letter started a new 90-day period for filing a petition and, in any event, that the IRS should be equitably estopped from relying on the statutory deadline because the March 3 letter contained erroneous information. The Tax Court agreed with the IRS and dismissed the petition. Rubel appeal to the Third Circuit.

The question before the Third Circuit was whether the 90-day deadline in Code Sec. 6015(e)(1)(A) is a jurisdictional requirement or a claims-processing deadline. The court noted that, if Code Sec. 6015(e)(1)(A) is a claims-processing statute, Rubel's failure to comply with it may be subject to waiver, forfeiture, and equitable tolling. If, on the other hand, the deadline in Code Sec. 6015(e)(1)(A) is jurisdictional, Rubel's failure to comply with it deprives the Tax Court of the authority to hear the case, even if equitable considerations would support extending the prescribed time period. Thus, the court stated, determining that a deadline is jurisdictional has the important consequence of limiting a court's power to decide a case.

The Third Circuit affirmed the Tax Court and held that the 90-day deadline in Code Sec. 6015(e)(1)(A) is a jurisdictional requirement and thus, the Tax Curt did not have jurisdiction to hear Rubel's case. The court noted that Code Sec. 6015(e)(1)(A) states that "the Tax Court shall have jurisdiction" if an individual files a petition in the court no later than 90 days after the IRS mails its notice of final determination. The court said that, for purposes of this analysis, it was required to presume that Congress knew that the term "jurisdiction" refers to the authority of a court to hear and decide a case and that it deliberately included that word in the statute. Therefore, in circumstances like this, where Congress clearly states that a threshold limitation on a statute's scope counts as jurisdictional, then courts and litigants will be duly instructed and will not be left to wrestle with the issue." Accordingly, Congress's explicit statement that Code Sec. 6015(e)(1)(A)'s time limit is jurisdictional means that it is and that the Tax Court lacks authority to consider untimely petitions.

The court also noted that the context of the provision - how Code Sec. 6015(e)(1)(A) fits within the statute as a whole - shows that it is jurisdictional. The statute's grant of jurisdiction to the Tax Court and the time limit for activating that jurisdiction, the court pointed, out are located within the same provision. Moreover, the court observed, the provision is located within the same subsection of Code Sec. 6015 that sets forth other conditions that trigger or limit the Tax Court's jurisdiction. The court concluded that the structure of Code Sec. 6015 reflects Congress's intent to set the boundaries of the Tax Court's authority.

For a discussion of innocent spouse relief and the procedures for contesting the IRS denial of such relief, see Parker Tax ¶260,560.

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IRS Did Not Abuse Its Discretion in Rejecting Nonprofit's Installment Agreement Request

The Tax Court held that an IRS settlement officer did not abuse his discretion in rejecting the installment agreement request of a nonprofit corporation that was delinquent in filing its Forms 990, Return of Organization Exempt from Income Tax, for the years at issue. The fact that the nonprofit had since filed late Forms 990 did not mean that the IRS had abused its discretion, because the filings were delinquent at the time of the request. First Rock Baptist Church Child Development Center v. Comm'r, 148 T.C. No. 17 (2017).

Background

First Rock Baptist Church Child Development Center is a separately incorporated affiliate of First Rock Baptist Church located in Washington, D.C. The Center and the Church had separate addresses and taxpayer identification numbers (TINs). The Center fell behind on its employment tax liabilities for ten calendar quarters during 2007-2010. It filed Forms 941, Employer's Quarterly Federal Tax Return, reporting payroll taxes due for these periods, but did not include any payments. As of November 2012, the assessed liabilities, including penalties and interest, totaled approximately $438,000. The IRS sent Forms 4340, Certificate of Assessments, Payments, and Other Specified Matters, confirming that these assessments were made against the taxpayer with the Center's TIN.

The IRS sent a Notice of Federal Tax Lien (NFTL) Filing and Your Right to a Hearing to the Center at its correct address in November 2012. The notice showed the Center's TIN and described the NFTL as having been filed to collect the Center's employment tax liabilities of approximately $438,000 for the ten calendar quarters ending June 30, 2010. However, the notice was addressed to First Rock Baptist Church. The notice also included a Form 668, Notice of Federal Tax Lien, which showed the notice as having been filed against a taxpayer located at the Center's address with the Center's TIN. It also showed the notice as having been filed to collect the Center's employment tax liabilities. The Form 668 also showed the name of the taxpayer as First Rock Baptist Church.

The Center and the Church requested a collection due process (CDP) hearing, and the case was assigned to a settlement officer (SO). In October 2013, the Center submitted an installment agreement request under its own TIN offering to make monthly payments of approximately $2,200. The SO determined that there was no alternative to collection, although the basis for her decision was unclear. The SO also determined that the NFTL was correctly and properly filed. In June 2014, the IRS issued a notice of determination sustaining the collection action by certified mail to the Center's address. The notice showed the Center's TIN but again was addressed to First Rock Baptist Church.

The Center and the Church filed a joint Tax Court petition in July 2014 contending that the NFTL should be withdrawn. In October 2015, the IRS moved to remand the case to its Appeals Office in order to further consider whether the NFTL should be withdrawn and to clarify why the SO rejected the Center's proposed installment agreement.

The case was then assigned to a new SO, who decided that the NFTL documentation was ambiguous and that the lien should be withdrawn. However, he determined that the Center's installment agreement proposal could not be granted because the Center was not in compliance with its return filing requirements. He noted that the Center was organized in 2006 but had not filed a Form 990, Return of Organization Exempt from Income Tax, for tax years 2006-2013.

The IRS issued a supplemental notice of determination in January 2016 which stated that the NFTL was being withdrawn and that the Center's installment request had been denied. This notice was mailed to the Center at its address and correctly showed the Center's TIN. Again, it was addressed to First Rock Baptist Church.

Taxpayer and IRS Arguments

In December 2016, the IRS filed a motion to dismiss on grounds of mootness. According to the IRS, the Center and the Church had secured the principal relief they requested, withdrawal of the NFTL. The IRS asserted that the Center had fully paid its liabilities for the first three quarters at issue and did not contest its liabilities for the remaining seven quarters. On the abuse of discretion issue, the IRS argued that the second SO did not abuse his discretion in rejecting the proposed installment agreement because the Center was not in full compliance with its Form 990 return filing obligations.

The Center responded that there were still outstanding tax liabilities for the seven quarters ending in June 2010, although it disputed its liability for the final quarter on the ground that its original Form 941 incorrectly doubled the amount owed. The Center said that it had claimed a refund on Form 941-X, Adjusted Employer's Quarterly Federal Tax Return or Claim for Refund, in August 2014. The Center also disputed its liability for certain penalties and interest, and noted that it had made several previous requests on Form 843, Claim for Refund and Request for Abatement, for abatements of late filing and failure to pay penalties as well as for penalties and interest for failure to file its Forms 990. Regarding the SO's rejection of its installment agreement request, the Center did not dispute that it was not in full compliance with its return obligations at the time the IRS issued the supplemental notice of determination. However, the Center said that it was now in full compliance with its tax obligations after filing late Forms 990 for the relevant years.

The Tax Court agreed with the IRS that the case was moot on the issue of the NFTL because the IRS had withdrawn it. The case was also moot regarding the Center's employment tax liabilities for the first three quarters of 2007 because the Center had fully paid them. The remaining issues for the Tax Court were (1) the outstanding liabilities for the other seven quarters of 2007-2010, and (2) whether the second SO's rejection of the Center's proposed installment agreement was an abuse of discretion.

The Tax Court held that under Code Sec. 6330(c)(2) it could consider only issues that were raised in the Center's CDP hearing, and that none of the Center's challenges to its employment tax liabilities had been raised in either the original or supplemental CDP hearings. The Center challenged its underlying employment tax liabilities for only one calendar quarter, the quarter ending June 30, 2010, on the basis that its original Form 941 incorrectly doubled the amount owed. The Tax Court found no evidence, and the Center did not contend, that this issue was raised in the Center's CDP hearings. Regarding its liability for penalties, the Center said that its August 2014 Form 843 referred to late filing and failure to pay penalties assessed for the June 30, 2010 quarter. The Tax Court also found no evidence that the Center raised this issue in its CDP hearings, nor did it raise this issue in its Tax Court petition. The Center also disputed its liability for interest and referred to its Form 843 claim for abatement of interest assessed in connection with the late filing of its Forms 990 for 2012 and 2014. The Center also failed to raise the interest issue in its CDP hearings; moreover, the Tax Court determined that it could not consider that issue in any event because the case before it concerned only the Center's employment tax liabilities.

The Tax Court also held that the second SO did not abuse his discretion in rejecting the Center's installment agreement request. There is no abuse of discretion, the court said, in rejecting an installment proposal where a taxpayer is not in compliance with its tax obligations for tax years after the years at issue. The Center acknowledged that it was delinquent in its Form 990 filing obligations at the time of its supplemental CDP hearing. The Tax Court said that, having filed delinquent Forms 990, the Center was free to submit a new installment agreement proposal with the IRS, which the IRS may well accept.

For a discussion of the criteria for obtaining installment agreements, see Parker Tax ¶250,515.

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Prison Inmate Not Eligible for Earned Income Tax Credit on Income Earned While in Hospital

The Tax Court held that a prison inmate who was transferred to a hospital while serving his sentence and earned income working at the hospital was not eligible for the earned income tax credit (EITC). As the court noted, an inmate in a penal institution is not eligible for the EITC, and the individual who claimed the EITC was still an inmate while residing in the hospital and the hospital qualified as a penal institution. Skaggs v. Comm'r, 148 T.C. No. 15 (2017).

In 2008, Kevin Skaggs was convicted in Kansas of several felony offenses and sentenced to 310 months in prison. From 2012 to 2016, Skaggs resided in Larned State Hospital, which was established to treat mentally ill inmates and to hold them in custody. The Kansas Department of Corrections listed his transfer as an inter-facility movement. Skaggs earned income working part time as a custodian for the hospital.

Skaggs filed his 2015 tax return reporting almost $3,000 in income, including $62 in taxes withheld by his employer. He claimed an earned income tax credit (EITC) of $224 for a total refund of $286. The IRS sent Skaggs a notice of deficiency denying his claimed EITC because, under Code Sec. 32(c)(2)(B)(iv), income earned while an inmate in a penal institution is not included in income for the purpose of calculating the EITC. The IRS determined a deficiency of $224 and withheld Skaggs' refund.

Skaggs filed a petition with the Tax Court and argued that while he was in the hospital in 2015, he was not an inmate and that the hospital was not a penal institution. Skaggs said he was not an inmate because he was not treated like an inmate and that his wages were not treated like the wages of an inmate. He asserted that he was subject to fewer restrictions, could wear his own clothes, and had more freedom to communicate with the outside world. He also said that his wages were not subject to the restrictions and mandatory deductions of the earnings of inmates in Kansas prisons.

The Tax Court rejected Skaggs' arguments and held that he was an inmate during the time he was confined to the state hospital and the hospital was considered a penal institution. Thus, Skaggs was an inmate in a penal institution for the year at issue and his earnings were not eligible for the EITC. Noting that neither the statute nor the regulations define inmate or penal institution, the Tax Court turned to the dictionary definition of an inmate, which specifically includes a person confined to a hospital. Likewise, the definition of a prison is defined as a place of confinement.

Although Skaggs asserted that he was no longer an inmate while confined to the hospital, his records showed the transfer as an inter-facility movement rather than a release. The Tax Court was not persuaded by Skaggs' argument that he was subject to fewer restrictions in the hospital, reasoning that inmates are often treated differently according to any number of factors.

The Tax Court also did not agree with Skaggs' main argument that the hospital was not a prison because it was not included in the list of correctional institutions in the state statute. The court found that the same statute designates the hospital as the state security hospital, which was established to hold mentally ill inmates in custody for treatment.

The Tax Court noted that inmates in the hospital are kept in separate quarters, their sentences are not tolled, and that inmates can be treated at the hospital only during their sentence. An inmate could be released from the hospital only once his or her sentence is over; if the inmate no longer needs treatment, the inmate is returned to prison. In the Tax Court's view, the state security hospital steps into the shoes of the prison while providing treatment; inmates are still undergoing punishment for a crime while they received treatment. The hospital was therefore a penal institution.

Finally, the Tax Court rejected Skaggs' contention that he was not a participant in a prison work program while in the hospital. The court said that this was irrelevant for the purpose of determining EITC eligibility. The court noted that it had previously held that the source of the income, including whether the employer is a government entity or private company and the location of the work, is not relevant to the EITC eligibility determination.

For a discussion of the earned income tax credit, see Parker Tax ¶102,101.