Amended Returns Don’t Help Taxpayer Minimize §6707A Penalties

us_tax_courtIn Yari v. Commissioner, 143 T.C. No. 7, the Tax Court upheld a $100,000 statutory maximum, penalty under IRC § 6707A(b)(2)(A) assessed against the taxpayer for failing to report a listed transaction.  The case presents an issue of first impression on the proper calculation of a penalty under IRC § 6707A(b).

The taxpayer participated in a listed Roth IRA transaction from 2002 to 2007.  The transaction involved the taxpayer forming a disregarded entity, Topaz Global Holdings, LLC, and a Nevada corporation, Faryar, Inc., which elected to be treated as an S-Corporation for federal income tax purposes.  The taxpayer opened a Roth IRA account in 2002 with an initial contribution of $3,000.  The Roth IRA acquired all of Faryar, Inc.’s stock for $3,000 and became the sole shareholder of the corporation.

From 2002 to 2007, Faryar, Inc. reported management fees from related entity Topaz Global Holdings, LLC and interest income of $1,221,778.  Because Faryar, Inc. was an S-Corporation with a Roth IRA as the sole shareholder, the income was not taxed at either the corporate level or the shareholder level.  The structure allowed the taxpayer to exceed Roth IRA contribution limits and decrease the income he otherwise would have reported because Topaz Global deducted the management fee paid to Faryar, Inc.

In IRS Notice 2004-8, the IRS designated these Roth IRA transactions as “abusive.”  The taxpayer filed a federal income tax return for 2004 in on October 17, 2005.  This return did not disclose the taxpayer’s participation in the Roth IRA transaction.  The IRS audited the taxpayer’s returns for 2002 through 2007 and issued notices of deficiency for each year.  The IRS determined that the taxpayer should have included $482,912 from the management fee transaction as income in the 2004 tax year.  After computational adjustments, this increased the taxpayer’s tax liability by $135,215.  The IRS issued notices of deficiency and the taxpayer when to the Tax Court.

During the course of the audit, the taxpayer amended his 2004 tax return to correct reported Schedule K-1 information.  The amended return also included $482,912 from the management fee transaction as income. The taxpayer then filed a second amended return claiming a net operating loss carryback from 2008, and again reporting the $482,912 management fee as income.

The taxpayer and the IRS settled the deficiency cases and entered into a closing agreement in 2011.  The closing agreement required the taxpayer to include certain amounts in his income for each of the tax years, including $482,912 for the 2004 tax year.  The Court entered stipulated decisions in the deficiency cases that reflected the closing agreement.

In September 2008, the IRS issued a IRC § 6707A penalty of $100,000 for the 2004 tax year because the taxpayer failed to disclose his participation in a listed transaction.  The IRS issued a Notice of Intent to Levy in February 2009 and the taxpayer timely requested a Collection Due Process (CDP) hearing.  Prior to the hearing, Congress amended IRC § 6707A as part of the Small Business Jobs Act (SBJA) to change the method of calculating the penalty.  The change was effective retroactively for penalties assessed after December 31, 2006.  The new statute designated a penalty of 75% of the decrease in tax shown on the return as a result of the listed transaction and set minimum and maximum penalties of $5,000 and $100,000, respectively, for individuals under IRC § 6707A(b).

The IRS suspended the CDP hearing to reconsider the calculation of the penalty and determined that the penalty did not need to be modified under the new statute.   The taxpayer took the position that the amended returns should be used to calculate the decrease in tax, and thus the penalty should be the statutory minimum of $5,000 under IRC § 6707A(b)(2)(B).  The revenue agent disagreed and used the original return to calculate the penalty, resulting in a maximum $100,000 liability under IRC § 6707A(b)(2)(A).  At the taxpayer’s request, the settlement officer issued a notice of determination sustaining the collection action.  The taxpayer challenged the calculation of the penalty and petitioned the Tax Court.

Despite stipulations to the Tax Court’s jurisdiction over this matter, the Court determined its jurisdiction over the matter and distinguished this case from Smith v. Commissioner, 133 T.C. 424 (2009).  In Smith, the Court found it lacked jurisdiction to redetermine an IRC § 6707A penalty because the penalty did not fit the statutory definition of deficiency and because the IRS could assess and collect the penalty without issuing a statutory notice of deficiency.  However, the Tax Court held that the Court does have jurisdiction to redetermine a liability challenge asserted by a taxpayer in a Collection Due Process hearing pursuant to IRC § 6330(d)(1).  Notably, the Tax Court reviewed the CDP determination de novo because the underlying tax liability was properly at issue.  Sego v. Commissioner, 114 T.C. 604, 610 (2000).

The taxpayer stipulated that he participated in a listed transaction and that he failed to properly disclose his participation.  The taxpayer argued that the amended returns should be used to calculate the decrease in tax, and thus the penalty should be the statutory minimum of $5,000, rather than the $100,000 maximum assessed by the IRS.  He based his argument on the plain language of the statute, the statutory scheme, and legislative history.

The Court held that “the statute is clear and unambiguous: The penalty is calculated with reference to the ‘tax shown on the return’. IRC § 6707A(b).”  In its analysis of legislative intent, the Tax Court found that Congress intended to penalize the failure to disclose participation in a listed transaction, not the tax savings produced by the transaction.  The Court also noted that Congress could have referenced “a” return in the statute, rather than “the” return, if it intended for the IRS to use amended returns in calculating the penalty under IRC § 6707A.  Thus, the Court upheld the maximum penalty of $100,000 assessed against the taxpayer.

The Tax Court did leave the door open for taxpayers who file an amended return prior to the due date of the original return.

Read the full opinion here: Yari v. Commissioner, 143 T.C. No. 7.

Tax Court: Challenge to Underlying Liability Does Not Extend Period for CDP Appeal

In a rare division opinion supplementing a previous division opinion, the Tax Court offers a primer on the definition of “deficiency” and its meaning for jurisdictional purposes. This opinion is not for the meek of heart nor for those not ready to tackle the nuance of Tax Court jurisdiction.

In response to a motion to certify an interlocutory appeal, Judge Joseph Gale lays out the statutory requirements for the court’s jurisdiction over deficiencies as well as collection actions. He also discusses the statutory grounds for variances in the 30-day response required for collection due process review (e.g., innocent spouse relief, interest abatement) and other non-deficiency actions (e.g., employment taxes, frivolous return penalties) in U.S. Tax Court.

The court did not certify the interlocutory appeal and affirmed the proposition that a challenge to the “underlying tax liability” in a collection due process hearing does not extend the period in which to file a petition for review with the Tax Court.

Read the entire opinion here:
Gray v. Commissioner (Gray II), 140 T.C. No. 9 (2013)

Tax Court: Second FPAA Invalid, Cannot Confer Jurisdiction

us_tax_courtIn Wise Guys Holdings v. Commissioner, the Tax Court has ruled that a second Final Partnership Administrative Adjustment (FPAA) issued to the same Tax Matters Partner for the same tax period is invalid where the issuance was not a result of fraud, malfeasance, or misrepresentation of material fact. The invalid FPAA cannot confer jurisdiction on the court in a TEFRA action where neither the Tax Matters Partner nor a notice partner filed a timely petition in response to the first FPAA. The petition was dismissed.

Find out why the Wise Guys lost their bet on the second FPAA here:
Wise Guys Holdings, LLC v. Commissioner, 140 T.C. No. 8 (2013)

Tax Court: Untimely CDP Petition Confers Jurisdiction for Interest Abatement Claim

In an opinion that may be instructive to tax practitioners reluctant to advance alternative theories for relief, the Tax Court held that it had jurisdiction to review the denial of a request for interest abatement that arose out of an untimely petition for review of a collection due process hearing.

The pro se petitioner had a collection due process hearing. In the hearing, petitioner challenged the underlying tax liability, renewed a claim for innocent spouse relief and requested abatement of interest. The Appeals Officer upheld the collection action against the petitioner in a written determination which also included a final determination as to petitioners request for interest abatement. Petitioner petitioned the Tax Court for review of the collection determination but failed to file the petition within the 30 day statute of limitations under Section 6330(d). Respondent filed a motion to dismiss for lack of jurisdiction. Petitioner appeared at the trial session to challenge respondent’s motion and raised the same claims in a hearing before the court that she raised in the appeals hearing. The Court heard petitioners claims and gave the parties an opportunity to brief the issue. On brief, petitioner once again raised all three claims that she made at the Office of Appeals.

Upon review of the parties’ arguments and the Appeals Officer’s case activity file, the Court found that it did not have jurisdiction to review the merits of the collection action and granted respondent’s motion to dismiss on that claim. However, the Court found that the final determination on the collection action also constituted a final determination as to petitioner’s request for interest abatement under Section 6404. The statute of limitations for review of a request for interest abatement is 180 days. The Court held that even though the petition was not timely to grant jurisdiction under Section 6330 it was timely as a request for review of an interest abatement and conferred jurisdiction upon the Court independent of the collection due process proceedings. The Court ordered further proceedings to determine whether respondent’s determination on the interest abatement claim was an abuse of discretion.

Read the opinion here:
Gray v. Commissioner, 138 T.C. No. 13 (2012)

Tax Court: Premature FPAA on Computational Items Invalid, Jurisdiction Denied

There are few areas of the tax code as complex and potentially confusing as the rules for TEFRA partnership proceedings. Even the most steely-eyed tax pros wince at the details. Nonetheless, TEFRA is at the heart of many of the transactions that the IRS has challenged over the course last decade and the courts are still sifting through the details.

In Rawls Trading, LP v. Commissioner the government sought a stay of proceedings on a Final Partnership Administrative Adjustment (FPAA) issued to one of three partnerships involved in a single tax-advantaged transaction. Respondent argued that the FPAA was issued prematurely and that the court should stay its proceedings until determinations were made on FPAAs issued to the two related partnerships which were party to the transaction. Petitioners argued for a consolidated hearing on all three FPAAs. The Tax Court chose a third path and raised the question of jurisdiction.

The FPAA for the upper tier partnership, which the government wanted stayed, contained only computational adjustments.  All of the adjusted items were held in the lower tier partnerships and the upper tier partnership FPAA only noted the consequences those adjustments on a pass-through basis.  The Court reasoned that if the adjustments on the upper tier partnership were only computational and the FPAA did not contain items that were subject to the Court’s determination in a deficiency proceeding then there was nothing for the court to determine in a deficiency proceeding. The Court made exactly such a finding and determined that the FPAA was invalid as filed. The Court dismissed the FPAA for lack of jurisdiction noting that it could not stay proceedings on an FPAA that did not confer jurisdiction on its own merits.

Yes, there is a little more to it than that, but Judge Vasquez does a better job of navigating the labyrinth of TEFRA to reach that conclusion in his opinion than I can in this short column. Nonetheless, this is an important decision in the field of TEFRA procedure and adds yet another layer of complexity to this already challenging area of the law.

Read the full opinion here:
Rawls, LP v. Commissioner, 138 T.C. No. 12 (2012)

Is Tax Litigation Irrational?

According to Supreme Court barrister Robert A. Long it may well be.

Our beloved world of tax litigation had its 15 minutes of fame this morning as the first argument challenging President Obama’s health care law involved the applicability of the Anti-Injunction Act. Probably best known among tax procedure wonks as the statute that prevents Federal district courts from hearing state tax disputes, the Anti-Injunction Act basically denies jurisdiction to challenge the merits of a tax until it has been paid. The argument facing the Court was whether the penalty provision for not participating in the Obama health care plan, which is enforced through the Internal Revenue Code, had to be imposed against an individual before the Court had jurisdiction to determine the Constitutionality of the law. Alas, early reports indicate that the assembled Justices were not impressed by the argument.

All of that aside, what really caught our attention was this exchange, reported by Politico, between Justice Scalia and counselor Robert A. Long:
Justice Scalia: …If it’s not jurisdictional what’s going to happen is you are going to have an intelligent federal court deciding whether you are going to make an exception. And there will be no parade of horribles because all federal courts are intelligent…
Mr. Long: Well, and, Justice Scalia, I can’t predict what would happen, but I would say that not all people who litigate about federal taxes are necessarily rational.

Gee, Mr. Long, we’re not gonna take that to heart.

Tax Court: Look to IRC to Determine Executor for Notice of Deficiency

In a division opinion, the Tax Court ruled that the beneficiary of an estate who signed the estate tax return and held property of the estate, but had not been appointed executor under state law, was the statutory executor of the estate under IRC Sec. 2203 for purposes of receiving and responding to a statutory notice of deficiency. As such, the Tax Court has jurisdiction to review the estate’s petition.

In an interesting practice note, the opinion also offered the parties guidance on the difference between a motion to dismiss and a motion for summary judgment under the Tax Court rules.

Read the opinion here:
Estate of Gudie, 137 T.C. No. 13 (2011)