California Journal of Tax Litigation, 2013 1st Quarter

In This Edition

Message from the Chair regarding the Tax Procedure and Litigation Committee meeting on February 1, 2013
David Klasing, Esq.,

A review of California Law School Taxpayer Clinics:


Editor’s Note

Committee Roster

Submission Deadlines

Message from The Chair

Hello again from your current Tax Procedure and Litigation Committee (“TPL Committee”) chair David Klasing!

I would like to thank Jane Becker, (Chair-Elect), Patrick Crawford, (Secretary) Joseph Wilson, (Newsletter Editor) and Robert Horwitz (Liaison to the Executive Tax Committee) for their leadership on the TPL Committee over the last quarter. I have come to know each as hard working, selfless and dedicated tax professionals.

During the TPL Committee’s meeting on November 2, 2012, in San Diego we discussed the following:

  • Topic and Author Selection ideas for the 2013 Washington Delegation;
  • Topic and Author Selection ideas for the 2013 Sacramento Delegation;
  • Article and Quick Point submission opportunities in the TPL Committee Newsletter and California Tax Lawyer;
  • Suggestions on 10 to 13 educational programs that the members are interested in for the 2013 Annual Tax Bar Meeting; and
  • Topic Ideas for Educational Webinars.

The TPL Committee Leadership wishes to thank those members of the Committee at large that have volunteered to write and present for the Washington and Sacramento Delegations, draft and submit articles and Quick points for our Committee Newsletter and for the California Tax Lawyer Magazine, who have offered suggestions on programs for the 2013 Annual Tax Bar Meeting and who are developing e-webinars.

TPL Sponsored Topics For The 2013 Annual Tax Bar Meeting

We hope that everyone is planning to attend the 2013 Annual Tax Bar Meeting. Our Committee has submitted for possible sponsorship and or co-sponsorship the following programs at the 2013 Annual Tax Bar Meeting, pending approval by the Executive Committee of the State Bar’s Taxation Section:

  • Representing taxpayers in sales tax audits and appeals (State Board of Equalization) with a review of the mechanics of a markup audit and how to successfully defend a markup audit;
  • Review of common conflicts of interest faced by tax professionals and practical advice on dealing with potential and actual conflicts (this class would qualify for ethics credit);
  • Hot topics in criminal taxation including recent case law addressing Fourth and Fifth Amendment issues in tax prosecutions and a review of the developments in the “required records” exception to the production of documents in criminal tax matters;
  • A review of information sharing programs in effect between California State taxing authorities (FTB, BOE and EDD) and between state authorities and the Federal Government. More particularly, when do state taxing authorities notify other state authorities and the IRS of audit results, what information is shared by the IRS with state taxing authorities, and assessment statute of limitation issues which result from these exchanges of information;
  • An update on international tax compliance issues including FACTA, FBAR penalties and opting out of the IRS voluntary disclose program. Also, the new streamlined filing compliance procedures related to the offshore bank accounts for non-resident U.S. taxpayers;
  • When to make a qualified offer per 26 USC section 7430. A review of the requirements for a qualified offer and how to use them in tax audits and subsequent litigation to help resolve a tax matter and to make it easier for a taxpayer to be awarded administrative and litigation costs;
  • A review of the “strong proof” rule, that is, the proof needed by a taxpayer to rebut a client’s original chosen structuring of the transaction at issue in tax litigation;
  • An update on the federal innocent spouse program (26 USC section 6015) including a review of the new equitable innocent spouse rules and recent court cases;
  • A review and update of state and federal offers in compromise programs including revisions to the OIC rules announced by the Service in May of 2012. This program will include a review of the offer in compromise programs offered by BOE, EDD and FTB;
  • A review and update of how taxing authorities may hold “responsible parties” individually liable for unpaid corporate and LLC sales and employment taxes, with an emphasis on 26 USC section 6672 and the dual assessment statute which authorizes the Board of Equalization to make dual assessments for defunct/out of business taxpayers and suspended corporations/LLCs;
  • The federal procedural roundtable as is traditionally offered by the TPL Committee;
  • Current topics in estate audits, appeals and litigation which would include issues being targeted by the Service for audit; and
  • The Top Ten Tax Shelters of 2013 and how the IRS is addressing them.

Many are working very hard to make this program a success. We hope to see you there.

Minutes of The November 2, 2012 TPL Committee Meeting

The minutes from the November 2, 2012, meeting are not available at this time, but if they become available, those minutes will be included in the May 2013 Newsletter.

February 1, 2013 TPL Committee Member Meeting

TPL just held its February Committee meeting at the State Board of Equalization (“BOE”)

Headquarters in Sacramento on February 1, 2013 from 11:00 to 3:00. The group heard from Randy Ferris, the Chief Counsel of the Legal Division, and a presentation from Anthony Epolite, Tax Counsel with the Appeals Division. Mr. Epolite discussed how to effectively represent a taxpayer before the Appeals Division (sales tax, income tax and property tax). Additional details about the success of the February meeting at the BOE will be included in the May 2013 Newsletter.

The TPL Committee Officers have agreed, very tentatively, on the following dates, locations, and topics for the upcoming year:

  • May 24, 2013, at Lavar Taylor’s offices in Santa Ana. Topic: the new IRS Offer in Compromise guidelines and how those guidelines are being implemented; and
  • August 2, 2013, in San Francisco, topic and location to be determined.

California Tax Lawyer

If you would like to have a “Quick Point” included in the upcoming issue of the California Tax Lawyer, send me any brief 400 to 600 word technical updates, procedural updates, observations on practice or policy matters, and commentaries you may want to include at

Tax Network Newsletter

We continue to solicit articles for upcoming editions of our Tax Network Newsletter. Please contact Joseph Wilson at if you would like to submit an article or gather more information or a helpful style manual for submitting articles for our next edition. The Newsletter continues to include wonderful information relevant to our members.

Bring Your Camera to The Annual Tax Bar Meeting and Quarterly Committee Meetings

The editors of the California Tax Lawyer would l
ike to include pictures of our activities. Please send me via e-mail any JPEGS you may have from our meetings, and be sure to identify each person in the photo and the event at which the photo was taken.

Hot Topics

Thanks to all those who have helped make Committee meetings successful and fun. Please come armed with “Hot Topics” for our upcoming meeting. Our members continue to lead, teach and provide insight in our field, so there is much to share.

I hope to see you in Santa Ana at for the upcoming May 2013 TPL Committee meeting!

A Review of California Law School Taxpayer Clinics

Editor’s Note: Low Income Taxpayer Clinics, staffed by law students and supervised by tax attorneys and professors, provide invaluable services to those who could not otherwise afford tax representation. We are pleased to include articles, which review the programs at the University of San Diego, Santa Clara University and Chapman University Schools of Law.

University of San Diego School of Law, Low Income Taxpayer Clinic

Submitted by Richard Carpenter, Esq.

Ever speak to a potential client who has a valid position in an on-going tax controversy with the IRS, but because of their modest income, they cannot afford to hire you as their tax attorney? If yes, then you probably considered that your options were limited to: (i) work on the matter pro-bono, or (ii) send them away without help. In fact, there is another option for you – refer them to one of California’s 14 IRS approved (and IRS partially funded) low income tax clinics (“Tax Clinic”) for assistance.

Most Tax Clinics represent low income taxpayers before the IRS in audit, appeals, and collection issues (OICs, payment plans) for free. Some Tax Clinics also represent low income taxpayers in Tax Court with S Calendar cases too.

“Low income” status is determined by reference to the federal poverty guidelines. At least 90% of taxpayers represented by a Tax Clinic must have income that does not exceed 250% of the federal poverty guidelines. Based on the 2012 poverty guidelines, the current income ceiling to qualify as a low income taxpayer is:

Size of Family UnitIncome Ceiling1

At the USD Tax Clinic, law students under the direction and supervision of its director assist the clients. Because the IRS has approved the USD Law Tax Clinic, the law students receive IRS “Special Orders,” which allow them to sign on POAs and communicate directly with the IRS on behalf of the client. It is a win/win situation because the low income taxpayer gets effective help with their federal tax problem for free and the law students receive practical, hands on tax controversy experience.

The USD Tax Clinic has been operating since 1999. The Clinic students are supervised by Richard A. Carpenter, Adjunct Professor of Law and Tax Clinic Director. Mr. Carpenter has been a tax attorney for twenty-nine years, is certified as a specialist in taxation law by the State Bar of California, and is a certified public accountant. He is the founder of the USD Tax Clinic and has been its director since it began in 1999.

To learn more about USD’s Tax Clinic visit the law school’s clinic program website at

Richard Carpenter, Esq.
San Diego, CA

Santa Clara University School of Law Low Income Taxpayer Clinic

Submitted by Caroline Chen, Esq.

Santa Clara University School of Law’s Low Income Taxpayer Clinic (“Tax Clinic”) provides free legal tax representation to low income taxpayers located in Santa Clara county and the surrounding counties. The Tax Clinic opened its doors in January 2012 and is currently housed at the Katherine and George Alexander Community Law Center. The Tax Clinic handles all aspects of controversy with the IRS, including assisting clients with audit representation, appeals representation, non-filers, collection issues, innocent spouse relief, and offers in compromise. In addition, Tax Clinic student attorneys represent taxpayers before the United States Tax Court. The Tax Clinic also may represent clients in state tax controversies that are directly related to their federal tax controversies.

The Tax Clinic is partially funded through a matching grant provided by the Low Income Taxpayer Clinic program, which is administered by the Internal Revenue Service’s Taxpayer Advocate Service. However, the Tax Clinic is completely independent of, and not associated with, the IRS or the federal government. The partial funding does not imply that the Tax Clinic has a preferential relationship with the IRS.

The Tax Clinic provides Santa Clara University law students the opportunity to represent clients before the IRS and/or Tax Court, develop professional skills and learn tax procedure while directly serving the community. The students are assigned cases throughout the semester and are responsible for all aspects of their client’s representation; from the initial interview and information intake, to case planning and research, to representation before the IRS and/or U.S. Tax Court.

The Clinic students are supervised by Caroline Tso Chen, Assistant Clinical Professor of Law and Tax Clinic Director. Prior to joining the faculty at Santa Clara University School of Law, Ms. Chen was a senior attorney at the Office of Chief Counsel of the Internal Revenue Service for 13 years, primarily with the Large Business & International Division.

In its first year of operation the Tax Clinic held 23 intake clinics, interviewed more than 70 prospective clients, and retained and represented 16 clients. Among the cases that the clinic has closed are two shining success stories.

The Tax Clinic’s first success story involved a husband and wife and their four children. The main issue was that the taxpayers’ mortgage interest deduction was being disallowed for several years. Due to their status as Mexican Nationals, the taxpayers were unable to secure a mortgage to buy a home. Wanting to help the taxpayers, a friend agreed to secure two mortgages and enter into the purchase agreement for the home if the taxpayers agreed to live in and maintain the house as well as make all of the payments on both mortgages. The taxpayers moved into the house and made all payments associated with the house. The friend never claimed the mortgage interest deduction on hi
s tax return. When the taxpayers deducted the mortgage interest, they were initially issued a refund. However, the IRS audited their return and, upon discovering that they did not hold legal title to the home, requested that they return the refund as well as penalties and accrued interest.

The student attorneys at the Tax Clinic reviewed the taxpayers’ case and immediately filed a Tax Court Petition for the taxpayers. They then wrote an Appeals Conference memorandum, which cited to case law supporting the taxpayers’ ability to claim the mortgage interest deduction as beneficial owners of the home despite not having legal title, collected substantiating documents, and argued the clients’ position before the IRS in an Appeal Conference. After hearing the student’s arguments and reviewing the documents, the Appeals Officer agreed with the students and conceded the case.

The Tax Clinic’s second success story involved a husband and wife who worked as medical couriers and used their own cars to make their deliveries. Their employers reimbursed them for only a portion of the standard mileage rate for the tax year at issue. Over the course of the year, their unreimbursed mileage expenses differential amounted to over $10,000, which the taxpayers deducted on their tax return. The IRS audited their return, rejected their claim for the unreimbursed mileage expenses, and assessed an additional tax liability of $2,000 including penalties and accrued interest.

Upon reviewing the taxpayer’s documents, the student attorneys discovered that not only were the taxpayers entitled to their original deduction, but also that they had accrued a greater mileage expense than originally claimed, which entitled them to a greater deduction. The students drafted a legal memorandum and collected substantiating documents. They then argued the clients’ position before the IRS in an Appeals Conference. The Appeals Officer agreed to concede the IRS’s case and the IRS set aside its previous demands for payment.

To learn more visit the Santa Clara Law School Tax Clinic’s website at

Caroline Chen, Esq.
Santa Clara, CA

Chapman University School of Law Low Income Taxpayer Clinic

Submitted by George L. Willis, Esq.

The Low Income Taxpayer Clinic (“Tax Clinic”) at the Chapman University School of Law (“Chapman”) operates one of the oldest qualified tax clinics as part of its JD Tax Law Emphasis certification and LLM in Taxation programs. Chapman’s Tax Clinic represents taxpayers in all stages of a federal tax controversy and routinely handles responses to Notices of Deficiency or Determination, Innocent Spouse cases, Identity Theft, Earned Income Tax Credit cases, Schedule C substantiation cases, issues with collections including Liens, Levies, Installment Agreements, Offer in Compromises and cases involving representation of pro se taxpayers with cases pending before the U.S. Tax Court.

As a law school Tax Clinic, Chapman’s representatives are senior law students who are under the supervision of attorney-professors authorized to practice before the IRS and in Tax Court. Before enrolling in the tax law clinic, students must take prerequisite tax law courses and must also be specially approved each semester by the Office of the Taxpayer Advocate, which assumed oversight of student practice before the IRS from the Office of Professional Responsibility in December 2012. If a student is assigned a Tax Court case and the matter does not settle before trial, the student may have the opportunity to present the case in court under the Tax Court’s rules of tax clinic practice.

During the typical semester in Chapman’s Tax Clinic, students learn rules of tax procedure and administration, practice client interviewing techniques and gain valuable negotiation skills in meetings with the IRS.

Often, the relatively small dollar values of these cases preclude taxpayers from retaining an attorney or CPA. It makes little sense to spend $1,000 on a professional in order to recoups $500 in taxes, yet $500 might represent a retired client’s groceries or rent for the month. As cases get larger, a few thousand dollar’s worth of Earned Income Credit in dispute can easily equal the security deposit needed to move to an apartment in a safer neighborhood for a single mother.

The Tax Clinic often acts as miracle workers for taxpayers for whom a few hundred dollars can mean the world. Since there is little or no cost to the client for the Tax Clinic’s services, student representatives have the luxury of putting in as many “billable” hours of time as are needed without having to worry about costing the client more than the underlying amount in controversy.

This is not to suggest that every case can be made a winner simply by spending more hours doing research or fact gathering. Some unfortunate (but very important) lessons that students learn in handling non-winning cases is how to educate clients in lay terms as to why the underlying tax deficiency is correct and to help clients through the maze of various collection alternatives.

Chapman’s Tax Clinic is a great resource for all parties involved in a tax controversy. First, the benefit to taxpayers who would otherwise go without representation is immeasurable. Next, the Tax Clinic benefits the IRS because they help facilitate settlements and resolve cases. The Tax Court also appreciates the work of the Tax Clinic because at Chapman Law we strive to make sure cases that should be settled actually settle. If a case cannot be settled, representation by a qualified clinic can greatly assist a taxpayer at trial. Finally, the students are winners because they gain valuable real-world experience handling live tax cases while still in school.

Chapman’s Tax Clinic is supervised by George Willis, Associate Clinical Professor and the Administrator of Graduate Tax Law Programs at Chapman Law. He joined Chapman in 1999 after working in practice as a Tax, Business and Estate Planning attorney, serving individuals and close corporations. Before opening his practice, he worked for the Internal Revenue Service, Estate and Gift Tax Division and at the First American Corporation under their general counsel.

To learn more about Chapman’s Tax Clinic visit its website at

George Willis, Esq.
Orange, CA

Chapman University School of Law Appellate Tax Advocacy Clinic

Submitted by A. Lavar Taylor, Esq.

Chapman launched an Appellate Tax Advocacy Clinic course in 2008. This clinical course lets students participate in docketed appellate tax cases conducted under the auspices of The Center for Fair Administration of Taxation. Here, students do not represent taxpayers, but rather they participate as amicus curiae in significant matters that effect federal, state or local tax law. The author is not aware of any other Law School in the nation with a Appellant Tax Advocacy Clinic of this kind.

Students research legal issues, draft briefs, and depending on the jurisdiction of the court and the nature of the case, present their brief before an appellate court.

Chapman’s Appellate Tax Advocacy Clinic is supervised by A. Lavar Taylor, Adjunct Professor of Law and Instructor of the Appellate Tax Advocacy Clinic. Mr. Taylor has more than 30 years of experience in handling civil and criminal tax controversies. Prior to private practice, he served as an Assistant U.S. Attorney in the Tax Division of the U.S. Attorney’s Office, a Senior Trial Attorney at the local IRS Office of Chief Counsel, and an Attorney in the General Litigation Division of IRS National Office of Chief Counsel in Washington, D.C.

To learn more about Chapman’s Appellate Tax Advocacy Clinic visit its website at

A. Lavar Taylor, Esq.
Santa Ana, CA


An Overview of The California State Board of Equalization’s Responsible Person Dual Assessment Authority

Submitted by Jane Becker, Esq.2

This article reviews the circumstances under which the SBE may assess responsible person liability pursuant to California Revenue & Taxation Code (“R&T”) section 6829 (personal liability of corporate officer for unpaid taxes) and discusses the substantive and procedural differences between “responsible person” liability under the California Code of Regulations, sections 1702.5 (Responsible Person Liability) 3 and 1702.6 (Suspended Corporations). 4

R&T Code section 6829(a) states that when a business terminates, dissolves or is abandoned, those who had general management authority to insure that sales taxes were remitted, or whose job descriptions included collecting and paying sales tax may be held responsible for the unpaid liabilities. A dual determination is a finding that the business entity and an individual (or, possibly, another entity) with management authority are both responsible for unpaid taxes.

The failure to remit taxes must have been willful, which section 6829(d) defines as actions, which were “intentional, conscious and voluntary.” The SBE has interpreted willfulness to require a showing that funds were available to pay other creditors (and were used to pay other creditors) while SBE taxes went unpaid. 5

A dual determination notice must be mailed to the responsible person in the time period set forth in section 6829(f). That is, it must be mailed within three years after the last day of the calendar month following the quarterly period in which SBE obtains “…actual knowledge (emphasis added) through its audit or compliance activities, or by written communication by the business…of the termination, dissolution or abandonment of the business…”

If SBE never obtains “actual knowledge” that an entity is out of business, it has eight years “… after the calendar month following the quarterly period…” in which the business terminates to mail a dual determination notice.

By its terms, R&T section 6829 prevents SBE from assessing against responsible parties until the time business operations have stopped. However, prior to the enactment of section 6829, SBE had taken the position that it may issue dual determinations against corporate officers during the time an entity has been suspended by the Franchise Tax Board for non-filing or non-payment of taxes, or by the Secretary of State for failing to file required statements of information.

The 1997 Freels Memorandum Opinion set forth SBE’s authority to do so, albeit with circular reasoning. 6 (It should be noted that there are other adverse procedural consequences to operating while suspended.)7

Following Freels, in 2000, the SBE issued Regulation section 1702.6 Suspended Corporations. It provides that a corporate officer or shareholder with control over operations or management of a closely held corporation during the time in which the corporation was suspended or any responsible person who fails to pay taxes shall be personally liable under the circumstances set forth below…” Regulation Section 1702.6 (a).

A responsible person is defined as an officer or shareholder who’s responsible for the filing of returns or the payment of tax and who derives “… a direct financial benefit from the failure to pay the tax liability.” A closely held corporation is one in which ownership is “concentrated in one individual, one family or a small number of individuals and the majority stockholders manage the business.” Regulation Section 1702.6(b)(1). Control of the management and operations means “…the power to manage or affect day to day operations of the business. For the purposes of this Regulation, it is rebuttably presumed (emphasis added) that a corporate officer has control over operations and management of the closely held corporation.” Regulation Section 1702.6(b)(3) (emphasis added).

On occasion, Regulation sections 1702.5 and 1702.6 are used interchangeably but there are significant differences.

Broadly put, the authority cited by SBE for Regulation 1702.5 includes R&T sections 7051 and specifically section 6829, a statute directing addressing responsible person liability. In adopting Regulation section 1702.6 the BOE did not cite R&T section 6829 as authority, but, rather cited R&T section 7051, which is a broadly drafted statute authorizing BOE to “prescribe, adopt, and enforce” rules and regulations to implement the administration and enforcement of the sales tax laws. It also cited R&T section 6066, which requires any person conducting business in California as a seller to apply for a permit for each place of business. As such, the statutory framework for each is different and the authority for the adoption of Regulation section 1702.6 is arguably nebulous.

More particularly, the two Regulations “…contain different requirements, definitions and presumptions.”8 These are discussed below.

Who may be a responsible person?

The scope of Regulation section 1702.5 is quite broad and is akin to 26 USC section 6672. It applies to anyone who has the authority or duty to ensure that sales taxes are paid, which includes employees and third party payors. Further, responsible person liability per Regulation section 1702.5 can be assessed against any person with responsibility for any business entity authorized under California law. Conversely, Regulation section 1702.6 is limited by its terms to corporate officers and shareholders of closely held corporations, but makes no reference to limited liability companies or other legally authorized entities (whether closely held or not).

Requirements for Finding a Person Responsible – Willfulness & Burden of Proof

Regulation Section 1702.5 – Responsible Person Liability requires that SBE establish that the failure to pay was done willfully i.e. consciously and intentionally. There is no such requirement under Regulation section 1702.6. 9

Thus, under Regulation section 1702.5, a taxpayer needs to establish that he was not a responsible party and the failure to act was not willfu1. Under Regulation section 1702.6 the taxpayer must establish that he was not an officer or shareholder during the relevant time period. If the taxpayer was an officer or shareholder, BOE has made a prima facie case. The taxpayer then has the burden of showing that he did not have control over operations and management, that is, day to day business operations. Under Regulation section 1702.5 there is no rebuttable presumption that a taxpayer must refute.

Under Regulation section 1
702.6, the officer or shareholder of a closely held corporation must establish a negative, that is, that he did not have control or a management position in the corporation. Once the taxpayer provides proof that he was not involved in the day to day business operations of the business (he had no banking authority, he did not hire or fire employees, work with vendors etc.), the burden shifts to SBE to show otherwise.

Statute of Limitations

As noted earlier, when a corporation terminates a business, SBE can assess responsible persons within approximately three and a half years after it receives actual notice of the termination. If it does not, it has approximately eight and a half years from the time the business closed. However, Regulation section 1702.6 provides that the determination of liability is governed by the same statute of limitations, which applies to assessing tax against the corporation (generally, three years + for filed returns, eight years + for unfiled returns).

Due Process & Legality Concerns

The unpublished decision of Latin v. SBE, 2009 Bankr. LEXIS 4523 (9th Circuit BAP 2009) is instructive and contains a detailed analysis of the differences between the Regulations. In Latin, SBE issued a prepetition notice of dual determination pursuant to Regulation section 1702.6. The taxpayer filed bankruptcy and SBE submitted a claim. The debtor objected and provided uncontroverted evidence that he had resigned from the corporation and not been an officer during the period of the dual determination. SBE argued that if that were true then Regulation section 1702.5 imposed liability and so its claim was valid. The Bankruptcy Appellate Panel ruled that due to significant differences between the two Regulations, the taxpayer had not been afforded due process: if BOE wanted to assess pursuant to Regulation section 1702.5, it was required to do so pursuant to its own procedural requirements that is, issue a Dual Determination citing Regulation section 1702.5 as its authority (which it had not done). The decision notes:

Debtor’s defense to Regulation section 1702.6 charge was proof by a preponderance of the evidence that he was not an officer of the corporation during the relevant time period who was in control over its operations and management or an officer charged with the responsibility for filing returns or paying the taxes. In each instance, the taxpayer’s liability rests on corporate officer status. In contrast, Regulation section 1702.5 required evidence to prove the elements of responsibility and willfulness were not present.

Therefore based on the differences between the two Regulations, we respectfully disagree with the bankruptcy court’s view that it was not important which Regulation the SBE relied on for its proof of claim. In sum, we hold debtor’s due process rights were violated when the bankruptcy court imposed personal liability on him for the corporation’s unpaid sales taxes under Regulation section 1702.5. The SBE neither relied on nor argued for liability under that Regulation in connection with its proof of claim. Latin, supra, pp. 24 – 26.

SBE’s institutional policy of piercing the corporate veil and assessing against responsible parties when a corporation is suspended was in issue in Ashok v. Parmar, 198 Cal. App. 4th 705, 2011 Cal. App. LEXIS 734. There, SBE, after audit, billed directly the owners of a closely held corporation for unpaid cigarette and tobacco taxes. The corporation paid the deficiency, and in extended legal proceedings, the owners litigated a refund claim on the basis that SBE had illegally assessed against them while they still operated in corporate form.

As the corporation paid the deficiency, and not the owners, it was held on appeal that the owners had no standing to pursue a refund claim. The trial courts finding, however, that the SBE had wrongly ignored the corporate form in assessing the owners was upheld. The Court noted that BOE had conceded “… the illegality of its former internal policy authorizing the assessment of individuals for the conduct of their suspended closely held corporations….” Ashok, supra, at p. 28

In conclusion, the requirements of each Regulation must be met on its own terms.

Jane Becker

1537 Pacific Avenue, Ste. 201
Santa Cruz, CA 95060
(831) 454-9415

Ninth Circuit Allows Taxpayer to Introduce New Materials for the First Time at Trial, Applying de novo Standard of Review in 6015(f) Innocent Spouse Case

Submitted by A. Lavar Taylor, Esq.10

In Wilson v. Commissioner, the Ninth Circuit, in a 2-1 decision, held that taxpayers who challenge the Commissioner’s denial of their claim for relief from joint liability under 26 USC section 6015(f) may introduce evidence in the court proceeding which was not presented to or considered by the IRS at the administrative level and that the Tax Court reviews the Commissioner’s denial of requests for relief under section 6015(f) under a de novo standard of review.

Ms. Wilson’s case has an interesting procedural history. Her former husband, unbeknownst to her, engaged in a Ponzi scheme. For years 1997 and 1998 he had income from offshore account activities that was not reported on the jointly filed returns. . A CPA recommended that Ms. Wilson and her husband file amended returns for these two years to report the income and that they file a joint return for 1999 reporting the income from these activities. Ms. Wilson followed this advice. The liabilities reported on the amended returns for 1997 and 1998 were not paid, nor was the liability reported on the return for 1999 paid.

Thereafter Ms. Wilson, acting in pro per, submitted a claim for relief under section 6015(f) to the Cincinnati Service Center. This claim was denied. Ms. Wilson, acting in pro per, requested a hearing with the Office of Appeals. While the case was pending with Appeals, she began divorce proceedings. Appeals eventually denied the claim for relief.

Ms. Wilson, acting in pro per, filed a Tax Court petition. A trial was held and evidence submitted. After the case was taken under submission by Judge Holmes, the Ninth Circuit handed down its decision in Ewing v. Commissioner, 439 F.3d 1009 (9th Cir. 2006) (holding that the Tax Court lacked jurisdiction to review the Commissioner’s denial of relief under section 6015(f)).

After Congress enacted legislation giving the Tax Court jurisdiction to review denials of claims for relief under section 6015(f), Judge Holmes reopened the record and arranged for pro bono counsel to represent Ms. Wilson. Additional evidence was presented, and Judge Holmes held that Ms. Wilson was entitled to relief from the joint liabilities for all three years.

The IRS appealed to the Ninth Circuit, contending that Judge Holmes erred in considering evidence that was not presented by Ms. Wilson to the IRS at the administrative level. The basis for this argument is that the Administrative Procedure Act (“APA”) applies to the Tax Court’s review of these types of cases.

The majority affirmed the Tax Court and held that the APA does not apply in this situation. The Tax Court reviews denials of claims for relief under section 6015(f) applying a de novo standard of review and may consider evidence not part of the administrative record. The majority offered a number of reasons for its conclusion. Because the opinion is very lengthy, the many reasons cited by the majority opinion in support of its holding will not be repeated here.

A number of the reasons cited by the majority in support of its holding were mentioned in an amicus brief submitted in the case, which was written by this author on behalf of the Center for the Fair Administration of Ta
xes. This amicus brief can be read by going to and clicking on the link to the amicus briefs, which have been filed by CFAT.

Notably, the majority also stated that, even if the APA applied, the APA’s exception to the “record rule” would apply in this case, allowing the Tax Court to consider evidence outside of the administrative record.

The dissent argued that the APA applies in this context and that the APA’s exception to the “record rule” does not apply in these types of cases. The dissent is also very lengthy. For that reason, the author suggests reviewing the dissenting opinion to understand the dissent’s rationale.

What makes this case particularly interesting is that the government effectively conceded that Ms. Wilson was entitled to relief under section 6015(f) if the evidence introduced at trial and considered by Tax Court could legally be taken into account by the Tax Court. In other words, the government was arguing that Ms. Wilson should be denied relief, not because she was substantively not entitled to relief based on all of the relevant facts, but only because she failed to include enough relevant facts in the administrative record to entitle her to relief.

The author questions why the government would pursue an appeal under these circumstances. The author finds it even more amazing that even one Court of Appeals Judge (Judge Bybee in this case) voted to effectively deny relief to Ms. Wilson when the government had conceded that consideration of all of the objective evidence would entitle her to relief under section 6015(f).

There are important lessons to be learned from this case and a caveat for those handling these types of cases now and in the future. The first lesson to be learned relates to the fact that Ms. Wilson was advised to and did in fact file amended returns for two of the three years at issue. Ms. Wilson could have avoided dealing with the “record rule” if she had never filed amended returns in the first place. If the IRS had ever audited the returns for the two years in question, she could have argued that she was entitled to relief under sections 6015(b) and (c), in addition to section 6015(f). Although the totality of the facts are not known to us, her decision to file amended joint returns with her husband may not have been wise. She may have been better off not signing the amended returns and raising an innocent spouse claim in any subsequent audit.

Second, she also was advised to file a joint return for the third year, which showed a significant balance due. Just as care needs to be taken by a prospective “innocent spouse” in deciding whether to sign an amended return which reports previously omitted income, care also needs to be taken in deciding whether to file an joint return in the situation faced by Ms. Wilson. In addition, care needs to be taken by those professionals who advise taxpayers in those situations.

Finally the caveat. The Ninth Circuit’s ruling may not be the last word on this issue. The government has until the beginning of March to file a Petition for Rehearing and/or Rehearing En Banc. The government could even seek Supreme Court review, for reasons that become more apparent after you read the dissent. Or the government could continue to litigate this issue in other Circuits, which could result in an adverse Supreme Court ruling at a later date. Thus, for the time being practitioners, even those in the Ninth Circuit, should proceed on the premise that all available evidence needs to be made a part of the administrative record in section 6015(f) cases and that, if there is important evidence which cannot be included in the administrative record for any reason, that this be properly documented in the administrative record.

A. Lavar Taylor, Esq.

Law Offices of A. Lavar Taylor
6 Hutton Center Dr., Ste. 880
Santa Ana, CA 92707

Navigating 2013: Innocent Spouse

Submitted by Barbara N. Doherty, Esq.

The Internal Revenue Service (IRS) is authorized by Internal Revenue Code (IRC) 26 USC section 6015(f) with discretion to grant innocent spouse relief to certain taxpayers who are jointly and severally liable for unpaid income tax, penalty and interest.11 This short note describes how to match the information requested by the current Form 8857 Request for Innocent Spouse Relief with the generous section 6015(f) innocent spouse review provisions described within IRS Notice 2012-8. Innocent spouse applicants who anticipate the analysis the IRS will perform on their applications for relief will significantly enhance the likelihood of relief.

A basic understanding of the innocent spouse process can be first obtained by reading the four-page Form 8857, the instructions to IRS Form 8857, IRS Revenue Procedure 2003-61, IRS Notice 2011-70, and IRS Notice 2012-8. These materials describe key factors that will be used by the IRS to evaluate all innocent spouse cases. A careful review of these materials will also establish some cases will be denied relief based on strict threshold criteria.

Tax practitioners must be able to analyze a taxpayer’s history and recognize when a valid innocent spouse fact pattern is present. Many eligible taxpayers are unable to successfully apply for innocent spouse relief without assistance. Others may never know they are eligible for innocent spouse relief. The misconceptions regarding relief pursuant to section 6015(f) are myriad. When an eligible taxpayer does apply for relief, a complete and descriptive application that anticipates the current IRS innocent spouse review procedures is critical.12

The IRS is required to review innocent spouse cases consistently, and in conformity with all relevant procedures and guidance. The IRS reviews all innocent spouse cases at a one central location pursuant to preliminary and final review procedures that are documented within an administrative file record.

The preliminary determination in an innocent spouse case often results in a denial based solely on the initial application materials.13There may be no verbal or written contact from the IRS, and no request for any additional information or fact verification. The preliminary review is based on an administrative review of extremely personal and subjective facts submitted in response to requests for information in the four-page application form. If the application is not presented in a logical and persuasive manner, the initial review will frequently lead to an initial denial of relief.14

Applications for innocent spouse relief must be prepared in anticipation of each of the subjective tests the IRS will use to evaluate the application materials. Although it should not be necessary for a tax lawyer to complete such an application, an application for innocent spouse relief is a difficult form for an untrained applicant. Careful consideration must be given to each piece of information provided by the requesting spouse.15

All requests for section 6015(f) innocent spouse relief are evaluated using specific factors the IRS has identified to analyze the relevant facts and circumstances. There are threshold criteria that must be met before the multi-fac
tor analysis is applied. For many cases, relief is denied based on arbitrary IRS determinations from a review of the specific factors that concludes a discretionary grant of innocent spouse relief is not justified. An application for innocent spouse relief from joint and several tax liabilities must carefully consider the information provided in the initial application materials in order to minimize the risk of an initial denial.

Innocent spouse applicants in 2013 have the benefit of two recent IRS changes to the review of applications for innocent spouse relief. First, IRS Notice 2011-70 eliminated the requirement that applicants apply within two years of the first IRS collection action. This change in July of 2011 resulted in many new cases that were either previously denied, or had not applied due to the two-year limitation.

The second group of IRS changes to innocent spouse review includes generous changes to the review procedures in IRS Notice 2012-8. Notice 2012-8 revises Revenue Procedure 2003-61 to provide that no one factor or a majority of factors necessarily controls the determination. This subtle change indicates that the knowledge factor (of whether the tax would be paid) should no longer have overarching weight in the overall analysis.

Other revisions within Notice 2012-8 are extremely helpful in close factual cases.

Another significant change in section 4.03(b) of Notice 2012-8 states that in cases in which a denial of relief will not cause an economic hardship, the economic hardship factor will be neutral. Prior to Notice 2012-8, the economic hardship factor could weigh negative, and constitute the factor that resulted in a denial of relief. This subtle adjustment may shift the overall evaluation, and produce an ultimate grant of relief for many more applicants.

The information submitted in a Form 8857 must describe all helpful and relevant facts and circumstances in terms of the seven listed factors set forth in Notice 2012-8. The application must persuade. The application must subtly advocate for innocent spouse relief.

The first listed factor in Notice 2012-8 is marital status. If a requesting spouse is separated, or divorced, or sufficiently separated from the non-requesting spouse, this factor will weigh in favor of relief. While Form 8857 does include basic questions that will determine the marital status issue, the review of the marital status factor is your first opportunity to include any additional information regarding the case that may bolster the overall innocent spouse presentation.

The second listed factor in Notice 2012-8 is economic hardship. If a requesting spouse cannot pay the liability without suffering economic hardship, this factor will weigh in favor of granting relief. Form 8857 requires a disclosure of current assets, and monthly income and expenses. Notice 2012-8 indicates economic hardship will weigh in favor of relief whenever income is less the 250% of national poverty guidelines. Notice 2012-8 also allows a requesting spouse’s monthly income to exceed allowable monthly expenses by $300 while still finding an economic hardship as a positive factor.

The changes to the economic hardship factor in Notice 2012-8 are helpful for requesting spouses. In cases where economic hardship may not be certain, be sure to include detailed medical expenses, vehicle repair bills, and any other non-ordinary but necessary expenses. Be creative in making a presentation. The IRS cannot review information that is not provided. A requesting spouse may not have an opportunity to supplement the information presented at the preliminary review. Provide as much detail and back-up documentation as is available to support the economic hardship. Economic hardship can evolve during the pendency of a request for innocent spouse relief. Update the application with new information if the requesting spouse has significant and detrimental economic changes.

Knowledge of whether the non-requesting spouse could pay the tax due on a joint return is the third listed factor within Notice 2012-8. Notice 2012-8 indicates no one factor, or majority of factors, will be determinative of the outcome. Previously the knowledge factor alone could bar relief. Notice 20102-8 includes additional guidance for evaluating cases with abusive marriages, and for cases in which a spouse exercises financial control over the requesting spouse.

Form 8857 in its current form focuses on the knowledge factor, and on the manner in which the factor has applied to section 6015(b) and (c) cases. A substantial portion of the innocent spouse precedent on the knowledge factor is based on whether a requesting spouse knew of the under-reported income or over-stated deductions; i.e. relief sought under provisions of section 6015(b) and (c) cases. Section 6015(f) applications for relief must provide as much information as possible to negate the requesting spouse’s knowledge that the non-requesting spouse could not, or would not, pay the tax.

In organizing the materials for the knowledge factor for section 6015(f) cases, keep in mind the knowledge factor analysis in section 6015(b) and (c) cases is different from the knowledge factor analysis in section 6015(f) cases. The differences between knowledge in these different types of cases are subtle. The knowledge factor analysis in a section 6015(f) case could be tainted by the knowledge factor analysis used in section 6015(b) and (c) cases if caution is not exercised. The knowledge questions on Form 8857 can become a trap. In a section 6015(f) case, the knowledge factor is used solely to determine whether the requesting spouse knew the non-requesting spouse could pay the tax.

The fourth listed factor is whether a divorce decree assigns responsibility for the repayment of taxes. Providing additional information about the divorce proceedings and any negotiations related to the couple’s tax obligations may also provide additional background information that will assist the IRS reviewer in reaching a grant of relief.

Significant benefit is the fifth factor listed in Notice 2012-8. Significant benefit exists when a requesting spouse receives benefits (beyond normal support) from the unpaid taxes. There are no questions on the current Form 8857 that will establish a basis for determining whether or not a requesting spouse has received unreasonable financial benefits while taxes went unpaid. An application for relief must include facts and information that will guide the reader to conclude no significant benefit was received from the unpaid taxes. This type of helpful information can be included in a brief taxpayer statement that accompanies the four-page Form 8857.

The sixth listed factor in Notice 2012-8 is compliance. Requesting spouses will receive a favorable review on this factor if they have been compliant in tax filing and payments for the years following the year(s) for which relief is requested. If the applicant has filed any returns late or without payment, a thorough explanation must be prepared with the 8857 information. Late filing and nonpayment can be explained, and this factor may still favor relief. On occasion, this factor will involve negotiation.

The last factor listed in Notice 2012-8 relates to the requesting spouse’s mental or physical health at the time the returns were signed, or the time relief is requested. Both can be important. The IRS will consider the nature, extent and duration of the condition. The IRS will consider this factor favorable if the requesting spouse was in poor mental or physical health. Form 8857 includes one question for mental and physical health that requires a detailed explanation, and appropriate documentation.

In all cases, a strong application and record must be made on the initial application for innocent spouse relief. Because the current Form 8857 does not necessarily elicit all the relevant facts and circumstances, applicants must carefully prepare applications that include all available information. Applicants must present the facts favorably as possible. Equally important is
to not overburden the reviewer with too much, or too distracting, detail. The best applications are complete, clear, and quickly lead the reviewer to a conclusion finding for innocent spouse relief.

Barbara N. Doherty

Barbara N. Doherty
1200 Mt. Diablo Blvd., Suite 209
Walnut Creek, CA 94596 
(925) 954-8625

Recent Cases of Interest

Robert S. Horwitz, Esq.

Over the past several years, practitioners’ attention has been focused on cases involving the application of the “required records” exception to the Fifth Amendment in grand jury tax investigations involving offshore accounts. In In re John Doe 1, 2012 U.S. App. LEXIS 25318 (3rd Cir. December 11, 2012), the Court addressed a different exception to a privilege: the crime-fraud exception to the attorney-client privilege.

A grand jury was investigating an alleged criminal tax scheme involving ABC Corporation, John Doe 1, its sole shareholder and president, and John Doe 2, his son. The corporation was started in 2004 and ceased operation in 2006. The two-phase scheme was described by the Third Circuit thusly:

In the acquisition phase, ABC Corp. acquired the stock of closely held companies. The target companies generally had large cash accounts, few or no tangible assets, and considerable tax liabilities. In the disposition phase, ABC Corp. would remove significant amounts of the target companies’ cash assets, transfer the stock of the target companies to two limited liability companies, and engage in various transactions that had the effect, it is alleged, of fraudulently eliminating the target companies’ tax liability. Having done so, John Doe 1 and John Doe 2 would then divert the target companies’ cash assets to themselves and their family members.

The grand jury had issued a subpoena to ABC Corporation, which produced certain documents and objected to production of other documents on privilege grounds and on the ground that the subpoenas were procedurally flawed. Rather than issue a new subpoena to the corporation, the grand jury issued subpoenas to two outside law firms, Blank Rome and La Cheen Wiffels, and to three attorneys who were formerly employed as in-house counsel by ABC. When the attorneys asserted attorney-client and work-product privilege, the Government moved to enforce the subpoenas. The district court found that the documents were either not privileged or that the crime-fraud exception applied and ordered production. In a separate order, the district court ordered former in-house counsel to produce documents and testify before the grand jury. ABC and both Does appealed.

The first issue addressed by the Court was whether it had jurisdiction over the orders being appealed. Normally, under the final judgment rule (only final judgments can be appealed), to obtain review of a compulsion order the person against whom the order is issued must refuse to comply and be held in contempt. The contempt order can then be appealed. An exception to this is where the documents are in the possession of a third party who is independent of the privilege holder and who would rather disclose the documents than risk being held in contempt. In such a situation, under Perlmen v. United States, 247 US 7 (1918), the privilege holder can appeal without a contempt order.

The Court had initially dismissed the appeal from the order directed to outside counsel, since outside counsel held documents on behalf of ABC, which could take possession of the documents, defy the order and be held in contempt. [This ignored the fact that the order required outside counsel to produce the records, so that transferring them to a third-party would be in violation of the order.] The Court had also dismissed appeals by the Does, since they did not have a legally cognizable interest in the documents. The Court had suggested that, on remand, the parties work out a procedure to allow the law firms to transfer documents to ABC, which could defy the order, be held in contempt and then appeal. The parties were unable to reach agreement, because the Government wanted a procedure under which the person to whom the documents were transferred would risk “significant contempt sanctions” while ABC wanted a procedure under which the documents would be deposited with the clerk of the court, which eliminated the risk of contempt sanctions. The Court of Appeals granted a motion for rehearing to revisit whether it had jurisdiction over the order to outside counsel.

The Government argued that in Mohawk Industries, 558 US 100 (2009), the Supreme Court had effectively overruled Perlman and, thus, an order adverse to a privilege could not be appealed until there was a final judgment. Mohawk Industries was a civil case in which the Supreme Court held that an order adverse to the attorney-client privilege is not within the scope of the collateral order doctrine, which allows an appeal from a small class of orders even though the litigation has not terminated. The Court of Appeal rejected the Government’s argument since Mohawk Industries did not discuss Perlman, did not involve a grand jury investigation, and dealt with a different exception to the finality rule than that carved out in Perlman.

The Court reaffirmed its earlier order dismissing ABC’s appeal of the order to its outside counsel. Since ABC controlled its outside counsel, it could take possession of the documents and risk contempt. The Court lifted the stay it had granted so that the district court could resolve the issue of how ABC was to proceed if it wanted to continue to assert the privilege. Since ABC was defunct, the threat of severe monetary sanctions was not effective. The Third Circuit stated that either the district court or ABC could appoint an individual who would be subject to sanctions to hold the documents on behalf of ABC. In response to ABC’s assertion that there was no one who would risk incarceration to vindicate its rights, the Court stated:

There must be some person or persons directing ABC Corp. to assert privilege over the withheld documents. If those person(s) are unwilling to suffer contempt sanctions, this only points out that the privilege holder has weighed its chances of success on appeal against the seriousness of the sanctions it will face for disobeying the District Court’s Order, and determined that it is unwise to seek immediate appeal.

As to the order issued to former in-house counsel, whose actions were not subject to ABC’s directions and who would not be willing to risk contempt, the Court held it had jurisdiction. Thus, the Court could address the merits of the appeal. Initially, the Court rejected ABC’s argument that the district court erred in holding that it did not have the right to preview grand jury questions in order to vindicate its privilege.

The Court noted a problem for ABC and its attorneys in addressing the merits of the district court’s decision: due to grand jury secrecy, they were not privy to information submitted by the Government under seal in support of its claim that the crime-fraud exception applied. Additionally, the district court’s orders had been filed under seal. ABC and its attorneys were only served with heavily redacted copies of the orders. While the Court of Appeals had access to the complete orders and the Government’s under seal filings, ABC and its attorneys did not. The Court of Appeals “sympathize[d]” with their “difficult position” in arguing about the applicability of the crime-fraud exception without knowing the facts underlying the district court’s decision. This is a recurring problem for parties who object to subpoenas in grand jury investigations: due grand jury secrecy, a party opposing enforcement will often be served with government pleadings that redact grand jury material relied on by the government to support its claims. Due to grand jury secrecy, the Court’s opin
ion did not detail the facts supporting its decision.

The Court then addressed the attorney-client and the work-product privileges. The attorney-client privilege protects from disclosure confidential communications between attorneys and clients for the purpose of obtaining or providing legal assistance in order to encourage full and frank communications between attorneys and clients. The work-product privilege protects the adversary system by allowing attorneys to prepare cases without fear that their work-product would be used against their clients. It only shields materials prepared or collected in anticipation of litigation.

The crime-fraud exception limits these privileges. To circumvent the privileges, the Government must make out a prima facie case that 1) the client was committing or intending to commit a crime or fraud and 2) the attorney-client communication was in furtherance of the alleged crime or fraud. The Court recognized a split among the circuits about the quantum of proof needed to establish the crime-fraud exception. The 2nd, 6th and 9th Circuits require a showing of probable cause or a reasonable basis to suspect that the attorney-client communication was in furtherance of a crime or fraud. The 7th and 5th Circuits require evidence sufficient to place upon the party asserting the privilege the burden to come forward with an explanation of why the proffered evidence does not undermine the privilege. Finally, the 4th, 11th and District of Columbia Circuits require sufficient evidence to support a finding that the exception applied.

The Third Circuit adopted the “reasonable basis” test, noting that neither speculation nor evidence of a “distant likelihood of corruption” is enough. The Court opined that this standard was sufficient to meet the needs of a grand jury investigation.

ABC advanced several arguments why the crime-fraud exception did not apply. First, it argued that several recent Tax Court cases establish that transfers by corporations to their shareholders were not fraudulent or criminal. The Court rejected this argument since the cases relied on involved transferee liability under 26 USC section 6901, which requires the court to look to state law, while the grand jury was investigating tax evasion under 26 USC section 7201 and conspiracy under 18 USC 371. Additionally, the Tax Court cases were fact specific. In the case before it, the evidence was sufficient to support an inference that ABC “played a distinctly different role in the alleged schemes” than the taxpayers in the Tax Court cases.

ABC also argued that since the alleged fraud involved the “disposition phase” of the transaction. Thus, the crime-fraud exception did not apply to any communications concerning the “acquisition phase.” The Court held that the “acquisition phase” was a necessary predicate of the “disposition phase” and therefore the district court did not err in holding that the in-house attorneys could be questioned about all phases of the transactions. The Court noted that for the crime-fraud exception to apply, the attorney does not need to be implicated in any crime/fraud or even know of the existence of the crime or fraud. As the Court stated:

The District Court found that there is a reasonable basis to suspect that ABC Corp. was engaged in a large-scale criminal scheme that consisted of multiple phases. Although ABC Corp. suggests that there is no evidence implicating its former in-house counsel in the allegedly fraudulent transactions that occurred in the disposition phase of the scheme, because it is the criminal intent of the client and not its attorneys that matters, it is irrelevant whether the in-house counsel were only engaged in the scheme’s initial phases. If the acquisition phase was a critical component of the criminal enterprise (as the District Court found), any legal advice that ABC Corp. obtained to further those acquisitions was used for an improper purpose and is not entitled to any protection otherwise afforded by the attorney-client privilege or work-product doctrine.

Because the work-product doctrine protected the interests of the attorney separately from that of the client, the Court recognized that the crime-fraud exception might not apply in certain circumstances. However, since former in-house counsel did not appeal the order, the Court did not reach the question of whether the district court erred in holding that the exception did not apply. The Court then addressed the district court’s ruling that certain documents in the custody of former in-house counsel were not protected by the privilege. It held that the district court did not err in determining that the crime-fraud exception applied.

In concluding, the Court summarized its opinion:

1. ABC Corp. has standing to contest the grand jury subpoenas because it claims privilege in the sought-after documents and testimony. John Doe 1 and John Doe 2, in contrast, lack standing because they are not privilege holders, and do not have any other legally cognizable interest in the documents or testimony.

2. Even though ABC Corp. has standing, we lack jurisdiction to hear its appeal from the March Order because ABC Corp. may travel the well-worn contempt path to jurisdiction. If ABC Corp. wishes to appeal this Order immediately, it must take possession of its documents from Blank Rome, refuse to produce them to the Government, and appeal any resulting contempt sanctions. Because the parties have been unable to agree on a mechanism for transferring the documents, we lift the stay to allow the District Court to effect an appropriate transfer. In doing so, the Court, if it wishes, may designate a representative of ABC Corp. to receive delivery of the documents or direct ABC Corp. to do so.

3. We have jurisdiction to hear the appeal by ABC Corp. from the June Order because that Order is not directed to it and its former employees are unlikely to risk contempt sanctions on its behalf. Contrary to the Government’s suggestion, we decline to hold that the Supreme Court’s decision in Mohawk Industries, Inc. v. Carpenter, 558 U.S. 100 (2009), precludes Perlman appeals by grand jury subjects.

4. Finally, in reaching the merits of ABC Corp.’s appeal from the June Order, we hold that the Court correctly (a) applied the crime-fraud exception to deny ABC Corp. a privilege protection over testimony and two documents sought from its former in-house counsel and (b) determined that three documents sought from those counsel do not qualify as privileged.

One panel member concurred in part, but dissented from the Court’s determination that it did not have jurisdiction over the appeal from the order directed to ABC’s outside attorneys under Perlman. ABC could not be in contempt as the orders directed its outside counsel. Its only recourse from the order was to appeal. The concurring member would have asserted jurisdiction over the appeal and affirmed the district court.

Another case involving an attorney’s communications with a client is United States v. Powers, 2012 U.S. App. LEXIS 25582 (1st Cir. December 14, 2012). In many criminal tax cases, the defendant will assert as an affirmative defense that he relied in good faith on the advice of a qualified tax professional. If sufficient evidence is offered to support such a defense, it can negate willfulness, an essential element in criminal tax cases. In Powers the Court addressed an issue that has split the circuits: what standard of review applies where a district court refuses to give a jury instruction on the advice of counsel defense.

The defendants, Powers and Mahan, operated a temporary worker agency. The agency paid temporary workers in cash, did not file W-2s or 1099s for the workers, and did not report the monies paid workers on Forms 940 or 941. A jury convicted both defendants of 1) conspiracy to defraud the U.S. by impeding the lawful functioning of the IRS and 2) mail fraud. Powers was also convicted of signing false returns and Mahan was convicted of procuring the preparation of false
returns. The tax loss was over $7.5 million. Powers was sentenced to 84 months imprisonment and Mahan was sentenced to 76 months. They were jointly ordered to pay restitution of over $8 million.

Their appeal did not challenge the sufficiency of the evidence, but instead claimed that erroneous evidentiary rulings and jury instructions undercut their main defense: that they in good faith believed that the workers were independent contractors and not employees. On appeal they argued that the failure of the trial court to instruct the jury on the defense of good faith reliance on a tax professional was prejudicial error.

As recited by the First Circuit, the evidence at trial established that a CPA was hired in 2000 to prepare individual and corporate returns. Defendants told the CPA to deduct $1.9 million on the corporate return for temporary workers. The CPA advised the defendants that if the temporary workers were independent contractors the corporation was required to issue 1099s to them. She also advised them on the test for determining whether a worker was an employee or an independent contractor. Because the defendants did not follow the CPA’s advice, she terminated her engagement.

During 2000, the corporation was audited by the state unemployment assistance agency. Defendants hired an attorney to represent the corporation during the audit. The audit and subsequent administrative appeal resulted in a 2004 determination that the workers were employees for whom the corporation had to obtain unemployment insurance. Shortly after this determination, the corporation stopped doing business.

A CI investigation followed. When interviewed by IRS agents, Powers stated that he was not aware that Forms 1099 had to be issued to independent contractors and was never advised that they should be issued. During opening statement in the criminal case, defense counsel stated that he would present evidence that, in treating the workers as independent contracts, the defendants relied on advice from the attorney who represented the corporation in the state case. No such evidence was presented. The trial court refused defendants’ request to instruct the jury on reliance on counsel since no evidence was presented to support this instruction and even if there was some evidence, the general instruction on “good faith” was sufficient.

Generally, a criminal defendant is entitled to an instruction on a theory of defense if there is evidence in the record to support that defense. The First Circuit started its discussion by noting a split in the circuits concerning the standard for reviewing a district court’s refusal to instruct on reliance on counsel. The First Circuit reviews this under a de novo standard; other circuits, including the Ninth Circuit, use an abuse of discretion standard.

Regardless of the standard used, the First Circuit noted that the reliance on advice of counsel defense is “is not available to one who omits to disclose material information to advisors or dictates imprudent outcomes to advisors.” This was sufficient to dispose of defendants’ claim. Not only did the defendants and their former attorney not testify, the Government offered into evidence information presented by the attorney during the state agency proceedings which falsely described the relationship between the corporation and its workers and included false invoices that the corporation claimed it had received from workers. According to the Court, the source of the false information and invoices would have been from defendants, who were copied on the correspondence to the state agency. Thus, even if the attorney advised the defendants that the corporation could treat the workers as independent contractors, he was relying on misrepresentations. Thus, the defendants could not have relied in good faith on the advice.

The defendants raised several other objections common in criminal tax cases. Often, the Government has an IRS agent testify as a summary witness. The agent who testified in this case referred to the cash payments the corporation made to temporary workers as “cash payroll.” Defendants objected that this was a legal conclusion and that the district court erred in allowing this testimony. The First Circuit rejected this argument:

IRS agents may testify as summary witnesses in tax evasion cases to “analyze facts already introduced into evidence and spell out the tax consequences that necessarily flow from those facts.” [Citation omitted.] One “limitation on this type of evidence is that the agent may not testify about the defendant’s state of mind.” Nor may he testify as to the meaning of provisions of the Internal Revenue Code.

The agent summarized financial records concerning the amount of cash payments to workers and the tax that would be owed on these payments, and did not testify about either the defendants’ state of mind or the meaning of any provisions of the Code. His characterization was supported by ample evidence in the record. The district court therefore did not abuse its discretion by not striking the agent’s reference to the payments as “cash payroll.” The Court also rejected the defendants’ claims that the trial court erred by allowing lay witnesses to opine that the temporary workers worked for the corporation (rather than for the corporation’s clients).

Another recent case involving reliance on advice of a tax professional is Rawls Trading, LP v. Commissioner, T.C. Memo 2012-340, which held that the purchaser of a Son of BOSS shelter was not liable for accuracy penalties due to reasonable cause. The case was the consolidation of two TEFRA partnership proceedings involving partnerships set up by Jerry Rawls. Each partnership engaged in a Son of BOSS transaction that generated over $200,000,000 in paper losses. The facts are somewhat unusual because the taxpayer was able to show that he was not sophisticated about financial or tax matters, that he did due diligence, and that the CPA who prepared his return was independent of the promoters.

Rawls was an engineer who, in the mid-1980s, co-founded Finiser. He borrowed against his home for his share of capital contributions to the corporation. By the late 1990s, Finiser was a leader in the field of fiber optics. It made an initial public offering in 1999. In 2000, Rawls decided to sell part of his Finiser stock. At that time, his net worth consisted almost entirely of the stock. He had no will, had done no estate planning and did not have a personal attorney. In late 1999, he received an unsolicited phone call from Heritage Organization, which promoted itself as a tax and estate planning business. He met with Heritage representatives, did an investigation of the company, including contacting several former Heritage clients. He spoke with his brother, a CPA, about the proposed Heritage plan. His brother spoke with several other CPAs and told Rawls that Heritage had a good reputation among local CPAs and that its proposed plan looked legitimate.

Based on his due diligence, Rawls retained Heritage to do estate and tax planning. Heritage required an upfront retainer of $22,500 plus 25% of the tax savings from the use of its strategy. Rawls believed that the tax strategy proposed by Heritage was a legitimate way to reduce taxes while at the same time allowing him to diversify his holdings and provide a chance for a profit.

Because he had no attorney, Rawls got two recommendations from Heritage. He contacted both firms and hired a firm whose partner was a highly regarded estate planner. The firm did not receive any payments from Heritage nor did it pay anything to Heritage for the referral. It charged Rawls a flat fee of $150,000 for estate planning and advice on the Heritage transaction. The firm was of the opinion that the first Son of BOSS transaction Heritage executed on behalf of Rawls was flawed and would not pass scrutiny. Even though Heritage’s principals disagreed with the firm’s analysis, it did a second Son of BOSS transaction, involving different entities. After Rawls signed factual representatio
ns, the firm issued a more likely than not opinion letter as to the second transaction. It opined that a) the short option was not a partnership liability, thus making Rawls’ basis in the long option his basis in the partnership, b) the partnership anti-abuse regulations did not apply and c) neither the substance-over-form nor the step-transaction doctrines applied.

The firm did not issue any opinion letter on the first transaction.

Rawls moved from Texas to California in 2000. He had been using a Texas-based CPA to prepare his tax returns prior to 2001. The CPA had no experience with California taxes, did not due complex tax returns and was planning to retire. Rawls therefore obtained the names of several accountants in California from Heritage. He selected Lawrence Poster as his CPA. Poster had a law degree from Cornell, had spent 20 years as a CPA with major accounting firms before starting his own practice and had prepared returns involving section 752 issues.

Before preparing the 2000 tax returns for Rawls and the entities involved in the two Son of BOSS transactions, Poster had conversations with Rawls about the transactions, verified facts with Heritage and reviewed the opinion letter for the second transaction. He was aware there was no opinion letter for the first transaction. Poster advised Rawls to report both transactions, but to assume that the returns would be audited. Poster charged Rawls his normal hourly fees. Although several of his clients were referred by Heritage, Poster did not receive any payments from, or pay any referral fees to, Heritage.

The 2000 tax return Poster prepared reported the flow through losses generated by the Son of BOSS transactions. It also reported $39 million in charitable contributions, only $208,000 of which were deductible in 2000 due to the large Son of BOSS losses. The IRS conducted TEFRA audits and issued FPAAs to both partnerships challenging the losses reported on the partnership returns and asserting accuracy-related penalties. Rawls’ post-trial briefs addressed only the penalties. The Tax Court opinion focused on Rawls’ claim that the partnerships had reasonable cause defenses to penalties.

The Tax Court stated that to show reasonable cause, Rawls “must prove that he exercised ordinary business care and prudence as to the disputed items.” He could not rely on the advice of the promoters of the shelter. In concluding that the law firm, but not Poster, was a “promoter,” the Tax Court stated

We find on the basis of the above that Lewis Rice [the law firm] was a promoter. Like the lawyer in 106 Ltd., the Lewis Rice lawyers were not being paid to evaluate a deal or to tweak it; they were being paid to make the transactions happen. They did more than simply evaluate Heritage’s strategies; they implemented them. They created the entities involved and prepared all the paperwork involved. Therefore, Mr. Rawls cannot rely on the advice of Lewis Rice because it was a promoter of the transactions involved.

However, we find that Mr. Poster was not a promoter and Mr. Rawls can rely on his advice if he satisfies the three-prong test. Unlike the advisers in 106 Ltd., Mr. Poster did not introduce or suggest the transaction to Mr. Rawls and he did not coordinate the transaction. Mr. Poster was advising Mr. Rawls within his field of expertise, and he followed his regular course of conduct in rendering his advice.

Furthermore, his compensation did not depend on the outcome of the transactions, and he charged his normal hourly rate.

Slip op. at 33-34.

The Tax Court rejected the IRS’s claim that the CPA was not “competent.” While he reached an erroneous conclusion, the Court noted that the CPA had a law degree, had substantial experience in accounting, and had advised other clients regarding short sales with section 752 issues. It also rejected the IRS’s argument that Rawls failed to provide the CPA with all relevant information. He provided the CPA with all information requested about the transaction and the CPA verified information with Heritage and read the opinion letter. Finding that Rawls did not hid anything from the CPA, the Court stated that “One of the reasons clients seek the advice of lawyers and accountants is that those advisers know what information is important and what questions to ask. Mr. Rawls provided the information he thought was necessary.” Slip op. at 37.

Finally, the Tax Court turned to the question of whether Rawls’ reliance on Poster was in good faith. The Tax Court found that Rawls was not a sophisticated investor and was unfamiliar with tax issues. Prior to 2000, his returns were all simple and did not present any complex issues. There was nothing that would suggest to a person of his education and experience that the advice was wrong or that it was “too good to be true.” Therefore, Rawls had reasonable cause and acted in good faith when he reported the transactions on his 2000 tax return.

Bridgmon v. Commissioner, TC Memo 2012-322, deals with the IRS’s use of telephonic CDP hearings. The taxpayer petitioned the Tax Court for review of a CDP determination upholding Final Notice/Notice of Intent to Levy. After the taxpayer failed to file returns for 2003 and 2004 the IRS issued a 90 day letter based on substitutes for return under 26 USC section 6020. In response, the taxpayer filed returns for both years. The IRS made assessments based on the amounts shown due on the returns, plus penalties and interest. The taxpayer also filed a late balance due return for 2005.

After the returns were filed the IRS sent the taxpayer balance due notices that did not contain explanations of how the it arrived at the amounts shown. In October, 2009, it sent her a Final Notice/Notice of Intent to Levy. The taxpayer filed a timely CDP request and checked the boxes “Installment Agreement” and “Offer in Compromise.” She also wrote as another reason for protesting “Wrong Amount.” She attached a statement concerning her financial situation and her numerous attempts to reach the IRS by phone.

The taxpayer lived in Florida, so the CDP was assigned to the Memphis appeals office, which sent her a letter scheduling a telephone conference for June 16, 2010, and stating that it could not consider any collection alternative unless all her returns were filed and she had submitted a completed Form 433A within 14 days. The taxpayer called the Memphis appeals office at the scheduled time (and several times thereafter), but no one answered. By letter dated June 16, 2010, the Memphis appeals office informed her that she had not called at the scheduled time or requested that the conference be rescheduled and, if she had any information she wished the IRS to consider, she should submit it within 14 days. On October 6, 2010, the appeals office issued a notice of determination sustaining levy action. The notice stated that the taxpayer had failed to call at the date and time scheduled and failed to submit information and, since she “did not cooperate with us,” it could not consider her claim that the amount was wrong. The taxpayer petitioned the Tax Court.

The Tax Court first addressed the taxpayer’s challenge to penalties for 2003 and 2004. It held that since she received a notice of deficiency for those years and did not petition the Tax Court, she could not challenge the penalties.

The Court then turned to her claim that she was entitled to a collection alternative. The IRS argued that the taxpayer was not, since she allegedly failed to call the appeals office at the scheduled time and did not submit a Form 433. The Court found the taxpayer’s testimony that she called the appeals office several times credible, even though the IRS files did not reflect receipt of any calls from her and it issued a letter stating that she did not call. The Court stressed the importance of the telephone conference, which was her opportunity to discuss with appeals why she disagreed with the notice, potential collection alternatives and to ask questions she might have. While the Tax Court on other occasions
has held that a failure to contact appeals for a conference and a failure to submit requested financial information can justify the appeals office’s determination not to consider collection alternatives, since she did attempt to phone, the failure of appeals to make additional efforts to contact the taxpayer was an abuse of discretion. The Court remanded the case back to appeals to consider issues raised by the taxpayer other than the amount of the liability.

In a not for publication decision, Ford Motor Co. v United States, Docket No. 10-1934 (6th Cir., Dec. 17, 2012), the Sixth Circuit addressed the issue of whether Ford was entitled to interest on an overpayment from the date it made a deposit or from the date the deposit was converted to an advance payment of tax. While under audit, Ford had made hundreds of millions of dollars of deposits. It subsequently requested that the deposits be converted to advance payments of tax. The IRS determined that Ford had overpaid its tax for the years for which the deposits were made. It refunded the amount of the overpayments with interest from the date the deposits were converted to advance payments. Ford sued for interest from the date of the deposits to the date of conversion. Affirming a district court judgment in favor of the Government, the Court held that there was no waiver of sovereign immunity under 26 USC section 6611 that would allow Ford to recover interest.

Prior to the enactment of 26 USC section 6603, the courts had recognized that a taxpayer can made a deposit of tax rather than a payment of tax. See Rosenman v. United States, 323 US 658 (1945). The IRS issued Rev. Proc. 84-58, which allowed a taxpayer to make a deposit of tax to stop the running of interest. The issue before the Court was whether a deposit in excess of the amount of tax subsequently determined to be due was an “overpayment” for purposes of 26 USC section 6611, which requires interest to be “allowed and paid” on any overpayment of tax.

The parties’ arguments were summarized by the Court:

The government seizes upon the plain meaning of the word “payment,” arguing that there can be no overpayment until there has actually been a payment–and there was no payment until Ford requested that its deposits be converted into tax payments. Prior to that point, Ford’s remittances were, at its own request, treated as deposits in the nature of a cash bond and Ford could have requested their return at any time. As Revenue Procedure 84-58 section 2.03 clearly states, “[a] deposit in the nature of a cash bond is not a payment of tax.” Accordingly, the government argues that it does not owe Ford interest from the date of the original remittances because they were indisputably made only as deposits, not as payments of any tax obligation.

Ford counters that the “most appropriate starting point” is not section 6611, but rather section 6601, the provision that governs underpayment interest. First, Ford contends that these two sections should be interpreted symmetrically because they both use very similar language, compare section 6601 (“date paid”), with section 6611 (“date of the overpayment”), and both deal with the accrual of interest on tax payments. Second, Ford notes that under section 6601(a), only a “payment” stops the accrual of underpayment interest against a taxpayer, and since a deposit in the form of a cash bond stops the accrual of interest from the date it is remitted, Rev. Proc. 84-58 Section 5.01, that deposit must be considered a payment under section 6601(a). And because a deposit is treated as a payment for underpayment interest purposes under section 6601, it should also be considered a payment for overpayment interest purposes under section 6611. In other words, if a mere deposit stops the accrual of underpayment interest, then a mere deposit must also start the accrual of overpayment interest.

The Court found both readings of the statutory provisions “plausible.” It noted that the Government’s reading ignored the fact that a remittance is treated as a payment under 26 USC section 6601, at least insofar as it stops the accrual of underpayment interest. Ford’s reading, on the other hand, ignored the “natural reading” of “date of overpayment” and the fact that secs. 6601 and 6611 do not use identical language. This made section 6611 “ambiguous as to when the accrual of overpayment interest begins.”

The Court then addressed waivers of sovereign immunity in the tax arena. Based on Supreme Court precedent, including Flora v. United States, 362 US 145 (1960), the Court read 28 USC section 1346(a)(1)’s waiver of sovereign immunity in a taxpayer’s suit to recover “any sum alleged to have been excessive or in any manner wrongfully collected,” to include interest on tax overpayments. This did not help Ford, since it hadn’t shown that there was an “overpayment” for the period prior to its conversion of the deposits.

The Court addressed Ford’s reliance on Rev. Proc. 84-58, noting that a revenue procedure does not have the status of a law or a regulation and does not bind courts or the IRS. Slip op. at 13. It found Ford’s interpretation of the revenue procedure “superior” to the Government’s “strained” reading. Since a revenue procedure was only a statement of procedure, it was not a good indicator of the scope of the waiver of sovereign immunity. The Court also found Ford’s argument about subsequent legislative history unpersuasive, since subsequent legislation is given little weight. The Court therefore ruled in favor of the Government.

The decision is of limited application, given the passage of section 6603 in 2004. Under that section, a deposit of tax is treated as a payment for purposes of section 6611 to the extent it is with respect to a “disputable tax.” Sec. 6603(d)(2)(A) defined “disputable tax” as “the amount of tax specified at the time of the deposit as the taxpayer’s reasonable estimate of the maximum amount of any tax attributable to disputable items.” An item is a disputable item if the taxpayer had a reasonable basis for its treatment of the item and it reasonably believes that the IRS has a reasonable basis for “disallowing the taxpayer’s treatment” of that item. Sec. 6603(d)(3)(A). Under 6003, a taxpayer can get interest, albeit computed at the Federal short-term rate (presently 0.24%) compounded daily, but only if the tax is disputable.

In Banister v. Department of Treasury, 2012 U.S. App. LEXIS 24179 (9th Cir. November 23, 2012), the Court affirmed a decision upholding a determination by OPR to disbar the plaintiff from practicing before the IRS. Banister admitted that he advised clients that they did not have to pay income tax because of his belief that a) the Sixteenth Amendment was not properly ratified and b) under 26 USC section 861, his clients were not subject to income tax. Banister argued that the Administrative Law Judge erroneously failed to consider his “good faith belief” defense in determining that Banister acted willfully. The Ninth Circuit held that a belief that the income tax law was unconstitutional could not be used as a good faith defense in a hearing to determine whether a person should be disbarred from practice before the IRS. In Cheek, 498 U.S. 192 (1991), the Supreme Court distinguished between “innocent mistakes” about the applicability of the tax law and a knowledge of the 26 USC section and a determination that the Code’s provisions were illegal or unenforceable. Since Banister’s belief about the invalidity of the Internal Revenue Code was irrelevant to the issue of willfulness, the ALJ’s findings were not erroneous.

The Ninth Circuit further noted that Banister admitted to conduct that constituted “disreputable behavior” under 31 CFR 10.50 (which authorizes the disbarment of a practitioner whose conduct is incompetent or disreputable). Advising clients not to pay tax based on positions he could not, in good faith, have believed were consistent with the law violated 31 CFR 10.51(a)(7) (which defines “disreputable conduct” as including “will
fully assisting, counseling, encouraging a client or prospective client in violating, or suggesting to a client or prospective client to violate, any Federal tax law, or knowingly counseling or suggesting to a client or prospective client an illegal plan to evade Federal taxes or payment thereof”), 31 CFR 10.51(a)(13) (giving a false opinion or engaging in a pattern of providing incompetent opinions in questions involving federal tax laws), and 31 CFR 10.22 (failing to exercise due diligence). His signing returns based on his espoused beliefs violated 31 CFR 10.34 (advising a client to take a frivolous position on a tax return).

Finally, given Banister’s admissions, the Court held that the ALJ did not err in refusing to allow discovery, witness testimony or cross examination.

In 1920, Justice Oliver Wendell Holmes, Jr., wrote a one-page seminal tax opinion, Rock Island, A. & L. R.v.United States, 254 US 141 (1920). It included the memorable sentence that “Men must turn square corners when they deal with the Government.” On November 29, 2012, the Tax Court issued a 107 page opinion in Romano-Murphy v. Commissioner, T.C. Memo. 2012-330, addressing the issue of whether the taxpayer is liable for a trust fund recovery penalty under 26 USC section 6672. Among other questions the Tax Court wrestled with was whether the business had overpaid its tax in an earlier period by less than $25, which amount should have been applied to the quarter for which the penalty was assessed.

Lynda Romano-Murphy was a founder and 25% co-owner of Nurses PRN, LLC (“NPRN”), a health-care staffing agency that supplied nurses on a temporary basis to hospitals. NPRN owed $346,732.38 in FICA and income withholding taxes. The IRS issued a letter to the taxpayer stating that it determined she was liable for a trust fund recovery penalty. Although she filed a protest, she was not granted an appeal hearing and the IRS assessed the penalty one month after it received her protest letter. The IRS issued lien and levy CDP notices and she filed a request for a CDP hearing, asserting that she was not liable for the penalty. The Appeals Office determined that she was a responsible person of the corporation who willfully failed to collect, account for and pay over the tax. She therefore petitioned the Tax Court.

The parties stipulated that Ms. Romano-Murphy was chief operating officer and secretary of NPRN, managed the payroll, accounting and accounts receivable departments, controlled the business’ finances, signed checks to creditors and signed the federal employment and income tax returns. The parties further stipulated that the business always operated at a loss, and for several quarters before the one in issue (second quarter of 2005) had failed to pay all the employment taxes due.

MSSI paid the IRS $1.6 million, of which only $73,000 was applied to the second quarter of 2005. The remainder was applied to employment tax owed for 2004.

Ms. Romano-Murphy became the vice-president, operations, of the MSSI subsidiary that acquired NPRN’s assets. During the one-year period she held this position, the subsidiary paid the IRS $70,000, which was applied to NPRN’s 2004 liabilities. After MSSI and its subsidiaries filed for bankruptcy, the IRS began a trust fund recovery penalty investigation and determined that Ms. Romano-Murphy was liable for the unpaid withholding tax.

After a lengthy recital of the facts, the Tax Court began its analysis by stating that where a taxpayer challenges the underlying tax liability in a CDP case, the Court applies a de novo standard of review. The Court outlined in detail employment tax laws, including the time for making deposits, the EFTS method of payment, and the trust fund recovery penalty.

The Court then addressed the first issue raised by the parties: whether the IRS should have applied to the second quarter of 2005 withholding tax the amounts deposited during that quarter, the $73,000 from the $1.6 million payment and the $70,000 received from the MSSI subsidiary that acquired NPRN’s assets. If applied to withholding tax, this would have reduced the trust fund recovery penalty to $40,000. The IRS argued that an employer cannot direct how deposits are to be applied, only how payments are to be applied, and that NPRN never gave written directions on how any payment was to be applied. [A taxpayer can direct how the IRS is to apply a voluntary payment as long as written directions are given at the time of payment.] Although the taxpayer testified that directions were given to the IRS, no document directing the IRS to apply any payments to 2005 withholding tax was introduced into evidence. The Tax Court held that no written directions were given, so that the IRS could apply the deposits and payments as it saw fit.

The Court then turned to the question of whether Ms. Romano-Murphy was a responsible officer. Given her position in the company (25% owner, COO, in charge of finances and signing checks to creditors), this issue was easily resolved. The Court rejected the taxpayer’s arguments that as a 25% owner she lacked authority and that as a member of an LLC, she was shielded from personal liability for the tax owed by the business. Since the IRS was not seeking to hold her directly liable for the debts of the LLC, but only for the unpaid withholding tax under section 6672, the limited liability afforded LLC members did not shield her from liability.

The Court then turned to the issue of willfulness. The Court summarized the rules concerning willfulness as follows:

  • A responsible person who knows that other creditors are being paid while the trust-fund taxes have not been paid is liable for the penalty.
  • There may be a “reasonable-cause defense” if the responsible person took reasonable efforts to make a payment to the United States and, because of circumstances outside the person’s control, the payment was not made. However, reasonable efforts at payment are to no avail if the responsible person pays other creditors.
  • In any event, payment of the trust fund taxes relieves the responsible person of liability under section 6672.

Given the stipulated facts, it was easy for the Tax Court to conclude that Romano-Murphy willfully failed to pay the withholding tax – she was aware throughout the second quarter of 2005 of the unpaid tax liability. Despite her claims that she made various efforts to pay the tax, she did not do so. She continued to authorize payments to other creditors. Her attempts to arrange a merger with another company that would have paid the tax is not a reasonable effort to pay the tax. Even if MSSI, in the merger agreement, assumed NPRN’s employment tax liability, this was insufficient to relieve Romano-Murphy of liability.

Justice Holmes’ opinion in Rock Island, A. & L.R. v. United States, held that a taxpayer could not file a refund suit unless it first filed an administrative refund claim. Protesting the proposed assessment before payment was not enough. The Court of Federal Claims recently addressed exceptions to the requirement of a formal claim for refund in Blue v. United States, 2012 US Claims LEXIS 1621 (December 20, 2012). The IRS conducted a correspondence audit with the taxpayer about the taxability of his pension. Determining that it was taxable, the IRS issued a notice of deficiency. Instead of petitioning the Tax Court, the taxpayer filed a protest with Appeals. Since no Tax Court petition was filed, the IRS assessed the tax, which the taxpayer paid.

More than a year later, the taxpayer received a letter from Appeals stating that his pension income was properly increased and, therefore, his “claim for refund in the amount of $2,847.00” was disallowed. The letter further advised that the taxpayer could seek a refund by filing a suit in district court or the Court of Federal Claims. He petitioned the Tax Court, which dismissed for lack of jurisdiction. He then filed a refund suit in the Court of Federal Claims.

The Government filed a motion for a more definite statement and a
motion to dismiss on the ground that the taxpayer had not filed an administrative claim for refund, which is a jurisdictional prerequisite to a refund suit. The taxpayer filed a motion for summary judgment. The Court denied all three motions, holding that it had jurisdiction and that the taxpayer’s complaint sufficiently apprised the Government of the basis of his claim.

In addressing the question of jurisdiction, the Court recognized that there are four exceptions to the requirement of a formal claim: 1) the informal claim doctrine, under which a timely informal written refund claim is sufficient if it apprises the IRS that a refund is sought, states the legal and factual basis of the claim and is subsequently followed by a formal claim for refund; 2) the waiver doctrine, where the IRS acts on an informal claim as if it were a formal claim; 3) the general claim doctrine, which is where a taxpayer files a timely formal general claim for refund and amends it by filing an amendment outside the period for filing a refund claim that makes the claim more specific; and 4) the germaneness doctrine, which is where the taxpayer files a timely formal claim for refund and subsequently, outside the period for filing a refund claim, files an amendment that raises a new legal issue that is “germane” to the original claim and is based on the same facts as the original claim.

Since the taxpayer never filed a formal refund claim, neither the germaneness doctrine nor the general claim doctrine applied. Even if the taxpayer’s protest was viewed as an informal claim, the informal claim doctrine did not apply since he never perfected it by filing a formal refund claim.

The Court held that the waiver doctrine applied. Under Angelus Milling Co. v. Commissioner, 325 US 293 (1945), if the IRS adjudicates a claim within the statutory period for filing a formal claim, the taxpayer’s failure to file a formal refund does not bar a refund suit. In the case before it, the IRS treated the protest as a claim for refund, as was evident by the fact that Appeals wrote the taxpayer that it was denying his refund claim and that he could file a refund suit. As a result, the IRS had waived the requirement of a formal refund claim and the Court therefore had jurisdiction.

As to the government’s motion for a more definite statement, which was based on the taxpayer’s failure to attach a copy of his refund claim to the complaint, the Court held that his factual allegations sufficiently apprised the Government of the basis for his claim. The Court denied the taxpayer’s motion for summary judgment, since there were insufficient facts concerning his claim.

In a decision that will have major implications for the OPR’s ability to police practitioners, the District Court for the District of Columbia invalidated the regulation making Circular 230 applicable to return preparers in Loving v. Internal Revenue Service, Civil No. 12-385(JEB). The plaintiffs were three return preparers who filed an action for declaratory and injunctive relief, seeking to invalidate the 2011 amendments to Circular 230 that extended its reach to return preparers who did not represent clients in audits or appeals.

The IRS’s authority to regulate persons who appear before it derives from 31 USC section 330. That section, which was enacted in 1884, empowers the Secretary of Treasury to

  1. Regulate the practice of representatives of persons before the Department of Treasury; and
  2. Before admitting a representative to practice, require that the representative demonstrate
    1. good character;
    2. good reputation;
    3. necessary qualifications to enable the representative to provide to persons valuable service;
    4. and competency to advise and assist persons in presenting their cases.

Sec. 330 additionally empowers the secretary to fine, suspend or disbar from practicing before the IRS an individual who is incompetent, disreputable, violates rules prescribed by the IRS, or willfully and with intent to defraud misleads or threatens a person being represented.

To determine the validity of the regulation, the Court applied the two-step analysis of Chevron USA v. NRDC, 467 US 837 (1984). Under step one of Chevron, the court must determine whether “Congress has spoken to the precise question at issue.” If the statute is ambiguous or silent on the matter, the court must then proceed to step two, to determine whether the agency interpretation is a reasonable construction of the statute.

Initially, the IRS claimed that Chevron was not applicable, since every agency has the inherent authority to regulate who practices before it. The Court rejected this argument, since it begged the question: were tax return preparers persons who practice before the IRS? Since the plaintiffs did not argue that, if the statute was ambiguous, the IRS’s interpretation would be arbitrary, capricious or manifestly contrary to the statute, Chevron’s step two analysis was not necessary. Thus, the only question was whether section 330 was ambiguous as to whether return preparers are “representatives” who “practice” before the IRS? This required an analysis of the statutory language.

The IRS asserted that “representative” and “practice” both have broad meanings and thus the words were ambiguous. The Court found that this “simplistic approach will not fly.” To determine whether the statutory language applied to return preparers required a review of the language of the statute as a whole. In so doing, the Court focused on subsection (a)(2)(D), which allows the Secretary to require the representative to demonstrate “competency to advise and assist persons in representing their cases.” This indicated that representatives who could be regulated by the Secretary assisted persons in “presenting a case.” While the IRS accepted that return preparers do not advise or assist in presenting their clients’ cases, it argued, instead, that it would be nonsensical for Congress to allow the IRS to regulate those who present cases, but not those who prepare returns, since only a small fraction of returns are audited and thus become “cases.” The Court found nothing strange about Congress wanting those who present cases to be more closely regulated than those who prepare returns.

Since the statutory language could not be viewed in a vacuum, the Court then moved to other related statutes that, in its view, undercut the IRS’s interpretation. These were the sections of the Internal Revenue Code that create “a relatively rigid penalty scheme to punish misdeeds by tax-return preparers.” The Court reasoned that if section 330 applied to return preparers, the IRS could do an end run around this statutory scheme by using its discretionary power to impose monetary sanctions on return preparers for conduct that otherwise would be subject to the Code’s penalty regime. Since these penalty provisions of the Code were specific statutes while section 330 was general, the Court declined to interpret section 330 in a way that conflicted with the specific statutory authority.

The Court also looked to section 6103(k)(5), which authorizes the IRS to disclose penalties to state and local agencies that register, regulate and license return preparers. That section lists several specific penalties, but not section 330. From this, the Court deduced that if Congress meant to empower the IRS to regulate return preparers, it was strange that the section was not listed as one of the penalties that could be disclosed to state and local agencies.

The Court then turned to section7407, which authorizes the IRS to bring an action to enjoin a return preparer from further engaging in certain types of conduct or from acting as a return preparer. Allowing the IRS to regulate return preparers, and disbar or suspend them, would mean that the IRS could side step the protections afforded by an injunction action in district court. This would make section7407 “a pointless statute.” The Court noted, however, that injunctive relief could be a mor
e potent weapon than mere disbarment, so that the statute might not be pointless. This was especially true in light of section7408, which allows injunctions against any person, including attorneys and CPAs, who are subject to Circular 230. Since the IRS did not address this point, the Court stated that it would not “generate” arguments the IRS did not make. The Court “concludes that together the statutory text and context unambiguously foreclose the IRS’s interpretation” of section330.

The Court next addressed several nontextual arguments advanced by the IRS, including that regulating return preparers was vital in protecting the federal interest in collecting the revenues, that the legislative history supports its interpretation, and that various regulations support its interpretation. The Court rejected the first argument, which it deemed a policy argument that is up to Congress to decide. The legislative history did not contain any clear evidence of congressional intent on the question before the Court. Finally, regulations promulgated by the IRS cannot change the meaning of a statute.

Based on its determination that the statute did not authorize the IRS to regulate return preparers, it granted declaratory relief that the regulations subjecting return preparers to Circular 230 were without statutory authority. The Court also permanently enjoined the IRS from enforcing the regulatory scheme against return preparers.

If the District Court’s decision is not reversed on appeal, the IRS will need to go to Congress to obtain authority to regulate return preparers. The decision may also have a broader reach. Although the Court limited its ruling to return preparers, its decision turned on the language of section 330(b)(2)(D), concerning persons presenting cases before the IRS. Attorneys and CPAs who advise clients on tax matters, do tax planning or prepare return, but do not represent clients before the IRS, do not “present cases.” Thus, they could argue that the IRS lacks authority to subject them to Circular 230.

Robert S. Horwitz, Esq.

Law Offices of A. Lavar Taylor
6 Hutton Center Dr., Ste. 880
Santa Ana, CA 92707

Note from The Editor

Tax Network is published quarterly.

Editor: Joseph P. Wilson, Esq.

Editor’s Note

In this edition, I would like to thank all those who participate or have participated in Low Income Taxpayer Clinics. The services that these clinics provide help those that cannot otherwise afford representation. The benefit to taxpayers who would otherwise go without representation is immeasurable. These tax clinics also benefit the IRS and Tax Court in addition to taxpayers because the clinics help facilitate settlement and resolutions which promotes more effective tax administration. I encourage practitioners to dedicate time and expertise to a local tax clinic. These clinics provide numerous opportunities for each other and the taxpayers.

I would also like to give a special thanks to Jane Becker and her trusted legal assistant, Ally Nelson. Both Jane and Ally contributed valuable time and energy to help edit this Newsletter.

This publication is designed as a discussion vehicle for professionals. The ideas presented herein should be researched independently and adequately, and not relied upon. This publication is not engaged in rendering legal, accounting, or other professional services. If legal advice or other expert assistance is required, the service of a competent professional should be sought.

Committee Roster

David Warren Klasing
Attorney at Law & CPA
The Tax Law Offices of David W. Klasing
2372 Morse Avenue
Irvine, CA 92614
Tel: 949-681-3502
Fax: 949-681-3504

Chair Elect
Jane Becker
Attorney at Law
The Law Offices of Jane Becker
1537 Pacific Avenue
Santa Cruz, CA 95060

First Vice Chair & Secretary
Attorney at Law
Law Offices of Patrick Crawford
1801 Century Park East
24th Floor, Suite 2400
Los Angeles, CA 90067
Tel: 310-488-5514
Fax: 424-288-4012

Second Vice Chair & Editor
Joseph P. Wilson
Attorney at Law
Law Offices of A. Lavar Taylor
6 Hutton Center, Suite 880
Santa Ana, CA 92627
Tel: 714-546-0445
Fax: 714-546-2604

Past Committee Chairpersons:

2012 Michel R. Stein
2011 Robert Horwitz
2010 Michael R.E. Sanders
2009 Kornelia Davidson
2008 LaVonne D. Lawson
2007 Cathy Stahler
2006 Joseph A. Broyles
2005 David B. Porter
2004 Steve Blanc
2003 Edward T. Perry
2002 Abraham Brown
2001 Dennis Perez
2000 Dennis Brager
1999 Woody Rowland
1998 Judy Hamilton
1997 Charlene Woodward
1996 David Lee Rice
1995 R. Todd Luoma
1994 A. Lavar Taylor
1993 Jennifer Miller Moss
1992 Evan Smith
1991 Mark Ericsson
1990 Jennifer Miller Moss

Submission Deadlines

Send Your Tax Network Submissions To:

Joseph P. Wilson
Attorney at Law
Law Offices of A. Lavar Taylor
6 Hutton Center, Suite 880
Santa Ana, CA 92627
Tel: 714-546-0445
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Submission Due Dates:

  • February Issue: January 18, 2013
  • May Issue: April 17, 2013
  • August Issue: July 18, 2013
  • November Issue: October 18, 2013


1 250% of Poverty Guidelines. Back

2 There was an amicus brief submitted in this case, which was written by A. Lavar Taylor on behalf of the Center for the Fair Administration of Taxes. Back

3 Section 1702.5 refers to Title 18 of the California Code of Regulations, section 1702.5 Back

4 Section 1702.6 Suspended Corporations refers to Title 18 of the California Code Regulations, section 1702.6 Back

5 State Board of Equalization Operations Memo Number 1160 (last revision December 15, 2010) section IV, Paragraph 5. Willfulness: “After determining who the responsible person or persons are for the entity, you must then establish whether that person or persons knowingly failed to pay the taxes. That is, were funds available to pay the taxes? Did the responsible person choose instead to make payment to others?” Back

6 Jack D. Freels, In the Matter of the Claim for Refund under the Sales and Use Tax Law; 1997 Cal. Tax LEXIS 277; MEM. OPIN. 97-001 “Under the statutory provisions of the Sales and Use Tax Law there is further authority to hold officers-shareholders of a suspended corporation liable for the sales tax which the
business owes the Sate and has already collected from customers as sales tax reimbursement. The officers … are the persons who conduct the business of the corporation, and if the Board were to pursue someone other than the corporation for liabilities generated during the period of suspension the persons to pursue are the persons who conduct the business.” Back

7 These included, but are not limited to: A suspended corporation lacks standing to pursue an appeal before the SBE. In Re DPEX, Inc., Case Number 287820, 207 Cal. Tax Lexis 46: “This Board has consistently held that a suspended corporation is without authority to prosecute, bring or maintain an appeal before the Board.” When suspended, the FTB will not process an amended return or issue refunds due for prior years when it was not suspended, and it will not honor a return extension request, thus causing the corporation to incur failure to file penalties. See Amertranz Worldwide, Inc. v. State Board of Equalization, 2004 Cal. Tax LEXIS 25; RJ Standard Corporation v. State Board of Equalization, 2004 Cal. Tax LEXIS 525. Further, if a corporate transferor has been suspended the transferee has no standing to contest the transferor’s liability. “A suspended corporation cannot file a protest or petition for reassessment. The assignee of a suspended corporation has the same disabilities as its assignor. (citation omitted). The transferee of a suspended corporation should also be subject to the same disabilities as an assignee.” Legal Ruling Number 395, California Franchise Tax Board, 1976 Cal. FTB LEXIS 1. Back

8 See In re: Todd S. Latin v. SBE, 2009 Bankr. Lexis 4523. Case noted as not for publication. Back

9 In Lonnie Davis Naefke, SBE Appeals Division Summary for Board Hearing, Case ID 458687 (undated) it is noted “… ‘willfulness’ is not an element of responsible personal liability under Regulation 1702.6. Thus, the only issue in dispute is whether the taxpayer was a responsible person, which means an officer or shareholder who was charged with the responsibility for the filing of returns or the payment of tax or who had a duty to act for the closely held corporation in complying with any provision of the Sales and Use Tax Law, and who derived a direct financial benefit from the failure to pay the tax liability.” Back

10 An amicus brief had been submitted in this case, which was written by A. Lavar Taylor on behalf of the Center for the Fair Administration of Taxes. Back

11 See the provisions within 26 U.S.C. section 6015(b) and (c) relief for understatements of income attributable to the non-requesting spouse. This note solely discusses the discretionary relief available under section 6015(f) relief from the joint and several liability of income tax debt. Back

12 Practitioners should make every effort to secure relief at the preliminary determination, at the final determination, at appeals, and prior to trial. Practitioners may come into an innocent spouse case shortly before trial. Quick action is required to utilize the reviewing court’s de novo standard of review, and to bolster the record to clearly establish a foundation for a favorable determination as to each of the factors evaluated in these cases. Back

13 Relief is usually granted at the preliminary review if the non-requesting spouse has been convicted of tax crimes. Similarly, relief is usually granted to the requesting spouse at the preliminary review stage if she has suffered severe physical abuse from the non-requesting spouse. The facts in most innocent spouse case facts are not as persuasive as these two examples. Back

14 In cases where relief is denied in full or in part, the Internal Revenue Manual (IRM) states Form 886-A will be sent to the requesting spouse and that it will contain sufficient information to provide the requesting spouse with the ability to adequately protest the adverse initial determination. See IRM, Innocent Spouse Workpaper Documentation. Notwithstanding this IRM guidance, Form 886-A is not always provided. On occasion a Form 886-A is secured only through specific and persistent requests. The information provided by 886-A is a critical requisite for the preparation of an effective protest or appeal of a denial of innocent spouse relief. Back

15 The IRS has recently prepared an expanded Form 8857 Request for Innocent Spouse Relief in draft form. The form has been expanded to seven pages and includes several new questions. A specific section was added to provide an opportunity for the requesting spouse to describe abuse from the non-requesting spouse. The draft Form 8857 indicates a revision date of December 2013 so practitioners may be able to utilize a final version of the new form by the end of the year. Back

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