California Journal of Tax Litigation, 2014 3rd Quarter

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In This Edition

Key Dates

Message from the Chair
LaVonne D. Lawson, Law Office of LaVonne Lawson

Photos from the May Meeting

Minutes of the May 30, 2014 Tax Procedure & Litigation Committee Meeting. Courtney
A. Hopley, Greenberg Traurig LLP

YTL Corner (All Readers Welcome).
A Tax Attorney’s Professional Conduct Is Governed By More Than Circular 230. John A. Harbin, The Law Offices of John A. Harbin

Practice Pointers.
Gregory Harper, Harper Legal Group, P.C.


Publication Submission Deadlines


Key Dates

August 29, 2014 – Quarterly meeting of the Tax Procedure & Litigation Committee. 11:00 a.m. – 3:00 p.m. Greenburg Traurig LLP, Four Embarcadero, Suite 3000, San Francisco. RSVP to LaVonne Lawson,

November 6 – 8, 2014 – Annual Meeting of the California Tax Bar and California Policy Conference, Loews Coronado Bay Resort, San Diego. Read about the program here, and make plans to participate.

Message from the Chair

LaVonne D. Lawson

Greetings! Well, I sure hope that you are having a wonderful summer. Now is the time to enjoy it. It may not feel like it right now, but in another month, we will greet the beginning of autumn (which will probably also feel a lot like summer out here – but that’s a different conversation).

As they say, “nothing is more certain than change,” and certainly we are heading for a change – marching to the conclusion of another year for our Tax Procedure and Litigation Committee. And what a year it’s been! As I started this term, I was thankful for the opportunity to chair this vibrant committee. And I remain thankful. This has been a great term shared with you, an incredible group of tax lawyers and practitioners. I worked with an excellent set of officers who will lead the charge going forward. Next term, Joe Wilson will step into the position of committee Chair. Courtney Hopley will become Chair Elect. And Carolyn Lee will be the new First Vice Chair/Secretary. The position of Second Vice Chair/Journal Editor will be filled by Kevan McLaughlin.

We Value Tradition (Or . . . If It Ain’t Broke, Don’t Fix It!).

Our committee has continued to do what it does well. For one thing, we meet in person, which offers a host of benefits. As you know, The Tax Procedure and Litigation Committee meets on a quarterly basis, generally twice annually in Northern California and twice annually in Southern California. We have a variety of members, located throughout the state, who have much to share. Meeting in person allows for the opportunity to communicate with practitioners we might not otherwise meet in our local activities, thereby expanding our networks. Our meetings also provide a setting to interact with government professionals, receive in-person presentations, and participate in lively conversations. This year, we met at the Board of Equalization Boardroom in Sacramento and received an excellent presentation from Kevin Hanks, Chief of Headquarters Operations Division. We also received a great presentation from Kristen Deazeley, Stakeholder Liaison for Small Business/Self-Employed Division, during our meeting in Santa Ana. At our upcoming meeting in San Francisco, we will receive, from our own committee members, a presentation on recent changes in offshore compliance programs.

Our committee has continued to do what it does well. For one thing, we meet in person, which offers a host of benefits. As you know, The Tax Procedure and Litigation Committee meets on a quarterly basis, generally twice annually in Northern California and twice annually in Southern California. We have a variety of members, located throughout the state, who have much to share. Meeting in person allows for the opportunity to communicate with practitioners we might not otherwise meet in our local activities, thereby expanding our networks. Our meetings also provide a setting to interact with government professionals, receive in-person presentations, and participate in lively conversations. This year, we met at the Board of Equalization Boardroom in Sacramento and received an excellent presentation from Kevin Hanks, Chief of Headquarters Operations Division. We also received a great presentation from Kristen Deazeley, Stakeholder Liaison for Small Business/Self-Employed Division, during our meeting in Santa Ana. At our upcoming meeting in San Francisco, we will receive, from our own committee members, a presentation on recent changes in offshore compliance programs.

Our committee members are active. Members participated in Sacramento and Washington D.C. Delegations. (These programs have, at times, also provided opportunity for newer and more experienced practitioners to work together.) Members put on webinars, participated in the Annual Income Tax Institute in three cities, and presented at the State Bar’s Solo and Small Firm Conference. Members are scheduled to present at the upcoming State Bar Annual Meeting in September and at the State Bar Annual Tax Section Meeting in November.

Our committee continues to put out an excellent publication: the California Journal of Tax Litigation. Our Journal provides an array of articles, information and updates that should be a “must have” for every tax lawyer’s library. In addition to allowing us to communicate as a committee, the Journal provides another platform by which our members can be published. Any of our members who have an interest in being published, either in our California Journal of Tax Litigation, or in the Taxation Section’s California Tax Lawyer, should not hesitate to reach out.

We Try New Things.

We also tried new things, some in response to requests from our membership. We have incorporated into our meetings, prior to our celebrated “Hot Topics” discussion, the opportunity to discuss law practice management issues (a time for straight talk about the business of law).

Our committee publication not only received a new name this year, it incorporated a couple of new columns: one focusing on practice management tips, and one focusing on issues particularly relevant to newer practitioners. The incorporation of new columns to reflect other perspectives on topical issues is consistent with our “the more the merrier” approach.

We are reaching out to others who may be interested in receiving our Journal and have
met with consistent interest. We have encouraged increased collaboration between newer and more experienced practitioners. I put out the call for collaboration for a lunchtime presentation at one of our meetings, and members stepped up to the challenge. Finally, I have invited the members of Tax Policy, Practice and Legislation Committee to join us at the upcoming meeting, in recognition of possibilities for collaboration when people come together.

The More, The Merrier!

No matter old or new, some things remain the same. This is a place where people are made to feel welcome. Anyone who wants to become more involved with the committee is encouraged to learn about the opportunities, which include writing, speaking, putting on webinars and participating in delegations. Such opportunity also includes committee leadership. The officer ladder consists of the following positions: Chair; Chair Elect; First Vice Chair/Secretary; and Second Vice Chair/Journal Editor. Members interested in learning about what these positions entail, or about how to get started, are encouraged to reach out to any officer.

Also, we in the Tax Procedure and Litigation Committee make sure to have fun! Come on out to our meeting this month, which is calendared for Friday, August 29th in beautiful San Francisco. The details are set forth below. Those who are available will also meet for dinner – venue to be determined at the meeting. A good time should be had by all.

Thank you for your continued support of the Tax Procedure and Litigation Committee. Thank you for a great year!

LaVonne Lawson
Chair, Tax Procedure & Litigation Committee
Law Office of LaVonne Lawson, a tax law firm focusing on tax controversy, located in Los Angeles.

Photos from the May Meeting

The TPL May 30, 2014 meeting featured speaker 
Kristen Deazeley, IRS Stakeholder Liaison (third from left), 
with David Rice, Lavar Taylor, LaVonne Lawson, 
Joyce Cheng, and Joe Wilson.

Chair LaVonne Lawson and Editor Carolyn Lee 
share a laugh while preparing to start the 
Q3 Committee meeting.

TPL members from northern and southern California 
came together for the May 2014 Committee meeting. 
Pictured: Haleh Naimi, Los Angeles; Courtney Hopley, 
San Francisco; Greg Harper, Richmond; Barbara Rosenfeld, 
Los Angeles; and Jim Counts, Hemet.

TPL Committee Secretary Courtney Hopley and 
Taxation Executive Committee member Haleh Naimi 
persuade the notoriously photo-shy Robert Horwitz 
to join them for a snapshot

Minutes of the May 30, 2014 Meeting of the Tax Procedure & Litigation Committee

Courtney A. Hopley, Secretary

Courtney A. Hopley,1 

The Tax Procedure & Litigation (TPL) Committee met at the Law Offices of A. Lavar Taylor in Santa Ana on May 30, 2014. [Editor’s Note: Look for the group photo of meeting participants later in this issue.] The Chair of the Committee, LaVonne Lawson, called the meeting to order. Ms. Lawson made a motion to approve the minutes and the motion was approved by a vote of the members present.

Guest Speaker Presentation.

Kristen Deazeley, IRS Stakeholder Liaison with experience as an IRS Revenue Agent, spoke regarding items of interest at the Stakeholder Liaison Office of the Internal Revenue Service. The Stakeholder Liaison Office provides outreach and education to practitioners and industry organizations representing small businesses and self-employed taxpayers to improve compliance. The Stakeholder Liaison Office identifies issues of concern for tax administration and elevates those issues for resolution. Ms. Deazeley highlighted the following topics and issues for the group.

  • Voluntary Classification Settlement Program. Ms. Deazeley discussed the benefits of and eligibility requirements for the Voluntary Classification Settlement Program (VCSP). The VCSP allows eligible taxpayers to reclassify their workers as employees for employment tax purposes while obtaining partial relief from federal employment tax and penalties. Committee members raised the issue that participation in the VCSP may increase the likelihood of a state audit with the Board of Equalization. Ms. Deazeley emphasized that, although the VCSP provides employment tax audit protection for prior years, it will not prevent an income tax audit.
  • Third-party Payroll Payer Theft. The IRS has identified issues with various third-party payers. Many employers outsource their payroll responsibilities to third-party payers who administer their payroll and employment taxes. The third party-payers include payroll service providers and reporting agents. The IRS has seen an increase in theft by third-party payers. Ms. Deazeley emphasized that employers are responsible for the payment of payroll and employment tax even if they engage third-party payers to administer their payroll and employment tax withholding. Many employers only discover an issue when they have received a bill from the IRS. Ms. Deazeley encouraged practitioners to alert the Stakeholder Liaison Office about theft issues.
  • Updated IRS Contact Information of Interest. Ms. Deazeley informed the TPL Committee that there have been revisions to the addresses and fax numbers for the CAF Unit. She also discussed E Services Transcript Delivery System, Online Payment Agreements and the Issue Management Resolution System.

Member Presentations.

Two TPL Committee members provided presentations during the meeting. Zaher Fallahi of Los Angeles, California provided an update regarding the recent revisions to Circular 230. Lavar Taylor discussed a recent employment tax case, SECC v. Commissioner. The TPL Committee would like to get more members involved in the meetings. Please contact LaVonne Lawson if you would like to present a topic at a future meeting.

Committee Business.

1. TPL Meeting Schedule.

The TPL Committee is planning for future meetings. Ms. Lawson solicited feedback from members on whether the meeting locations were inconvenient for practitioners in Los Angeles. Committee members discussed the possibility of allowing practitioners to attend the meeting by phone. The TPL Committee will reach out to the State Bar regarding conference call vendors. The Committee wil
l revisit this issue at the Committee’s fourth quarter meeting, to take place during the California Bar Taxation Section’s Annual Meeting in November.

2. DC Delegation.

Robert Horwitz provided a report on the recent DC Delegation in May 2014. The TPL Committee submitted three papers on procedural topics. Participants met with officials at the Department of Treasury, Internal Revenue Service, Joint Committee on Taxation and the Senate Finance Committee. Participants also attended a luncheon at the United States Tax Court. For the first time, the DC Delegation met with the Kathryn Keneally at the Tax Division of the Department of Justice (DOJ). The DOJ meeting was well received, so the Tax Section plans to make it a part of the annual schedule.

Paper topic proposals for the 2015 Delegation are due at the Annual Meeting in November 2014. Each topic proposal must identify an IRS employee who is interested in hearing about the topic. Paper topics may be submitted to LaVonne Lawson. The DC Delegation provides an excellent opportunity to be published in the California Tax Lawyer and Tax Notes. The Tax Section provides a $750 stipend per paper to travel to Washington, D.C.

3. Sacramento Delegation.

The due date for proposals for the 2015 Sacramento Delegation is in August. Topics may be submitted to LaVonne Lawson. The Tax Section recently passed a motion to provide a small stipend for participants in the Sacramento Delegation.

4. Webinars.

The State Bar is providing the opportunity for TPL Committee members to present webinars on tax topics. Recordings of the webinars are available on the State Bar website.

5. California Tax Lawyer.

The California Tax Lawyer is requesting articles from the TPL Committee. Members can also submit Quick Points of up to 400 words.

6. California Tax Litigation Journal.

The TPL Committee continues to explore opportunities to increase the distribution of its quarterly publication, the California Journal o Tax Litigation. Currently, the Journal is only available to Tax Section members via an HTML link. The TPL Committee would like to make the journal available to business groups and schools.

7. Journal Editor Elections.

The TPL Committee is currently holding elections for the Journal Editor position. Votes will be collected and counted by TPL Secretary Courtney Hopley at

8. Hot Topics and Law Practice Management.

Committee members discussed hot topics and issues in law practice management.

9. Next Meeting and Adjournment.

The next Committee meeting is scheduled on August 29, 2014 at Greenberg Traurig, LLP in San Francisco. All other business having been completed, Ms. Lawson adjourned the meeting.

YTL Corner (All Readers Welcome)

YTL Corner (All Readers Welcome) addresses professional development for lawyers new to the tax community and for all tax attorneys. The column welcomes contributor John A. Harbin, who has been active in numerous state tax and local law and accounting professional trade organizations. In addition to participating in the Tax Procedure and Litigation Committee, Mr. Harbin is active with the Los Angeles County Tax Bar.

John A. Harbin 2

A Tax Attorney’s Professional Conduct Is Governed By More Than Circular 230.

Tax attorneys not only are required to adhere to Circular 230 rules of professional conduct, but also the rules of the California State Bar. The State Bar recently filed fifteen proposed rules of Professional Conduct with the Supreme Court of California. The Court will review and approve such proposed changes based upon its inherent and constitutional authority over the practice of law in California (In Re Attorney Discipline, 19 Cal.4th 582(1998) and pursuant to the Court’s authority under sections 6076 and 6077 of the California Business and Professions Code. I have analyzed the proposed changes and I believe several are worthy of further review for new tax lawyers – and all tax attorneys.

Rule 1.0: Purpose and Scope of the Rules of Professional Conduct

(a) Purpose: The purposes of the following Rules are:

  1. To protect the public;
  2. To protect the interests of clients;
  3. To protect the integrity of the legal system and to promote the administration of justice; and
  4. To promote respect for, and confidence in, the legal profession.

(b) Scope of the Rules:

  1. These Rules, together with any standards adopted by the Board of Trustees of the State Bar of California pursuant to these Rules, regulate the conduct of lawyers and are binding upon all members of the State Bar and all other lawyers practicing law in this state.
  2. A willful violation of these Rules is a basis for discipline.
  3. Nothing in these Rules or the comments to the Rules is intended to enlarge or to restrict the law regarding the liability of lawyers to others.

(c) Comments: The comments following the Rules do not add obligations to the Rules but provide guidance for their interpretation and for acting in compliance with the Rules.

A few of the comments to Rule 1.0 are worth noting, particularly for attorneys in solo or small firm practice who share space (and possibly consult to ensure competent representation) with other attorneys. Hanging out a shingle is increasingly common for new attorneys coping with the challenging legal job market, offering few associate positions in established firms.

Rule 1.0.1: Terminology

Rule 1.0.1 (c) defines “Firm” or “law firm” as a law partnership; a professional law corporation; a sole proprietorship or an association engaged in the practice of law; or lawyers employed in a legal services organization or in the legal department, division or office of a corporation, of a government organization, or of another organization.

Rule 1.1.1 (g) defines “partner” as a member of a partnership, a shareholder in a law firm organized as a professional corporation, or a member of an association authorized to practice law.

Rule 1.0.1 Comments

Under paragraph 1.0.1 (b)(2), a willful violation of a rule does not require that the lawyer intended to violate the rule, but merely a willingness to commit the act, knowledge of what he was doing or not doing, and that he intended his acts or omissions. Phillips v State Bar, 49 Cal.3d 944, 952 (1989); and Business and Professions Code section 6077.

Firm or Law Firm – Whether two or more lawyers constitute a law firm can depend on the specific facts. For example, two practitioners who share office space and occasionally consult or assist each other ordinarily would not be regarded as constituting a law firm. However, if they present themselves to the public in a way that suggests that they are a law firm or conduct themselves as a law firm, they may be regarded as a law firm for purposes of these Rules. The terms of any formal agreement between associated lawyers are relevant in determining whether they are a firm, as is the fact that they have mutual access to information concerning the clients they serve.

Whether a lawyer who is denominated as “of counsel” should be deemed a member of a law firm will also depend on the specific facts. The term “of counsel” implies that the lawyer so designated has a relationship with the law firm, other than as a partner or associate, or officer or shareholder that is close, personal, continuous, and regular. Even when a lawyer has associated as “of counsel” with another lawyer and is providing extensive legal services on a matter,
they will not necessarily be considered the same law firm for purposes of dividing fees under Rule 1.5.1 where, for example, they both continue to maintain independent law practices with separate identities, separate addresses of record with the State Bar, and separate clients, expenses, and liabilities. Chambers v. Kay, 29 Cal.4th 142 (2002).

Lawyers need to balance the need for generating business with the profession in which they have chosen, and the rules governing such profession. To the extent the relationship between a law firm and a lawyer is sufficiently “close, personal, regular, and continuous,” such that the lawyer is held out to the public as “of counsel” for the law firm, the relationship of the law firm and of counsel lawyer will be considered a single firm for purposes of disqualification. People ex rel. Department of Corporation v Speedee Oil Change Systems, Inc., 20 Cal.4th 1135 (1999).

Rule 1.1: Competence

(a) A lawyer shall not intentionally, recklessly, or repeatedly fail to perform legal service with competence.

(b) For purposes of this Rule, “competence” in any legal service shall mean to apply the 1) diligence, 2) learning and skill, and 3) mental, emotional and physical ability reasonably necessary for the performance of such service.

(c) If a lawyer does not have sufficient learning and skill when the services are undertaken, the lawyer may nonetheless provide competent representation by 1) associating with or, where appropriate, professionally consulting another lawyer who the lawyer reasonably believes to be competent, 2) acquiring sufficient learning and skill before performance is required, or 3) referring the matter to another lawyer who the lawyer reasonably believes to be competent.

Rule 1.1 Comment

[1] It is the duty of every lawyer to provide competent legal services to the client.

[2] Competence under paragraph (b) includes the obligation to act with reasonable diligence on behalf of a client. . . A lawyer must act with commitment and dedication to the interests of the client and with zeal in advocacy on the client’s behalf. . . The lawyer’s duty to act with reasonable diligence does not require the use of offensive tactics or preclude the treating of all persons involved in the legal process with courtesy and respect.

A lawyer may accept representation where the requisite level of competence can be achieved by reasonable preparation. If one is engaged for a particular job that requires additional training, and the lawyer obtains such additional skills without harming the client’s interests during the delay while such training is obtained, then being employed on such engagement is proper under Rule 1.1.

Rule 1.4: Communication

(a) A lawyer shall:

  1. Promptly inform the client of any decision or circumstance with respect to which written disclosure or the client’s informed consent, as defined in Rule 1.0(e), is required by these Rules or the State Bar Act;
  2. reasonably consult with the client about the means by which to accomplish the client’s objectives in the representation;
  3. keep the client reasonably informed about significant developments relating to the representation;
  4. promptly comply with reasonable requests for information;
  5. promptly comply with reasonable client requests for access to significant documents necessary to keep the client reasonably informed about significant developments relating to the representation, which the lawyer may satisfy by permitting the client to inspect the documents or by furnishing copies of the documents to the client; and
  6. consult with the client about any relevant limitation on the lawyer’s conduct when the lawyer knows that the client expects assistance not permitted by these Rules or other law.

(b) A lawyer shall explain a matter to the extent reasonably necessary to permit the client to make informed decisions regarding the representation.

(c) A lawyer shall promptly communicate to the lawyer’s client:

  1. all terms and conditions of any offer made to the client in a criminal matter; and
  2. all amounts, terms, and conditions of any written offer of settlement made to the client in all other matters.

Rule 1.4 Comment

[1] Whether a particular development is significant will generally depend upon the surrounding facts and circumstances. A change in lawyer personnel might be a significant development depending on whether responsibility for overseeing the client’s work is being changed, whether the new attorney will be performing a significant portion or aspect of the work, and whether staffing is being changed from what was promised to the client.

[2] A lawyer may comply with paragraph (a)(5) by providing to the client copies of significant documents by electronic or other means. . .A lawyer must comply with paragraph (a)(5) without regard to whether the client has complied with an obligation to pay the lawyer’s fees and costs.


[6] A lawyer need not inform the client of the substance of a written offer of a settlement in a civil matter if the client has previously instructed that such an offer will be acceptable or unacceptable, or has previously authorized the lawyer to accept or to reject the offer, and there has been no change in circumstances that requires the lawyer to consult with the client.

In Closing:

Here are a few words of wisdom you may be inclined to greet with an eye-roll. Ignore them at the peril to your reputation.

  • Clients are most upset when a lawyer does not return a client’s telephone calls, e-mails, or correspondence. Many of the most well regarded attorneys follow this practice: “r\Return your client’s telephone calls within 24 hours.” It will serve you well. In addition, prompt communication to a client, especially the bad news, will prevent a small problem from hemorrhaging to a major headache. Clients just want to be kept informed. It shows respect.
  • The basic tenet you should attempt to follow is to do no harm to your client. Is your client better for having engaged your services?

Of course, you can never prevail in every case. However, if you follow some of the basic principles outlined in the above-referenced rules of professional conduct, your clients will have been served well.

Practice Pointers : Getting and Handling the Business

Gregory Harper

Gregory Harper3

Getting The Business.

Many of us in the tax arena work for ourselves or in very small firms of two to four lawyers. If we are fortunate we have steady taxation business. For those fortunate few, life is grand. However, what about the rest of us? How do we get business and what do we do when we get it? An even bigger question is: What do I do when a client wants me to handle something other than a taxation issue?

Deciding On Practice Arenas.

I call it “arenas” because the law business is as competitive as any sport. Just because you say you are a tax lawyer does not mean you cannot practice in other areas. The California Rules of Professional Conduct allow you to branch out if you can do so competently. See Rule of Professional Conduct 3-110. When we think of obtaining business from either new clients or former clients who have returned, we often think, “what can I do to get more business?” From my days as a rookie until now I continue to ask veteran lawyers what they do to build their practice.

Here are my personal and anecdotal findings:

  • How to choose your particular practice arenas: “Choose one practice area you like and one practice area that makes money.” I chose taxation law, where I had experience in tax and as well as experience
    in complete financial planning, including budgeting, net worth analysis, estate, disability and retirement planning. As a second practice area, I chose criminal law, because I had experience, extensive training (three death penalty trials) and the possibility of more potential clients.

Let the world know how good you are.

1.Web sites. With the internet age many marketing companies have arisen. They claim to have a better way to help you “game” the internet with a presence that will result in your name coming out on top when someone does an internet search for a tax lawyer. The pitch sometimes comes from a subsidiary of another web site builder you may have used. As a word of caution, the company’s pitch may conclude with an expensive campaign where results depend solely on how much money you invest in their internet campaign services. I offer this as the voice of experience, having had different web sites for several years.

2.Past performance highlighted during the marketing pitch is no indication of future results. Unfortunately after going through thousands of dollars with many of the more prominent web marketing service companies, I have received a total of ZERO paying clients. (Call me if you would like more information about my experience.) While I have not given up on the web, I am not prepared to starve relying on the internet for business.

3.Participating in your community. I have heard this advice from many successful attorneys. Usually you can participate as a politician or board member for a public entity, e.g., your school board, the local housing commission, a Rotary club, your sorority, etc. Being active in the community lets you learn while you show the world what you can do while doing some good.

Here is an example: Several years ago during the first offshore voluntary disclosure program a gentleman walked into my office. He had a few days to comply with the upcoming program submission deadline. He had visited the big accounting and law firms in the area and was not happy with what he saw and heard. He was referred to me. As we talked, this prospective client said he had been referred by several sources. One was a friend of his who knew of my work with the Berkeley Housing Advisory Commission and as a trustee at the largest church in Oakland. He further related that his friend heard from others I was fair, and that I could analyze a complex spreadsheet and bring clarity to it for regular people while making sure the Board asked the right questions. This individual’s friend already had “sold” my legal services before the client walked through the door.

4.Give back though pro bono services. Similar to participating in your community, providing pro bono legal services just makes sense. Some people just need the help. Many times others see selfless work and hire the apparently dedicated lawyer. The advice here is to treat all unpaid work as paid work. Do not use a lesser effort. Be generous with your time and skill. You will be rewarded.

Resources For Handling The Business.

Tax lawyers, given the complex nature of our work, have the analytical skills and problemsolving capabilities that may be leveraged to provide legal services in other practice areas. Our clients usually trust us and our judgment. What do you do when our clients’ trust leads them to ask us to handle something outside of taxation?

As an example, say you are representing a client in a matter involving trust taxation. The case also involves trust law and fiduciary liability. Opposing counsel presents legal and procedural issues that are outside your expertise, even with co-counsel experienced in probate administration. What resources are available to you to competently represent your client?

1. Follow your usual practice. Lexis Advantage is my usual resource for primary online research. Call the research attorneys, who typically are helpful. What if you still have questions? Lexis Advantage emails research links which send you to other areas, and allow you to cobble together a solution. They also may suggest more time-consuming research.

2. Test drive a couple of online resources. If Lexis Advantage can’t do the trick, how about Westlaw’s Practical Law? Contact Westlaw to review a new product called Practical Law. Practical law is used by law firms as a way of getting up to speed on an unfamiliar legal topic. The resource offers a learning tool that may permit the firm to develop competence, and accept and handle a case with reasonable competence. I have tried Practical Law and found it has advantages and disadvantages.

Practical Law advertises that it can help you become familiar with any legal practice area including taxation. In my opinion, Practical Law is excellent in the trust and estates area, with many checklists and well written pleadings. Compare Practical Law to LexisNexis, where if you want to draft a pleading you have to navigate between Matthew Bender’s Pleading and Practice and Points and Authorities. Practical Law uses the resources of Westlaw with additional research done by practitioners. Practical Law provides pleadings in a single format, from caption to proof of service and exhibit treatment. I have found it to be superb in the offshore disclosure area and the treatment of long term capital gains. However – again, in my experience – Practical Law could use improvement in any tax area outside of offshore asset disclosure. There are essentially no usable checklists. My view is that Practical Law is of very little assistance to a tax practice. This may change over time. Please note, Westlaw is available sans Practical Law.

Trusts and estates lawyers also may find Practical Law to be a useful resource, and many tax attorneys also have an estate planning or trust and estate litigation practice. For the complex trust action described above, using Westlaw’s Practical Law I deciphered the area of trustee liability. The authority was excellent. Practical Law had more citations than LexisNexis. Nevertheless, both legal research services had the same basic law. However, Westlaw was more in-depth in its research and required less time in the area of trustee liability.

3. Weigh the costs and return on investment. My firm has LexisNexis for approximately $237/month. The subscription includes Matthew Bender for pleadings, the annotated Federal and State Codes, and many treatises including some published by the Rutter Group. Limited criminal information is available (remember, criminal law is my secondary practice arena). However, additional and more extensive criminal research is available for free online in sources such as Findlaw and Google Docs. Depending on your subscription, research efficiency may make a cost difference. I found that Westlaw took less time to accomplish our research tasks.

A comparable Westlaw package is available for $375/month. Sales people will think of many promotional reasons to persuade you to choose their product. Please note that, in my view, the major differences between LexisNexis and Westlaw are that you will usually and probably spend less time researching and drafting documents with Westlaw. Whether the additional expense for Westlaw is worth it is up to you. Remember that Practical Law currently is not strong in the tax area. If you decide to explore Practical Law using the usual seven-day trial period, one week is not adequate for a thorough review, so pick one or two practice areas and go for it.

In sum, LexisNexis is substantially less expensive than Westlaw. Westlaw/Practical Law may save you a lot of time. I currently use LexisNexis and it has suited my firm for years; Westlaw is a bit rich for us. It should be noted discounts for web services can be negotiated by groups.

I trust this gives some insight into obtaining and servicing our new and continuing clients to the best of our ability. Don’t hesitate to get in touch to share ideas for practice development –

Thank you for the opportunity to work together. Al
ways have respect and be lawyerly.


Taxation Of Medical Marijuana Dispensaries — Part Two of a Three Part Series.

Joseph P. Wilson

Joseph P. Wilson4

This is the second article of a three part series of articles. In the first article published in the Q2 Issue of the California Journal of Tax Litigation I discussed the federal income tax treatment of medical marijuana dispensaries. In this article I will discuss the California income tax treatment of medical marijuana dispensaries. This article does not focus on other taxes such as sale and use and business license taxes. In the next article, I will discuss numerous concerns and issues applicable to professionals who counsel and provide advice to the organizations, entities and individuals who are engaged with the medical marijuana industry.

Recap Of The Part One Article Dealing With Federal Tax Treatment.

Under the federal tax regime, the Internal Revenue Service and the United States Tax Court both take the position that any business that sells marijuana, even if for medical reasons, cannot deduct necessary and ordinary business expenses like a normal business. Section 280E of the Internal Revenue Code is the hammer behind this rule. The hand holding that hammer is the Controlled Substances Act (CSA), which was adopted in 1970. The CSA details the federal government’s position that marijuana is a drug that has no accepted medical use. For this reason, the manufacture, distribution or possession of marijuana, even if for medical purposes as established under state law, is a federal criminal offense. Consequently, while medical marijuana dispensaries are required to pay taxes on their earnings, they are not entitled to deduct business expenses such as rent, advertising and employee costs at the federal level. Does California treat these medical marijuana businesses and owners more favorably for income tax purposes?

California’s Income Tax Treatment Of Medical Marijuana Dispensaries.

In stark contrast to federal law, California law allows for the distribution of medical marijuana under Proposition 215, the Compassionate Use Act of 1996 (CUA). The initiative exempted certain patients and their primary caregivers from criminal liability under state law for the possession and cultivation of marijuana. In 2003, the California Legislature enacted additional legislation related to medical marijuana, requiring the Attorney General to adopt “guidelines to ensure the security and nondiversion of marijuana grown for medical use.” Although the CUA legalized the sale of medical marijuana, interestingly, it did not address the tax treatment of these activities. The 2003 guidelines published by the Attorney General also do not address the tax treatment. The guidelines simply refer to the California Board of Equalization’s online publication regarding sales taxes applicable to medical marijuana activities. There is no discussion of the state income tax treatment of these activities under the CUA or the Attorney General’s guiltiness. Moreover, the California Revenue and Taxation Code does not carve out any exceptions for these types of business activities.

Thus, the applicable law that applies might be surprising to those who thought that, because this medical marijuana sales is a legal activity in California, the tax treatment might be more favorable than the tax treatment under federal law. The reality is that in certain circumstances the tax treatment in California is even worse than the tax treatment under federal law. Even though medical marijuana is legal under Proposition 215, the distribution of medical marijuana is considered drug trafficking for California tax purposes, under the California Revenue and Taxation Code for individuals. However, the distribution and sale of medical marijuana is not considered drug trafficking for California tax purposes under the California Revenue and Taxation Code for corporations. Does this mean that corporations get breaks that individuals do not? Well, in this particular circumstance, the answer is yes, corporations do.

Personal Income Tax Treatment Of Medical Marijuana Dispensaries.

Pursuant to § 17201(c) of the Revenue and Taxation Code, California conforms to Part IX of Subchapter B of Chapter 1 of Subtitle A of the Internal Revenue Code. Part IX of the Internal Revenue Code includes § 280E. Therefore, California follows § 280E of the Internal Revenue Code with respect to personal income tax treatment of medical marijuana dispensaries. The Public Affairs Office of the FTB confirmed that this is the State’s position on the subject. Thus, for personal income tax purposes, the marijuana dispensaries are not entitled to deduct necessary and ordinary business expenses related to income derived from medical marijuana dispensaries. This would apply to medical marijuana dispensaries that operate as sole proprietorships, partnerships, LLCs taxed as a partnership, or trusts. A question remains whether corporations who have elected Subchapter S status will receive similar tax treatment. However, the bottom line is that when it comes to personal income taxes, California conforms with the federal government and will disallow the business expenses for these activities, even though medical marijuana dispensaries are legal in the State of California. Of course, California goes one step further than the federal government, making the state tax treatment of these activities possibly even worse than the federal tax treatment in certain situations.

Section 280E of the Internal Revenue Code disallows business expenses if the income is derived from drug trafficking activities. However, this section does not disallow costs of goods sold. California Revenue and Taxation Code § 17282 states that no deductions (including deductions for cost of goods sold) shall be allowed to any taxpayer on any of his or her gross income directly derived from illegal activities but only if the taxpayer was determined to be engaged in criminal profiteering or for related activities enumerated in Revenue and Taxation Code § 17282(a). Those activities include drug trafficking, which for personal income tax purposes conforms with § 280E. For this limitation to apply, the current law expressly states that a taxpayer must be found to be engaged in these activities through a final determination in a criminal proceeding, or a proceeding in which the state, county, city or other political subdivision was a party. If this occurs the income tax treatment of medical marijuana dispensaries is even more severe in California than under Federal law.

Corporate Income Tax Treatment Of Medical Marijuana Dispensaries.

California treats the income taxation of medical marijuana dispensaries that are taxed as corporate entities more favorably. This is because the corporate tax code under Part 11 of the California Revenue and Taxation Code does not have a provision similar to the personal tax code to make it conform with § 280E of the Internal Revenue Code. The conforming provision under § 17201(c) of the Revenue and Taxation Code does not apply to the California corporation tax code.

This means that a medical marijuana dispensary that is taxed as a corporation under the California Revenue and Taxation Code may, absent a final determination in a criminal proceeding that the corporation is participating in drug trafficking, be allowed full deductions for business expenses and cost of goods sold. The California Revenue and Taxation Code under § 24436.1 mirrors the language of § 17282 and disallows all deductions if the taxpayer was determined to be engaged in criminal profiteering or for related activities in a criminal proceeding, or a proceeding in which the state, county, city or
other political subdivision was a party. Absent such determination, however, a medical marijuana dispensary taxed as a corporation under Part 11 of the California Revenue and Taxation Code should be allowed to deduct all its necessary and ordinary business expenses and cost of goods sold assuming the dispensary has adequate records to substantiate these items.

Based on the language contained in Revenue and Taxation Code §§ 17282(a) and 24436.1(a), it is clear that a state criminal proceeding would trigger the disallowance of the deductions, but the Code does not directly address a federal criminal proceeding. The Code section appears to include any court that is located in the State of California. The statutes only require the State or a political subdivision to be a party to the proceeding in which the taxpayer was determined to be engaged in the activities. The participation of the State or a political subdivision in a federal court proceeding is a gray area, and would have to be reviewed before determining the applicability of Revenue and Taxation Code §§ 17282 or 24436.1. The proceedings referred to in Revenue and Taxation Code §§ 17282(b) or 24436.1(b) are by their terms not limited to criminal proceedings. So presumably any other type of proceeding applies, including appeals of business license revocations. Also, I would assume that if there is a federal criminal proceeding involving a dispensary located in California that the amount of applicable restitution should include amounts owed to the State. This could make California a party to a case brought in federal court. Also, a federal determination that the activities are illegal is res judicata and binding on the State of California, and the supremacy clause trumps the California statute. It remains to be seen how broadly the Franchise Tax Board interprets this Code section.

Although this article focuses mainly on the income tax treatment of the dispensary activities, one might be curious to know whether an individual with a prescription from a licensed physician is entitled to take a medical expense deduction related to the prescribed medical marijuana. IRS Revenue Ruling 97-9 addressed this question. The IRS takes the position that the cost of prescribed marijuana is not a deductible medical expense under federal law, even if California law permits its use when prescribed by a physician and the taxpayer has a prescription. Section 213 of the Internal Revenue Code allows a deduction for uncompensated expenses of an individual for a medicine or drug that is prescribed and legally procured. However, an amount paid to obtain a controlled substance (such as marijuana) for medical purposes violates the federal Controlled Substances Act because it has not been legally procured. At least until the law is changed, California conforms to IRC § 213, so no deduction is allowed for California purposes, even though California allows the legal use of marijuana when prescribed by a physician.

In Summary –

California models the IRS and disallows all business expenses if the medical marijuana dispensary is not being taxed as a corporation under the State Revenue and Taxation Code. If the medical marijuana dispensary has been structured in a way to be taxed as a corporation under the Revenue and Taxation Code, it is entitled to deduct all of its necessary and ordinary business expenses assuming it has adequate records to substantiate these expenses. If there is a criminal court or other proceeding in which the state, county, city or other political subdivision was a party and it was determined that the medical marijuana dispensary engaged in illegal activities, the dispensary will not be allowed to deduct the business expenses or the cost of goods sold, regardless of whether the dispensary is structured to be taxed as a corporation, flow-through entity or sole proprietor.

In the third and final part of this three part series, I will review the problems and concerns that all practitioners need to know about before providing legal advice or representing a medical marijuana dispensary. Concerns include how filing a tax return may constitute an admission by the taxpayer that he or she is engaged in illegal drug trafficking and how practitioners who assist these taxpayers may by in technical violation of Circular 230, State Bar rules of professional conduct and, arguably, considered to be “aiding and abetting” the taxpayer in the commission of a federal offense.

Treasury Publishes Final Revisions To Circular 230, Making Significant Changes Affecting All Practitioners.

Zaher Fallahi

Zaher Fallahi5

Section 330 of Title 31 of the United States Code authorizes the Secretary of the Treasury to regulate practice before the Treasury Department (Treasury). The Secretary has published regulations governing practice before the Internal Revenue Service (IRS) in Title 31 Code of Federal Regulations (C.F.R.) Part 10 and reprinted the regulations as Treasury Department Cir. No. 230 (Rev. 6-2014) (Cir. 230). Treasury and the IRS have consistently maintained that tax practitioners must meet minimum standards of conduct with respect to written tax advice and those who do not should be subject to disciplinary action, including suspension or disbarment from practicing before the IRS. Under these principles, the regulations have been amended from time to time to address issues relating to tax opinions and written tax advice, also known as covered opinions, contained in former §§ 10.35 and 10.37.

Obstacles Inherent In Former Cir. 230 §§ 10.35 And 10.37.

The now-former sections 10.35 and 10.37 provided comprehensive rules with respect to written tax advice. Specifically, former § 10.35 provided extensive rules for tax opinions that constitute covered opinions under Cir. 230. Covered opinions include written advice concerning a listed transaction, a transaction with the principal purpose of tax avoidance or evasion, a transaction with a significant purpose of tax avoidance or evasion and, if the advice is a reliance opinion, a marketed opinion subject to conditions of confidentiality or subject to a contractual protection.

Many tax practitioners believed that former rules governing written tax advice were overbroad, were difficult to apply, and did not necessarily produce higher quality tax advice. Practitioners indicated that the rules unduly interfered with their client relationships, and were not an ethical standard that everyone could comprehend easily. Some practitioners also expressed concern that these rules reduced, rather than enhanced, tax compliance due to the perception that a covered opinion required more time to produce and therefore was more expensive for the client than other tax advice. It also had been suggested that the Cir. 230 covered opinion rules increased the likelihood that practitioners would provide oral advice to their clients when written advice was more appropriate, because former Cir. 230 § 10.35 did not govern oral advice.

Another concern that Treasury heard from practitioners related to the unrestrained use of disclaimers on nearly every practitioner communication regardless of whether the communication contained tax advice. Practitioners opined that this practice discouraged compliance with the ethical requirements, because some practitioners had concluded that if they include a disclaimer, they were free to disregard the standards in former § 10.35 regarding written tax advice. The disclaimers also caused confusion for clients because clients often did not understand why the disclaimer was there, or the disclaimer’s consequences. In addition, practitioners complained that the overuse of disclaimers caused clients to completely ignore them, and may have rendered their use in some circumstances irreleva

Guidance Regarding Written Tax Advice.

Although in general practitioners favored reasonable regulations for written tax advice, they expressed little support for several of the rules contained in the former Cir. 230. Treasury received numerous requests to revise the rules. After years of experience with those rules, the government and practitioners agreed that the covered opinion rules were often burdensome and provided only minimal taxpayer protection. Overall, the benefit was insufficient to justify the additional costs associated with practitioners’ compliance with the covered opinion rules.

The revised regulations regarding covered opinions, among other changes, were proposed on September 17, 2012. After careful deliberation, including considering the public’s experience with, and comments on, these rules, Treasury published the final revised Cir. 230 with a June 12, 2014 effective date. These revisions are designed, in part, to provide a more flexible standard for all written tax advice.

Revised Cir. 230 §10.37 replaced former §10.35 and requires, among other things, that (i) practitioners base their written advice on reasonable, factual, and legal assumptions, (ii) reasonably consider all relevant facts and circumstances that the practitioner knows or reasonably should know, (iii) use reasonable efforts to identify and ascertain the facts relevant to written advice on each Federal tax matter, (iv) not rely upon representations (including statements, findings or agreements) of the taxpayer or any other person if reliance on them would be unreasonable, (v) apply pertinent law and legal authorities to facts, and (vi) not, in evaluating a Federal tax matter, take into account the possibility that a tax return will not be audited or that a matter will not be raised on audit.

Under revised §10.37(a)(3), a practitioner’s reliance on representations, statements, findings, or agreements is unreasonable if the practitioner knows or reasonably should know that one or more representations or assumptions on which any representation is based are incorrect, incomplete or inconsistent.

As for relying on the advice of others, under revised § 10.37(b), a practitioner may only rely on the advice of another person if the advice was reasonable and the reliance is in good faith considering all the facts and circumstances.

A practitioner’s comments or recommendations to the government on matters of general policy are not considered written tax advice on a Federal tax matter and are not subject to Cir. 230. For example, if a law firm submitted comments on proposed regulations to Treasury or the IRS on a client’s behalf, that submission would not be considered written advice on a Federal tax matter because comments on proposed regulations are government submissions on matters of general policy. Furthermore, continuing education presentations provided to an audience solely for the purpose of enhancing practitioners’ professional knowledge on Federal tax matters, such as presentations at tax professional organization meetings, are not considered written advice. However, presentations marketing or promoting transactions that result in items or positions taken on a tax return will be considered tax advice on Federal tax matters.

Treasury estimates that elimination of the collection of information requirements for making certain disclosures in the Cir. 230 covered opinion rules should save tax practitioners and their clients a minimum of $5,333,200 per year. This estimate does not include the burden reduction and the corresponding cost savings associated with tax practitioners having to determine whether a covered opinion and any related disclosure is necessary. Treasury expects that the elimination of the covered opinion rules will result in additional and significant savings for both tax practitioners and taxpayers – not to mention an increase in written advice without the burdens of the former Cir. 230 regulations.

Practitioner Competence Now Formally Addressed.

Former Cir. 230 §10.35 pertaining to covered opinions was eliminated with overwhelming support from practitioners and the public. Revised Cir. 230 §10.35 now governs “Competence,” which previously was not specifically addressed in Cir. 230. Revised § 10.35 requires that a practitioner possess the necessary competence to engage in practice before the IRS. Competent practice requires the appropriate level of knowledge, skill, thoroughness, and preparation necessary for the matter for which the practitioner is engaged. A practitioner may become competent to practice before the IRS through various methods, such as consulting with experts in the relevant area or studying the relevant law. It will be interesting to see how implementation of revised §10.35 will play out in light of the Loving v. IRS case: on-Court-Ruling-Related-to-Return- Preparers

Elimination Of The Ubiquitous Cir. 230 Or IRS Disclaimer.

Because revised Cir. 230 §10.37 does not include the previous disclosure requirements pertaining to written advice, disclaimers regarding advice that include any reference to Cir. 230 or to IRS disclosure requirements are now false and misleading. On June 17, 2014, Karen Hawkins, Director of the Office of Professional Responsibility (OPR), stated that the OPR will send letters directing practitioners to stop using Cir. 230 disclaimers when OPR becomes aware that such language still is in use.

Firms Required To Ensure Staff Compliance With All Cir. 230 Provisions.

Former §10.36 (a) provided requirements for practitioners to establish procedures to ensure staff compliance with former §10.35. The revised Cir. 230 amended §10.36 to require compliance with Cir. 230 generally, rather only in specific part. The expanded §10.36 requires firms to have procedures in place to ensure Cir. 230 compliance with respect to a firm’s tax return preparation practice. The revised §10.36 applies to every member of firm management subject to Cir. 230.

Expedited Discipline Proceedings For Practitioners Who Fail To File Their Own Tax Returns.

The revised Cir. 230 regulations expanded the categories of violations subject to OPR’s expedited disciplinary proceedings addressed in Cir. 230 §10.82, to include failure to comply with a practitioner’s personal tax filing obligations when such failure to file demonstrates a pattern of willful, disreputable conduct (see Cir. 230 § 10.51). These regulations also clarified that OPR has exclusive responsibility for matters related to practitioner discipline, including disciplinary proceedings and sanctions. The scope of these regulations is limited to practice before the IRS and does not alter or supplant other ethical standards applicable to practitioners, such as the California Rules of Professional Conduct.

Make Sure You Have Your Very Own Copy Of Treasury Department Cir. No. 230 (Rev. 6-2014).

Treasury no longer publishes Cir. 230 in paper form. Download a complete copy of the revised regulation HERE.

Recent Cases of Interest

Robert S. Horwitz6

In this issue of the California Journal of Tax Litigation Robert Horwitz profiles five litigation actions, including continued erosion of the government’s power to regulate tax return preparers following Loving and the courts’ consistent interpretation of the work product doctrine so that this privilege is of little value in practical application.

While often ignored by practitioners, since U.S. v. Powell, 379 U.S. 48 (1964), summons enforcement is one area of tax practice and procedure that has received repeated attention from the Supreme Court. The Court’s most recent foray into this area is United States v. Clarke, 573 U.S. ____ (2014), where it addressed the issue of the showing needed for a party in a summons enforcement proceeding to be entitled to an evidentiary hearing in which it can question the IRS agent about the reason for issuing the summons. The answer given by the Court is that the taxpayer is entitled to an evidentiary hearing only when it “points to specific facts or circumstances plausibly raising an inference of bad faith.”

The Court laid out some of the basics. Under 26 USC § 6201(a), Congress has “authorized and required” the IRS “to make the enquiries, determinations and assessments of all taxes” imposed by the Internal Revenue Code. To assist the IRS in its function, Congress has given the IRS broad authority to issue summonses under IRC § 7602. Where a taxpayer does not comply with a summons, the IRS can bring an action to enforce the summons in district court. The Court stated that to obtain an enforcement order, the IRS “need only demonstrate good faith in issuing the summons,” citing United States v. Stuart, 489 U.S. 353, 359 (1989).

To establish good faith, the IRS must establish each of element of the four-prong test laid out in Powell: 1) the IRS investigation is being conducted for a legitimate purpose, 2) the material sought may be relevant to that purpose, 3) the information sought is not already in the IRS’s possession and 4) the administrative steps required by the Code have been followed. The Court noted that the IRS usually establishes that it meets the four prongs through an affidavit from the issuing IRS agent. A taxpayer can challenge the summons and seek to have it quashed “on any appropriate grounds.” Reisman v. Caplin, 375 U.S. 440,449 (1964).

In Clarke, the IRS was conducting an examination of Dynamo Holdings, LP, for the tax years 2005 through 2007. The examination focused on large interest expenses claimed on those returns. Dynamo agreed to an extension of the statute of limitations until 2010. When the IRS requested that Dynamo agree to a further extension, the company refused. The IRS then issued summonses to four persons it believed had information and records relevant to the examination. Only one of the summoned persons complied. The IRS issued an FPAA in December, 2010. Dynamo timely petitioned the Tax Court. Two months after the petition was filed, the United States filed an action in district court to enforce the summonses against the three persons who did not comply.

In district court, the respondents asserted that the IRS issued the summonses in bad faith, to “punish” Dynamo for not agreeing to extend the statute and to do an end run around the Tax Court’s restrictions on discovery and sought an evidentiary hearing. They submitted an affidavit from the attorney for the person who complied with the summons. The affidavit stated that the IRS attorneys who were handling the Tax Court case conducted the interview. The district court denied the request for an evidentiary hearing regarding the IRS’s motives and ordered the summonses enforced. The respondents appealed to the Eleventh Circuit. Determining that the district court abused its discretion in not granting an evidentiary hearing, the Eleventh Circuit reversed. In doing so, it held that bare allegations of improper motive are sufficient to entitle a person to an evidentiary hearing. This put the Eleventh Circuit in conflict with every other circuit that had considered the issue. The Supreme Court granted the United States’s petition for certiorari.

The Supreme Court reversed the Eleventh Circuit. Although summons enforcement cases are adversarial in nature, they are meant to be summary proceedings. The purpose is only to ensure that the IRS summons was issued in good faith and not to oversee the IRS determination to investigate:

As part of the adversarial process concerning a summons’ validity, the taxpayer is entitled to examine an IRS agent when the taxpayer can point to specific facts or circumstances plausibly raising an inference of bad faith. Naked allegations of improper purpose are not enough. The taxpayer must offer dome credible evidence of bad faith. But circumstantial evidence can suffice to meet that burden. The taxpayer need only make a showing of facts that give rise to a plausible inference of improper motive. In reversing the district court, the Eleventh Circuit viewed bare allegations as sufficient to entitle a party to an evidentiary hearing. Although some evidence was presented by the summoned parties, the Eleventh Circuit never assessed whether the evidence sufficed to support a plausible inference of improper motive. The Supreme Court remanded the case, directing the court of appeals to consider the respondent’s evidentiary submissions in light of the standard enunciated by the Supreme Court. In doing so, the Supreme Court noted that the court of appeals must take into account the district court’s “broad discretion to determine whether a taxpayer has shown enough to require the examination of IRS investigators.” The district court’s determination was entitled to deference if it used the correct legal standard. This deference does not extend to the legal issue of what is an illicit motive.

The Supreme Court did not reach the issue of whether the purposes claimed by the respondents were improper. Thus, on remand, if the court of appeals determines that the motives alleged were improper and that the evidence presented was sufficient to raise a “plausible inference” of that IRS had these motives in issuing the summonses, it can still reverse the district court and direct it to hold an evidentiary hearing.

On July 25, 2014, the Eleventh Circuit issued a not-for-publication remand order to the district court. The Eleventh Circuit directed the district court to “ask and answer” the question whether, in light of “the evidence and affidavits highlighted by the Supreme Court, the parties opposing enforcement had raised a plausible inference of improper purpose” and whether the allegedly improper purposes were “improper as a matter of law.” A copy of the remand is available here: es/201213190.rem.pdf .

Another recent summons enforcement case that has some interest is Schlaeffer v. United States, (SDNY 6/2/14), a decision by a magistrate judge. The case was a petition to quash an IRS summons brought by Mr. Schlaeffer and a group of German companies, called the Schlaeffer Group, that he controlled. The Schlaeffer Group manufactures and distributes bearings and other automotive and industrial components. Mr. Schlaeffer and the Schlaeffer Group will be referred to here collectively as “the taxpayers.”

In July 2008, the Schlaeffer Group made a tender offer to purchase stock of Continental AG (“Conti”), a German supplier of automotive and industrial parts, at €74 per share. It anticipated purchasing less than half of the Conti stock. Due to the downturn in the economy, however, in September 2008, the Schlaeffer Group wound up owning 89.9% of Conti for a total price of €11 billion. The acquisition was funded by a consortium of banks (“the Consortium”). By February 2009, Conti stock was trading for €11. The Schlaeffer Group was faced with solvency problems and the need to refinance the debt and restructure the corporate group.

Due to the complexity of the U.S. tax issues involved in the Conti acquisition as well as the refinancing and restructuring, the Schlaeffer Group retained Denton USA, LLP, and Ernst & Young (“EY”) to provide tax advice, including advice on potential U.S. tax consequences of the transactions, the potential for an IRS challenge of the Schlaeffer Group’s tax treatment, and the potential risk if the tax treatments were challenged. Given the magnitude and complexity of the tax issues, the amounts involved, and because Mr. Schlaeffer’s individual returns had been audited for 2001-2003 and 2006-2008, it was believed that an audit of the returns for the tax years 2009 and 2010 was inevitable.

During 2008 and 2009, EY and Denton w
orked to put together a viable refinancing and restructuring plan and to evaluate the potential tax implications. Schlaeffer, the Schlaeffer Group, EY and Denton viewed their communications as confidential. Schlaeffer sought a private letter ruling (PLR). The PLR ruling was favorable as to the “proposed core tax treatment” of the refinancing and restructuring.

The Consortium was concerned about the U.S. tax consequences during their negotiations with the Schlaeffer Group. Early in the negotiations, it agreed to a “ringfencing agreement” under which the banks would subordinate payment of their claims for up to €885 million of Mr. Schlaeffer’s personal tax liabilities and agreed to provide a €250 million line of credit to pay his taxes.

The banks had obtained advice from their tax advisors about the possible tax implications of the transaction to Mr. Schlaeffer and the Schlaeffer Group. To assist in addressing the tax issues, the Consortium and the Schlaeffer Group entered into a confidentiality agreement, which provided that they would share confidential legal analyses of the tax implications of the refinancing and restructuring transactions. Under this agreement, communications that were privileged under the attorney-client, work product, or IRC § 7525 tax practitioner privilege would remain privileged and protected even though the communications were provided to the other party.

Mr. Schlaeffer’s belief in the inevitability of an audit for the tax years 2009 and 2010 was justified. In 2012, the IRS began to audit his and the Schlaeffer Group’s returns. During the audit, the IRS requested that the taxpayers provide documents concerning the refinancing and restructuring transactions. In response, the taxpayers produced tens of thousands of pages of documents, as did EY. The taxpayers also provided the IRS with a privilege log. Among the documents listed were EY tax memos. The IRS summoned EY to produce the all documents that the taxpayers claimed were privileged, including the tax memos it prepared. The taxpayers thereupon filed a petition to quash.

The basis of the taxpayers’ petition was the claim that the documents summoned, including the EY tax memos, were privileged and that the privilege was not waived when the memos were provided to the Consortium under the confidentiality agreement since the taxpayers and the Consortium had a “common legal interest.”

The court began its analysis by discussing the statutory tax practitioner privilege of § 7525, which is co-terminus with the attorney client privilege. Because the privileges are coterminous, the tax practitioner privilege can be waived in the same manner as the attorney client privilege. Since the tax practitioner privilege was created by federal statute, it is governed by the federal common law attorney-client privilege.

The federal attorney-client privilege protects communications between attorney and client that are intended to be, and are in fact, kept confidential and that are for the purpose of obtaining or providing legal advice. Because the attorney-client privilege runs counter to the judicial interest in disclosure, it is applied “only where necessary to achieve its purpose.” The party asserting the privilege has the burden of proving that the privilege has not been waived, which occurs when the client voluntarily discloses the communication.

An exception to the waiver rule is the “common legal interest” or “joint defense” rule. The exception applies to disclosures by parties represented by separate counsel who are engaged in a “common legal enterprise.” This requires a showing that the parties have a common legal, as opposed to commercial, interest and that the disclosure is made in the course of formulating a common legal strategy. A common legal interest exists where the parties have been co-parties in litigation or have formed a coordinated legal strategy.

The court noted that although the privilege was claimed for thousands of EY documents, only the EY Tax Memo was provided to the court in camera. The court assumed that if this memo was not privileged, then none of the documents were privileged. The taxpayers argued that they had a common legal interest with the Consortium in Mr. Schlaeffer’s tax liability and in the tax memos, because the banks in the Consortium had agreed to fund Mr. Schlaeffer’s tax liability. According to the taxpayers, this was especially true because of the near certainty of an IRS audit and the need to prepare to contest any proposed tax adjustments. The court rejected this argument. According to the court, the Consortium needed access to the taxpayers’ legal advice in order to assess its credit risk. While acknowledging that the banks had an “enormous stake in the tax consequences of Schlaeffer’s refinancing and restructuring decisions” and that these decisions presented complex legal issues and analyses, at bottom the shared common interest was economic: the Consortium was interested in having the transaction get favorable tax treatment to ensure that the Schlaeffer Group could service the debt. While this obtaining this assurance depended on legal analysis, this does not equate to a common legal interest.

After reviewing cases dealing with common legal interest, the court then turned to the question of whether the EY tax memo was privileged under the work product doctrine. Under Second Circuit case law, the work product doctrine only applies when the documents were prepared in anticipation of litigation. If the documents would have been prepared in a similar form absent anticipated litigation, the work product privilege does not apply. For the privilege to apply, the document does not need to be prepared in anticipation of the specific litigation in which the privilege is raised.

Before deciding whether the documents were protected by the work product doctrine, the court first addressed the IRS claim that the work product privilege had been waived by disclosure to the Consortium. The privilege is waived only by disclosure to an adversary or where the disclosure materially increases the likelihood of disclosure to an adversary. There was no waiver of any work product privilege because the taxpayers and the Consortium were not adverse. Because the parties had agreed in writing to maintain the confidentiality of the documents, disclosure to the Consortium did not materially increase the likelihood of disclosure to adverse parties.

Turning to the merits of the work product claim, the court described the EY tax memo that had been provided in camera as discussing the arguments and counter-arguments that could be made by the IRS and the taxpayers concerning the tax consequences of the refinancing and restructuring transaction but never discussed litigation. “Rather, the memorandum contains detailed and thorough legal analysis as to the propriety of the proposed measures” and advocated what specific transactional steps should be taken.

For purposes of determining whether the document was prepared in anticipation of litigation, the court accepted the taxpayers’ contention that they believed that litigation over the tax consequences of the refinancing and restructuring was inevitable. This required the court to determine whether the document “would have been created in essentially similar form” had litigation not been anticipated. This required the taxpayers to show that they would not have had complex legal analysis of the tax consequences of the transaction prepared absent the possibility of litigation. The court assumed that Schlaeffer was a rationale businessperson. Given the complexity of the transaction, the retention of outside attorneys and advisors to examine the tax consequences was required regardless of whether litigation was anticipated. There was no evidence that EY’s advice would have been different in form or substance had litigation not been anticipated. The court noted that under Circular 230, a tax advisor in rendering advice is not to take into consideration the possibility of an audit or a judicial proceeding. Since EY would have been legally ob
ligated to engage in a similar analysis regardless of any anticipated litigation, the court held that the work-product privilege did not protect the documents from disclosure. Thus, it recommended that the summons be enforced.


IRC section 6701 imposes a penalty on persons who aid and abet the understatement of tax.

Subsection (a) provides:

Any person–

  1. who aids or assists in, procures, or advises with respect to, the preparation or presentation of any portion of a return, affidavit, claim, or other document,
  2. who knows (or has reason to believe) that such portion will be used in connection with any material matter arising under the internal revenue laws, and
  3. who knows that such portion (if so used) would result in an understatement of the liability for tax of another person,shall pay a penalty with respect to each such document in the amount determined under subsection (b).The penalty is $1,000 per taxpayer with respect to whom there is an understatement, unless the taxpayer is a corporation, in which case the penalty is $10,000.

In Carlson v United States, 754 F.3d 1223 (11th Cir. 2014), the Court faced the issue of whether the district court erred in instructing a jury that the Government had to prove that the plaintiff was liable for the §6701 penalty by a preponderance of the evidence, instead of clear and convincing evidence. The court of appeals held that the district court did err both in instructing the jury on burden of proof and in denying the plaintiff’s motion for judgment as to several of the penalties.

The plaintiff Carlson had been a return preparer with Jackson Hewitt (“JH”). Carlson was not a CPA. Carlson learned about return preparation by attending in-house seminars at JH. Carlson used tax preparation software that provided questions for clients to answer. A tax return would be generated based on the clients’ answers. In Carlson’s first year at JH, she only prepared individual returns. In subsequent years Carlson also prepared corporate returns.

In 2006, after a principal of JH was arrested, the plaintiff left the company. During Carlson’s five years with JH, she had prepared about 1,500 returns. The IRS determined that deductions could not be substantiated on forty (40) of the returns. It assessed penalties against Carlson under § 6701. Carlson paid fifteen percent (15%) of the amount assessed and filed a refund claim. After the claim was denied, Carlson filed a refund suit in district court. Prior to trial, the Government conceded the penalty as to thirteen of the forty returns in issue. Trial was to a jury concerning the remaining twenty-seven returns. Over Carlson’s objection, the district court instructed the jury that the Government had to prove liability by a preponderance of the evidence. The jury returned a verdict for the Government and judgment was entered against Carlson for $119,117.12. Carlson appealed.

The district court set out two primary issues on appeal: first, did the district court err in instructing on the burden of proof? Second, did the district court err in denying plaintiff’s motion for judgment under F. R. Civ. Pro. Rule 50(a)?

The Court first addressed the burden of proof issue. Under Eleventh Circuit precedent, the Government must prove fraud in a civil case by clear and convincing evidence. This is the same burden imposed in other circuits. Thus, resolution of the question turned on whether § 6701 requires the Government to prove fraud. Noting that section 6701 requires proof that the preparer “knows that such portion (if so used) would result in an understatement of tax,” the Court stated that this is a scienter requirement. The Government must prove that the return preparer had “actual knowledge that the document would deprive the Government of the tax it is owed.” This means that the Government “must prove that the preparer deceitfully prepared the return knowing it misrepresented or concealed something that understates the correct tax. This is a classic case of fraudulent conduct.”

The Court rejected the Government’s argument that § 6701 is not a fraud statute because it does not use the word “fraud.” The Court found that this was immaterial since the conduct that the Government must prove meets the definition of fraud. In support of its position, the Court cited Mullikin v. U.S., 952 F.2nd 920 (6th Cir. 1991), and Lamb v. U.S., 977 F.2nd 1296 (8th Cir. 1992), as two cases in which the Government argued – and the courts agreed — that § 6701 requires fraud. [Mullikin held that §§ 6700 and 6701 were “ant-fraud” provisions and Lamb cited Mullikin on this point. But enough quibbling.] The Court disagreed with the holding of the Eight Circuit in Mattingly v. U.S., 922 F.2nd 785 (1991), that the Government’s burden of proof in a § 6701 case is by a preponderance of the evidence because that section does not refer to evasion of tax. According to the Carlson court, “evasion of tax” is not needed for fraud; but if it is, then § 6701 requires “evasion of tax” since it requires proof that there was knowledge of the understatement.

The Court further excoriated the Mattingly decision for concluding that §§ 6700-6703 require a “single standard of proof” and that § 6701 is part of a “nonfraud penalty scheme.” According to the Eleventh Circuit, there is no basis for the first conclusion. As to the second conclusion, § 6701 is one of three return preparer civil penalty provisions, the others being § 6694(a) (penalty for an unreasonable position on a return) and § 6694(b) (reckless or willful understatement); neither of which requires actual knowledge of an understatement. Unlike the other two return preparer penalty provisions, § 6701 “requires proof that the return preparer knew that his or her conduct would defraud the Government.” The preparer penalty structure indicates that § 6701 was designed to require a higher level of culpability, which in turn requires a clear and convincing burden of proof. Thus, the district court erred in instructing the jury that the Government must prove liability for the penalties by a preponderance and the Court could not conclude that this error was harmless.

The Court then turned to the second issue, whether the district court erred in denying the motion for judgment as a matter of law. Carlson had moved for judgment under FRCP Rule 50(a) as to twelve of the twenty-seven returns on the ground that there was no evidence from which the jury could conclude that Carlson had actual knowledge that the returns included an understatement of tax. The Court stated that the Government presented no evidence that Carlson actually knew that these returns understated tax; only that the taxpayers could not substantiate the deductions. Carlson had presented witnesses who testified that she had no knowledge that the returns understated tax. The Government contended that the inability of the taxpayers to substantiate deductions was “sufficient proof” of actual knowledge.

The Court rejected the Government’s contention. First, the argument would shift the burden of proof to Carlson if the return had errors. Second, without supporting evidence, the jury could not reasonably infer actual knowledge. The Court then examined the evidence that had been presented regarding each of the twelve penalties. As an example of the evidence, the taxpayer in one case testified that his wife provided inaccurate information to Carlson. Three other taxpayers testified that, to their knowledge, their return was correct but they settled with the IRS because it was too expensive to litigate. Regarding another return, an IRS agent testified that whether Carlson properly treated items on the return was “a close judgment call.”

Based on the evidence, the Court reversed the district court as to twelve of the penalties. It remanded for a new trial on the other fifteen penalties.


Now there is one more KPMG abusive shelter case that the ta
xpayer has appealed: Reddam v. Commissioner, F.3rd (9th Cir. 2014). Taxpayer Reddam reported a capital loss of $50,164,421 on his 1999 tax return. The loss was generated through the use of KPMG’s Offshore Portfolio Investment Strategy (“OPIS”). Reddam used this loss to offset the capital gain he earned from the sale of a business he founded.

When Reddam realized he would owe millions in tax on the gain he had, he began investigating various tax shelters Reddam decided on KPMG’s OPIS transaction. OPIS was presented by KPMG as designed to minimize taxable gains and maximize taxable losses. Reddam testified that he did not understand how OPIS worked when it was explained to him by KPMG. Reddam further testified that KPMG charged fees based on tax savings rather than on potential gain. Reddam also testified that KPMG and the president of his own corporation both recommended that he get independent advice before going into OPIS since KPMG was both marketing and advising on the transaction. Reddam did not heed these recommendations. Instead, Reddam plunked down $6 million to do the transaction. After all, v had $48 million of gain he wanted to eliminate for tax purposes. Reddam testified that he entered into OPIS both to save taxes and to make a profit.

The Court described the “byzantine OPIS transaction.” As a first step, Reddam entered into an investment advisory agreement with a firm owned by former KPMG partners. Then several entities were created: Clare Street, LLC, a domestic limited liability company owned by a foreign person, Clare Street, Ltd., a Cayman Island corporation owned by the LLC, and Cormorant, LP, a Cayman Island limited partnership whose general partner was Clare St. Ltd. and whose limited partner was the LLC.

The next step required Reddam to deposit $6 million into a Deutsche Bank (“DB”) account. Of this amount, $2.5 million was used to purchase DB stock. The rest of the money was used (a) to enter into a rate swap transaction with the LLC and (b) to buy a call option from the LLC that gave it the right to either purchase fifty percent (50%) of Clare Street Ltd, or receive the value of the company in cash.

The third step was for Clare Street Ltd. to borrow $42 million from DB to purchase DB stock that served as collateral for the loan. There followed the next step, where Clare Street Ltd. also entered into several option transactions with DB. In the fifth step, Clare Street Ltd. sold the stock back to DB for a price set in advance to guarantee that Clare Street Ltd. would not make a profit. The sale proceeds (nothing more than bookkeeping entries) were used to retire the loan from DB. Sixth, Reddam purchased call options from DB. Seventh, Reddam exercised the call option with the LLC, electing to receive cash rather than stock in Clare Street Ltd. In the eighth and ninth steps, Reddam sold back his call options to DB for a small gain, and he sold his DB stock for a small gain.

Now for the tax aspect of this transaction infused with malarkey, or maybe purported economic substance. Reddam claimed that because he and Clare Street Ltd. were related parties under IRC § 318 (he held options to purchase fifty percent (50%) of the stock of Clare Street Ltd.), the sale by Clare Street Ltd. of the stock to DB was not a redemption, but rather a dividend, and that Clare Street Ltd.’s $42 million basis in the DB stock was attributed to Reddam’s basis in DB stock. Thus, when Reddam sold the DB stock, he had a loss of more than $41 million rather than a gain. Reddam used similar logic to claim huge losses on the other option and rate swap transactions. Reddam claimed that this gave him a total capital loss of $50.2 million. Because Reddam did not accept the settlement the IRS offered in the early 2000s to taxpayers who invested in OPIS, the IRS issued a Notice of Deficiency for the tax year 1999.

In addition to testimony from taxpayer Reddam, the Tax Court heard testimony from two expert witnesses, one for Reddam and one for the IRS. Both experts testified that, under certain circumstances, OPIS presented an opportunity to make a profit based on the possible price of DB stock when it was sold. The IRS expert testified that the transaction could result in a profit under ten percent (10%) of the possible price scenarios while Reddam’s expert testified it could result in a profit under twenty-three percent (23%) to twenty-five percent (25%) of the possible price scenarios. The Tax Court found the expert testimony of minimal value because it did “little to aid in our determination of whether a profit was reasonably likely in the OPIS transaction.” The court did, however, find value in the testimony of Reddam’s expert that the taxpayer overpaid for the elements of the transaction by more than $2.25 million.

The IRS advanced five separate theories for why the transaction should be disregarded for tax purposes. The Tax Court only discussed one theory: that the transaction lacked economic substance. Based on the evidence presented, the Tax Court held that the transaction lacked economic substance. No big surprise there.

While the Ninth Circuit has eschewed a “rigid” two-prong analysis of economic substance, in practice, it usually looks at whether a transaction had economic substance from both a subjective and an objective perspective. Addressing first the subjective inquiry, the Ninth Circuit held that there was sufficient evidence to support the Tax Court’s rejection of Reddam’s testimony that he had a non-tax motive and to find, instead, that his efforts at reducing taxes demonstrated his true motives.

Reddam argued that his case differed from other cases involving similar transactions due to his “investment diligence.” Given Reddam’s failure to seek outside independent advice and his failure to investigate the complex OPIS transaction, the Ninth Circuit held that the Tax Court was justified in finding that Reddam’s motive was avoidance of tax.

Turning to the objective inquiry, the Court stated that “even if a transaction could ‘as a theoretical matter … result in economic gain,’ it nonetheless lacks economic substance if it was ‘executed in such a manner as to insure that the net result … would be a tax deductible loss.’” Reddam argued that his expert’s testimony was “implicitly adopted” by the Tax Court and that a 23-25% profit potential meant that the transaction had economic substance. The IRS argued that Reddam’s motive was sufficient to show a lack of economic substance.

The Ninth Circuit refused to adopt either argument since the test in such cases is “part of a pragmatic total inquiry.” The “application of the economic substance doctrine turns not only on the percentage of possible profit or loss underlying Reddam’s OPIS transaction, but also on the likely corresponding magnitude of those profits or losses and how they would be reported for tax purposes.” The loss that the transaction was designed to create from the $42 million basis shift “would always (even under Reddam’s expert’s calculations) have overshadowed any possible gain.” Reddam was mistaken in his belief that the Tax Court held that a transaction with a ten percent (10%) to twenty-five (25%) chance of generating a profit always lacked economic substance. “Rather the overall structure of the OPIS transaction compels the conclusion that it would be purchased solely for its ability to create capital losses.” Thus, the judgment of the Tax Court was affirmed.


The first quarter 2013 issue of the newsletter of the Tax Procedure and Litigation Committee Journal of Tax Litigation Recent Cases of Interest column discussed the district court’s decision in Loving, which held that the IRS could not regulate unenrolled return preparers. The discussion concluded with these words:

Although the Court limited its ruling to return preparers, its decision turned on the language of § 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 repr
esent clients before the IRS, do not “present cases.” Thus, they could argue that the IRS lacks authority to subject them to Circular 230.

The district court’s recent decision in Ridgely v. Lew (USDC DC, No. 1:12-cv-00565 (July 16, 2014)) proved these words true.

The plaintiff in Ridgely is a CPA who brought an action for (i) declaratory relief that the IRS’s Circular 230 prohibition on contingent fees for the preparation and filing of “Ordinary Refund Claims” was an invalid exercise of authority and (ii) injunctive relief barring the IRS from enforcing the prohibition. Ridgely alleged that the prohibition caused him to lose clients and income. Both Ridgely and the IRS moved for summary judgment. Finding that the statutory language of 31 U.S.C. § 330 and the D.C. Circuit’s opinion in Lovingrequired a conclusion that the prohibition was in contravention of the authority granted the IRS, the district court granted Ridgely’s motion for summary judgment.

According to the court, there are three stages to a taxpayer’s interaction with the IRS: (1) assessment and collection, (2) examination and (3) appeals. If the taxpayer disputes the IRS Appeals Office’s determination, the taxpayer can then seek review in court. After this brief overview, the court defined what it meant by “Ordinary Refund Claims.” These are refund claims prepared when a taxpayer believes the original return overstated tax and, consequently, files a refund claim prior to or during an examination but before legal proceedings begin or before formal legal representation by the CPA.

The IRS’s authority to regulate practice before the IRS is contained in 31 U.S.C. § 330. In case you have forgotten, that section provides, in relevant part:

  1. Subject to section 500 of title 5, the Secretary of the Treasury may–
    1. regulate the practice of representatives of persons before the Department of the 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; and
      4. competency to advise and assist persons in presenting their cases.
  2. After notice and opportunity for a proceeding, the Secretary may suspend or disbar from practice before the Department, or censure, a representative who–
    1. is incompetent;
    2. is disreputable;
    3. violates regulations prescribed under this section; or
    4. with intent to defraud, willfully and knowingly misleads or threatens the person being represented or a prospective person to be represented.

The Secretary may impose a monetary penalty on any representative described in the preceding sentence. If the representative was acting on behalf of an employer or any firm or other entity in connection with the conduct giving rise to such penalty, the Secretary may impose a monetary penalty on such employer, firm, or entity if it knew, or reasonably should have known, of such conduct. Such penalty shall not exceed the gross income derived (or to be derived) from the conduct giving rise to the penalty and may be in addition to, or in lieu of, any suspension, disbarment, or censure of the representative.

The Secretary may impose a monetary penalty on any representative described in the preceding sentence. If the representative was acting on behalf of an employer or any firm or other entity in connection with the conduct giving rise to such penalty, the Secretary may impose a monetary penalty on such employer, firm, or entity if it knew, or reasonably should have known, of such conduct. Such penalty shall not exceed the gross income derived (or to be derived) from the conduct giving rise to the penalty and may be in addition to, or in lieu of, any suspension, disbarment, or censure of the representative.


(d) Nothing in this section or in any other provision of law shall be construed to limit the authority of the Secretary of the Treasury to impose standards applicable to the rendering of written advice with respect to any entity, transaction plan or arrangement, or other plan or arrangement, which is of a type which the Secretary determines as having a potential for tax avoidance or evasion.

Under the authority of § 330, the IRS promulgated the regulations commonly referred to as Circular 230. Prior to 1994, Circular 230 did not regulate fees. In that year, it was amended to prohibit contingent fees for preparing original tax returns. In 2007, § 10.27 of Circular 230 was amended to prohibit contingent fees “in any matter before the Internal Revenue Service,” with certain limited exceptions. These exception did not include amended returns or refund claims. Section 10.27 defines “matter before the Internal Revenue Service” as including “tax planning and advice, preparing or filing or assisting in preparing or filing returns or claims for refund or credit, and all matters connected with a presentation to the Internal Revenue Service or any of its officers or employees relating to a taxpayer’s rights, privileges, or liabilities.”

The district court discussed the standards governing summary judgment the standards relate to the review of administrative decisions under the Administrative Procedures Act (APA). The APA standard is different from that which applies in other types of cases, since the APA specifically empowers a court to review agency actions, findings and conclusions and set them aside if they are in excess of statutory authority. 5 U.S.C. § 706(2)(C). A court’s function in these cases is “to determine whether or not as a matter of law the evidence in the administrative record permitted the agency to make the decision it did.” The review is conducted under the two-step Chevron standard.

The Court focused on the Treasury’s authority under § 330 to “regulate the practice of representatives of persons before the Department of Treasury.” Step one of Chevron required the Court to determine whether § 330 “unambiguously forecloses” the IRS’s interpretation that a CPA is acting as a representative who practices before the IRS when the CPA prepares and files an Ordinary Refund Claim. The Loving court had “venture[d] down this particular rabbit hole,” and held that, in light of the text, history and context of § 330, preparation of all or a substantial proportion of a return or refund claim by an unlicensed return preparer was not practice before the IRS. Logically, then, the preparation and filing of a claim for refund was not practice before the IRS. Thus, the IRS’s interpretation “failed at both Chevron step 1 and Chevron step 2.”

The Court turned first to the interpretation of “representative” and “practice.” Under Loving, a representative is someone who with authority to bind others, and return preparers cannot legally act on the taxpayer’s behalf or legally bind the taxpayer. In light of Loving, § 330’s use of “representative” does not include refund claim preparers who are CPAs. Similarly, because Loving held that “practice” under § 330 refers to practice during an investigation, adversarial hearing or other adjudicative proceeding, the preparation or filing of an Ordinary Refund Claim by a CPA is not “practice” before the IRS.

Additionally, following Loving, the district court held that Congress’s “comprehensive scheme” for regulating return preparers through penalties for abuse “supports the conclusion” that Congress meant to distinguish between the preparation and filing of returns, on the one hand, and a subsequent adjudication, on the other. Section 330’s grant of authority was limited to the second category. Reviewing briefly § 330’s history, the district court held that the original language of § 330 focused on representatives advising and assisting persons in “the presentation of their cases” and that this was not changed by subsequent amendment of the st
atute. A CPA who prepares and files a refund claim before becoming a legal representative of the taxpayer and presenting the taxpayer’s case is not within the scope of § 330.

The district court then turned to the IRS’s “only . . . non-conclusory argument,” which is that because Ridgely is a CPA he is a representative who practices before the IRS. This argument was found wanting. First, according to the district court, it is inconsistent with the word “practice” found in § 330. Second, it would read the word “representative” out of the statute. Third, under this interpretation, the IRS could regulate every action of a CPA regardless of whether he or she was representing clients before the IRS. It disagreed with the contention that a CPA is subject to IRS regulation because he or she may occasionally practice before the IRS.

Because the prohibition of contingent fees for the preparation and filing of “Ordinary Refund Claims” was beyond the ambit of the statutory authority granted by § 330, the district court permanently enjoined the IRS from enforcing the prohibition.

The remaining question is which lawyer, law firm or CPA firm will file an action challenging the IRS’s authority to regulate their practice of advising clients in tax matters outside the context of representation in an audit or other proceeding?


This is not a tax case, but it probably is relevant to many of you. In United States v Hom, the court had to decide whether an account set up with an offshore internet gaming site was a “financial account” for purposes of the FBAR provisions. The defendant Hom gambled on several internet poker sites. To fund his gambling, Hom had set up accounts with the poker sites into which he could deposit, and from which he could withdraw, funds. Until 2006, Hom used to transfer funds to the gambling websites. In that year, refused to allow U.S. customers to transfer funds to online gambling sites, so Hom switched to Western Union. In both 2006 and 2007, Hom had over $10,000 on account with the gambling websites. The IRS audited Hom and assessed FBAR non-willful penalties of $30,000 for 2006 (for the account and the two gambling accounts) and $10,000 for 2007 (for the one poker site Hom used in that year). When Hom did not pay, the Government sued to collect the assessment.

The court first reviewed the Bank Secrecy Act and 31 C.F.R. § 103.24, which provides that a person with a financial interest in or signatory authority over a bank, financial or securities account in a foreign country is required to report the relationship to Treasury. Under 31 C.F.R. § 103.27, a person has to file a report by June 30 for foreign financial accounts if the combined balance in the accounts exceeds $10,000 in the prior year. The district court held that Hom was obligated to report the accounts with the offshore sites. Due to Hom’s failure to do so, he was liable for the penalties. Hom was a United States person, so he was subject to the reporting provisions. Hom admitted that he had a financial interest in the and poker websites, but argued that none of the accounts was a “bank or other financial account.” Thus, the reporting provisions did not apply. Section 5312 of Title 31 lists twenty-six (26) types of entities that may qualify as “financial institutions.” In U.S. v. Clines, 958 F.2nd 578 (4th Cir. 1992), the court held that any entity that holds funds for third parties and disburses the funds at the third party’s directions functions similarly to a bank and is therefore a financial institution. The Ninth Circuit, in United States v. Dela Espriella, 781 F.2nd 1432 (1985), held that “financial institution” was to be broadly defined. The gambling websites and held funds for third parties that the depositors could use. Relying on Clines and Dela Espriella, the district court held that the gambling websites and fell within the definition of financial institution for purposes of the Bank Secrecy Act.

The district court next addressed the question of whether the internet websites were based in a foreign country. Hom argued that for the account to be in a foreign country the funds had to be in a foreign country. Since the internet sites Hom used had bank accounts in the U.S., he argued that the account was not in a foreign country. The court held that it was irrelevant where the foreign institutions had accounts. What was relevant was whether Hom’s accounts were with foreign institutions.

On the Government’s motion, the court took judicial notice of information on the websites of the three entities that they were located outside the U.S. It held that they were foreign financial institutions. In reaching its conclusion, the district court gave Chevrondeference to the 2011 FinCen amendments to the Bank Secrecy Act regulations that an account is not a foreign account if it is with a financial institution located in the U.S. Language in the FBAR instructions that the location of the account, not of the financial institution, was determinative, was given no weight.

The last question that needed to be addressed was whether the aggregate balance in the accounts was more than $10,000 in each year. Since Hom admitted that the balance was not, all of the elements needed for the non-willful penalty to apply were met. The district court also rejected Hom’s contention that under the Internal Revenue Manual, the IRS abused its discretion in assessing the maximum non-willful penalties against him. The district court therefore granted the Government’s summary judgment motion.

Carolyn: the 11th circuit yesterday came out with a not for publication order in the remand on Clarke. Please add to the end of the Clarke discussion the following:

On July 25, 2011, the Eleventh Circuit issued a not-for-publication remand summoned order to the district court, available at es/201213190.rem.pdf . The Eleventh Circuit directed the district court, on remand, to “ask and answer” the question whether, in light of “the evidence and affidavits highlighted by the Supreme Court the parties opposing enforcement had raised a plausible inference of improper purpose and whether the allegedly improper purposes were “improper as a matter of law.” July 29, 2014

Are you reading someone else’s copy of this issue of the California Journal of Tax Litigation?Receive your own copy as well as all the announcements and updates from the Tax Procedure & Litigation Committee of theTaxation Section of the California State Bar Association.Join the Tax Procedure & Litigation Committee!Send an email message to Chair LaVonne Lawson,
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Past Committee Chairpersons:2013 David Warren Klasing
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1. Courtney A. Hopley, Secretary of the Tax Procedure & Litigation Committee, represents clients in federal and state tax controversies, practicing in the San Francisco offices of Greenberg Traurig LLP.

2. John A. Harbin, The Law Offices of John Harbin, is a veteran California tax litigator with additional training as a certified public accountant. Mr. Harbin is a sole proprietor operating his law practice in Coronado, California. Mr. Harbin’s practice focuses on tax controversy, bankruptcy and civil litigation.

3. Gregory Harper, Harper Legal Group, P. C., has a solo legal practice in Point Richmond, California, specializing in tax and criminal law.

All comments regarding third-party products and services are the opinion of Mr. Harper, and not the Taxation Section or the Tax Procedure and Litigation Committee of the California State Bar Association.

4. Joseph P. Wilson practices tax controversy, with particular expertise in civil and criminal tax defense, at the Wilson Tax Law Group, serving California clients from his base in Orange County.

5. Zaher Fallahi, Attorney at Law, CPA, specializes in tax controversy and return preparation from offices in Orange County and Los Angeles. Mr. Fallahi’s firm also provides legal services involving civil litigation, estate planning and the US Treasury-Office of Foreign Assets Control (OFAC) matters

6. Robert Horwitz generously continues his contribution to this publication of lively summaries of recent opinions of particular interest to tax practitioners. Mr. Horwitz practices civil and criminal tax matters, including audits, appeals and criminal investigations before the Internal Revenue Service and state taxing authorities, and in trials in both federal and state courts. Mr. Horwitz is a member of the Law Offices of A. Lavar Taylor, APC, located in Santa Ana.

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