Guidance on SLL Claims • Revised Innocent-Spouse Provisions • CDP Procedures Finalized • Tax Shelter Disclosure

Editor:

Mark H. Ely, J.D., CPA
Partner
Washington National Tax
KPMG LLP
Washington, DC

Editor's note: Mr. Ely is former chair of the AICPA Relations with the IRS Committee. Messrs. Burke, Blair and Welty and Ms. Corbet are members of that committee.

Tax Court Provides Guidance on Pre-1998 SLL Claims

Whether a loss qualifies for specified-liability loss (SLL) treatment under Sec. 172(f) is a highly litigated area of tax law. Although the provision has been amended twice since its enactment in 1978, neither Congress nor the Service has provided authoritative guidance on characterizing an SLL. As such, practitioners turn to case law, which seems to change whenever a new case is litigated. Although current Sec. 172(f) is clear and unambiguous, many taxpayers have pending losses and issues prior to the last amendment in 1998.

Sec. 172

Generally, under Sec. 172(a), a taxpayer can carry back a net operating loss (NOL) two years, or carry it forward 20 years. Sec. 172(f) is an exception to the two-year carryback rule, which provided for a 10-year carryback for SLLs.

Originally, Sec. 172(f)(1)(B) limited SLLs to product liability losses. In 1984, Congress amended the provision to include losses "with respect to" a liability that arose under a Federal or state law or out of any tort of the taxpayer. In addition, the act that gave rise to the liability must have occurred at least three years prior to the tax year.

Most taxpayers interpreted the phrase "with respect to" as meaning any cost associated with a liability arising under Federal or state law or any tort of the taxpayer. The only interpretive guidance for taxpayers was a few letter rulings, which were, in most cases, taxpayer-favorable and at times a relaxed interpretation of expenses the IRS allowed as SLLs. However, the Service did not issue regulations or release any revenue rulings to provide guidance.

Cases

In Sealy Corp., 107 TC 177 (1996), aff'd, 171 F3d 655 (9th Cir. 1999), the IRS contended that expenses incurred in complying with Federal laws were not SLLs. In Sealy, the expenses were legal, accounting and professional fees incurred as a result of SEC and ERISA reporting requirements and IRS audits. In Sealy, the court ignored the phrase "with respect to" and permitted deductions only for losses resulting from obligations enumerated in Federal or state statutes. Any associated costs were deemed too attenuated to be afforded SLL status.

Sec. 172(f)(1)(B) was amended by the Tax and Trade Relief Extension Act of 1998. The ambiguous phrase "with respect to" was deleted and the types of liabilities considered SLLs were specifically listed.

In Host Marriott, 267 F3d 363 (4th Cir. 2001), aff'g 113 FSupp 2d 790 (DC MD 2000), the Fourth Circuit held that interest payments on Federal income tax deficiencies were SLLs under Sec. 172. The taxpayer had argued that the acts giving rise to the interest liabilities were deficient tax filings in previous years. The taxpayer argued further that the interest obligation was intertwined with the obligation to pay unpaid taxes, because it could not pay the interest obligation separately from the taxes; therefore, the interest was afforded Sec. 172 SLL treatment. The district court distinguished the facts in Host Marriott from Sealy because, in Sealy, the expenses were professional fees that the taxpayer incurred at his own will and were not imposed by a statute. As such, Host Marriott opened the door for renewed liberal interpretation of Sec 172(f).

In Intermet Corp., 117 TC No. 13 (2001), the issue was whether state tax deficiencies and interest on Federal and state tax deficiencies qualified as SLLs. Intermet Corp. maintained that the deficiencies and interest were liabilities arising out of state or Federal law and the acts giving rise to the liabilities occurred in 1986, 1987 and 1988, more than three years prior to 1992. The IRS contended that Sec. 172(f) was intended only for a "narrow class of liabilities," such as tort and product liability. The Service also argued that even if the interest was considered an SLL because interest accrues daily, the act that gave rise to the liability did not occur more than three years prior to 1992. As such, any interest accruing from 19891992 did not qualify.

The Tax Court held that the state deficiencies and state and Federal interest qualified as Sec. 172(f) SLLs. The state deficiencies and related interest arose out of Michigan law; the interest on Federal deficiencies arose out of the Code. Since state and Federal law expressly imposed such liabilities, they fell within the Sec. 172(f)(1)(B) criteria and qualified as SLLs.

Conclusion

Because the IRS did not issue Sec. 172(f) regulations before Congress amended the statute in 1998, taxpayers must rely on case law. Although the decisions in Intermet and Host Marriott are taxpayer-favorable, they are only a precedent for taxpayers with claims arising before 1998 (the year in which Congress amended the statute). After 1998, a taxpayer's liability must be one of the enumerated liabilities under the statute to qualify as an SLL.

Going forward, the Service will probably issue an Action on Decision providing taxpayers with some guidance on how to address the complexities of Sec. 172(f) prior to the 1998 amendment. Without IRS guidance, taxpayers must continue to rely on decisions that mirror the taxpayer's facts.

From Rene M. Corbet, CPA, and Salvatore M. Di Costanzo, J.D., Ernst & Young LLP, New York, NY

Defining the Revised Innocent-spouse Provisions

To address widely perceived injustices arising from joint and several liability for spouses who filed joint returns, Congress, as part of the Internal Revenue Service Restructuring and Reform Act of 1998 (IRSRRA), expanded the possibilities for relief from joint liability. In enacting Sec. 6015, Congress provided three separate statutory bases for innocent-spouse relief. Two of these arise only when a taxpayer's tax increases.

Relief from Tax Increases

Sec. 6015(b) provides relief from joint liability if five conditions are met:

1. A joint return was filed;

2. On the return, an understatement of tax was attributable to erroneous item(s) of the spouse (i.e., the nonrequesting spouse) with whom the spouse requesting relief (i.e., the requesting spouse) filed the return;

3. The requesting spouse established that at the time that the return was signed, he had no knowledge or reason to know of a tax understatement;

4. Taking into account all the facts and circumstances, holding the requesting spouse liable for the understatement would be inequitable; and

5. The requesting spouse elected the benefits of Sec. 6013(b) no later than two years after the date collection activities began as to him.

Sec. 6013(b) is analogous to pre-IRSRRA Sec. 6013(e), but was expanded to include all items adjusted (but not limited to those that were "grossly erroneous").

Relief is not available to a spouse whose income or deductions or both are the cause of the tax increase.

The third requirement of Sec. 6015(b), that the requesting spouse had no knowledge or reason to know of a tax understatement at the time the taxpayers filed the joint return, was considered by the Tax Court in Butler, 114 TC 276 (2000). In Butler, the court adopted its precedents on pre-IRSRRA Sec. 6013(e). It stated:

...if a reasonably prudent taxpayer in his or her position, at the time he or she signed the return, could be expected to know that the return contained an understatement or that further investigation was warranted. The spouse seeking relief has a "duty of inquiry"...In deciding whether a spouse "has reason to know" of an understatement, we undertake a subjective inquiry, and we recognize several factors that are relevant to our analysis, including: (1) The alleged innocent spouse's level of education; (2) the spouse's involvement in the family's business and financial affairs; (3) the presence of expenditures that appear lavish or unusual when compared to the family's past income levels, income standards, and spending patterns; and (4) the culpable spouse's evasiveness and deceit concerning the couple's finances.

In Braden, TC Memo 2001-69, the court compared two of its prior holdings—Cheshire, 115 TC 15 (2000) and Varney, TC Memo 1991-14 —as illustrative of the facts that distinguish between a requesting spouse having reason to know and meeting his duty to inquire.

In Cheshire, the requesting spouse knew that her husband had received a large sum from his retirement plan. The retirement proceeds were incorrectly reported as partially nontaxable on the taxpayers' joint return. The court concluded the requesting spouse had knowledge of the amount of the retirement distribution and that she "knew or had reason to know of the understatement."

In Varney, distributions from an IRA belonging to the requesting spouse's deceased wife were not reported. Before dying, the wife withdrew the funds from her IRA and deposited them into a joint account. When the requesting spouse inquired about the large deposit into the couple's joint account, his wife told him that the funds were from accumulated savings. The Braden court concluded that "the taxpayer had satisfied his duty of inquiry and did not know that the funds received were the result of a distribution from his spouse's IRA." Accordingly, the requesting spouse qualified for relief.

Under prior law, a conflict existed between the circuits as to the appropriate test for determining if a spouse had knowledge of adjusted deductions. The Tax Court in Bokum, 94 TC 126 (1990), aff'd, 992 F2d 1132 (11th Cir. 1993), found that the same tests were to be applied for deductions as for income. The Eleventh Circuit adopted the Tax Court's standard.

The Bokum standard was rejected by the Second and Ninth Circuits. In both Friedman, 53 F3d 523 (2d Cir. 1995), and Price, 887 F2d 959 (9th Cir. 1989), the courts held that applying the omission-of-income test to cases involving the disallowance of deductions would eviscerate the innocent-spouse defense, because merely looking at the return informs the spouse of the transaction that gave rise to the deduction. Instead, the Second and Ninth Circuits require a taxpayer to establish that "she [or he] did not know and did not have reason to know that the deduction would give rise to a substantial understatement."

There are still no precedents that provide any guidance as to whether the courts will harmonize their opinions consistent with congressional intent that innocent-spouse relief be viewed more expansively.

Allocation of Increased Tax

Sec. 6015(c) allows a requesting spouse to elect to allocate a tax deficiency if (1) a joint return was filed and (2) at the time of the election, the requesting spouse was no longer married to, was legally separated from or had not been a member of the same household as the nonrequesting spouse at any time during the 12-month period ending on the date the election was filed. For Sec. 6015(c) purposes (unlike for Sec. 6015(b) and (f)), whether the election is equitable or inequitable is irrelevant.

Relief under Sec. 6015(c) is limited. First, a Sec. 6015(c) election would be invalid if the assets were transferred between the requesting spouse and the nonrequesting spouse as part of a fraudulent scheme. Second, relief is not available to the extent that the requesting spouse had actual knowledge of an item giving rise to a deficiency at the time he signed the return. Third, relief is available only to the extent that the liability exceeds the value of any disqualified assets (as defined in Sec. 6015(c)(4)(B)) transferred to the requesting spouse by the nonrequesting spouse.

Of these limits, the only one discussed is the preclusion of relief when the requesting spouse had actual knowledge of the item giving rise to the deficiency.

In Cheshire, the Tax Court found that relief would be precluded if a requesting spouse knew of the item that led to the deficiency, but was unaware of the proper reporting requirements. The nonrequesting spouse received a pension distribution that the requesting spouse believed included nontaxable portions.

The court stated:

We believe the knowledge standard for purposes of section 6015(c)(3)(C) is an actual and clear awareness (as opposed to reason to know) of the existence of an item which gives rise to the deficiency (or portion thereof). In the case of omitted income (such as the situation involved herein), the electing spouse must have an actual and clear awareness of the omitted income. Section 6015(c)(3)(C) does not require actual knowledge on the part of the electing spouse as to whether the entry on the return is or is not correct. (Emphasis in original.)

The court further held that "generally, ignorance of the tax law is not a defense to a deficiency."

In King, 116 TC 16 (2001), the Tax Court established its test for determining whether a taxpayer had actual knowledge of a deduction. The requesting and nonrequesting spouses had filed a joint return in which they claimed a loss from the nonrequesting spouse's cattle-raising activity. The Service disallowed the loss under Sec. 183 as an activity not engaged in for profit.

The court held that when the item giving rise to the deficiency is a disallowed deduction, actual knowledge must include knowledge of the facts that caused the disallowance of the deduction. In King, the fact that gave rise to the adjustment was the nonrequesting spouse's lack of a profit objective. The requesting spouse knew of the loss but expected the activity to become profitable. For this reason, the Service did not meet its burden of proving that the requesting spouse had actual knowledge of the nonrequesting spouse's lack of a profit motive, and, therefore, the court granted relief.

Relief Due to Inequity

Sec. 6015(f) provides:

Under procedures prescribed by the Secretary, if—(1) taking into account all the facts and circumstances, it is inequitable to hold the individual liable for any unpaid tax or, any deficiency (or any portion of either); and

(2) relief is not available to such individual under subsection (b) or (c), the Secretary may relieve such individual of such liability.

Pre-IRSRRA Sec. 6013(e) required a consideration of whether it was inequitable to grant relief. In Braden, the court stated:

"[s]ince section 6015(b)(1)(D) is substantially identical to former section 6013(e)(1)(D), we may look to cases applying former section 6013(e)(1)(D) to inform our analysis under section 6015(b)(1)(D). See Butler v. Commissioner, 114 T.C. 276 (2000).

As Sec. 6015(f)(1) is a duplicate of Sec. 6015(b)(1)(D), it is highly likely that the court will make a similar interpretation.

In Silverman, 116 F3d 172 (1997), in overturning the Tax Court's more restrictive view of former Sec. 6013(e), the Sixth Circuit stated, "The innocent spouse provision should be construed and applied liberally in favor of those for whom it was designed to protect"; see Friedman, 53 F3d 523 (2d Cir. 1995), aff'g in part and rev'g in part, TC Memo 1993-549; Perry, TC Memo 1992-258; and Allen, 514 F2d 908 (5th Cir. 1975), aff'g in part and rev'g in part, 61 TC 125 (1973).

In Makalintal, TC Memo 1996-9, the Tax Court recapitulated its holdings on the issue of inequity under the former section:

In light of all of the facts and circumstances, it would be inequitable to hold petitioner liable for the alleged understatement...This issue turns largely on the question of whether petitioner benefitted directly or indirectly from the understatements of tax. Flynn v. Commissioner, supra at 367; Bell v. Commissioner, T.C. Memo. 1989-107; sec. 1.6013-5(b), Income Tax Regs. Normal support of a spouse and children is not regarded as a significant benefit and is to be considered in light of the circumstances of the parties. Sanders v. United States, 509 F.2d 162, 168 (5th Cir. 1975); Flynn v. Commissioner, supra at 367; Bell v. Commissioner, supra. Also to be considered is whether the spouse claiming relief has been deserted, divorced, or separated. Kistner v. Commissioner, T.C. Memo. 1995-66; sec. 1.6013-5(b), Income Tax Regs.

Significantly, the Tax Court also stated:

Further, in deciding whether it would be inequitable to hold a spouse liable for understatements of tax, it is relevant to consider the probable future hardships that would be imposed on the spouse seeking relief, if such relief were denied.

Under pre-IRSRRA Sec. 6013(e) (as will assuredly be required under current law), taxpayers bore the burden of proving that they did not receive a significant benefit from the understatement, other than normal support. This burden must be met with specific facts on lifestyle, expenditures, asset acquisitions and the disposition of the benefits of the understatement.

In considering the facts and circumstances that favor a finding of inequity, the courts have considered the departure of a spouse, whether the spouse had to pursue further education to support the spouse and family, a reduction in living standard, the lack of accumulated liquid assets, a reduction of income and physical or mental abuse.

The courts have not found that the requesting spouse's retention of the family home or automobile weigh against relief.

In Rev. Proc. 2000-15, the Service established the threshold conditions that taxpayers must satisfy before it will consider a request for equitable relief under Sec. 6015(f), as well as the circumstances under which the IRS will ordinarily grant Sec. 6015(f) relief and the factors weighing in favor and against that relief.

Rev. Proc. 2000-15 does not provide relief when the requesting spouse knowingly filed a fraudulent return or took part in the fraudulent transfer of assets. Relief is also limited by the disqualified-asset-transfer limits under Sec. 6015(c)(4)(B).

The Service lists those circumstances under which it will ordinarily grant equitable relief under Sec. 6015(f). When the tax is unpaid at the time the taxpayers file a request:

• The requesting spouse can no longer be married to (or has to be legally separated from) the nonrequesting spouse or cannot have been a member of the same household as the nonrequesting spouse at any time during the 12-month period ending on the date relief was requested;
• At the time the return was signed, the requesting spouse had no knowledge or reason to know that the tax would not be paid. The requesting spouse must establish that it was reasonable for the requesting spouse to believe that the nonrequesting spouse would pay the reported liability.
• The requesting spouse will suffer economic hardship, as defined under Regs. Sec. 301.6343-1(b)(4), which limits relief to taxpayers unable to pay reasonable basic living expenses. It appears that under Rev. Proc. 2001-15, the Service adopted a far more stringent definition of hardship than had been applied previously.
• The procedure also includes a list of circumstances under which the IRS will grant equitable relief. No single circumstance is determinative; the Service considers and weighs whether:
• The requesting spouse was separated (whether legally separated or living apart) or divorced from the nonrequesting spouse.
• The requesting spouse would suffer economic hardship.
• The requesting spouse was abused by the nonrequesting spouse.
• The requesting spouse did not know and had no reason to know that the liability would not be paid. For a liability that arose from a deficiency, whether the requesting spouse did not know and had no reason to know of the items giving rise to the deficiency.
• The nonrequesting spouse had a legal obligation pursuant to a divorce decree or an agreement to pay the outstanding liability. This would not be a circumstance weighing in favor of relief if the requesting spouse knew or had reason to know (at the time the divorce decree or agreement was entered into) that the nonrequesting spouse would not pay the liability.
• The liability for which relief was sought was solely attributable to the nonrequesting spouse.

Circumstances weighing against relief include:

• The unpaid liability or item that gave rise to the deficiency was attributed to the requesting spouse.
• The requesting spouse knew or had reason to know of the item that gave rise to a deficiency or that the reported liability would be unpaid when the return was signed. This is an extremely strong factor weighing against relief.
• The requesting spouse had significantly benefited (beyond normal support) from the unpaid liability or items that gave rise to the deficiency; see Regs. Sec. 1.6013-5(b).
• The requesting spouse would not experience economic hardship.
• The requesting spouse had not made a good-faith effort to comply with Federal income tax laws in the tax years following the tax year(s) to which the request for relief relates.
• The requesting spouse had a legal obligation pursuant to a divorce decree or agreement to pay the liability.

Procedure for Requesting Innocent-Spouse Relief

To request innocent-spouse relief, a spouse must file Form 8857, Request for Innocent Spouse Relief, within two years of the first collection activity against the requesting spouse after July 22, 1998.

If the IRS denies the request, the requesting spouse must file a petition with the Tax Court during the 90-day period beginning on the date on which the Service mailed (by certified or registered mail) a determination notice denying relief.

If the IRS fails to issue a valid notice of determination within six months of filing a relief request, the spouse could file a petition with the court during the 90-day period beginning after the expiration of the six-month period (Sec. 6015(e)(1)(A)).

In Heit, Docket No. 5503-00 (2001), a determination notice issued by the Service included a series of errors, including a misstatement of the date for filing a Tax Court petition. The taxpayer filed her petition by the date stated in the notice. The Service moved the court to dismiss the taxpayer's petition, claiming that the petition was not timely. The Tax Court held that the notice was invalid and allowed the taxpayer's petition to stand as being filed within six months after her request for relief.

From Timothy Burke, CPA, J.D., Burke and Associates, Braintree, MA

CDP Procedures Finalized

Treasury has issued final regulations on taxpayers' rights to collection due-process (CDP) hearings as provided under the Revenue Reconciliation Act of 1998 in Secs. 6320 and 6330. Regulations provide the procedures for:

1. Notifying taxpayers when the IRS files a notice of Federal tax lien (NFTL);

2. Notifying taxpayers before the Service levies a tax;

3. Notifying taxpayers of their right to a CDP hearing for both of the above; and

4. Conducting CDP hearings and appealing the results.

The final regulations apply to any NFTL filed, or any levy occurring, after Jan. 8, 1999.

Notice Procedures

The IRS should issue an NFTL within five business days after it files a lien. The Service must send pre-levy notices to taxpayers at least 30 days before the levy. Notices should include the statutory provisions and procedures on release of liens or relating to levy and sale of property, and should also include alternatives that may prevent further levies (such as an installment agreement).

The IRS must deliver an NFTL to taxpayers either by personal delivery (leaving the notice at the taxpayer's dwelling or usual place of business) or by certified or registered mail sent to the taxpayer's last-known address. An NFTL informs taxpayers of their right to request a CDP hearing.

A proper delivery starts the period within which a taxpayer must request a CDP hearing, even if the taxpayer does not receive the notice. If a taxpayer does not receive a notice and the IRS determines that it did not properly deliver the notice, it will provide the taxpayer with a substitute CDP notice and an opportunity to request a hearing. The validity and priority of an NFTL are not affected.

Requesting a CDP Hearing

Taxpayers must request a Sec. 6320 NFTL CDP hearing by the 30th day after the fifth business day within the period in which the IRS must give notice of filing. In case of a substitute notice, the taxpayer must make a request by the 30th day after the date of the substitute notice. Taxpayers must request a Sec. 6330 pre- or post-levy CDP hearing by the 30th day after the date of the CDP notice. Requests must be in writing (to resolve potential disputes over timeliness).

Form 12153, Request for a Due Process Hearing, should be included with the notice the taxpayer uses to request a hearing. However, a written request in any form that includes the taxpayer's name, address and daytime telephone number, and is signed and dated by the taxpayer or authorized representative, will be accepted. The request should include a statement explaining why the taxpayer disagrees with the NFTL or levy, and should be filed with the IRS office and address indicated on the CDP notice. If the CDP notice does not provide that address, it must be filed with the compliance director for the area where the taxpayer resides or has its principal place of business.

Importantly, when a potential exists for multiple CDP notice filings for the same tax liability, taxpayers must request a hearing in response to the first notice. The IRS's position is that a taxpayer is entitled to only one CDP hearing on a particular tax and period, determined by the first filing of either a Sec. 6320 NFTL CDP notice or a Sec. 6330 (levy) CDP notice. Therefore, if a hearing is not requested as a result of the first notice, the taxpayer forgoes any right to a CDP hearing and judicial review for that tax liability.

If a request for a CDP hearing is not timely, the taxpayer might still request an "equivalent hearing" with Appeals, which would follow the same procedures and consider the same issues it would have for a CDP hearing. Appeals does not, however, issue a determination notice, but instead issues a decision letter. The issue consideration is the same; the difference is that neither Sec. 6320 nor Sec. 6330 authorizes a taxpayer to appeal the Appeals decision. (A taxpayer may, under certain circumstances, however, request Tax Court review of an Appeals denial of joint and several liability relief under Sec. 6015.)

Taxpayers are encouraged to discuss their concerns with the IRS employee involved in the collection action or filing the NFTL before or after requesting the CDP hearing, perhaps resolving some matters before (or without) Appeals' involvement. Appeals still includes any resolved matters in the NFTL determination notice, unless the taxpayer waives in writing Appeals' consideration of the matter.

How Is a Hearing Conducted?

Consideration in Appeals should be by an employee that has had no prior involvement with the tax liability (unless the taxpayer waives this requirement). The hearing is informal, may not necessarily involve a face-to-face meeting and may consist of telephone or written communication, or both. Before the hearing, the hearing officer should have obtained verification that statutory and administrative requirements have been met.

Appeals has authority to consider and determine the validity, sufficiency and timeliness of any CDP notice.

The taxpayer is to provide all relevant information Appeals requests.

A spousal defense might be raised if the Service has not previously made a final determination as to such spousal defense in a final determination letter or statutory deficiency notice.

Underlying Tax Liability

At the taxpayer's request, Appeals may consider the validity of the underlying tax liability not considered in any other previous administrative or judicial proceeding. If Appeals has previously considered any dispute of underlying tax liability for the tax in question, any further consideration at a CDP hearing would be discretionary with Appeals. If consideration is granted, any underlying tax liability issue would not be considered a part of the CDP hearing. Additionally, underlying tax liability determinations made by Appeals, which resulted from the hearing, and included in the determination notice, may not be reviewed by a district court or the Tax Court.

Any challenge of the underlying tax liability must be raised in the first CDP hearing offered; Secs. 6320(c) and 6330(c)(4) preclude raising the same issue in a subsequent CDP hearing, unless there is a change in circumstances that affects the determination. Significantly, it is the position of Treasury, that just the prior opportunity for consideration of the underlying liability precludes a challenge to the underlying tax liability during a subsequent CDP hearing. Essentially, the waiver of an opportunity to challenge the underlying tax liability at the first opportunity is a waiver of right of an administrative challenge at a CDP hearing.

Hearing Conclusion and Determination Notice

At the conclusion of a CDP hearing, Appeals will issue a determination notice. This notice should respond to all appropriate issues and challenges raised by the taxpayer, as well as to offers made. It should also address whether the continued existence of the filed NFTL or proposed collection "represents a balance between the need for the efficient collection of taxes and the legitimate concern of the taxpayer that any collection action be no more intrusive than necessary" (Regs. Secs. 301.6320-1(e)(3), Q&A-E8(i), and 301.6330-1(e)(3), Q&A-E8(i)). The taxpayer then has the right to appeal the determination to the Tax Court or district court within 30 days, commencing on the day after the date of the determination notice.

The regulations provide no timing requirements as to when a CDP hearing must actually be held, or when a determination notice must be issued, except that they must be done "as soon as possible."

Other Provisions

Other provisions of the regulations include:

• An NFTL can cover more than one tax period; the notice covers each tax period listed in the NFTL.
• If the IRS files for the same tax period in more than one place of filing, the taxpayer will be notified of each place of filing.
• Notice is not given to a nominee of a person holding the taxpayer's property, but only to the person liable for the tax (as described in Sec. 6321).
• Notice is given in case of a subsequent NFTL filing for the same tax period(s). However, such subsequent notices do not necessarily provide the taxpayer the right to a CDP hearing.

Statute of Limitations and Continued Collection Activity

The limitations periods under Secs. 6502, 6531 and 6532 are suspended by Secs. 6320(c) and 6330(e) after a taxpayer requests a CDP hearing.

Levy actions subject to a CDP levy (but not a lien) hearing are suspended. Levy actions are not suspended during an NFTL CDP hearing. The IRS is not prohibited from proceeding with enforcement actions, for taxes or periods or both, not covered by a CDP notice and hearing, and may file an NFTL for periods and taxes that are the subject of a Sec. 6330 (levy) CDP notice.

In issuing the final regulations, Treasury rejected commentators' proposals that "potentially affected third parties" (not liable for the tax) also be entitled to notice of their rights when a lien is filed and to a hearing with Appeals before the IRS levies on the property. Treasury concluded that persons entitled to receive CDP notices were only those liable for the tax (as described in Sec. 6321). They also reasoned that other administrative (or judicial, when necessary) remedies are available to protect the rights of potentially affected third parties.

From Ronald J. Blair, CPA, MBA, Director of Financial Affairs & Lecturer in Federal Tax, School of Management, The University of Texas at Dallas, Dallas, TX

Ann. 2002-2: The Carrot and the Stick?

On Dec. 20, 2001, the IRS issued Ann. 2002-2, outlining a new initiative to encourage taxpayers to disclose their involvement in tax shelters in exchange for a waiver of accuracy-related penalties under Sec. 6662. At the same time, Commissioner Langdon issued a memorandum to Large and Mid-Size Business Division personnel on applying Sec. 6662 penalties in examinations involving listed transactions and other potentially abusive tax shelters. The clear implication of Ann. 2002-2 and the memorandum is that the Service will pursue penalties vigorously if taxpayers fail to disclose their tax shelter transactions.

Historically, conventional wisdom provided that if a taxpayer's tax shelter transaction were examined, the taxpayer would have little exposure to Sec. 6662 penalties, for two primary reasons. First, in most transactions, the taxpayer relied on a "more likely than not" opinion that the tax treatment would be sustained if challenged on the merits. Under Regs. Sec. 1.6664-4(e), a more-likely-than-not opinion may be taken into account in establishing reasonable cause to avoid Sec. 6662 penalties. Second, even if the IRS questioned a taxpayer's good-faith reliance on a more-likely-than-not opinion, from a practical standpoint, it has routinely waived penalties to encourage settlement and avoid time-consuming, costly litigation. Accordingly, most taxpayers believe that they are better off playing the audit lottery and avoiding an examination of a transaction's merits altogether. In contrast, disclosure would almost certainly mean examination (and possibly litigation) of the transaction's merits.

Ann. 2002-2 places certain significant limits on the penalty waiver, which can be interpreted as a demarcation line that the Service believes separates aggressive tax shelter transactions from potential criminal conduct. Specifically, Ann. 2002-2 excludes transactions that (1) did not, in fact, occur, in whole or in part, but for which the taxpayer claimed a tax benefit on his returns; (2) involved the taxpayer's fraudulent concealment of the amount or source of any item of gross income; (3) involved the taxpayer's concealment of its interest in (or signature or other authority over) a financial account in a foreign country; (4) involved the taxpayer's concealment of a distribution from, a transfer of assets to, or that the taxpayer was a grantor of, a foreign trust; or (5) involved the treatment of personal, household or living expenses as deductible trade or business expenses. Indeed, Ann. 2002-2 specifically provides that this initiative neither affects whether the IRS will impose any civil penalties other than Sec. 6662 penalties, nor whether it will investigate any associated criminal conduct or recommend prosecution for violation of any criminal statute.

The Service waives Sec. 6662 penalties if a taxpayer discloses the tax shelter before the earlier of (1) the date the shelter is an issue raised during an examination or (2) April 23, 2002. In determining whether disclosure is timely, a tax shelter is considered raised during an examination if (1) the person examining the return communicated to the taxpayer knowledge about the specific shelter no later than Dec. 21, 2001, (2) the examiner made a request to the taxpayer for information and (3) the taxpayer could not make a complete response to that request without giving the examiner knowledge of the tax shelter.

To qualify for a penalty waiver, taxpayers must provide the IRS with certain information:

• A statement describing the material facts of the shelter;
• A statement describing the taxpayer's tax treatment of the shelter;
• The tax years affected by the shelter;
• For a Coordinated Industry Case taxpayer, a statement that the taxpayer will agree to address the disclosed item under the Accelerated Issue Resolution process described in Rev. Proc. 94-67, if requested to do so by the Service.
• The names and addresses of (1) any parties who promoted, solicited or recommended the taxpayer's participation in the shelter transaction and who had a financial interest (including the receipt of fees) in the taxpayer's decision to participate and (2) if known to the taxpayer, any parties who advised the promoter, solicitor or recommender with respect to the shelter;
• A statement agreeing to provide, if requested, copies of all of the following:

—All transactional documents, including agreements, contracts, instruments and schedules and, if the taxpayer's participation in the transaction was promoted, solicited or recommended by any other party, all material received from that other party or that party's adviser(s);

—All internal documents or memoranda used by the taxpayer in the decisionmaking process, including information presented to the taxpayer's board of directors; and

—All opinions and memoranda that provide a legal analysis of the item, whether prepared by the taxpayer or its tax professional.

• A penalty-of-perjury statement that the person signing the disclosure has examined the disclosure and that to the best of his knowledge and belief, the information provided as part of the disclosure contains all relevant facts and is true, correct and complete. For an individual taxpayer, the declaration must be signed and dated by the taxpayer, and not his representative. In the case of a corporate taxpayer, the declaration must be signed and dated by a corporate officer with personal knowledge of the facts. If the corporate taxpayer is a member of an affiliated group filing consolidated returns, a penalty-of-perjury statement must also be signed, dated and submitted by an officer of the group's common parent. The person signing for a trust, a state law partnership or a limited liability company must be, respectively, a trustee, general partner or member-manager with personal knowledge of the facts. A stamped signature is not permitted.

Many practitioners have expressed concern that their clients will make a blanket waiver of privilege by disclosing all opinions or memoranda that provide a legal analysis of the tax shelter transaction. Several senior IRS officials have publicly stated that the Service is not seeking a blanket waiver of privilege. Instead, it seeks disclosure of the opinion or legal analysis that serves as the basis of the taxpayer's good faith-belief that a transaction's tax treatment more likely than not would be sustained on the merits if challenged. To address the waiver issue, the IRS has indicated that it is willing to discuss negotiating written agreements on the scope of any privilege or waiver.

As recently stated by Deputy Assistant Treasury Secretary for Tax Policy, Pamela Olsen, the IRS believes that "disclosure really matters" and that "penalties can apply if the taxpayer does not act in good faith in its dealings with the IRS, and the failure to disclose the transaction shows a lack of good faith."

From M. Todd Welty, J.D., CPA, Meadows, Owens, Collier, Reed, Cousins & Blau, L.L.P., Dallas, TX