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Return Disclosure Statements * Update on Innocent Spouse Relief * New IRS Resolution Programs * Nondischargeable State Taxes
Editor:
Editor's note: Mr. Ely is former chair of the AICPA Tax Practice and Procedures Committee. Ms. Jacobs and Messrs. Dougherty, Marchbein and Burke are committee members.
Disclosure Statement Filed with Return Sec. 6694 generally imposes a penalty on a return preparer if any part of a liability understatement in a return or refund claim is based on a position that did not have a realistic possibility of being sustained on its merits and the preparer knew (or reasonably should have known). The penalty is $250, unless there is reasonable cause for the understatement and the preparer acted in good faith. Regs. Sec. 1.6694-2(b) provides that the realistic-possibility-of-success standard is met if a reasonable and well-informed analysis by a tax adviser would lead to the conclusion that a position has approximately a one-in-three (or greater) likelihood of being sustained on its merits. The $250 penalty will not be imposed even though a position does not have a realistic possibility of being sustained, if it is not frivolous and is adequately disclosed. Under Regs. Sec. 1.6694-2(c)(2), a frivolous position is one that is patently improper. Adequate disclosure generally occurs if made on Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement. The latter form is used to disclose a return position contrary to regulations. Form 8275 is used for all other disclosures. Either form is filed with the original or amended return or refund claim. In certain circumstances, disclosure may be made on a return pursuant to the IRS's annual revenue procedure, which will be considered adequate to avoid the preparer penalty. Rev. Proc. 99-41 is currently in effect for 1999 returns. Additional disclosure is unnecessary for any issue listed in the procedure, provided the forms and attachments are completed in a clear manner and in accordance with the applicable instructions. The figures on the forms must be verifiable. A number is considered verifiable if, on examination, a taxpayer can show its origin and that he acted in good faith, even if the Service does not accept the number. Form 8275 or 8275-R should contain information about a position taken and the specific rule supporting it, whether a position is contrary to a rule (such as a statute or regulation) or revenue ruling, the item by name, form (or schedule) or line number on the return, and the amount, as well as a complete description of the facts and nature of the controversy affecting the item's tax treatment or a listing of the legal issues. (Certain other information is required if the issue relates to a passthrough entity.) Disclosure is not adequate, unless the form is completed in accordance with the instructions. Some practitioners have expressed concern that filing a disclosure statement will automatically result in an examination of a return. The IRS has indicated that use of the form does not mean an examination will occur, as this is not a criterion for audit selection. Experience indicates that filing the form does not automatically lead to an examination. Practitioners should also consider Circular 230, which governs practice before the Service when signing returns, and the recently issued AICPA Statements on Standards for Tax Services. From Joe Marchbein, CPA, RBG & Co, LLP, St. Louis, MO
Update on Innocent Spouse Relief Since the enactment of the Internal Revenue Service Restructuring and Reform Act of 1998 (IRSRRA '98), taxpayers have been enjoying the benefits of liberalized rules for innocent spouse relief. Former Sec. 6013(e) enumerated a list of strict conditions that resulted in denial of most applications; under new Sec. 6015(b), (c) and (f), a taxpayer may generally qualify for relief on a jointly filed return under one or more of the following circumstances: 1. One spouse establishes that, in signing the return, he did not know (and had no reason to know) there was an understatement of tax attributable to the erroneous items of the other spouse, or did not know the understatement's extent; 2. A divorced or separated individual requests allocation of a liability, so that he becomes responsible only for the portion of the deficiency allocable to that person; or 3. A taxpayer is not eligible for relief under one of the first two categories, but it would be equitable to grant relief, given consideration of the facts and circumstances. (For a full discussion of the provisions, see Foran and Foran, "Innocent Spouse Rules Provide Relief," TTA, Jan. 2000, p. 26.)
Initial Cases Cases filed under prior law have been considered under the new provisions. In the first half of 2000, the Tax Court handed down three decisions that addressed whether it had jurisdiction to review an IRS denial of relief requested under Sec. 6015(b), (c) or (f). In Field Service Advice 9929019, the Service agreed that the Tax Court had jurisdiction to review denials of requests under Sec. 6015(b) and (c). However, because Sec. 6015(e) explicitly sets out the rules for petitioning the Tax Court and the equitable relief provision is spelled out in Sec. 6015(f), the IRS strongly contended that the court did not have jurisdiction to review denials for relief under Sec. 6015(f). However, in Michael B. Butler, 114 TC 276 (2000), and Diane Fernandez, 114 TC 324 (2000), the Tax Court disagreed. In each case, the taxpayer had requested relief under Sec. 6015(b) or (c) or both, as well as under Sec. 6015 (f), and, in each, the Tax Court held that it had jurisdiction to review a denial of Sec. 6015(f) relief. In Thomas Corson, 114 TC 354 (2000), the Tax Court pulled together different parts of the statute to support its ruling that a nonelecting spouse should receive notice and could be a party to considerations, when the Service had granted the electing spouse relief. (See News Notes, "Innocent Spouse Relief," TTA, July 2000, p. 460, for a fuller explanation.) Since those cases, the Tax Court has confirmed (or extended) its position on its jurisdiction under Sec. 6015 in several additional decisions; see Fredi Lynn Charlton, 114 TC 333 (2000); Kathy A. King, 115 TC No. 8; and Kathryn Cheshire, 115 TC No.15, in which the IRS was still contending that the Tax Court lacked jurisdiction to decide whether it properly denied Sec. 6015(f) relief to a taxpayer. The court referred to its reasoning in Butler, and reaffirmed its jurisdiction. It also invited the spouse to file a motion if the Service denied relief.
Later Tax Court Cases In King, a divorced husband and wife were each assessed identical deficiencies. Although the husband did not contest the assessment in court, he contended that he should be allowed to challenge his ex-wife's request for innocent spouse relief. The Tax Court said in part:
The court relied on Charlton, Butler, Fernandez and particularly Corson, and extended the taxpayer's rights further:
The Tax Court noted in Cheshire that the IRS "acknowledges that we have jurisdiction to review his denial of innocent spouse relief under section 6015(f)." In Cheshire, a husband had retired early and taken a distribution of his retirement account. Some of the money was rolled over to a qualified account, but about $180,000 was used to pay off the couple's mortgage and other family and business expenses. The wife was fully aware of the retirement distribution, as well as the interest earned on the unspent funds. When signing the tax return (which the husband had prepared), the wife inquired about the distribution's taxability. The husband falsely told her that he had consulted with a CPA, who said that the amount used to pay off the mortgage was not taxable. (Some interest income was also omitted from the tax return.) The wife accepted this explanation and signed the return. After the divorce, the wife applied for innocent spouse relief under Sec. 6015(b), (c) and (f). The Service allowed her relief for her ex-husband's Schedule C expenses and some other items he had omitted. However, the IRS asserted that the wife had actual knowledge of the distribution and the omitted interest and was, therefore, liable for the understatement on those items, as well as for the accuracy-related penalty. At trial, the wife claimed that she did not have knowledge of the distribution's tax consequences and, therefore, fulfilled the statute's requirement. The Tax Court disagreed:
Based on this interpretation, the court held that the wife was not entitled to innocent spouse relief for the omitted retirement distribution or interest. The court examined the Service's denial of relief from the accuracy-related penalty under Sec. 6015(f). Because the wife did ask her husband about the tax consequences and he told her that he had consulted a CPA, it was inequitable to hold the wife liable for the accuracy-related penalty. Thus, it determined that the IRS had abused its discretion in failing to grant this portion of the relief sought under Sec. 6015(f).
Other Jurisdictions As of this writing, other courts have not yet addressed the issue of Sec. 6015(f) relief. One recent case avoided any review of innocent spouse relief, basing its decision on other grounds. In Stolle, DC Cal., 3/15/00, a California district court stated that enough community property was available to satisfy a deceased husband's debt under California law. The court did not address whether his wife was an innocent spouse. Instead, it said that:
The court found for the IRS in French, Bank DC Ohio, 5/1/00, holding that the Service appropriately refused the innocent spouse claim presented under Sec. 6015(b). It then went on to state:
Conclusion Soon after French, IRS Chief Counsel issued N(35)000-338 to announce the IRS's change in litigation position on whether its determination under Sec. 6015(f) can be reviewed by a court. N(35)000-338 directs staff not to contest the jurisdiction of the Tax Court, district court, bankruptcy court or the Court of Federal Claims to review abuse-of-discretion denials for Sec. 6015(f) relief. This may pave the way for more courts to examine whether the Service has abused its discretion in not granting equitable relief to claims under the innocent spouse rules. However, for the near term, it may be wiser for a claimant to look to the Tax Court, which has explicitly claimed jurisdiction to review Sec. 6015(f) refusals, rather than taking a chance on an unknown result in another court. From Harriet A. Jacobs, CPA, MST, Skokie, IL
Update on New IRS Resolution Programs During 2000, the IRS introduced several new programs to accelerate issue resolution.
PFA Pilot Program A Pre-Filing Agreement (PFA) pilot program was announced in February (Notice 2000-12). Under the pilot program, large businesses could request examination and resolution of specific issues for returns they expected to file between September and December 2000. The goal of the program is to enable taxpayers and the Service to resolve issues prior to filing that would otherwise be disputed in post-filing audits. A PFA is a closing agreement between a taxpayer and the IRS, covering one or more specific issues arising from transactions that the taxpayer conducted during a tax period ending before the agreement's date. The PFA program specifies how the transactions will be treated on returns filed after the agreement date. A PFA may also resolve related issues affecting other tax periods. The PFA pilot program was open only to taxpayers in the Service's Large and Mid-Size Business Division (LMSB). The LMSB consists of businesses with assets of at least $5 million. In addition, to qualify for the pilot, a taxpayer must have had a coordinated examination team on site. For the pilot, the IRS considered entering into a PFA on any issue involving the application of settled legal principles, with certain specified exceptions. Examples of issues suitable for resolution through a PFA include: 1. Valuation of assets (except in the context of transfer pricing) and the allocation of the purchase or sale price of a business among the assets acquired or sold; 2. Identification and documentation of hedging transactions; 3. Issues relating to in-house research expenses under Sec. 41; 4. Allocation of costs among different categories of deductible and capitalizable items in which there is a published revenue ruling (e.g., repairs, advertising and Y2K costs); 5. Determination of which costs are investigatory costs incurred to determine whether to enter a new business and which business to enter, for purposes of qualifying as start-up costs under Sec. 195; 6. Determination of "market" for taxpayers using the lower-of-cost-or-market method of inventory valuation for inactive market situations; see Regs. Sec. 1.471-4(b); 7. Whether a taxpayer's financial statement preparation of its LIFO inventory is consistent with the LIFO conformity requirement under Regs. Sec. 1.472-2(e); 8. Whether a taxpayer's inventory contains "subnormal" goods (within the meaning of Regs. Sec. 1.471-2(c)) and the valuation placed thereon; 9. Whether a taxpayer is considered the tax owner of property produced under Regs. Sec. 1.263A-2(a)(1)(ii)(A); 10. Whether a manufacturing contract newly entered into by a taxpayer must be accounted for as a long-term contract under Sec. 460; and 11. The determination of appropriate asset classes for depreciable property placed in service during a tax period. A PFA program will not be entered into for the following: 1. Issues that can be included in an advance pricing agreement under Rev. Proc. 96-53 (e.g., transfer pricing); 2. Issues that can be resolved by requesting a change in accounting method on Form 3115, Application for Change in Accounting Method; 3. Issues under the jurisdiction of the Commissioner, Tax Exempt and Government Entities Division (e.g., employee plans); 4. Issues on transactions that lack a bona fide business purpose or have as their principal purpose the reduction of Federal taxes; 5. The satisfaction, for purposes of Subtitle F (Procedure and Administration), of reasonable cause, due diligence, good faith, clear and convincing evidence or any similar standard; and 6. The applicability of any penalty or criminal sanction. In addition, the Service will not entertain a request for a PFA in the following circumstances: 1. Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) partnership issues; 2. An issue that is (or will be) the subject of a pending or contemporaneous request for a letter ruling or a change in accounting method by the taxpayer; 3. A taxpayer's proposed resolution of the issue is contrary to a letter ruling, technical advice memorandum or closing agreement previously issued to (or about) the taxpayer; 4. A taxpayer's proposed resolution of an issue is contrary to a position adverse to the taxpayer that was proposed by the IRS in response to a letter ruling (or accounting method change) request that the taxpayer withdrew; or 5. The issue is the subject of litigation (or has been designated for litigation by the Office of Chief Counsel) between the Service and a taxpayer for a previous tax period. The IRS's acceptance of a taxpayer's request to attempt to reach a PFA on a specified issue(s) does not suspend or waive the normal filing requirements for any tax returns affected by the proposed PFA. If a PFA is reached before filing of the return, the taxpayer will report the transaction(s) addressed in the PFA in accordance with its terms. If a PFA is not executed prior to filing the return(s), the Service and the taxpayer may continue to attempt to resolve the issue and enter into a PFA under these procedures until July 31, 2001. If, as of July 31, 2001, the IRS and a taxpayer have not entered into a PFA and the Service disagrees with the taxpayer's tax treatment of the transaction(s), they can continue to try to reach an agreement using accelerated issue resolution procedures under Rev. Proc. 94-67. This continuation of the issue resolution process does not require a new application. In addition to the AIR procedures, a taxpayer retains the right to pursue administrative appeal, either by requesting an early referral to Appeals or by protesting any proposed deficiency related to the issue. The IRS received approximately 19 applications for the pilot program and accepted 12. As of Sept. 1, 2000, of these 12, three closing agreements were executed and five agreements were in final review. At the conclusion of the pilot, the IRS will evaluate the program to determine if it will offer it on a permanent basis. The program will probably be adopted and possibly expanded to a broader base of taxpayers.
MAAP To decrease its cycle time and inventory of Appeals cases, a new initiative called the Mutually Accelerated Appeals Process (MAAP) was introduced by the Service in June (IR-2000-42). The goal of this program is to increase customer satisfaction by reducing the time to resolve coordinated examination program (CEP) cases in Appeals. CEP does examinations of the nation's largest corporations. Because CEP cases generally involve complex issues, it usually takes approximately 790 days to complete the Appeals process. MAAP is available for cases involving $10 million or more in disputed tax. Under the MAAP initiative, both a taxpayer and Appeals must agree to a specific schedule to resolve all issues. In addition, they must agree to add resources and accelerate the pace to meet the specified schedule. At the beginning of the Appeals process, the taxpayer signs a statement agreeing to try to resolve the issues before an agreed-on date. The IRS committed 50 Appeals officers to the MAAP initiative in 2000. Appeals will review the existing cases to determine how it might accelerate case resolution by adding team members, shifting workload among current team members or creating new teams. In addition, Appeals will review all new cases to determine whether MAAP would be appropriate to accelerate resolution of each individual case. The factors used to consider MAAP applicability include the taxpayer's cooperation level, age and status of the case, and whether IRS Specialists are required to resolve the case.
CCR To resolve issues more quickly, a pilot program, called Comprehensive Case Resolution (CCR), was introduced by the Service in August (Notice 2000-43). The purpose of the CCR program is to accelerate the resolution of CEP cases with open issues involving multiple years. The pilot program was available to CEP taxpayers with at least one year open in Examinations and at least one year docketed in Counsel or in Appeals. The IRS hopes that the program will benefit both taxpayers and the Service, by reducing costs, burdens and delays through quicker case completion. Generally, all issues that could be considered by the IRS Appeals function will be suitable for the CCR program. If an issue has already been agreed on between the taxpayer and Exam or Appeals, it generally will not be re-opened. Further, certain issues (such as TEFRA partnership issues under Sec. 6231 and issues designated for litigation by Chief Counsel) will be excluded from the program. The selection criteria for the CCR pilot program include the following: (1) the taxpayer is already taking part in an LMSB CEP program and in an Appeals process; (2) the number of LMSB examination years is substantially complete; and (3) the Appeals issues will not be settled before the first issue resolution conference is held. In addition, for the pilot program, some of the factors the IRS is considering in the selection process are: (1) having a cross-section of taxpayers of various sizes, representing different industry lines, a geographical dispersion of cases and a variety of issues; (2) the availability of Service resources in LMSB, Appeals and Chief Counsel; (3) the likelihood of the case being resolved through this process; and (4) for a docketed year, the ability to comply with the Tax Court's procedures and deadlines. Applications for the pilot program were due to the IRS team manager or CCR coordinator, Cary Russ, by Sept. 29, 2000, and the Service was to select the participants by Oct. 31, 2000. After a case is accepted for the CCR pilot program, a team consisting of members from LMSB, Appeals and Counsel (if there is a docketed case) will be formed to resolve all open issues. Within 30 days of a taxpayer being accepted into the program, the CCR team will contact the taxpayer to schedule an initial planning meeting, at which the parties will establish an expedited time frame for resolving all open issues. The CCR process will follow the existing Appeals conference format and procedures. One difference is that the ex-parte communications prohibitions do not apply to the CCR process; all CCR team members may talk to other IRS employees about the case without the taxpayer's presence. If an agreement on the issues is reached, the Appeals closing process will be followed. If an agreement is not reached within one year of the initial CCR conference, Appeals will issue a statutory deficiency notice on the disagreed-on issues. For taxpayers, the most significant benefit of this program is the avoidance of "hot interest." For tax years under audit, the CCR process occurs before the issuance of the 30-day letter and is intended to replace the Appeals process. Because hot interest does not begin to run on a proposed tax deficiency for the tax years under examination, this could mean substantial savings for taxpayers. The disadvantage is that taxpayers do not get an independent Appeals assessment of the case. The resolution is a joint decision of Appeals and the other Service functions involved.
Summary The overriding theme of the new initiatives introduced by the IRS during 2000 is quicker issue resolution. For some large taxpayers, the average number of open years currently is 13. The IRS wants to resolve issues earlier and close some of the open years for taxpayers. The benefits to taxpayers of these new programs include reduced costs, burdens and delays as a result of quicker resolution of issues and completion of cases. From Jim Dougherty, Director, Tax Controversy, and Tracey Fielman, Manager, Tax Controversy, Washington National Tax, Deloitte & Touche LLP, Washington, DC
Rulings that State Taxes Are Nondischargeable in a Bankruptcy Proceeding Have Broad Ramifications In a series of decisions beginning with Schlossberg v. Maryland, 119 F3d 1140 (4th Cir. 1997), and most recently Massachusetts v. Gosselin, DC Mass, 7/31/00, courts have concluded that state taxes are not dischargeable in a bankruptcy proceeding. Each of these decisions is predicated on an interpretation of Seminole Tribe of Florida v. Florida, 517 US 44 (1996), in which the Supreme Court held that the Eleventh Amendment to the Constitution precluded states from being the subject of lawsuits in a Federal court, unless the state's laws waived immunity. In Seminole Tribe, the Supreme Court established two requirements for a state to be subject to an adjudication in Federal court: "first, whether Congress has 'unequivocally expressed' its intent to abrogate the immunity...and second, whether Congress has acted pursuant to a valid exercise of power."
Statutory Tests for Dischargeability The Bankruptcy Code provides that income taxes are dischargeable if three tests are met: 1. Under 11 USC Section 507 (a)(8)(A)(i), a return (whether or not filed) must have a filing date (including extensions) three years before the filing of a bankruptcy petition. 2. Under 11 USC Section 507 (a)(8)(A)(ii), the tax to be discharged must not have been assessed within 240 days before the bankruptcy petition's filing date. Note: when an offer-in-compromise is made within the 240-day period, the statute tolls from the time the offer is pending, plus an additional 30 days. 3. Under 11 USC Section 523 (a)(1)(B) (in conjunction with 11 USC Section 523(a)(8)), the tax to be discharged must relate to a return filed after the date on which it was last due, under applicable law or under any extension, and two years before the date of the filing of the petition. Note: there is a growing body of law on nondischargeability of taxes for sequential nonfilers. These provisions were intended to address both state and Federal tax delinquencies (the dischargeability of Federal taxes is unaffected by the courts' holdings). Section 106 of the Bankruptcy Code is entitled "Waiver of Sovereign Immunity." However, while Congress intended Section 106 to provide for the discharge of state taxes, the courts have ruled (with one exception) that Congress did not have the authority to enact legislation that affected state taxes.
Ramifications Historically, due to either local practice or the primacy of Federal law, the IRS has often been considered as a creditor of utmost importance. While the Service's legal standing on collection of past due taxes has not changed, the effect of these recent decisions will assuredly affect taxpayers' and their advisers' actions. The greatest impact will occur when financial circumstances require choosing between a payment of dischargeable Federal income taxes and nondischargeable taxes (including trustee taxes and state income taxes). When a business will continue operating, a taxpayer may make choices that will leave Federal income taxes unpaid. Further, for taxpayers considering installment payment agreements with the IRS and a state taxing authority, they should consider entering into an agreement with the state before finalizing an agreement with the Service.
Possible Strategies for Resolving Outstanding State Taxes Many states have adopted programs similar to the IRS's offer-in-compromise program, which provides the opportunity to address state tax delinquencies. As established government policies, these programs provide a basis for financially troubled taxpayers to request the assistance of the bankruptcy court in resolving a state tax issue. Section 525(a) of the bankruptcy code makes it unlawful to "revoke, suspend or refuse to renew a license, permit, charter, franchise or other similar grant, to condition such a grant, to discriminate with respect to such a grant against, to deny employment to, or terminate the employment of an individual solely on the basis that such individual has filed bankruptcy." If a taxpayer has filed for bankruptcy (particularly under Chapter 11 or 13), it can bring a court action to request that the state government consider the taxpayer's settlement offer. This request would appear to qualify for an exemption from the immunity from suit provided to the states by Seminole Tribe. In Ex parte Young, 209 US 123 (1908), the Supreme Court ruled that "an individual may obtain injunctive relief in order to remedy a state officer's ongoing violation of federal law." Accordingly, for taxpayers with nondischargeable state taxes who qualify for the state equivalent of the Service's offer-in-compromise, it would appear that bankruptcy counsel can request that a court order the state to treat the bankrupt taxpayer in a manner consistent with its established policies. Support for the position that a state government can be ordered to consider a bankrupt taxpayer for an offer-in-compromise is provided by two cases adjudicated in the Bankruptcy Court in West Virginia. In both these cases, the court held that the IRS's policy of refusing to consider offers from debtors in bankruptcy proceedings violated Bankruptcy Code provisions prohibiting discrimination against persons who have filed bankruptcy; see Mills and Chapman (6/23/99). While this litigation procedure can be avoided if states fairly comply with their settlement procedures, financially troubled taxpayers may wish to avail themselves of the opportunity for judicial consideration of a state's actions in dealing with their financial issues. Additionally, Section 362 of the Bankruptcy Code provides for an automatic stay on "any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate." While the courts disagree about the extent that assets (including a debtor's wages) can be protected during a bankruptcy proceeding, if they are protected, a state cannot attempt to collect on them during the proceeding. In states in which the statute of limitations on the collection of past due taxes is not tolled by the filing of a bankruptcy petition or the pendency of a bankruptcy will impede collection of tax for a substantial time, a state may be motivated to join in the taxpayer's reorganization plan.
Conclusion Court decisions that hold that state taxes are not dischargeable in a bankruptcy proceeding affect taxpayers and their advisers in their consideration of the most rational method of addressing tax delinquencies. These decisions may require a reconsideration of longstanding thought on addressing tax delinquencies. From Timothy Burke, CPA, J.D., Burke and Associates, Braintree, MA |
