Editor:

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

Editor's note: Mr. Ely is the immediate past chair of the AICPA Tax Division's Relations with the IRS Committee. Ms. Butler and Mr. Oveson are committee members.

Working Condition Fringe Benefits * Third-Party Checkbox Initiative * Corporate Charter Suspension and Limitations Period for Filing Tax Court Petition * "Need-to-Know" Third-Party Information and Other IRS Sources

De Minimis and Working Condition Fringe Benefits Reexamined

In American Airlines, Inc., 204 F3d 1103 (2000), aff'g and rev'g 40 Fed. Cl. 712 (1998), the Federal Circuit agreed with a Court of Federal Claims ruling on the tax treatment of gift vouchers and certain per-diem al-lowances that did not qualify as working condition fringe benefits. However, the appeals court did not agree with the lower court's grant of summary judgment for per diems given on overnight trips (i.e., travel requiring at least one overnight stay away from an employee's home base) and remanded the case for further findings of fact on whether American Airlines "reasonably expected" the amounts paid in per diems to its flight crew to be incurred.

Background

From 19851988, American Airlines provided a $36 per-diem allowance to its flight crew and flight attendants, for meals and incidental expenses while away on overnight and turnaround trips (i.e., travel involving departure and return to a home base on the same day). American Airlines considered several factors in determining the per-diem amount, including industry standards, the experience and judgment of its management, Federal per-diem rates ($14/day) and cost estimates prepared by a consulting firm. Per-diem amounts were separately identified on employees' paychecks. American Airlines did not require its employees receiving per diems to substantiate their actual travel expenses.

American Airlines also provided its flight crew (e.g., pilots and engineers), based in Dallas-Fort Worth (DFW), eight hours of this per-diem allowance for each day of training at the DFW facility. In addition, union contracts required the airline to provide on-board meals for pilots and flight engineers on certain flights.

In 1985, a major competitor's labor strike increased American's passenger loads, which resulted in an increase workload on its employees. As a gesture of appreciation, American Airlines gave each employee two $50 "Be My Guest" American Express restaurant vouchers. The employees' names were not included on the vouchers, and there were no restrictions on transferability. If the purchase was less than $50, no refund was given.

American Airlines' Position

American Airlines did not treat the benefits as wages and, therefore, did not withhold employment taxes, relying on the following arguments:

The IRS's Position

On audit, the IRS concluded that American Airlines should have treated each benefit as wages and withheld the appropriate employment taxes. The Service concluded that tax was due on (1) one-sixth (or $6) of the $36 per diem for overnight trips, (2) all the per diem for turnaround trips and training days, (3) $10 for each on-board meal and (4) the full face of the vouchers.

The IRS issued an assessment and American Airlines paid the full amount and filed employment tax refund claims. The Service disallowed the claims, and the airline filed a refund action in the Court of Federal Claims.

Court of Federal Claims

The court granted summary judgment in favor of the IRS. It held that the per-diem payments for overnight trips were not excludible from wages, because American Airlines had not shown that they were based on expenses reasonably expected to be incurred and, therefore, did not meet the definition of "wages" under Regs. Secs. 31.3401(a)-1(b)(2) and 31.3121(a)-1(h). Further, the court concluded that, in the absence of substantiation, $14/day (the Federal per-diem rate at that time) was the objectively reasonable amount for meal expenses. Thus, $22 (the amount paid over $14/day) should be treated as taxable wages. The court also rejected American Airlines' argument that the per diems should be treated as working condition fringe benefits under Sec. 132(a)(3), because such treatment would require that the employer substantiate the amount of such expenses or have a reasonable belief that employees were keeping adequate records to substantiate their expenses over $14/day under the requirements in Sec. 274(d). Thus, the only amount that qualified as a working condition fringe benefit was the $14 Federal rate, which was deemed reasonable in the absence of substantiation.

The court also held that the per diems for turnaround trips and training were not excludible from wages, because the payments did not meet the requirement that they were "reasonably expected to be incurred." The court also held that these were not working condition fringe benefits, because such payments were not deductible under Sec. 162(a)(2).

The court held that American Airlines could not rely on the Rev. Rul. 69-592 netting rule, because it applies on an employee-by-employee basis: i.e., it allows an employer to exclude particular nonovernight travel allowance payments only when the employer (at the time of the payment) reasonably believes that particular employees will incur deductible travel expenses during the year in excess of the employer's travel allowance payments. American Airlines did not produce any documentation to show that it could reasonably believe that this was the case.

For on-board meals, the Service conceded that they were not wages subject to withholding, because, under Sec. 119, they qualified as meals provided for the employer's convenience. However, because the per-diem amounts that should have been treated as taxable to the employees was $22/day instead of $6/day, the IRS asked for an offset of the additional taxes owed against the taxes paid for the on-board meals.

The court also held the gift vouchers were not excludible from wages as de minimis fringe benefits, because American had not shown that it was administratively impractical for it to account for the vouchers. Every employee received two vouchers totaling a face value of $100, and this amount could have easily been included in every employee's paycheck.

Federal Circuit

American Airlines appealed the Court of Federal Claims decision, claiming that the court erred in holding that (1) certain per-diem payments were not excludible from wages as travel expense payments; (2) certain per-diem payments were not excludible from wages as working condition fringe benefits; and (3) the American Express vouchers were not excludible from wages as de minimis fringe benefits.

The Federal Circuit affirmed the lower court's decision that the per-diem allowances did not qualify as working condition fringe benefits. However, the Court of Appeals reversed and remanded the issue of whether the travel expense regulations applied to American Airlines' per-diem allowances during the years at issue. The Federal Circuit affirmed the lower court's grant of summary judgment on the taxability of the vouchers.

Implications to Employers

American Airlines serves as a reminder that the de minimis fringe benefit exclusion of Sec. 132(a)(4) is very narrowly defined and is intended to be a rule of administrative convenience to relieve employers of having to trace small, infrequently provided benefits.

In addition, the decision reiterates that substantiation requirements must be met to exclude reimbursements of travel expenses as working condition fringe benefits.

From Kimberly A. Butler, J.D., CPA, Coca-Cola Enterprises, Inc., Woodstock, GA

IRS Approves Third-Party Checkbox Initiative

Beginning with the 2001 filing season, with the "check of a box," paid preparers who have their clients' permission will be able to work directly with the IRS to resolve tax return processing issues (IR-2000-23). The checkbox will be available for all Forms 1040 (except Telefile).

Currently, practitioners and other paid preparers must file Form 2848, Power of Attorney and Declaration of Representative, or Form 8821, Third Party Authorization Disclosure, to discuss any details of a return, including how it was prepared, payment and refund issues and mathematical errors. Once the new initiative is implemented, a taxpayer's designee will be permitted to speak directly to IRS Customer Service Representatives over the phone to provide requested information and answer questions.

Each year, approximately 8 million pieces of correspondence specifically about processing tax returns are sent out during tax season. Up to 90% of the issues raised in these letters could be resolved over the telephone with a paid preparer, drastically reducing the correspondence burden on taxpayers and the Service.

Further, it is estimated that over a million hours could be saved with the elimination of correspondence be-tween the IRS and preparers by allowing the Service to deal directly with the designees. Taxpayers spend an estimated 75,000 hours preparing Forms 8821. Because issues (such as processing disputes) will be resolved immediately, additional time will be saved in eliminating unnecessary post-filing contacts. It is estimated that over a million taxpayers will use the checkbox option instead of filing Form 2848. This adds up to 1.9 million hours initially not being spent in preparing these forms. Twenty-seven percent of the notices sent to taxpayers for processing issues are for paid preparer returns. Taxpayers should save approximately 779,000 hours by opting to automatically refer return processing issues to their preparers.

Attorneys, CPAs, enrolled agents and actuaries will still need a power of attorney to represent taxpayers in more complex matters. Federal law and regulations prohibit anyone who does not meet Circular 230 requirements from representing clients before the IRS. This issue had been a stumbling block to the implementation of the Checkbox Initiative, until a clear distinction was established between limited third-party disclosure for the purpose of responding to issues and questions on a single year's return and issues that required a power of attorney. The Checkbox Initiative will eliminate the need for a power of attorney only for informational issues arising during return processing. Examples of issues still requiring an executed Form 2848 are examination matters, underreported income notices and appeals and collection notices.

The idea to use a checkbox has been proposed by stakeholder groups for many years. Many state revenue agencies are successfully using the procedure, to the delight of practitioners filing returns in those states. The AICPA has been among the groups that have endorsed this concept over the years. (Most recently, the South Florida Citizen Advocacy Panel (which includes members who are CPAs, attorneys and enrolled agents) has advocated the use of the checkbox.)

In a letter to Robert C. Wilkerson, IRS Assistant Commissioner (Customer Service), David A. Lifson, Chair of the AICPA Tax Executive Committee, said, "We are extremely grateful and encouraged by the Checkbox Initiative announced in IR-2000-23. For many years, the AICPA has requested procedures that would grant limited authority to third parties to discuss with the IRS factual issues regarding tax returns without the necessity of the third party obtaining a power of attorney. We regard the Checkbox Initiative as a good first step in creating such procedures."

The AICPA Tax Executive Committee also supports the expansion of the checkbox to other than paid preparers. "This third party authorization would be particularly helpful for many taxpayers who are most in need of assistance with their tax matters, such as the elderly, the incapacitated, and taxpayers who do not understand English." In announcing the proposal, Commissioner Rossotti indicated that expansion of the proposal to include friends and family would be considered in the future, after the initial proposal is implemented next year. Initially, however, the checkbox designation will be limited to paid preparers.

The AICPA Tax Executive Committee did make two recommendations for improving the usefulness of the Checkbox Initiative. First, it recommended a change in the manner in which a third party is notified of a problem. The AICPA would prefer that correspondence or telephone calls come directly to the third party rather than to the taxpayer.

Second, the AICPA recommended the expansion of the issues that could be covered by the checkbox procedure. It would like to see factual matters beyond those referred to in IR-2000-23. Issues such as CP-2000 notices generated from mismatched Forms 1099 should be included in the Checkbox Initiative; the AICPA does not believe that dealing with such matters would constitute representation requiring power of attorney.

Clearly the Service does listen to taxpayers' wishes. The Checkbox Initiative is something to look forward to in the next filing season.

From Val W. Oveson, National Tax Advocate, Internal Revenue Service, Washington, DC

Corporation Whose Charter Was Suspended Lacks Capacity to File Tax Court Petition

The Tax Court held that a California corporation whose corporate charter was suspended at the time it filed a Tax Court petition (and was not reinstated until after expiration of the 90-day period for filing a petition under Sec. 6213) lacked the capacity to litigate before the court under Tax Court Rule 60(c), and dismissed the petition.

In David Dung Le, M.D., Inc., 114 TC No. 18, a California medical corporation had its corporate charter suspended on April 1, 1999 for nonpayment of state income taxes. On July 1, 1999, the IRS issued a deficiency notice to the corporation. The corporation's counsel filed a petition with the Tax Court on Aug. 12, 1999. The corporation's charter, however, was not revived until Feb. 28, 2000.

The Service moved to dismiss the petition on the ground that the Tax Court lacked jurisdiction; because its corporate privileges were suspended when the petition was filed, the corporation lacked the capacity to file the petition. The taxpayer argued that the revival of its status meant that it was entitled to maintain the action.

As a preliminary matter, the court explained that Tax Court Rule 60(c) requires that a taxpayer seeking to petition the court have the capacity to engage in litigation. The court further explained that whether a taxpayer possessed the requisite capacity was determined with reference to state law. Examining California law, the court concluded that the corporation lacked the necessary capacity. The court distinguished the present case from cases in which a petition was filed on time by an improper party and the proper party was given a reasonable time to ratify the petition. The court noted that, in ratification cases, the proper party had the capacity to file the petition at the time the petition was filed, while the corporation in the present case lacked the capacity to file a petition at the time of filing.

In so holding, the court also rejected the corporation's argument that revival of the corporation's powers during the litigation (but after the 90-day filing period under Sec. 6213), should allow it to continue to litigate the case. The fact that the corporation's status was not reinstated during the 90-day period was fatal, because California law did not operate to toll the filing period from running during the period of suspension.

From Kenneth S. Savell, J.D., LL.M., KPMG LLP, Washington, DC

Exam Team Can Only Obtain Third-Party Tax Information Possessed by Other IRS Sources on a "Need to Know" Basis

In Field Service Advice 200018015 (1/12/00), the IRS Chief Counsel concluded that a taxpayer's examination team may access information provided to the Service by other parties to a transaction involving the taxpayer, as long as the team demonstrates that it has a "need to know" such information to audit the taxpayer.

A corporate subsidiary, S, and several unrelated entities participated in a "lease stripping" transaction. An IRS audit team examining the subsidiary's parent company, P, began considering whether the losses reported by S were allowable. To develop facts necessary to evaluate potential theories for the disallowance of the claimed losses (including the applicability of Sec. 482 and the sham-transaction doctrine), P's exam team sought guidance from Counsel as to the circumstances under which it could obtain and use tax information from other Service sources about the unrelated entities, including audits of those entities. The exam team also sought advice from Counsel as to any restrictions on its use of information obtained by summonsing third parties in P's examination.

• Access to audit information of other parties to transaction: P's exam team sought to obtain from internal IRS sources information about the lease transaction that other parties to the transaction provided to the Service on their own returns or in audits of their own returns. Counsel concluded that, under Sec. 6103(h)(1), P's audit team could access the information as long as the team demonstrated that it had a "need to know" such information to perform its audit of P. Counsel explained that disclosure was authorized, for example, if the information was helpful in identifying parties to the transaction or in analyzing the legal and factual issues.
• Disclosure to taxpayer of third-party tax information: P's exam team sought to disclose the information it obtained to P in its Revenue Agent's Report (RAR). Sec. 6103(h)(4) authorizes disclosure of return information of third-party taxpayers that are not parties to an administrative tax proceeding only if: (1) the treatment of an item reflected on the third party's return is directly related to the resolution of an issue in the proceeding (Sec. 6103(h)(4)(B)); or (2) the third party's information directly relates to a transactional relationship between a person who is a party to the proceeding and the taxpayer, which directly affects the resolution of the issue in the proceeding (Sec. 6103(h)(4)(C)). Taking the position that an audit is an "administrative tax proceeding" (a position on which Federal courts have disagreed), Counsel concluded that the third parties' information related to the lease-stripping transaction under examination, and therefore could be disclosed to P in an RAR.
• Disclosure to taxpayer of information obtained by summons relating to other parties to transaction under exam: P's exam team obtained information relating to other parties to the lease transaction in which S participated by summonsing third parties. Counsel explained that the relevant inquiry was whether the summonsed information was P's return information. Citing Sec. 6103(e)(1)(D) (which provides for disclosure of a parent's or subsidiary's return to a parent) and Sec. 6103(e)(7) (which provides for disclosure of return information to persons authorized to receive the return if such disclosure would not "seriously impair Federal tax ad-ministration"), Counsel concluded that P's exam team could disclose the information to P, because it related to P's liability.
• Access to information concerning other parties to the transaction in which the taxpayer's subsidiary participated: P's exam team sought to obtain from internal IRS sources (such as other exam teams and issue specialists) information on whether other parties to the specific lease transaction in which S participated also participated in other lease-stripping transactions unrelated to P's exam. Counsel concluded that the exam team might obtain such information under Sec. 6103(h)(1) if the team demonstrates that it has a "need to know." Counsel cautioned, however, that, although the transactions may be similar to the transaction at issue, they are unrelated to the transaction under exam, and therefore the information may not be disclosed to P. Counsel explained that, although courts have admitted "pattern evidence" in tax shelter cases when a transaction's substance is questioned (i.e., evidence that parties to the proceeding engaged in similar transactions with other third parties), it did not believe that Sec. 6103 or its legislative history supports disclosure of "pattern evidence" in tax proceedings.
• Disclosure to taxpayer in RAR of information obtained by summons of other parties to a transaction evidencing participation in transactions similar to transaction under audit: Again citing Sec. 6103(e)(1)(D) and (e)(7), Counsel concluded that P's exam team could disclose the information in the RAR, subject to the proviso that such disclosure would not seriously impair tax administration.

From Kenneth S. Savell, J.D., LL.M., KPMG LLP, Washington, DC