The Tax Adviser, June 2007

News Notes

Circular 230 Penalty •
GO Zone Depreciation •
Sec. 409A Final regs. (box)

Editor:
Lesli S. Laffie, J.D., LL.M.

Notice 2007-39 contains guidance on the imposition of monetary penalties for prohibited conduct under Section 10.52 of Circular 230, Regulations Governing the Practice of Attorneys, Certified Public Accountants, Enrolled Agents, Enrolled Actuaries, and Appraisers Before the Internal Revenue Service. The American Jobs Creation Act of 2004 (AJCA) amended 31 USC Section 330 (which authorizes the regulation of practice before the Service) to allow monetary penalties to be imposed on a practitioner who (1) is incompetent, (2) is disreputable, (3) violates regulations under 31 USC Section 330 or (4) willfully and knowingly misleads or threatens represented parties or a prospective party with an intent to defraud. (The regulations under that section are known as Circular 230.) Guidance and examples are provided as to the amount of the penalty and its imposition on a practitioner’s employer or firm.

Penalty amount: Under the AJCA amendments, the maximum amount of the penalty will be the income derived by engaging in the prohibited conduct. The IRS has clarified that, if the prohibited conduct is a single part of a larger engagement, the maximum penalty will be the income derived from the entire engagement. If the entire engagement commenced before Oct. 23, 2004, the maximum penalty will be determined on a pro-rata basis to exclude amounts attributable to activities before the AJCA effective date. The Service may impose separate penalties against a practitioner and any employer or firm; they cannot exceed the income received by the sanctioned party. Further, the IRS may impose a penalty that is less than the statutory maximum based on (1) the culpability of the violating practitioner or the practitioner’s employer or firm or (2) whether there was a duty owed a client, the actual harm done to a client or other mitigating factors. “Mitigating factors” will include whether the practitioner, employer or firm took prompt action to correct the noncompliance, promptly ceased to engage in the prohibited conduct, attempted to rectify any harm done by the conduct or undertook measures to ensure the conduct would not be repeated.

Generally, the Service will not impose a penalty when there have been minor technical violations with little or no injury to a client, the public or tax administration, and with little likelihood of repeated misconduct.

Separate penalty: Guidance has also been provided as to when separate penalties may be imposed on a practitioner’s employer or firm. Under the AJCA amendments, penalties may be imposed on an employer or firm when the violating practitioner acts on behalf of the employer or firm and the latter knew, or should have known, of the prohibited conduct.

A practitioner is deemed to have acted on behalf of an employer or firm if:

An agency relationship existed between the practitioner and the employer or firm;
The purpose of the relationship was to provide services in connection with practice before the IRS; and
The prohibited conduct arose in connection with the agency relationship.

An employer or firm is deemed to know or should have known about misconduct if:

One or more of the principal management or officers of the employer or firm, or a branch office of either, knew or had information that would lead a person of similar experience and background reasonably to have known of the prohibited conduct; or
The employer or firm, either through willfulness, recklessness or gross indifference, did not take reasonable steps to ensure compliance with Circular 230, and a practitioner of that employer or firm engaged in prohibited conduct that harmed a client, the public or tax administration.

The IRS, when determining whether to impose a penalty on an employer or firm, will also consider the gravity of the misconduct, any history of noncompliance, the presence of measures meant to prevent noncompliance and corrective measures taken after discovery of noncompliance. Future guidance may be issued as to other factors that may be considered in determining whether a penalty should be imposed.

GO Zone Depreciation

Notice 2007-36 contains guidance on the extended placed-in-service dates for the 50% additional first-year depreciation available for certain Gulf Opportunity (GO) Zone property and provides additional rules on the “original use” requirement. (GO Zone property is depreciable property that meets the definitions in Sec. 1400N(d)(2) and Notice 2006-77, Section 2.02.) These rules require that the (1) property’s original use commence with the taxpayer in the GO Zone after Aug. 27, 2005 and (2) property be placed in service by the taxpayer before 2008 or 2009.

The Tax Relief and Health Care Act of 2006 extended these placed-in-service dates for certain properties until Dec. 31, 2010. Assuming all other requirements are met, the extended placed-in-service dates are available to properties located in the (1) Louisiana parishes of Calcasieu, Cameron, Orleans, Plaquemines, St. Bernard, St. Tammany and Washington; and (2) Mississippi counties of Hancock, Harrison, Jackson, Pearl River and Stone.

The bonus depreciation deduction is available only for the adjusted basis of such property attributable to manufacture, construction or production before Jan. 2, 2010. These amounts, referred to as “progress expenditures,” are amounts paid or incurred and properly chargeable to capital account with regard to the property. Progress expenditures properly chargeable to capital account depend on whether the property was produced by the taxpayer or someone else for the taxpayer. The progress expenditure rules do not apply to property described in Sec. 1400N(d)(6)(B)(ii)(II) and certain types of personal property. For purposes of the GO Zone rules, “original use” means the first use to which the property is put, whether or not that use corresponds to the property’s use by the taxpayer. Used and reconditioned property can qualify under certain circumstances, as long as it has not been previously used within the GO Zone.

IRS Issues Final Rules on Nonqualified Deferred Compensation

The Service issued final regulations on nonqualified deferred-compensation arrangements under Sec. 409A (TD 9321, 4/10/07). These rules generally follow the proposed regulations (REG-158080-04, 10/4/05), but provide additional guidance and clarify many key issues, including:

Liberalizing the definition of the underlying stock for stock options and stock appreciation rights (SARs) that may be permitted without triggering the application of Sec. 409A;
Easing the ability to extend the exercise period for stock options and SARs without triggering Sec. 409A;
Clarifying that payments can be limited based on an objective, defined formula or a fixed limit established on or before the date, time and form of payment is required under Sec. 409A;
Adding guidance on payments under the short-term deferral exception to Sec. 409A;
Clarifying that deferred-compensation payments can be delayed if payment would jeopardize the employer’s ability to continue as a going concern;
Providing more exceptions for severance-pay arrangements;
Clarifying the definition of a deferred-compensation payment; and
Providing more flexible rules on the treatment of similar deferred-compensation arrangements as one plan for purposes of the Sec. 409A penalties.

The final regulations were effective April 17, 2007, but generally apply starting in 2008 and may be applied retroactively. All deferred-compensation arrangements must be in writing and in compliance with Sec. 409A by Dec. 31, 2007. Plans are not required to be amended retroactively to cover the period from the Jan. 1, 2005 effective date of Sec. 409A through the end of the transition period, but must show operational compliance with the rules during that time.

Additional separate guidance is expected to address the prohibition on offshore funding and springing trusts, application of the rules to partnership arrangements, and income calculation and inclusions, none of which is covered in the final regulations. (For a discussion of the proposed regulations, see Singer, “Deferred Compensation for Executives under Sec. 409A,” Part I, TTA, July 2006, p. 402, and Part II, TTA, August 2006, p. 476.)