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Federal Tax Bulletin - Issue 43 - August 14, 2013


Parker's Federal Tax Bulletin
Issue 43     
August 14, 2013     

 

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 1. In This Issue ... 

 

Tax Briefs

CPA's Calculation of Penalty Amount Causes Court to Admonish IRS; Debtor Required to Exhaust All Administrative Remedies Before Proceeding in Court; Final Regs Provide Guidance on Transfers to RICs and REITs ...

Read more ...

Final Meal and Entertainment Expense Regs Clarify Who Is Subject to the Limitations

The IRS has issued final regulations that clarify who is subject to the deduction limitations on meal and entertainment expenses in situations involving professional employer organizations (PEOs). T.D. 9625 (8/1/13).

Read more ...

Estate Loses $144,000 Refund After Failing to Properly Designate Payment as a Deposit

A district court held that because an estate did not properly designate a payment as a deposit, and the estate tax return was filed more than three years after the payment was made, the estate was not entitled to a refund of a $144,000 overpayment. Syring v. U.S., 2013 PTC 236 (W. D. Wisc. 8/8/13).

Read more ...

Consultant Not an "Employer" With Respect to Work for Foreign Government; SEP Contributions Disallowed

The Ninth Circuit affirmed a Tax Court decision that held that the taxpayer, as a common law employee of a foreign government, was not an "employer" under Code Sec. 401(c)(4) with respect to the earnings from the foreign government and thus barred him from deducting SEP contributions. Rosenfeld v. Comm'r, 2013 PTC 234 (9th Cir. 8/8/13).

Read more ...

IRS Delays Shutdown of Disclosure Authorization and Electronic Account Resolution Products

The planned shutdown of the Disclosure Authorization and Electronic Account Resolution products on August 11, 2013, has been delayed until September 2 while the IRS completes the transition to its new web portal. IRS Website (8/9/13).

Read more ...

IRS Postpones August 30th Furlough; Cites Successful Cost-Cutting Measures

The IRS announced it will be open on Friday, August 30, following the postponement of its fifth scheduled agency-wide employee furlough day. IRS Website (8/7/13).

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Failure to File Correct IRS Form Subjects Minister's Income to Self-Employment Tax

A minister who took a vow of poverty was liable for self-employment tax on payments made on his behalf by his church because he failed to timely file an exemption certificate or designate the payments as a parsonage allowance. Rogers v. Comm'r, T.C. Memo. 2013-177 (8/1/13).

Read more ...

Company's Dividend Deductions Don't Meet All-Events Test

The annual and termination dividends credited by an accrual-basis life insurance company to its policyholders in one year but not paid until the following year were not deductible until the year of payment because the deductions did not satisfy the all-events test for the tax years in which they were accrued. New York Life Insurance Company v. U.S., 2013 PTC 226 (2d Cir. 8/1/13).

Read more ...

IRS's Penalties Disallowed as an Administrative Expense in Bankruptcy Case

Because a bankruptcy trustee did not show reasonable cause for late filing of the bankruptcy estate's S corporation tax returns, late-filing penalties were upheld; however, the penalties did not constitute a priority administrative claim under Bankruptcy Code Section 503(b)(1)(A), and the case was remanded to see if the penalties qualified as an administrative expense for other reasons. In re 800Ideas.Com, Inc., 2013 PTC 222 (B.A.P. 9th Cir. 7/22/13).

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Former Client Helps Convict BDO Accountant of Filing False Returns

A former client's testimony, as well as a recording between the former client and his personal accountant, was allowed into evidence to help convict a former BDO Seidman accountant on charges of preparing and filing fraudulent returns for the client. U.S. v. Favato, 2013 PTC 229 (3d Cir. 8/5/13).

Read more ...

Nonresident Alien's Refund Claim Barred under Three-Year Look-Back Period

A nonresident alien's claim for a refund of taxes withheld by his employer was barred under the three-year look-back period because his refund claim was not filed within three years of the filing of his return. Boeri v. U.S., 2013 PTC 223 (Fed. Cir. 7/31/13).

Read more ...

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 2. Tax Briefs 


Bankruptcy

CPA's Calculation of Penalty Amount Causes Court to Admonish IRS: In In re Breland, 2013 PTC 220 (S.D. Ala. 7/29/13), the affidavit of a CPA who disagreed with the IRS's calculation of the proper penalty amount relating to past due taxes of a debtor in bankruptcy was sufficient by itself to raise an issue of material fact as to the IRS's calculation of the penalty. As a result, the court admonished the IRS to do more to establish that the amount of the penalty was correct and rejected the IRS's request for summary judgment.

Debtor Required to Exhaust All Administrative Remedies Before Proceeding in Court: In In re Parham, 2013 PTC 228 (Bankr. E.D. Tenn. 7/29/13), a bankruptcy court held that the debtors could not proceed with their motion to hold the IRS in contempt for violating the discharge injunction in 11 U.S.C. Section 524(a)(2) and (3) by acting to collect a debt that had been discharged in the debtors' chapter 13 case. According to the court, the debtors could not seek an award of damages against the IRS until they had exhausted the administrative remedies available to them within the IRS.


C Corporations

Final Regs Provide Guidance on Transfers to RICs and REITs: In T.D. 9626 (8/2/13), the IRS issued final regulations that provide guidance on certain transfers of property from a C corporation to a regulated investment company or a real estate investment trust. [Code Sec. 337].


Deductions

IRS Exam Team Urged to Abandon Intangible Asset Argument: In CCA 201330034, the Chief Counsel's Office advised that an IRS exam team abandon its argument that the infrastructure assets at issue are intangible assets with an indeterminate useful life; further factual development was needed to determine whether the assets are intangible assets under Reg. Sec. 1.263(a)-4(d)(8)(i) or dedicated improvements under Reg. Sec. 1.263(a)-4(d)(8)(iv). Based on the facts provided, the Chief Counsel's Office said the infrastructure assets appeared to be dedicated improvements. [Code Sec. 167].


Healthcare

IRS Issues Guidance on Branded Prescription Drug Fee: In Notice 2013-51, the IRS provides guidance on the branded prescription drug fee for the 2014 fee year related to (1) the submission of Form 8947, Report of Branded Prescription Drug Information, (2) the time and manner for notifying covered entities of their preliminary fee calculation, (3) the time and manner for submitting error reports for the dispute resolution process, and (4) the time for notifying covered entities of their final fee calculation.


Penalties

Taxpayer Liable for $50,000 Fine for Filing False Return: In U.S. v. Jaramillo, 2013 PTC 230 (9th Cir. 8/2/13), the Ninth Circuit upheld a district court's order and rejected the taxpayer's challenge to the $50,000 fine imposed on him following his guilty-plea conviction for willful filing of a false tax return. [Code Sec. 7206(1)].


Procedure

Court Questions Whether Summonses on Taxpayer's Bank Account Were Appropriate: In Charles v. U.S., 2013 PTC 218 (W.D. Mich. 2013), a district court remanded a case where a taxpayer argued that a domestic bank account was clearly not a numbered account and that the no notice summonses issued under Code Sec. 7609(c)(3) were improper and that alternative methods had to be used to obtain an account holder's identity. Noting that the taxpayer's arguments presented two issues of first impression that were not heard by the magistrate judge, the district court remanded the case for the judge to rule on whether (1) two no notice summonses relating to the taxpayer were appropriately issued upon a numbered account; and (2) if the summonses were improper, does their issuance and use of the information obtained provide sufficient grounds to taint enforcement of the contested summonses. [Code Sec. 7609].

Court Won't Extend Mitigation Rules to Taxpayers: In Barclay Associates, Inc. v. IRS, 2013 PTC 232 (D. V.I. 8/1/13), the district court of the Virgin Islands held that it could not extend the mitigation statute to avoid the statute of limitations where the taxpayers claimed they were being unfairly taxed for certain years by both the Virgin Islands Bureau of Internal Revenue and the IRS. Because the taxpayers' purported circumstance of adjustment was outside the scope of Code Sec. 1312(1), the court concluded that the mitigation statute did not apply. [Code Sec. 1312].


Property Transactions

Temporary Regs Apply to Mixed Straddle Election: In T.D. 9627 (8/2/13), the IRS issued temporary regulations that apply to taxpayers electing to establish a mixed straddle using straddle-by-straddle identification. The temporary regulations explain how to account for unrealized gain or loss on a position held by a taxpayer before the time the taxpayer establishes a mixed straddle using straddle-by-straddle identification. The text of these temporary regulations also serves as the text of the proposed regulations. [Code Sec. 1092].

IRS Issues Proposed Regs on Mixed Straddles: In REG-112815-12 (8/2/13), the IRS issued proposed regulations that apply to taxpayers electing to establish a mixed straddle using straddle-by-straddle identification. [Code Sec. 1092].


Retirement Plans

Code Sec. 219(c) Renamed: In Pub. L. 113-22, signed into law by President Obama on July 30, 2013, renames Code Sec. 219(c) from SPECIAL RULES FOR CERTAIN MARRIED INDIVIDUALS to KAY BAILEY HUTCHISON SPOUSAL IRA. [Code Sec. 219].

In Notice 2013-52, the IRS provides guidance on the corporate bond monthly yield curve (and the corresponding spot segment rates), and the 24-month average segment rates under Code Sec. 430(h)(2). In addition, the notice provides guidance as to the interest rate on 30-year Treasury securities under Code Sec. 417(e)(3)(A)(ii)(II) as in effect for plan years beginning before 2008, the 30-year Treasury weighted average rate under Code Sec. 431(c)(6)(E)(ii)(I), and the minimum present value segment rates under Code Sec. 417(e)(3)(D) as in effect for plan years beginning after 2007. [Code Sec. 430].


RICs, REITs, and REMICs

Proposed Regs Would Revise Certain RIC Examples: In REG-114122-12 (8/2/13), the IRS issued proposed regulations that would revise examples that illustrate the controlled group rules related to regulated investment companies (RICs). The proposed revisions would resolve an issue with how the controlled group rules should be applied in connection with the RIC asset diversification test. [Code Sec. 851].


Tax Payments

IRS Releases Draft Form for Calculating Net Investment Income Tax: On August 7, the IRS released a draft version of Form 8960, Net Investment Income Tax Individuals, Estates, and Trusts. No instructions were released with the form. [Code Sec. 1411].


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 3. In-Depth Articles 

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Final Meal and Entertainment Expense Regs Clarify Who Is Subject to the Limitations

Many small and medium-sized companies are outsourcing their human resources, benefits, and payroll administrative tasks to professional employer organizations (PEOs) in an effort to reduce their overall labor costs. With the increase in the use of PEOs, have come several new tax issues. One of those issues is how the meal and entertainment deduction limitation rules of Code Sec. 274 apply; in other words do the limitations apply to the PEO, the company that hired the PEO, or the employee? Last year, the IRS issued proposed regulations, which it finalized earlier this month in T.D. 9625 (8/1/13).

The final regulations clarify the definition of reimbursement or other expense allowance arrangement for purposes of determining how the deduction limitations apply to reimbursement arrangements between the three parties.

Background

Under Code Sec. 274(a)(1) deductions for certain expenses for entertainment, amusement, or recreation activities and for facilities used in connection with entertainment, amusement, or recreation activities are limited. Code Sec. 274(n)(1) generally limits the amount allowable as a deduction for any expense for food, beverages, entertainment activities, or entertainment facilities to 50 percent of the amount otherwise allowable. However, the limitations of Code Sec. 274(a)(1) and Code Sec. 274(n)(1) do not apply to an expense described in Code Sec. 274(e)(3).

In general, Code Sec. 274(e)(3) excepts from the limitations of Code Sec. 274(a) expenses a taxpayer pays or incurs in performing services for another person under a reimbursement or other expense allowance arrangement with the other person. The exception applies if the taxpayer is an employee performing services for an employer and the employer does not treat the reimbursement for the expenses as compensation and wages to the taxpayer. In that case, the employee is not treated as having additional compensation and has no deduction for the expense. The employer bears and deducts the expense and is subject to the deduction limitations.

If the employer treats the reimbursement as compensation and wages, the employee may be able to deduct the expense as an employee business expense. Under Reg. Sec. 1.274-2(f)(2)(iv)(b), the employee bears the expense and is subject to the deduction limitations, while the employer deducts an expense for compensation, which is not subject to the deduction limitations.

The Code Sec. 274(e)(3) exception also applies if the taxpayer performs services for a person other than an employer and the taxpayer accounts (i.e., substantiates) to that person. Therefore, in a reimbursement or other expense allowance arrangement in which a client or customer reimburses the expenses of an independent contractor, the deduction limitations do not apply to the independent contractor to the extent the independent contractor accounts to the client by substantiating the expenses. Reg. Sec. 1.274-2(f)(2)(iv) provides that, if the independent contractor is subject to the deduction limitations, the limitations do not apply to the client.

One of the first cases to deal with the entertainment deduction limitations and PEOs was Transport Labor Contract/Leasing, Inc. v. Comm'r, 461 F.3d 1030 (8th Cir. 2006), rev'g 123 T.C. 154 (2004). In that case, Transport Labor Contract/Leasing, Inc. (TLC) provided PEO services by hiring truck drivers as its employees and then leasing them to its trucking company clients. TLC paid truck drivers a per diem allowance that it did not treat as compensation. It billed the client that was leasing the drivers for the drivers' wages and per diem allowances, and the client paid TLC. TLC provided its clients with the expense substantiation information required by Code Sec. 274(d). The Tax Court applied the Code Sec. 274(n) limitation to TLC as the drivers' common law employer.

The Eighth Circuit reversed, stating that the Tax Court should have considered Code Sec. 274(e)(3)(B). In determining to whom the Code Sec. 274(n) limitation applies, the Eighth Circuit said that because TLC's per diem payments were not treated as truck driver wages, the limitation did not apply to the drivers. Thus, the question was whether the limitation applied to TLC or the trucking companies. The Eighth Circuit concluded that because TLC paid per diem expenses to the truck drivers and provided the trucking company clients with the expense substantiation information required by Code Sec. 274(d), the trucking companies were subject to the limitation. The court also noted that there was substantial documentary evidence establishing that TLC and its clients entered into a reimbursement or other expense allowance arrangement that satisfied the requirements of Reg. Sec. 1.62-2(c) through (f) and, therefore, satisfied Code Sec. 274(e)(3).

In Rev. Rul. 2008-23, the IRS acquiesced to the result in the TLC decision and similarly ruled that the party that ultimately bears the expense in a three-party reimbursement arrangement is subject to the Code Sec. 274(n) limitation. The revenue ruling clarified that a party's status as a common law employer is not relevant to the Code Sec. 274(n) analysis, which the Eighth Circuit's opinion could be read to imply.

Rev. Rul. 2008-23 clarified another issue raised by the TLC opinion. To define the term reimbursement or other expense allowance arrangement for purposes of Code Sec. 274(e)(3), the Eighth Circuit looked to Reg. Sec. 1.274-2(f)(2)(iv)(a), which provides that the term reimbursement or other expense allowance arrangement in Code Sec. 274(e)(3) has the same meaning as in Code Sec. 62(a)(2)(A) (dealing with employee business expenses and previously labeled Code Sec. 62(2)(A)), but without regard to whether the taxpayer is an employee of the person for whom the taxpayer provides services. Thus, the court defined reimbursement or other expense allowance arrangement for purposes of Code Sec. 274(e)(3) by reference to Code Sec. 62(a)(2)(A) and Reg. Sec. 1.62-2, which provide the rules for the employee reimbursement arrangements called accountable plans.

According to the IRS, the TLC court's definition was inaccurate to the extent it relied on the accountable plan rules, which cover employee reimbursement arrangements only, in determining the existence of a reimbursement or other expense allowance arrangement for purposes of identifying who bears the expense under Code Sec. 274(e)(3)(B).

Thus, Rev. Rul. 2008-23 clarified that the Reg. Sec. 1.274-2(f)(2)(iv)(a) reference to Code Sec. 62(a)(2)(A) predated the enactment of Code Sec. 62(c), which addresses certain arrangements not treated as reimbursement arrangements, and the accountable plan regulations, which govern employer-employee reimbursement arrangements and their employment tax consequences. Therefore, Rev. Rul. 2008-23 holds that the Code Sec. 274(e)(3) exception may apply to an expense reimbursement arrangement without regard to whether it is an accountable plan.

Definition of "Reimbursement or Other Expense Allowance Arrangement"

Under the regulations, a reimbursement or other expense allowance arrangement involving employees is an arrangement under which an employee receives an advance, allowance, or reimbursement from a payor (the employer, its agent, or a third party) for expenses the employee pays or incurs in performing services as an employee. A reimbursement or other expense allowance arrangement involving persons that are not employees is an arrangement under which an independent contractor receives an advance, allowance, or reimbursement from a client or customer for expenses the independent contractor pays or incurs in performing services if either:

(1) a written agreement between the parties expressly provides that the client or customer will reimburse the independent contractor for expenses that are subject to the deduction limitations; or

(2) a written agreement between the parties expressly identifies the party that is subject to the Code Sec. 274(n) limitations.

Rules for Two-Party Reimbursement Arrangements Clarified

The regulations clarify that the rules for applying the exceptions to the Code Sec. 274(a) and (n) deduction limitations apply to reimbursement or other expense allowance arrangements with employees, whether or not a payor is an employer. Under the regulations, a payor includes an employer, an agent of the employer, or a third party. For example, either an independent contractor or a client or customer may be a payor of a reimbursement arrangement. Thus, any party that reimburses an employee is a payor and bears the expense if the payment is not treated as compensation and wages to the employee.

The regulations also address situations where a reimbursement or other expense allowance arrangement between an independent contractor and a client or customer includes an agreement expressly providing that the client or customer will reimburse the independent contractor for expenses that are subject to the deduction limitations. In that case, the deduction limitations do not apply to an independent contractor that accounts to the client within the meaning of Code Sec. 274(d) and the associated regulations, but they do apply to the independent contractor and not to the client if the independent contractor fails to account to the client. Alternatively, the parties may enter into an express agreement identifying the party that is subject to the deduction limitations.

Multiple-Party Reimbursement Arrangements Analyzed Separately

The regulations provide that multiple-party reimbursement arrangements are separately analyzed as a series of two-party reimbursement arrangements. Thus, for example, an arrangement in which (1) an employee pays or incurs an expense subject to limitation, (2) the employee is reimbursed for that expense by another party (the initial payor), and (3) a third party reimburses the initial payor's payment to the employee, is analyzed as two two-party reimbursement arrangements. One arrangement is that between the employee and the initial payor, and another arrangement is that between the initial payor and the third party.

Example 1: Megan, an employee, performs services under an arrangement in which LMN, an employee leasing company, pays Megan a per diem allowance of $10 for each day that Megan performs services for LMN's client, ABC, while traveling away from home. The per diem allowance is a reimbursement of travel expenses for food and beverages that Megan pays in performing services as an employee. LMN enters into a written agreement with ABC under which ABC agrees to reimburse LMN for any substantiated reimbursements for travel expenses, including meals, that LMN pays to Megan. The agreement does not expressly identify the party that is subject to the deduction limitations. Megan performs services for ABC while traveling away from home for 10 days and provides LMN with substantiation that satisfies the applicable substantiation requirements of $100 of meal expenses incurred by Megan while traveling away from home. LMN pays Megan $100 to reimburse those expenses pursuant to their arrangement. LMN delivers a copy of Megan's substantiation to ABC. ABC pays LMN $300, which includes $200 compensation for services and $100 as reimbursement of LMN's payment of Megan's travel expenses for meals. Neither LMN nor ABC treats the $100 paid to Megan as compensation or wages.  

In this case, Megan and LMN have established a reimbursement or other expense allowance arrangement. Because the reimbursement payment is not treated as compensation and wages paid to Megan, she is not subject to the Code Sec. 274 deduction limitations. Instead, under his analysis, LMN, the payor, is subject to the deduction limitations. Because the agreement between LMN and ABC expressly states that ABC will reimburse LMN for expenses for meals incurred by employees while traveling away from home, LMN and ABC have established a reimbursement or other expense allowance arrangement. LMN accounts to ABC for ABC's reimbursement in the required manner by delivering to ABC a copy of the substantiation LMN received from Megan. Therefore, under this analysis, ABC, and not LMN, is subject to the Code Sec. 274 deduction limitations.

Example 2: The facts are the same as in Example 1 except that, under the arrangements between Megan and LMN and between LMN and ABC, Megan provides the substantiation of the expenses directly to ABC, and ABC pays the per diem directly to Megan. In this case, Megan and ABC have established a reimbursement or other expense allowance arrangement. Because Megan substantiates directly to ABC and the reimbursement payment was not treated as compensation and wages paid to Megan, Megan is not subject to the Code Sec. 274 deduction limitations. ABC, the payor, is subject to the Code Sec. 274 deduction limitations.

Example 3: The facts are the same as in Example 1, except that the written agreement between LMN and ABC expressly provides that the deduction limitations will apply to ABC. LMN and ABC have established a reimbursement or other expense allowance arrangement. Because the agreement provides that the deduction limitations apply to ABC, ABC, and not LMN, is subject to the Code Sec. 274 deduction limitations.

Example 4: The facts are the same as in Example 1, except that the agreement between LMN and ABC does not provide that ABC will reimburse LMN for travel expenses. In this case, the arrangement between LMN and ABC is not a reimbursement or other expense allowance arrangement. Therefore, even though LMN accounts to ABC for the expenses, LMN is subject to the Code Sec. 274 deduction limitations.

For a discussion of the of meal and entertainment expenses, see Parker Tax ¶91,115.

[Return to Table of Contents]

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Estate Loses $144,000 Refund After Failing to Properly Designate Payment as a Deposit

The difference between characterizing a remittance to the IRS as a deposit or a tax payment can have significant ramifications. It's generally preferable to have the remittance characterized as a deposit because there is no statute of limitations on when a deposit can be recovered. However, for a remittance to be characterized as a deposit, the taxpayer must include with the payment a written statement designating it as a deposit. In Syring v. U.S., 2013 PTC 236 (W. D. Wisc. 8/8/13), an estate neglected to do this when it made a payment with its estate tax extension request. When the return was finally filed, the estate had overpaid the tax by $144,000 and was due a refund. However, because the remittance with the extension request was not properly designated as a deposit, and the estate tax return was filed more than three years after the payment was made, the estate was not entitled to a refund of the $144,000 overpayment.

Facts

Marshall Syring died on October 14, 2005. Leone Syring, appointed as the estate's personal representative, hired Roger Peterson, CPA, to prepare the estate's tax return. Under Code Sec. 6075(a), the return was due on or before July 14, 2006. Peterson estimated that the total estate tax would be $600,000 but that the estate was eligible to pay the tax over a 10 year period because it qualified as a small business. Consistent with Peterson's advice, on July 14, 2006, the estate filed an application for extension and sent $170,000 to the IRS and $170,000 to Wyoming. In paying the IRS, the estate did not include a written statement designating the amount as a deposit as required by Rev. Proc. 2005-18.

Even with the extension to January 14, 2007, the estate missed the deadline to file a tax return. Instead, more than three years later, the estate filed it tax return on February 19, 2010, reporting no estate tax due. The IRS then conducted an audit and determined that the estate owed taxes in the amount of $25,526. The estate did not challenge the amount of the assessed estate tax, but requested the IRS return $144,474, comprising the original remittance less the assessed estate tax.

The IRS denied the estate's refund request on the grounds that the remittance was properly treated as a partial tax payment, rather than a deposit, in light of estate's failure to provide the IRS with a written statement designating the remittance as a deposit, as required by Rev. Proc. 2005-18. Because it was treated as a payment, the estate's claim fell outside the three-year tax recovery period under Code Sec. 6511(a) and (b)(2)(A).

Under Code Sec. 6511(a), a refund claim for an overpayment of tax must be filed by the taxpayer within three years from the time the return was filed or two years from the time the tax was paid, whichever of those periods expires later. Under Code Sec. 6511(b)(2)(A), if the refund claim was filed by the taxpayer during that three-year period, the amount of the credit or refund cannot exceed the portion of the tax paid within the period, immediately preceding the filing of the claim, equal to three years plus the period of any extension of time for filing the return.

The estate argued that the $170,000 payment was a deposit under Code Sec. 6603. Code Sec. 6603 provides that a taxpayer may make a cash deposit with the IRS which can be used to pay any tax which has not been assessed at the time of the deposit. To the extent the deposit is used by the IRS to pay tax, the tax is treated as paid when the deposit is made.

The procedures for designating a payment as a deposit, rather than a tax payment, are contained in Rev. Proc. 2005-18. Under Section 4 of that procedure, a taxpayer may make a deposit under Code Sec. 6603 by remitting to the IRS Center at which the taxpayer is required to file its return, or to the appropriate office at which the taxpayer's return is under exam, a check or a money order accompanied by a written statement designating the remittance as a deposit. The written statement also must include:

(1) the type(s) of tax;

(2) the tax year(s); and

(3) a statement described in Section 7.02 of Rev. Proc. 2005-18 identifying the amount of, and basis for, any disputable tax.

Undesignated remittances treated as tax payments are applied to the earliest tax year for which there is a liability, and is applied first to tax, then penalties and finally to interest. An undesignated remittance treated as a payment of tax is posted to the taxpayer's account as a payment upon receipt, or as soon as possible thereafter, and may be assessed, provided that assessment will not imperil a criminal investigation or prosecution. The amount of an undesignated remittance treated as a payment is taken into account by the IRS in determining the existence of a deficiency and whether a notice of deficiency is required to be issued.

District Court's Opinion

The district court had to determine whether the estate's remittance was a deposit or a tax payment. In making this determination, the court applied a fact-and-circumstances test, which considered the following three factors: (1) when the tax liability was defined, (2) the taxpayer's intent in remitting the money, and (3) how the IRS treated the remittance upon receipt. The court said that, ultimately, the determination of whether a remittance is a deposit or tax payment is a question of law for the court.

Timing of Determination of Tax Liability

With respect to the first factor of when the tax liability was defined, the court said this factor looks at whether the tax liability was defined at the time the remittance was made. A remittance made before the tax liability is defined tips the balance toward a finding of a deposit. According to the court, the undisputed facts established that there was neither a formal assessment nor a defined tax liability at the time the remittance was made. The IRS argued that this factor should weigh in favor of the finding of a tax payment because the estate had initially determined that it owed over $600,000 of estate tax and made the $170,000 remittance in response to that asserted tax liability.

The court noted that the IRS's approach would collapse this factor into the second factor, which focuses on the taxpayer's subjective perception of how much tax he or she owes. The better view, the court said, was for this first factor to focus on whether, objectively, the IRS had defined the taxpayer's tax obligation. This approach, the court noted, was consistent with other courts' treatment of this factor. The first factor therefore weighed in favor of categorizing the remittance as a deposit, the court concluded.

Taxpayer's Intent

Citing the Seventh Circuit's decision in Moran v. U.S., 63 F.3d 663 (7th Cir. 1993), the district court observed that the taxpayer's intent has an important place in the facts-and-circumstances test. According to the district court, courts may derive that intent only from reasonable interpretations of the taxpayer's actions, not from the taxpayer's after-the-fact claims and rationalizations. Here, the court concluded, Leone failed to put forth sufficient evidence from which the court could conclude that she intended to make a deposit when she signed the check to the IRS. Indeed, the court found the evidence was clearly to the contrary.

A written statement designating the remittance as a deposit, as required by Code Sec. 6603 and Rev. Proc. 2005-18, is prima facie evidence that a taxpayer intends to make a deposit in submitting the money. Not only was this evidence lacking, Leone failed to offer an affidavit, declaration, or other testimony describing her intent at the time she made the payment. As such, the court said, there was no direct evidence indicating her intent in making the remittance. Thus, the court could only derive intent from other indirect evidence. Since it was undisputed that Leone relied on the estate's accountant for advice and recommendations in making the remittance, the court looked to the accountant's advice and recommendations to determine Leone's intent.

The court also examined the accountant's actions to determine his intent in delivering his professional opinions to Leone. The court concluded that the accountant's actions, advice, and recommendations all demonstrated Leone's intent to make a partial tax payment in remitting the original $170,000. In coming to this conclusion, the court cited the accountant's advice that the estate was large enough to owe federal and state estate taxes. In connection with this debt, the court noted, the accountant advised that payments of $170,000 each to the federal and state government would be due before July 14, 2006. The court also cited the accountant's advice that the estimated federal estate tax would be more than $600,000 but that the full amount need not be paid immediately because the estate qualified to pay the tax over the next 10 years.

Having indisputably acted promptly on this advice, the court concluded, no reasonable person could find that Leone considered the remittance to be a deposit rather than a down payment on the estate's larger tax liability. The evidence was equally overwhelming that the accountant considered the remittance to be a partial tax payment when he recommended that the estate pay it. First, the court noted, the accountant calculated the estimated estate tax liability based on an assumption and valuation method he deemed appropriate at the time, rather than based purely on speculation. Leone had conceded, the court noted, that the accountant used fair market value to calculate the value of the gross estate. The estimated total federal estate tax of over $600,000 was made under the assumption that the estate qualified as a qualifying small business, which the accountant deemed appropriate at the time.

The court also noted that, after concluding that the estate owed federal estate tax and being provided with the opportunity to postpone the deadline of paying that tax, the estate's accountant filed Form 4768 with the IRS on behalf of the estate, requesting only an extension of time for filing the tax return. An extension of time for filing a return does not operate to extend the time for paying the tax. To apply for an extension of time to pay the tax, the court noted, the taxpayer must

(1) check the appropriate boxes on Form 4768, and

(2) provide the IRS with a written statement demonstrating either there are reasonable causes to delay payments or there are undue hardships to pay tax on time.

Despite these straightforward instructions being included in Part III of Form 4768, the accountant neither checked any of the boxes in Part III of the form, nor provided any written statements to the IRS explaining any difficulties the estate had in paying the estimated estate taxes. Instead, the accountant entered $170,000 in Part IV, line 1 of Form 4768, which the accountant represented was the amount of estate taxes estimated to be due then, as well as instructed Leone to submit that amount to the IRS. The court concluded that the way the accountant completed Form 4768, together with the fact that the accountant had informed Leone that the estate owed federal estate taxes but did not have to pay the full amount, strongly suggested to the court that the accountant intended the remittance to be a partial tax payment.

With respect to Leone's contention that the printed Form 4768 did not contain a column for deposits, meaning that a remittance made along with the form could still be a deposit, the court agreed that, in certain circumstances, a remittance made along with a printed Form 4768 might not be a tax payment. However, the court said that this fact did not support a finding that the estate intended to make a deposit in this situation, at least in the face of overwhelming, contemporaneous evidence to the contrary.

The court also disagreed with the estate's assertion that a remittance is a deposit if made to stop interest and penalties. While it is true that the intent to stop interest and penalties may support a finding that a taxpayer intends to make a deposit, the court said that an intent to stop interest and penalties does not exclude the possibility that the taxpayer intended to make a tax payment in remitting the money. In fact, the court said, making a large tax payment before a formal assessment has the same practical effect of mitigating or preventing any interest or penalties due to underpayment or untimeliness. Therefore, the taxpayer's intent of stopping interest and penalties is, at most, another fact to determine whether the taxpayer intended to make a deposit or a tax payment.

IRS's Treatment of Remittance

The final factor the court considered was the IRS's treatment of the remittance itself, which the court concluded also weighed in favor of the IRS. First, the court noted, the estate acknowledged not providing the IRS with any written statement designating the remittance as a deposit. Second, the parties agreed that the IRS recorded the remittance as a payment received upon receiving the remittance, rather than a deposit. Third, the IRS credited the amount directly to the estate's account, rather than put the remittance in a separate account for deposit. All of those actions strongly suggested that the IRS conformed to Rev. Proc. 2005-18 and treated the remittance as a tax payment. The court rejected the estate's contention that the IRS's failure to calculate interest accrued on the remittance contradicted the IRS's position that it treated the remittance as a tax payment. According to IRS testimony, the IRS's computer does not start calculating interest accrued on an estate's tax payment before the return is filed and the tax liability is determined.

Conclusion

Although the first factor in the facts-and-circumstances test used by the district court weighed in favor of the estate's position, its intent to make a down payment on its tax liability and the fact that IRS treated the remittance as a tax payment tipped the balance to a finding that the $170,000 was a tax payment. The district court noted that while this result may seem unfair because the government is allowed to keep a payment that it concedes was not due tax laws are not normally characterized by case-specific exceptions reflecting individualized equities. The court concluded that the estate was unable to meet its burden of demonstrating that the remittance was a deposit.

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Consultant Was Not An "Employer" With Respect to Work for a Foreign Government; SEP Contributions Disallowed

While the term employer is straightforward in most situations, the line may be blurred where a taxpayer is self-employed. Whether a taxpayer is considered his or her own employer has ramifications such as whether or not the individual can contribute to a simplified employee pension (SEP) plan and take a deduction for the contribution. If the individual does so contribute but should not have, additional taxes, as well as excise tax penalties apply. That was the situation in Rosenfeld v. Comm'r, 2013 PTC 234 (9th Cir. 8/8/13), where a freelance writer accepted an assignment to work for a foreign government, whose contract with the writer specified that he was self-employed and that the foreign government would not withhold taxes. The taxpayer then contributed money to his SEP and deducted the contributions.

The IRS challenged the deductions, and the Tax Court held that the taxpayer was an employee under common law factors, and that the portion of his SEP contribution relating to his work for the foreign government was disallowed.

Observation: In the lower court decision, the Tax Court recognized the difficulty of the interplay between Code Sec. 3121 and Code Sec. 401(c) and thus did not uphold the IRS's penalty assessment against the taxpayer.

On appeal, the taxpayer argued that the Tax Court was wrong in finding he was an employee and that, because he worked for a foreign government, he was considered his own employer. Unfortunately, the Ninth Circuit agreed with the Tax Court and upheld the tax deficiency and excise tax penalties against the taxpayer.

Facts

Michael Rosenfeld graduated from the University of Southern California with a master's degree in journalism and has worked as a corporate marketing executive, financial writer, and journalist for over 20 years. In 1985, he started his own consulting business, representing clients in a variety of professional services. In 1994, he left his consulting business to work in corporate communications and marketing. In 1999, he reestablished his business and currently works as a consultant for his business.

In July or August 2003, in an effort to expand into the British investment community, Michael met with the deputy consul general, Brian Conley, of the British Consulate General (BCG) in the United States. During the meeting Mr. Conley indicated that the BCG might be interested in using Michael's services to promote British companies seeking to invest in the United States and to assist U.S. companies interested in investing in the United Kingdom.

After several meetings discussing Michael's qualifications, the BCG formally offered Michael a full-time appointment for a three-year defined term. Michael signed a letter of appointment dated September 22, 2003, and was appointed at the level of "Trade Officer Grade US 8." The letter provided for annual increases to his salary depending on satisfactory services, as determined by the BCG. The BCG, as a foreign employer of a U.S. citizen, categorized Michael as self-employed for tax purposes. The BCG did not withhold taxes from Michael's salary, and Michael was responsible for all federal, state, and local taxes and for self-employment taxes.

IRS Deficiency Assessment

On Schedule C of his 2003 Form 1040, Michael reported total gross receipts of almost $110,000 and total expenses of $37,280, and a deduction for the business use of his home. As a self-employed individual, Michael contributed to an SEP plan on the basis of his consultant earnings. Michael reported gross receipts from the BCG on Schedule C and also contributed to an SEP plan on the basis of those earnings. In 2003 he contributed $12,242 to his SEP plan.

In a notice of deficiency, the IRS determined, in part, that Michael was: (1) a common law employee of the BCG and consequently was not entitled to report gross receipts and expenses associated with his work for the BCG on Schedule C for 2003; (2) subject to an excise tax under Code Sec. 4973 for excess contributions to an SEP plan; and (3) liable for the accuracy-related penalty under Code Sec. 6662(a).

Simplified Employee Pension Plans

A SEP plan is a plan under which an employer makes direct contributions to its employees' individual retirement accounts or individual retirement annuities (IRAs).

Under Code Sec. 404(a)(8), an employer can deduct certain contributions to an employee's SEP plan. For purposes of Code Sec. 404(a)(8), the term "employee" includes an individual who is an employee within the meaning of Code Sec. 401(c)(1), and the employer of such an individual is the person treated as his employer under Code Sec. 401(c)(4).

Under Code Secs. 401(c), 404(h), 408(k)(7), and Reg. Sec. 1.401-10(b)(2), self-employed individuals and sole proprietors are treated as their own employers and employees for purposes of SEP plan deductions. For purposes of applying Code Sec. 401 through Code Sec. 404, if a self-employed individual is engaged in more than one trade or business, each business is considered a separate employer. A self-employed individual is treated as his own employer if he satisfies the definition of employer under Code Sec. 401(c)(4). Additionally, under Code Sec. 408(k)(7), a self-employed individual must also be his own employee and is treated as such if he satisfies the definition of employee under Code Sec. 401(c)(1).

The Parties Arguments

Michael argued that he satisfied the requirements of Code Sec. 401(c) and was qualified to make and deduct contributions to his SEP plan derived from both his consultant business and BCG earnings. The IRS did not contest that Michael was entitled to deduct contributions to his SEP plan from the earnings derived from his consultant business. The IRS did contest, however, Michael's deductions to his SEP plan with respect to his BCG earnings.

Michael said that as an employee of a foreign government, he is self-employed pursuant to Code Sec. 3121(b)(11) and is treated as his own employee under Code Sec. 401(c)(1) and (2). Code Sec. 3121(b)(11) provides that service performed in the employ of a foreign government (including service as a consular or other officer or employee or a nondiplomatic representative) is not considered employment for purposes of social security and Medicare taxes, and is thus exempt from such taxes.

Michael argued that even if the court concluded that he was a common law employee of the BCG, he was still his own employer under Code Sec. 401(c)(4) with respect to his BCG earnings. Consequently, he is entitled to deduct the contributions to his SEP plan that are attributable to his BCG earnings. Code Sec. 401(c)(4) provides that an individual who owns the entire interest in an unincorporated trade or business is treated as his own employer.

Michael also cited the legislative history of Code Sec. 401(c) in support of his argument that he was his own employer with respect to his BCG earnings. He cited a House report, which defines an employee for purposes of retirement plan contributions, as a self-employed individual. Michael argued that, on the basis of the legislative history, a common law employee who has self-employment earnings is treated as an owner-employee and is entitled to make retirement plan contributions and deduct those contributions on the basis of the self-employment income.

Tax Court Holding

The Tax Court sided with the IRS. The court noted that the term employee is not defined in the Code. An individual's status as an employee is a factual question that depends on the application of common law concepts. Among the relevant factors in determining the substance of an employment relationship are: (1) the degree of control exercised by the principal over the details of the individual's work; (2) the taxpayer's investment in facilities; (3) the taxpayer's opportunity for profit or loss; (4) the permanency of the relationship between the parties; (5) the principal's right of discharge; (6) whether the work performed is an integral part of the principal's business; (7) what relationship the parties believe they are creating; and (8) the provision of employee benefits.

The Tax Court addressed each factor and found that the factors either favored the IRS's position or were neutral. For example, the court found that the BCG had the right to exercise control over Michael's work, which favored the IRS's position. With respect to employee benefits and Michael's testimony that he did not receive sick pay, overtime pay, retirement benefits, or life insurance and received only minimal remuneration for health and dental insurance, the court noted that, in 2003, Michael accrued annual and sick leave and had the opportunity to participate in the BCG's health insurance and pension plans but declined to do so. Considering all the facts and circumstances, the court concluded that Michael was a common law employee of the BCG.

The court found that, as a common law employee of the BCG, Michael was not an employer under Code Sec. 401(c)(4) with respect to his BCG earnings, which barred him from contributing to an SEP and deducting contributions based on those earnings.

The court also rejected Michael's reliance on Levine v. Comm'r, T.C. Memo. 2005-86, a case in which the taxpayer entered into a personal services contract with the U.S. State Department to manage and implement the Department's worldwide industrial hygienist field technical services program. The taxpayer in that case, the court noted, provided significant explanatory evidence of her position with the Department, including her employment contract. The employment contract described, in detail, her employment duties, how she performed her duties, and how she interacted with employees and supervisors. In contrast, the court observed, Michael provided mere generalities as to his tasks, his employment position, and the control the BCG exercised over his position.

The phrase self employed for tax purposes in the letter of appointment did not reflect the BCG's understanding of Michael's employment status. Rather, the court said, it reflected the tax consequences for a U.S. citizen employed by a foreign government. The letter of appointment was unambiguous regarding Michael's employment relationship. The BCG offered him a full-time appointment as a Trade Officer US8 with a fixed monthly salary. The court noted that the record did not reflect that the BCG intended to hire Michael as an independent contractor. The fact that the BCG did not withhold taxes from Michael's pay did not establish either his or the BCG's intent regarding his relationship with the BCG, the court said.

Ninth Circuit's Analysis

The Ninth Circuit affirmed the Tax Court's decision. With respect to whether Michael, as a common law employee of the BCG, still could have contributed to a SEP based on his BCG earnings, the Ninth Circuit agreed with the Tax Court's interpretation of the Code Sec. 401(c)(4). Because Michael did not own any interest in the BCG, the court found that he was not an employer under Code Sec. 401(c)(4) with respect to his BCG earnings, thus leaving him ineligible to contribute to an SEP and deduct contributions based on those earnings.

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IRS Delays for Three Weeks Shutdown of Disclosure Authorization and Electronic Account Resolution Products

The planned shutdown of the Disclosure Authorization and Electronic Account Resolution products on August 11, 2013, has been delayed until September 2 while the IRS completes the transition to its new web portal. IRS Website (8/9/13).

IRS Disclosure Authorization (DA) and Electronic Account Resolution (EAR) users have an additional three weeks to use both electronic products while the IRS completes the transition to its new web portal. The products were originally scheduled to disappear on August 11. According to the IRS, once the portal transition work is complete, DA and EAR will be retired as previously planned and will be unavailable for use after September 1.

Due largely to low usage of e-Service's DA and EAR, the IRS decided earlier this year to retire and remove the two applications effective August 11. Last year, the IRS said, users submitted less than 10 percent of all disclosure authorizations through the DA application. Similarly, only 3 percent of all account-related issues came in through the EAR application.

In anticipation of this change, the IRS increased the number of employees who process authorizations and has improved internal work processes to decrease the average processing time significantly from the current 10-day processing period.

The IRS said it will continue to explore better ways to reduce processing time and improve overall service to the users. However, current budget cuts will impact their dedicated resources to this program and they are working to determine the impact on processing time.

Compliance Tip: Once IRS removes the two applications, former DA users will need to complete Form 2848, Power of Attorney and Declaration of Representative, or Form 8821, Tax Information Authorizations, and mail or fax it to the appropriate IRS location listed on the form's instructions. According to the IRS, former DA users should allow at least four days for the authorization to post to the IRS database before requesting a transcript through the Transcript Delivery System. Former EAR users should call the Practitioner Priority Service at 1-866-860-4259 for help resolving account-related issues.

The IRS said it is continuing to look for ways to improve its current processes and is exploring an improved electronic solution for DA and EAR in the future.

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IRS Postpones August 30th Furlough; Cites Successful Cost-Cutting Measures

The IRS announced it will be open on Friday, August 30, following the postponement of its fifth scheduled agency-wide employee furlough day. IRS Website (8/7/13).

Plans to close the IRS on Friday, August 30, have been cancelled. According to Danny Werfel, IRS Acting Commissioner, the IRS has made substantial progress in cutting costs such that it has postponed the furlough day scheduled for August 30. He said that the IRS still has more work to do on the budget and cost-savings, so it will reevaluate in early September and make a final determination as to whether another furlough day will be necessary in September.

IRS has so far taken three furlough days on May 24, June 14, and July 5, due to the current budget situation, including the sequester.

month, the IRS was also able to cancel the previously scheduled July 22nd furlough day due to cost-cutting efforts.

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Failure to File Correct IRS Form Subjects Minister's Income to Self-Employment Tax

A minister who took a vow of poverty was liable for self-employment tax on payments made on his behalf by his church because he failed to timely file an exemption certificate or designate the payments as a parsonage allowance. Rogers v. Comm'r, T.C. Memo. 2013-177 (8/1/13).

Donald Rogers was a pastor for the Pentecostals of Wisconsin (PoW). PoW was registered as a nonstock corporation, and Donald was its registered agent. Donald signed a vow of poverty, which stated that any donation/honorarium or endowment given to Donald personally would be considered the property of PoW and, in turn, PoW would provide for Donald's needs. In 2007, in return for his ministerial services, PoW paid Donald's personal credit card bills, utility bills, and home mortgage payments for a total of $43,200. Donald and his wife, Vyon, timely filed their joint 2007 federal income tax return. They reported wage income and itemized deductions for home mortgage interest and charitable contributions. They did not report any income from amounts paid by PoW on their behalf or file a certificate of exemption from self-employment tax. The IRS issued a notice of deficiency based on the couple's failure to report taxable income from amounts paid by PoW on their behalf and assessed an accuracy-related penalty.

Code Sec. 61 defines gross income as all income from whatever source derived, including compensation for services. Under Code Sec. 107, gross income does not include, in the case of a minister of the gospel, the rental allowance paid to him as part of his compensation, to the extent used by him to rent or provide a home.

A duly ordained, commissioned, or licensed minister of a church in the exercise of his ministry is engaged in carrying on a trade or business and is subject to self-employment tax unless the minister timely files Form 4361, Application for Exemption From Self-Employment Tax for Use by Ministers, Members of Religious Orders and Christian Science Practitioners.

Observation: Form 4361 must filed by the due date of the individual's return (including extensions) for the second year in which the individual has received at least $400 of net earnings from self-employment, any of which was ministerial income.

Donald argued that, while members of religious orders who have taken a vow of poverty are subject to tax on income received in their individual capacities, they are not subject to tax on income received merely as agents of the orders of which they are members.

The Tax Court held that the payments made by the church on Donald's and Vyon's behalf constituted income to the couple. Because Donald and Vyon failed to timely file an exemption certificate, they were liable for self-employment tax on the payments. Since the home mortgage payments made by the church on Donald's behalf were not designated as a parsonage allowance, the couple was not entitled to exclude the mortgage payments under Code Sec. 107. In rejecting Donald's argument that he received the payments as an agent of the church, the court noted that Donald did not receive a salary from a third party or remit any income to the church by assignment. The mortgage payments made by PoW applied to a house owned solely by the couple, and the personal credit card and utility payments served only to benefit the couple in meeting their basic living expenses.

The court found that Donald and Vyon would be liable for an accuracy-related penalty after final computations of the deficiency if the total understatement of income exceeded $5,000. The couple's mistake of law that the church's corporate sole structure and vow of poverty would exempt them from tax was insufficient to show that they acted reasonably and in good faith in failing to report the income. Additionally, they could not show that they reasonably relied on the advice from a tax professional. The court noted that the couple was not negligent and, if the understatement was less than $5,000, they would not be subject to the penalty.

For a discussion of the taxation of minister income, see Parker Tax ¶15,520.

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Company's Dividend Deductions Did Not Meet All-Events Test; No Deduction Allowed

The annual and termination dividends credited by an accrual-basis life insurance company to its policyholders in one year but not paid until the following year were not deductible until the year of payment because the deductions did not satisfy the all-events test for the tax years in which they were accrued. New York Life Insurance Company v. U.S., 2013 PTC 226 (2d Cir. 8/1/13).

New York Life Insurance Company, a mutual life insurance company, is a calendar-year, accrual-basis taxpayer. The company issued policies that entitled its holders to receive a policyholder dividend a share of the company's annual divisible surplus. Certain whole life policyholders were paid an annual dividend, comprised of the policyholder's share of the company's surplus, on the policy's anniversary date. The timing of the distribution of the annual dividend depended on the policy's anniversary date and the schedule of the policyholder's premium payment. The company's practice was to credit a policyholder's account with the amount of the annual dividend on a date before the policy's anniversary date but not pay the dividend until after the anniversary date. The company paid the annual dividend if the policyholder paid the policy premium and the policy was in force on the anniversary date. For most policies, the credit date fell within the same calendar year as the policy anniversary date. For policies with January anniversary dates, the credit date and anniversary date fell within different calendar years. New York Life deducted from its gross income the annual dividends amounts based on the credit dates rather than on the anniversary dates when the dividends were paid. Certain policies were also eligible for a termination dividend, which was paid to the policyholder or beneficiary upon the policy's termination.

On its federal income tax returns for 1990 through 1995, New York Life deducted the annual and termination policyholder dividends as accrued expenses, even though they were not paid until the following years. The IRS disallowed the deductions on the basis that the company could not deduct the dividends until the year of payment. In contesting the ruling, New York Life paid the taxes and filed a refund claim for $99.66 million in a district court. The district court dismissed the suit, concluding that New York Life failed to show that the expenses satisfied the all-events test of Reg. Sec. 1.461-1(a)(2) for the tax years in which they were accrued.

Code Sec. 808 allows life insurance companies to deduct from gross income an amount equal to the policyholder dividends paid or accrued during the tax year. Reg. Sec.1.461-1(a)(2) provides that a liability is incurred and generally taken into account for federal income tax purposes in the tax year in which (1) all events have occurred that establish the fact of liability, (2) the amount of the liability can be determined with reasonable accuracy, and (3) economic performance has occurred with respect to the liability.

Observation: To satisfy the conditions of the all-events test, the liability must be final and definite in amount, must be fixed and absolute, and must be unconditional. Thus, a liability does not accrue as long as it remains contingent.

New York Life argued that, in each year at issue, it made one of three combinations of dividend payments to eligible policyholders: an annual dividend, a termination dividend, or both an annual and termination dividend. Each year, the company calculated the annual and termination dividends it expected to pay the following year and claimed the amounts as a deduction for an accrued dividend under Code Sec. 808.

The IRS claimed that the deductions did not satisfy the all-events test, which governs the deductibility of accrued but unpaid expenses.

The Second Circuit held that, because the company's liability for the two dividends was contingent, all events had not occurred to fix the company's liability for the tax years in which it took the deductions. The court noted that the all-events test set forth in Reg. Sec. 1.461-1(a)(2) governs whether the liability for the policyholder dividends accrued during the tax year. The court looked to U.S. v. Hughes Properties, Inc., 476 U.S. 593 (1986) and U.S. v. General Dynamics Corp., 481 U.S. 239 (1987), which held that it is fundamental to the all-events test that a liability be firmly established to be deductible and a taxpayer may not deduct a contingent liability or an estimate of an anticipated expense, no matter how statistically certain. The court rejected New York Life's argument that the last event for purposes of the all-events test occurred when the January policyholders paid the final premium to keep their policies in force through the January anniversary dates, because the policyholders' decision to keep the policy in force through the anniversary date did not occur until January of the following year. Policyholders could surrender their policies for cash value at any time.

The court found that, for policies with January anniversary dates, the company had no obligation to pay the policyholder an annual dividend if the policy was surrendered before the anniversary date. The company also had no obligation to pay either an annual or termination dividend in the following tax year, as neither dividend was unconditionally due. The court concluded that the requirements of the all-events test were not satisfied, and the judgment of the district court was affirmed.

For a discussion of the all-events test, see Parker Tax ¶241,520.

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No Reasonable Cause Shown for Bankruptcy Trustee's Untimely Filed Returns; IRS's Claim for Penalties as Administrative Expense Disallowed

Because a bankruptcy trustee did not show reasonable cause for late filing of the bankruptcy estate's S corporation tax returns, late-filing penalties were upheld; however, the penalties did not constitute a priority administrative claim under Bankruptcy Code Section 503(b)(1)(A), and the case was remanded to see if the penalties qualified as an administrative expense for other reasons. In re 800Ideas.Com, Inc., 2013 PTC 222 (B.A.P. 9th Cir. 7/22/13).

In January 2007, 800Ideas.Com, Inc., an S corporation, filed a Chapter 7 bankruptcy petition. Richard Kipperman was appointed as the bankruptcy trustee. The corporation's liabilities exceeded its assets, and its main asset was a potential right in an excise tax refund for 2006. In March 2007, Richard asked the debtor's prepetition accountant to prepare the 2006 tax return. He was advised that the return would be completed by April 2008. However, the return was not completed and filed until January 2010. The IRS processed the return and disallowed $1,950 of the $38,197 claimed refund. The bankruptcy estate received the refund in June 2011. In July 2011, a second accountant completed and filed the debtor's 2007, 2008, 2009, and 2010 returns. The 2008 and 2010 returns stated that the debtor had zero tax liability. After processing the returns, the IRS assessed penalties against the debtor for 2008 and 2010 failing to timely file its returns.

The IRS filed a Request for Payment of Internal Revenue Taxes in bankruptcy court based on the 2008 and 2010 late-filing penalties and asserted that the penalties were an administrative priority expense. Richard objected to the claim, arguing that his failure to timely file the debtor's tax returns was due to reasonable cause. The bankruptcy found that Richard had no reasonable cause to delay filing the returns at issue while waiting for the excise tax refund and allowed the IRS's claim for penalties as an administrative expense. Richard timely filed a notice of appeal of the bankruptcy court order.

Code Sec. 6037 provides that an S corporation must file a return each tax year. When a corporation files for bankruptcy, it is the trustee's duty to file the corporation's tax returns. A penalty is imposed under Code Sec. 6699 if an S corporation fails to timely file a return unless the failure was due to reasonable cause. The penalty is $195 a month times the number of S shareholders. If the corporation has no assets or income, the trustee may ask the IRS to be relieved of the reporting obligation by following the procedure in Rev. Proc. 84-59.

Administrative expenses of a bankruptcy estate are given second priority under Bankruptcy Code Section 507 and include the actual, necessary costs and expenses of preserving the estate under Bankruptcy Code Section 503.

Richard argued that the penalties were not based on any unpaid tax incurred by the bankruptcy estate, and the claim should be treated as a subordinated penalty claim.

The IRS contended that Richard had an obligation to file 800Idea.com's tax returns, and the corporation's insolvency did not constitute reasonable cause to excuse the assessed penalties. The IRS also argued the penalties were entitled to administrative expense priority as an actual and necessary cost and expense of preserving the estate.

The Bankruptcy Appellate Panel affirmed the bankruptcy court holding that Richard failed to show that he had reasonable cause for his delay in filing 800Idea.com's tax returns. Richard's claim that the late filing was based on his mistaken belief that the debtor's insolvency automatically relived him of the obligation to file the returns was rejected because he showed no factors that were beyond his control in filing the returns. The court noted that Richard's lack of diligence in supervising the accountants, deliberate decision to delay filing the returns, and failure to pursue the IRS procedure which may have relieved him of the burden of filing the returns provided ample basis to find no reasonable cause and sustain the assessment of penalties.

The court looked to case law in Abercrombie v. Hayden Corp., 139 F.3d 755 (9th Cir. 1998), which found that, for an administrative expense to be actual and necessary, the claim must have arisen from a transaction with the debtor in possession and must directly and substantially benefit the estate. The court noted that the primary goal of a bankruptcy case was to minimize costs to preserve limited assets of the bankruptcy estate for the benefit of unsecured creditors. The penalties were not incurred in the operation of the business and did not benefit or preserve the bankruptcy estate. Since Richard was not operating the corporation's business, to allow administrative expense priority to the IRS's claim would be detrimental to the unsecured creditors. Therefore, the penalties were not eligible for administrative expense priority. However, the court remanded the case to the bankruptcy court to determine if the penalties qualify as an administrative expense for other reasons.

For a discussion of the penalty for failing to file an S corporation return, see Parker Tax ¶36,540.

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Former Client's Testimony Helps Convict BDO Accountant of Preparing and Filing Fraudulent Returns

A former client's testimony, as well as a recording between the former client and his personal accountant, was allowed into evidence to help convict a former BDO Seidman accountant on charges of preparing and filing fraudulent returns for the client. U.S. v. Favato, 2013 PTC 229 (3d Cir. 8/5/13).

Stephen Favato was an accountant with the accounting firm BDO Seidman. While at BDO, Stephen prepared personal tax returns for Daniel Funsch, CEO of Intarome Fragrance Corporation. Stephen prepared and filed a fraudulent tax return for Funsch for the 2002. He also prepared false returns for Funsch for 2003 and 2004. These returns contained false claims for (1) expenses and depreciation for a commercial yacht owned by Great Escape Yachts, LLC, which Funsch held for personal use (i.e., the yacht scheme); (2) a reduction in the actual gain Funsch recognized on the sale of his personal residences (i.e., the real estate scheme); and (3) falsely increased charitable donation reports (i.e., the charity scheme).

During a trial, the IRS presented recorded conversations, documentary evidence, and testimony to demonstrate that Stephen knowingly and willfully prepared the fraudulent returns for tax years 2002, 2003, and 2004. The only recorded conversations between Funsch and Stephen were from tax years 2003 and 2004, so the IRS relied on Funsch's testimony to establish Stephen's complicity in the 2002 tax return. Over Stephen's objection, the district court also admitted portions of a 2002 recorded conversation between Funsch and his then-personal accountant, John Rosenberger, as a prior consistent statement to rebut Stephen's assertion that Funsch had fabricated trial testimony about Stephen's involvement in the 2002 return. Stephen also objected to the model jury instruction used at trial. The jury found Stephen guilty of both the aforementioned counts, and Stephen filed a motion for acquittal and another motion for a new trial on the grounds that there was insufficient evidence to support the jury's verdict. The district court denied both motions and Stephen appealed to Third Circuit.

The Third Circuit affirmed the district court's judgment. With respect to the district court's ruling on the admissibility of a prior consistent statement, the court noted that there are four criteria that must be met for the proper admission of a prior consistent statement: (1) The declarant must testify at trial and be subject to cross-examination; (2) there must be an express or implied charge of recent fabrication or improper influence or motive of the declarant's testimony; (3) the proponent must offer a prior consistent statement that is consistent with the declarant's challenged in-court testimony; and, (4) the prior consistent statement must be made before the time that the supposed motive to falsify arose.

The district court did not abuse its discretion in admitting the 2002 recordings. Funsch's statements to Rosenberger about Stephen's complicity in the Yacht Scheme met the aforementioned criteria. First, Funsch testified at trial and was subject to cross-examination. Second, during cross-examination, Stephen's questions plainly accused Funsch of having the improper motive to do/say anything to stay out of jail, including lie about Stephen's complicity in the yacht scheme. Third, the two Rosenberger recordingsthe prior consistent statements in questionwere consistent with Funsch's trial testimony about Stephen's involvement in the yacht scheme. Finally, the statements were made during the pre-motive period. The district court determined that the motive to lie period began when Funsch was first confronted by the government; Funsch made these statements before that confrontation.

The court also found that the challenged jury instructions were not erroneous, and that the district court properly denied Stephen's motion for acquittal because the evidence was sufficient to establish his guilt. Finally, with respect to Stephen's argument that he should get a new trial because the jury's verdict was contrary to the weight of the evidence, the court said the IRS's evidence was sufficient to support Stephen's conviction.

For a discussion of the criminal penalties for filing false and fraudulent returns, see Parker Tax ¶277,110.

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Nonresident Alien's Claim for Refund of Taxes Withheld by His Employer Was Barred under the Three-Year Look-Back Period

A nonresident alien's claim for a refund of taxes withheld by his employer was barred under the three-year look-back period because his refund claim was not filed within three years of the filing of his return. Boeri v. U.S., 2013 PTC 223 (Fed. Cir. 7/31/13).

Mario Boeri, an Italian citizen who never lived or worked in the United States, worked for Verizon Corporation. In 2003, Mario chose to participate in the company's voluntary separation plan and, under the plan, was awarded a separation payment of over $247,000 in 2004. Over two distributions in March and August 2004, Verizon withheld approximately $71,000, including U.S. income tax withholding, social security tax, and Medicare tax. In 2009, Mario filed a 2004 Form 1040NR, U.S. Nonresident Alien Income Tax Return, seeking a refund of the taxes withheld by Verizon. The IRS denied Mario's refund request on the ground that his return was filed more than three years after its due date. Mario appealed to the U.S. Court of Federal Claims. The Claims Court held that Mario could not recover the withheld taxes because his refund request was not made within the three-year statute of limitations period. Mario appealed. Under Code Sec. 6511(b)(2), a claim for credit or refund of an overpayment of tax must be filed by the taxpayer within three years from the time the return was filed or two years from the time the tax was paid, whichever period expires later. Under Code Sec. 6513(b)(1), any tax deducted and withheld at the source during the calendar year will, with respect to the recipient of the income, be deemed to have been paid by the recipient on April 15 following the close of the tax year.

Observation: For purposes of the statute of limitations for refund claims, any return filed before the due date of the return is treated as filed on the due date of the return, and any tax payment made before the due date of the payment is treated as made on the due date of the payment.

Mario argued that the three-year look-back period did not apply because he was seeking a correction of an erroneous withholding rather than a refund of a tax overpayment. Thus, he argued, his particular circumstances did not come within the scope of the three-year look-back provision of Code Sec. 6511.

The Federal Circuit affirmed the Claims Court decision and held that Mario failed to bring his refund claim within three years of when the tax was paid. The look-back provisions of Code Sec. 6511(b)(2) limit the refund available to Mario to taxes paid within the applicable look-back period. Here, the court stated, the applicable period is the three-year period immediately preceding the filing of the March 2009 refund claim. Mario's withholdings were deemed paid to him in the two distributions on March and August 2004.

The court noted that there was some question as to whether Mario's taxes were withheld under Internal Revenue Code Chapter 24, Collection of Income Tax at Source on Wages, or if they were withheld under Internal Revenue Code Chapter 3, Withholding of Tax on Nonresident Aliens and Foreign Corporations. If Mario's taxes were withheld under Chapter 3, then Code Sec. 6513(b)(1) would not apply. The court brought up the issue itself, only to ensure that Mario could not be afforded relief if his withholdings came under Chapter 3.The court concluded that it was irrelevant whether the taxes were withheld under Chapter 3 or Chapter 24, since the withheld taxes were deemed paid outside of the three-year look-back period. The court concluded that Mario's taxes were deemed paid more than three years before the filing of his refund request.

For a discussion of the statute of limitations on refund claims, see Parker Tax ¶261,180.

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