IRS Puts Employers on Notice Regarding Reimbursement Arrangements That Don't Qualify as Accountable Plans

This week, the IRS issued a ruling that provides important guidance for employers that issue reimbursements to employees and other workers. In Rev. Rul. 2012-25, the IRS clarifies that an arrangement that recharacterizes taxable wages as nontaxable reimbursements or allowances does not satisfy the business connection requirement of the accountable plan rules. The IRS refers to this as wage recharacterization because the amount being paid is not an expense reimbursement but rather a substitute for an amount that would otherwise be paid as wages.

Rev. Rul. 2012-25 includes four situations three of which illustrate arrangements that impermissibly recharacterize wages. The fourth situation illustrates an arrangement that does not impermissibly recharacterize wages, where an employer prospectively alters its compensation structure to include a reimbursement arrangement.

Background

In determining adjusted gross income, Code Sec. 62(a)(2)(A) provides that an employee can deduct certain business expenses paid in connection with the performance of services as an employee under a reimbursement or other expense allowance arrangement. Code Sec. 62(c) provides that, for this purpose, an arrangement is not treated as a reimbursement or other expense allowance arrangement if (1) the arrangement does not require the employee to substantiate the expenses covered by the arrangement to the person providing the reimbursement, or (2) the arrangement provides the employee the right to retain any amount in excess of the substantiated expenses covered under the arrangement.

Under Reg. Sec. 1.62-2(c), if a reimbursement or other expense allowance arrangement meets the requirements of business connection, substantiation, and returning amounts in excess of substantiated expenses, all amounts paid under the arrangement are treated as paid under an accountable plan.

COMPLIANCE TIP: Amounts treated as paid under an accountable plan are excluded from an employee's gross income, are exempt from withholding and payment of employment taxes, and are not reported as wages on the employee's Form W-2. If the arrangement fails any one of the accountable plan requirements, amounts paid under the arrangement are treated as paid under a nonaccountable plan, must be included in the employee's gross income for the tax year, are subject to withholding and payment of employment taxes, and must be reported as wages or other compensation on the employee's Form W-2.

An arrangement satisfies the business connection requirement if it provides advances, allowances, or reimbursements only for business expenses that are allowable as deductions and that are paid or incurred by the employee in connection with the performance of services as an employee of the employer. Thus, not only must an employee actually pay or incur a deductible business expense, but also the expense must arise in connection with the employment for that employer.

The regulations provide that the business connection requirement is not satisfied if a payor pays an amount to an employee regardless of whether the employee incurs or is reasonably expected to incur deductible business expenses.

Tax Treatment of Employee Business Expenses

The Tax Reform Act of 1986 significantly changed the rules for deducting employee business expenses by converting most of these expenses into itemized deductions that an employee can deduct only to the extent the aggregate of such expenses exceeded 2 percent of adjusted gross income (the 2-percent floor). However, the 1986 Act left in place a taxpayer's ability to deduct from gross income and without regard to the 2-percent floor, employee business expenses incurred by the taxpayer as part of a reimbursement or other expense allowance arrangement with his or her employer.

After enactment of the 1986 Act, tax practitioners proposed that employers could use reimbursement and expense allowance arrangements to (1) eliminate the effect of the 2-percent floor on deductible employee expenses, and (2) save both employer and employee employment taxes, by restructuring their compensation packages to convert a portion of an employee's compensation into a nontaxable reimbursement. This restructuring would permit employers to pay a lesser total amount while increasing employees' after-tax compensation.

Code Sec. 62(c) was enacted to prevent such restructuring of compensation arrangements and permit an above-the-line deduction only for expenses reimbursed under what legislative history referred to as an accountable plan.

In issuing regulations under Code Sec. 62(c), the IRS noted that, while an employer may establish or modify its compensation structure to include nontaxable reimbursement under an accountable plan, recharacterizing as nontaxable reimbursements amounts that would otherwise be paid as wages violates the business connection requirement, and more specifically, the reimbursement requirement. This is true even if an employee actually incurs a deductible expense in connection with employment with the employer.

Wage Recharacterization

According to the IRS, the presence of wage recharacterization is based on all the facts and circumstances. Generally, wage recharacterization is present when an employer structures compensation so that the employee receives the same or a substantially similar amount whether or not the employee has incurred deductible business expenses related to the employer's business.

Wage recharacterization may occur in different situations. For example, an employer recharacterizes wages if it temporarily reduces taxable wages, substituting the reduction in wages with a payment that is treated as a nontaxable reimbursement and then, after total expenses have been reimbursed, increases taxable wages to the prior wage level. Similarly, an employer recharacterizes wages if it pays a higher amount as wages to an employee only when the employee does not receive an amount treated as nontaxable reimbursement and pays a lower amount as wages to an employee only when the employee also receives an amount treated as nontaxable reimbursement. An employer also recharacterizes wages if it routinely pays an amount treated as a nontaxable reimbursement to an employee who has not incurred bona fide business expenses.

Three of the scenarios in Rev. Rul. 2012-25 illustrate situations in which there is wage recharacterization. In Situation 1, a company contracts with cable providers and employs technicians to install cable television systems at residential locations on behalf of different cable providers. Employee technicians are required to provide the tools and equipment necessary to complete the various installation jobs to which they are assigned. The company compensates its employees on an hourly basis, which takes into account the fact that technicians are required to provide their own tools and equipment.

The company decides to begin reimbursing its technicians for their tool and equipment expenses through a tool reimbursement arrangement (i.e., a tool plan). Under the company's tool plan, a technician provides the company with an amount equivalent to the technician's tool and equipment expenses incurred in connection with providing services to the company. The company takes the technician's total expenses for the year and divides the total amount by the number of hours a technician is expected to work over the course of a year to arrive at an hourly tool rate. Once the company has determined the hourly tool rate amount for a technician, it pays the technician a reduced hourly compensation rate and an hourly tool rate. The company treats the reduced hourly compensation as taxable wages and treats the hourly tool rate as a nontaxable reimbursement. The hourly tool rate plus the reduced hourly compensation rate approximately equal the pre-tool plan compensation rate. The tool plan tracks the hourly tool rate up to the amount of substantiated tool and equipment expenses. Once a technician has received tool plan payments for the total amount of his or her tool and equipment expenses, the company stops paying the technician an hourly tool rate but increases the technician's hourly compensation to the pre-tool plan hourly compensation rate.

According to the IRS, the company's tool plan in Situation 1 does not satisfy the business connection requirement of the accountable plan rules because the employer pays the same gross amount to a technician regardless of whether the technician incurs (or is reasonably expected to incur) expenses related to the company's business. Specifically, the tool plan ensures that a technician receives approximately the same gross hourly amount by substituting a portion of what was paid as taxable wages with a tool rate amount that is treated as nontaxable reimbursement, and then increasing the wages again once all tool expenses have been reimbursed. Accordingly, the purported tool reimbursements are merely a recharacterization of wages because approximately the same amount is paid in all circumstances. The fact that a technician actually incurs a deductible expense in connection with employment does not cure the incidence of wage recharacterization. The arrangement fails to satisfy the business connection requirement. Therefore, without regard to whether it meets the other requirements of an accountable plan, the company's tool plan is not an accountable plan.

In Situation 2, an employer is a staffing contractor that employs nurses and provides their services to hospitals throughout the country for short-term assignments. The employer compensates all the nurses on an hourly basis and the hourly compensation amount does not vary depending on whether the hospital is located away from the assigned nurse's tax home.

When the employer sends nurses on assignment to hospitals that require them to travel away from their tax home and incur deductible expenses in connection with the employer's business, the employer treats a portion of the nurses' hourly compensation as a nontaxable per diem allowance for lodging, meals, and incidental expenses under a per diem plan; the employer treats the remaining portion of the nurses' hourly compensation as taxable wages. When the employer sends the nurses on assignment to hospitals within commuting distance of their tax home, the employer treats all the nurses' compensation as taxable wages. In each case, the nurses receive the same total compensation per hour.

According to the IRS, the employer's per diem plan in Situation 2 does not satisfy the business connection requirement of the accountable plan rules because it pays the same gross amount to nurses regardless of whether the nurses incur (or are reasonably expected to incur) travel expenses related to the employer's business. The purported per diem payments are merely recharacterized wages because nurses receive the same gross compensation per hour regardless of whether travel expenses are incurred (or are reasonably expected to be incurred). The fact that a nurse traveling away from his or her tax home actually incurs a deductible expense in connection with employment does not cure the incidence of wage recharacterization. The arrangement fails to satisfy the business connection requirement and, thus, without regard to whether it meets the other requirements of an accountable plan, the employer's per diem plan is not an accountable plan.

In Situation 3, the employer is a construction firm that employs workers to build commercial buildings throughout a major metropolitan area. As part of their duties, some of workers are required to travel between construction sites or otherwise use their personal vehicles for business purposes. These workers incur deductible business expenses in operating their personal vehicles in connection with their employment. The employer compensates all its workers for their services on an hourly basis, which the employer treats as taxable wages. The employer also pays all its workers, including those who are not required to travel or otherwise use their personal vehicles for business, a flat amount per pay period that the employer treats as a nontaxable mileage reimbursement.

The IRS ruled that employer's mileage reimbursement plan in Situation 3 does not satisfy the business connection requirement of the accountable plan rules because it operates to routinely pay an amount as a mileage reimbursement to workers who have not incurred (and are not reasonably expected to incur) deductible business expenses in connection with the employer's business. The purported mileage reimbursement is merely recharacterized wages because all workers receive an amount as a mileage reimbursement regardless of whether they incur (or are reasonably expected to incur) mileage expenses. The arrangement fails to satisfy the business connection requirement. Therefore, without regard to whether it meets the other requirements of an accountable plan, the employer's mileage reimbursement plan is not an accountable plan.

In Situation 4, an employer operates a cleaning services company that employs cleaning professionals to perform house cleaning services for the employer's clients. Employee cleaning professionals are required to provide the cleaning products and equipment necessary to complete the cleaning service jobs to which they are assigned. The employer pays the employees on an hourly basis, which takes into account that employees are required to provide their own cleaning products and equipment. The employer decides to begin reimbursing employees for their cleaning and equipment expenses through a reimbursement arrangement. The employer prospectively alters its compensation structure by reducing the hourly compensation paid to all employees. Under the employer's new reimbursement arrangement, employees can substantiate to the employer the actual amount of deductible expenses incurred in purchasing their cleaning products and equipment in connection with performing services for the employer. The employer reimburses its employees for substantiated expenses incurred in performing services for the employer. Any reimbursement paid under the employer's reimbursement arrangement is paid in addition to the hourly compensation paid for the employees' services. Employees who do not incur expenses for cleaning products and equipment in connection with their jobs or who do not properly substantiate such expenses, continue to receive the lower hourly rate and do not receive any reimbursement and are not compensated in another way (for example, with a bonus) to substitute for the reduction in the hourly compensation. The employer treats the hourly compensation as taxable wages and treats reimbursements for cleaning and equipment expenses as nontaxable reimbursements.

The IRS ruled that, in Situation 4, the employer's reimbursement arrangement satisfies the business connection requirement of the accountable plan rules. This is because the employer's plan reimburses employees only when a deductible business expense has been incurred in connection with performing services for the employer, and the reimbursement is not in lieu of wages that the employees would otherwise receive. Although the employer has reduced the amount of compensation it pays all its employees, the reduction in compensation is a substantive change in the employer's compensation structure. Under the arrangement, reimbursement amounts are not guaranteed and employees who do not incur expenses in connection with the employer's business, or who do not properly substantiate such expenses, continue to receive the reduced hourly compensation amount. These employees do not receive any reimbursement and are not compensated in another way to make up for the reduction in the hourly rate. The employer's reimbursement arrangement does not operate to pay the same or a substantially similar gross amount to an employee regardless of whether the employee incurs (or is reasonably expected to incur) expenses related to the employer's business. The reimbursement is paid in addition to the employees' wages rather than as a substitute for wages that would otherwise be paid. Thus, the employer's reimbursement arrangement satisfies the business connection requirement. Therefore, as long as the substantiation and return of excess amounts requirements are also met, the employer's reimbursement arrangement is an accountable plan.

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Proposed Regs Would Make Major Changes to UNICAP Cost Allocations

The uniform capitalization rules of Code Sec. 263A require the capitalization of all direct costs and certain indirect costs properly allocable to (1) real property and tangible personal property produced by the taxpayer, and (2) real property and personal property acquired by the taxpayer for resale. Thus, Section 263A costs are not deductible.

Section 263A costs are defined as the costs a taxpayer must capitalize under Code Sec. 263A. Thus, Section 263A costs are the sum of a taxpayer's Section 471 costs, its additional Section 263A costs, and interest capitalizable under Code Sec. 263A(f). Additional Section 263A costs are defined as the costs, other than interest, that were not capitalized under the taxpayer's method of accounting immediately before the effective date of Code Sec. 263A (adjusted as appropriate for any changes in methods of accounting for Code Sec. 471 costs), but that are required to be capitalized under Code Sec. 263A. For new taxpayers, additional Code Sec. 263A costs are defined as the costs, other than interest, that the taxpayer must capitalize under Code Sec. 263A, but that the taxpayer would not have been required to capitalize if the taxpayer had been in existence before the effective date of Code Sec. 263A.

Generally, in allocating additional Code Sec. 263A costs, taxpayers may elect to use a facts-and circumstances allocation method, such as the specific identification method, burden rate, standard cost method, or any other method to allocate direct and indirect costs to units of property produced or acquired for resale, if the method is reasonable. However, taxpayers are also authorized to use one of two simplified methods to allocate costs to eligible property produced or eligible property acquired for resale in lieu of a facts-and-circumstances allocation method.

There has been an ongoing controversy over the inclusion of negative amounts in additional Section 263A costs and whether aggregate additional Section 263A costs may be a negative number. A negative amount may occur, for example, when a taxpayer includes book costs greater than those required for tax purposes in the Section 471 cost of inventory. For example, if a taxpayer included book depreciation in Section 471 costs and the book depreciation is greater than tax depreciation for the year, the taxpayer may have capitalized too much depreciation for purposes of Code Sec. 263A and must reduce total Section 263A costs by the excess. A negative amount may result if the taxpayer does not adjust the Section 471 costs to remove this excess depreciation amount but instead makes a negative adjustment to its additional Section 263A costs. Some taxpayers have reasoned that allowing negative amounts is consistent with the purpose of the simplified methods to alleviate the administrative burden of complying with the capitalization rules of Code Sec. 263A and reducing the overcapitalization that sometimes results.

To address this issue, the IRS has issued proposed regulations (REG-126770-06) that provide that, generally, taxpayers may not include negative amounts in additional Section 263A costs. However, to reduce the administrative burden for smaller taxpayers using the simplified production method for which the costs and burdens of excluding negative amounts from additional Section 263A costs may otherwise outweigh the benefits, the proposed regulations allow producers with average annual gross receipts of $10 million or less to include negative amounts in additional Section 263A costs under the simplified production method.

COMPLIANCE TIP: These regulations are proposed to apply after they are finalized. Thus, they will be effective at some future date.

Prohibition on Negative Amounts

To reduce the distortions that occur by including negative amounts under the simplified methods, the proposed regulations provide that, subject to certain exceptions, taxpayers may not include negative amounts in additional section 263A costs.

Under the proposed regulations, a taxpayer must reduce its Section 471 costs by those costs that the taxpayer capitalizes to its inventory (or other eligible property) in its financial statements that may not be capitalized under either Reg. Sec. 1.263A-1(c)(2) or Reg. Sec. 1.263A-1(j)(2)(ii), and those period costs that the taxpayer capitalizes to its inventory (or other eligible property) in its financial statements that, under Reg. Sec. 1.263A-1(j)(2), the taxpayer chooses not to capitalize under Code Sec. 263A (for example, Code Sec. 179 costs). A taxpayer that reduces its Section 471 costs must use a reasonable method that approximates the manner in which the taxpayer originally capitalized the costs to its inventory (or other eligible property) in its financial statements.

Exception to Prohibition on Negative Amounts

Currently, the regulations under Code Sec. 263A authorize taxpayers to use two simplified methods to allocate costs to eligible property produced or eligible property acquired for resale: (1) the simplified production method, and (2) the simplified resale method.

The simplified methods differ from facts-and-circumstances methods in that, as applied to inventories, they allocate a pool of capitalizable costs (additional Section 263A costs) between ending inventory and cost of goods sold using a defined ratio and are an exception to the general rule that additional Section 263A costs must be allocated to specific items of inventory. Thus, the simplified methods are intended to reduce the complexity and administrative burdens of having to develop detailed cost accounting systems for the additional costs required to be capitalized under Section 263A.

To reduce the administrative burden for smaller taxpayers using the simplified production method for which the costs and burdens of excluding negative amounts from additional Section 263A costs may otherwise outweigh the benefits, the proposed regulations would allow producers with average annual gross receipts of $10 million or less to include negative amounts in additional Section 263A costs under the simplified production method.

Additionally, because negative additional Section 263A costs cause less distortion under the simplified resale method than under the simplified production method, the proposed regulations would allow taxpayers using the simplified resale method to remove Section 471 costs that are not required to be capitalized for tax purposes from ending inventory by treating them as negative additional Section 263A costs. The proposed regulations would generally prohibit treating cash or trade discounts as negative amounts under any of the simplified methods.

Failure to Bring Doctor's Note Precludes Finding of Financial Disability; Statute of Limitations Not Suspended

Generally, the statute of limitations that applies to a taxpayer's refund or credit claim depends on whether or not the taxpayer filed a return. If the taxpayer filed a return, the claim for refund or credit must be filed within three years of the date the return was filed or within two years of the date the tax was paid, whichever is later. If the taxpayer was not required to file a return, the claim for credit or refund must be filed within two years of the date the tax was paid. However, there is a special exception, under Code Sec. 6511(h), which allows for the suspension of the statute of limitations during any period of an individual's life where the individual is financially disabled.

In Abston v. Comm'r, 2012 PTC 250 (8th Cir. 8/31/12), the taxpayer argued that she was financially disabled and thus the statute for requesting a refund should have been suspended. While she had submitted documentation that she believed proved she was financially disabled, the Eighth Circuit upheld a lower court ruling that her failure to submit a physician's statement, as required by Rev. Proc. 99-21, was fatal to her claim. In so ruling, the Eighth Circuit became the first appellate court to address this issue.

OBSERVATION: Prior to the Eighth Circuit's decision, several district courts had dismissed taxpayer refund suits because the taxpayer's claim of financial disability was not supported by a physician's statement as required by Rev. Proc. 99-21.

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Background

On April 15, 2003, the due date for her 2002 federal income tax return, Rani Abston knew the IRS would apply any refund to repay her defaulted student loans. Consequently, she did not file a return and claim a $2,859 refund until February 2007, after she resolved her student loan obligations. In June 2008, the IRS denied the claim because it was not timely filed. The June 2008 denial letter advised Rani that she could appeal the decision and that exceptions extending the time to file refund claims included financial disability. The letter recited the statutory definition of financial disability, and urged Rani to review IRS Pub. 556, Examination of Returns, Appeal Rights, and Claims for Refund, for additional details regarding the exceptions.

Rani subsequently met with an IRS Appeals Officer but came with nothing, and her claim was denied. She was advised of her option to seek judicial review of the denial. Rani filed suit in a district court and submitted an affidavit and 137 pages of medical records that chronicled her medical conditions. The district court granted the IRS summary judgment, concluding that Rani did not offer the necessary evidence to permit consideration of whether the limitations period was suspended by Code Sec. 6511(h).

Rani appealed to the Eighth Circuit, arguing that the district court erred in ruling that her failure to submit a physician's statement, as required by Rev. Proc. 99-21, was fatal to her claim of financial disability. According to Rani, the failure to comply with Rev. Proc. 99-21 should not be dispositive, and the district court should have made an independent determination that she was financially disabled for purposes of Code Sec. 6511(h).

Eighth Circuit's Analysis

The Eighth Circuit agreed with the lower court and held that Rani's refund claim was untimely under the three-year look back limitation in Code Sec. 6511(b)(2)(A). The Eighth Circuit began by noting that, in U.S. v. Brockamp, 519 U.S. 347 (1997), a unanimous Supreme Court held that courts may not use nonstatutory equitable reasons to prevent the statute of limitations, as set forth in Code Sec. 6511, from applying. Code Sec. 6511(h), the court observed, allows the limitations period to be suspended where the taxpayer is financially disabled. Code Sec. 6511(h) defines financial disability and specifies the manner in which a taxpayer may establish that he or she qualifies for the exception, including furnishing proof of the existence of such disability in a manner required by the IRS. In Rev. Proc. 99-21, the IRS requires the taxpayer to prove a medically determinable physical or mental impairment. Part of that proof, the court noted, is a doctor's note, the contents of which are specified in Rev. Proc. 99-21.

The court cited several reasons for rejecting Rani's argument that the failure to comply with Rev. Proc. 99-21 should not be dispositive and that the district court should have considered her medical records. First, the contention was contrary to the plain meaning of the statute, the court said. Federal courts have no jurisdiction over a tax refund suit until a claim for refund or credit has been duly filed with the IRS, according to the provisions of law. And Code Sec. 6511(h)(2)(A) expressly provides that a taxpayer is not considered financially disabled unless proof of a disabling impairment is furnished in such form and manner as the IRS may require. The court concluded that Rani's refund claim was not duly filed, and the district court did not have the power to decide that she was financially disabled in the absence of a duly filed claim. Second, the independent judicial determination of financial disability Rani was seeking, the court said, was the kind of nonstatutory tolling the Supreme Court specifically barred its Brockamp decision.

Finally, although Rani complained that Rev. Proc. 99-21 was adopted without the benefit of notice-and-comment rulemaking, the Eighth Circuit noted that she cited no authority suggesting that the IRS was not authorized to address this issue in a revenue procedure. In Code Sec. 6511(h)(2)(A), the court observed, Congress did not direct the IRS to issue requirements by regulation, as it has elsewhere in the Code. Knowing that the IRS would need to fairly and efficiently process a potentially large number of financial disability claims, Congress instructed the IRS to prescribe the method by which an individual could prove such impairment. In Rev. Proc. 99-21, the court stated, the IRS logically prescribed, Bring a doctor's note.

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IRS Provides Tax Relief to Victims of Hurricane Isaac; Deadlines Extended to Jan. 11, 2013

The IRS is providing tax relief to individuals and businesses affected by Hurricane Isaac. IR-2012-70 (9/5/12).

Following recent disaster declarations for individual assistance issued by the Federal Emergency Management Agency (FEMA), the IRS announced today that affected taxpayers in Louisiana and Mississippi will receive tax relief, and other locations may be added in coming days based on additional damage assessments by FEMA.

The tax relief postpones various tax filing and payment deadlines that occurred on or after August 26. As a result, affected individuals and businesses will have until January 11, 2013, to file these returns and pay any taxes due. This includes corporations and businesses that previously obtained an extension until September 17, 2012, to file their 2011 returns and individuals and businesses that received a similar extension until October 15. It also includes the estimated tax payment for the third quarter of 2012, normally due September 17.

The IRS will abate any interest, late-payment or late-filing penalty that would otherwise apply. In addition, the IRS is waiving failure-to-deposit penalties for federal employment and excise tax deposits normally due on or after August 26 and before September 10, if the deposits are made by September 10, 2012. The tax relief is part of a coordinated federal response to the damage caused by the hurricane and is based on local damage assessments by FEMA. So far, IRS filing and payment relief applies to the following localities, which are considered a covered disaster area for purposes of Reg. Sec. 301.7508a-1(d)(2):

(1) In Louisiana: Ascension, Jefferson, Lafourche, Livingston, Orleans, Plaquemines, St. Bernard, St. Charles, St. John the Baptist and St. Tammany parishes;

(2) In Mississippi: Hancock, Harrison, Jackson and Pearl counties.

PRACTICE TIP: If an affected taxpayer receives a penalty notice from the IRS, the taxpayer should call the telephone number on the notice to have the IRS abate any interest and any late-filing or late-payment penalties that would otherwise apply. Penalties or interest will be abated only for taxpayers who have an original or extended filing, payment, or deposit due date, including an extended filing or payment due date, that falls within the postponement period. The IRS automatically identifies taxpayers located in the covered disaster area and applies automatic filing and payment relief. But affected taxpayers who live or have a business located outside the covered disaster area must call the IRS disaster hotline at 1-866-562-5227 to request this tax relief.

For a discussion of the special rules that apply to losses occurring in federally declared disaster areas, see Parker Tax ¶84,545.

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Tax Court Allows Most of Sales Consultant's Travel Expenses

Where a sales consultant, who traveled a lot for work, provided receipts for several categories of expenses and the receipts reflected the type of expenditure, the date, the amount, and the location, such expenses were deductible. Wade v. Comm'r, T.C. Summary 2012-85 (8/28/12).

In 2008, Jeremy Wade was a sales consultant for eyewear. For the first four months of 2008, Jeremy worked as an employee for Marcolin USA selling glasses to optometrists and to other retail eyewear outlets. For the remainder of 2008, Jeremy worked as an independent sales consultant for Aspex Eyewear, Inc., doing essentially the same thing. With respect to both jobs, Jeremy's travel, meal, and entertainment expenses were not reimbursed by Marcolin or Aspex.

It was Jeremy's practice to travel to certain cities and visit existing and potential eyewear clients. Sometimes he was able to return home, and other times he would remain in the location overnight. His sales territory was extensive and included cities in three states, including the one in which he lived. Each day he would record in his log the city to which he had driven. He drove 26,000 miles for business during 2008, and the distance traveled was similar each month. Thus, he drove 8,667 miles for employee business and 17,333 miles for his independent sales consultant business.

In each of those cities, Jeremy visited the same existing and potential clients. He identified the names of the establishments and the people with whom he had discussed the eyewear products. Occasionally, Jeremy would take a client or a potential client to lunch or dinner, and for each occasion he identified the name of the person and the nature of the discussions. Occasionally, Jeremy also purchased meals for himself when away from home on sales trips. Jeremy was not reimbursed for his expenses.

In addition to his eyewear sales, Jeremy was attempting to establish a photography business, and during 2008 he photographed a few weddings and did some promotional photo shoots for musicians. Although he incurred some expenses for his activity, he performed it without charge in an attempt to introduce his photography capability to the public. Jeremy did not incur any travel expenses in connection with this activity as he used his wife's car.

On his 2008 income tax return, Jeremy took deductions for expenses on Schedule A and on two Schedules C. On his Schedule A, Jeremy claimed a deduction for $13,344 of employee expenses, which were detailed on a Form 2106-EZ, Unreimbursed Employee Business Expenses, attached to the 2008 return. The IRS disallowed the $13,344 deduction in its entirety. On a Schedule C concerning his photography activity, Jeremy claimed a deduction for car and truck expenses of $3,640, and the IRS allowed $39. On Jeremy's Schedule C for his activity as an independent sales consultant, he took a deduction for car and truck expenses of $14,170, and the IRS allowed $925. The IRS also assessed an accuracy-related penalty. The case did not elaborate on why the IRS disallowed the majority of Jeremy's deductions.

The Tax Court held that Jeremy could deduct substantially more than what the IRS allowed. With respect to Jeremy's auto expense, the court noted that he used the standard mileage rate approach for claiming a deduction for travel by car and kept records reflecting each city to which he traveled, and he was able to identify that the travel was in pursuit of business activity. The court determined he was entitled to $4,377 as an itemized deduction on Schedule A and $9,793 as a business expense on Schedule C for his travel expenses.

The Tax Court denied Jeremy's travel expenses connected with his photography activity because he used his wife's automobile and did not bear any of the expense of its operation. Nor did he reimburse her for its use. Accordingly, the court held that he could not deduct more than the $39 the IRS allowed with respect to the photography activity.

The court also noted that, with respect to his other expenditures, Jeremy provided receipts for several categories of expenses and the receipts reflected the type of expenditure, the date, the amount, and usually the location. The court allowed deductions for these expenses also. However, the court disallowed deductions where Jeremy designated some of the receipts as being for gifts, but did not identify the recipients or the business nature of the gifts.

For a discussion of the deductibility of travel expenses, see Parker Tax ¶91,105.

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Third Circuit Reverses Tax Court; Entity Was Not a Valid Partnership

Where the parties to a transaction agreed to shield a purported partner's investment from any meaningful risk, that lack of meaningful risk weighed heavily in determining that the purported partner was not a bona fide partner. Historic Boardwalk Hall, LLC v. Comm'r, 2012 PTC 247 (3d Cir. 8/27/12).

A taxpayer may use federal historic rehabilitation tax credits (HRTCs) to lessen the cost of restoring historic property. These credits were at issue in connection with the restoration of an iconic venue known as the East Hall (also known as Historic Boardwalk Hall), located on the boardwalk in Atlantic City, New Jersey. The New Jersey Sports and Exposition Authority (NJSEA), a state agency that owned a leasehold interest in the East Hall, was tasked with restoring it. After learning of the market for HRTCs among corporate investors, and of the additional revenue that market could bring to the state through a syndicated partnership with one or more investors, NJSEA created a New Jersey limited liability company, Historic Boardwalk Hall, LLC (HBH), and subsequently sold a membership interest in HBH to a wholly owned subsidiary of Pitney Bowes, Inc. (PB). Through a series of agreements, the transactions that were executed to admit PB as a member of HBH and to transfer ownership of NJSEA's property interest in the East Hall to HBH were designed so that PB could earn the HRTCs generated from the East Hall rehabilitation.

The IRS determined that HBH was simply a vehicle to impermissibly transfer HRTCs from NJSEA to PB and that all HRTCs taken by PB should be reallocated to NJSEA. The Tax Court disagreed, and upheld the allocation of the HRTCs to PB through its membership interest in HBH. The IRS appealed to the Third Circuit.

The Third Circuit reversed the Tax Court and held that, because PB lacked a meaningful stake in either the success or failure of HBH, it was not a bona fide partner in HBH. As a result, it was not entitled to the HRTCs it had taken on its return. In reaching its conclusion, the court applied the test outlined by the Supreme Court in Comm'r v. Culbertson, 337 U.S. 733 (1949). The Culbertson test, the court observed, illustrates the principle that for income tax purposes, a transaction must be judged by its substance rather than its form. It is used to analyze the bona fides of a partnership and to decide whether a taxpayer's interest is a bona fide equity partnership participation. The court noted that, to determine under Culbertson whether PB was a bona fide partner in HBH, the totality of the circumstances had to be considered. The court was swayed by the fact that PB had no meaningful downside risk because it was, for all intents and purposes, certain to recoup the contributions it had made to HBH and to receive the primary benefit it sought the HRTCs or their cash equivalent. In making this determination, the court noted that the IRS was not claiming, and the court was not suggesting, that a limited partner is prohibited from capping its risk at the amount it invests in a partnership. Such a cap, in and of itself, the court noted, would not jeopardize its partner status for tax purposes. The court also recognized that a limited partner's status as a bona fide equity participant will not be stripped away merely because it successfully negotiated measures that minimized its risk of losing a portion of its investment in an enterprise. In the instant case, however, the parties agreed to shield PB's investment from any meaningful risk and that lack of meaningful risk, the court said, weighs heavily in determining whether PB is a bona fide partner in HBH.

The court also noted that PB's avoidance of all meaningful downside risk in HBH was accompanied by a dearth of any meaningful upside potential. Despite the smoke and mirrors of the financial projections, the court stated, the parties behind-the-scenes statements revealed that they never anticipated that the fair market value of PB's interest would exceed its accrued but unpaid preferred return. According to the court, that was hardly surprising because the substance of the transaction indicated that this was not a profit-generating enterprise.

For a discussion of the factors involved in determining the existence of a partnership, see Parker Tax ¶20,105.

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Tax Court Rejects Attempt to Deduct Artificially Created $37 Million Loss; Penalties Upheld

Where the essence of the taxpayers' transaction was to simply create an artificial multimillion-dollar tax loss that the taxpayers could report as an offset to their unrelated capital gains of a similar amount, the loss was disallowed. Gerdau Macsteel, Inc. & Affiliated Subs. v. Comm'r, 139 T.C. No. 5 (8/30/12).

Gerdau Macsteel, Inc. (GMI) and its subsidiaries are an affiliated group. During the affiliated group's tax year ended October 31, 1997 (FY 1997), the group actively pursued two sales expected to result in millions of dollars in taxable capital gains for FY1997 and FY 1998. The affiliated group's outside accountants were Deloitte & Touche, LLP (D&T). Mindful of the expected gains, D&T approached the taxpayers with an idea that it promoted to create a multimillion-dollar tax loss to shelter the gains for federal income tax purposes. The scheme involved the group benefits plan under which GMI provides health and welfare benefits to its eligible employees and their dependents and two inactive corporations. In order to report a desired tax loss of approximately $38 million to shelter the affiliated group's taxable gains, the group entered into a series of interrelated transactions in late October 1997 that included, among others, a recapitalization of one of the inactive subsidiaries (QHMC) and GMI's transfer to the other inactive subsidiary and its transfer to the recapitalized inactive subsidiary in exchange for newly issued Class C stock of $38 million and the assumption of certain contingent liabilities (i.e., GMI's obligations to pay medical plan benefits (MPBs) under its benefits plan), which the affiliated group valued at $37,989,000.

GMI and its subsidiaries reported that the transfers qualified for nonrecognition under Code Sec. 351(a) and that the basis of the subsidiary in the class C stock was determined by taking into account the $38 million transferred to the other inactive subsidiary but not the value of the MPBs. Each share of class C stock was entitled to receive annual dividends of $9.50 and was not allowed to receive any other dividend. Upon the class C stock's redemption, which the subsidiary and the class C shareholders could respectively cause five and seven years after the stock's issuance, the class C shareholders were entitled to receive for each share the greater of $125 or an amount equal to the lesser of a percent of any cumulative cost savings in MPBs or of the subsidiary's book net equity. The transactions were structured in such a way that it was highly likely when the class C stock was issued that the class C stock would be redeemed within the five- and seven-year periods and that the redemption payment would be $125 per share. Shortly after the transfer to the second inactive subsidiary, the first inactive subsidiary sold its class C stock to a former employee of a GMI subsidiary for $11,000 (the difference between $38 million and $37,989,000). The affiliated group claimed that the first inactive subsidiary realized a $37,989,000 short-term capital loss on the sale, and used that loss to offset the group's unrelated capital gains totaling a similar amount.

After the transactions, GMI continued to process claims for MPBs, and GMI's handling of the claims transferred to the second inactive subsidiary was the same as the handling of claims with respect to individuals whose MPBs were not transferred to that subsidiary. The reimbursements by the second inactive subsidiary to GMI for claims were made through intercompany entries recorded on GMI's books as a receivable due from the second inactive subsidiary and recorded on that subsidiary's books as a payable. The second inactive subsidiary lent the $38 million to a subsidiary of the affiliated group, and it eventually reimbursed GMI for the MPBs when it received payments on the loan.

The Tax Court held that the class C stock was nonqualified preferred stock under Code Sec. 351(g) because it did not participate in corporate growth to any significant extent within the meaning of Code Sec. 351(g)(3)(A). Accordingly, pursuant to the agreement of the parties, GMI was not entitled to deduct the claimed capital loss.

The Tax Court also concluded that the transactions underlying the claimed capital loss lacked economic substance. According to the court, the QHMC transactions were structured as an elaborate and devious multistep transaction, each individual step of which D&T promoted as meeting a literal reading of the Code, the regulations thereunder, and various judicial and administrative interpretations. The essence of the transactions, however, was simply to create an artificial multimillion-dollar tax loss that the taxpayers could report as an offset to their unrelated capital gains of a similar amount. Although taxpayers may structure their business transactions in a manner that produces the least amount of tax, the court stated, the economic substance doctrine requires that a court disregard a transaction that a taxpayer enters into without a valid business purpose in order to claim tax benefits not contemplated by a reasonable application of the language and the purpose of the Code or the regulations. Such a transaction is disregarded even though it may otherwise comply with the literal terms of the Code and the regulations. The court concluded that the QHMC transactions lacked economic substance and affirmed the IRS's determination that none of the related transaction costs of $352,000 were deductible.

For a discussion of the economic substance doctrine, see Parker Tax ¶99,700.

Taxpayer's Attempt to Take Double Deduction Fails

A capital loss claimed by the taxpayer in an earlier year could not later be claimed again as environmental remediation expense deductions. Thrifty Oil Co. & Subs. v. Comm'r, 139 T.C. No. 6 (2012).

Thrifty Oil Co. and Subsidiaries filed consolidated federal income tax returns for its fiscal years ending Sept. 30, 2000, 2001, and 2002. On those returns, it claimed environmental remediation expense deductions. The IRS disallowed the claimed deductions after determining that they were each the second tax deduction P had claimed for a single economic loss. The first deduction had been reported as a capital loss on Thrifty's federal income tax return for Sept. 30, 1996, and carried forward, with the last portion claimed on its federal income tax return for its fiscal year ending Sept. 30, 2001.

The IRS argued that the claimed deductions duplicated $18,347,205 in capital loss deductions Thrifty claimed for years not before the Tax Court, and thus Thrifty was not entitled to up to $18,347,205 of the claimed environmental remediation expense deductions. Thrifty asserted that the capital loss and the environmental remediation expense deductions did not represent the same economic loss.

The Tax Court agreed with the IRS and held that the capital loss and the environmental remediation expense deductions represented costs associated with the cleanup of the Golden West Refinery property. The capital loss represented the unpaid liability, and the environmental remediation expense deductions represented the actual cost when paid.

According to the court, Thifty's deducting the unpaid liability in the form of a capital loss, and then deducting it again when paid, was the core problem of the case. Since the capital loss deductions and the environmental remediation expense deductions represented the same economic loss, the court said Thrifty had to point to a specific provision authorizing the double deduction. Thrifty failed in this regard because it could only point to Code Sec. 162. General deduction provisions are insufficient, the court said. Citing its decision in O'Brien v. Comm'r, 79 T.C. 776 (1982), the Tax Court noted that it had previously held that Code Sec. 162 does not reflect a clear declaration of intent to allow a double deduction.

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Regs Address Foreign Currency Denominated Debt Instruments and Hedging Transactions

Temporary and proposed regulations provide that if a taxpayer has identified multiple hedges as being part of a qualified hedging transaction, and the taxpayer has terminated at least one but less than all of the hedges (including a portion of one or more of the hedges), the taxpayer must treat the remaining hedges as having been sold for fair market value on the date of disposition of the terminated hedge. T.D. 9598 (9/6/12); REG-138489-09 (9/6/12).

Under Reg. Sec. 1.988-5(a)(6)(ii), a taxpayer that disposes of all or a part of the qualifying debt instrument or hedge prior to the maturity of the qualified hedging transaction, or that changes a material term of the qualifying debt instrument or hedge, is viewed as legging out of integrated treatment. One of the consequences of legging out is that if the hedge is disposed of, the qualifying debt instrument is treated as sold for its fair market value on the date of disposition of the hedge (leg-out date). Any gain or loss on the qualifying debt instrument from the date of identification to the leg-out date is recognized on the leg-out date. The intended result of this deemed disposition rule is that the gain or loss on the qualifying debt instrument will generally be offset by the gain or loss on the hedge.

According to the IRS, some taxpayers who are in a loss position with respect to a qualifying debt instrument that is part of a qualified hedging transaction are interpreting the legging-out rules to permit the recognition of the loss on the debt instrument without recognition of all the corresponding gain on the hedging component of the transaction. Taxpayers claim to achieve this result by hedging nonfunctional currency debt instruments with multiple financial instruments and selectively disposing of less than all of these positions. Taxpayers take the position that Reg. Sec. 1.988-5(a)(6)(ii)(B) triggers the entire loss in the qualifying debt instrument but not the gain in the remaining components of the hedging side of the integrated transaction.

For example, a taxpayer may fully hedge a fixed rate nonfunctional currency denominated debt instrument that it has issued with two swaps--a nonfunctional currency/dollar currency swap and a fixed for floating dollar interest rate swap. The effect of matching the currency swap with the foreign currency denominated debt is to create synthetic fixed rate U.S. dollar debt, while the effect of the interest rate swap is to simultaneously transform the synthetic fixed rate U.S. dollar debt into synthetic floating rate U.S. dollar debt. Thus, assuming that the applicable rules are otherwise satisfied, the taxpayer will have effectively converted the fixed rate foreign currency denominated debt instrument into a synthetic floating rate U.S. dollar denominated debt instrument.

As the U.S. dollar declines in value relative to the foreign currency in which the debt instrument is denominated, the taxpayer disposes of the interest rate swap while keeping the currency swap in existence. The taxpayer takes the position that the disposition of the interest rate swap allows it to treat the debt instrument as having been terminated on the date of disposition and claims a loss on the debt instrument without taking into account the offsetting gain on the remaining component of the hedge. Thus, the taxpayer claims the transaction generates a net loss. According to the IRS, these results are inappropriate under the legging-out rules since the claimed loss is largely offset by unrealized gain on the remaining component of the hedging transaction. Therefore, the IRS issued the temporary and proposed regulations to clarify the rules regarding the consequences of legging-out of qualified hedging transactions that consist of multiple components.

OBSERVATION: The regulations provide that no inference is intended regarding the merits of the position taken by the taxpayer with respect to the transaction described above (or comparable positions taken by taxpayers with respect to similar transactions) in the case of transactions occurring before the date these regulations are effective, and in appropriate cases the IRS may challenge the claimed results.

The temporary and proposed regulations, which are effective for leg-outs that occur on or after September 6, 2012, provide that if a hedge with more than one component has been properly identified as being part of a qualified hedging transaction, and at least one but not all of the components of the hedge that is a part of the qualified hedging transaction has been terminated or disposed of, all of the remaining components of the hedge (as well as the qualifying debt) will be treated as sold for their fair market value on the leg-out date of the terminated hedge. Similarly, if a part of any component of a hedge (whether a hedge consists of a single or multiple components) has been disposed of, the remaining part of that component (as well as other components in the case of a hedge with multiple components) that is still in existence (as well as the qualifying debt instrument) will be treated as sold for its fair market value on the leg-out date of the terminated hedge.

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Termination of Equity Split-Dollar Life Insurance Arrangements Triggers Income to Shareholders

Upon the termination of a split-dollar life insurance arrangement (SDLIA), two S shareholders realized taxable compensation income in the amount of the difference between the amount they reimbursed their S corporation for and the amount the S corporation had paid in premiums on the policies. Neff v. Comm'r, T.C. Memo. 2012-244 (8/27/12).

Steven Neff and Bradley Jensen each owned a 50 percent interest in Neff & Jensen Construction, Inc. In February 2002, they formed Neff & Jensen Leasing, Inc., as a subchapter S corporation (N & J Management) to provide management, personnel, and accounting services for a number of related companies and businesses, including N & J Construction. All of the stock in N & J Management was owned by an employee stock ownership plan (ESOP), also formed in February 2002. Steven and Bradley were the officers of N & J Management and were the only trustees of the ESOP. After forming N & J Management, the employees of N & J Construction and the related companies continued doing the same work but they became employees of N & J Management and participants in the ESOP.

During 2002 and 2003, N & J Management made premium payments on six life insurance policies covering the lives of Steven and Bradley. These policies were entered into for business and estate planning purposes--namely, to fund cross-purchase buy-sell stock agreements entered into between the two owners and to provide estate liquidity upon their deaths. N & J Management's agreement to pay premiums due on the six life insurance policies on the owners' lives was based on, and related to, the employment relationship they had with and the services they provided for N & J Management. The obligation of N & J Management to pay premiums due on the six life insurance policies was part of four equity split-dollar life insurance arrangements (SDLIAs) that were memorialized in four essentially identical written SDLIA agreements that were entered into in March 2002, between Steven and Bradley as the sole shareholders and N & J Management. Under the SDLIA agreements, formal ownership rights in the six life insurance policies were held by Steven and Bradley, not N & J Management. As the employer, however, N & J Management agreed and was obligated to pay the premiums due on the life insurance policies, and Steven and Bradley agreed that upon either termination of the life insurance policies or upon termination of the SDLIAs for some other reason (such as upon a third-party sale of N & J Management and regardless of whether the life insurance policies were canceled), N & J Management would have the right to be reimbursed an amount equal to the lesser of the total premiums it had paid on the six life insurance policies or the total cash surrender value of the policies.

The SDLIA agreements provided, in part, that N & J Management would have no incidents of ownership over the policies and only had the right to collect its interest in the policy proceeds upon the owners' deaths, the termination of the agreement for any reason whatsoever, or upon the lapse, cancellation, or surrender of the policies. Further, the SDLIA agreements acknowledged that N & J Management's life insurance policy premium payments created indebtedness from Steven and Bradley to N & J Management and described N & J Management's premium payments as advances.

After December 2003, N & J Management made no further payments on the six life insurance policies. N & J Management released its interest in the policies (namely, its premium reimbursement rights) with respect to which N & J Management, in less than two years, had paid $842,345 in premiums.

Steven and Bradley's accountants assumed a life expectancy for each man of 85 and an interest rate of 6 percent. They calculated the December 2003 present value of N & J Management's $842,345 reimbursement rights at $131,969. In January of 2004, Steven and Bradley wrote personal checks totaling $131,969 to N & J Management. The checks were deposited into N & J Management's bank account on January 13, 2004. Funding for the $131,969 came from Steven and Bradley's draw on the accumulated cash value of the six underlying life insurance policies.

On audit, the IRS determined that on termination of the SDLIA arrangements in December 2003, Steven and Bradley realized taxable compensation income of $710,376, the difference between what they reimbursed N & J Management and what N & J Management paid in premiums on the policies.

Steven and Bradley argued that no termination or rollout of the SDLIAs occurred, that they purchased from N & J Management for a discounted present value only contract rights that they paid fair value for, that the SDLIAs remained in effect, and that they were not released from debt. Thus, they realized no compensation.

The Tax Court held that Steven and Bradley realized $710,376 of taxable income. Because the SDLIAs in these cases were entered into on March 6, 2002, and were not substantially modified before termination, the final regulations that cover these transactions did not apply. Instead, Rev. Ruls. 64-328 and 66-110, and IRS Notice 2002-8 applied to the SDLIAs because they were entered into after January 27, 2002, but on or before September 17, 2003. Under those rules, for each year an SDLIA was in effect, an employee was required to include in taxable income the total value or cost of the economic benefit received each year by the employee, less any amount contributed by the employee. Steven and Bradley did not include in their taxable income any amount with regard to the economic benefits they received in 2002, 2003, or 2004 with regard to the SDLIAs.

According to the court, it was obvious that a cancellation, an unwinding, a release, or a rollout of N & J Management's interests in the SDLIAs occurred. The formal SDLIA agreements may not have been technically or formally terminated by a written document, but as of the end of December 2003, the SDLIA arrangements were unwound, and N & J Management was released from its obligation as employer to provide further funding on the life insurance policies.

In December 2003, the Tax Court stated, upon rollout of the SDLIAs, the income Steven and Bradley realized under Code Sec. 61, or alternatively the taxable value of property transferred to them under Code Sec. 83, was the $710,376 difference between the $842,345 that N & J Management paid in premiums on their behalf and that was owed by them and the $131,969 they reimbursed N & J Management. Clearly, Steven and Bradley realized an accession to wealth of $710,376 for the additional premiums N & J Management paid. This occurred in the context of and related to their employment with N & J Management, and the $710,376 constitutes compensation income to them.

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Failure to Identify Partners in Partnership Extends Statute, Tax Court Holds

Where partners in a partnership were not appropriately identified to the IRS, the statutory period for assessing tax on the partnership was open and the doctrine of estoppel did not preclude the IRS's assertion to that effect. Gaughf Properties, L.P, v. Comm'r, 139 T.C. No. 7 (9/10/12).

In 1999, Gaughf Properties, a partnership, entered a complicated series of transactions involving currency options and stock trades. Two LLCs and an S corporation also took part in the transactions. All four entities were formed in 1999 and were owned either directly or indirectly by Andrew and/or Nan Gaughf. The transactions, which were facilitated by the accounting firm of KPMG and the law firm of Jenkens & Gilchrist, were intended to yield losses that would offset substantial unrealized gains in stock owned by Andrew by inflating the outside basis in the partnership.

Andrew and Nan were indirect partners of the partnership but did not list certain information identifying themselves as partners on the partnership's 1999 tax return. The IRS was in possession of certain information identifying Andrew and Nan as partners, which it had obtained when certain forms were filed on behalf of the four entities in 1999. The IRS possessed additional identifying information that it had obtained as a result of a summons issued to the law firm that had helped Andrew and Nan complete the transactions. However, the identifying information was not furnished to the IRS in accordance with certain requirements of Reg. Sec. 301.6223(c)-1T.

The IRS issued a final partnership administrative adjustment (FPAA) to Gaughf Properties in March 2007. According to the IRS, the partnership failed to recognize approximately $4.5 million in gross income resulting from the expiration of a currency option. Two issues in that case were separated and presented to the Tax Court. Those issues were (1) whether, on March 30, 2007, the statutory period for assessing tax attributable to partnership items was open under Code Sec. 6229(e), and (2) whether, under the doctrine of estoppel, the IRS was precluded from asserting the statutory period for assessing tax attributable to partnership items was open on March 30, 2007, with respect to Andrew and Nan.

The IRS argued that the identifying information referred to in Code Sec. 6229(e) was not furnished to it because no documents it received satisfied the requirements of Reg. Sec. 301.6223(c)-1T. Under those provisions, if certain information regarding the partners in a partnership is not filed with the IRS, then the statute of limitations remains open. In addition to contesting the IRS's position, the partnership argued that (1) the IRS failed to prove that it did not receive the required information from KPMG; (2) the IRS actually used information in its possession that identified the Gaughfs as indirect partners in Gaughf Properties; and (3) Reg. Sec. 301.6229(e)-1T, which incorporates Reg. Sec. 301.6223(c)-1T regarding the procedure for furnishing identifying information for purposes of Code Sec. 6229(e), was invalid.

The Tax Court held that the statutory period for assessing tax on the partnership was open under Code Sec. 6229(e) and that the doctrine of estoppel did not preclude the IRS's assertion to that effect. The Tax Court found that the information required under Code Sec. 6229(e) and the applicable regulations identifying the Gaughfs as partners in Gaughf Properties was not furnished to the IRS. As a result, the court held that the IRS's statutory-period-for-assessment arguments were satisfied.

With respect to the partnership's and the Gaughfs' allegations that the IRS caused numerous delays in the case while also changing its positions, the Tax Court said that the Gaughfs and other relevant entities were responsible for many of the delays and changed positions taken by the IRS through their implementation of a complex transaction to increase basis in a partnership, their inconsistent and incomplete reporting of facts regarding the transaction, and their failure to list the Gaughfs as indirect partners in Gaughf Properties. These facts helped provide support for the court's decision to reject all of the partnership's and the Gaughfs' estoppel arguments based on delay of the case.

For a discussion of the statute of limitations with respect to partnerships and their partners, see Parker Tax ¶260,130.

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