Vince Nardone: Tax and Controversy

Work-Product Doctrine and Tax Accrual Workpapers - IRS Prevails

Columbus, Ohio tax attorney, Vince Nardone, discusses the recent decision of U.S. v. Textron Inc., 577 F.3d 21, (1^st Circuit August 13, 2009). 

The question for the court was whether the attorney-work-product doctrine shields from an IRS summons tax-accrual workpapers prepared by lawyers and others in Textron's Tax Department to support Textron's calculation of tax reserves for its audited corporate financial statements.  As we all know now from the earlier decisions, Textron is a major aerospace and defense conglomerate, with well over a hundred subsidiaries, whose consolidated tax return is audited by the IRS on a regular basis.  Textron refused to produce its tax-accrual workpapers, asserting that they were privileged and that the summons was issued for an improper purpose.  The IRS ultimately filed an action in federal district court to enforce the summons.

On August 28, 2007, the district court held that Textron’s tax-accrual workpapers were protected by the work-product doctrine because the taxpayer would not have prepared them—but for—the fact that Textron anticipated the possibility of litigation with the IRS.  On January 1, 2009, the First Circuit, affirming the district court, held that Textron’s tax-accrual workpapers were protected by the work-product doctrine.  But, the court set aside the district court’s ultimate determination that the work-product doctrine was not waived, and sent the case back to the district court to reassess the question of whether disclosure of the auditor’s workpapers would reveal the information contained in Textron’s workpapers.  On rehearing, enbanc, the court reversed its own decision and concluded that Textron’s workpapers, which were prepared to support financial filings and gain auditor approval, were not protected by the work-product privilege.

The case ultimate stands for the proposition that tax-accrual workpapers prepared by lawyers and others in a corporate taxpayer's tax department to support a taxpayer's calculation of tax reserves for its audited corporate financial statements are independently required by statutory and audit requirements.  And thus, the attorney-work-product doctrine does not shield work papers from an Internal Revenue Service summons, where immediate motive for preparing the work papers is to fix the amount of tax reserve on a taxpayer's books and to obtain a clean financial opinion from its auditor.  It is not enough to trigger work-product protection that the document's subject matter relates to a subject that might conceivably be litigated.  Rather, the work-product doctrine protects materials prepared for any litigation or trial as long as they were prepared by or for party to subsequent litigation.  The court reasoned that the work product privilege is centrally aimed at protecting the litigation process, specifically; work done by counsel to help him in litigating a case.  It is not a privilege designed to help a lawyer prepare corporate documents or other materials prepared in the ordinary course of business.  See the attached case for further analysis and reasoning of the court.

Download Textron - October 19, 2009

United States Tax Court to IRS - Basis overstatement is not omission of income.

In Kenneth Beard v. Commissioner, TC Memo 2009-184 the Tax Court held that an overstatement of basis is not an omission of gross income for purposes of Internal Revenue Code section 6501.  Why is that important?  Well, Section 6501 provides that, unless extended or suspended, the statute of limitations on assessment for income taxes is three years from the later of when the return was filed or the return's due date.  One exception, however, is where the original return as filed omitted gross income in an amount exceeding 25% of the gross income that was stated on the return, the three-year rule is replaced with a six-year rule.  Thus, the IRS can go back 6 years rather than 3 years if this exception applies.

In Beard,the IRS had determined that the taxpayer had overstated his basis in two S corporations sold during the taxable year 1999, thus causing an understatement of gross income by more than 25 percent of the amount stated in the taxpayer's return.  The issue for decision was whether, under those circumstances, the taxpayer's actually omitted income, giving rise to an an extended 6-year period of limitations.  The court recognized that the general definition of gross income in the context of a trade or business meant the total of the amounts received or accrued from the sale of goods or services.  The IRS tried to argue that the overstatement of basis in a context outside of the sale of goods or services should constitute an omission from gross income.  Rejecting that argument, the court held that the taxpayers did not omit income from their return.  Therefore, the taxpayers were not subject to the 6-year period of limitations.  Great result for the taxpayers.

See the full case attached.Download Basis and sol - as of August 19, 2009

Coming Soon, Discussion on Internal Revenue Service's Plan to Audit Employment Tax Returns

IRS - Tax Return Errors

The Internal Revenue Service (IRS) recently announced the most common errors made on tax returns.  Please see the document below for a list of those errors by simply clicking on the link.  The IRS lists errors such as: (i) failing to include your social security number and (ii) misspelling a dependent's last name.  Why is it important to avoid these errors?  Well, it will certainly cause the processing of your tax return by the IRS to be slowed.  More importantly, however, by making errors on your return you expose yourself to a higher risk of being audited?  Take the time to review your return and avoid those common errors identify on the document below. 

Download DOC

Vince Nardone Speaks to CPAs at GBQ Regarding Due Diligence Requirements of a Tax Return Preparer

I spoke today to GBQ's Tax group regarding a tax return preparer's due diligence requirements in preparing a client's tax return.  As a tax return preparer, you must be aware of these rules and the Internal Revenue Service's commitment to hold you to a heightened standard.  See the attached presentation below.

Download Due Diligence Requirements - Tax Return Preparer

Nardone Speaks at The Ohio Society of CPAs' 2008 Mega Tax Conference

Each year the Ohio Society of CPAs puts on a very good conference that they refer to as the Mega Tax Conference. It occurs in December of each year. I had the pleasure of speaking the first day on Federal and State Tax Appeals. I have included by presentation material and attached it below. I will be following up with the materials on the Criminal Tax Fraud and Investigation presentation that I gave on the second day as well.Download Federal and State Tax Appeals

Nardone Speaks to Ohio Society of CPAs - Due Diligence Requirements for a Tax Return Preparer

I spoke with the Ohio Society of CPAs yesterday regarding a tax return preparer's due diligence requirements when relying upon a client's furnishing of information for that person's individual income tax return or their business return.  With enforcement up and the economy down, tax return preparer's must be vigilant and ensure that they are comfortable with their client's representations before placing those representations on a tax return.  Remember, as the accountant, when you sign that return as the preparer you are stating that to the best of your knowledge all of the information on this return is true and correct.  I believe it is fair to say that this includes your belief that the information your client has provided you is true and correct, again to the best of your knowledge.  I have attached my power point slide and also my more detailed outline on the subject.  See below.

Download tax_return_preparer_due_diligence_requirements_blog.pdf

Download outline_tax_controversy_tax_return_preparer_due_diligence_v_2.pdf

IRS Fails to Obtain Tax Accrual Workpapers - Work Product Privilege Applies

In Regions Financial Corp. & Subs. v. United States, 101 AFTR 2d 2008-2179, the Internal Revenue Service attempted to obtain the taxpayers tax accrual work papers regarding a contested transaction that the taxpayer had entered into.  At the time, the Service was reviewing the taxpayer's tax liability for 2002 and 2003.  During those years, the taxpayer entered into "listed transactions" or, for simplicity, tax shelters.  The Service served a summons on Ernst & Young LLP, the accounting firm that audited the taxpayer's accounting information.  The taxpayer instructed E&Y to withhold certain documents and to not turn over those documents to the Service.  The litigation then ensued.

The area of dispute dealt with whether a taxpayer must produce its tax accrual work papers in responseto an IRS summons?  To answer that question, the court stated it must address: (i) whether the summons is proper under the four-part test laid out by the United States Supreme Court in United States v. Powell, 379 US 48 (1964), (ii) whether any of the documents are privileged, (iii) if certain documents are privileged, whether the privilege has been waived, and (iv) can the IRS overcome the privilege by showing substantial hardship?  The Regions court found that it did not need to address Steps 1 and 4 because the taxpayer was not arguing that the summons was improper and the Service was not arguing a hardship.  Thus, the case came down to Steps 2 and 3, which are discussed below.

In determining whether a privilege applied, the court recognized that the work-product privilege applies to IRS summonses.  The primary element within the work-product privilege is whether the documents were prepared in anticipation of litigation.  The taxpayer and the Service, however, disagreed on the test to determine whether the documents at issue were prepared in anticipation of litigation in the context of an IRS Summons.  The Service argued that the proper test was the “primary motive purpose” test, which states that litigation need not be imminent as long as the primary motivating purpose behind the creation of the document was to aid in possible future litigation.  The taxpayer argued that the “because of litigation” test applied, which states that in light of the nature of the document and the factual situation in the particular case, the document can be fairly be said to have been prepared or obtained because of the prospect of litigation.  According to many courts, the “because of litigation” test affords the taxpayers a broader protection.  Ultimately, the court agreed with the taxpayer that the proper test was the “because of litigation” standard.

In determining whether the documents were prepared in anticipation of litigation under the "because of litigation" standard, the court went onto say that were it not for anticipated litigation, the taxpayer would not have had to worry about contingent liabilities and would not have needed to elicit opinions regarding the likely results of litigation.  The court also cited United States v. Textron, 507 F. Supp. 2d 138 for support of its analysis.  In Textron, the court applied the “because of litigation” test and held that tax accrual work papers were protected under the work product privilege stating that there would have been no need to create a reserve in the first place, if Textron had not anticipated a dispute with the IRS that was likely to result in litigation or some other adversarial proceeding.  Ultimately, the Regions court determined that the contested documents contained precisely the kind of legal analysis that the work product doctrine exits to protect.  It is important to note that the court did not protect the underlying facts of the transaction from being disclosed.  Rather, it was the mental impressions and opinions of the taxpayer’s lawyers that were protected.

The court also found that the taxpayer did not waive its privilege when it turned over the documents to its auditors.  The court stated that the auditor, although independent, was not an adversary of the taxpayer and the parties had entered into a confidentiality agreement to protect the disclosure of the information.

See the case for further discussion.

Download case_tax_accrual_work_papers.pdf

 

IRS Updates Procedures for Correcting Retirement Plan Errors

Recently, the Service updated its guidance on its voluntary correction program for employee retirement plans.  See Revenue Procedure 2008-50, which I have included below.  The update provides for an expansion of the correction programs and supposedly additional flexibility.  This will be helpful, if true.  As an example, one of the more common situations I see with closely-held businesses is the violation of the Plan when it comes to borrowing from the Plan.  That is, either borrowing the allowable amount and not paying it back, or borrowing to much from the beginning.  The question then comes up as to how do we deal with that violation under the Employee Plans Compliance Resolution System ("EPCRS"). 

According to the Service, under EPCRS, plan sponsors and plan professionals can correct certain errors in employee retirement plans, in some cases without having to notify the IRS.  Correcting plans in this way allows participants to continue receiving tax-favored retirement benefits and protects the retirement benefits of employees and retirees.

There are three levels of correction programs in EPCRS:

• The Self-Correction Program (SCP) permits a plan sponsor to correct insignificant operational failures in plans such as qualified plans, 403(b) plans, SEPs or SIMPLE IRA plans without having to notify the IRS and without paying any fee or sanction.  In many instances, a plan sponsor may correct significant operational failures without notifying the IRS and without paying a fee or sanction. 
  
• The Voluntary Correction Program (VCP) allows a plan sponsor, at any time before an audit, to pay a limited fee and receive the IRS’s approval for a correction of a qualified plan, a 403(b) plan, SEP or SIMPLE IRA plan.
  
• The Audit Closing Agreement Program (Audit CAP) allows a sponsor to correct a failure or an error that has been identified on audit and pay a sanction based on the nature, extent and severity of the failure being corrected.

In revising the EPCRS revenue procedure, the IRS incorporated comments from the retirement plans community by adding flexibility and increasing correction methods. The new guidance, which is a revenue procedure, makes the following improvements:

• Expands the availability of SCP in situations where operational mistakes have been partially corrected when the plan comes under examination.  Also, new examples relating to the exclusion of employees from 401(k) plans have been added to the standardized corrections. The new examples will benefit those who use SCP to correct the failures described in those examples.
  
• Establishes streamlined application procedures under VCP for numerous issues, including failure to amend plans for law changes, loan problems, failure to make minimum distributions to participants, excess elective deferrals made by participants to 401(k) plans and plans established by ineligible employers. In addition, streamlined application procedures have been developed for SEPs, SARSEPs and SIMPLE IRAs.
  
• Includes a sample application format that may be used for all other VCP applications.  “These revised application procedures should make the correction programs more accessible to small business employers,” said Joyce Kahn, who directs the voluntary compliance program. “Also, we anticipate that the new procedures will facilitate an expedited review of a significant number of VCP applications.”
  
• Makes it easier to correct loan failures under VCP.  Loans that violate section 72(p) of the Internal Revenue Code may still be corrected even if the loans do not violate the terms of the plan. Also, in many cases, the fee under VCP for correcting loan failures will be reduced by 50 percent.

See the Service's New Release 2008-96. 

Again, according to the Service, “The improved correction for participant loans should enable many more participants to bring delinquent loans from retirement plans back into compliance without incurring the tax consequences resulting from those loans being treated as taxable distributions under section 72(p).”  See News Release 2008-96.

See the entire Revenue Procedure directly below.

Download correcting_plan_errors_rev_proc_200850.pdf

Internal Revenue Service Attorneys Discuss Section 3509 as the Service Continues its Assault on Small Business in the Employment Tax Area - Tax Audits

In Chief Counsel Advice 200825043, the Internal Revenue Service examined Internal Revenue Code section 3509 in the context of a worker classification issue.  The Service, among other things, stated that in order to further compliance with worker classification for employment tax purposes, the Code prescribes reduced rates of tax for employers in certain situations involving misclassification of workers. Section 3509 reduces an employer's liability for federal income tax withholding and the employee portion of the FICA taxes where the employer failed to deduct and withhold those taxes because it treated the employee as a nonemployee. Section 3509(a). That liability is reduced from the amount the employer was required to withhold to 1.5% of the employee's wages for federal income tax withholding, and from 7.65% of the employee's wages to 20% of such amount for the employee's portion of the FICA tax. Section 3509(a). If the employer failed, without reasonable cause to comply with applicable information reporting requirements consistent with the treatment of the employee as a nonemployee (e.g., filing a Form 1099-MISC, Miscellaneous Income), the percentages are doubled so that the employer pays 3% of the employee's wages for federal income tax withholding and 40% of the amount of the employee's FICA tax (i.e., 40% of 7.65% of the employee's wages). Both rates must be used and they cannot be applied separately, except under special circumstances applicable only to statutory employees.

See the entire text of the CCA below.

Download 3509.PDF