Vince Nardone: Tax and Controversy

Internal Revenue Service Announces Disciplinary Sanctions Against Tax Professionals

In 2009-83, 2009-46 IRB 647, the Internal Revenue Service Office of Professional Responsibility announces recent disciplinary sanctions involving attorneys, certified public accountants, enrolled agents, enrolled actuaries, enrolled retirement plan agents, and appraisers. These individuals are subject to the regulations governing practice before the Internal Revenue Service, which are set out in Title 31, Code of Federal Regulations, Part 10, and which are published in pamphlet form as Treasury Department Circular No. 230.  The regulations prescribe the duties and restrictions relating to such practice and prescribe the disciplinary sanctions for violating the regulations.

These announcements should be a reminder to tax professionals of the importance of following the rule of law and ensuring that you do not cross the line.  I always advocate for my clients and want to aggressively pursue tax savings opportunities.  But, as tax professionals, you have to be aware of where tax planning or avoidance ends and where tax evasion begins.

Please see the attached Announcement 2009-83 for the details of the various disciplinary proceedings against professionals that crossed the line. 

Download Announcement 2009-83, Vince Nardone, Tax Attorney

Columbus Tax Attorney Vince Nardone Discusses the Worker, Homeownership, and Business Assistance Act of 2009.

On November 6th, Obama signed H.R. 3548, the ''Worker, Homeownership, and Business Assistance Act of 2009'' (the Act) into law (P.L. 111-92).  The signing came just one day after the House passed it and two days after the Senate did. In typical Democratic fashion, Obama calls it the business assistance act; however, it is less than favorable.  As an example, the Act stiffens penalties for partnerships and S corporations.

Under the old law, civil penalties apply for failure to file a partnership and S corporation returns. The penalty is $89 times the number of partners or shareholders for each month (or fraction of a month) that the failure continues, up to a maximum of 12 months for returns required to be filed after December 31, 2008.   Under the Act, however, the base amount on which a penalty is computed for a failure with respect to filing either a partnership or S corporation return for a tax year beginning after Dec. 31, 2009, is increased to $195 per partner or shareholder.  According to RIA Checkpoint, “Over the fiscal period 2011 to 2019, this provision is projected to raise $642 million (partnership penalties) and $587 million (S corporation penalties).

Please see the full Act attached.Download Legislation - Worker's, Homeownership Tax Act - November 2009

Joel Case Highlights Importance of Business Owners Staying Involved in Tax Matters

In Joel v. United States, (2008) 102 AFTR 2d 2008-5298, the Federal District Court held that an Optometrist/majority shareholder of a business was responsible for the Trust Fund Penalty under Internal Revenue Code Section 6672.  To provide some background on Section 6672, the Internal Revenue Code requires employers to withhold social security, medicare, and federal income taxes from their employees' wages.  These withholding taxes are part of the wages of the employee, held by the employer in trust for the government.  

To discourage employers from using the trust fund monies, Congress created a penalty under Section 6672 for those who fail to remit these withheld taxes to the government.  In general, section 6672 imposes the penalty on those Responsible Persons that act willfully.  The Sixth Circuit, which covers Ohio where I practice, has identified five factors that are indicia of whether an individual is a responsible person: (i) the duties of the individual; (ii) whether the individual had check signing authority; (iii) whether the individual is an officer, director, or shareholder of the corporation; (iv) whether the individual has the ability to hire and fire employees; and (v) the extent to which the individual, along with others, controls the finances of the company.

In Joel, the majority shareholder owned and operated a group of optometry stores.  The stores ultimately began to experience financial problems and did what many financially distressed businesses are tempted to do, use the trust fund monies to pay vendors and other creditors at the detriment of the Internal Revenue Service.  The Service then moved to assess the Trust Fund Penalty against the majority shareholder, who then argued that he was not a responsible person.  To support that argument, the taxpayer argued that he was not an officer and was not involved in the day to day activities of the business.  The Court in rejecting that argument highlighted the following facts: (i) the taxpayer personally participated in negotiations with creditors regarding late payments; (ii) made the decision to pledge certain assets for the benefit of creditors; (iii) attempted to sell the businesses to payoff the creditors, and (iv) the taxpayer's signature was on the withholding tax returns for the business.

This case is very common and causes many business owners to be liable for the Trust Fund Penalty; although they may not be the cause of the failure to make the payments or feel that they are not involved in the day to day activities of the business.  This is a very hard pill to swallow and a hard lesson to learn.  To protect themselves and insulate themselves from the potential of the Trust Fund Penalty certain measures should be in place prior to taking over or owning a business.  

See the case attached. 

Download case_withholding_to_be_put_on_blog.pdf

Internal Revenue Service Issues Proposed Regulations on Return Preparer Penalty - Tax Penalties and Relief

The IRS has issued proposed regulations on tax return preparer penalties under Internal Revenue Code sections 6694 and 6695. Among other matters, the proposed regulations address the new standards of conduct that must be met to avoid imposition of the tax return preparer penalty under section 6694 and the broadened scope of the definition of income tax return preparers. According to the Service, the regulations will be finalized by the end of 2008, with the expectation that the final regulations will apply to returns and refund claims (and advice given) after they are published, but in no event sooner than Dec. 31, 2008.

The proposed regulations conform existing regulations to the changes made by the Small Business Act, discussed below. In applying the proposed regulations, the IRS says that it will attempt to avoid a heavy handed approach and implement a "balanced enforcement program" for tax return preparers. I must take a wait and see approach on that statement, however, before I swallow the Kool-Aid. The IRS also intends to modify its internal guidance so that a referral by revenue agents to the IRS Office of Professional Responsibility (OPR) will not be per se mandatory when IRS assesses a section 6694(a) tax return preparer penalty against a tax return preparer who is also a practitioner under Circular 230 (i.e., the final regs governing the rules of practice before IRS). In matters involving non-willful conduct, IRS will generally look for a pattern of failing to meet the required section 6694(a) penalty standards before making an OPR referral, although any egregious conduct subjecting a tax return preparer to penalty may form a basis for a such a referral.

As to the penalties and the standards, a summary of the Small business Act are discussed below. For returns prepared after May 25, 2007, the Small Business Act:

• Expanded the tax return preparer penalties to all types of tax returns, not just income tax returns, including estate and gift tax, employment tax, and excise tax returns. Section 7701(a)(36), as amended by Small Business Act § 8246(a)(1))
• Raised the penalties imposed on return preparers for understatements due to unreasonable positions from $250 to the greater of $1,000 or 50% of the income derived (or to be derived) by the preparer with respect to the return or claim. It also raised penalties for understatements due to willful or reckless conduct from $1,000 to the greater of $5,000 or 50% of the income derived by the preparer with respect to the return or claim.
• Established a higher standard of conduct for preparers to avoid imposition of penalties when IRS alleges that the preparer knew or reasonably should have known of an unreasonable position. For undisclosed positions, the old standard required the position taken on the return to have a "realistic possibility of being sustained on its merits," which section 1.6694-2(b) translated as a one in three (approximately 33%) or greater likelihood of being sustained on its merits. The new standard for undisclosed positions requires "a reasonable belief that the position would more likely than not be sustained on its merits," which translates to approximately 51% or greater likelihood. This is significantly higher than the substantial authority standard that applies to taxpayers other than preparers.

• Established a higher standard of conduct for disclosed unreasonable positions. Under the old standard, a preparer could avoid penalties on disclosed unreasonable positions if the position wasn't frivolous. The new standard requires a preparer to have a reasonable basis for the disclosed position—the same standard for disclosed positions as for taxpayers other than preparers. Section 6694, as amended by Small Business Act § 8246).

See the full text of the proposed regulations attached below.

Download temp_proposed_regulations_1500292.PDF

Guidance on Tax Return Preparer Penalty - Tax Penalties

In Revenue Procedure 2008-14, the Internal Revenue Service ("IRS") recently provided guidance regarding circumstances under which a disclosure on a return is adequate for purposes of tax return preparers avoiding the §6694(a) penalty for understatement due to unrealistic positions taken on a return. Generally, to be considered adequate, the disclosure must be made on an income tax return. The taxpayer must furnish all the required information in accord with applicable forms and instructions, and money amounts entered must be verifiable. The amounts are verifiable if, on audit, the taxpayer can show origin of the numbers, even if ultimately rejected by the IRS, and can show good faith in applying the numbers to the return.

As background, §6694(a) imposes a penalty on a tax return preparer for filing a return or claim for refund that results in an understatement of liability due to a position of which the preparer knew or should have known, if the preparer did not have a reasonable belief that the position would more likely than not be sustained on the merits and the position was not disclosed in accordance with §6662(d)(2)(B)(ii). The penalty is equal to the greater of $1,000 or 50% of the income derived (or to be derived) by the preparer with respect to the return or claim.

This revenue procedure applies to any income tax return filed on a 2007 tax form for a taxable year beginning in 2007, and to any income tax return filed on a 2007 tax form in 2008 for a short taxable year beginning in 2008.

Download return_preparer.PDF

Collection Due Process Hearing appealed, Taxpayer Successful (I think).

In this case, an auto dealership was granted a second remanded CDP hearing on IRS's administrative determination to proceed with liens for its employment tax deficiencies and penalties: The appeals officer erred in original hearing insofar as failing to properly consider taxpayer's underlying liabilities disputes and argument that penalties should be abated on basis of bank errors in EFTPS transactions. Although taxpayer wasn't entitled to abatement on basis of certain other theories it was advancing, it was entitled to be heard on bank error/EFTPS transaction error theory. So, officer was ordered to give that issue proper consideration on remand. Officer was also ordered to consider effect of IRS's earlier failure to properly apply certain agreed payments and adjustments. And, while he had been correct insofar as determining that taxpayer had not submitted necessary information to support any collection alternative during original hearing, officer was required to re-consider same in light of foregoing issues and to conduct renewed balancing analysis. See Don Johnson Motors v. U.S., DC TX, 101 AFTR 2d ¶2008-335 attached. 

Now, this case highlights that in some instances appeals officers make mistakes in these cases, but the question I have is: Is it worth appealing and maybe it is. Because what you do not hear about is what happens when the case is remanded.  That is, most of these cases are procedural errors and once it is remanded to the appeals officer you are likely to find that the appeals officer corrects the procedural error and the end-result is the same. That is, the taxpayer loses. What is more important is working with the appeals officer at the appeals so that the taxpayer can obtain a satisfactory result without having to pursue litigation, which in most instances is cost prohibitive—although I recognize that you may obtain that one appeals officer that is simply not going to work with you.

This case also provides a good discussion on reasonable cause and the abatement of certain penalties.

Download 1373689.PDF

Tax Attorneys and Accountants Beware: Valuation Penalty Applies

The Service has stated in a memorandum (AM 2007-0017, 10/31/07) that it may assess a Section 6695A penalty against an appraiser for appraisals prepared after 5/25/07 that are used in connection with an estate or gift tax return or claim for refund or credit that results in a gross valuation misstatement. It also said that no limitations period applies to the assessment of Section 6695A penalties.  See the IRS memorandum below.

REFERENCE: 200542034, October 21, 2005, Released

CC:PA:APJP:B02, POSTF-119683-05, UILC: 6695.01-00, 7701.18-00

TEXT:

date: July 14, 2005

to: Joseph M. Abele

Associate Area Counsel (Philadelphia, Group 1)

(Small Business/Self-Employed)

(CC:SB:2:PHI:1)

from: Ashton P. Trice

Branch Chief, Administrative Provisions & Judicial Practice, Branch 2

(Procedure & Administration)

(CC:PA:APJP:B02)

subject: Application of the preparer penalty under section 6695(d)

This Chief Counsel Advice responds to your request for assistance dated April 14, 2005. This advice may not be used or cited as precedent.

ISSUES

1) Whether the "income tax return preparer" for purposes of applying the penalty under section 6695(d) is an S corporation or the sole-shareholder/owner of the S corporation who signed most of the returns.
2) Whether the penalty under section 6695(d) can be assessed when the preparer failed to produce copies of returns prepared or list of clients served pursuant to a summons and also failed to comply fully with a court order resulting from a summons enforcement hearing, which required the preparer produce copies of the bills to clients.

CONCLUSIONS

1) The penalty under section 6695(d) should be assessed against the S corporation  [*2]  if the shareholder is an employee of the S corporation under common law rules. If the shareholder is not an employee, the penalty should be assessed against the shareholder directly.
2) The Service can assess the penalty against the income tax return preparer under section 6695(d) when the preparer failed to comply with a summons or court order relating to the Service's request for returns or preparer's list retained under section 6107(b).

FACTS

A Subchapter S corporation (S Corporation) is in the business of tax return preparation. S corporation has one shareholder (Shareholder) and at least one employee, the niece of the shareholder (Niece). It is unclear whether others are employed by S Corporation, as well. The Service doesnot know all the details pertaining to the relationship between the Shareholder and S Corporation. Shareholder has not received wages from S Corporation. S Corporation did pay wages to Niece for the services she performed for the company.

Both Shareholder and Niece have signed returns as the preparer for S corporation. Shareholder has prepared the majority of the returns that S Corporation prepared for clients. Approximately one-half of the returns Shareholder signed  [*3]  included the name and EIN of S Corporation. Shareholder signed the other approximate half of the returns using only her name and social security number.

A revenue agent conducted an audit of S Corporation. The Service requested the list of returns, and/or copies of returns, required to be maintained pursuant to section § 6107(b) from Shareholder for the [TEXT REDACTED] and [TEXT REDACTED] taxable years. Shareholder did not cooperate and the Service summoned the returns. The Service commenced an action to enforce the summons. During the enforcement action, Shareholder stated that she could not retrieve and print the requested information from her computer and was concerned about the revenue agent having the social security numbers of her client base. Therefore, the Court ordered Shareholder to produce her bills to clients. Following the enforcement action, Shareholder produced these records pertaining to approximately 400 returns, which were incomplete in some respects. The Service's computer records indicate that Shareholder and S Corporation prepared approximately 1500 returns during the years at issue. Thus, the Service assessed the penalty under section 6695(d) for the remaining  [*4]  approximately 1100 returns against Shareholder and S Corporation separately.

LAW AND ANALYSIS

Any person who is an income tax return preparer with respect to any return or claim for refund who fails to comply with section 6107(b) with respect to such return or claim shall pay a penalty of $ 50 for each such failure, unless it is shown that such failure is due to reasonable cause and not due to willful neglect. I.R.C. § 6695(d). The maximum penalty imposed under this subsection on any person with respect to any return period shall not exceed $ 25,000. Id.

Section 6107(b) requires an income tax return preparer with respect to a return or claim for refund, for a period of three years after the close of the return period, to (1) retain a completed copy of the return or claim, or retain, on a list, the name and taxpayer identification number of the taxpayer for whom the return or claim was prepared; and (2) make the copy or list available for inspection upon request by the Service.

Issue 1: Whether S Corporation or Shareholder is the preparer subject to penalty

An income tax return preparer is any person who prepares for compensation, or who employs one or more persons to prepare for compensation,  [*5]  all or a substantial portion of any return of tax imposed by subtitle A or any claim for refund of tax imposed by Subtitle A. I.R.C. § 7701(a)(36)(A); Treas. Reg. § 301.7701- 15(a). In addition, the regulations under section 6107 provide the general rule that, where there is an employment arrangement between two or more income tax return preparers, the person who employs (or engages) one or more other persons to prepare for compensation any return or claim for refund (other than for the person) shall be considered to be the sole income tax return preparer. Treas. Reg. § 1.6107-1(c).

In the instant case, S Corporation employed Niece (and possibly others) to prepare tax returns. Because S Corporation employs agents or employees to prepare income tax returns for compensation, S Corporation is an income tax return preparer with respect to those returns or claims for refund for purposes of sections 6107(b) and 6695(d).

Likewise, with respect to the returns Shareholder prepared, the issue of who is subject to the section 6695(d) penalty depends upon whether S Corporation employed Shareholder. Whether S Corporation employed Shareholder is determined under common law rules applicable in determining  [*6]  the employer-employee relationship. See Nu-Look Design, Inc. v. Commissioner, 356 F.3d 290 (3d Cir. 2004); American Consulting Corp. v. United States, 454 F.2d 473, 477 (3d Cir. 1971). Several factors used to determine the existence of the employer-employee relationship are (1) the right to control the details of the work; (2) furnishing of tools and the work place; (3) withholding of taxes, workmen's compensation and unemployment insurance funds; (4) right to discharge; and (5) permanency of the relationship. American Consulting Corp., 454 F.2d at 477; See Treas. Reg. § 31.3121(d)-1(c)(2). Although no one factor is controlling, the most important factors is the right to control. Id. Some cases have held that where a sole-shareholder of an S corporation is the "central worker" of the corporation and performs more than minor services for the corporation, the sole-shareholder should be treated as an employee. See, e.g., Nu-Look Design, Inc., 356 F.3d 290; Spicer Accounting, Inc. v. United States, 918 F.2d 90 (9th Cir. 1990).

If facts reveal that there was an employer-employee relationship between S Corporation and Shareholder for some or all of the returns Shareholder signed, then  [*7]  with respect to those returns, the penalty under section 6695(d) should only be asserted against S Corporation. If facts show that there was no employer-employee relationship for some or all of the returns Shareholder signed, then with respect to those returns, the penalty under section 6695(d) should only be asserted against Shareholder as the actual preparer. If S Corporation did not employ Shareholder, then Shareholder should be considered the preparer because she prepared the returns for compensation.

You wondered if the fact that Shareholder signed the majority of the returns was a key factor here, especially as Shareholder signed half of the returns using only her own name and EIN. Because we don't believe this action bears on the test for determining whether Shareholder is an employee, we don't believe that this fact is key to determining the applicability of the section 6695(d) penalty. We also note that the individual who prepares a taxpayer's return is required to sign the return and provide his or her taxpayer identification number. I.R.C. §§ 6109(a)(4), 6695(b), (c); Treas. Reg. §§ 301.6109-2(a)(1), 1.6695-1(b)(1). Failure to do so may result in a penalty, absent reasonable  [*8]  cause. I.R.C. § 6695(b), (c). If there is an employment arrangement between two or more income tax return preparers, the identification number of the employer must also appear on the return or claim. I.R.C. § 6109(a)(4); Treas. Reg. § 301.6109-2(a)(1). Similarly, failure to provide the employer identification number may result in a penalty, absent reasonable cause. See I.R.C. § 6695(c). In this case it appears that the name and EIN of the S corporation did not appear on all of the returns prepared by the shareholder. As it is not clear whether or not the shareholder was an employee of the S corporation, we do not have sufficient facts to determine if the absence of the S corporation's identification was due to an error or because there was no employment arrangement between Shareholder and S Corporation. As stated above, the key test here for purposes of section 6695(d) is whether Shareholder was an employee of S Corporation.

Issue 2: Whether the section 6695(d) penalty can be assessed

In this case, pursuant to the Court's determination at the summons enforcement action, Shareholder produced "buck slips," or bills to the clients, for approximately 400 of the estimated 1500 returns  [*9]  at issue. The Service assessed a penalty under section 6695(d) for each failure to provide the information with respect to the remaining approximately 1100 returns. In a subsequent e-mail, you questioned whether the section 6695(d) penalty could be asserted here where the Court ordered the employee only to produce the "buck slips" or bills to the clients and did not order the preparer to produce copies of the returns. It is unclear from the facts provided exactly why the Court ordered the bills to be produced in lieu of other records required to be maintained and produced under section 6107(b). As it does not appear from the facts that a penalty was assessed for any instance where the bills to clients were produced, we do not need to address such a situation here.

In addition, keep in mind that if, as the case develops, Shareholder establishes enough facts to prove that the failure to provide the information with respect to the taxpayer was due to reasonable cause and not due to willful neglect, then the penalty will need to be abated with respect to each instance for which she establishes reasonable cause. See I.R.C. 6695(d).

CASE DEVELOPMENT, HAZARDS AND OTHER CONSIDERATIONS

[TEXT  [*10]  REDACTED]

This writing may contain privileged information. Any unauthorized disclosure of this writing may undermine our ability to protect the privileged information. If disclosure is determined to be necessary, please contact this office for our views