February 12, 2016
Opening briefs have been filed in the Ninth Circuit in United States v. Sanmina, where the IRS is appealing a decision by the U.S. District Court for the Northern District of California holding that the attorney-client privilege and work product doctrine protect two memoranda prepared by Sanmina’s in-house tax attorneys. In its opening brief, the IRS is advancing a narrow view of attorney-client privilege and an expansive view of waiver.
Sanmina claimed a $503 million worthless stock deduction on its return. To support its return position, Sanmina provided the IRS a valuation report prepared by outside counsel DLA Piper. The valuation report included a footnote stating that the authors reviewed the two in-house tax attorney memos. The district court held that both memos were protected by the attorney-client privilege and work product doctrine and that no waiver occurred when Sanmina gave the memos to DLA Piper or when DLA Piper referenced them in the valuation report.
On appeal, the IRS contests the threshold applicability of the attorney-client privilege and work product doctrine as to only one of the memos and argues waiver as to both. The IRS argues that the memo was not privileged because it was “to file” and there is no evidence that (1) the memo was reviewed by anyone else in the company, (2) the company sought legal advice from the in-house attorney; or (3) it contained confidential client communications. According to the IRS: “The attorney-client privilege does not extend to an unsolicited memorandum prepared by Sanmina’s in-house tax counsel for their own records.” The IRS also argues that the work product doctrine does not apply because there was insufficient evidence that the memo was prepared because of anticipated litigation. On the issue of waiver, the IRS claims there was a subject matter waiver when Sanmina disclosed the valuation report to the IRS. The IRS also takes the position that Sanmina waived the privilege earlier when it disclosed the memos to outside counsel. “Because DLA Piper was not acting as a lawyer in preparing the valuation report, Sanmina’s disclosures to DLA Piper were not protected by the attorney-client privilege.” As to work product, the IRS argues Sanmina waived that protection when it produced the memos to outside counsel, knowing they would provide the valuation report to the IRS.
In its answering brief, Sanmina asserts that the IRS waived its arguments about the privileged status of the memo by not raising them at the district court. Below, the IRS argued the memo constituted business not legal advice, but abandoned that argument on appeal. Sanmina also challenges the IRS’s factual characterization of the memo, as well as the IRS’s contention that the tax attorney was not anticipating litigation. On the waiver point, Sanmina argues that the valuation report did not disclose the contents of the privileged memos, nor was disclosure of the memos to outside counsel inconsistent with maintaining their confidentiality as to the IRS.
The IRS’s reply brief is due March 9.
February 12, 2014
Yesterday, the D.C. Circuit unanimously held in Loving v. IRS, that the IRS lacks statutory authority to regulate tax-return preparers. See our previous coverage here. In its February 11 decision, the court characterized the IRS’s interpretation as “atextual and ahistorical,” and, more humorously, as a large elephant trying to emerge from a small mousehole.
In 2011, the IRS for the first time attempted to regulate tax-return preparers, issuing regulations requiring that paid tax-return preparers pass an initial certification, pay annual fees, and complete at least 15 hours of continuing education courses each year. The IRS estimated that the regulations would apply to between 600,000 and 700,000 tax-return preparers. Before 2011, the IRS had never taken the position that it had the authority to regulate tax-return preparers. According to the D.C. Circuit panel (Kavanaugh, Sentelle, and Williams): “In light of the text, history, structure, and context of the statute, it becomes apparent that the IRS never before adopted its current interpretation for a reason: It is incorrect.”
The IRS claimed that 31 U.S.C. § 330 provided statutory authority for the regulations. That statute authorizes the IRS to “regulate the practice of representatives of persons before the Department of Treasury.” 31 U.S.C. § 330(a)(1). The D.C. Circuit cited the familiar two-step Chevron standard of review: (1) is the statute ambiguous, and (2) if so, is the agency’s interpretation reasonable. The court of appeals concluded that the “IRS’s interpretation fails at Chevron step 1 because it is foreclosed by the statute,” and, in any event, “would also fail at Chevron step 2 because it is unreasonable in light of the statute’s text, history, structure, and context.” The court of appeals cited six reasons foreclosing the IRS’s interpretation of the statute:
First, the D.C. Circuit concluded that the term “representative” generally is understood to refer to an agent with authority to bind others. “Put simply, tax-return preparers are not agents. They do not possess legal authority to act on the taxpayer’s behalf.” Second, the preparation of a tax return does not constitute “practice . . . before the Department of the Treasury.” “Practice before” an agency generally implies an investigation, adversarial hearing, or other adjudicative proceeding. Moreover, a related section of the statute allows the Secretary of the Treasury to require that a representative admitted to practice before the agency demonstrate four qualities, one of which is “competency to advise and assist persons in presenting their cases.” 31 U.S.C. § 330(a)(2). Filing a tax return is not understood in ordinary usage to be “presenting a case.” Third, the original version of the statute, enacted in 1884, referred to “agents, attorneys, or other persons representing claimants before [the] Department.” The court of appeals concluded that this original language clearly would not encompass tax return preparers. When the statute was recodified in 1982, the phrase, “agents, attorneys, or other persons representing claimants” was simplified to “representatives of persons,” but the language change expressly was not intended to effect a substantive change. Fourth, the IRS’s interpretation is inconsistent with the “broader statutory framework,” in which Congress has enacted a number of statutes specifically directed at tax-return preparers and imposing civil penalties. Those statutes would not have been necessary, the court reasoned, if the IRS had authority to regulate tax-return prepares. Fifth, if Congress had intended to confer such broad regulatory authority upon the IRS, allowing it to regulate “hundreds of thousands of individuals in the multi-billion dollar tax-preparation industry,” the statute would have been clearer. Referring to the statutory language, the court of appeals concluded: “we are confident that the enacting Congress did not intend to grow such a large elephant in such a small mousehole.” Sixth, the court noted that the IRS in the past had made statements and issued guidance indicating that it did not believe it had authority to regulate tax-return preparers. The court found it “rather telling that the IRS had never before maintained that it possessed this authority.”
The decision ends with the court of appeals noting that new legislation would be needed to allow the IRS to regulate tax-return preparers.
Given that the membership of the D.C. Circuit has recently expanded to include three additional judges, the government might believe that it is worthwhile to seek rehearing en banc before the full court. A petition for rehearing would be due on March 28. If the government does not seek rehearing, a petition for certiorari would be due on May 12. Whether it pursues the litigation further or not, the government can be expected to seek new legislation that would give the IRS the regulatory authority that the court of appeals refused to find.
January 16, 2014
That didn’t take long. Less than two weeks after learning that the parties would not be mediating their dispute (see our previous report here), the Ninth Circuit issued a brief five-page unpublished opinion affirming the Bergmann case in favor of the government. The court held that the time for filing a qualified amended return for an undisclosed listed transaction terminates when the promoter (here, KPMG) is first contacted by the IRS about examining the transaction, not when the IRS later determines the transaction is a tax shelter.
To recap the issue (see our original report here), under Treas. Reg. § 1.6664-2(c)(3)(ii), as in effect when the Bergmanns filed their amended return, the time to file a qualified amended return terminates when the IRS first contacts a “person” concerning liability under 26 U.S.C. § 6700 (a promoter investigation) for an activity with respect to which the taxpayer claimed a tax benefit. The Bergmanns claimed tax benefits from a Short Option Strategy promoted by KPMG on their 2001 tax return. The IRS served summonses on KPMG in March 2002 for its role in promoting the Short Option Strategy transactions. The Bergmanns did not file their qualified amended return until March 2004, shortly after KPMG identified the Bergmanns as among those taxpayers who participated in the transaction. The Bergmanns argued that “person” as used in the regulation meant only those persons liable for a promoter penalty under 26 U.S.C. § 6700.
The Ninth Circuit quickly dispatched the taxpayers’ argument, characterizing their interpretation of the regulation as “impermissibly rendering its text and purpose nonsensical.” Under the express language of the regulation, it applies when the promoter is “first contacted,” not found liable. The court of appeals concluded by observing that the purpose of qualified amended returns is to encourage and reward taxpayers who “voluntarily disclose abusive tax practices, thereby saving IRS resources.” Here, the taxpayers did not amend their return until after KPMG gave their names to the IRS.
April 10, 2013
[Note: Miller & Chevalier member and former Commissioner of Internal Revenue Lawrence B. Gibbs is among the five former Commissioners who filed an amicus brief in support of the Government in the Loving appeal.]
Five former IRS Commissioners filed an amicus brief in support of the Government’s appeal of the district court decision invalidating the IRS’s registration regime for paid tax return preparers. The former Commissioners “take no position regarding whether the manner in which the Treasury has chosen to regulate tax return preparers is advisable, but they strongly disagree with the District Court’s view that Congress has not empowered Treasury to do so.” Under 31 U.S.C. § 330, the Treasury Department is authorized to “regulate the practice of representatives of persons before the Department of Treasury.” The district court held that, although the statute did not define “the practice of representatives,” the surrounding statutory text made clear that Congress used “practice” to refer to “advising and assisting persons in presenting their case,” not simply preparing returns. In their amicus brief, the former Commissioners argue that filing a tax return does, in fact, constitute presenting a case. The amicus brief explains that an increasingly wide variety of government assistance programs are administered through the federal income tax system, including a number of refundable tax credits (the earned income credit, health insurance cost credit, etc.). Accordingly, the tax return preparer is not simply calculating tax liability; he or she also is often representing the taxpayer in pursuing claims for federal assistance. Because disbursements of benefits under these government assistance programs is administered largely through self-reporting on a tax return, it is essential, the former Commissioners argue, that paid tax return preparers be regulated so that taxpayers can identify the credits and benefits to which they are entitled and so that both the government and taxpayers are protected against fraud.
The National Consumer Law Center and National Community Tax Coalition also filed a joint amicus brief arguing for reversal of the district court’s decision. That brief documents “rampant” fraud and incompetence in the paid preparation industry, especially on the part of fringe return preparers, such as payday loan stores.
April 5, 2013
The Government has filed its brief in the taxpayers’ appeal to the Ninth Circuit of the Tax Court’s decision that the mortgage interest deduction applies on a per residence rather than per taxpayer basis. See our previous coverage here. Section 163(h)(3) limits deductible mortgage interest to “acquisition indebtedness” of $1,000,000 and “home equity indebtedness” of $100,000. With their Beverly Hills home and Rancho Mirage secondary residence, domestic partners Bruce Voss and Charles Sophy had considerably more indebtedness, and argued that, together, they should be able to deduct interest paid on up to $2.2 million of acquisition and home equity indebtedness because the limitations should be applied on a per taxpayer rather than per residence basis. In its opposition brief, the Government argues that the statutory text supports a per residence limitation. The statute refers to acquisition or home equity indebtedness “with respect to any qualified residence of the taxpayer.” According to the Government, “the word ‘indebtedness’ is used in direct relation to the ‘residence,’ and the word ‘taxpayer’ is used only in connection with the ‘residence,’ not with the ‘indebtedness.’” The Government also finds support for its position in the Code’s definition of “acquisition indebtedness” as indebtedness incurred in acquiring a residence, not as indebtedness secured in acquiring a taxpayer’s portion of a residence. Turning to policy arguments, the Government observes that the taxpayers’ interpretation would create an unintended marriage penalty. Married taxpayers filing separately are limited to acquisition and home equity indebtedness of one-half the otherwise allowable amount, or $500,000 and $50,000 respectively.
In their reply brief, the taxpayers argue that the general rule of section 163(a) (“There shall be allowed as a deduction all interest paid within the taxable year on indebtedness.”) must be read as referring to the taxpayer’s indebtedness. This “clearly implied” meaning, they argue, should inform the interpretation of the mortgage interest deduction provisions. The taxpayers also seek support for their interpretation in references in the legislative history to the indebtedness on the qualified residence as being “the taxpayer’s debt.” With respect to the Government’s marriage penalty argument, the taxpayers note that the Code often treats married couples as a single taxpayer, and married couples enjoy many benefits from that treatment, benefits that are not enjoyed by domestic partners. The reply brief concludes with the following: “Once Congress made the decision to treat spouses as a single taxpayer, the resulting benefits and burdens must be respected equally. In this case, Taxpayers should not be assigned the burden (or penalty) that results from the Tax Court’s convoluted reading of section 163(h)(3) which treats Taxpayers as a married couple, when they receive none of the marriage benefits.”
April 2, 2013
Two days after the D.C. Circuit denied its motion for stay pending appeal, the Government moved for an expedited appeal and concurrently filed its opening brief. The Government seeks an expedited resolution of its appeal of the decision of the U.S. District Court for the District of Columbia (Judge James E. Boasberg) invalidating a licensing regime for paid federal tax return preparers. Under the Government’s proposed briefing schedule, briefing would be complete by May 31, 2013. The Appellees have consented to the Government’s proposed briefing schedule.
In its opening brief, the Government argues that the tax return preparer regulations are a reasonable interpretation of an ambiguous statutory grant of authority to regulate the “practice of representatives before the Department of Treasury.” The district court had held that the Treasury Department was not entitled to any Chevron deference because the statute, 31 U.S.C. 330(a)(1) unambiguously did not authorize the regulation of individuals whose only role is the preparation of the return. The Government argues that “neither the actual language nor the overall context of 31 U.S.C. 330(a) unambiguously forecloses the Secretary’s interpretation that the term ‘ practice of representatives before the Department of the Treasury’ includes the practice of tax-return preparers.” The Government pointed to the absence of a definition — either in the Code or in ordinary meaning — of “practice” that would exclude mere return preparation. The Government also seizes on language in 31 U.S.C. 330(a)(2) authorizing the Secretary of the Treasury to require that representatives who practice before it demonstrate “necessary qualifications to enable the representative to provide to persons valuable service.” The Government reasons that, because tax return preparers provide a “valuable service,” they should be deemed to “practice” before the Treasury Department. Acknowledging that the statute authorizes the Treasury Department to require a representative to demonstrate “competency to advise and assist persons in presenting their cases,” the Government contends that Congress did not intend by that language to limit the Treasury Department’s authority to regulate tax-return preparers whose representation ends with preparing the tax return.
March 15, 2013
Yesterday, in Loving v. IRS (the subject of a recent post), the Government filed its reply brief in support of its motion to stay the district court’s injunction of the new registration regime for paid tax-return preparers. With respect to its likelihood of success on the merits, the Government argued the ambiguity of the statute authorizing Treasury to “regulate the practice of representatives of persons before” it. With respect to the threat of irreparable harm, the Government argued that the injunction risked delaying the implementation of the regulatory regime until the 2015 return-preparation season and that the problem of unregulated return preparers represents a “major public concern.”
Government Seeks Appellate Stay of Order Enjoining Enforcement of New Registration Regime for Paid Tax Return Preparers
March 13, 2013
The Government has appealed to the D.C. Circuit from the district court decision enjoining the IRS from enforcing its new registration regime for paid tax return preparers. Loving v. IRS, D.C. Cir. No. 13-5061. The Government has also asked the court of appeals to stay the decision pending appeal, after the district court declined to grant a stay. The Government’s stay motion recites that, the appeal has not yet been authorized by the Solicitor General’s office, but that, if the appeal is authorized, the Government intends to file its opening brief in March and to move for an expedited oral argument.
To recap the district court’s decision: In 2011, the Treasury Department promulgated regulations that extended Circular 230 (the regulations that govern practice before the IRS) to non-attorney, non-CPA tax-return preparers who prepare and file tax returns for compensation. Under the new regulations, tax-return preparers must register before they can practice before the IRS, and they are deemed to practice before the IRS even if their only function is to prepare and submit tax returns. In order to register initially, tax return preparers must pass a qualification exam and pay a fee. To maintain their registration each year, they must pay a fee and take at least fifteen hours of continuing education courses. The IRS estimated that the new regulation sweeps in 600,000 to 700,000 new tax return preparers who were previously unregulated at the federal level.
Three tax return preparers who were not previously regulated by Circular 230 brought suit challenging the 2011 regulations and seeking declaratory and injunctive relief. In January 2013, the U.S. District Court for the District of Columbia (Boasberg, J.) granted the plaintiffs’ motion for summary judgment. The court recognized that, under Mayo Foundation, the two-step analysis of Chevron should be applied to determine the validity of the regulations. The court explained, however, that “the battle here will be fought and won on Chevron step one” because “Plaintiffs offer no independent argument for why, if the statute is ambiguous, the IRS’s interpretation would be ‘arbitrary or capricious . . .’ under Chevron step two.” Focusing in this way on the unambiguous statutory text, the court held that the Treasury Department lacked statutory authority to issue the regulations.
The court rejected the Government’s argument that the agency had inherent authority to regulate those who practice before it, because a statute (31 U.S.C. § 330) specifically defined the scope of the Treasury Department’s authority. Under that statute, the Treasury Department is authorized to “regulate the practice of representatives of persons before the Department of Treasury.” The district court held that, although the statute did not define “the practice of representatives,” the surrounding statutory text made clear that Congress used “practice” to refer to “advising and assisting persons in presenting their case,” not simply preparing returns. Turning to provisions in the Internal Revenue Code that regulate tax return preparers, the court reasoned that Congress could not have intended § 330 to be the authority for regulating tax return preparers because “statutes scattered across Title 26 of the U.S. Code create a careful, regimented schedule of penalties for misdeeds by tax-return preparers.” The court rejected the Government’s resort to policy arguments. “In the land of statutory interpretation, statutory text is king.” Holding that the new regulations were ultra vires, the court enjoined the IRS from enforcing the registration regime.
In the motion for a stay pending appeal filed with the district court, the Government argued that the injunction substantially disrupted the IRS’s tax administration and that shutting down the program would be costly and complex. The district court was not persuaded, concluding that “[t]hese harms, to the extent they exist are hardly irreparable, and some cannot even be traced to the injunction.”
The Government’s stay motion in the court of appeals, filed February 25, argues that “[f]ailure to grant the stay will work a substantial and irreparable harm to the Government and the taxpaying public, crippling the Government’s efforts to ensure that individuals who prepare tax returns for others are both competent and ethical.” According to the Government’s brief, the “IRS estimates that fraud, abuse, and errors cost the taxpaying public billions of dollars annually.” In their March 8 response, the Plaintiffs/Appellees argue that the Government failed to establish any imminent irreparable harm traceable to the injunction, noting that even the Government acknowledged that most of the alleged harms would not occur until 2014. The tax return preparers also emphasize that the injunction merely preserves the historical status quo.
February 8, 2013
The Bergmanns participated in a listed transaction promoted by KPMG, known as the Short Option Strategy. When the Bergmanns filed their amended return in March 2004, the IRS had already served KPMG with summonses targeted at KMPG’s promotion of the Short Option Strategy. As discussed in an earlier post, the Tax Court held that the Bergmanns failed to timely file a qualified amended return and thus were subject to the 20-percent accuracy related penalty. Under the regulations in effect when the taxpayers filed their return, the time for filing a qualified amended return terminated when “any person described in § 6700(a) (relating to the penalty for promoting abusive tax shelters) is first contacted by the Internal Revenue Service concerning an examination of an activity described in § 6700(a) with respect to which the taxpayer claimed any benefit on the return . . . .” Treas. Reg. § 1.6664-2(c)(3)(ii). The Tax Court rejected the Bergmanns’ argument that the promoter provision of the qualified amended return regulations required the IRS to establish that KPMG was liable for the § 6700 promoter penalty.
On appeal, the Bergmanns’ principal argument is that the Tax Court erroneously applied the current qualified amended return regulation rather than the regulation in effect when the amended return was filed. The current regulation, Treas. Reg. § 1.6664-2(c)(3)(i)(B), which applies to amended returns filed on or after March 2, 2005, treats as a terminating event the “date any person is first contacted by the IRS concerning an examination of that person under § 6700 . . . for an activity with respect to which the taxpayer claimed any benefit on the return,” rather than the date “any person described in § 6700(a)” is contacted. The Bergmanns acknowledge that their amended return would be untimely under the current regulations.
The Bergmanns argue that the Tax Court must have relied on the current regulations because its paraphrase of the regulation tracks the language of current regulation. In its brief, the Government argues that it was clear from both the post-trial briefing and the Tax Court’s decision that the Tax Court was fully aware of which regulation was controlling and in fact cited the correct version. The Government then argues that the Tax Court correctly interpreted the operative regulation. Because the terminating event is the “first contact” with the promoter, the timing should not turn on the ultimate results of the § 6700 investigation of the promoter. And, the Government argues, any ambiguity in the regulations should be resolved by deference to the agency’s interpretation of the regulation. The Treasury Decision accompanying the amended version of the promoter provision explained that the new language was intended to “clarify the existing rules,” and, specifically, that the language “clarifies that the period for filing a qualified amended return terminates on the date the IRS first contacts a person concerning an examination under section 6700, regardless of whether the IRS ultimately establishes that such person violated section 6700.” T.D. 9186, 2005-1 C.B. at 791-82. The taxpayers’ reply brief largely ignores the Government’s arguments. Oral argument has not yet been scheduled.
Briefing Underway in Ninth Circuit on Question of Mortgage Interest Deduction for Non-married Couples
February 6, 2013
Last spring, the Tax Court held in Sophy v. Commissioner, that the limitations on indebtedness for the mortgage interest deduction are applied on a per residence rather than per taxpayer basis. The taxpayers appealed to the Ninth Circuit (Nos. 12-73257 and 12-73261), and filed their opening brief on January 30. The government’s response is due in March.
Under I.R.C. § 163(h)(3), taxpayers are allowed to deduct “qualified residence interest,” which includes interest paid or accrued on acquisition indebtedness with respect to any qualified residence of the taxpayer, or home equity indebtedness with respect to any qualified residence of the taxpayer. For purposes of the deduction, acquisition indebtedness is capped at $1 million and home equity indebtedness is capped at $100,000, for a total indebtedness limit of $1.1 million on up to two residences. The taxpayers, an unmarried couple registered as domestic partners with the State of California, had approximately $2.7 million of indebtedness associated with their primary residence in Beverly Hills and secondary residence in Rancho Mirage, California. They argued that, together, they should be able to deduct interest paid on up to $2.2 million of indebtedness, or $1.1 million each. The Tax Court rejected this position. Parsing the language of the statute, the Tax Court noted repeated references to “residence” in the provisions on the indebtedness limitations and concluded that the limitations are “residence focused rather than taxpayer focused.” The Tax Court also found support for treating the $1.1 million limitation as a per residence rather than per taxpayer limitation in the subsection of § 163(h) that provides that married taxpayers who file separate returns are limited to half of the otherwise allowable amount of indebtedness, and in the general rule that married couples filing jointly are subject to the $1.1 million limitation.
On appeal, the taxpayers argue that § 163(h) should be construed consistently with I.R.C. § 121, which limits the exclusion of gain from the sale of a taxpayer’s “principal residence” to $250,000. Under the regulations, the limitation is applied on a per taxpayer, not per residence basis. Section 163(h) defines “principal residence” with reference to § 121. The taxpayers also argue there is no reason to treat non-married couples the same as married couples for purposes of § 163(h) because differential treatment “is consistent with various provisions of the Code where there is a different result for similarly situated taxpayers based on filing status.”
Ninth Circuit to Rule on Timing for Filing a Qualified Amended Return for an Undisclosed Listed Transaction
May 1, 2012
The taxpayers in Bergmann v. Commissioner are appealing an adverse Tax Court decision, 137 T.C. No. 10, holding that they failed to timely file a qualified amended return for 2001 and thus are liable for the 20-percent accuracy related penalty. The taxpayers participated in a listed transaction promoted by KPMG, known as the Short Option Strategy. In 2004, two years after the IRS issued a summons to KPMG specifically identifying the Short Option Strategy transaction, the Bergmanns filed an amended return disclaiming the tax benefits of the transaction. The case concerns the interpretation of Treas. Reg. § 1.6664-2(c)(3)(ii) (2004), which establishes rules on the timing of filing a qualified amended return for undisclosed listed transactions. If an amended return is filed before certain terminating events, additional tax reported on the amended return will be treated as if it were reported on the original return. Under the “promoter provision,” the amended return must be filed before the IRS first contacts a person concerning liability under section 6700 (a promoter investigation). The Tax Court rejected the taxpayers’ argument that the IRS must establish that the target of the promoter investigation is in fact liable for a promoter penalty. The Tax Court also held that, in investigating the promoter, the IRS need only identify the “type” of transaction in which the taxpayer engaged, not the specific transaction or the identity of the taxpayer.
In 2000-2001, taxpayer Jeffrey Bergmann was a tax partner in KPMG’s Stratecon Group, which the Tax Court characterizes as “focused on designing, promoting and implementing aggressive tax planning strategies for high-net-worth individuals.” In tax years 2000 and 2001, Bergmann entered into a “Short Option Strategy” transaction promoted by fellow KPMG partner Jeffrey Greenberg. This transaction was identified by the IRS as an abusive tax shelter in Notice 2000-44, 2000-2 C.B. 255 (transactions generating losses by artificially inflating basis). The taxpayers (Bergmann and his wife) claimed losses for the 2000 and 2001 Short Option Strategy transactions on their 2001 return, but filed an amended return in March 2004 removing the losses attributable to the transactions and paying approximately $200,000 in additional tax. The IRS treated the qualified amended return as untimely and assessed accuracy-related penalties.
Under Treas. Reg. § 1.6664-2(c)(3)(ii), as in effect when the Bermanns filed their amended return, the time to file a qualified amended return terminates when the IRS first contacts a person “concerning” liability under section 6700 (a promoter investigation) for an “activity” with respect to which the taxpayer claimed a tax benefit. The IRS served KPMG with two summonses in March 2002, one of which was specifically targeted at KPMG’s involvement in promoting transactions covered by Notice 2000-44. Attempting to disassociate their transaction from those that were the subject of the KPMG investigation, the taxpayers argued that Greenberg acted in his individual capacity in advising them, not as an agent of KPMG. The Tax Court rejected this argument, concluding that the transactions in which the taxpayers engaged were within the scope of Greenberg’s responsibilities as a KPMG partner and also concluding that KPMG had not limited Greenberg’s authority to engage in Notice 2000-44 transactions with other KPMG partners, including Bergmann. The Tax Court also rejected the taxpayers’ argument that the promoter investigation must specifically identify the “activity” that gave rise to the tax benefit. The Tax Court held that the summons need only refer to the “type” of transaction in which the taxpayer participated. The court found that the March 2002 summons met this requirement because it specifically identified the transaction as the same or substantially similar to the transaction identified in Notice 2000-44.
The Tax Court noted that disclosure of the transaction after the Notice 2000-44 summons was served on KPMG would not have been voluntary. The Tax Court explained that the purpose of the promoter provision is to encourage taxpayers to voluntarily disclose abusive tax shelters. That purpose is effectuated by terminating the period to file a qualified amended return when disclosure would no longer be voluntary.
The Tax Court addressed a second issue as well. At first glance, the taxpayers appeared to be subject to the 40% gross overvaluation penalty because the scheme depended on what was found to be an artificially inflated based. They argued, however, that the tax underpayment was not “attributable to” the overvaluation because the Commissioner contended (and the taxpayers eventually conceded) that the entire transaction should be disallowed for lack of economic substance, thereby making the valuation irrelevant. The Tax Court noted that this type of bootstrapping argument has been rejected by several circuits, which have held that the 40% penalty applies when overvaluation is intertwined with a tax avoidance scheme, but that Ninth Circuit precedent has accepted the argument. Keller v. Commissioner, 556 F.3d 1056. Accordingly, the Tax Court rejected the IRS’s attempt to impose a 40% penalty, and the taxpayers were assessed only the standard 20% accuracy-related penalty. The IRS has not appealed this issue.
The taxpayers’ opening brief is due on May 16. The case is docketed in the Ninth Circuit as No. 12-70259.