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Former Tax Court Judge Diane L. Kroupa Sentenced in Connection with Tax Evasion Matter

by | Jun 22, 2017 | ,

We have previously blogged on the criminal tax proceedings related to former US Tax Court Judge Kroupa (see here and here). In October 2016, Judge Kroupa pleaded guilty to multiple tax criminal charges related to her tax returns and interactions with the Internal Revenue Service. Based on sentencing guidelines, the recommended sentence was between 30‒37 months. Judge Kroupa and the government submitted filings on the appropriate sentence, in which Judge Kroupa provided detailed reasons why she believed the court should impose a sentence of 20 months imprisonment. These filings can be found here and here. According to a report in today’s BNA Daily Tax Report, the court sentenced Judge Kroupa to 34 months in prison and ordered her to pay $457,000 in restitution, which is owed jointly with her former husband. She was also sentenced to three years of supervised release. Judge Kroupa’s former husband was sentenced to 24 months in prison and one year of supervised release.



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The “Issue of First Impression” Defense to Penalties

by | Jun 14, 2017 | ,

The Internal Revenue Code (Code) contains various provisions regarding the imposition of penalties and additions to tax. The accuracy-related penalty under section 6662(a), which imposes a penalty equal to 20 percent of the amount of any understatement of tax, is commonly asserted on the grounds that the taxpayer was negligent, disregarded rules or regulations, or had a substantial understatement of tax. Over the years, the Internal Revenue Service (IRS) has become increasingly aggressive in asserting penalties and generally requires that taxpayers affirmatively demonstrate why penalties should not apply, as opposed to the IRS first developing the necessary facts to support the imposition of penalties.

There are many different defenses available to taxpayers depending on the type and grounds upon which the penalty is asserted. These defenses include the reasonable basis and adequate disclosure defense, the substantial authority defense, and the reasonable cause defense.

Another defense available to taxpayers is what we will refer to as the “issue of first impression” defense. The Tax Court’s recent opinion in Peterson v. Commissioner, 148 T.C. No. 22, reconfirms the availability of this defense. In that case, the substantive issue was the application of section 267(a) to employers and employee stock ownership plan (ESOP) participants. The court, in a published T.C. opinion (see here for our prior discussion of the types of Tax Court opinions) held in the IRS’s favor on the substantive issue but rejected the IRS’s assertion of an accuracy-related penalty for a substantial understatement of tax on the ground that it had previously declined to impose a penalty in situations where the issue was one not previously considered by the Tax Court and the statutory language was not entirely clear.

The Tax Court’s opinion in Peterson is consistent with prior opinions by the court in situations involving the assertion of penalties in cases of first impression. In Williams v. Commissioner, 123 T.C. 144 (2004), for instance, the substantive issue was whether filing bankruptcy alters the normal Subchapter S rules for allocating and deducting certain losses. The Tax Court agreed with the IRS’s position, but it declined to impose the accuracy-related penalty because the case was an issue of first impression with no clear authority to guide the taxpayer. The court found that the taxpayer made a reasonable attempt to comply with the code and that the position was reasonably debatable.

Similarly, in Hitchens v. Commissioner, 103 T.C. 711 (1994), the court addressed, for the first time, an issue related to the computation of a taxpayer’s basis in an entity. Despite holding for the IRS, the court rejected the accuracy-related penalty. It stated “[w]e have specifically refused to impose additions to tax for negligence, etc., where it appeared that the issue was one not previously considered by the Court and the statutory language was not entirely clear.” Other cases are in accord. See Braddock v. Commissioner, 95 T.C. 639, 645 (1990) (“as we have previously noted, this issue has never before, as far as [...]

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Dealing with Allocations of Tax Liabilities in Non-IRS Agreements

by and | May 23, 2017 | ,

Taxpayers often enter into tax sharing agreements to agree on how the parties may allocate current or future tax liabilities or potential refund. Sometimes these agreements are heavily negotiated (e.g., a corporation acquiring a subsidiary of an unrelated party); sometime they are not (e.g., marital settlement agreements among individuals with little assets). A recent US Tax Court (Tax Court) opinion is a reminder that such agreements between private parties are not binding on the Internal Revenue Service (IRS) in a tax proceeding.

In Asad v. Commissioner, the IRS disallowed certain deductions for rental-property losses claimed by the taxpayers on their joint returns for two years. The taxpayers, who had since divorced, both sought relief from joint and several liability under Internal Revenue Code (Code) Section 6015. In their divorce agreement, the taxpayers agreed that each would be liable for 50 percent of the tax liabilities for the two years. The IRS conceded that each taxpayer should be relieved of joint and several liability for a fraction of the liabilities (28 percent and 41 percent for the ex-wife and 72 percent and 59 percent for the ex-husband). At trial, the taxpayers argued that they should each be liable for 50 percent of the tax liabilities in accordance with the divorce agreement.

The Tax Court disagreed.  It reasoned that although the divorce agreement established the taxpayers’ rights against each other under state law, it did not control their liabilities to the IRS.  The court noted that case law, legislative committee reports, and reports issued by the Department of Treasury and the General Accounting Office have all observed that though divorce decrees may provide for an allocation of liabilities, such an allocation is not binding on creditors who do not participate in the divorce proceeding, and binding the IRS to such a divorce decree was impractical. Accordingly, in this case, though the taxpayers would have agreed to a 50/50 split on the tax liability, their divorce agreement did not alter their liabilities to the IRS.

Practice point:  When negotiating agreement containing a sharing of tax liabilities, taxpayers should remember that such agreement is not binding on the IRS, which is not a party to that agreement.  In the event one party is ultimately found liable for more than the amount or percentage dictated in an agreement, that party must seek contribution from the other party and cannot force the IRS to collect from the other party.



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Chief Special Trial Judge Panuthos to Step Down, Effective September 1, 2017

by | May 16, 2017 | ,

Last week, the US Tax Court (Tax Court) announced that Chief Special Trial Judge (STJ) Peter J. Panuthos has decided to step down as Chief STJ, effective September 1, 2017. STJ Lewis R. Carluzzo will take over as Chief STJ beginning September 1, 2017. STJ Panuthos has been Chief STJ for the past 25 years, and has a long list of accomplishments, including assisting in the expansion of pro bono services to unrepresented taxpayers. The Tax Court’s press release provides more background on STJs Panuthos and Carluzzo.

STJs are an important part of the Tax Court, and perform many different functions for the Court. The statutory authority for STJs is found in Internal Revenue Code (Code) Section 7443A(a), which authorizes the Chief Judge of the Tax Court to appoint STJs. Code Section 7442A(b) provides that the Chief Judge may assign a variety of proceedings to be heard by STJs, any declaratory judgment proceeding, any proceeding under Code Section 7463 (relating to small tax case procedures), any proceeding where the amount in dispute does not exceed $50,000, lien/levy proceedings, certain employment status proceedings, whistleblower proceedings and any other proceedings which the Chief Judge may designate. Although STJs may potentially hear a wide variety of matters, most cases conducted by STJs related to small tax proceedings where the amount in dispute is less than $50,000. These cases are conducted as informally as possible and the rules of evidence are relaxed; however, the trade-off is that these types of cases are not appealable by either party and may not be treated as precedent for any other case (although there is no prohibition against citing such cases for their persuasive value). For more information on the statutory and Tax Court rules on STJs, see here.



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Canadian Tax Court Holds that Agreements Reached Under the Mutual Agreement Procedure are Binding on the Canada Revenue Agency

by and | May 9, 2017 | , , ,

On March 10, 2017, the Tax Court of Canada held that agreements reached under the Mutual Agreement Procedure (MAP) precluded the Canada Revenue Agency (CRA) from redetermining the transfer prices of rock salt sold by Sifto Canada Corp. (Sifto Canada) to a related party in the United States.

In 2006, Sifto Canada reevaluated the transfer pricing of its rock salt sales to its US affiliate for 2002 through 2006. Siftco Canada discovered that the sales prices had been for less than an arm’s length price and in 2007 made an application to the CRA’s voluntary disclosure program reporting additional income from the sale of rock salt for 2002-2006 of over C$13 million. In 2008, the CRA accepted the application and assessed additional tax on that income.

After the assessment, Sifto Canada applied to the Canadian Competent Authority (CCA) and its US affiliate applied to the United States Competent Authority (USCA) for relief from double taxation under Articles IX and XXVI of the Convention between Canada and the United States of America with Respect to Taxes on Income and on Capital, as amended (the Treaty). The CRA did not audit Sifto Canada during this time and based its position paper on Sifto Canada’s voluntary disclosure application. Under the MAP process, the USCA and CCA then agreed to the transfer prices.

During the negotiation process for the MAP, the CRA began auditing the transfer prices of the rock salt for those years and then, subsequent to the signing of the MAP agreements, the CRA determined that the transfer prices should have been even higher than the amounts reported by Sifto Canada in the voluntary disclosure and issued further reassessments of its tax.

The CRA argued that: (1) the MAP agreements only provided relief from double taxation and did not set transfer prices; (2) the CCA only entered into agreements with the USCA and did not enter into a binding agreement with Sifto Canada regarding the transfer prices; and (3) that the government had a duty to reassess the tax once it determined that the transfer prices were not at arm’s length.

The Tax Court of Canada did not agree with the CRA and held the government to its MAP agreements. The Court found that by reaching an agreement under the MAP process, the CCA necessarily had to find that the transfer prices were at arm’s length under the Treaty. Further, the Court found that under the factual matrix of this case, the CCA’s letters exchanged with Siftco Canada clearly described the terms of the MAP agreements, asked Siftco Canada to accept those terms, and Sifto Canada then accepted the terms establishing a binding agreement. Finally, the Court found the agreements were not “indefensible on the facts and the law” and thus were binding on the Canadian government.

Practice Point:  This case is helpful to taxpayers with cross-border transactions between the US and Canada and demonstrates that MAP agreements are binding on the CRA.



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The IRS’s Assault on Section 199 (Computer Software) Doesn’t Compute

by , and | Apr 24, 2017 | , , , , ,

Internal Revenue Code Section 199 permits taxpayers to claim a 9 percent deduction related to the costs to develop software within the U.S. The relevant regulations and their interpretation, however, place substantial restrictions on claiming the benefit.

Moreover, the regulations and the government’s position haven’t kept up with the technological advances in computer software.

Before claiming the deduction on your return, consider that the Internal Revenue Service has this issue within its sights, and perhaps it will be the subject of one of their new “campaigns.”

In 2004, Congress enacted I.R.C. Section 199 to tip the scales of global competitiveness more in favor of American business. The main motivation of the statute was to create jobs by encouraging businesses to manufacture and produce their products in the U.S. The tax benefit, however, isn’t available for services, a theme that pervades many of the provisions in the statute and regulations.

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Originally published in Bloomberg BNA Daily Tax Report – April 24, 2017 – Number 77



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Overview of Tax Litigation Forums

by and | Apr 21, 2017 | , , , , ,

Taxpayers can choose whether to litigate tax disputes with the Internal Revenue Service (IRS) in the US Tax Court (Tax Court), federal district court or the Court of Federal Claims. Claims brought in federal district court and the Court of Federal Claims are tax refund litigation: the taxpayer must first pay the tax, file a claim for refund, and file a complaint against the United States if the claim is not allowed. Claims brought in the Tax Court are deficiency cases: the taxpayer can file a petition against the IRS Commissioner after receiving a notice of deficiency and does not need to pay the tax beforehand.

As demonstrated in the chart below, approximately 97 percent of tax claims are instituted in the Tax Court. It should be noted that, after a taxpayer files a petition in Tax Court, the taxpayer no longer has the option of bringing the claim in any other court for the year(s) at issue.

Tax Court Versus Tax Refund Litigation

Source: https://www.irs.gov/uac/soi-tax-stats-chief-counsel-workload-tax-litigation-cases-by-type-of-case-irs-data-book-table-27

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APA Challenge to Notice of Deficiency: QinetiQ Requests Supreme Court Review

by and | Apr 13, 2017 | , , , ,

On April 4, 2017, QinetiQ U.S. Holdings, Inc. petitioned the US Supreme Court to review the US Court of Appeals for the Fourth Circuit’s decision that the Administrative Procedure Act of 1946 (APA) does not apply to the Internal Revenue Service (IRS) Notices of Deficiency. We previously wrote about the case (QinetiQ U.S. Holdings, Inc. v. Commissioner, No. 15-2192) here, here, here and here. To refresh, the taxpayer had argued in the US Tax Court that the Notice of Deficiency issued by the IRS, which contained a one-sentence reason for the deficiency determination, violated the APA because it was “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” The APA provides a general rule that a reviewing court that is subject to the APA must hold unlawful and set aside an agency action unwarranted by the facts to the extent the facts are subject to trial de novo by the reviewing court. The Tax Court disagreed, emphasizing that it was well settled that the court is not subject to the APA and holding that the Notice of Deficiency adequately notified the taxpayer that a deficiency had been determined under relevant case law. The taxpayer appealed to the 4th Circuit, which ultimately affirmed the Tax Court’s decision. (more…)



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Santander Holdings USA Asks the Supreme Court to Address Economic Substance Doctrine

by | Apr 7, 2017 | , , ,

From 2003 to 2007, Sovereign Bancorp, Inc. (Sovereign) – now known as Santander Holdings USA, Inc. (Santander) – engaged in a so-called STARS transaction with Barclays Bank. According to Santander, “[b]y engaging in the STARS transaction, Sovereign transferred some of its income tax liability from the United States to the United Kingdom,” it “secured a loan of $1.15 billion,” and it received a payment “which effectively reduced its lending costs.” On its Federal corporate income tax returns for those years, Sovereign claimed foreign tax credits (FTCs) for UK taxes it paid in connection with the STARS transaction. It also claimed deductions for the interest paid on the $1.15 billion loan.

In 2009, the Internal Revenue Service (IRS) issued a Notice of Deficiency disallowing Sovereign’s FTCs and its deductions for interest paid on the $1.15 billion loan. The IRS did not challenge Sovereign’s compliance with the statutory and regulatory rules governing FTCs, instead arguing that Sovereign’s STARS transaction lacked “economic substance.” Sovereign paid the deficiency and sued for a refund in the US District Court for the District of Massachusetts. When the district court held for Sovereign on both issues, the IRS appealed to the US Court of Appeals for the First Circuit, but only with respect to the FTC issue. The crux of the issue was how to treat the UK taxes and the related FTCs for purposes of the “economic substance” analysis. Relying on Salem Financial, Inc. v. U.S., 786 F.3d 932 (Fed. Cir. 2015), and Bank of New York Mellon Corp. v. Comm’r, 801 F.3d 104 (2d Cir. 2015), the IRS argued that the UK taxes should be treated as an expense but that the related FTCs should be ignored in determining pre-tax profit. Citing IES Indus., Inc. v. U.S., 253 F.3d 350 (8th Cir. 2001), and Compaq Computer Corp. v. Comm’r, 277 F.3d 778 (5th Cir. 2001), Sovereign argued that either both should be included in the profit analysis or both should be ignored. The First Circuit held that Sovereign’s STARS transaction lacked “economic substance,” and upheld the disallowance of the FTCs at issue. In doing so, it treated the UK taxes as expenses that reduced pre-tax profit and ignored the related FTCs, following the Federal and Second Circuit’s approach. Santander Holdings USA, Inc. v. U.S., 844 F.3d 15 (1st Cir. 2016).

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Tax Court Holds Section 883 Regulations Valid under Chevron Test

by | Apr 3, 2017 | , , , ,

On March 28, 2017, the US Tax Court issued its opinion in Good Fortune Shipping SA v. Commissioner, 148 T.C. No. 10, upholding the validity of regulations issued under Internal Revenue Code (Code) Section 883.

Code Section 887(a) imposes a four percent tax on a foreign corporation’s US-source gross transportation income for each year. Code Section 883(c)(1) exempts from US tax a foreign corporation’s gross income from the international operation of ships if the foreign country in which the corporation is organized grants an equivalent exemption to corporations organized in the United States. Code Section 883(c)(1) provides that this exemption does not apply if 50 percent or more of the value of a foreign corporation’s stock is owned, directly or indirectly, by individuals who are not residents of a foreign country that grants an equivalent exemption to US corporations. Regulations issued under Section 883 provide that ownership through shares of a foreign corporation issued in bearer form is disregarded in determining whether the corporation passes the 50 percent or more test (Ownership Regulations).

The taxpayer in Good Fortune Shipping challenged the validity of the Ownership Regulations. It based its challenge on its claim that the Ownership Regulations do not satisfy the two prongs of the test under Chevron USA, Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984). This argument, in turn, was based primarily—if not exclusively—on the taxpayer’s assertion that US Congress had left no “gap” in Code Section 883 for US Department of the Treasury and the Internal Revenue Service (IRS) to fill; this is because the operative term “own” that appears in the statute has a common, ordinary meaning such that further interpretation by the IRS is not necessary. Thus, the taxpayer argued, the Ownership Regulations fail step one of the Chevron analysis. (more…)



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