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District Court Broadly Interprets Informal Claim Doctrine

by Kevin Spencer and McDermott Will & Emery | Oct 5, 2021 | Court Procedure Matters, Tax Refunds, Trial Courts

Internal Revenue Code (Code) section 7803(a)(3)(C) provides that taxpayers have “the right to pay no more than the correct amount of tax.” However, there are two relevant considerations to this “right.” First, the Internal Revenue Service (IRS) must take the appropriate steps before it can assess and collect any amount of tax beyond that reported by the taxpayer. Second, taxpayers who believe they overpaid their tax must take affirmative steps to protect their rights to claim a refund before the period of limitations on seeking a refund expires. We recently provided an overview of these steps.

Taxpayers traditionally claim the right to an income tax refund (or credit) by filing a formal amended tax return using the appropriate form prescribed by the IRS (e.g., Form 1040X, Form 1120X, etc.) under IRS procedures and guidelines (e.g., Code section 6402 and the underlying regulations). However, in some situations, taxpayers can assert a valid refund claim through other means such as correspondence or other written communications with the IRS that is not made by filing a formal amended tax return. Courts have consistently recognized the validity of so-called “informal” refund claims and explained that such claims must have a written component that gives the IRS sufficient notice of the fact that the taxpayer believes they have overpaid their income tax and that a refund is due.

Likewise, the IRS acknowledges the propriety of the informal claim doctrine. However, the IRS’s position appears to be inconsistent as Internal Revenue Manual 25.6.1.10.2.6(3) (09-29-2015) references the judicially-created informal claim doctrine noted above, but Publication 5125, which discusses the IRS’s Large Business & International examination process, states that the claim must also be made under penalties of perjury. (See: Internal Revenue Manual 25.6.1.10.2.6.3 (09-29-2015).)

The recent district court decision in Johnson v. United States (No. 2:10-cv-01561-TLN-JDP (E.D. Cal., Sept. 30, 2021) addressed whether correspondence between taxpayers and the Taxpayer Advocate Service (TAS) can give rise to an informal claim. The taxpayers in that case reviewed copies of their tax account transcripts for several years and determined that funds offset by the IRS from tax years 2013 and 2014 and applied to earlier tax years were incorrect because there was no liability remaining in those earlier years. Specifically, the taxpayers argued that they were entitled to refunds for tax years 2009 and 2010 and relied on discussions and correspondence with TAS, including a faxed letter summarizing the timeline of the issues, to support their position that their refund claim was timely under the informal claim doctrine. The IRS argued that the informal claim doctrine did not apply because the letter did not include facts sufficient to apprise the IRS of the factual basis for the claims; the letter only referenced 2009 (and therefore was insufficient for 2010) and was not signed under penalties of perjury.

The district court sided with the taxpayers regarding the year 2009, finding that the letter constituted an informal claim under the judicially-created informal claim [...]

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IRS Acknowledges Limitations on Use of Outside Contractors in Audits

by Kevin Spencer, Evan Walters and McDermott Will & Emery | Sep 10, 2021 | IRS Audits, IRS Guidance, Trial Courts

Several years ago, it came to light that the Internal Revenue Service (IRS) had hired a law firm to assist with transfer pricing matters in an ongoing audit of a large corporate taxpayer. Contemporaneous with that hiring, the IRS issued temporary regulations providing that third-party contractors “may receive books, papers, records, or other data summoned by the IRS and take testimony of a person who the IRS has summoned as a witness to provide testimony under oath” and “clarifying that contractors are permitted to participate fully in a summons interview.” We previously discussed this highly controversial position here.

Congress seemingly disapproved of the IRS practice of outsourcing legal and audit services to private law firms. In 2019, it enacted Internal Revenue Code (Code) Section 7602(f) as part of the Taxpayer First Act. That provision prohibits the IRS from hiring outside contractors for purposes other than providing “expert evaluation and assistance” and specifically prohibits non-IRS employees from questioning witnesses under oath. However, no definition was provided as to the meaning “expert evaluation and assistance.”

The IRS recently finalized regulations (applicable to summonses served on after August 6, 2020) providing taxpayer-favorable guidance on the meaning of “expert evaluation and assistance.” Under the final regulations, the IRS may not engage outside legal counsel unless the attorney is hired by the IRS for expertise in (A) foreign, state or local law, (B) non-tax substantive law that is relevant to an issue in the examination, or (C) knowledge, skills or abilities other than providing legal services as an attorney (such as a translator). In addition, the final regulations prohibit IRS contractors from asking a witness (or his or her representative) to clarify an objection or assertion of privilege, as well as from asking questions to witnesses generally, when the witness is under oath.

Practice Point: The final regulations provide helpful guidance to taxpayers regarding the role that outside contractors can play in IRS audits and provide a much-needed deterrent on the IRS’s outsourcing of audits to private law firms. However, taxpayer who believe that the IRS is using outside counsel may want to request in writing a list of all third parties that the IRS contacts during the course of the examination.

Weekly IRS Roundup June 7 – June 11, 2021

by McDermott Will & Emery | Jun 14, 2021 | Appellate Courts, Court Procedure Matters, IRS Guidance, Tax Reform, Tax Refunds, Trial Courts

Presented below is our summary of significant Internal Revenue Service (IRS) guidance and relevant tax matters for the week of June 7, 2021 – June 11, 2021. Additionally, for continuing updates on the tax impact of COVID-19, please visit our resource page here.

June 7, 2021: The IRS issued a news release announcing it has begun sending letters to inform more than 36 million American families of their potential eligibility to receive monthly Child Tax Credit payments beginning in July, pursuant to the expansion of the Child Tax Credit under the American Rescue Plan Act of 2021 (ARPA).

June 8, 2021: The IRS issued a news release, soliciting applications for 80 vacancies within its Procurement office, including vacancies for contract specialists who assist the IRS in the procurement and administration of third-party contracts.

June 8, 2021: The IRS issued a news release reminding taxpayers who make estimated tax payments that the second installment of estimated taxes for 2021 is due June 15, 2021.

June 9, 2021: The IRS issued a news release announcing the disbursement of more than 2.3 million Economic Impact Payments worth more than $4.2 billion, bringing the total amount of disbursements under ARPA to more than 169 million payments worth approximately $395 billion.

June 10, 2021: The IRS issued Notice 2021-36, announcing that the applicability date for certain regulations under sections 59A and 6038A of the Code, which set forth various reporting requirements with respect to qualified derivative payments (QDPs) for purposes of the base erosion and anti-abuse tax (BEAT), is delayed to the 2023 taxable year.

June 11, 2021: The IRS issued final regulations regarding the new mandatory 60-day postponement of certain tax deadlines due to a federally-declared disaster, enacted as section 7805A(d) of the Code by the Further Consolidated Appropriations Act, 2020.

June 11, 2021: The IRS issued Revenue Ruling 2021-11, providing the semi-annual Standard Industry Fare Level (SIFL) rates and terminal charges used in computing the value of noncommercial flights on employer-provided aircrafts for purposes of the taxation of fringe benefits under section 61 of the Code. The Revenue Ruling provides both unadjusted SIFL rates and SIFL rates adjusted for relief provided to the airline industry by COVID-related legislation.

June 11, 2021: The IRS issued an Action on Decision, announcing it would not acquiesce to TriNet Group, Inc. v. United States, 979 F.3d 1311 (11th Cir. 2020), which held that a professional employer organization (PEO) had “control of the payment of wages” to its clients’ employees and therefore the PEO—not its clients—was the “employer” (under section 3401(d) of the Code) eligible to claim Federal Insurance Contributions Act (FICA) tip tax credits with respect to such wages.

June 11, 2021: The IRS issued a news release and two sets of FAQs, providing assistance to families and small businesses claiming [...]

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Ninth Circuit Holds Tax Form is Substance

by Kevin Spencer and McDermott Will & Emery | Jun 4, 2021 | Appellate Courts, Court Procedure Matters, Trial Courts

The substance over form doctrine (and related step transaction and economic substance doctrines) are often invoked by courts to disallow tax consequences that seem too good to be true. Courts have struggled for years with how to properly apply these doctrines. Those advocating against application usually rely on the famous passage by Judge Learned Hand in Helvering v. Gregory, 69 F.2d 809, 810 (2d Cir. 1934): “Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.” Those advocating for this position seek shelter in cases like Commissioner v. Court Holding Co., 324 U.S. 331, 334 (1945), in which the Supreme Court of the United States stated, “the incidence of taxation depends upon the substance of a transaction. …. To permit the true nature of a transaction to be disguised by mere formalisms, which exist solely to alter tax liabilities, would seriously impair the effective administration of the tax policies of Congress.” But ultimately, as the Supreme Court explained in Gregory v. Helvering, 293 U.S. 465, 469 (1935), “the question for determination is whether what was done, apart from the tax motive, was the thing which the statute intended.”

However, what the statute intended is not always easy to determine. In Mazzei v. Commissioner, No. 18-82451 (9th Cir. June 2, 2021), the US Court of Appeals for the Ninth Circuit answered this question in the context of tax motivated transactions involving the since-repealed foreign service corporation (FSC) regime that was complied with all the formalities required by the Internal Revenue Code but which the Internal Revenue Service (IRS) asserted should nonetheless be recharacterized under the substance over form doctrine. The Court noted it is a “black-letter principle” and courts follow “substance over form” in construing and applying the tax laws. However, this doctrine is not a “smell test” but rather a tool of statutory construction that must be applied based on the statutory framework at issue. Thus, in appropriate situations where Congress indicates that form should control, the substance over form doctrine is abrogated.

That is exactly what happened in Mazzei. Agreeing with the First, Second and Sixth Circuits, which had previously addressed similar issues, the Ninth Circuit found that the statutory framework and history indicated that Congress did not intend for the substance over form doctrine to apply to the FSC regime. While “[i]t may have been unwise for Congress to allow taxpayers to pay reduced taxes” under the statutory scheme, “it is not our role to save the [IRS] from the inescapable logical consequence of what Congress has plainly authorized.”

Practice Point: The distinction between tax avoidance (permissible) and tax avoidance (impermissible) is not always an obvious line. Taxpayers should be able to rely on the words used by Congress when enacting tax laws, but courts [...]

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Supreme Court Opens Door to APA Challenge of Overreaching IRS Information Reporting Regime

by Kevin Spencer, Jenny L. Johnson Ware and McDermott Will & Emery | May 28, 2021 | Appellate Courts, Court Procedure Matters, IRS Audits, IRS Guidance, Trial Courts

In CIC Services, LLC v. Internal Revenue Service, a unanimous US Supreme Court allowed CIC, a tax advisor, to proceed with a pre-enforcement challenge to the Internal Revenue Service’s (IRS) “reportable transaction” regime. CIC alleged that the IRS violated the Administrative Procedure Act (APA) when it issued Notice 2016-66 (Notice), deeming certain micro-captive insurance transactions as “reportable transactions” and sought an order enjoining enforcement of the Notice. The IRS sought to avoid judicial review by hiding behind the Anti-Injunction Act’s (AIA) bar on suits brought “for the purpose of restraining the assessment or collection of any tax.” Disagreeing with the trial and appellate courts, the Supreme Court allowed CIC’s suit to proceed, finding that CIC was challenging a regulatory mandate separate from any tax. As the Court explained, “The tax appears on the scene – as criminal penalties do too – only to sanction that mandate’s violation.” By choosing to address their concerns about micro-captive transactions by imposing a non-tax reporting obligation, Congress and the IRS “took suits to enjoin their regulatory response outside the Anti-Injunction Act’s domain.”

On remand, the Court’s decision leaves open questions that the lower courts must now address while also providing meaningful clues about how the Court may approach future disputes over IRS enforcement strategies. Such questions include: (1) does the reportable transaction regime as the IRS currently administers it violate the APA (See: Mann Construction, Inc. v. United States, No. 1:20-cv-11307 (E.D. Mich. May 13, 2021) (holding that IRS Notice requiring disclosure of listed transactions was not subject to APA’s notice-and-comment requirement); (2) would the AIA bar a suit to enjoin enforcement of a reporting obligation brought by a taxpayer, as opposed to an advisor; (3) how onerous must the challenged requirement be; (4) how disconnected from the tax penalty must the challenged requirement be and (5) is the existence of criminal penalties sufficient and/or necessary to exempt a challenge from the AIA?

Practice Point: APA challenges in tax cases have steadily increased since the Supreme Court’s rejection of tax exceptionalism 10 years ago in Mayo Foundation for Medical Education & Research v. United States, 562 U.S. 44 (2011). As tax law continues to get more complicated and the IRS issues additional guidance, we can expect this trend to continue. Understanding how to use the APA to challenge the overreaching of the IRS is an important tool for taxpayers and tax advisors alike. In the absence of a clear congressional mandate, any new enforcement policy issued by the IRS may be fair game for an APA challenge. The Supreme Court has opened the door to judicial review of unsanctioned IRS programs that place unfair burdens on taxpayers. And, this issue extends beyond the reportable transaction regime, including to the information reporting proposals recently announced by the Biden Administration.

Eighth Circuit Holds the Mayo in Tax Regulation Invalidity Case

by Kevin Spencer and McDermott Will & Emery | May 17, 2021 | Appellate Courts, Court Procedure Matters, Tax Reform, Trial Courts

In the latest tax regulation deference case, the Eighth Circuit provided guidance to taxpayers and tax practitioners on the “analytical path” to resolve the question of whether a tax regulation is a valid interpretation of the Internal Revenue Code. The court held that the regulation was invalid in part because it unreasonably added conditions to the statutory requirements for qualified educational organizations, however, it was valid as to its interpretation regarding the permissible scope of the taxpayer’s activities to fit within the applicable statute. The opinion is noteworthy for its detailed examination of statutory and legislative history, judicial interpretations and agency position during legislation in its analysis of Congress’ intent.

Deference is one topic that captivates many, and tax cases referencing Chevron, Skidmore and Auer (and more recently Kisor) always grab attention. The latest deference case in the tax area is Mayo Clinic v. United States, No. 19-3189 (8th Cir. May 13, 2021). For some background on deference, including the district court proceedings in the Mayo Clinic case, see here.

In the Mayo Clinic case, the question was whether the taxpayer was a “qualified organization” exempted from paying unrelated business income tax (UBIT) on unrelated debt-financed income under Internal Revenue Code (Code) Section 514(c)(9)(C)(i). Answering this question required determining whether the taxpayer was an “educational organization which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activity are regularly carried on” within the meaning of Code Section 170(b)(1)(A)(ii). Relying in part on Treasury Regulation Section 1.170A-9(c)(1), the government asserted that the taxpayer was not a qualified organization because it was not an educational organization because its primary function was not the presentation of formal instruction (primary-function requirement) and its noneducational activities were not merely incidental to the educational activities (merely-incidental requirement). The district court – Mayo Clinic v. United States, 412 F.Supp.3d 1038 (D. Minn. 2019) – held in favor of the taxpayer and invalidated the regulation, holding that the primary-function requirement and the merely-incidental requirement were not intended by Congress to be included in the statute. The Eighth Circuit reversed and remanded the decision. Implementing the longstanding two-pronged deference test under Chevron U.S.A. Inc. v. NRDC, 467 U.S. 837 (1984) and acknowledging recent precedent in Kisor v. Wilkie, 139 S.Ct. 2400 (2019), the Mayo Clinic court emphasized that the question before it was whether the government “stayed within the bounds of its statutory authority.” To answer this question, the court stated that to determine whether the statute was unambiguous required examining the statutory history and applying traditional tools of statutory construction. This led the Eighth Circuit to trace the evolution of the Code over more than a century, focusing on changes to statutory language, legislative history, agency positions during the legislative process and judicial interpretations of the law.

Based on this exhaustive analysis of the evolution of [...]

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Finding John Doe: IRS Steps up Enforcement Efforts to Take the Anonymity Out of Virtual Currency

by McDermott Will & Emery | Apr 21, 2021 | Court Procedure Matters, IRS Audits, IRS Guidance, Trial Courts

The Internal Revenue Service (IRS) is stepping up its virtual currency enforcement, and taxpayers who have engaged in a cryptocurrency transaction should immediately assess any potential tax implications as the IRS has recently issued two John Doe summonses to popular exchanges. These are the first it has issued in about three years, sending a very clear signal that the IRS is ready to tackle what it believes to be a continuing noncompliance. A US Federal District Court in Massachusetts upheld the summons issued to Circle Internet Financial Inc., including the popular cryptocurrency exchange Poloniex, while a US Federal Court for the Northern District of California required the government to submit a response explaining its need for the information requested in its summons to Kraken. (See: In re Tax Liability of John Does, No. 21-cv-2201, ECF No. 8 (N.D. Cal. Mar. 31, 2021)).

Filed on April 14, 2021, the government’s response provided numerous examples of how the data received in the Coinbase summons required additional requests in order for the exchange to locate actual taxpayers. The response argued that the need for multiple follow-ups defeated the purpose of the summons. It also described how information in Kraken’s possession, such as accountholder telephone numbers and email addresses, will facilitate the IRS’s ability to utilize relevant cryptocurrency platform data in its possession that was received from other sources relating to foreign-based cryptocurrency exchanges. Noting the potential for abuse by an accountholder, the response provided an example of an individual falsifying their identity as the basis for its need for complete account history in order to catch these issues. In addition, the response stated, “[m]atching the IP addresses for Kraken users to IP addresses and other data points in the IRS’s information will allow the IRS to link substantive account information from multiple sources for a single individual taxpayer and make a more accurate initial determination of whether that individual is in compliance with the internal revenue laws.”

It remains to be seen how the court will react to the government’s response. What is clear, though, from the response and the accompanying affidavit is that the IRS has made significant progress in its analysis of this data and its ability to follow leads. As a result, now is the time for individuals involved in these transactions to consult a tax professional to determine if they have any tax liability or potential exposure, including criminal exposure. After the Coinbase summons, the IRS issued 10,000 letters to taxpayers regarding virtual currency transactions. In the wake of these summonses, and potentially others, it is only a matter of time before the IRS reaches out to thousands of other taxpayers.

It is also clear that the enforcement arm of the IRS is working very closely with its counterparts around the world. The need for email addresses and phone numbers mentioned above to use foreign data certainly drives this point home. Even more so, as a precursor of things to [...]

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Exxon Prevails in $200 Million Tax Penalty Case

by Kevin Spencer and McDermott Will & Emery | Jan 26, 2021 | Appellate Courts, IRS Appeals, Settlements, Tax Refunds, Trial Courts

On January 13, 2021, the US District Court for the Northern District of Texas ruled in favor of Exxon Mobil Corporation (“Exxon”) in its battle against the government over tax penalties. Exxon filed amended returns for its 2006-2009 tax years seeking a $1.35 billion tax refund based upon a change of character of certain transactions (from mineral leases to purchase transactions). The government disallowed the refund claims and imposed a $200 million penalty pursuant to Internal Revenue Code (IRC) section 6676. Exxon paid the penalty and filed suit for a refund.

We have written extensively concerning IRC section 6676, warning taxpayers of this potential landmine. See, e.g., “Taxpayers Should Prepare for the Next Penalty Battleground” Roberson, Spencer and Walters, Law360 (May 21, 2019) and “Expect More Civil Tax Penalties—So, Now What?” Roberson and Spencer, Tax Executive (Sept. 27, 2019). To recap, IRC Section 6676 was enacted in 2007 in response to the high number of meritless refund claims being filed at the time. It imposes a 20% penalty to the extent that a claim for refund or credit with respect to income tax is made for an “excessive amount.” An “excessive amount” is defined as the difference between the amount of the claim for credit or refund sought and the amount that is actually allowable. For example, if the taxpayer claims a refund of $2 million and the Internal Revenue Service (IRS) allows only $1 million, the taxpayer can still be penalized $200,000.Significantly, IRC section 6676 does not require the IRS to show any fault or culpability on the part of the taxpayer—e.g., negligence, disregard of rules or regulations, etc. IRC section 6676(a) originally provided a “reasonable basis” defense (which is applicable to the Exxon case), but in 2015 Congress amended the statute and now requires a showing of “reasonable cause.” Neither the Code nor the regulations provide for any other defense to the IRC section 6676 penalty. Moreover, the penalty is immediately assessable, meaning taxpayers cannot fight the IRS in a pre-payment forum like the US Tax Court but must first pay the penalty and seek redress in a refund form.

In Exxon, the government argued that the court should overlay a subjective element on “reasonable basis,” as the US Circuit Court for the Eighth Circuit did in Wells Fargo & Co. v. United States, 957 F.3d 840 (8th Cir. 2020). Our prior coverage of this case can be found here. The Exxon court declined the invitation. Instead, the court explained IRC section 6676 “focuses on whether the claim had a reasonable basis, not on whether the taxpayer had a reasonable basis.” The court agreed with Exxon that its position in the refund claim that its transactions were purchases was reasonable based on the relevant authorities. It further found that the company had “colorable support for its legal contention that a change that affects whether, not when, an item comes into income is not [...]

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Let’s All Stop and Reflect for a Moment

by McDermott Will & Emery | Dec 21, 2020 | Appellate Courts, Tax Reform, Trial Courts

In a recent article for the American Bar Association’s ABA Tax Times, McDermott partner Andrew R. Roberson reflected on 2020 and the importance of giving back.

“From COVID-19 to the Black Lives Matter movement; from home office and Zoom to remote learning for students; and so on—these events have impacted us all, both on professional and personal levels.”

Access the article.

Tax Court Announces New Case Management System to Go Live Before New Year’s

by Kevin Spencer and McDermott Will & Emery | Dec 18, 2020 | Court Procedure Matters, Trial Courts

We previously reported on the US Tax Court’s (Tax Court) announcement that it was changing its case management system, DAWSON (Docket Access Within a Secure Online Network). This morning, the Tax Court issued a press release confirming the launch of DAWSON on December 28, 2020. Temporary credentials for taxpayers and practitioners already registered for electronic access will be sent no later than December 28, 2020, and will be valid for seven days. Expanded guidance on using DAWSON, including FAQs, will be available shortly on the Tax Court’s website.

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