2007 Midyear meeting of the ABA Tax Section

This past week the Tax Section of the American Bar Association held its midyear meeting in Hollywood, Florida. I was able to attend two break-out sessions of interest – Tax Shelters and Court Procedure and Practice.

Caveat: As stated by the Government attorneys at these sessions: Their comments do not necessarily represent the views of the Government but are their respective individual views on the subject matter. Therefore, out of respect I will not associate any of the statement with the individual who made the statement.

Tax Shelters – The first topic of interest was whether the doctrine of economic substance was going to be codified. The government officials recognize that our tax system is based on a code and taxpayers are entitled to certainty based on those rules. However, the tax system is also based on a series of principles that guide taxpayers and their planners. These principles underlie the code and must be accounted for when considering various the planning opportunities that exist. These principles are flexible and therefore to “codify” these doctrines would enable a certain segment of “tax planners” to plan around the definition. Thus, whereby previously the flexible and evolving doctrine would have voided the doctrine, the plan may be structured to avoid the literal terms of the definition of economic substance. Compare Coltec with UPS. Thus understandably, the government officials were not enthusiastic about seeking a codification of the economic substance doctrine. As will be discussed later, the IRS and Treasury Department are already concerned about the next generation of tax shelters and want a system which is flexible enough to combat the new generation of “tax shelters”, without resorting to another series of code changes that we saw in the 1980’s such as the passive activity loss rules.

Observation: Although I tend to agree and sympathize with the government, the one problem that I see is that the doctrine of economic substance depends on which circuit the individual resides and which forum the taxpayer elects to enter into. For example a taxpayer who resides in the Fifth Circuit has a better opportunity to prevail on the same transaction without incurring a 40% penalty than a taxpayer that resides in the Fourth and Third circuits. (Compare Compaq and Todd with ACM, Long Term Capital, and Rice's Toyota World, Inc.). Let alone the lack of uniform definition will cause forum shopping to arise based on the definition of economic substance. Compare Coltec with Salina. Thus, the doctrine of consistency is being violated. Therefore, I recommend that we all stay tuned to see whether the Supreme Court grants Coltec’s Writ of Certiorari.

Another topic was the tax shelter regulations and Circular 230. As stated before the Government is concerned about the next generation of tax shelters. With that said, it was stated that the “new” provisions of Circular 230 are too weak. In their opinion, Circular 230 has been reduced to a disclaimer statement on letters, e-mails, etc. Thus, expect new guidance shortly. Along those reins, the Government is looking forward to receiving comments as to the tax shelter regulations concerning “Transaction of Interest” (aka Listed Light). The concern is that if taxpayers do not report these transactions then the IRS may view the transaction as a deadly sin, even though the transaction was not designed to avoid taxes. On the other extreme to much information will cause the IRS to be overwhelmed. Members of the ABA’s Tax Shelter sub-committee will submit their respective views on the matter so stay tuned.

Court Procedure and Practice – The topics of interest that were discussed was Dual Prosecution and Textron. To say that at times it was contentious is an understatement. As most readers are aware the Service’s policy has changed concerning Dual Prosecutions. In summary, the prior policy was once criminal prosecution was over then civil action commenced. The reason for the policy is the limited discovery in criminal proceedings in contrast to the open discovery rules of civil litigation. Fast forward, the IRS wants those that promote the new generation of tax shelters to understand that they face criminal and civil sanctions for these shelters. Thus, the policy was revisited due to the tax shelter that we have seen. See KPMG trial in New York.

As pointed out by the audiences’ questions, the problem lies in preparing the civil cases. Needless to say a deposition and a trial proceeding were the Fifth is asserted carries presumptions against the taxpayer. Just as important is the government’s use of “pattern evidence” wherein a taxpayer is subpoenaed to testify as to a transaction that he/she was involved with. Needless to say, the testimony of the witness will be used against the witness when the investors’ transaction is at issue and may be used against the witness if a criminal proceeding is sought. Needless to say this raises a concern for both the investor and his counsel, as in criminal cases there is that old presumption of innocence.

The next issue involved U.S. v. Textron. Textron is a summons case concerning “tax accrual workpapers”. The facts are straightforward: Textron’s in-house counsel provided the accountants for purposes of certifying the financial statements a spreadsheet that lists the issues identified by the tax advisors and, for each issue, the hazards of litigation percentage determined by the tax advisors. Needless to say the government wants this document and is claiming under Powell that it is entitled to these documents. Textron is asserting three privileges: Attorney-client, Section 7525 and work-product. The case has been fully briefed and closing arguments were heard just last week.

The issue is not one of discovery as that standard is relatively light and favorable for the government. But rather this is a battle as to the work-product doctrine and what the government intends to do not with the worksheet but with the attorneys. After all the premise of the Governments’ position is clear: there was subject matter waiver and therefore the attorneys and the documents they relied to form their opinions are now fair game. Compare Arthur Young with Roxworthy and Adlman. With FIN 48 Disclosures on IRS Examinations and Administrative Practice being unanimously passed, it would be wise to monitor Textron as it proceeds up the judicial chain.

Finally, I attended the Court Procedure and Practice Officers and Committee meeting. The Committee will be submitting our views to the Court’s new rules. The IRS is concerned about premature assessments due to the new rules concerning the social security numbers. The ABA is concerned about greater access to on-line documents as currently only those practitioners in Washington, D.C. will have access to the on-line documents.

The topics for the Washington meeting in May were discussed. Of interest will be FIN 48, TEFRA settlements, the importance if any of burden of proof (see McCord) and a workshop for young lawyers as to responding to the government’s request for information.

Announcement 2006-100: Appeals Closing Cases Involving Unsettled Listed Transactions

Announcement 2006-100 provides in relevant part:

"When a settlement cannot be reached by the Office of Appeals in a case that is not docketed in the Tax Court, it is expected that the case will proceed to litigation. The Service wants to ensure that it has fully developed the limited number of unagreed cases that involve listed transactions (within the meaning of Treas. Reg. § 1.6011-4) before it sends a statutory notice of deficiency (or other determination notice triggering litigation rights) to the taxpayer. Consequently, the Service is revising its procedures to provide that when the Office of Appeals and the taxpayer are unable to reach a satisfactory settlement in a nondocketed case involving a listed transaction, the Office of Appeals will close out its consideration, notify the taxpayer, and send the case to the appropriate Operating Division for further handling."

Announcement 2006-100 has created quite a stir. For an interesting discussion see Stranton, IRS Officials Defend New Approach to Appeals, Penalties. Vol. 52 TNT No. 13, p. 222 (December 29, 2006). In the article the statement is made: “Indeed some practitioners view the notice as an end run around discovery rules in court.”

Announcement 2006-100 provides in relevant part:

"When a settlement cannot be reached by the Office of Appeals in a case that is not docketed in the Tax Court, it is expected that the case will proceed to litigation. The Service wants to ensure that it has fully developed the limited number of unagreed cases that involve listed transactions (within the meaning of Treas. Reg. § 1.6011-4) before it sends a statutory notice of deficiency (or other determination notice triggering litigation rights) to the taxpayer. Consequently, the Service is revising its procedures to provide that when the Office of Appeals and the taxpayer are unable to reach a satisfactory settlement in a nondocketed case involving a listed transaction, the Office of Appeals will close out its consideration, notify the taxpayer, and send the case to the appropriate Operating Division for further handling."

Announcement 2006-100 has created quite a stir. For an interesting discussion see Stranton, IRS Officials Defend New Approach to Appeals, Penalties. Vol. 52 TNT No. 13, p. 222 (December 29, 2006). In the article the statement is made: “Indeed some practitioners view the notice as an end run around discovery rules in court.”

There is reason for this concern. It cannot be ignored that the Office of Chief Counsel has been emphatic that, as to Son-of Boss transactions, the IRS will vigorously pursue those taxpayers that did not participate in the settlement initiative. Message being delivered by the IRS: "Concede or be prepared to litigate."

Now it appears that the message the IRS is saying: "Hold it. We need time to prepare the case prior to sending the case for litigation." Private practitioners cannot ignore that the Office of Chief Counsel is highly involved in making sure that the Son-of-Boss cases are properly being developed. Moreover, these teams from the Office of Chief Counsel are further limited in terms number and personnel (i.e. litigators) while the Son-of-Boss cases are numerous (over 500 and some reports say over 1,000). Thus, it is not surprising that the Office of Chief Counsel wants the cases developed when the case is docketed not that the case has to be developed when the case arrives for litigation.

So what is that private practitioners are faced with: Counsel attorneys assisting the revenue agents through a plethora of the Son-of-Boss cases using IDR’s, interviews, possibly summons to develop these cases. In the meantime the private practitioner will not have access to the same information (see section 6103) while the IRS’s attorney has access to multiple years and multiple cases without fear of discovery and can develop the facts as they deem necessary.

Observation: Are we heading for another showdown similar to the Mary Kay Ash problem? In Ash v. Commissioner, 96 T.C. 459 (1991), the IRS successfully modified/overturned Universal Manufacturing Co. v. Commissioner, 93 T.C. 589 (1989), and Westreco, Inc. v. Commissioner, T.C. Memo. 1990-501. Will the Tax Court be sympathetic to the taxpayer?. If a guess was to be ventured – probably not. See Judge Swift’s concurring opinion in Ash v. Commissioner, 96 T.C. at 478 – 481.

Thus under this new policy let the obvious be stated - Leverage is in the facts. The IRS has only only a window of time to develop the facts. Therefore be careful when agreeing to the statute extensions being requested from the IRS as your leverage as to the “keys to the facts” may have been waived away – turned over to the IRS.