What is in the Pipeline?

Being that I worked in the IRS’s Office of Chief Counsel for 13 years, the question tends to be asked: What are the issues that the IRS is looking at? My response is usually a shrug because I really do not know how the IRS determines what issues are the “hot issues.” But what I can relay to you is the advice that a very senior and experienced Special Trial Attorney once gave me: “If you want to know the issues that are on the radar screen read the journal.” This blog is not intended as a plug but since that time I have read the daily Tax Notes Reports, the BNA daily reports and the Wall Street Journal. Curiously, his advice has been rather accurate.

These trade journals in the last six moths have revealed that the usual cast of characters, Family Limited Partnerships (See January 6, 2007 Year in Review) and Tax Shelters (See Below), are alive and well. But, because of their success in these ventures, it appears that the IRS’s Office of Chief Counsel appears eager to venture back into the contentious area of section 482 and possibly into a new one Private Foundations.

For example, Tax Notes Today on November 15, 2006 issued a story on IRS Chief Counsel Donald Korb discussing recent internal tax guidance. Per the article, Mr. Korb states “that Chief Counsel is focused on “protecting the integrity of U.S. tax law in a global economy” by ‘keeping an eye on highly engineered and abusive transactions.”.” See Nadal, Korb Discusses International Tax Developments, Praises IRS’s Success, 2006 TNT 220-3. Now fast forward to this past week and another headline concerning the section 482 litigation that the IRS has undertaken. See Nutt, Another Transfer Pricing Dispute in the Litigation Pipeline, 2007 TNT 15-13. It appears due to the IRS recent well publicized settlement  in GlaxoSmithKline, the Office of Chief Counsel had gotten rid of the bad taste of  Xilinx v.  Commissioner, 125 T.C. 37 (2005);  Eli Lilly v. Commissioner, 856 F.2d 855 (7th Cir. 1988) revg. 84 T.C. 996; Bausch & Lomb v.Commissioner, 92 T.C. 525 (1989); Sundstrand v. Commissioner, 96 T.C. 226 (1991); Seagate Technology v. Commissioner, 102 T.C. 149 (1994). Throw in their victories in the tax shelter wars and you can feel the IRS’s confidence permeating through the air. So now the Office of Chief Counsel is seeking section 482 adjustments from Symantec Corp. See Docket No. 12075-06.

Word to the Wise to my fellow tax practitioners - Become familiar with the 482 regulations especially the new regulations issued under 482 during the summer of 2006. See T.D. 9278. See also Nutt, No Saftey in the Harbor: New Transfer Pricing Services Regs., 2006 TNT 167-4. The reason is simple Section 482 does not apply just to large multi-national corporations. It can and will be applied to mid-size corporations or any corporation that ventures into this area. Stated otherwise, the IRS is issuing these regulations for a reason and its litigators are once again becoming conversant in these complex regulations. Thus, expect 482 issues to once again surface. Therefore, it will be time again for lawyers and the accounting firms to work together in addressing the 482 issues and resolving the issue at the exam level and if need be visa vi litigation.

Observation: A successful strategy that I saw during my time with the Office of Chief Counsel was implemented by Baker& McKenzie. The strategy was to turn over a summary report, the economist report, and the underlying source documents that were compliant with the regulations under 6662, while retaining the entire legal analysis. See United States v. Bell, 1994 WL 665295 (N.D.Cal.1994). As to the attorney’s underlying analysis, the strategy was to preserve the work product doctrine and attorney client privilege. See United States v. Roxworthy, 457 F.3d 590 (6th Cir. 2006). Whether this strategy is successful in today’s environment of 26 C.F.R. § 1.6662-6, the tax shelter regulations/wars remains to be seen. See FIN 48 and Textron (Blog dated January 21, 2007).

Another topic that I have been seeing with regularity being discussed in the Wall Street Journal and the tax journals is in regard to non-profits/charitable organizations. A recent article in Tax Notes – VanDenburgh, Harmelink, Nichols, Various Motivations Behind Family Charitable Foundations, 114 Tax Notes 205 (Jan. 15, 2007) - provides an excellent overview of the positive/negatives of family charitable foundations. The article points out as well the abuses of the same and reminds the readers that the IRS has listed certain charitable organizations as “notorious tax scams”. The result was certain changes in the Pension Protection Act of 2006. Therefore, expect the IRS to monitor this area. The only question is who from the IRS will be monitoring the situation – i.e. check how the IRS is organized and you will certain divisions are limited in numbers. Last time I looked the Brahma Bulls of Chief Counsel’s office, the Special Trial Attorneys, were in the Large Business Division and they are rather busy with the shelter wars. The question for Chief Counsel’s office is - who is going to be the enforcer/hammer?

Then here is FIN 48. A blog is not the proper forum to discuss the issues surrounding this area but I would submit the following -both the attorneys and the accountants must work together on these matters. The IRS will be looking at the disclosures emanating from FIN 48 as part of their document request. Word to the wise – Become familiar better yet - know and understand FIN 48. If I were back in the Office of Chief Counsel, I would ask every revenue agent I was working with to issue an IDR as to every issue identified under FIN 48 in the first package of IDR’s.

Finally, there is the old and reliable economic substance doctrine. The government filed its objection to Coltec’s Writ for Certiorari. See 2007 TNT 16-16. No surprise as the Government acknowledges a new test and that there are various formulations to the economic substance test. The Government states that the Supreme Court should not grant Coltec’s Writ as no matter what standard was applied Coltec would lose. Query: Then why the need for the new standard, if not for the reason that the Federal Circuit did not believe that the other standards of its sister circuits were insufficient.

It will be interesting to see whether the Supreme Court accepts this case. For purposes of consistency to fellow taxpayers I hope the Supreme Court does. Otherwise, those living in the Fifth, and to an extent the Eleventh Circuit, will have a certain advantage as to the economic substance doctrine that are not found in the other circuits. See Compaq Computer Corp. v. Commissioner, 277 F.3d 778 (5th Cir. 2001) and United Parcel Service of America v. Commissioner, 254 F. 3d 1014 (11th Cir. 2001).

Family Limited Partnerships - Appeals settlement Guidelines

The IRS recently issued its Appeals Settlement Guidelines for Family Limited Partnerships and Family Limited Liability Companies. The guidelines issued cover four separate topics:

(i) whether the fair market value of transfers of family limited partnership or corporation interests, by death or gift, is properly discounted from the pro rata value of the underlying assets;
(ii) whether the fair market value at date of death of Code section 2036 or 2038 transfers should be included in the gross estate;
(iii) whether there is an indirect gift of the underlying assets, rather than the family limited partnership interests, where the transfers of assets to the family limited partnership (funding) occurred either before, at the same time, or after the gifts of the limited partnership interest were made to family members;
(iv) whether an accuracy-related penalty under section 6662 is applicable to any portion of the deficiency.

The IRS recently issued its Appeals Settlement Guidelines for Family Limited Partnerships and Family Limited Liability Companies. The guidelines issued cover four separate topics:

(i) whether the fair market value of transfers of family limited partnership or corporation interests, by death or gift, is properly discounted from the pro rata value of the underlying assets;
(ii) whether the fair market value at date of death of Code section 2036 or 2038 transfers should be included in the gross estate;
(iii) whether there is an indirect gift of the underlying assets, rather than the family limited partnership interests, where the transfers of assets to the family limited partnership (funding) occurred either before, at the same time, or after the gifts of the limited partnership interest were made to family members;
(iv) whether an accuracy-related penalty under section 6662 is applicable to any portion of the deficiency.

As to the issue of valuation/discounts the guidelines noted that the United States Tax Court had in three cases McCord v. Commissioner, 120 T.C. 358 (2003); Lappo v. Commissioner, T.C. Memo 2003-258 and Peracchio v. Commissioner, T.C. Memo. 2003-280 allowed combined discounts of 32%, 27%, and 29%, respectively. That is the good news. However, the news may even be better as it must be remembered that McCord was reversed and the discounts claimed by the estate were upheld by the 5th Circuit. See Succession of McCord v. Commissioner, 461 F.3d 614 (5th Cir. 2006). In addition, in its guidelines the IRS tries to distinguish Estate of Kelley v. Commissioner, T.C. Memo. 2005-235 were the Court approved of a combined discount of approximately 35%. Thus, the discounts allowed by the Courts may even be higher than the discounts referred to by the IRS in its settlement guidelines. For an interesting article concerning the amount of discounts being obtained in South Florida See Pratt, Kiziah, Pokorny, Family Limited Partnerships: Are They Still Alive and Kicking,Vol. 81 Florida Bar Journal No. 1 (January 2007).

As to the issue of section 2036, the IRS recognized that the issue will come down to whether the taxpayer retained a sufficient interest in the property or whether there was a bona fide sale for full and adequate consideration. It should be noted that the decision in Estate of Bongard v. Commissioner, 124 T.C. 95 (2005) was entered on September 7, 2006 and it appears that no appeal was filed. For an interesting discussion as to the issues surrounding section 2036 we recommend the following three part articles: August, Dawson, Maxfield, and Pollingue, The IRS Continues its Section 2036 Assault on FLPs – (Part 1 through Part 3), Business Entities (WG&L).

As to the issue of gift on formation, the good news is that the argument is not nearly as broad as originally advocated by the IRS. Rather, the argument is being limited to those arguments raised in Shepherd v. Commissioner, 115 T.C. 376 (2000).

As to the impositions of penalties, the IRS's position may be distributing to some practitioners. In the Appeals Coordinated Issue Settlement Guidelines Issue, the IRS relies on Long Term Capital Holdings v. United States, 330 F. Supp.2d 122, 199 (D. Conn. 2004), aff’d 2005 U.S. App. LEXIS 20988 (2005). Long Term Capital is a tax shelter case wherein the Court imposed on 40% penalties where the Court found that the tax opinion was not timely received and the law firm did not conduct sufficient due diligence in discerning the validity of the taxpayer’s factual representations. It is interesting that the IRS is citing to tax shelter cases when analyzing the reasonable cause exception as it applies to estate tax issues. The days of relying on the planner’s advice and the planner not performing any subsequent due diligence may have come to an end.