Complimentary Issue: Parker's Federal Tax Bulletin August 14,2013

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Issue 43

August 14, 2013

Tax Briefs

CPA's Calculation of Penalty Amount Causes Court to Admonish IRS; Debtor Required to Exhaust AllAdministrative Remedies Before Proceeding in Court; Final Regs Provide Guidance on Transfers toRICs and REITs ...

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Final Meal and Entertainment Expense Regs Clarify Who Is Subject to the Limitations

The IRS has issued final regulations that clarify who is subject to the deduction limitations on meal andentertainment expenses in situations involving professional employer organizations (PEOs). T.D. 9625(8/1/13).

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Estate Loses $144,000 Refund After Failing to Properly Designate Payment as a Deposit

A district court held that because an estate did not properly designate a payment as a deposit, andthe estate tax return was filed more than three years after the payment was made, the estate was notentitled to a refund of a $144,000 overpayment. Syring v. U.S., 2013 PTC 236 (W. D. Wisc. 8/8/13).

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Consultant Not an "Employer" With Respect to Work for Foreign Government; SEP ContributionsDisallowed

The Ninth Circuit affirmed a Tax Court decision that held that the taxpayer, as a common lawemployee of a foreign government, was not an "employer" under Code Sec. 401(c)(4) with respect tothe earnings from the foreign government and thus barred him from deducting SEP contributions.Rosenfeld v. Comm'r, 2013 PTC 234 (9th Cir. 8/8/13).

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IRS Delays Shutdown of Disclosure Authorization and Electronic Account Resolution Products

The planned shutdown of the Disclosure Authorization and Electronic Account Resolution products onAugust 11, 2013, has been delayed until September 2 while the IRS completes the transition to its newweb portal. IRS Website (8/9/13).

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IRS Postpones August 30th Furlough; Cites Successful Cost-Cutting Measures

The IRS announced it will be open on Friday, August 30, following the postponement of its fifthscheduled agency-wide employee furlough day. IRS Website (8/7/13).

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Failure to File Correct IRS Form Subjects Minister's Income to Self-Employment Tax

A minister who took a vow of poverty was liable for self- employment tax on payments made on hisbehalf by his church because he failed to timely file an exemption certificate or designate thepayments as a parsonage allowance. Rogers v. Comm'r, T.C. Memo. 2013-177 (8/1/13).

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Company's Dividend Deductions Don't Meet All-Events Test

The annual and termination dividends credited by an accrual-basis life insurance company to itspolicyholders in one year but not paid until the following year were not deductible until the year of

payment because the deductions did not satisfy the all- events test for the tax years in which they wereaccrued. New York Life Insurance Company v. U.S., 2013 PTC 226 (2d Cir. 8/1/13).

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IRS's Penalties Disallowed as an Administrative Expense in Bankruptcy Case

Because a bankruptcy trustee did not show reasonable cause for late filing of the bankruptcy estate'sS corporation tax returns, late- filing penalties were upheld; however, the penalties did not constitute apriority administrative claim under Bankruptcy Code Section 503(b)(1)(A), and the case was remandedto see if the penalties qualified as an administrative expense for other reasons. In re 800Ideas.Com,Inc., 2013 PTC 222 (B.A.P. 9th Cir. 7/22/13).

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Former Client Helps Convict BDO Accountant of Filing False Returns

A former client's testimony, as well as a recording between the former client and his personalaccountant, was allowed into evidence to help convict a former BDO Seidman accountant on chargesof preparing and filing fraudulent returns for the client. U.S. v. Favato, 2013 PTC 229 (3d Cir. 8/5/13).

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Nonresident Alien's Refund Claim Barred under Three-Year Look-Back Period

A nonresident alien's claim for a refund of taxes withheld by his employer was barred under the three-year look-back period because his refund claim was not filed within three years of the filing of hisreturn. Boeri v. U.S., 2013 PTC 223 (Fed. Cir. 7/31/13).

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Bankruptcy

CPA's Calculation of Penalty Amount Causes Court to Admonish IRS: In In re Breland, 2013 PTC 220(S.D. Ala. 7/29/13), the affidavit of a CPA who disagreed with the IRS's calculation of the proper penaltyamount relating to past due taxes of a debtor in bankruptcy was sufficient by itself to raise an issue ofmaterial fact as to the IRS's calculation of the penalty. As a result, the court admonished the IRS to domore to establish that the amount of the penalty was correct and rejected the IRS's request forsummary judgment.

Debtor Required to Exhaust All Administrative Remedies Before Proceeding in Court: In In re Parham,2013 PTC 228 (Bankr. E.D. Tenn. 7/29/13), a bankruptcy court held that the debtors could not proceedwith their motion to hold the IRS in contempt for violating the discharge injunction in 11 U.S.C. Section524(a)(2) and (3) by acting to collect a debt that had been discharged in the debtors' chapter 13 case.According to the court, the debtors could not seek an award of damages against the IRS until they hadexhausted the administrative remedies available to them within the IRS.

C Corporations

Final Regs Provide Guidance on Transfers to RICs and REITs: In T.D. 9626 (8/2/13), the IRS issuedfinal regulations that provide guidance on certain transfers of property from a C corporation to aregulated investment company or a real estate investment trust. [Code Sec. 337].

Deductions

IRS Exam Team Urged to Abandon Intangible Asset Argument: In CCA 201330034, the Chief Counsel'sOffice advised that an IRS exam team abandon its argument that the infrastructure assets at issue areintangible assets with an indeterminate useful life; further factual development was needed todetermine whether the assets are intangible assets under Reg. Sec. 1.263(a)-4(d)(8)(i) or dedicatedimprovements under Reg. Sec. 1.263(a)-4(d)(8)(iv). Based on the facts provided, the Chief Counsel'sOffice said the infrastructure assets appeared to be dedicated improvements. [Code Sec. 167].

Healthcare

IRS Issues Guidance on Branded Prescription Drug Fee: In Notice 2013-51, the IRS providesguidance on the branded prescription drug fee for the 2014 fee year related to (1) the submission ofForm 8947, Report of Branded Prescription Drug Information, (2) the time and manner for notifyingcovered entities of their preliminary fee calculation, (3) the time and manner for submitting error reportsfor the dispute resolution process, and (4) the time for notifying covered entities of their final feecalculation.

Penalties

Taxpayer Liable for $50,000 Fine for Filing False Return: In U.S. v. Jaramillo, 2013 PTC 230 (9th Cir.8/2/13), the Ninth Circuit upheld a district court's order and rejected the taxpayer's challenge to the$50,000 fine imposed on him following his guilty-plea conviction for willful filing of a false tax return.[Code Sec. 7206(1)].

Procedure

Court Questions Whether Summonses on Taxpayer's Bank Account Were Appropriate: In Charles v.U.S., 2013 PTC 218 (W.D. Mich. 2013), a district court remanded a case where a taxpayer argued thata domestic bank account was clearly not a numbered account and that the no notice summonsesissued under Code Sec. 7609(c)(3) were improper and that alternative methods had to be used toobtain an account holder's identity. Noting that the taxpayer's arguments presented two issues of firstimpression that were not heard by the magistrate judge, the district court remanded the case for thejudge to rule on whether (1) two no notice summonses relating to the taxpayer were appropriatelyissued upon a numbered account; and (2) if the summonses were improper, does their issuance anduse of the information obtained provide sufficient grounds to taint enforcement of the contestedsummonses. [Code Sec. 7609].

Court Won't Extend Mitigation Rules to Taxpayers: In Barclay Associates, Inc. v. IRS, 2013 PTC 232 (D.V.I. 8/1/13), the district court of the Virgin Islands held that it could not extend the mitigation statute toavoid the statute of limitations where the taxpayers claimed they were being unfairly taxed for certainyears by both the Virgin Islands Bureau of Internal Revenue and the IRS. Because the taxpayers'purported circumstance of adjustment was outside the scope of Code Sec. 1312(1), the courtconcluded that the mitigation statute did not apply. [Code Sec. 1312].

Property Transactions

Temporary Regs Apply to Mixed Straddle Election: In T.D. 9627 (8/2/13), the IRS issued temporaryregulations that apply to taxpayers electing to establish a mixed straddle using straddle-by-straddleidentification. The temporary regulations explain how to account for unrealized gain or loss on aposition held by a taxpayer before the time the taxpayer establishes a mixed straddle using straddle-by-straddle identification. The text of these temporary regulations also serves as the text of theproposed regulations. [Code Sec. 1092].

IRS Issues Proposed Regs on Mixed Straddles: In REG-112815-12 (8/2/13), the IRS issued proposedregulations that apply to taxpayers electing to establish a mixed straddle using straddle-by-straddle

identification. [Code Sec. 1092].

Retirement Plans

Code Sec. 219(c) Renamed: In Pub. L. 113-22, signed into law by President Obama on July 30,2013, renames Code Sec. 219(c) from SPECIAL RULES FOR CERTAIN MARRIED INDIVIDUALS to KAYBAILEY HUTCHISON SPOUSAL IRA. [Code Sec. 219].

In Notice 2013-52, the IRS provides guidance on the corporate bond monthly yield curve (and thecorresponding spot segment rates), and the 24-month average segment rates under Code Sec.430(h)(2). In addition, the notice provides guidance as to the interest rate on 30-year Treasurysecurities under Code Sec. 417(e)(3)(A)(ii)(II) as in effect for plan years beginning before 2008, the 30-year Treasury weighted average rate under Code Sec. 431(c)(6)(E)(ii)(I), and the minimum presentvalue segment rates under Code Sec. 417(e)(3)(D) as in effect for plan years beginning after 2007.[Code Sec. 430].

RICs, REITs, and REMICs

Proposed Regs Would Revise Certain RIC Examples: In REG-114122-12 (8/2/13), the IRS issuedproposed regulations that would revise examples that illustrate the controlled group rules related toregulated investment companies (RICs). The proposed revisions would resolve an issue with how thecontrolled group rules should be applied in connection with the RIC asset diversification test. [CodeSec. 851].

Tax Payments

IRS Releases Draft Form for Calculating Net Investment Income Tax: On August 7, the IRS released adraft version of Form 8960, Net Investment Income Tax Individuals, Estates, and Trusts. No instructionswere released with the form. [Code Sec. 1411].

Final Meal and Entertainment Expense Regs Clarify Who IsSubject to the Limitations

Many small and medium-sized companies are outsourcing their human resources, benefits, andpayroll administrative tasks to professional employer organizations (PEOs) in an effort to reduce theiroverall labor costs. With the increase in the use of PEOs, have come several new tax issues. One ofthose issues is how the meal and entertainment deduction limitation rules of Code Sec. 274 apply; inother words do the limitations apply to the PEO, the company that hired the PEO, or the employee?Last year, the IRS issued proposed regulations, which it finalized earlier this month in T.D. 9625(8/1/13).

The final regulations clarify the definition of reimbursement or other expense allowance arrangementfor purposes of determining how the deduction limitations apply to reimbursement arrangementsbetween the three parties.

Background

Under Code Sec. 274(a)(1) deductions for certain expenses for entertainment, amusement, or

recreation activities and for facilities used in connection with entertainment, amusement, or recreationactivities are limited. Code Sec. 274(n)(1) generally limits the amount allowable as a deduction for anyexpense for food, beverages, entertainment activities, or entertainment facilities to 50 percent of theamount otherwise allowable. However, the limitations of Code Sec. 274(a)(1) and Code Sec. 274(n)(1)do not apply to an expense described in Code Sec. 274(e)(3).

In general, Code Sec. 274(e)(3) excepts from the limitations of Code Sec. 274(a) expenses a taxpayerpays or incurs in performing services for another person under a reimbursement or other expenseallowance arrangement with the other person. The exception applies if the taxpayer is an employeeperforming services for an employer and the employer does not treat the reimbursement for theexpenses as compensation and wages to the taxpayer. In that case, the employee is not treated ashaving additional compensation and has no deduction for the expense. The employer bears anddeducts the expense and is subject to the deduction limitations.

If the employer treats the reimbursement as compensation and wages, the employee may be able todeduct the expense as an employee business expense. Under Reg. Sec. 1.274-2(f)(2)(iv)(b), theemployee bears the expense and is subject to the deduction limitations, while the employer deductsan expense for compensation, which is not subject to the deduction limitations.

The Code Sec. 274(e)(3) exception also applies if the taxpayer performs services for a person otherthan an employer and the taxpayer accounts (i.e., substantiates) to that person. Therefore, in areimbursement or other expense allowance arrangement in which a client or customer reimburses theexpenses of an independent contractor, the deduction limitations do not apply to the independentcontractor to the extent the independent contractor accounts to the client by substantiating theexpenses. Reg. Sec. 1.274-2(f)(2)(iv) provides that, if the independent contractor is subject to thededuction limitations, the limitations do not apply to the client.

One of the first cases to deal with the entertainment deduction limitations and PEOs was TransportLabor Contract/Leasing, Inc. v. Comm'r, 461 F.3d 1030 (8th Cir. 2006), rev'g 123 T.C. 154 (2004). In thatcase, Transport Labor Contract/Leasing, Inc. (TLC) provided PEO services by hiring truck drivers asits employees and then leasing them to its trucking company clients. TLC paid truck drivers a perdiem allowance that it did not treat as compensation. It billed the client that was leasing the drivers forthe drivers' wages and per diem allowances, and the client paid TLC. TLC provided its clients with theexpense substantiation information required by Code Sec. 274(d). The Tax Court applied the CodeSec. 274(n) limitation to TLC as the drivers' common law employer.

The Eighth Circuit reversed, stating that the Tax Court should have considered Code Sec. 274(e)(3)(B).In determining to whom the Code Sec. 274(n) limitation applies, the Eighth Circuit said that becauseTLC's per diem payments were not treated as truck driver wages, the limitation did not apply to thedrivers. Thus, the question was whether the limitation applied to TLC or the trucking companies. TheEighth Circuit concluded that because TLC paid per diem expenses to the truck drivers and providedthe trucking company clients with the expense substantiation information required by Code Sec.274(d), the trucking companies were subject to the limitation. The court also noted that there wassubstantial documentary evidence establishing that TLC and its clients entered into a reimbursementor other expense allowance arrangement that satisfied the requirements of Reg. Sec. 1.62-2(c) through(f) and, therefore, satisfied Code Sec. 274(e)(3).

In Rev. Rul. 2008-23, the IRS acquiesced to the result in the TLC decision and similarly ruled that theparty that ultimately bears the expense in a three-party reimbursement arrangement is subject to theCode Sec. 274(n) limitation. The revenue ruling clarified that a party's status as a common lawemployer is not relevant to the Code Sec. 274(n) analysis, which the Eighth Circuit's opinion could beread to imply.

Rev. Rul. 2008-23 clarified another issue raised by the TLC opinion. To define the term reimbursementor other expense allowance arrangement for purposes of Code Sec. 274(e)(3), the Eighth Circuitlooked to Reg. Sec. 1.274-2(f)(2)(iv)(a), which provides that the term reimbursement or other expenseallowance arrangement in Code Sec. 274(e)(3) has the same meaning as in Code Sec. 62(a)(2)(A)(dealing with employee business expenses and previously labeled Code Sec. 62(2)(A)), but withoutregard to whether the taxpayer is an employee of the person for whom the taxpayer providesservices. Thus, the court defined reimbursement or other expense allowance arrangement forpurposes of Code Sec. 274(e)(3) by reference to Code Sec. 62(a)(2)(A) and Reg. Sec. 1.62-2, whichprovide the rules for the employee reimbursement arrangements called accountable plans.

According to the IRS, the TLC court's definition was inaccurate to the extent it relied on theaccountable plan rules, which cover employee reimbursement arrangements only, in determining the

existence of a reimbursement or other expense allowance arrangement for purposes of identifyingwho bears the expense under Code Sec. 274(e)(3)(B).

Thus, Rev. Rul. 2008-23 clarified that the Reg. Sec. 1.274-2(f)(2)(iv)(a) reference to Code Sec.62(a)(2)(A) predated the enactment of Code Sec. 62(c), which addresses certain arrangements nottreated as reimbursement arrangements, and the accountable plan regulations, which governemployer-employee reimbursement arrangements and their employment tax consequences.Therefore, Rev. Rul. 2008-23 holds that the Code Sec. 274(e)(3) exception may apply to an expensereimbursement arrangement without regard to whether it is an accountable plan.

Definition of "Reimbursement or Other Expense Allowance Arrangement"

Under the regulations, a reimbursement or other expense allowance arrangement involvingemployees is an arrangement under which an employee receives an advance, allowance, orreimbursement from a payor (the employer, its agent, or a third party) for expenses the employeepays or incurs in performing services as an employee. A reimbursement or other expense allowancearrangement involving persons that are not employees is an arrangement under which an independentcontractor receives an advance, allowance, or reimbursement from a client or customer for expensesthe independent contractor pays or incurs in performing services if either:

(1) a written agreement between the parties expressly provides that the client or customer willreimburse the independent contractor for expenses that are subject to the deduction limitations; or

(2) a written agreement between the parties expressly identifies the party that is subject to the CodeSec. 274(n) limitations.

Rules for Two-Party Reimbursement Arrangements Clarified

The regulations clarify that the rules for applying the exceptions to the Code Sec. 274(a) and (n)deduction limitations apply to reimbursement or other expense allowance arrangements withemployees, whether or not a payor is an employer. Under the regulations, a payor includes anemployer, an agent of the employer, or a third party. For example, either an independent contractor ora client or customer may be a payor of a reimbursement arrangement. Thus, any party thatreimburses an employee is a payor and bears the expense if the payment is not treated ascompensation and wages to the employee.

The regulations also address situations where a reimbursement or other expense allowancearrangement between an independent contractor and a client or customer includes an agreementexpressly providing that the client or customer will reimburse the independent contractor for expensesthat are subject to the deduction limitations. In that case, the deduction limitations do not apply to anindependent contractor that accounts to the client within the meaning of Code Sec. 274(d) and theassociated regulations, but they do apply to the independent contractor and not to the client if theindependent contractor fails to account to the client. Alternatively, the parties may enter into an expressagreement identifying the party that is subject to the deduction limitations.

Multiple-Party Reimbursement Arrangements Analyzed Separately

The regulations provide that multiple-party reimbursement arrangements are separately analyzed asa series of two-party reimbursement arrangements. Thus, for example, an arrangement in which (1) anemployee pays or incurs an expense subject to limitation, (2) the employee is reimbursed for thatexpense by another party (the initial payor), and (3) a third party reimburses the initial payor'spayment to the employee, is analyzed as two two-party reimbursement arrangements. Onearrangement is that between the employee and the initial payor, and another arrangement is thatbetween the initial payor and the third party.

Example 1: Megan, an employee, performs services under an arrangement in which LMN, anemployee leasing company, pays Megan a per diem allowance of $10 for each day that Meganperforms services for LMN's client, ABC, while traveling away from home. The per diem allowance is areimbursement of travel expenses for food and beverages that Megan pays in performing services asan employee. LMN enters into a written agreement with ABC under which ABC agrees to reimburseLMN for any substantiated reimbursements for travel expenses, including meals, that LMN pays toMegan. The agreement does not expressly identify the party that is subject to the deductionlimitations. Megan performs services for ABC while traveling away from home for 10 days andprovides LMN with substantiation that satisfies the applicable substantiation requirements of $100 ofmeal expenses incurred by Megan while traveling away from home. LMN pays Megan $100 to

reimburse those expenses pursuant to their arrangement. LMN delivers a copy of Megan'ssubstantiation to ABC. ABC pays LMN $300, which includes $200 compensation for services and $100as reimbursement of LMN's payment of Megan's travel expenses for meals. Neither LMN nor ABCtreats the $100 paid to Megan as compensation or wages.

In this case, Megan and LMN have established a reimbursement or other expense allowancearrangement. Because the reimbursement payment is not treated as compensation and wages paid toMegan, she is not subject to the Code Sec. 274 deduction limitations. Instead, under his analysis,LMN, the payor, is subject to the deduction limitations. Because the agreement between LMN and ABCexpressly states that ABC will reimburse LMN for expenses for meals incurred by employees whiletraveling away from home, LMN and ABC have established a reimbursement or other expenseallowance arrangement. LMN accounts to ABC for ABC's reimbursement in the required manner bydelivering to ABC a copy of the substantiation LMN received from Megan. Therefore, under thisanalysis, ABC, and not LMN, is subject to the Code Sec. 274 deduction limitations.

Example 2: The facts are the same as in Example 1 except that, under the arrangements betweenMegan and LMN and between LMN and ABC, Megan provides the substantiation of the expensesdirectly to ABC, and ABC pays the per diem directly to Megan. In this case, Megan and ABC haveestablished a reimbursement or other expense allowance arrangement. Because Megansubstantiates directly to ABC and the reimbursement payment was not treated as compensation andwages paid to Megan, Megan is not subject to the Code Sec. 274 deduction limitations. ABC, thepayor, is subject to the Code Sec. 274 deduction limitations.

Example 3: The facts are the same as in Example 1, except that the written agreement between LMNand ABC expressly provides that the deduction limitations will apply to ABC. LMN and ABC haveestablished a reimbursement or other expense allowance arrangement. Because the agreementprovides that the deduction limitations apply to ABC, ABC, and not LMN, is subject to the Code Sec.274 deduction limitations.

Example 4: The facts are the same as in Example 1, except that the agreement between LMN andABC does not provide that ABC will reimburse LMN for travel expenses. In this case, the arrangementbetween LMN and ABC is not a reimbursement or other expense allowance arrangement. Therefore,even though LMN accounts to ABC for the expenses, LMN is subject to the Code Sec. 274 deductionlimitations.

For a discussion of the of meal and entertainment expenses, see Parker Tax ¶91,115.

[Return to Table of Contents]

Estate Loses $144,000 Refund After Failing to Properly Designate Payment as a Deposit

The difference between characteriz ing a remittance to the IRS as a deposit or a tax payment canhave significant ramifications. It's generally preferable to have the remittance characterized as adeposit because there is no statute of limitations on when a deposit can be recovered. However, for aremittance to be characterized as a deposit, the taxpayer must include with the payment a writtenstatement designating it as a deposit. In Syring v. U.S., 2013 PTC 236 (W. D. Wisc. 8/8/13), an estateneglected to do this when it made a payment with its estate tax extension request. When the returnwas finally filed, the estate had overpaid the tax by $144,000 and was due a refund. However,because the remittance with the extension request was not properly designated as a deposit, and theestate tax return was filed more than three years after the payment was made, the estate was notentitled to a refund of the $144,000 overpayment.

Facts

Marshall Syring died on October 14, 2005. Leone Syring, appointed as the estate's personalrepresentative, hired Roger Peterson, CPA, to prepare the estate's tax return. Under Code Sec.6075(a), the return was due on or before July 14, 2006. Peterson estimated that the total estate taxwould be $600,000 but that the estate was eligible to pay the tax over a 10 year period because itqualified as a small business. Consistent with Peterson's advice, on July 14, 2006, the estate filed anapplication for extension and sent $170,000 to the IRS and $170,000 to Wyoming. In paying the IRS,the estate did not include a written statement designating the amount as a deposit as required by Rev.Proc. 2005-18.

Even with the extension to January 14, 2007, the estate missed the deadline to file a tax return.Instead, more than three years later, the estate filed it tax return on February 19, 2010, reporting no

estate tax due. The IRS then conducted an audit and determined that the estate owed taxes in theamount of $25,526. The estate did not challenge the amount of the assessed estate tax, but requestedthe IRS return $144,474, comprising the original remittance less the assessed estate tax.

The IRS denied the estate's refund request on the grounds that the remittance was properly treated asa partial tax payment, rather than a deposit, in light of estate's failure to provide the IRS with a writtenstatement designating the remittance as a deposit, as required by Rev. Proc. 2005-18. Because it wastreated as a payment, the estate's claim fell outside the three-year tax recovery period under CodeSec. 6511(a) and (b)(2)(A).

Under Code Sec. 6511(a), a refund claim for an overpayment of tax must be filed by the taxpayerwithin three years from the time the return was filed or two years from the time the tax was paid,whichever of those periods expires later. Under Code Sec. 6511(b)(2)(A), if the refund claim was filedby the taxpayer during that three-year period, the amount of the credit or refund cannot exceed theportion of the tax paid within the period, immediately preceding the filing of the claim, equal to threeyears plus the period of any extension of time for filing the return.

The estate argued that the $170,000 payment was a deposit under Code Sec. 6603. Code Sec. 6603provides that a taxpayer may make a cash deposit with the IRS which can be used to pay any taxwhich has not been assessed at the time of the deposit. To the extent the deposit is used by the IRSto pay tax, the tax is treated as paid when the deposit is made.

The procedures for designating a payment as a deposit, rather than a tax payment, are contained inRev. Proc. 2005-18. Under Section 4 of that procedure, a taxpayer may make a deposit under CodeSec. 6603 by remitting to the IRS Center at which the taxpayer is required to file its return, or to theappropriate office at which the taxpayer's return is under exam, a check or a money orderaccompanied by a written statement designating the remittance as a deposit. The written statementalso must include:

(1) the type(s) of tax;

(2) the tax year(s); and

(3) a statement described in Section 7.02 of Rev. Proc. 2005-18 identifying the amount of, and basisfor, any disputable tax.

Undesignated remittances treated as tax payments are applied to the earliest tax year for which thereis a liability, and is applied first to tax, then penalties and finally to interest. An undesignated remittancetreated as a payment of tax is posted to the taxpayer's account as a payment upon receipt, or assoon as possible thereafter, and may be assessed, provided that assessment will not imperil acriminal investigation or prosecution. The amount of an undesignated remittance treated as a paymentis taken into account by the IRS in determining the existence of a deficiency and whether a notice ofdeficiency is required to be issued.

District Court's Opinion

The district court had to determine whether the estate's remittance was a deposit or a tax payment. Inmaking this determination, the court applied a fact-and-circumstances test, which considered thefollowing three factors: (1) when the tax liability was defined, (2) the taxpayer's intent in remitting themoney, and (3) how the IRS treated the remittance upon receipt. The court said that, ultimately, thedetermination of whether a remittance is a deposit or tax payment is a question of law for the court.

Timing of Determination of Tax Liability

With respect to the first factor of when the tax liability was defined, the court said this factor looks atwhether the tax liability was defined at the time the remittance was made. A remittance made beforethe tax liability is defined tips the balance toward a finding of a deposit. According to the court, theundisputed facts established that there was neither a formal assessment nor a defined tax liability atthe time the remittance was made. The IRS argued that this factor should weigh in favor of the findingof a tax payment because the estate had initially determined that it owed over $600,000 of estate taxand made the $170,000 remittance in response to that asserted tax liability.

The court noted that the IRS's approach would collapse this factor into the second factor, whichfocuses on the taxpayer's subjective perception of how much tax he or she owes. The better view, thecourt said, was for this first factor to focus on whether, objectively, the IRS had defined the taxpayer's

tax obligation. This approach, the court noted, was consistent with other courts' treatment of this factor.The first factor therefore weighed in favor of categoriz ing the remittance as a deposit, the courtconcluded.

Taxpayer's Intent

Citing the Seventh Circuit's decision in Moran v. U.S., 63 F.3d 663 (7th Cir. 1993), the district courtobserved that the taxpayer's intent has an important place in the facts-and-circumstances test.According to the district court, courts may derive that intent only from reasonable interpretations of thetaxpayer's actions, not from the taxpayer's after- the- fact claims and rationalizations. Here, the courtconcluded, Leone failed to put forth sufficient evidence from which the court could conclude that sheintended to make a deposit when she signed the check to the IRS. Indeed, the court found theevidence was clearly to the contrary.

A written statement designating the remittance as a deposit, as required by Code Sec. 6603 and Rev.Proc. 2005-18, is prima facie evidence that a taxpayer intends to make a deposit in submitting themoney. Not only was this evidence lacking, Leone failed to offer an affidavit, declaration, or othertestimony describing her intent at the time she made the payment. As such, the court said, there wasno direct evidence indicating her intent in making the remittance. Thus, the court could only deriveintent from other indirect evidence. Since it was undisputed that Leone relied on the estate'saccountant for advice and recommendations in making the remittance, the court looked to theaccountant's advice and recommendations to determine Leone's intent.

The court also examined the accountant's actions to determine his intent in delivering his professionalopinions to Leone. The court concluded that the accountant's actions, advice, and recommendationsall demonstrated Leone's intent to make a partial tax payment in remitting the original $170,000. Incoming to this conclusion, the court cited the accountant's advice that the estate was large enough toowe federal and state estate taxes. In connection with this debt, the court noted, the accountantadvised that payments of $170,000 each to the federal and state government would be due beforeJuly 14, 2006. The court also cited the accountant's advice that the estimated federal estate tax wouldbe more than $600,000 but that the full amount need not be paid immediately because the estatequalified to pay the tax over the next 10 years.

Having indisputably acted promptly on this advice, the court concluded, no reasonable person couldfind that Leone considered the remittance to be a deposit rather than a down payment on the estate'slarger tax liability. The evidence was equally overwhelming that the accountant considered theremittance to be a partial tax payment when he recommended that the estate pay it. First, the courtnoted, the accountant calculated the estimated estate tax liability based on an assumption andvaluation method he deemed appropriate at the time, rather than based purely on speculation. Leonehad conceded, the court noted, that the accountant used fair market value to calculate the value of thegross estate. The estimated total federal estate tax of over $600,000 was made under the assumptionthat the estate qualified as a qualifying small business, which the accountant deemed appropriate atthe time.

The court also noted that, after concluding that the estate owed federal estate tax and being providedwith the opportunity to postpone the deadline of paying that tax, the estate's accountant filed Form4768 with the IRS on behalf of the estate, requesting only an extension of time for filing the tax return.An extension of time for filing a return does not operate to extend the time for paying the tax. To applyfor an extension of time to pay the tax, the court noted, the taxpayer must

(1) check the appropriate boxes on Form 4768, and

(2) provide the IRS with a written statement demonstrating either there are reasonable causes to delaypayments or there are undue hardships to pay tax on time.

Despite these straightforward instructions being included in Part III of Form 4768, the accountant neitherchecked any of the boxes in Part III of the form, nor provided any written statements to the IRSexplaining any difficulties the estate had in paying the estimated estate taxes. Instead, the accountantentered $170,000 in Part IV, line 1 of Form 4768, which the accountant represented was the amount ofestate taxes estimated to be due then, as well as instructed Leone to submit that amount to the IRS.The court concluded that the way the accountant completed Form 4768, together with the fact that theaccountant had informed Leone that the estate owed federal estate taxes but did not have to pay thefull amount, strongly suggested to the court that the accountant intended the remittance to be a partialtax payment.

With respect to Leone's contention that the printed Form 4768 did not contain a column for deposits,meaning that a remittance made along with the form could still be a deposit, the court agreed that, incertain circumstances, a remittance made along with a printed Form 4768 might not be a tax payment.However, the court said that this fact did not support a finding that the estate intended to make adeposit in this situation, at least in the face of overwhelming, contemporaneous evidence to thecontrary.

The court also disagreed with the estate's assertion that a remittance is a deposit if made to stopinterest and penalties. While it is true that the intent to stop interest and penalties may support a findingthat a taxpayer intends to make a deposit, the court said that an intent to stop interest and penaltiesdoes not exclude the possibility that the taxpayer intended to make a tax payment in remitting themoney. In fact, the court said, making a large tax payment before a formal assessment has the samepractical effect of mitigating or preventing any interest or penalties due to underpayment oruntimeliness. Therefore, the taxpayer's intent of stopping interest and penalties is, at most, anotherfact to determine whether the taxpayer intended to make a deposit or a tax payment.

IRS's Treatment of Remittance

The final factor the court considered was the IRS's treatment of the remittance itself, which the courtconcluded also weighed in favor of the IRS. First, the court noted, the estate acknowledged notproviding the IRS with any written statement designating the remittance as a deposit. Second, theparties agreed that the IRS recorded the remittance as a payment received upon receiving theremittance, rather than a deposit. Third, the IRS credited the amount directly to the estate's account,rather than put the remittance in a separate account for deposit. All of those actions strongly suggestedthat the IRS conformed to Rev. Proc. 2005-18 and treated the remittance as a tax payment. The courtrejected the estate's contention that the IRS's failure to calculate interest accrued on the remittancecontradicted the IRS's position that it treated the remittance as a tax payment. According to IRStestimony, the IRS's computer does not start calculating interest accrued on an estate's tax paymentbefore the return is filed and the tax liability is determined.

Conclusion

Although the first factor in the facts-and-circumstances test used by the district court weighed in favorof the estate's position, its intent to make a down payment on its tax liability and the fact that IRStreated the remittance as a tax payment tipped the balance to a finding that the $170,000 was a taxpayment. The district court noted that while this result may seem unfair because the government isallowed to keep a payment that it concedes was not due tax laws are not normally characterized bycase-specific exceptions reflecting individualized equities. The court concluded that the estate wasunable to meet its burden of demonstrating that the remittance was a deposit.

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Consultant Was Not An "Employer" With Respect to Work for a Foreign Government; SEP ContributionsDisallowed

While the term employer is straightforward in most situations, the line may be blurred where a taxpayeris self- employed. Whether a taxpayer is considered his or her own employer has ramifications suchas whether or not the individual can contribute to a simplified employee pension (SEP) plan and takea deduction for the contribution. If the individual does so contribute but should not have, additionaltaxes, as well as excise tax penalties apply. That was the situation in Rosenfeld v. Comm'r, 2013 PTC234 (9th Cir. 8/8/13), where a freelance writer accepted an assignment to work for a foreigngovernment, whose contract with the writer specified that he was self- employed and that the foreigngovernment would not withhold taxes. The taxpayer then contributed money to his SEP and deductedthe contributions.

The IRS challenged the deductions, and the Tax Court held that the taxpayer was an employee undercommon law factors, and that the portion of his SEP contribution relating to his work for the foreigngovernment was disallowed.

Observat ion: In the lower court decision, the Tax Court recognized the difficulty of the interplaybetween Code Sec. 3121 and Code Sec. 401(c) and thus did not uphold the IRS's penalty assessmentagainst the taxpayer.

On appeal, the taxpayer argued that the Tax Court was wrong in finding he was an employee andthat, because he worked for a foreign government, he was considered his own employer.

Unfortunately, the Ninth Circuit agreed with the Tax Court and upheld the tax deficiency and excise taxpenalties against the taxpayer.

Facts

Michael Rosenfeld graduated from the University of Southern California with a master's degree injournalism and has worked as a corporate marketing executive, financial writer, and journalist for over20 years. In 1985, he started his own consulting business, representing clients in a variety ofprofessional services. In 1994, he left his consulting business to work in corporate communicationsand marketing. In 1999, he reestablished his business and currently works as a consultant for hisbusiness.

In July or August 2003, in an effort to expand into the British investment community, Michael met withthe deputy consul general, Brian Conley, of the British Consulate General (BCG) in the United States.During the meeting Mr. Conley indicated that the BCG might be interested in using Michael's servicesto promote British companies seeking to invest in the United States and to assist U.S. companiesinterested in investing in the United Kingdom.

After several meetings discussing Michael's qualifications, the BCG formally offered Michael a full-time appointment for a three-year defined term. Michael signed a letter of appointment datedSeptember 22, 2003, and was appointed at the level of "Trade Officer Grade US 8." The letterprovided for annual increases to his salary depending on satisfactory services, as determined by theBCG. The BCG, as a foreign employer of a U.S. citizen, categorized Michael as self- employed fortax purposes. The BCG did not withhold taxes from Michael's salary, and Michael was responsible forall federal, state, and local taxes and for self- employment taxes.

IRS Deficiency Assessment

On Schedule C of his 2003 Form 1040, Michael reported total gross receipts of almost $110,000 andtotal expenses of $37,280, and a deduction for the business use of his home. As a self- employedindividual, Michael contributed to an SEP plan on the basis of his consultant earnings. Michaelreported gross receipts from the BCG on Schedule C and also contributed to an SEP plan on thebasis of those earnings. In 2003 he contributed $12,242 to his SEP plan.

In a notice of deficiency, the IRS determined, in part, that Michael was: (1) a common law employee ofthe BCG and consequently was not entitled to report gross receipts and expenses associated with hiswork for the BCG on Schedule C for 2003; (2) subject to an excise tax under Code Sec. 4973 forexcess contributions to an SEP plan; and (3) liable for the accuracy- related penalty under Code Sec.6662(a).

Simplified Employee Pension Plans

A SEP plan is a plan under which an employer makes direct contributions to its employees' individualretirement accounts or individual retirement annuities (IRAs).

Under Code Sec. 404(a)(8), an employer can deduct certain contributions to an employee's SEP plan.For purposes of Code Sec. 404(a)(8), the term "employee" includes an individual who is an employeewithin the meaning of Code Sec. 401(c)(1), and the employer of such an individual is the persontreated as his employer under Code Sec. 401(c)(4).

Under Code Secs. 401(c), 404(h), 408(k)(7), and Reg. Sec. 1.401-10(b)(2), self- employed individualsand sole proprietors are treated as their own employers and employees for purposes of SEP plandeductions. For purposes of applying Code Sec. 401 through Code Sec. 404, if a self- employedindividual is engaged in more than one trade or business, each business is considered a separateemployer. A self- employed individual is treated as his own employer if he satisfies the definition ofemployer under Code Sec. 401(c)(4). Additionally, under Code Sec. 408(k)(7), a self- employedindividual must also be his own employee and is treated as such if he satisfies the definition ofemployee under Code Sec. 401(c)(1).

The Parties Arguments

Michael argued that he satisfied the requirements of Code Sec. 401(c) and was qualified to make anddeduct contributions to his SEP plan derived from both his consultant business and BCG earnings.The IRS did not contest that Michael was entitled to deduct contributions to his SEP plan from theearnings derived from his consultant business. The IRS did contest, however, Michael's deductions to

his SEP plan with respect to his BCG earnings.

Michael said that as an employee of a foreign government, he is self- employed pursuant to CodeSec. 3121(b)(11) and is treated as his own employee under Code Sec. 401(c)(1) and (2). Code Sec.3121(b)(11) provides that service performed in the employ of a foreign government (including serviceas a consular or other officer or employee or a nondiplomatic representative) is not consideredemployment for purposes of social security and Medicare taxes, and is thus exempt from such taxes.

Michael argued that even if the court concluded that he was a common law employee of the BCG, hewas still his own employer under Code Sec. 401(c)(4) with respect to his BCG earnings. Consequently,he is entitled to deduct the contributions to his SEP plan that are attributable to his BCG earnings.Code Sec. 401(c)(4) provides that an individual who owns the entire interest in an unincorporated tradeor business is treated as his own employer.

Michael also cited the legislative history of Code Sec. 401(c) in support of his argument that he washis own employer with respect to his BCG earnings. He cited a House report, which defines anemployee for purposes of retirement plan contributions, as a self- employed individual. Michaelargued that, on the basis of the legislative history, a common law employee who has self- employmentearnings is treated as an owner-employee and is entitled to make retirement plan contributions anddeduct those contributions on the basis of the self- employment income.

Tax Court Holding

The Tax Court sided with the IRS. The court noted that the term employee is not defined in the Code.An individual's status as an employee is a factual question that depends on the application ofcommon law concepts. Among the relevant factors in determining the substance of an employmentrelationship are: (1) the degree of control exercised by the principal over the details of the individual'swork; (2) the taxpayer's investment in facilities; (3) the taxpayer's opportunity for profit or loss; (4) thepermanency of the relationship between the parties; (5) the principal's right of discharge; (6) whetherthe work performed is an integral part of the principal's business; (7) what relationship the partiesbelieve they are creating; and (8) the provision of employee benefits.

The Tax Court addressed each factor and found that the factors either favored the IRS's position orwere neutral. For example, the court found that the BCG had the right to exercise control overMichael's work, which favored the IRS's position. With respect to employee benefits and Michael'stestimony that he did not receive sick pay, overtime pay, retirement benefits, or life insurance andreceived only minimal remuneration for health and dental insurance, the court noted that, in 2003,Michael accrued annual and sick leave and had the opportunity to participate in the BCG's healthinsurance and pension plans but declined to do so. Considering all the facts and circumstances, thecourt concluded that Michael was a common law employee of the BCG.

The court found that, as a common law employee of the BCG, Michael was not an employer underCode Sec. 401(c)(4) with respect to his BCG earnings, which barred him from contributing to an SEPand deducting contributions based on those earnings.

The court also rejected Michael's reliance on Levine v. Comm'r, T.C. Memo. 2005-86, a case in whichthe taxpayer entered into a personal services contract with the U.S. State Department to manage andimplement the Department's worldwide industrial hygienist field technical services program. Thetaxpayer in that case, the court noted, provided significant explanatory evidence of her position withthe Department, including her employment contract. The employment contract described, in detail, heremployment duties, how she performed her duties, and how she interacted with employees andsupervisors. In contrast, the court observed, Michael provided mere generalities as to his tasks, hisemployment position, and the control the BCG exercised over his position.

The phrase self employed for tax purposes in the letter of appointment did not reflect the BCG'sunderstanding of Michael's employment status. Rather, the court said, it reflected the taxconsequences for a U.S. citizen employed by a foreign government. The letter of appointment wasunambiguous regarding Michael's employment relationship. The BCG offered him a full- timeappointment as a Trade Officer US8 with a fixed monthly salary. The court noted that the record didnot reflect that the BCG intended to hire Michael as an independent contractor. The fact that the BCGdid not withhold taxes from Michael's pay did not establish either his or the BCG's intent regarding hisrelationship with the BCG, the court said.

Ninth Circuit's Analysis

The Ninth Circuit affirmed the Tax Court's decision. With respect to whether Michael, as a common lawemployee of the BCG, still could have contributed to a SEP based on his BCG earnings, the NinthCircuit agreed with the Tax Court's interpretation of the Code Sec. 401(c)(4). Because Michael did notown any interest in the BCG, the court found that he was not an employer under Code Sec. 401(c)(4)with respect to his BCG earnings, thus leaving him ineligible to contribute to an SEP and deductcontributions based on those earnings.

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IRS Delays for Three Weeks Shutdown of Disclosure Authorization and Electronic Account ResolutionProducts

The planned shutdown of the Disclosure Authorization and Electronic Account Resolution products onAugust 11, 2013, has been delayed until September 2 while the IRS completes the transition to its newweb portal. IRS Website (8/9/13).

IRS Disclosure Authorization (DA) and Electronic Account Resolution (EAR) users have an additionalthree weeks to use both electronic products while the IRS completes the transition to its new webportal. The products were originally scheduled to disappear on August 11. According to the IRS, oncethe portal transition work is complete, DA and EAR will be retired as previously planned and will beunavailable for use after September 1.

Due largely to low usage of e-Service's DA and EAR, the IRS decided earlier this year to retire andremove the two applications effective August 11. Last year, the IRS said, users submitted less than 10percent of all disclosure authorizations through the DA application. Similarly, only 3 percent of allaccount- related issues came in through the EAR application.

In anticipation of this change, the IRS increased the number of employees who process authorizationsand has improved internal work processes to decrease the average processing time significantly fromthe current 10-day processing period.

The IRS said it will continue to explore better ways to reduce processing time and improve overallservice to the users. However, current budget cuts will impact their dedicated resources to thisprogram and they are working to determine the impact on processing time.

Compliance Tip: Once IRS removes the two applications, former DA users will need to completeForm 2848, Power of Attorney and Declaration of Representative, or Form 8821, Tax InformationAuthorizations, and mail or fax it to the appropriate IRS location listed on the form's instructions.According to the IRS, former DA users should allow at least four days for the authorization to post tothe IRS database before requesting a transcript through the Transcript Delivery System. Former EARusers should call the Practitioner Priority Service at 1-866-860-4259 for help resolving account- relatedissues.

The IRS said it is continuing to look for ways to improve its current processes and is exploring animproved electronic solution for DA and EAR in the future.

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IRS Postpones August 30th Furlough; Cites Successful Cost-Cutting Measures

The IRS announced it will be open on Friday, August 30, following the postponement of its fifthscheduled agency-wide employee furlough day. IRS Website (8/7/13).

Plans to close the IRS on Friday, August 30, have been cancelled. According to Danny Werfel, IRSActing Commissioner, the IRS has made substantial progress in cutting costs such that it haspostponed the furlough day scheduled for August 30. He said that the IRS still has more work to do onthe budget and cost- savings, so it will reevaluate in early September and make a final determinationas to whether another furlough day will be necessary in September.

IRS has so far taken three furlough days on May 24, June 14, and July 5, due to the current budgetsituation, including the sequester.

month, the IRS was also able to cancel the previously scheduled July 22nd furlough day due to cost-cutting efforts.

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Failure to File Correct IRS Form Subjects Minister's Income to Self-Employment Tax

A minister who took a vow of poverty was liable for self- employment tax on payments made on hisbehalf by his church because he failed to timely file an exemption certificate or designate thepayments as a parsonage allowance. Rogers v. Comm'r, T.C. Memo. 2013-177 (8/1/13).

Donald Rogers was a pastor for the Pentecostals of Wisconsin (PoW). PoW was registered as anonstock corporation, and Donald was its registered agent. Donald signed a vow of poverty, whichstated that any donation/honorarium or endowment given to Donald personally would be consideredthe property of PoW and, in turn, PoW would provide for Donald's needs. In 2007, in return for hisministerial services, PoW paid Donald's personal credit card bills, utility bills, and home mortgagepayments for a total of $43,200. Donald and his wife, Vyon, timely filed their joint 2007 federal incometax return. They reported wage income and itemized deductions for home mortgage interest andcharitable contributions. They did not report any income from amounts paid by PoW on their behalf orfile a certificate of exemption from self-employment tax. The IRS issued a notice of deficiency basedon the couple's failure to report taxable income from amounts paid by PoW on their behalf andassessed an accuracy- related penalty.

Code Sec. 61 defines gross income as all income from whatever source derived, includingcompensation for services. Under Code Sec. 107, gross income does not include, in the case of aminister of the gospel, the rental allowance paid to him as part of his compensation, to the extent usedby him to rent or provide a home.

A duly ordained, commissioned, or licensed minister of a church in the exercise of his ministry isengaged in carrying on a trade or business and is subject to self- employment tax unless the ministertimely files Form 4361, Application for Exemption From Self-Employment Tax for Use by Ministers,Members of Religious Orders and Christian Science Practitioners.

Observat ion: Form 4361 must filed by the due date of the individual's return (including extensions) forthe second year in which the individual has received at least $400 of net earnings from self-employment, any of which was ministerial income.

Donald argued that, while members of religious orders who have taken a vow of poverty are subjectto tax on income received in their individual capacities, they are not subject to tax on income receivedmerely as agents of the orders of which they are members.

The Tax Court held that the payments made by the church on Donald's and Vyon's behalf constitutedincome to the couple. Because Donald and Vyon failed to timely file an exemption certificate, theywere liable for self- employment tax on the payments. Since the home mortgage payments made bythe church on Donald's behalf were not designated as a parsonage allowance, the couple was notentitled to exclude the mortgage payments under Code Sec. 107. In rejecting Donald's argument thathe received the payments as an agent of the church, the court noted that Donald did not receive asalary from a third party or remit any income to the church by assignment. The mortgage paymentsmade by PoW applied to a house owned solely by the couple, and the personal credit card and utilitypayments served only to benefit the couple in meeting their basic living expenses.

The court found that Donald and Vyon would be liable for an accuracy- related penalty after finalcomputations of the deficiency if the total understatement of income exceeded $5,000. The couple'smistake of law that the church's corporate sole structure and vow of poverty would exempt them fromtax was insufficient to show that they acted reasonably and in good faith in failing to report the income.Additionally, they could not show that they reasonably relied on the advice from a tax professional.The court noted that the couple was not negligent and, if the understatement was less than $5,000,they would not be subject to the penalty.

For a discussion of the taxation of minister income, see Parker Tax ¶15,520.

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Company's Dividend Deductions Did Not Meet All-Events Test; No Deduction Allowed

The annual and termination dividends credited by an accrual-basis life insurance company to itspolicyholders in one year but not paid until the following year were not deductible until the year ofpayment because the deductions did not satisfy the all- events test for the tax years in which they wereaccrued. New York Life Insurance Company v. U.S., 2013 PTC 226 (2d Cir. 8/1/13).

New York Life Insurance Company, a mutual life insurance company, is a calendar-year, accrual-basis taxpayer. The company issued policies that entitled its holders to receive a policyholderdividend a share of the company's annual divisible surplus. Certain whole life policyholders were paidan annual dividend, comprised of the policyholder's share of the company's surplus, on the policy'sanniversary date. The timing of the distribution of the annual dividend depended on the policy'sanniversary date and the schedule of the policyholder's premium payment. The company's practicewas to credit a policyholder's account with the amount of the annual dividend on a date before thepolicy's anniversary date but not pay the dividend until after the anniversary date. The company paidthe annual dividend if the policyholder paid the policy premium and the policy was in force on theanniversary date. For most policies, the credit date fell within the same calendar year as the policyanniversary date. For policies with January anniversary dates, the credit date and anniversary datefell within different calendar years. New York Life deducted from its gross income the annual dividendsamounts based on the credit dates rather than on the anniversary dates when the dividends werepaid. Certain policies were also eligible for a termination dividend, which was paid to the policyholderor beneficiary upon the policy's termination.

On its federal income tax returns for 1990 through 1995, New York Life deducted the annual andtermination policyholder dividends as accrued expenses, even though they were not paid until thefollowing years. The IRS disallowed the deductions on the basis that the company could not deductthe dividends until the year of payment. In contesting the ruling, New York Life paid the taxes and fileda refund claim for $99.66 million in a district court. The district court dismissed the suit, concluding thatNew York Life failed to show that the expenses satisfied the all- events test of Reg. Sec. 1.461-1(a)(2)for the tax years in which they were accrued.

Code Sec. 808 allows life insurance companies to deduct from gross income an amount equal to thepolicyholder dividends paid or accrued during the tax year. Reg. Sec.1.461-1(a)(2) provides that aliability is incurred and generally taken into account for federal income tax purposes in the tax year inwhich (1) all events have occurred that establish the fact of liability, (2) the amount of the liability canbe determined with reasonable accuracy, and (3) economic performance has occurred with respect tothe liability.

Observat ion: To satisfy the conditions of the all- events test, the liability must be final and definite inamount, must be fixed and absolute, and must be unconditional. Thus, a liability does not accrue aslong as it remains contingent.

New York Life argued that, in each year at issue, it made one of three combinations of dividendpayments to eligible policyholders: an annual dividend, a termination dividend, or both an annual andtermination dividend. Each year, the company calculated the annual and termination dividends itexpected to pay the following year and claimed the amounts as a deduction for an accrued dividendunder Code Sec. 808.

The IRS claimed that the deductions did not satisfy the all- events test, which governs the deductibilityof accrued but unpaid expenses.

The Second Circuit held that, because the company's liability for the two dividends was contingent, allevents had not occurred to fix the company's liability for the tax years in which it took the deductions.The court noted that the all- events test set forth in Reg. Sec. 1.461-1(a)(2) governs whether the liabilityfor the policyholder dividends accrued during the tax year. The court looked to U.S. v. HughesProperties, Inc., 476 U.S. 593 (1986) and U.S. v. General Dynamics Corp., 481 U.S. 239 (1987), whichheld that it is fundamental to the all- events test that a liability be firmly established to be deductibleand a taxpayer may not deduct a contingent liability or an estimate of an anticipated expense, nomatter how statistically certain. The court rejected New York Life's argument that the last event forpurposes of the all- events test occurred when the January policyholders paid the final premium tokeep their policies in force through the January anniversary dates, because the policyholders'decision to keep the policy in force through the anniversary date did not occur until January of thefollowing year. Policyholders could surrender their policies for cash value at any time.

The court found that, for policies with January anniversary dates, the company had no obligation topay the policyholder an annual dividend if the policy was surrendered before the anniversary date.The company also had no obligation to pay either an annual or termination dividend in the followingtax year, as neither dividend was unconditionally due. The court concluded that the requirements ofthe all- events test were not satisfied, and the judgment of the district court was affirmed.

For a discussion of the all- events test, see Parker Tax ¶241,520.

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No Reasonable Cause Shown for Bankruptcy Trustee's Untimely Filed Returns; IRS's Claim forPenalties as Administrative Expense Disallowed

Because a bankruptcy trustee did not show reasonable cause for late filing of the bankruptcy estate'sS corporation tax returns, late- filing penalties were upheld; however, the penalties did not constitute apriority administrative claim under Bankruptcy Code Section 503(b)(1)(A), and the case was remandedto see if the penalties qualified as an administrative expense for other reasons. In re 800Ideas.Com,Inc., 2013 PTC 222 (B.A.P. 9th Cir. 7/22/13).

In January 2007, 800Ideas.Com, Inc., an S corporation, filed a Chapter 7 bankruptcy petition. RichardKipperman was appointed as the bankruptcy trustee. The corporation's liabilities exceeded its assets,and its main asset was a potential right in an excise tax refund for 2006. In March 2007, Richard askedthe debtor's prepetition accountant to prepare the 2006 tax return. He was advised that the return wouldbe completed by April 2008. However, the return was not completed and filed until January 2010. TheIRS processed the return and disallowed $1,950 of the $38,197 claimed refund. The bankruptcy estatereceived the refund in June 2011. In July 2011, a second accountant completed and filed the debtor's2007, 2008, 2009, and 2010 returns. The 2008 and 2010 returns stated that the debtor had zero taxliability. After processing the returns, the IRS assessed penalties against the debtor for 2008 and 2010failing to timely file its returns.

The IRS filed a Request for Payment of Internal Revenue Taxes in bankruptcy court based on the 2008and 2010 late- filing penalties and asserted that the penalties were an administrative priority expense.Richard objected to the claim, arguing that his failure to timely file the debtor's tax returns was due toreasonable cause. The bankruptcy found that Richard had no reasonable cause to delay filing thereturns at issue while waiting for the excise tax refund and allowed the IRS's claim for penalties as anadministrative expense. Richard timely filed a notice of appeal of the bankruptcy court order.

Code Sec. 6037 provides that an S corporation must file a return each tax year. When a corporationfiles for bankruptcy, it is the trustee's duty to file the corporation's tax returns. A penalty is imposedunder Code Sec. 6699 if an S corporation fails to timely file a return unless the failure was due toreasonable cause. The penalty is $195 a month times the number of S shareholders. If the corporationhas no assets or income, the trustee may ask the IRS to be relieved of the reporting obligation byfollowing the procedure in Rev. Proc. 84-59.

Administrative expenses of a bankruptcy estate are given second priority under Bankruptcy CodeSection 507 and include the actual, necessary costs and expenses of preserving the estate underBankruptcy Code Section 503.

Richard argued that the penalties were not based on any unpaid tax incurred by the bankruptcyestate, and the claim should be treated as a subordinated penalty claim.

The IRS contended that Richard had an obligation to file 800Idea.com's tax returns, and thecorporation's insolvency did not constitute reasonable cause to excuse the assessed penalties. TheIRS also argued the penalties were entitled to administrative expense priority as an actual andnecessary cost and expense of preserving the estate.

The Bankruptcy Appellate Panel affirmed the bankruptcy court holding that Richard failed to show thathe had reasonable cause for his delay in filing 800Idea.com's tax returns. Richard's claim that the latefiling was based on his mistaken belief that the debtor's insolvency automatically relived him of theobligation to file the returns was rejected because he showed no factors that were beyond his controlin filing the returns. The court noted that Richard's lack of diligence in supervising the accountants,deliberate decision to delay filing the returns, and failure to pursue the IRS procedure which may haverelieved him of the burden of filing the returns provided ample basis to find no reasonable cause andsustain the assessment of penalties.

The court looked to case law in Abercrombie v. Hayden Corp., 139 F.3d 755 (9th Cir. 1998), whichfound that, for an administrative expense to be actual and necessary, the claim must have arisen froma transaction with the debtor in possession and must directly and substantially benefit the estate. Thecourt noted that the primary goal of a bankruptcy case was to minimize costs to preserve limitedassets of the bankruptcy estate for the benefit of unsecured creditors. The penalties were not incurredin the operation of the business and did not benefit or preserve the bankruptcy estate. Since Richardwas not operating the corporation's business, to allow administrative expense priority to the IRS'sclaim would be detrimental to the unsecured creditors. Therefore, the penalties were not eligible for

administrative expense priority. However, the court remanded the case to the bankruptcy court todetermine if the penalties qualify as an administrative expense for other reasons.

For a discussion of the penalty for failing to file an S corporation return, see Parker Tax ¶36,540.

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Former Client's Testimony Helps Convict BDO Accountant of Preparing and Filing Fraudulent Returns

A former client's testimony, as well as a recording between the former client and his personalaccountant, was allowed into evidence to help convict a former BDO Seidman accountant on chargesof preparing and filing fraudulent returns for the client. U.S. v. Favato, 2013 PTC 229 (3d Cir. 8/5/13).

Stephen Favato was an accountant with the accounting firm BDO Seidman. While at BDO, Stephenprepared personal tax returns for Daniel Funsch, CEO of Intarome Fragrance Corporation. Stephenprepared and filed a fraudulent tax return for Funsch for the 2002. He also prepared false returns forFunsch for 2003 and 2004. These returns contained false claims for (1) expenses and depreciation fora commercial yacht owned by Great Escape Yachts, LLC, which Funsch held for personal use (i.e., theyacht scheme); (2) a reduction in the actual gain Funsch recognized on the sale of his personalresidences (i.e., the real estate scheme); and (3) falsely increased charitable donation reports (i.e.,the charity scheme).

During a trial, the IRS presented recorded conversations, documentary evidence, and testimony todemonstrate that Stephen knowingly and willfully prepared the fraudulent returns for tax years 2002,2003, and 2004. The only recorded conversations between Funsch and Stephen were from tax years2003 and 2004, so the IRS relied on Funsch's testimony to establish Stephen's complicity in the 2002tax return. Over Stephen's objection, the district court also admitted portions of a 2002 recordedconversation between Funsch and his then-personal accountant, John Rosenberger, as a priorconsistent statement to rebut Stephen's assertion that Funsch had fabricated trial testimony aboutStephen's involvement in the 2002 return. Stephen also objected to the model jury instruction used attrial. The jury found Stephen guilty of both the aforementioned counts, and Stephen filed a motion foracquittal and another motion for a new trial on the grounds that there was insufficient evidence tosupport the jury's verdict. The district court denied both motions and Stephen appealed to ThirdCircuit.

The Third Circuit affirmed the district court's judgment. With respect to the district court's ruling on theadmissibility of a prior consistent statement, the court noted that there are four criteria that must be metfor the proper admission of a prior consistent statement: (1) The declarant must testify at trial and besubject to cross-examination; (2) there must be an express or implied charge of recent fabrication orimproper influence or motive of the declarant's testimony; (3) the proponent must offer a priorconsistent statement that is consistent with the declarant's challenged in-court testimony; and, (4) theprior consistent statement must be made before the time that the supposed motive to falsify arose.

The district court did not abuse its discretion in admitting the 2002 recordings. Funsch's statements toRosenberger about Stephen's complicity in the Yacht Scheme met the aforementioned criteria. First,Funsch testified at trial and was subject to cross-examination. Second, during cross-examination,Stephen's questions plainly accused Funsch of having the improper motive to do/say anything to stayout of jail, including lie about Stephen's complicity in the yacht scheme. Third, the two Rosenbergerrecordingsthe prior consistent statements in questionwere consistent with Funsch's trial testimony aboutStephen's involvement in the yacht scheme. Finally, the statements were made during the pre-motiveperiod. The district court determined that the motive to lie period began when Funsch was firstconfronted by the government; Funsch made these statements before that confrontation.

The court also found that the challenged jury instructions were not erroneous, and that the district courtproperly denied Stephen's motion for acquittal because the evidence was sufficient to establish hisguilt. Finally, with respect to Stephen's argument that he should get a new trial because the jury'sverdict was contrary to the weight of the evidence, the court said the IRS's evidence was sufficient tosupport Stephen's conviction.

For a discussion of the criminal penalties for filing false and fraudulent returns, see Parker Tax¶277,110.

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Nonresident Alien's Claim for Refund of Taxes Withheld by His Employer Was Barred under the Three-

Year Look-Back Period

A nonresident alien's claim for a refund of taxes withheld by his employer was barred under the three-year look-back period because his refund claim was not filed within three years of the filing of hisreturn. Boeri v. U.S., 2013 PTC 223 (Fed. Cir. 7/31/13).

Mario Boeri, an Italian citizen who never lived or worked in the United States, worked for VerizonCorporation. In 2003, Mario chose to participate in the company's voluntary separation plan and, underthe plan, was awarded a separation payment of over $247,000 in 2004. Over two distributions in Marchand August 2004, Verizon withheld approximately $71,000, including U.S. income tax withholding,social security tax, and Medicare tax. In 2009, Mario filed a 2004 Form 1040NR, U.S. Nonresident AlienIncome Tax Return, seeking a refund of the taxes withheld by Verizon. The IRS denied Mario's refundrequest on the ground that his return was filed more than three years after its due date. Marioappealed to the U.S. Court of Federal Claims. The Claims Court held that Mario could not recover thewithheld taxes because his refund request was not made within the three-year statute of limitationsperiod. Mario appealed. Under Code Sec. 6511(b)(2), a claim for credit or refund of an overpayment oftax must be filed by the taxpayer within three years from the time the return was filed or two years fromthe time the tax was paid, whichever period expires later. Under Code Sec. 6513(b)(1), any taxdeducted and withheld at the source during the calendar year will, with respect to the recipient of theincome, be deemed to have been paid by the recipient on April 15 following the close of the tax year.

Observat ion: For purposes of the statute of limitations for refund claims, any return filed before thedue date of the return is treated as filed on the due date of the return, and any tax payment madebefore the due date of the payment is treated as made on the due date of the payment.

Mario argued that the three-year look-back period did not apply because he was seeking acorrection of an erroneous withholding rather than a refund of a tax overpayment. Thus, he argued, hisparticular circumstances did not come within the scope of the three-year look-back provision of CodeSec. 6511.

The Federal Circuit affirmed the Claims Court decision and held that Mario failed to bring his refundclaim within three years of when the tax was paid. The look-back provisions of Code Sec. 6511(b)(2)limit the refund available to Mario to taxes paid within the applicable look-back period. Here, the courtstated, the applicable period is the three-year period immediately preceding the filing of the March2009 refund claim. Mario's withholdings were deemed paid to him in the two distributions on March andAugust 2004.

The court noted that there was some question as to whether Mario's taxes were withheld under InternalRevenue Code Chapter 24, Collection of Income Tax at Source on Wages, or if they were withheldunder Internal Revenue Code Chapter 3, Withholding of Tax on Nonresident Aliens and ForeignCorporations. If Mario's taxes were withheld under Chapter 3, then Code Sec. 6513(b)(1) would notapply. The court brought up the issue itself, only to ensure that Mario could not be afforded relief if hiswithholdings came under Chapter 3.The court concluded that it was irrelevant whether the taxes werewithheld under Chapter 3 or Chapter 24, since the withheld taxes were deemed paid outside of thethree-year look-back period. The court concluded that Mario's taxes were deemed paid more thanthree years before the filing of his refund request.

For a discussion of the statute of limitations on refund claims, see Parker Tax ¶261,180.

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