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Attentione! International Employment | US Employees in Italy

This Freeman Law Insights blog regards considerations, challenges, and opportunities for a domestic U.S. employer looking to or engaged in the employ a U.S. citizen who resides in the country of Italy. This is not legal advice; just legal information, unless you paid for it. However, the legge information here should be useful for those U.S. employers interested in expanding the now ubiquitous U.S. employee remote work regime into the country of Italy.

Employer of Record. The U.S. employer should first evaluate and consider engaging an employer of record who is active in such services in the country where the U.S. citizen will perform the work. An employer of record is, essentially, a third-party service that operates as an employer on a hiring U.S. company’s behalf. This allows the hiring company to avoid having to establish an entity in the foreign country. The employer of record usually handles the legal requirements for complying with the foreign laws for payroll, contracts, and benefits.

Military Considerations. If the employee is a dependent of a member of the U.S. military, the employee should be aware that the rules of Status of Forces Privileges (SOFA) may or may not jeopardy certain military privileges by virtue of the employee’s employ while stationed overseas. See, for example, SOFA information on work in Italy here (Spouse Employment). However, the SOFA privilege matters were recently (August 30, 2023) modified to mitigate the adverse consequences to those U.S. citizen dependents on military bases in, for example, Italy and who work for a U.S. employer, provided that the U.S. citizen has a missione visa. See Telework to US Employers. And, U.S. employees who qualify for the approved telework as such likely fall under U.S. and not Italian employment laws.

Worker Tax Matters. The wages paid to the U.S. citizen living in Italy and working for a U.S. employer are subject to U.S. federal income tax withholding. Limited exceptions apply. A U.S. citizen living and working in Italy is required to file a U.S. tax return and a similar return in Italy, reporting wages from the U.S. employer-issued Form W2. The employee should be advised to engage independent tax counsel because the confluence of U.S. and Italy personal tax laws is or can be complicated.

Worker Social Security. For example, the U.S. employer is likely not required to pay Italian social security because of the Totalization Agreement in place between the U.S. and Italy. The U.S. employer usually must withhold FICA and Social Security from the wages earned by the U.S. citizen working overseas. The U.S. citizen may be taxed, under Italian law, for the amounts withheld for U.S. employment tax purposes (i.e., for FICA and Social Security), and then the U.S. citizen may later receive a credit pursuant to a foreign tax credit for subsequent U.S. tax returns. An exemption may be established through the Totalization Agreement between the U.S. and Italy, and the recently-issued SOFA Telework changes may have mitigated, if not eliminated, that duplication of social security for the U.S. citizen working under the military Telework regime. The U.S. employer generally must request a Certificate of Coverage to establish the U.S. citizen’s exemption from Italian social security. See also the Certificate of Coverage Request Form for online application for Certificate.

Earned Income Tax Exclusion for the US Worker. The U.S. citizen may also benefit from an exclusion for foreign earned income, if the U.S. citizen meets the requirements applicable for the exclusion. However, the employee may be subject to a double taxation initially, which may then entitle the employee to a refund, based on a foreign tax credit application in later filing years in the U.S.

Written Agreement. In any case, a written contract for remote work between the hiring entity and the U.S. citizen overseas is recommended and advisable (and may be required under Italian law, for example), whether for contract labor or employment. And, an employer of record is recommended, whether the worker is treated as an employee or an independent contractor (the distinction of which has its own set of considerations).

Closing. Italy has a complex system for employment matters, and the international aspects of the potential employer-employee relationship make the arrangement even more cumbersome. But, with attention to detail (and legal and tax requirements), the arrangement is achievable and will not be the first of its kind. Below is a schedule of resources and information on this subject.

Informational Resources for Telework of US Citizens in Italy
Status of Forces Agreement (SOFA) – Italy	https://home.army.mil/italy/my-garrison-Italy/pcsguidevic/living-vicenza/spouse-employement
Telework to U.S. Employers – Italy (missione visa required) (August 30, 2023)	https://home.army.mil/italy/my-garrison-Italy/telework
IRS Guidance – Federal Income Tax Withholding for Persons Employed Abroad by a U.S. Person	https://www.irs.gov/individuals/international-taxpayers/persons-employed-abroad-by-a-us-person
Department of State – U.S. Embassy & Consulate in Italy	https://it.usembassy.gov/u-s-citizen-services/local-resources-of-u-s-citizens/visiting-living/ https://it.usembassy.gov/u-s-citizen-services/irs/
IRS Guidance – Foreign Earned Income Exclusion – What is Foreign Earned Income	https://www.irs.gov/individuals/international-taxpayers/foreign-earned-income-exclusion-what-is-foreign-earned-income
IRS Guidance – Foreign Earned Income Exclusion	https://www.irs.gov/individuals/international-taxpayers/foreign-earned-income-exclusion
IRS Foreign Tax Credit	https://www.irs.gov/individuals/international-taxpayers/foreign-tax-credit
IRS Guidance – FBAR Reporting for Foreign Financial Accounts	https://www.irs.gov/businesses/small-businesses-self-employed/report-of-foreign-bank-and-financial-accounts-fbar
Department of State – Telework Guidance for Overseas Family Members	https://www.state.gov/global-community-liaison-office/family-member-employment/telework
U.S. – Italian Social Security Agreement	https://www.ssa.gov/international/Agreement_Texts/italy.html
Social Security Administration – Totalization Agreement with Italy	https://www.ssa.gov/international/Agreement_Pamphlets/italy.html US International Social Security Agreements
Social Security Administration – Certificate of Coverage for Employee Exemption in Italy	https://www.ssa.gov/international/Agreement_Pamphlets/italy.html#certificate2 https://opts.ssa.gov/s/ (online application for Certificate)

Tax Court In Brief

The Tax Court December 26, 2021 – January 1, 2022

The Tax Court December 13 – 18, 2021

The Tax Court December 6 – December 10, 2021
Tax Court Case: Coggin v. Comm’r, 157 T.C. No. 12 | December 8, 2021 | Weiler, J. | Dkt. No. 21580-19
The Tax Court in Brief November 29 – December 3, 2021

The Tax Court in Brief November 22 – November 26, 2021

901 S. Broadway v. Comm’r, No. 14179-17, T.C. Mom 2021-132 | November 23, 2021 | Halpern
Sand Inv. Co. v. Comm’r; 157 T.C. Memo. 11, 2021 | November 23, 2021 Lauber, J. | Dkt. No. 7307-19

The Tax Court in Brief November 15 – November 19, 2021

The Tax Court in Brief November 8 – November 12, 2021

Peak v. Comm’r, T.C. Memo 2021-128
Knox v. Comm’r, T.C. Memo. 2021-126
Smaldino v. Comm’r, T.C. Memo 2021-127

The Tax Court in Brief October 25 – October 29, 2021

Tribune Media et al. v. Comm’r, Nos. 20940-16 & 20941-16, T.C. Memo 2021-122
Cashaw v. Comm’r, No. 9352-16L, T.C. Memo 2021-123
Albert G. Hill, III v. Comm’r; T.C. Memo. 2021-121

The Tax Court in Brief October 18 – October 22, 2021

Goldberg v. Comm’r, T.C. Memo. 2021-119 | October 19, 2021 | Paris, J. | Dkt. No. 12871-18L

The Tax Court in Brief October 4 – October 8, 2021

Crim v. Comm’r, T.C. Memo. 2021-117
Leyh v. Comm’r, 157 T.C. No. 7
Suzanne Jean McCrory v. Comm’r, T.C. Memorandum 2021-116

The Tax Court in Brief September 27 – October 1, 2021

Whistleblower 14377-16W v. Comm’r, T.C. Memo. 2021-113
Gregory v. Comm’r, T.C. Memo. 2021-115

The Tax Court in Brief September 20 – September 24, 2021

Daniel Omar Parker and Chantrell Antoine Parker v. Comm’r, No. 13231-19, T.C. Memo 2021-111

The Tax Court in Brief September 13 – September 17, 2021

Donna M. Sutherland v. Comm’r, No. 3634-18, T.C. Memo 2021-110

The Tax Court in Brief August 30 – September 3, 2021

Karson C. Kaebel v. Comm’r, No. 16171-18P, T.C. Memo 2021-109

The Tax Court in Brief August 30 – September 3, 2021

Tax Court Case: Sherrie L. Webb v. Comm’r; T.C. Memo. 2021-105
Wai-Cheung Wilson Chow and Deanne Chow v. Comm’r, No. 14249-18W, T.C. Memo 2021-106
Tax Court Case: Gaston v. Comm’r, T.C. Memo. 2021-107

The Tax Court in Brief August 23 – August 27, 2021

Estate of Charles P. Morgan, Deceased, Roxanna L. Morgan, Personal Representative and Roxanna L. Morgan v. Comm’r, T.C. Memo 2021-104
Vera v. Comm’r, 157 T.C. No. 6

The Tax Court in Brief August 16 – August 20, 2021

Catlett v. Comm’r, No. 13058-14, T.C. Memo 2021-102
Catherine S. Toulouse v. Comm’r, 157 T.C.
Lissack v. Comm’r, 157 T.C. No. 5
Deborah C. Wood v. Comm’r; T.C. Memo. 2021-103

The Tax Court in Brief August 9 – August 13, 2021

Manuelito B. Rodriguez & Paz Rodriguez v. Comm’r, No. 19122-19
Christian D. Silver v. Comm’r, T.C. Memo 2021-98
Wathen v. Comm’r, No. 4310-18, T.C. Memo 2021-100
Kidz University, Inc. v. Comm’r, T.C. Memo. 2021-101

The Tax Court in Brief August 2 – August 6, 2021

Tax Court Case : Belair v. Comm’r, Bench Opinion
Rogers v. Commissioner, 157 T.C. No. 3
Today’s Health Care II LLC. v. Comm’r, 2021 T.C. Memo 2021-96
Jerry R. Abraham and Debra J. Abraham. v. Comm’r, 2021 T.C. Memo 2021-97

The Tax Court in Brief July 26 – July 31, 2021

Tax Court Case: Harrington v. Comm’r, T.C. Memo. 2021-95
Ononuju v. Commissioner, T.C. Memo. 2021-94
Tax Zuo v. Comm’r, No. 5716-19S, 2021 BL 279235, 2021 Us Tax Ct. Lexis 53

The Tax Court in Brief July 19 – July 23, 2021

Tax Court Case: Morris F. Garcia, Deceased, and Sharon Garcia v. Commissioner
Tax Court Case: New World Infrastructure Organization v. Commissioner, T.C. Memo. 2021-91

The Tax Court in Brief July 12 – July 16, 2021

Tax Court Case: Blossom Day Care Centers, Inc. v. Comm’r, 2021 T.C. Memo 2021-87
Tax Court Case: Berger v. Commissioner, T.C. Memo. 2021-89
Tax Court Case: Morreale v. Commissioner, T.C. Memo. 2021-90

The Tax Court in Brief July 5 – July 9, 2021

Peter Freund v. Commissioner, T.C. Memo. 2021-83
Delgado v. Commissioner, T.C. Memo. 2021-84
Mathews v. Commissioner, T.C. Memo. 2021-85

The Tax Court in Brief June 21 – June 25, 2021

Tax Court Case: Ervin v. Commissioner, T.C. Memo. 2021-75
Hussey v. Commissioner, 156 T.C. No. 12

The Tax Court in Brief June 14 – June 18, 2021
Bell Capital Management, Inc. v. Commissioner, T.C. Memo. 2021-74
The Tax Court in Brief May 31 – June 4, 2021

ES NPA Holding, LLC v. Commissioner, T.C. Memo. 2021-68
Michael Torres v. Commissioner, T.C. Memo. 2021-66
New Capital Fire, Inc. v. Commissioner, T.C. Memo. 2021-67

The Tax Court in Brief May 24 – May 28, 2021

Estate of Grossman v. Comm’r, T.C. Memo. 2021-65

The Tax Court in Brief May 17 – May 21, 2021

Fumo v. Comm’r, T.C. Memo. 2021-31
PEEPLES v. Comm’r, Summary Op
Shitrit v. Commissioner, T.C. Memo. 2021-63
Ginos v. Comm’r, T.C. Memo. 2021-14
Mason v. Comm’r, T.C. Memo. 2021-64

The Tax Court in Brief May 10 – May 14, 2021

Jenkins v. Commissioner, T.C. Memo. 2021-54
Adler v. Commissioner, T.C. Memo. 2021-56
Bailey v. Commissioner, T.C. Memo. 2021-55
Battat v. Commissioner, T.C. Memo. 2021-5
ESTATE OF MORRISSETTE, T.C. Memo. 2021-60

The Tax Court in Brief May 3 – May 7, 2021

Chancellor v. Comm’r, T.C. Memo. 2021-50
Barnes v. Comm’r, T.C. Memo. 2021-49
Jacobs v. Comm’r, T.C. Memo. 2021-51
Berry v. Comm’r, T.C. Memo. 2021-52
Tikar, Inc. v. Comm’r, T.C. Memo. 2021-53

The Tax Court in Brief April 26 – April 30, 2021

Plentywood Drug, Inc.
Ronnie S. Baum and Teresa K. Baum v. Comm’r, T.C. Memo 2021-46
Mylan, Inc. & Subsidiaries v. Commissioner, 156 T.C. No. 10
Aschenbrenner v. Comm’r, Bench Opinion
Stankiewicz v. Comm’r, 2021 BL 156162
Haghnazarzadeh v. Comm’r, T.C. Memo 2021-47
Woll v. Comm’r, Bench Opinion

The Tax Court in Brief April 19 – April 23, 2021

Tax Court Case: Colton v. Comm’r, T.C. Memo 2021-44

The Tax Court in Brief April 11 – April 16, 2021

De Los Santos v. Comm’r, 156 T.C. No. 9
Tax Court Case: Flynn v. Comm’r, T.C. Memo 2021-43

The Tax Court in Brief April 05 – April 09, 2021

Tax Court Case Reston and Elizabeth Olsen
Andrew and Sara Berry

The Tax Court in Brief March 29 – April 2, 2021

Crandall v. Comm’r
Rowen v. Comm’r
Purple Heart Patient Center, Inc. v. Comm’r
Walton v. Comm’r| T.C. Memo. 2021-40
Max v. Comm’r| T.C. Memo. 2021-37
Rowen v. Comm’r| 156 T.C. No. 8

The Tax Court in Brief March 22 – March 26, 2021

American Limousines, Inc. v. Comm’r
Martin v. Comm’r, T.C. Memo. 2021-35

The Tax Court in Brief – March 15 – March 19, 2021
Catania v. Commissioner, T.C. Memo. 2021-33 | March 15, 2021 | Vasquez, J. | Dkt. No. 13332-19
The Tax Court in Brief – March 8 – 12, 2021

Clarence J. Mathews v. Comm’r, T.C. Memo 2021-28 March 9, 2021
Smith v. Comm’r, T.C. Memo. 2021-29
Caylor Land & Development, Inc. v. Commissioner, T.C. Memo. 2021-30
Brian E. Harriss, T.C. Memo. 2021-31

The Tax Court in Brief – March 1-5, 2021

The Tax Court in Brief – February 22 – 26, 2021

The Tax Court in Brief February 15 – February 19, 2021

Tax Court Case: Kramer v. Comm’r, T.C. Memo. 2021-16
Estate of Warne v. Comm’r, T.C. Memo. 2021-17
Blum v. Comm’r, T.C. Memo. 2021-18
San Jose Wellness v. Comm’r, 156 T.C. No. 4

The Tax Court in Brief February 8 – February 12, 2021

BM Construction v. Comm’r, T.C. Memo. 2021-13
Complex Media, Inc. v. Comm’r, T.C. Memo. 2021-14

The Tax Court in Brief – January 25 – 29, 2021

Costello v. Comm’r, T.C. Memo. 2021-9
Grajales v. Comm’r, 156 T.C. No. 3
Reynolds v. Comm’r, T.C. Memo. 2021-10
Whatley v. Comm’r, T.C. Memo. 2021-11
Sells v. Comm’r, T.C. Memo. 2021-12

The Tax Court in Brief January 18 – January 22, 2021

Adams Challenge (UK) Limited v. Comm’r, 156 T.C. No. 2
Aspro, Inc. v. Comm’r, T.C. Memo. 2021-8

The Tax Court in Brief – January 11 – 15, 2021

Kennedy v. Comm’r, T.C. Memo. 2021-3
Ramey v. Comm’r, 156 T.C. No. 1
Filler v. Comm’r, T.C. Memo. 2021-6

Freeman Law’s Top 10 Tax Court Cases of 2020

Frost v. Comm’r, 152 T.C. No. 2 (Jan. 7, 2020)
Laidlaw’s Harley Davidson Sales, Inc. v. Comm’r, 154 T.C. No. 4 (Jan. 16, 2020)
Chadwick v. Comm’r, 154 T.C. No. 5 (Jan. 21, 2020)
Oakbrook Land Holdings, LLC v. Comm’r, 154 T.C. No. 10 (May 12, 2020)
Sage v. Comm’r, 154 T.C. No. 12 (June 2, 2020)
Ruesch v. Comm’r, 154 T.C. No. 13 (June 25, 2020)
Barnhill v. Comm’r, 155 T.C. No. 1 (July 21, 2020)
Bemmelen v. Comm’r, 155 T.C. No. 4 (Aug. 27, 2020)
Thompson v. Comm’r, 155 T.C. No. 5 (Aug. 31, 2020)
Bemmelen v. Comm’r, 155 T.C. No. 4 (Aug. 27, 2020)

The Tax Court in Brief November 14 – November 20, 2020

Bruno v. Comm’r, T.C. Memo. 2020-156
Aghadjanian v. Comm’r, T.C. Memo. 2020-155
Kane v. Comm’r, T.C. Memo. 2020-154

The Tax Court in Brief – November 7 – November 13, 2020

The Tax Court in Brief October 31 – November 6, 2020

Glade Creek Partners, LLC, Sequatchie Holdings, LLC, TMP v. Comm’r, T.C. Memo. 2020-148
Leith v. Comm’r, T.C. Memo. 2020-149

The Tax Court in Brief October 24 – October 30, 2020

Sharma v. Comm’r, T.C. Memo. 2020-147

The Tax Court in Brief October 17 – October 23, 2020

Giambrone v. Comm’r, T.C. Memo. 2020-145
Coleman v. Comm’r, T.C. Memo. 2020-146

The Tax Court in Brief October 10 – October 16, 2020

Jesus R. Oropeza v. Comm’r, 155 T.C. No. 9
Watts v. Comm’r, T.C. Memo. 2020-143
The Morning Star Packing Company, L.P., et al. v. Comm’r, T.C. Memo. 2020-142
Watts v. Comm’r, T.C. Memo. 2020-143

The Tax Court in Brief October 3 – October 9, 2020

Doyle v. Comm’r, T.C. Memo. 2020-139
Spagnoletti v. Comm’r, T.C. Memo. 2020-140
Worthington v. Comm’r, T.C. Memo. 2020-141

The Tax Court in Brief September 28 – October 2, 2020

Lucero v. Comm’r, T.C. Memo. 2020-136

The Tax Court in Brief September 21 – September 25, 2020

Patel v. Comm’r, T.C. Memo. 2020-133
Robinson v. Comm’r, T.C. Memo. 2020-134

The Tax Court in Brief September 12 – 18, 2020

Deckard v. Comm’r, 155 T.C. No. 8
Cindy Damiani v. Comm’r, T.C. Memo. 2020-132
Felix Ewald Friedel v. Comm’r, T.C. Memo. 2020-131

Tax Court in Brief September 5 – 11, 2020

Sutherland v. Comm’r, 155 T.C. No. 6
Fowler v. Comm’r, 155 T.C. No. 7
Robert J. Belanger v. Comm’r, T.C. Memo. 2020-130
Korean-American Senior Mutual Association, Inc., T.C. Memo. 2020-129

The Tax Court in Brief August 29 – September 4, 2020

Savedoff v. Comm’r, T.C. Memo. 2020-125
Daichman v. Comm’r, T.C. Memo. 2020-126
Douglas M. Thompson and Lisa Mae Thompson v. Comm’r, 155 T.C. No. 5
Dickinson v. Commissioner, T.C. Memo. 2020-128
Franklin v. Commissioner, T.C. Memo. 2020-127

The Tax Court in Brief August 22 – August 28, 2020

Swanberg v. Comm’r, T.C. Memo. 2020-123
Rivas v. Comm’r, T.C. Memo. 2020-124
Whistleblower v. Comm’r, 155 T.C. No. 2
TGS-NOPEC Geophysical Company & subsidiaries v. Comm’r, 155 T.C. No. 3.
Van Bemmelen v. Comm’r, 155 T.C. No. 4

The Tax Court in Brief August 15 – August 21, 2020

Emanouil v. Comm’r, T.C. Memo. 2020-120
Nirav B. Babu, T.C. Memo. 2020-121
Brashear v. Comm’r, T.C. Memo. 2020-122

The Tax Court in Brief August 1 – August 7, 2020

Reflectxion Resources, Inc. v. Comm’r, T.C. Memo. 2020-114
Red Oak Estates, LLC v. Commissioner, T.C. Memo. 2020-116
Cottonwood Place, LLC v. Commissioner, T.C. Memo. 2020-115
Schroeder v. Comm’r, T.C. Memo. 2020-117
Stevens v. Comm’r, T.C. Memo. 2020-118

The Tax Court in Brief – July 25 – July 31, 2020
Biggs-Owens v. Comm’r, T.C. Memo. 2020-113 | July 30, 2020 | Urda, J. | Dkt. No. 15274-17L
The Tax Court in Brief – July 19 – July 24, 2020

The Tax Court in Brief July 12 – July 17, 2020

Duffy v. Comm’r, T.C. Memo. 2020-108 Smith Lake, LLC, David Hewitt, TMP v. Comm’r, T.C. Memo. 2020-84
Weiderman v. Comm’r, T.C. Memo. 2020-109
Robert Elkins v. Comm’r, T.C. Memo. 2020-110

The Tax Court in Brief July 6– July 10, 2020

The Tax Court in Brief June 29 – July 3, 2020

The Tax Court in Brief The Week of June 22, 2020

Lloyd v. Comm’r, T.C. Memo. 2020-92 | June 22, 2020 | Halpern, J. | Dkt. No. 12309-17
Plateau Holdings, LLC, Waterfall Development Manager, LLC, TMP v. Comm’r, T.C. Memo. 2020-93
Lumpkin One Five Six, LLC v. Comm’r, T.C. Memo. 2020-94
Vivian Ruesch v. Comm’r, 154 T.C. No. 13 | June 25, 2020 | Lauber, J. | Dkt. No. 6188-19P

The Tax Court in Brief June 15 – 19, 2020

The Tax Court in Brief June 8 – 12, 2020

The Tax Court in Brief June 1-7, 2021

The Tax Court in Brief May 25 – 29, 2020

Gluck v. Comm’r, T.C. Memo. 2020-66
Amanda Iris Gluck Irrevocable Trust v. Comm’r, T.C. Memo. 154 T.C. No. 11
Thoma v. Comm’r, T.C. Memo. 2020-67
Novoselsky v. Comm’r, T.C. Memo. 2020-68
Engle v. Comm’r, T.C. Memo. 2020-69
Larkin v. Comm’r, T.C. Memo. 2020-70

The Tax Court in Brief May 18 – 22, 2020

Nesbitt v. Comm’r, T.C. Memo. 2020-61
Pope v. Comm’r, T.C. Memo. 2020-62
Richlin v. Comm’r, T.C. Memo. 2020-60
Frantz v. Comm’r, T.C. Memo. 2020-64
Peacock v. Comm’r, T.C. Memo. 2020-63
Joseph v. Comm’r, T.C. Memo. 2020-65
Serrano v. Comm’r, T.C. Summ. Op. 2020-15
\n\n[/cs_content_seo][cs_element_text _id=”20″ ][cs_content_seo]Tax Court January 31 – February 4, 2022

The Tax Court January 9 -15th 2022

The Tax Court December 26, 2021 – January 1, 2022

The Tax Court December 13 – 18, 2021

The Tax Court in Brief December 6 – December 10, 2021

Coggin v. Comm’r, 157 T.C. No. 12 | December 8, 2021 | Weiler, J. | Dkt. No. 21580-19

The Tax Court in Brief November 29 – December 3, 2021

The Tax Court in Brief November 22 – November 26, 2021

901 S. Broadway v. Comm’r, No. 14179-17, T.C. Mom 2021-132 | November 23, 2021 | Halpern
Sand Inv. Co. v. Comm’r; 157 T.C. Memo. 11, 2021 | November 23, 2021 Lauber, J. | Dkt. No. 7307-19

The Tax Court in Brief November 15 – November 19, 2021

The Tax Court in Brief November 8 – November 12, 2021

Peak v. Comm’r, T.C. Memo 2021-128
Knox v. Comm’r, T.C. Memo. 2021-126
Smaldino v. Comm’r, T.C. Memo 2021-127

The Tax Court in Brief October 25 – October 29, 2021

Tribune Media et al. v. Comm’r, Nos. 20940-16 & 20941-16, T.C. Memo 2021-122
Cashaw v. Comm’r, No. 9352-16L, T.C. Memo 2021-123
Albert G. Hill, III v. Comm’r; T.C. Memo. 2021-121

The Tax Court in Brief October 18 – October 22, 2021

Goldberg v. Comm’r, T.C. Memo. 2021-119 | October 19, 2021 | Paris, J. | Dkt. No. 12871-18L

The Tax Court in Brief October 4 – October 8, 2021

Crim v. Comm’r, T.C. Memo. 2021-117
Leyh v. Comm’r, 157 T.C. No. 7
Suzanne Jean McCrory v. Comm’r, T.C. Memorandum 2021-116

The Tax Court in Brief September 27 – October 1, 2021

Whistleblower 14377-16W v. Comm’r, T.C. Memo. 2021-113
Gregory v. Comm’r, T.C. Memo. 2021-115

The Tax Court in Brief September 20 – September 24, 2021

Daniel Omar Parker and Chantrell Antoine Parker v. Comm’r, No. 13231-19, T.C. Memo 2021-111

The Tax Court in Brief September 13 – September 17, 2021

Donna M. Sutherland v. Comm’r, No. 3634-18, T.C. Memo 2021-110

The Tax Court in Brief August 30 – September 3, 2021

Karson C. Kaebel v. Comm’r, No. 16171-18P, T.C. Memo 2021-109

The Tax Court in Brief August 30 – September 3, 2021

The Tax Court in Brief August 23 – August 27, 2021

Estate of Charles P. Morgan, Deceased, Roxanna L. Morgan, Personal Representative and Roxanna L. Morgan v. Comm’r, T.C. Memo 2021-104
Vera v. Comm’r, 157 T.C. No. 6

The Tax Court in Brief August 16 – August 20, 2021

Catlett v. Comm’r, No. 13058-14, T.C. Memo 2021-102
Catherine S. Toulouse v. Comm’r, 157 T.C.
Lissack v. Comm’r, 157 T.C. No. 5
Deborah C. Wood v. Comm’r; T.C. Memo. 2021-103

The Tax Court in Brief August 9 – August 13, 2021

The Tax Court in Brief August 2 – August 6, 2021

The Tax Court in Brief July 26 – July 31, 2021

Tax Court Case: Harrington v. Comm’r, T.C. Memo. 2021-95
Ononuju v. Commissioner, T.C. Memo. 2021-94
Tax Zuo v. Comm’r, No. 5716-19S, 2021 BL 279235, 2021 Us Tax Ct. Lexis 53

The Tax Court in Brief July 19 – July 23, 2021

Tax Court Case: Morris F. Garcia, Deceased, and Sharon Garcia v. Commissioner
New World Infrastructure Organization v. Commissioner, T.C. Memo. 2021-91

The Tax Court in Brief July 12 – July 16, 2021

Tax Court Case: Blossom Day Care Centers, Inc. v. Comm’r, 2021 T.C. Memo 2021-87
Tax Court Case: Berger v. Commissioner, T.C. Memo. 2021-89
Morreale v. Commissioner, T.C. Memo. 2021-90

The Tax Court in Brief July 5 – July 9, 2021

Peter Freund v. Commissioner, T.C. Memo. 2021-83
Delgado v. Commissioner, T.C. Memo. 2021-84
Mathews v. Commissioner, T.C. Memo. 2021-85

The Tax Court in Brief June 21 – June 25, 2021

Tax Court Case: Ervin v. Commissioner, T.C. Memo. 2021-75
Hussey v. Commissioner, 156 T.C. No. 12

The Tax Court in Brief June 14 – June 18, 2021

Bell Capital Management, Inc. v. Commissioner, T.C. Memo. 2021-74

The Tax Court in Brief May 31 – June 4, 2021

ES NPA Holding, LLC v. Commissioner, T.C. Memo. 2021-68
Michael Torres v. Commissioner, T.C. Memo. 2021-66
New Capital Fire, Inc. v. Commissioner, T.C. Memo. 2021-67

The Tax Court in Brief May 24 – May 28, 2021

Estate of Grossman v. Comm’r, T.C. Memo. 2021-65

The Tax Court in Brief May 17 – May 21, 2021

Fumo v. Comm’r, T.C. Memo. 2021-31
PEEPLES v. Comm’r, Summary Op
Shitrit v. Commissioner, T.C. Memo. 2021-63
Ginos v. Comm’r, T.C. Memo. 2021-14
Mason v. Comm’r, T.C. Memo. 2021-64

The Tax Court in Brief May 10 – May 14, 2021

The Tax Court in Brief May 3 – May 7, 2021

The Tax Court in Brief April 26 – April 30, 2021

The Tax Court in Brief April 19 – April 23, 2021

Tax Court Case: Colton v. Comm’r, T.C. Memo 2021-44

The Tax Court in Brief April 11 – April 16, 2021

De Los Santos v. Comm’r, 156 T.C. No. 9
Tax Court Case: Flynn v. Comm’r, T.C. Memo 2021-43

The Tax Court in Brief April 05 – April 09, 2021

Tax Court Case Reston and Elizabeth Olsen
Andrew and Sara Berry

The Tax Court in Brief March 29 – April 2, 2021

Crandall v. Comm’r
Rowen v. Comm’r
Purple Heart Patient Center, Inc. v. Comm’r
Walton v. Comm’r| T.C. Memo. 2021-40
Max v. Comm’r| T.C. Memo. 2021-37
Rowen v. Comm’r| 156 T.C. No. 8

The Tax Court in Brief March 22 – March 26, 2021

American Limousines, Inc. v. Comm’r
Martin v. Comm’r, T.C. Memo. 2021-35

The Tax Court in Brief – March 15 – March 19, 2021

Catania v. Commissioner, T.C. Memo. 2021-33 | March 15, 2021 | Vasquez, J. | Dkt. No. 13332-19

The Tax Court in Brief – March 8 – 12, 2021

The Tax Court in Brief – March 1-5, 2021

The Tax Court in Brief – February 22 – 26, 2021

The Tax Court in Brief February 15 – February 19, 2021

Tax Court Case: Kramer v. Comm’r, T.C. Memo. 2021-16
Estate of Warne v. Comm’r, T.C. Memo. 2021-17
Blum v. Comm’r, T.C. Memo. 2021-18
San Jose Wellness v. Comm’r, 156 T.C. No. 4

The Tax Court in Brief February 8 – February 12, 2021

BM Construction v. Comm’r, T.C. Memo. 2021-13
Complex Media, Inc. v. Comm’r, T.C. Memo. 2021-14

The Tax Court in Brief – January 25 – 29, 2021

Costello v. Comm’r, T.C. Memo. 2021-9
Grajales v. Comm’r, 156 T.C. No. 3
Reynolds v. Comm’r, T.C. Memo. 2021-10
Whatley v. Comm’r, T.C. Memo. 2021-11
Sells v. Comm’r, T.C. Memo. 2021-12

The Tax Court in Brief January 18 – January 22, 2021

Adams Challenge (UK) Limited v. Comm’r, 156 T.C. No. 2
Aspro, Inc. v. Comm’r, T.C. Memo. 2021-8

The Tax Court in Brief – January 11 – 15, 2021

Kennedy v. Comm’r, T.C. Memo. 2021-3
Ramey v. Comm’r, 156 T.C. No. 1
Filler v. Comm’r, T.C. Memo. 2021-6

Freeman Law’s Top 10 Tax Court Cases of 2020

The Tax Court in Brief November 14 – November 20, 2020

Bruno v. Comm’r, T.C. Memo. 2020-156
Aghadjanian v. Comm’r, T.C. Memo. 2020-155
Kane v. Comm’r, T.C. Memo. 2020-154

The Tax Court in Brief – November 7 – November 13, 2020

The Tax Court in Brief October 31 – November 6, 2020

Glade Creek Partners, LLC, Sequatchie Holdings, LLC, TMP v. Comm’r, T.C. Memo. 2020-148
Leith v. Comm’r, T.C. Memo. 2020-149

The Tax Court in Brief October 24 – October 30, 2020

Sharma v. Comm’r, T.C. Memo. 2020-147

The Tax Court in Brief October 17 – October 23, 2020

Giambrone v. Comm’r, T.C. Memo. 2020-145
Coleman v. Comm’r, T.C. Memo. 2020-146

The Tax Court in Brief October 10 – October 16, 2020

The Tax Court in Brief October 3 – October 9, 2020

Doyle v. Comm’r, T.C. Memo. 2020-139
Spagnoletti v. Comm’r, T.C. Memo. 2020-140
Worthington v. Comm’r, T.C. Memo. 2020-141

The Tax Court in Brief September 28 – October 2, 2020

Lucero v. Comm’r, T.C. Memo. 2020-136

The Tax Court in Brief September 21 – September 25, 2020

Patel v. Comm’r, T.C. Memo. 2020-133
Robinson v. Comm’r, T.C. Memo. 2020-134

The Tax Court in Brief September 12 – 18, 2020

Deckard v. Comm’r, 155 T.C. No. 8
Cindy Damiani v. Comm’r, T.C. Memo. 2020-132
Felix Ewald Friedel v. Comm’r, T.C. Memo. 2020-131

Tax Court in Brief September 5 – 11, 2020

Sutherland v. Comm’r, 155 T.C. No. 6
Fowler v. Comm’r, 155 T.C. No. 7
Robert J. Belanger v. Comm’r, T.C. Memo. 2020-130
Korean-American Senior Mutual Association, Inc., T.C. Memo. 2020-129

The Tax Court in Brief August 29 – September 4, 2020

The Tax Court in Brief August 22 – August 28, 2020

The Tax Court in Brief August 15 – August 21, 2020

Emanouil v. Comm’r, T.C. Memo. 2020-120
Nirav B. Babu, T.C. Memo. 2020-121
Brashear v. Comm’r, T.C. Memo. 2020-122

The Tax Court in Brief August 1 – August 7, 2020

The Tax Court in Brief – July 25 – July 31, 2020

Biggs-Owens v. Comm’r, T.C. Memo. 2020-113 | July 30, 2020 | Urda, J. | Dkt. No. 15274-17L

The Tax Court in Brief – July 19 – July 24, 2020

The Tax Court in Brief July 12 – July 17, 2020

Duffy v. Comm’r, T.C. Memo. 2020-108 Smith Lake, LLC, David Hewitt, TMP v. Comm’r, T.C. Memo. 2020-84
Weiderman v. Comm’r, T.C. Memo. 2020-109
Robert Elkins v. Comm’r, T.C. Memo. 2020-110

The Tax Court in Brief July 6– July 10, 2020

The Tax Court in Brief June 29 – July 3, 2020

The Tax Court in Brief The Week of June 22, 2020

The Tax Court in Brief June 15 – 19, 2020

The Tax Court in Brief June 8 – 12, 2020

The Tax Court in Brief June 1-7, 2021

Kroner v. Comm’r, T.C. Memo. 2020-73 | June 1, 2020 | Marvel P. L. | Dkt. No. 23983-14

The Tax Court in Brief May 25 – 29, 2020

The Tax Court in Brief May 18 – 22, 2020

Nesbitt v. Comm’r, T.C. Memo. 2020-61
Pope v. Comm’r, T.C. Memo. 2020-62
Richlin v. Comm’r, T.C. Memo. 2020-60
Frantz v. Comm’r, T.C. Memo. 2020-64
Peacock v. Comm’r, T.C. Memo. 2020-63
Joseph v. Comm’r, T.C. Memo. 2020-65
Serrano v. Comm’r, T.C. Summ. Op. 2020-15
\n\n[/cs_content_seo][cs_element_text _id=”21″ ][cs_content_seo]Tax Court January 31 – February 4, 2022

The Tax Court January 9 -15th 2022

The Tax Court December 26, 2021 – January 1, 2022

The Tax Court December 13 – 18, 2021

The Tax Court in Brief December 6 – December 10, 2021
Coggin v. Comm’r, 157 T.C. No. 12 | December 8, 2021 | Weiler, J. | Dkt. No. 21580-19
The Tax Court in Brief November 29 – December 3, 2021

The Tax Court in Brief November 22 – November 26, 2021

901 S. Broadway v. Comm’r, No. 14179-17, T.C. Mom 2021-132 | November 23, 2021 | Halpern
Sand Inv. Co. v. Comm’r; 157 T.C. Memo. 11, 2021 | November 23, 2021 Lauber, J. | Dkt. No. 7307-19

The Tax Court in Brief November 15 – November 19, 2021

The Tax Court in Brief November 8 – November 12, 2021

Peak v. Comm’r, T.C. Memo 2021-128
Knox v. Comm’r, T.C. Memo. 2021-126
Smaldino v. Comm’r, T.C. Memo 2021-127

The Tax Court in Brief October 25 – October 29, 2021

Tribune Media et al. v. Comm’r, Nos. 20940-16 & 20941-16, T.C. Memo 2021-122
Cashaw v. Comm’r, No. 9352-16L, T.C. Memo 2021-123
Albert G. Hill, III v. Comm’r; T.C. Memo. 2021-121

The Tax Court in Brief October 18 – October 22, 2021

Goldberg v. Comm’r, T.C. Memo. 2021-119 | October 19, 2021 | Paris, J. | Dkt. No. 12871-18L

The Tax Court in Brief October 4 – October 8, 2021

Crim v. Comm’r, T.C. Memo. 2021-117
Leyh v. Comm’r, 157 T.C. No. 7
Suzanne Jean McCrory v. Comm’r, T.C. Memorandum 2021-116

The Tax Court in Brief September 27 – October 1, 2021

Whistleblower 14377-16W v. Comm’r, T.C. Memo. 2021-113
Gregory v. Comm’r, T.C. Memo. 2021-115

The Tax Court in Brief September 20 – September 24, 2021

Daniel Omar Parker and Chantrell Antoine Parker v. Comm’r, No. 13231-19, T.C. Memo 2021-111

The Tax Court in Brief September 13 – September 17, 2021

Donna M. Sutherland v. Comm’r, No. 3634-18, T.C. Memo 2021-110

The Tax Court in Brief August 30 – September 3, 2021

Karson C. Kaebel v. Comm’r, No. 16171-18P, T.C. Memo 2021-109

The Tax Court in Brief August 30 – September 3, 2021

The Tax Court in Brief August 23 – August 27, 2021

Estate of Charles P. Morgan, Deceased, Roxanna L. Morgan, Personal Representative and Roxanna L. Morgan v. Comm’r, T.C. Memo 2021-104
Vera v. Comm’r, 157 T.C. No. 6

The Tax Court in Brief August 16 – August 20, 2021

Catlett v. Comm’r, No. 13058-14, T.C. Memo 2021-102
Catherine S. Toulouse v. Comm’r, 157 T.C.
Lissack v. Comm’r, 157 T.C. No. 5
Deborah C. Wood v. Comm’r; T.C. Memo. 2021-103

The Tax Court in Brief August 9 – August 13, 2021

The Tax Court in Brief August 2 – August 6, 2021

The Tax Court in Brief July 26 – July 31, 2021

Tax Court Case: Harrington v. Comm’r, T.C. Memo. 2021-95
Ononuju v. Commissioner, T.C. Memo. 2021-94
Tax Zuo v. Comm’r, No. 5716-19S, 2021 BL 279235, 2021 Us Tax Ct. Lexis 53

The Tax Court in Brief July 19 – July 23, 2021

Tax Court Case: Morris F. Garcia, Deceased, and Sharon Garcia v. Commissioner
New World Infrastructure Organization v. Commissioner, T.C. Memo. 2021-91

The Tax Court in Brief July 12 – July 16, 2021

Tax Court Case: Blossom Day Care Centers, Inc. v. Comm’r, 2021 T.C. Memo 2021-87
Tax Court Case: Berger v. Commissioner, T.C. Memo. 2021-89
Morreale v. Commissioner, T.C. Memo. 2021-90

The Tax Court in Brief July 5 – July 9, 2021

Peter Freund v. Commissioner, T.C. Memo. 2021-83
Delgado v. Commissioner, T.C. Memo. 2021-84
Mathews v. Commissioner, T.C. Memo. 2021-85

The Tax Court in Brief June 21 – June 25, 2021

Tax Court Case: Ervin v. Commissioner, T.C. Memo. 2021-75
Hussey v. Commissioner, 156 T.C. No. 12

The Tax Court in Brief June 14 – June 18, 2021
Bell Capital Management, Inc. v. Commissioner, T.C. Memo. 2021-74
The Tax Court in Brief May 31 – June 4, 2021

ES NPA Holding, LLC v. Commissioner, T.C. Memo. 2021-68
Michael Torres v. Commissioner, T.C. Memo. 2021-66
New Capital Fire, Inc. v. Commissioner, T.C. Memo. 2021-67

The Tax Court in Brief May 24 – May 28, 2021

Estate of Grossman v. Comm’r, T.C. Memo. 2021-65

The Tax Court in Brief May 17 – May 21, 2021

Fumo v. Comm’r, T.C. Memo. 2021-31
PEEPLES v. Comm’r, Summary Op
Shitrit v. Commissioner, T.C. Memo. 2021-63
Ginos v. Comm’r, T.C. Memo. 2021-14
Mason v. Comm’r, T.C. Memo. 2021-64

The Tax Court in Brief May 10 – May 14, 2021

The Tax Court in Brief May 3 – May 7, 2021

The Tax Court in Brief April 26 – April 30, 2021

The Tax Court in Brief April 19 – April 23, 2021

Tax Court Case: Colton v. Comm’r, T.C. Memo 2021-44

The Tax Court in Brief April 11 – April 16, 2021

De Los Santos v. Comm’r, 156 T.C. No. 9
Tax Court Case: Flynn v. Comm’r, T.C. Memo 2021-43

The Tax Court in Brief April 05 – April 09, 2021

Tax Court Case Reston and Elizabeth Olsen
Andrew and Sara Berry

The Tax Court in Brief March 29 – April 2, 2021

Crandall v. Comm’r
Rowen v. Comm’r
Purple Heart Patient Center, Inc. v. Comm’r
Walton v. Comm’r| T.C. Memo. 2021-40
Max v. Comm’r| T.C. Memo. 2021-37
Rowen v. Comm’r| 156 T.C. No. 8

The Tax Court in Brief March 22 – March 26, 2021

American Limousines, Inc. v. Comm’r
Martin v. Comm’r, T.C. Memo. 2021-35

The Tax Court in Brief – March 15 – March 19, 2021
Catania v. Commissioner, T.C. Memo. 2021-33 | March 15, 2021 | Vasquez, J. | Dkt. No. 13332-19
The Tax Court in Brief – March 8 – 12, 2021

The Tax Court in Brief – March 1-5, 2021

The Tax Court in Brief – February 22 – 26, 2021

The Tax Court in Brief February 15 – February 19, 2021

Tax Court Case: Kramer v. Comm’r, T.C. Memo. 2021-16
Estate of Warne v. Comm’r, T.C. Memo. 2021-17
Blum v. Comm’r, T.C. Memo. 2021-18
San Jose Wellness v. Comm’r, 156 T.C. No. 4

The Tax Court in Brief February 8 – February 12, 2021

BM Construction v. Comm’r, T.C. Memo. 2021-13
Complex Media, Inc. v. Comm’r, T.C. Memo. 2021-14

The Tax Court in Brief – January 25 – 29, 2021

Costello v. Comm’r, T.C. Memo. 2021-9
Grajales v. Comm’r, 156 T.C. No. 3
Reynolds v. Comm’r, T.C. Memo. 2021-10
Whatley v. Comm’r, T.C. Memo. 2021-11
Sells v. Comm’r, T.C. Memo. 2021-12

The Tax Court in Brief January 18 – January 22, 2021

Adams Challenge (UK) Limited v. Comm’r, 156 T.C. No. 2
Aspro, Inc. v. Comm’r, T.C. Memo. 2021-8

The Tax Court in Brief – January 11 – 15, 2021

Kennedy v. Comm’r, T.C. Memo. 2021-3
Ramey v. Comm’r, 156 T.C. No. 1
Filler v. Comm’r, T.C. Memo. 2021-6

Freeman Law’s Top 10 Tax Court Cases of 2020

The Tax Court in Brief November 14 – November 20, 2020

Bruno v. Comm’r, T.C. Memo. 2020-156
Aghadjanian v. Comm’r, T.C. Memo. 2020-155
Kane v. Comm’r, T.C. Memo. 2020-154

The Tax Court in Brief – November 7 – November 13, 2020

The Tax Court in Brief October 31 – November 6, 2020

Glade Creek Partners, LLC, Sequatchie Holdings, LLC, TMP v. Comm’r, T.C. Memo. 2020-148
Leith v. Comm’r, T.C. Memo. 2020-149

The Tax Court in Brief October 24 – October 30, 2020

Sharma v. Comm’r, T.C. Memo. 2020-147

The Tax Court in Brief October 17 – October 23, 2020

Giambrone v. Comm’r, T.C. Memo. 2020-145
Coleman v. Comm’r, T.C. Memo. 2020-146

The Tax Court in Brief October 10 – October 16, 2020

The Tax Court in Brief October 3 – October 9, 2020

Doyle v. Comm’r, T.C. Memo. 2020-139
Spagnoletti v. Comm’r, T.C. Memo. 2020-140
Worthington v. Comm’r, T.C. Memo. 2020-141

The Tax Court in Brief September 28 – October 2, 2020

Lucero v. Comm’r, T.C. Memo. 2020-136

The Tax Court in Brief September 21 – September 25, 2020

Patel v. Comm’r, T.C. Memo. 2020-133
Robinson v. Comm’r, T.C. Memo. 2020-134

The Tax Court in Brief September 12 – 18, 2020

Deckard v. Comm’r, 155 T.C. No. 8
Cindy Damiani v. Comm’r, T.C. Memo. 2020-132
Felix Ewald Friedel v. Comm’r, T.C. Memo. 2020-131

Tax Court in Brief September 5 – 11, 2020

Sutherland v. Comm’r, 155 T.C. No. 6
Fowler v. Comm’r, 155 T.C. No. 7
Robert J. Belanger v. Comm’r, T.C. Memo. 2020-130
Korean-American Senior Mutual Association, Inc., T.C. Memo. 2020-129

The Tax Court in Brief August 29 – September 4, 2020

The Tax Court in Brief August 22 – August 28, 2020

The Tax Court in Brief August 15 – August 21, 2020

Emanouil v. Comm’r, T.C. Memo. 2020-120
Nirav B. Babu, T.C. Memo. 2020-121
Brashear v. Comm’r, T.C. Memo. 2020-122

The Tax Court in Brief August 1 – August 7, 2020

The Tax Court in Brief – July 25 – July 31, 2020
Biggs-Owens v. Comm’r, T.C. Memo. 2020-113 | July 30, 2020 | Urda, J. | Dkt. No. 15274-17L
The Tax Court in Brief – July 19 – July 24, 2020

The Tax Court in Brief July 12 – July 17, 2020

Duffy v. Comm’r, T.C. Memo. 2020-108 Smith Lake, LLC, David Hewitt, TMP v. Comm’r, T.C. Memo. 2020-84
Weiderman v. Comm’r, T.C. Memo. 2020-109
Robert Elkins v. Comm’r, T.C. Memo. 2020-110

The Tax Court in Brief July 6– July 10, 2020

The Tax Court in Brief June 29 – July 3, 2020

The Tax Court in Brief The Week of June 22, 2020

The Tax Court in Brief June 15 – 19, 2020

The Tax Court in Brief June 8 – 12, 2020

The Tax Court in Brief June 1-7, 2021

The Tax Court in Brief May 25 – 29, 2020

The Tax Court in Brief May 18 – 22, 2020

Nesbitt v. Comm’r, T.C. Memo. 2020-61
Pope v. Comm’r, T.C. Memo. 2020-62
Richlin v. Comm’r, T.C. Memo. 2020-60
Frantz v. Comm’r, T.C. Memo. 2020-64
Peacock v. Comm’r, T.C. Memo. 2020-63
Joseph v. Comm’r, T.C. Memo. 2020-65
Serrano v. Comm’r, T.C. Summ. Op. 2020-15
\n\n[/cs_content_seo][cs_element_text _id=”22″ ][cs_content_seo]Tax Court January 31 – February 4, 2022

The Tax Court January 9 -15th 2022

The Tax Court December 26, 2021 – January 1, 2022

The Tax Court December 13 – 18, 2021

The Tax Court in Brief December 6 – December 10, 2021
Coggin v. Comm’r, 157 T.C. No. 12 | December 8, 2021 | Weiler, J. | Dkt. No. 21580-19
The Tax Court in Brief November 29 – December 3, 2021

Plateau Holdings, LLC, Waterfall Development Manager, LLC, TMP v. Comm’r (Plateau II), T.C. Memo. 2021-133 | November 30, 2021 | Lauber, J. | Dkt. No. 12519-16
FAB Holdings, LLC v. Comm’r; Berritto v. Comm’r; T.C. Memo. 2021-135 | November 30, 2021 Copeland, J. | Docket Nos. 21971-17 22152-17
Hong Jun Chan v. Comm’r, No. 21904-19, T.C. Memo. 2021-136 | December 1, 2021 | Lauber
Soni v. Comm’r; T.C. Memo. 2021-137 | December 1, 2021 Lauber, J. | Dkt. No. 15328-15

The Tax Court in Brief November 22 – November 26, 2021

901 S. Broadway v. Comm’r, No. 14179-17, T.C. Mom 2021-132 | November 23, 2021 | Halpern
Sand Inv. Co. v. Comm’r; 157 T.C. Memo. 11, 2021 | November 23, 2021 Lauber, J. | Dkt. No. 7307-19

The Tax Court in Brief November 15 – November 19, 2021

The Tax Court in Brief November 8 – November 12, 2021

Peak v. Comm’r, T.C. Memo 2021-128
Knox v. Comm’r, T.C. Memo. 2021-126
Smaldino v. Comm’r, T.C. Memo 2021-127

The Tax Court in Brief October 25 – October 29, 2021

Tribune Media et al. v. Comm’r, Nos. 20940-16 & 20941-16, T.C. Memo 2021-122
Cashaw v. Comm’r, No. 9352-16L, T.C. Memo 2021-123
Albert G. Hill, III v. Comm’r; T.C. Memo. 2021-121

The Tax Court in Brief October 18 – October 22, 2021

Goldberg v. Comm’r, T.C. Memo. 2021-119 | October 19, 2021 | Paris, J. | Dkt. No. 12871-18L

The Tax Court in Brief October 4 – October 8, 2021

Crim v. Comm’r, T.C. Memo. 2021-117
Leyh v. Comm’r, 157 T.C. No. 7
Suzanne Jean McCrory v. Comm’r, T.C. Memorandum 2021-116

The Tax Court in Brief September 27 – October 1, 2021

Whistleblower 14377-16W v. Comm’r, T.C. Memo. 2021-113
Gregory v. Comm’r, T.C. Memo. 2021-115

The Tax Court in Brief September 20 – September 24, 2021

Daniel Omar Parker and Chantrell Antoine Parker v. Comm’r, No. 13231-19, T.C. Memo 2021-111

The Tax Court in Brief September 13 – September 17, 2021

Donna M. Sutherland v. Comm’r, No. 3634-18, T.C. Memo 2021-110

The Tax Court in Brief August 30 – September 3, 2021

Karson C. Kaebel v. Comm’r, No. 16171-18P, T.C. Memo 2021-109

The Tax Court in Brief August 30 – September 3, 2021

The Tax Court in Brief August 23 – August 27, 2021

Estate of Charles P. Morgan, Deceased, Roxanna L. Morgan, Personal Representative and Roxanna L. Morgan v. Comm’r, T.C. Memo 2021-104
Vera v. Comm’r, 157 T.C. No. 6

The Tax Court in Brief August 16 – August 20, 2021

Catlett v. Comm’r, No. 13058-14, T.C. Memo 2021-102
Catherine S. Toulouse v. Comm’r, 157 T.C.
Lissack v. Comm’r, 157 T.C. No. 5
Deborah C. Wood v. Comm’r; T.C. Memo. 2021-103

The Tax Court in Brief August 9 – August 13, 2021

The Tax Court in Brief August 2 – August 6, 2021

The Tax Court in Brief July 26 – July 31, 2021

Tax Court Case: Harrington v. Comm’r, T.C. Memo. 2021-95
Ononuju v. Commissioner, T.C. Memo. 2021-94
Tax Zuo v. Comm’r, No. 5716-19S, 2021 BL 279235, 2021 Us Tax Ct. Lexis 53

The Tax Court in Brief July 19 – July 23, 2021

Tax Court Case: Morris F. Garcia, Deceased, and Sharon Garcia v. Commissioner
New World Infrastructure Organization v. Commissioner, T.C. Memo. 2021-91

The Tax Court in Brief July 12 – July 16, 2021

Tax Court Case: Blossom Day Care Centers, Inc. v. Comm’r, 2021 T.C. Memo 2021-87
Tax Court Case: Berger v. Commissioner, T.C. Memo. 2021-89
Morreale v. Commissioner, T.C. Memo. 2021-90

The Tax Court in Brief July 5 – July 9, 2021

Peter Freund v. Commissioner, T.C. Memo. 2021-83
Delgado v. Commissioner, T.C. Memo. 2021-84
Mathews v. Commissioner, T.C. Memo. 2021-85

The Tax Court in Brief June 21 – June 25, 2021

Tax Court Case: Ervin v. Commissioner, T.C. Memo. 2021-75
Hussey v. Commissioner, 156 T.C. No. 12

The Tax Court in Brief June 14 – June 18, 2021
Bell Capital Management, Inc. v. Commissioner, T.C. Memo. 2021-74
The Tax Court in Brief May 31 – June 4, 2021

ES NPA Holding, LLC v. Commissioner, T.C. Memo. 2021-68
Michael Torres v. Commissioner, T.C. Memo. 2021-66
New Capital Fire, Inc. v. Commissioner, T.C. Memo. 2021-67

The Tax Court in Brief May 24 – May 28, 2021

Estate of Grossman v. Comm’r, T.C. Memo. 2021-65

The Tax Court in Brief May 17 – May 21, 2021

Fumo v. Comm’r, T.C. Memo. 2021-31
PEEPLES v. Comm’r, Summary Op
Shitrit v. Commissioner, T.C. Memo. 2021-63
Ginos v. Comm’r, T.C. Memo. 2021-14
Mason v. Comm’r, T.C. Memo. 2021-64

The Tax Court in Brief May 10 – May 14, 2021

The Tax Court in Brief May 3 – May 7, 2021

The Tax Court in Brief April 26 – April 30, 2021

The Tax Court in Brief April 19 – April 23, 2021

Tax Court Case: Colton v. Comm’r, T.C. Memo 2021-44

The Tax Court in Brief April 11 – April 16, 2021

De Los Santos v. Comm’r, 156 T.C. No. 9
Tax Court Case: Flynn v. Comm’r, T.C. Memo 2021-43

The Tax Court in Brief April 05 – April 09, 2021

Tax Court Case Reston and Elizabeth Olsen
Andrew and Sara Berry

The Tax Court in Brief March 29 – April 2, 2021

Crandall v. Comm’r
Rowen v. Comm’r
Purple Heart Patient Center, Inc. v. Comm’r
Walton v. Comm’r| T.C. Memo. 2021-40
Max v. Comm’r| T.C. Memo. 2021-37
Rowen v. Comm’r| 156 T.C. No. 8

The Tax Court in Brief March 22 – March 26, 2021

American Limousines, Inc. v. Comm’r
Martin v. Comm’r, T.C. Memo. 2021-35

The Tax Court in Brief – March 15 – March 19, 2021
Catania v. Commissioner, T.C. Memo. 2021-33 | March 15, 2021 | Vasquez, J. | Dkt. No. 13332-19
The Tax Court in Brief – March 8 – 12, 2021

The Tax Court in Brief – March 1-5, 2021

The Tax Court in Brief – February 22 – 26, 2021

The Tax Court in Brief February 15 – February 19, 2021

Tax Court Case: Kramer v. Comm’r, T.C. Memo. 2021-16
Estate of Warne v. Comm’r, T.C. Memo. 2021-17
Blum v. Comm’r, T.C. Memo. 2021-18
San Jose Wellness v. Comm’r, 156 T.C. No. 4

The Tax Court in Brief February 8 – February 12, 2021

BM Construction v. Comm’r, T.C. Memo. 2021-13
Complex Media, Inc. v. Comm’r, T.C. Memo. 2021-14

The Tax Court in Brief – January 25 – 29, 2021

Costello v. Comm’r, T.C. Memo. 2021-9
Grajales v. Comm’r, 156 T.C. No. 3
Reynolds v. Comm’r, T.C. Memo. 2021-10
Whatley v. Comm’r, T.C. Memo. 2021-11
Sells v. Comm’r, T.C. Memo. 2021-12

The Tax Court in Brief January 18 – January 22, 2021

Adams Challenge (UK) Limited v. Comm’r, 156 T.C. No. 2
Aspro, Inc. v. Comm’r, T.C. Memo. 2021-8

The Tax Court in Brief – January 11 – 15, 2021

Kennedy v. Comm’r, T.C. Memo. 2021-3
Ramey v. Comm’r, 156 T.C. No. 1
Filler v. Comm’r, T.C. Memo. 2021-6

Freeman Law’s Top 10 Tax Court Cases of 2020

The Tax Court in Brief November 14 – November 20, 2020

Bruno v. Comm’r, T.C. Memo. 2020-156
Aghadjanian v. Comm’r, T.C. Memo. 2020-155
Kane v. Comm’r, T.C. Memo. 2020-154

The Tax Court in Brief – November 7 – November 13, 2020

The Tax Court in Brief October 31 – November 6, 2020

Glade Creek Partners, LLC, Sequatchie Holdings, LLC, TMP v. Comm’r, T.C. Memo. 2020-148
Leith v. Comm’r, T.C. Memo. 2020-149

The Tax Court in Brief October 24 – October 30, 2020

Sharma v. Comm’r, T.C. Memo. 2020-147

The Tax Court in Brief October 17 – October 23, 2020

Giambrone v. Comm’r, T.C. Memo. 2020-145
Coleman v. Comm’r, T.C. Memo. 2020-146

The Tax Court in Brief October 10 – October 16, 2020

The Tax Court in Brief October 3 – October 9, 2020

Doyle v. Comm’r, T.C. Memo. 2020-139
Spagnoletti v. Comm’r, T.C. Memo. 2020-140
Worthington v. Comm’r, T.C. Memo. 2020-141

The Tax Court in Brief September 28 – October 2, 2020

Lucero v. Comm’r, T.C. Memo. 2020-136

The Tax Court in Brief September 21 – September 25, 2020

Patel v. Comm’r, T.C. Memo. 2020-133
Robinson v. Comm’r, T.C. Memo. 2020-134

The Tax Court in Brief September 12 – 18, 2020

Deckard v. Comm’r, 155 T.C. No. 8
Cindy Damiani v. Comm’r, T.C. Memo. 2020-132
Felix Ewald Friedel v. Comm’r, T.C. Memo. 2020-131

Tax Court in Brief September 5 – 11, 2020

Sutherland v. Comm’r, 155 T.C. No. 6
Fowler v. Comm’r, 155 T.C. No. 7
Robert J. Belanger v. Comm’r, T.C. Memo. 2020-130
Korean-American Senior Mutual Association, Inc., T.C. Memo. 2020-129

The Tax Court in Brief August 29 – September 4, 2020

The Tax Court in Brief August 22 – August 28, 2020

The Tax Court in Brief August 15 – August 21, 2020

Emanouil v. Comm’r, T.C. Memo. 2020-120
Nirav B. Babu, T.C. Memo. 2020-121
Brashear v. Comm’r, T.C. Memo. 2020-122

The Tax Court in Brief August 1 – August 7, 2020

The Tax Court in Brief – July 25 – July 31, 2020
Biggs-Owens v. Comm’r, T.C. Memo. 2020-113 | July 30, 2020 | Urda, J. | Dkt. No. 15274-17L
The Tax Court in Brief – July 19 – July 24, 2020

The Tax Court in Brief July 12 – July 17, 2020

Duffy v. Comm’r, T.C. Memo. 2020-108 Smith Lake, LLC, David Hewitt, TMP v. Comm’r, T.C. Memo. 2020-84
Weiderman v. Comm’r, T.C. Memo. 2020-109
Robert Elkins v. Comm’r, T.C. Memo. 2020-110

The Tax Court in Brief July 6– July 10, 2020

The Tax Court in Brief June 29 – July 3, 2020

The Tax Court in Brief The Week of June 22, 2020

The Tax Court in Brief June 15 – 19, 2020

The Tax Court in Brief June 8 – 12, 2020

The Tax Court in Brief June 1-7, 2021

The Tax Court in Brief May 25 – 29, 2020

The Tax Court in Brief May 18 – 22, 2020

Nesbitt v. Comm’r, T.C. Memo. 2020-61
Pope v. Comm’r, T.C. Memo. 2020-62
Richlin v. Comm’r, T.C. Memo. 2020-60
Frantz v. Comm’r, T.C. Memo. 2020-64
Peacock v. Comm’r, T.C. Memo. 2020-63
Joseph v. Comm’r, T.C. Memo. 2020-65
Serrano v. Comm’r, T.C. Summ. Op. 2020-15
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Everything that You Need to Know about IRS Offers in Compromise

All About IRS Offers in Compromise

An economic downturn increases the ability for thousands of Americans to settle their outstanding tax debt with the IRS. That means that for many, now may be the time to take advantage of the economic uncertainty and to position themselves for a successful tax settlement—and a fresh start.

An offer in compromise (OIC) is an agreement between a taxpayer and the Internal Revenue Service (IRS) to settle a tax liability for less than the full amount owed.[1] For many taxpayers, the IRS’s Offer in Compromise program is a path toward a fresh start. To qualify, a taxpayer must submit an offer package (including all required documentation and forms) that meets IRS criteria. Taxpayers should take care to comply with all applicable IRS criteria—submitting a non-compliant or rejected offer may harm the taxpayer’s position or ability to submit a subsequent offer with success.

Section 7122 of the Code provides broad authority to the Secretary to compromise any case arising under the internal revenue laws, as long as the case has not been referred to the Department of Justice for prosecution or defense.

The IRS will accept an offer in compromise when it is unlikely that the tax liability can be collected in full and the amount offered reasonably reflects the taxpayer’s “collection potential,” a term of art that is defined in IRS regulations. The goal of an offer in compromise is to collect such amounts as early and efficiently as possible. Taxpayers with significant tax debts can potentially take advantage of the IRS’s Offer in Compromise Program and a skilled tax attorney can help navigate the regulatory complexities and position a taxpayer for the best possible settlement with the IRS.

Official IRS policies provide that an Offer in Compromise is a tool for providing taxpayers with a “fresh start” and reaching a resolution that is in the best interest of both the taxpayer and the IRS:

The ultimate goal [of the Offer in Compromise Program] is a compromise which is in the best interest of both the taxpayer and the Service. Acceptance of an adequate offer will also result in creating for the taxpayer an expectation of and a fresh start toward compliance with all future filing and payment requirements.

Thus, acceptance of an offer in compromise conclusively settles the liability of the taxpayer, absent fraud or mutual mistake.[2] Compromise with one taxpayer, however, does not extinguish the liability of any person not named in the offer who is also liable for the tax to which the offer relates. The Service may therefore continue to take action to collect from any person not named in the offer.

An offer to compromise a tax liability must be submitted in writing on the IRS’s Form 656, Offer in Compromise. None of the standard terms can be removed or altered, and the form must be signed under penalty of perjury. The offer should include the legal grounds for compromise, the amount the taxpayer proposes to pay, and the payment terms. Payment terms include the amounts and due dates of the payments. The offer should also contain any other information required by Form 656 or IRS regulations.

An offer to compromise a tax liability should set forth the legal grounds for compromise and should provide enough information for the Service to determine whether the offer fits within its acceptance policies. There are three categories for OIC relief: (1) Doubt as to liability; (2) Doubt as to collectability; and (3) Promotion of effective tax administration.

(1) Doubt as to liability

Doubt as to liability exists where there is a genuine dispute as to the existence or amount of the correct tax liability under the law. Doubt as to liability does not exist where the liability has been established by a final court decision or judgment concerning the existence of the liability.

An offer to compromise based on doubt as to liability generally will be considered acceptable if it reasonably reflects the amount the Service would expect to collect through litigation. This analysis includes consideration of the hazards of litigation that would be involved if the liability were litigated. The evaluation of the hazards of litigation is not an exact science and is within the discretion of the Service.

(2) Doubt as to collectability

Doubt as to collectability exists in any case where the taxpayer’s assets and income cannot satisfy the full amount of the liability.

An offer to compromise based on doubt as to collectability generally will be considered acceptable if it is unlikely that the tax can be collected in full and the offer reasonably reflects the amount the Service could collect through other means, including administrative and judicial collection remedies. See Policy Statement P-5-100. This amount is the reasonable collection potential of a case. In determining the reasonable collection potential of a case, the Service will take into account the taxpayer’s reasonable basic living expenses. In some cases, the Service may accept an offer of less than the total reasonable collection potential of a case if there are special circumstances.

(3) Promotion of effective tax administration

The Service may compromise to promote effective tax administration where it determines that, although collection in full could be achieved, collection of the full liability would cause the taxpayer economic hardship. Economic hardship is defined as the inability to pay reasonable basic living expenses. See § 301.6343-1(d). No compromise may be entered into on this basis if the compromise of the liability would undermine compliance by taxpayers with the tax laws.

An offer to compromise based on economic hardship generally will be considered acceptable when, even though the tax could be collected in full, the amount offered reflects the amount the Service can collect without causing the taxpayer economic hardship. The determination to accept a particular amount will be based on the taxpayer’s individual facts and circumstances.

If there are no other grounds for compromise, the Service may compromise to promote effective tax administration where a compelling public policy or equity considerations identified by the taxpayer provide a sufficient basis for compromising the liability. Compromise will be justified only where, due to exceptional circumstances, collection of the full liability would undermine public confidence that the tax laws are being administered in a fair and equitable manner. The taxpayer will be expected to demonstrate circumstances that justify compromise even though a similarly situated taxpayer may have paid his liability in full. No compromise may be entered into on this basis if compromise of the liability would undermine compliance by taxpayers with the tax laws.

An offer to compromise based on compelling public policy or equity considerations generally will be considered acceptable if it reflects what is fair and equitable under the particular facts and circumstances of the case.

Under §7122(c) factors such as equity, hardship, and public policy will be considered in certain circumstances where granting an offer in compromise will promote effective tax administration. The legislative history of this provision (H. Conf. Rep. 599, 105th Cong., 2d Sess. 289 (1998)) states that:

the conferees expect that the present regulations will be expanded so as to permit the IRS, in certain circumstances, to consider additional factors (i.e., factors other than doubt as to liability or collectibility) in determining whether to compromise the income tax liabilities of individual taxpayers. For example, the conferees anticipate that the IRS will take into account factors such as equity, hardship, and public policy where a compromise of an individual taxpayer’s income tax liability would promote effective tax administration. The conferees anticipate that, among other situations, the IRS may utilize this new authority, to resolve longstanding cases by forgoing penalties and interest which have accumulated as a result of delay in determining the taxpayer’s liability. The conferees believe that the ability to compromise tax liability and to make payments of tax liability by installment enhances taxpayer compliance. In addition, the conferees believe that the IRS should be flexible in finding ways to work with taxpayers who are sincerely trying to meet their obligations and remain in the tax system. Accordingly, the conferees believe that the IRS should make it easier for taxpayers to enter into offer-in-compromise agreements, and should do more to educate the taxpaying public about the availability of such agreements.

The IRS will generally take into account a number of circumstances bearing on potential economic hardship, including:

The taxpayer’s age, employment status and history, ability to earn, number of dependents, and status as a dependent of someone else;
The amount reasonably necessary for food, clothing, housing (including utilities, home-owner insurance, home-owner dues, and the like), medical expenses (including health insurance), transportation, current tax payments (including federal, state, and local), alimony, child support, or other court-ordered payments, and expenses necessary to the taxpayer’s production of income (such as dues for a trade union or professional organization, or child care payments which allow the taxpayer to be gainfully employed);
The cost of living in the geographic area in which the taxpayer resides;
The amount of property exempt from levy which is available to pay the taxpayer’s expenses;
Any extraordinary circumstances such as special education expenses, a medical catastrophe, or natural disaster; and
Any other factor that the taxpayer claims bears on economic hardship and brings to the attention of the director.

The following non-exclusive list of factors support (but are not conclusive of) a determination that collection would cause economic hardship:

Taxpayer is incapable of earning a living because of a long term illness, medical condition, or disability, and it is reasonably foreseeable that taxpayer’s financial resources will be exhausted providing for care and support during the course of the condition;
Although taxpayer has certain monthly income, that income is exhausted each month in providing for the care of dependents with no other means of support; and
Although taxpayer has certain assets, the taxpayer is unable to borrow against the equity in those assets and liquidation of those assets to pay outstanding tax liabilities would render the taxpayer unable to meet basic living expenses.

Making the Offer

The offer should include all information necessary to verify the grounds for compromise. Except for offers to compromise based solely on doubt as to liability, this includes financial information provided in a manner approved by the Service. Individual or self-employed taxpayers must submit a Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, together with any attachments or other documentation required by the Service. Corporate or other business taxpayers must submit a Form 433-B, Collection Information Statement for Businesses, together with any attachments or other documentation required by the Service. The Service may require the corporate officers or individual partners of a business taxpayer to complete a Form 433-A.

A Pending Offer

Section 6331(k)(1) generally prohibits the IRS from making a levy on a taxpayer’s property or rights to property while an offer to compromise a liability is pending with the Service, for 30 days after the rejection of an offer to compromise, or while an appeal of a rejection is pending. The statute of limitations on collection is suspended while levy is prohibited. An offer to compromise becomes pending when it is accepted for processing. The Service accepts an offer to compromise for processing when it determines that: the offer is submitted on the proper version of Form 656 and Form 433-A or B, as appropriate; the taxpayer is not in bankruptcy; the taxpayer has complied with all filing and payment requirements listed in the instructions to Form 656; the taxpayer has enclosed the application fee, if required; and the offer meets any other minimum requirements established by the Service. A determination that the offer meets these minimum requirements means that the offer is processable.

Returned Offers

If an offer to compromise accepted for processing does not contain sufficient information to permit the Service to evaluate whether the offer should be accepted, the Service will request that the taxpayer provide the needed additional information. If the taxpayer does not submit the additional information that the Service has requested within a reasonable time period after such a request, the Service may return the offer to the taxpayer. The Service also may return the offer after it has been accepted for processing if:

The Service determines that the offer was submitted solely to delay collection;
The taxpayer fails to file a return or pay a liability;
The taxpayer files for bankruptcy;
The offer is no longer processable; or
The offer was accepted for processing in error.

The Taxpayer’s Ability to Pay

Courts have held that the “[t]he IRS may reject an offer-in-compromise because the taxpayer’s ability to pay exceeds the compromise proposal.”[3] Under IRS procedures, the agency will not accept a compromise that is less than the reasonable collection value of the case, absent a showing of special circumstances. See Rev. Proc. 2003–71(2). The IRS considers the reasonable collection value of a case to be the funds available after the taxpayer meets basic living expenses. Id.

The IRS determines the taxpayer’s ability to pay based on the tax liabilities (assessed and unassessed) due at the time the offer is submitted.

When the IRS receives an offer in compromise submission, the IRS will generally complete an initial calculation to determine if the taxpayer can fully pay the tax debt through an installment agreement based on the IRS’s applicable guidelines. If the initial calculation indicates that the taxpayer cannot full pay the tax through an installment agreement, the IRS will continue its OIC investigation to determine the taxpayer’s reasonable collection potential (RCP).

In determining whether an offer reasonably reflects collection potential, the IRS takes into consideration amounts that might be collected from (1) the taxpayer’s assets, (2) the taxpayer’s present and projected future income, and (3) third parties (e.g., persons to whom the taxpayer had transferred assets). Although most doubt as to collectability offers only involve consideration of the taxpayer’s equity in assets and future disposable income over a fixed period of time, the IRS on occasion also will consider whether the taxpayer should be expected to raise additional amounts from assets in which the taxpayer’s interest is beyond the reach of enforced collection (e.g., interests in property located in foreign jurisdictions or held in tenancies by the entirety).

Taxpayer Documents

If during the IRS’s OIC investigation, the financial information provided by the taxpayer becomes older than 12 months and it appears significant changes have occurred, the IRS will generally request updated information. If the taxpayer’s circumstances have significantly changed since the submission of the OIC (for example, a change of employment, loss of job, etc.), the IRS will generally seek updated information.

Equity in Assets

The IRS will seek to determine the taxpayer’s equity in his or her assets. In doing so, the IRS may, among other steps, review the following documents to determine whether there are undisclosed assets or income and to assist in valuing the property:

Divorce decrees or separation agreements to determine the disposition of assets in the property settlements;
Homeowners or renters insurance policies and riders to identify high value personal items such as jewelry, antiques, or artwork;
Financial statements recently provided to lending institutions or others to identify assets or income that may not have been revealed on the CIS.

Ongoing Businesses

For an ongoing business, the IRS may make field calls to validate the existence and value of business assets and inventory. The IRS may follow other special procedures related to an on-going business, and in some situations, the IRS may accept offers for less than the business’s RCP.

Net Realizable Equity

For offer in compromise purposes, a taxpayer’s assets are valued at net realizable equity (NRE).

Net realizable equity is defined as the quick sale value (QSV) less amounts owed to secured lien holders with priority over the federal tax lien, if applicable, and applicable exemption amounts

The QSV is defined as an estimate of the price a seller could get for the asset in a situation where financial pressures motivate the owner to sell in a short period of time, usually 90 calendar days or less. Generally, the QSV is less than the fair market value (FMV) of the asset.

Generally, QSV is calculated at 80% of FMV. IRS guidance provides that a higher or lower percentage may be applied in determining QSV when appropriate, depending on the type of asset and current market conditions. If, based on the current market and area economic conditions, it is believed that the property would quickly sell at full FMV, then the IRS may consider QSV to be the same as FMV. This is occasionally found to be true in real estate markets where real estate is selling quickly at or above the listing price. If the IRS believes that the value chosen represents a fair estimate of the price a seller could get for the asset in a situation where the asset must be sold quickly (usually 90 calendar days or less) then the IRS may use a percentage other than 80%. Generally, it is the policy of the IRS to apply QSV in valuing property for offer purposes.

When a particular asset has been sold (or a sale is pending) in order to fund the offer, the IRS will not provide for a reduction for QSV. Instead, it will verify the actual sale price, ensuring that the sale is an arms-length transaction, and use that amount as the QSV. The IRS may allow for a reduction for the costs of the sale and the expected current-year tax consequence to arrive at the NRE of the asset.

Jointly Held Assets

When taxpayers submit separate offers but have jointly-owned assets, the IRS will generally allocate equity in the assets equally between the owners. However, the IRS will allocate the equity in a different manner under certain circumstances: If the joint owners demonstrate that their interest in the property is not equally divided, the IRS will allocate the equity based on each owner’s contribution to the value of the asset.

If the joint owners have joint and individual tax liabilities included in the offer in compromise, the IRS will generally apply the equity in assets first to the joint liability and then to the individual liability.

For property held as tenancies by the entirety when the tax is owed by only one spouse, the taxpayer’s portion is usually considered to be 50% of the property’s NRE. However, applicable state law, such as community property and registered domestic partnership laws, may impact property ownership rights and may change the taxpayer’s interest in assets that should be included in RCP for offer in compromise purposes.

Assets Held By Others as Transferees, Nominees, or Alter Egos

The IRS will also conduct an investigation to determine what degree of control the taxpayer has over assets and income that are in the possession of others, particularly when the offer will be funded by a third party.

The IRS will seek to determine whether there are any transferee, nominee, or alter ego issues present. If the IRS determines that the taxpayer has a beneficial interest in assets or income streams that are held by a transferee, nominee, or alter ego, the IRS will reflect the value of such assets or interest in the RCP.

Cash

When determining an individual taxpayer’s RCP, the IRS will generally utilize the amount of cash listed on the taxpayer’s Form 433-A (OIC) for the amount of cash in the taxpayer’s bank accounts, though it will reduces such amount by $1,000.

When determining a business taxpayer’s RCP, the IRS will generally utilize the amount listed on the Form 433-B(OIC) for the amount of cash in the taxpayer’s bank account. The $1,000 reduction applicable to individual bank accounts is not applicable with respect to business taxpayers.

The IRS will review the taxpayer’s checking account statements over a reasonable period of time, generally three months for wage earners and six months for taxpayers who are non-wage earners. The IRS will seek to ascertain whether there is unusual activity, such as deposits in excess of reported income, withdrawals, transfers, or checks for expenses not reflected on the CIS.

If a taxpayer offers the balances of certain accounts—for example, certificate of deposit, savings bonds, etc.—to fund the proposed offer, the IRS may allow for any penalty for early withdrawal and allow for expected current year tax consequences with respect to the account withdrawal.

Securities and Stocks of Closely Held Entities

Financial securities are considered an asset and the IRS includes their value in its determination of the taxpayer’s the RCP.

If the taxpayer proposes to liquidate an investment in order to fund the proposed offer in compromise, the IRS will allow for the associated fees in addition to any penalty imposed on the taxpayer for early withdrawal, as well as the expected current year tax consequences.

In order to determine the value of “closely held” stock that is not traded publicly or for which there is no established market, the IRS may consider the following methods to value the stock:

a recent annual report to stockholders.
recent corporate income tax returns.
an appraisal of the business as a going concern by a qualified and impartial appraiser.

IRS standards provide that when a taxpayer holds only a negligible or token interest in the stock, or has made no investment and exercises no control over the corporate affairs, it is permissible to assign no value to the stock.

The IRS may be skeptical when a taxpayer claims that they have no interest in a closely held corporation or family owned business but the facts indicate that their interest may have been transferred or assigned. Under such circumstances, the IRS will generally conduct additional investigative measures.

There are additional considerations when it comes to offers involving closely held entities:

Compensation to Corporate Officers – The IRS may not allow wages and/or other compensation, (i.e., draws) paid to corporate officers in excess of applicable expenses allowable per National and Local standards as business expenses. The officer’s ownership interest in the business and any control over the compensation received is generally a consideration in the IRS’s determination of whether the officer compensation is deemed excessive.
Stock Holder Distributions and Repayment of Loans to Officers – Because these expenses are discretionary in nature, the IRS may evaluate distributions of this nature made after the incurrence of the outstanding tax liability under the “dissipated asset” provisions. Loans to officers are generally considered an account receivable and valued according to their collectability. If the IRS believes that the taxpayer may be receiving income from loans and that their wages are not reasonable, the IRS may consider a referral to the Examination Division.
Stock Held by Beneficial Owner – The value of stock ownership in a closely held corporation/LLC is generally included in the RCP of a taxpayer submitting an offer to compromise their individual liabilities.

Virtual Currency. The taxpayer may have in interest or ownership in virtual currency (e.g. bitcoin). A virtual currency is an electronic currency that isn’t legal tender and isn’t issued by a government. For tax purposes, the transactions are treated as an exchange of property. The IRS will generally include the value of virtual currency in the taxpayer’s RCP. The value will generally be determined in the same manner as a publicly traded stock.

Life Insurance

The IRS will may treat life insurance differently depending upon the type and nature of the insurance policy. The IRS will seek to identify the type of insurance, the conditions for borrowing or cancellation, and the current loan and cash values on the policy.

Under IRS guidance, life insurance as an investment (e.g., whole life) is generally not considered “necessary.”

When determining the value in a taxpayer’s insurance policy, consider:

If the taxpayer will retain the insurance policy then the equity is considered to be the cash surrender value
If the taxpayer will sell the policy to help fund the proposed offer, then the taxpayer’s “equity” is considered to be the amount that the taxpayer will receive from the sale of the policy. Documentation from a broker may be required to verify the selling price and related expenses.
If the taxpayer will borrow on the policy to help fund the proposed offer, then the taxpayer’s “equity” is considered to be the cash loan value less any prior policy loans or automatic premium loans required to keep the contract in force.

The IRS will generally allow reasonable premiums for term life insurance policies as a necessary expense.

If the taxpayer has a whole life policy, the IRS will generally allow a reasonable amount of the premiums that is attributable to the death benefit under the policy.

Retirement or Profit-Sharing Plans

Funds held in a retirement or profit-sharing plan are considered an asset and must be valued for purposes of the offer in compromise.

The IRS considers does not consider contributions to voluntary retirement plans to be a necessary expense. The IRS provides for a number of rules based upon the type of account at issue:

If…	And…	Then…
The account is an Individual Retirement Account (IRA), 401(k), or Keogh Account	The taxpayer is not retired or close to retirement	Equity is the cash value less any tax consequences for liquidating the account and early withdrawal penalty, if applicable.
The account is an Individual Retirement Account (IRA), 401(k), or Keogh Account	The taxpayer is retired or within one year of retirement	· Equity is the cash value less any tax consequences for liquidating the account and early withdrawal penalty, if applicable. · The plan may be considered as income, if the income from the plan is required to provide for necessary living expenses.
The contribution to a retirement plan is required as a condition of employment	The taxpayer is able to withdraw funds from the account	Equity is the amount the taxpayer can withdraw less any tax consequences and early withdrawal penalty, if applicable.
The contribution to an employer’s plan is required as a condition of employment	The taxpayer is unable to withdraw funds from the account but is permitted to borrow on the plan	Equity is the available loan value.
Any retirement plan that may not be borrowed on or liquidated until separation from employment	The taxpayer is retired, eligible to retire, or close to retirement	Equity is the cash value less any tax consequences for liquidating the account and early withdrawal penalty, if applicable, or plan may be considered as income if the income from the plan is necessary to provide for necessary living expenses.
The plan may not be borrowed on or liquidated until separation from employment and the taxpayer has no ability to access the funds within the terms of the offer	The taxpayer is not eligible to retire until after the period for which we are calculating future income	The plan has no equity.
The taxpayer may not access the funds in the retirement account due to an existing loan	The taxpayer is not eligible to retire until after the period for which we are calculating future income	Determine what equity remains in the account taking into consideration when the loan was taken out, whether the proceeds were used for necessary living expenses, and the remaining equity in the account. If the loan proceeds were used for necessary and allowable expenses and you confirm the taxpayer cannot further access (borrow against) the account given the outstanding loan, the value of the account should be the equity remaining in the plan less the amount of the loan. If the loan proceeds were not used for necessary and allowable living expenses, the IRS may analyze the proceeds under the dissipation of assets rules.
The plan includes a stock option	The taxpayer is eligible to take the option	Equity is the value of the stock at current market price less any expense to exercise the option.

Furniture, Fixtures, and Personal Effects

The IRS will generally accept the taxpayer’s declared value of household goods unless there are articles of extraordinary value, such as antiques, artwork, jewelry, or collector’s items. In such cases, the IRS may even personally inspect the assets.

There is a statutory exemption from IRS levies that applies to a number of items, including the taxpayer’s furniture and personal effects. This exemption amount is updated on an annual basis. This exemption applies only to individual taxpayers.

The property is owned jointly with any person who is not liable for the tax, the IRS will determine the value of the taxpayer’s proportionate share of property before allowing the levy exemption.

While the furniture or fixtures used in a business may not qualify for the personal effects exemption, they may qualify for the levy exemption as tools of a trade.

If the property has a valid encumbrance with priority over the NFTL, the IRS will allow the encumbrance in addition to the statutory exemption.

Motor Vehicles, Airplanes, and Boats

Equity in motor vehicles, airplanes, and boats is included in the taxpayer’s RCP. The general rule for determining Net Realizable Equity applies when determining equity in these assets. However, unusual assets such as airplanes and boats may require an appraisal to determine FMV.

In most cases, the IRS will discounted at 80% of FMV to arrive at the QSV for a vehicle.

The IRS will exclude $3,450 per car from the QSV of vehicles owned by the taxpayer and used for work, the production of income, and/or the welfare of the taxpayer’s family (up to two cars for joint taxpayers and one vehicle for a single taxpayer).

Note that when assets in this category are used for business purposes, they may be considered income producing assets.

Real Estate

The IRS will seek to verify the FMV of real property. FMV is defined as the price at which a willing seller will sell, and a willing buyer will pay, for the property, given time to obtain the best and highest possible price. The IRS will seek to verify the type of ownership through warranty and mortgage deeds, and may seek to verify or determine the FMV of the property through various sources, including:

The value listed on real estate tax assessment statements.
Market comparables.
Recent purchase prices.
An existing contract to sell.
Recent appraisals.
A homeowner’s insurance policy.

The equity in real estate is included when calculating the taxpayer’s RCP to determine an acceptable offer amount.

Note, however, that there may be circumstances in which an offer under ETA or Doubt as to Collectibility with Special Circumstances (DATCSC) may be appropriate for an amount which does not include some or all of the real property equity.

For real estate and other related property held as tenancies by the entirety when the tax is owed by only one spouse, the IRS usually treats the taxpayer’s portion as 50% of the property’s NRE.

Accounts and Notes Receivable

Accounts and notes receivable are considered assets unless the IRS makes a determination to treat them as part of the taxpayer’s income stream when they are required for the production of income. When the IRS determins that liquidation of a receivable would be detrimental to the continued operation of an otherwise profitable business, the receivable may be treated as future income.

Accounts Receivable – The value of accounts receivable to be included in the taxpayer’s RCP may be adjusted based on the age of the account. Accounts receivable that are current (i.e. less than or equal to 90 days past due is generally considered current for these purposes) generally may be discounted at Quick Sale Value (QSV), if the taxpayer presents accounting or industry rules or other substantiation providing for devaluation of such accounts. If the account is determined to be delinquent it may be discounted appropriately based on the age of the receivable and the potential for collection.

When the receivables have been sold at a discount or pledged as collateral on a loan, the IRS will apply the provisions of IRC 6323(c) to determine the lien priority of commercial transactions and financing agreements.

The IRS may closely examine accounts of significant value that the taxpayer is not attempting to collect, or that are receivable from officers, stockholders, or relatives.

In order to determine the value of a note receivable, the IRS may consider, among other things, the following:

Whether it is secured and if so by what asset(s),
What is collectible from the borrower, and
If it could be successfully levied upon.

Income-Producing Assets

When an offer includes business assets, the IRS conducts an analysis to determine if certain assets are essential for the production of income. When it has been identified that an asset or a portion of an asset is necessary for the production of income, the IRS will adjust the income or expense calculation for the taxpayer to account for the loss of income stream if the asset was either liquidated or used as collateral to secure a loan to fund the offer.

The IRS will generally use the following procedures when valuing income-producing assets:

If…	Then…
There is no equity in the assets	There is no adjustment necessary to the income stream.
There is equity and no available income stream (i.e. profit) produced by those assets	There is no adjustment necessary to the income stream.
There are both equity in assets that are determined to be necessary for the production of income and an available income stream produced by those assets	The IRS will compare the value of the income stream produced by the income producing asset(s) to the equity that is available.
An asset used in the production of income will be liquidated to help fund an offer	The IRS may adjust the income to account for the loss of the asset.
A taxpayer borrows against an asset that is necessary for the production of income, and devotes the proceeds to the payment of the offer.	The IRS may allow the loan payment as an expense and will consider the effect that the loan will have on the future income stream.

As a general rule, equity in income-producing assets will not be added to the taxpayer’s RCP of a viable, ongoing business, unless the IRS determines that the assets are not critical to business operations. However, the IRS will include equity in real property in the calculation of RCP.

Moreover, even though rental property, owned by the taxpayer, may produce income, the IRS will generally include the equity in the taxpayer’s RCP. However, an adjustment to the taxpayer’s future income value may be appropriate if the taxpayer will be borrowing against or selling the property to fund the proposed offer.

The following examples provides some guidance with respect to the treatment of equity and income produced by assets:

Example:

(1) A business depends on a machine to manufacture parts and cannot operate without this machine. The equity is $100,000. The machine produces net income of $5,000 monthly. The RCP should include the income produced by the machine, but not the equity. Equity in this machine will generally not be included in the RCP because the machine is needed to produce the income, and is essential to the ability of the business to continue to operate.

The IRS considers it to be in the government’s best interests to work with taxpayer in this situation to maintain business operations.

Based on a taxpayer’s specific circumstances, there may instances where the IRS will treat the income producing assets in a Subchapter S corporation in a similar manner to assets owned by a taxpayer’s sole proprietorship business. Factors that are considered in this analysis include:

Type of business activity
Taxpayer’s occupation
Current income received from the corporation as salary and the amount of future income that the taxpayer will receive
Current income received from corporation as dividend
Ability of the taxpayer to sell their interest in the corporation

Inventory, Machinery, Equipment, and Tools of the Trade

Inventory, machinery, and equipment may be considered income-producing assets. In order to determine the value of business assets, the IRS may use the following:

For assets commonly used in many businesses, such as automobiles and trucks, the value may be determined by consulting trade association guides.
For specialized machinery and equipment suitable for only certain applications, the IRS may consult a trade association guide, secure an appraisal from a knowledgeable and impartial dealer, or contact the manufacturer.
When the property is unique or difficult to value and no other resource will meet the need, the IRS may utilize the services of an IRS valuation engineer.
The IRS may ask the taxpayer to secure an appraisal from a qualified business appraiser.

There is a statutory exemption from levy that applies to an individual taxpayer’s tools used in a trade or business, which the IRS will allow in addition to any encumbrance that has priority over the NFTL. Whether an automobile is a tool of the trade depends on the taxpayer’s trade. The levy exemption amount is updated on an annual basis.

Business as a Going Concern

The IRS may evaluate a business as a going concern when determining the RCP of an operating business that is owned individually or by a corporation, partnership, or LLC. The IRS recognizes that a business may be worth more than the sum of its parts when sold as a going concern.

To determine the value of a business as a going concern, the IRS will consider the value of its assets, future income, and intangible assets such as:

Ability or reputation of a professional.
Established customer base.
Prominent location.
Well known trade name, trademark, or telephone number.
Possession of government licenses, copyrights, or patents.

Generally, the difference between what an ongoing business would realize if sold on the open market as a going concern and the traditional RCP analysis is attributable to the value of these intangibles.

Dissipation of Assets

The inclusion of dissipated assets in the calculation of the reasonable collection potential (RCP) is no longer applicable, except where it can be shown that the taxpayer sold, transferred, encumbered or otherwise disposed of assets in an attempt to avoid the payment of the tax liability or used the assets or proceeds (other than wages, salary, or other income) for other than the payment of items necessary for the production of income or the health and welfare of the taxpayer or their family, after the tax has been assessed or during a period of up to six months prior to or after the tax assessment.

The evaluation of a taxpayer’s interest in property held as a nominee, transferee, or alter ego is evaluated separately from the determination of whether the taxpayer may have dissipated an asset in an attempt to avoid the payment of tax.

Generally, the IRS uses a three-year time frame to determine if it is appropriate to include a dissipated asset in the taxpayer’s RCP.

Even if the transfer and/or sale took place more than three years prior to the offer submission, the IRS may deem it appropriate to include an asset in the calculation of RCP if the asset transfer and/or sale occurred during a period of up to six months prior to or after the assessment of the tax liability. If the asset transfer took place upon notice of or during an examination, the IRS may not apply these time frames based on the circumstances of the case. Where the IRS is considering the inclusion of a dissipated asset, it may also look at whether the funds were used for health/welfare of the family or production of income.

Note that if the tax liability at issue did not exist prior to the transfer or the transfer occurred prior to the taxable event giving rise to the tax liability, generally, a taxpayer cannot be said to have dissipated the assets in disregard of the outstanding tax liability.

If a taxpayer withdraws funds from an IRA to invest in a business opportunity but does not have any tax liability prior to the withdrawal, the IRS will not consider the funds to have been dissipated.

Any tax paid as a result of the sale of dissipated assets may be allowed as a reduction to the value placed on the dissipated asset.

Retired Debt

Retired debt is considered an expected change in necessary or allowable expenses. The necessary/allowable expenses may decrease after the retirement of the debt, which would change the taxpayer’s ability to pay.

For example, required child support payments may stop before the future income period ends. Under IRS standards, these retired payments would generally increase the taxpayer’s ability to pay.

Future Income

Future income is defined by IRS guidance as an estimate of the taxpayer’s ability to pay based on an analysis of gross income, less necessary living expenses, for a specific number of months into the future.

As a general rule, the IRS uses the taxpayer’s current income in the analysis of the taxpayer’s future ability to pay. This may include situations where the taxpayer’s income has been recently reduced based on a change in occupation or employment status.

The IRS will also consider the taxpayer’s overall general circumstances, including age, health, marital status, number and age of dependents, level of education or occupational training, and work experience.

Depending on the circumstances, the IRS may place a different value on future income than current or past income indicates. The IRS may also seek to secure a future income collateral agreement based on the taxpayer’s earnings potential.

If…	Then…
Income will increase or decrease or current necessary expenses will increase or decrease	Adjust the amount or number of payments to what is expected during the appropriate number of months.
A taxpayer is temporarily or recently unemployed or underemployed	The IRS will generally use the level of income expected if the taxpayer were fully employed and if the potential for employment is apparent. The IRS will also consider special circumstances or ETA issues.
A taxpayer is unemployed and is not expected to return to their previous occupation or previous level of earnings	When considering future income, the IRS will allow anticipated increases in necessary living expenses and/or applicable taxes.
A taxpayer is long-term unemployed	The IRS will use the taxpayer’s current income in the future income calculation. If there is a verified expectation the taxpayer will be securing employment then the use of anticipated future income may be appropriate. The IRS may use anticipated future income where the future employment is uncertain.
A taxpayer is long-term underemployed	The IRS will generally use the taxpayer’s current income.
A taxpayer has an irregular employment history or fluctuating income	The IRS may use the taxpayer’s average earnings over the three prior years. However, this does not apply to wage earners. Calculations for wage earners are generally based on current income unless the taxpayer has unique circumstances.
A taxpayer is in poor health and their ability to continue working is questionable	The IRS will generally reduce the number of payments to the appropriate number of months that it is anticipated the taxpayer will continue working. The IRS will consider special circumstances that may warrant adjustments.
A taxpayer is close to retirement and has indicated they will be retiring	If the taxpayer can substantiate that retirement is imminent, the IRS will generally adjust the taxpayer’s future earnings and expenses accordingly. If not, the IRS will generally base the calculation on current earnings.
Taxpayer is currently receiving overtime.	If the overtime is regular and customary, it will generally be included in current income. If the overtime is sporadic, the IRS will use the taxpayer’s base pay.
The taxpayer is at or above the full retirement age to receive social security benefits and has decided to continue working	If the taxpayer is past the age when the taxpayer’s income does not impact receipt of their full social security benefits, the IRS may include the taxpayer’s potential social security benefits in current income. The IRS may seek to determine the taxpayer’s potential benefits by having the taxpayer secure an estimate from the Social Security Administration.
A taxpayer will file a petition for liquidating bankruptcy	Under these circumstances, the IRS may reduce the value of future income. It will not reduce the total value of future income to an amount less than what could be paid toward non-dischargeable periods, or what could be recovered through bankruptcy, whichever is greater.

Allowable Expenses

Allowable expenses consist of necessary and conditional expenses. Allowable expenses are discussed below.

Necessary Expenses

A necessary expense is one that is necessary for the production of income or for the health and welfare of the taxpayer’s family. The national and local expense standards serve as guidelines in determining a taxpayer’s basic living expenses.

Taxpayers are allowed the National Standard Expense amount for their family size, without a need to substantiate the amount actually spent.[4] However, if the total amount claimed is more than the total allowed by the National Standards, the taxpayer is required to provide documentation to substantiate and justify that the allowed expenses are inadequate to provide basic living expenses.

National Standards

The IRS’s Offer in Compromise Program was impacted by a 1995 IRS initiative designed to ensure uniform treatment of similarly situated taxpayers. In administering its collection operations, including both the installment agreement program and the compromise program, the IRS has always permitted taxpayers to retain funds to pay reasonable living expenses.

In 1995, the IRS adopted and published national and local standards for determining allowable expenses, which were designed to apply to all collection actions, including offers to compromise. National expense standards were derived from the Bureau of Labor Statistics Consumer Expenditure Survey and were promulgated for expense categories such as food, clothing, personal care items, and housekeeping supplies. Local expense standards derived from Census Bureau data were promulgated for housing, utilities, and transportation.

The IRS allowable expense criteria play an important role in determining whether taxpayers are candidates for an offer in compromise.

Housing and Utilities

When determining a taxpayer’s housing and utility expense, the IRS seeks to use an amount that provides for basic living expenses. The IRS requires that deviations from the expense standards be verified, reasonable, and documented.

Transportation Expenses

Transportation expenses are considered necessary when they are used by taxpayers and their families to provide for their health and welfare and/or the production of income.

The transportation standards are designed to account for loan or lease payments—referred to as ownership costs—and additional amounts for operating costs broken down by Census Region and Metropolitan Statistical Area. Operating costs include maintenance, repairs, insurance, fuel, registrations, licenses, inspections, parking and tolls.

Ownership Expenses – Expenses are allowed for the purchase or lease of a vehicle. Taxpayers are generally allowed the local standard or the amount actually paid, whichever is less, unless the taxpayer provides documentation to verify and substantiate that the higher expenses are necessary.

Operating Expenses – The IRS will generally allow the full operating costs portion of the local transportation standard, or the amount actually claimed by the taxpayer, whichever is less. Substantiation for this allowance is generally not required unless the amount claimed is more than the total allowed by any of the transportation standards.

A taxpayer who commutes long distances to reach his place of employment, he may be allowed greater than the standard operating expenses, as the additional operating expense would generally meet the production of income test.

If the taxpayer has a vehicle that is over eight years old or has reported mileage of 100,000 miles or more, an additional monthly operating expense of $200 will generally be allowed per vehicle (up to two vehicles when a joint offer is submitted).

Other Expenses

Other expenses may be allowed in determining the value of future income for IRS offer purposes. The expense, however, generally must meet the necessary expense test by providing for the health and welfare of the taxpayer and/or his or her family or must be for the production of income. This is determined based on the facts and circumstances of each case.

Generally, the repayment of loans incurred to fund the offer and secured by the taxpayer’s assets will be allowed, if the asset is necessary for the health and welfare of the taxpayer and/or their family, i.e. taxpayer’s residence, and the repayment amount is reasonable. The same rule applies whether the equity is paid to the IRS before the offer is submitted or will be paid upon acceptance of the offer.

Minimum payments on student loans guaranteed by the federal government are allowed for the taxpayer’s post-high school education. Proof of payment, however, must generally be provided. If student loans are owed, but no payments are being made, the IRS may not allow them, unless the non-payment is due to circumstances of financial hardship, e.g. unemployment, medical expenses, etc.

Education expenses are generally allowed only for the taxpayer and only if it they are required as a condition of present employment. Expenses for dependents to attend colleges, universities, or private schools may not be allowed by the IRS unless the dependents have special needs that cannot be met by public schools.

Child support payments for natural children or legally adopted dependents may generally be allowed based on the taxpayer’s situation. A copy of the court order and proof of payments should be provided as part of the offer submission. If no payments are being made, the IRS may not allow the expense, unless the nonpayment was due to temporary job loss or illness.

The IRS will generally not allow payments for expenses, such as college tuition or life insurance for children, made pursuant to a court order. The IRS’s position is that the fact that the taxpayer may be under court order to make payments with respect to such expenses does not change the character of the expense. Therefore, the fact that a taxpayer is under court order to provide a payment may not elevate that expense to allowable status as an offer expense, if the Service would not otherwise allow it.

Generally, charitable contributions are not allowed in the RCP calculation. However, charitable contributions may be an allowable expense if they are a condition of employment or meet the necessary expense test.

Payments being made to fund or repay loans from voluntary retirement plans will generally not be allowed by the IRS. Taxpayers who cannot repay these loans will have a tax consequence in the year that the loan is declared in default and that consequence should be estimated and allowed as an additional tax expense on the IET for the required number of months necessary to cover the additional tax consequence.

Current taxes are allowed regardless of whether the taxpayer made them in the past or not. If an adjustment to the taxpayer’s income is made, an adjustment of the tax liability must also be made. Current taxes include federal, state, and local taxes. In a wage earner situation, allow the amount shown on the pay stub. If the current withholding amount is insufficient or was recently adjusted to substantially over-withhold, the tax expenses should be based on the actual tax expense.

Shared Expenses

Generally, the IRS will only a taxpayer the expenses that the taxpayer is required to pay. Consideration must be given to situations where the taxpayer shares expenses with another. Shared expenses may exist in one of two situations:

An offer is submitted by a taxpayer who shares living expenses with another individual who is not liable for the tax.
Separate offers are submitted by two or more persons who owe joint liabilities and/or separate liabilities and who share the same household.

Generally, the assets and income of a non-liable person are excluded from the computation of the taxpayer’s ability to pay. Treasury Reg. 301.7122-1 (c) (2) (ii) (A) only applies in non-liable situations.

Calculation of Future Income

Future income is defined as an estimate of the taxpayer’s ability to pay based on an analysis of gross income, less necessary living expenses, for a specific number of months into the future. The number of months used depends on the payment terms of the offer.

If…	Then…
The offer will be paid in 5 months or less and 5 or fewer payments	The IRS will use the realizable value of assets plus the amount that could be collected in 12 months.
The offer is payable in six to 24 months	The IRS will use the realizable value of assets plus the amount that could be collected in 24 months.

Note:

Generally, the amount to be collected from future income is calculated by taking the projected gross monthly income, less allowable expenses, and multiplying the difference by the number of months applicable to the terms of offer.

For lump sum cash and periodic payment offers, when there are less than 12 or 24 months remaining on the statutory period for collection, the IRS will use the number of months remaining on the statutory period for collection.

Calculation of Future Income – Cultivation and Sale of Marijuana in Accordance with State Laws

The value of future income when a taxpayer is involved in the cultivation and sale of marijuana, in accordance with applicable state laws, should be based on the following guidance:

The IRS will determine the taxpayer’s gross income over a specific time period (normally annually);
The IRS will limit allowable expenses consistent with Internal Revenue Code Section 280E, where a taxpayer may not deduct any amount for a trade or business where the trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances;

Since only expenses that are allowable based on current federal law will be included in determining future income value, the taxpayer’s most recent income tax return is generally the most appropriate document to use when completing the income/expense table.

Limited Liability Companies (LLC) Issues

Offers in compromise from a LLC involve unique issues, especially when the liabilities include employment or excise taxes.

The classification of the LLC for federal tax purposes is important. Yet, classification of the LLC for federal tax purposes does not negate state law provisions concerning the legal status of the LLC. For example:

Classification of an LLC as a partnership does not mean the member/owners have liability for LLC debts as would be the case in a state law partnership.
Under certain circumstances, an LLC may be disregarded as an entity separate from its owner. This classification does not mean that an LLC owned by an individual is the equivalent of a sole proprietorship.

Financial Analysis of an LLC

As with any entity, the IRS will require sufficient information to make an informed decision on the acceptability of the taxpayer’s compromise proposal. This requires a financial statement from the LLC, as well as employment tax liabilities for wages paid prior to January 1, 2009, where the classification of the LLC is a disregarded entity even though the LLC is not the liable taxpayer.

The IRS will generally also seek financial information of all member owners, except when a member owner holds only a negligible or token interest, has made no or minimal investment and exercises no control over the corporate affairs unless other factors are present to indicate the information is necessary to determine the acceptability of the taxpayer’s offer.

Financial Analysis of a Partnership Interest

Since the taxpayer’s interest in any asset should be included in RCP, if the taxpayer has any interest in a partnership, the IRS will make a determination of the appropriate value to include in an acceptable offer amount. The taxpayer’s interest in a partnership may be as a general or limited partner.

Generally, the value of the taxpayer’s interest would either be the taxpayer’s share of the underlying assets or the value of the transferable interest. The determination of the correct valuation may also be based on other factors, including whether the taxpayer is a general partner, how the taxpayer’s interest was acquired, how the assets of the partnership were acquired, the taxpayer’s relationship to the other partners, and the liquidity of the transferable interest.

Offer in Compromise Submitted on Cases Involving Collection Statute Expiration Date Extensions

Taxpayers that previously extended the CSED in connection with an installment agreement may request approval of an OIC.

Payment Terms

Payment terms are negotiable, but the IRS will request that they provide for payment of the offered amount in the least time possible. If a taxpayer is planning to sell asset(s) to fund all or a portion of the offer, the payment terms for the offer may need to provide for immediate payment of the amounts received from the sale. If the taxpayer is planning to borrow a portion of the money, the payment terms of the offer may need to provide for payment of the borrowed portion at the time the funds are received.

For those taxpayers who agree to shorter payment terms, fewer months of future income are required:

Payment Type	Payment Terms	Number of Months Future Income Required
Lump Sum Cash	5 or less installments within 5 months	12 months or the remaining statutory period, whichever is less
Periodic Payment	Within 6 to 24 months	24 months or the remaining statutory period, whichever is less

While a periodic payment offer is being evaluated by the Service, the taxpayer is required to make subsequent proposed periodic payments as they become due. Even though there is no requirement that the payments be made monthly or in equal amounts, the IRS will base offer payments on the taxpayer’s specific situation and ability to pay. While the calculation of RCP and consideration of any special circumstances will ultimately assist the IRS in determining an acceptable offer amount, the IRS is not bound by the offer amount or the terms proposed by the taxpayer.

The Law

Offers in Compromise are generally and primarily governed by I.R.C. section 7122 and the regulations thereunder. We have provided the current versions of those most relevant authorities below:

I.R.C. Sec. 7122

(a)Authorization. The Secretary may compromise any civil or criminal case arising under the internal revenue laws prior to reference to the Department of Justice for prosecution or defense; and the Attorney General or his delegate may compromise any such case after reference to the Department of Justice for prosecution or defense.

(b)Record. Whenever a compromise is made by the Secretary in any case, there shall be placed on file in the office of the Secretary the opinion of the General Counsel for the Department of the Treasury or his delegate, with his reasons therefor, with a statement of—

(1) The amount of tax assessed,

(2) The amount of interest, additional amount, addition to the tax, or assessable penalty, imposed by law on the person against whom the tax is assessed, and

(3) The amount actually paid in accordance with the terms of the compromise.

Notwithstanding the foregoing provisions of this subsection, no such opinion shall be required with respect to the compromise of any civil case in which the unpaid amount of tax assessed (including any interest, additional amount, addition to the tax, or assessable penalty) is less than $50,000. However, such compromise shall be subject to continuing quality review by the Secretary.

(c)Rules for submission of offers-in-compromise

(1)Partial payment required with submission

(A)Lump-sum offers

(i)In general

The submission of any lump-sum offer-in-compromise shall be accompanied by the payment of 20 percent of the amount of such offer.

(ii)Lump-sum offer-in-compromise

For purposes of this section, the term “lump-sum offer-in-compromise” means any offer of payments made in 5 or fewer installments.

(B)Periodic payment offers

(i)In general

The submission of any periodic payment offer-in-compromise shall be accompanied by the payment of the amount of the first proposed installment.

(ii)Failure to make installment during pendency of offer

Any failure to make an installment (other than the first installment) due under such offer-in-compromise during the period such offer is being evaluated by the Secretary may be treated by the Secretary as a withdrawal of such offer-in-compromise.

(2)Rules of application

(A)Use of payment

The application of any payment made under this subsection to the assessed tax or other amounts imposed under this title with respect to such tax may be specified by the taxpayer.

(B)Application of user fee

In the case of any assessed tax or other amounts imposed under this title with respect to such tax which is the subject of an offer-in-compromise to which this subsection applies, such tax or other amounts shall be reduced by any user fee imposed under this title with respect to such offer-in-compromise.

(C)Waiver authority

The Secretary may issue regulations waiving any payment required under paragraph (1) in a manner consistent with the practices established in accordance with the requirements under subsection (d)(3).

(3)Exception for low-income taxpayers

Paragraph (1), and any user fee otherwise required in connection with the submission of an offer-in-compromise, shall not apply to any offer-in-compromise with respect to a taxpayer who is an individual with adjusted gross income, as determined for the most recent taxable year for which such information is available, which does not exceed 250 percent of the applicable poverty level (as determined by the Secretary).

(d)Standards for evaluation of offers

(1)In general

The Secretary shall prescribe guidelines for officers and employees of the Internal Revenue Service to determine whether an offer-in-compromise is adequate and should be accepted to resolve a dispute.

(2)Allowances for basic living expenses

(A)In general

In prescribing guidelines under paragraph (1), the Secretary shall develop and publish schedules of national and local allowances designed to provide that taxpayers entering into a compromise have an adequate means to provide for basic living expenses.

(B)Use of schedules

The guidelines shall provide that officers and employees of the Internal Revenue Service shall determine, on the basis of the facts and circumstances of each taxpayer, whether the use of the schedules published under subparagraph (A) is appropriate and shall not use the schedules to the extent such use would result in the taxpayer not having adequate means to provide for basic living expenses.

(3)Special rules relating to treatment of offersThe guidelines under paragraph (1) shall provide that—

(A) an officer or employee of the Internal Revenue Service shall not reject an offer-in-compromise from a low-income taxpayer solely on the basis of the amount of the offer,

(B)in the case of an offer-in-compromise which relates only to issues of liability of the taxpayer—

(i) such offer shall not be rejected solely because the Secretary is unable to locate the taxpayer’s return or return information for verification of such liability; and

(ii) the taxpayer shall not be required to provide a financial statement, and

(C) any offer-in-compromise which does not meet the requirements of subparagraph (A)(i) or (B)(i), as the case may be, of subsection (c)(1) may be returned to the taxpayer as unprocessable.

(e)Administrative review. The Secretary shall establish procedures—

(1) for an independent administrative review of any rejection of a proposed offer-in-compromise or installment agreement made by a taxpayer under this section or section 6159 before such rejection is communicated to the taxpayer; and

(2) which allow a taxpayer to appeal any rejection of such offer or agreement to the Internal Revenue Service Independent Office of Appeals.

(f)Deemed acceptance of offer not rejected within certain period. Any offer-in-compromise submitted under this section shall be deemed to be accepted by the Secretary if such offer is not rejected by the Secretary before the date which is 24 months after the date of the submission of such offer. For purposes of the preceding sentence, any period during which any tax liability which is the subject of such offer-in-compromise is in dispute in any judicial proceeding shall not be taken into account in determining the expiration of the 24-month period.

(g)Frivolous submissions, etc. Notwithstanding any other provision of this section, if the Secretary determines that any portion of an application for an offer-in-compromise or installment agreement submitted under this section or section 6159 meets the requirement of clause (i) or (ii) of section 6702(b)(2)(A), then the Secretary may treat such portion as if it were never submitted and such portion shall not be subject to any further administrative or judicial review.

(Aug. 16, 1954, ch. 736, 68A Stat. 849; Pub. L. 94–455, title XIX, § 1906(b)(13)(A), Oct. 4, 1976, 90 Stat. 1834; Pub. L. 104–168, title V, § 503(a), July 30, 1996, 110 Stat. 1461; Pub. L. 105–206, title III, § 3462(a), (c)(1), July 22, 1998, 112 Stat. 764, 766; Pub. L. 109–222, title V, § 509(a), (b), May 17, 2006, 120 Stat. 362, 363; Pub. L. 109–432, div. A, title IV, § 407(d), Dec. 20, 2006, 120 Stat. 2962; Pub. L. 113–295, div. A, title II, § 220(y), Dec. 19, 2014, 128 Stat. 4036; Pub. L. 116–25, title I, §§ 1001(b)(1)(F), 1102(a), July 1, 2019, 133 Stat. 985, 986.)

Treas. Reg. Sec. 301.7122-1 Compromises.

(a) In general

(1) If the Secretary determines that there are grounds for compromise under this section, the Secretary may, at the Secretary’s discretion, compromise any civil or criminal liability arising under the internal revenue laws prior to reference of a case involving such a liability to the Department of Justice for prosecution or defense.

(2) An agreement to compromise may relate to a civil or criminal liability for taxes, interest, or penalties. Unless the terms of the offer and acceptance expressly provide otherwise, acceptance of an offer to compromise a civil liability does not remit a criminal liability, nor does acceptance of an offer to compromise a criminal liability remit a civil liability.

(b) Grounds for compromise –

(1) Doubt as to liability. Doubt as to liability exists where there is a genuine dispute as to the existence or amount of the correct tax liability under the law. Doubt as to liability does not exist where the liability has been established by a final court decision or judgment concerning the existence or amount of the liability. See paragraph (f)(4) of this section for special rulesapplicable to rejection of offers in cases where the Internal Revenue Service (IRS) is unable to locate the taxpayer‘s return or return information to verify the liability.

(2) Doubt as to collectibility. Doubt as to collectibility exists in any case where the taxpayer‘s assets and income are less than the full amount of the liability.

(3) Promote effective tax administration.

(i) A compromise may be entered into to promote effective tax administration when the Secretary determines that, although collection in full could be achieved, collection of the full liability would cause the taxpayer economic hardship within the meaning of § 301.6343-1.

(ii) If there are no grounds for compromise under paragraphs (b)(1), (2), or (3)(i) of this section, the IRS may compromise to promote effective tax administration where compelling public policy or equity considerations identified by the taxpayer provide a sufficient basis for compromising the liability. Compromise will be justified only where, due to exceptional circumstances, collection of the full liability would undermine public confidence that the tax laws are being administered in a fair and equitable manner. A taxpayer proposing compromise under this paragraph (b)(3)(ii) will be expected to demonstrate circumstances that justify compromise even though a similarly situated taxpayer may have paid his liability in full.

(iii) No compromise to promote effective tax administration may be entered into if compromise of the liability would undermine compliance by taxpayers with the tax laws.

(c) Special rules for evaluating offers to compromise –

(1) In general. Once a basis for compromise under paragraph (b) of this section has been identified, the decision to accept or reject an offer to compromise, as well as the terms and conditions agreed to, is left to the discretion of the Secretary. The determination whether to accept or reject an offer to compromise will be based upon consideration of all the facts and circumstances, including whether the circumstances of a particular case warrant acceptance of an amount that might not otherwise be acceptable under the Secretary’s policies and procedures.

(2) Doubt as to collectibility –

(i) Allowable expenses. A determination of doubt as to collectibility will include a determination of ability to pay. In determining ability to pay, the Secretary will permit taxpayers to retain sufficient funds to pay basic living expenses. The determination of the amount of such basic living expenses will be founded upon an evaluation of the individual facts and circumstances presented by the taxpayer‘s case. To guide this determination, guidelines published by the Secretary on national and local living expense standards will be taken into account.

(ii) Nonliable spouses –

(A) In general. Where a taxpayer is offering to compromise a liability for which the taxpayer‘s spouse has no liability, the assets and income of the nonliable spouse will not be considered in determining the amount of an adequate offer. The assets and income of a nonliable spouse may be considered, however, to the extent property has been transferred by the taxpayer to the nonliable spouse under circumstances that would permit the IRS to effect collection of the taxpayer‘s liability from such property (e.g., property that was conveyed in fraud of creditors), property has been transferred by the taxpayer to the nonliable spouse for the purpose of removing the property from consideration by the IRS in evaluating the compromise, or as provided in paragraph (c)(2)(ii)(B) of this section. The IRS also may requestinformation regarding the assets and income of the nonliable spouse for the purpose of verifying the amount of and responsibility for expenses claimed by the taxpayer.

(B) Exception. Where collection of the taxpayer‘s liability from the assets and income of the nonliable spouse is permitted by applicable state law (e.g., under state community property laws), the assets and income of the nonliable spouse will be considered in determining the amount of an adequate offer except to the extent that the taxpayer and the nonliable spouse demonstrate that collection of such assets and income would have a material and adverse impact on the standard of living of the taxpayer, the nonliable spouse, and their dependents.

(3) Compromises to promote effective tax administration –

(i) Factors supporting (but not conclusive of) a determination that collection would cause economic hardship within the meaning of paragraph (b)(3)(i) of this section include, but are not limited to –

(A) Taxpayer is incapable of earning a living because of a long term illness, medical condition, or disability, and it is reasonably foreseeable that taxpayer‘s financial resources will be exhausted providing for care and support during the course of the condition;

(B) Although taxpayer has certain monthly income, that income is exhausted each month in providing for the care of dependents with no other means of support; and

(C) Although taxpayer has certain assets, the taxpayer is unable to borrow against the equity in those assets and liquidation of those assets to pay outstanding tax liabilities would render the taxpayer unable to meet basic living expenses.

(ii) Factors supporting (but not conclusive of) a determination that compromise would undermine compliance within the meaning of paragraph (b)(3)(iii) of this section include, but are not limited to –

(A) Taxpayer has a history of noncompliance with the filing and payment requirements of the Internal Revenue Code;

(B) Taxpayer has taken deliberate actions to avoid the payment of taxes; and

(C) Taxpayer has encouraged others to refuse to comply with the tax laws.

(iii) The following examples illustrate the types of cases that may be compromised by the Secretary, at the Secretary’s discretion, under the economic hardship provisions of paragraph (b)(3)(i) of this section:

Example 1.

The taxpayer has assets sufficient to satisfy the tax liability. The taxpayer provides full time care and assistance to her dependent child, who has a serious long-term illness. It is expected that the taxpayer will need to use the equity in his assets to provide for adequate basic living expenses and medical care for his child. The taxpayer’s overall compliance history does not weigh against compromise.

Example 2.

The taxpayer is retired and his only income is from a pension. The taxpayer’s only asset is a retirement account, and the funds in the account are sufficient to satisfy the liability. Liquidation of the retirement account would leave the taxpayer without an adequate means to provide for basic living expenses. The taxpayer’s overall compliance history does not weigh against compromise.

Example 3.

The taxpayer is disabled and lives on a fixed income that will not, after allowance of basic living expenses, permit full payment of his liability under an installment agreement. The taxpayer also owns a modest house that has been specially equipped to accommodate his disability. The taxpayer’s equity in the house is sufficient to permit payment of the liability he owes. However, because of his disability and limited earning potential, the taxpayer is unable to obtain a mortgage or otherwise borrow against this equity. In addition, because the taxpayer’s home has been specially equipped to accommodate his disability, forced sale of the taxpayer’s residence would create severe adverse consequences for the taxpayer. The taxpayer’s overall compliance history does not weigh against compromise.

(iv) The following examples illustrate the types of cases that may be compromised by the Secretary, at the Secretary’s discretion, under the public policy and equity provisions of paragraph (b)(3)(ii) of this section:

Example 1.

In October of 1986, the taxpayer developed a serious illness that resulted in almost continuous hospitalizations for a number of years. The taxpayer’s medical condition was such that during this period the taxpayer was unable to manage any of his financial affairs. The taxpayer has not filed tax returns since that time. The taxpayer’s health has now improved and he has promptly begun to attend to his tax affairs. He discovers that the IRS prepared a substitute for return for the 1986 tax year on the basis of information returns it had received and had assessed a tax deficiency. When the taxpayer discovered the liability, with penalties and interest, the tax bill is more than three times the original tax liability. The taxpayer’s overall compliance history does not weigh against compromise.

Example 2.

The taxpayer is a salaried sales manager at a department store who has been able to place $2,000 in a tax-deductible IRA account for each of the last two years. The taxpayer learns that he can earn a higher rate of interest on his IRA savings by moving those savings from a money management account to a certificate of deposit at a different financial institution. Prior to transferring his savings, the taxpayer submits an e-mail inquiry to the IRS at its Web Page, requesting information about the steps he must take to preserve the tax benefits he has enjoyed and to avoid penalties. The IRS responds in an answering e-mail that the taxpayer may withdraw his IRA savings from his neighborhood bank, but he must redeposit those savings in a new IRA account within 90 days. The taxpayer withdraws the funds and redeposits them in a new IRA account 63 days later. Upon audit, the taxpayer learns that he has been misinformed about the required rollover period and that he is liable for additional taxes, penalties and additions to tax for not having redeposited the amount within 60 days. Had it not been for the erroneous advice that is reflected in the taxpayer’s retained copy of the IRS e-mail response to his inquiry, the taxpayer would have redeposited the amount within the required 60-day period. The taxpayer’s overall compliance history does not weigh against compromise.

(d) Procedures for submission and consideration of offers –

(1) In general. An offer to compromise a tax liability pursuant to section 7122 must be submitted according to the procedures, and in the form and manner, prescribed by the Secretary. An offer to compromise a tax liability must be made in writing, must be signed by the taxpayer under penalty of perjury, and must contain all of the information prescribed or requested by the Secretary. However, taxpayers submitting offers to compromise liabilities solely on the basis of doubt as to liability will not be required to provide financial statements.

(2) When offers become pending and return of offers. An offer to compromise becomes pending when it is accepted for processing. The IRS may not accept for processing any offer to compromise a liability following reference of a case involving such liability to the Department of Justice for prosecution or defense. If an offer accepted for processing does not contain sufficient information to permit the IRS to evaluate whether the offer should be accepted, the IRS will request that the taxpayer provide the needed additional information. If the taxpayer does not submit the additional information that the IRS has requested within a reasonable time period after such a request, the IRS may return the offer to the taxpayer. The IRS may also return an offer to compromise a tax liability if it determines that the offer was submitted solely to delay collection or was otherwise nonprocessable. An offer returned following acceptance for processing is deemed pending only for the period between the date the offer is accepted for processing and the date the IRS returns the offer to the taxpayer. See paragraphs (f)(5)(ii) and (g)(4) of this section for rules regarding the effect of such returns of offers.

(3) Withdrawal. An offer to compromise a tax liability may be withdrawn by the taxpayer or the taxpayer‘s representative at any time prior to the IRS’ acceptance of the offer to compromise. An offer will be considered withdrawn upon the IRS’ receipt of written notification of the withdrawal of the offer either by personal delivery or certified mail, or upon issuance of a letter by the IRS confirming the taxpayer‘s intent to withdraw the offer.

(e) Acceptance of an offer to compromise a tax liability.

(1) An offer to compromise has not been accepted until the IRS issues a written notification of acceptance to the taxpayeror the taxpayer‘s representative.

(2) As additional consideration for the acceptance of an offer to compromise, the IRS may request that taxpayer enter into any collateral agreement or post any security which is deemed necessary for the protection of the interests of the United States.

(3) Offers may be accepted when they provide for payment of compromised amounts in one or more equal or unequal installments.

(4) If the final payment on an accepted offer to compromise is contingent upon the immediate and simultaneous release of a tax lien in whole or in part, such payment must be made in accordance with the forms, instructions, or procedures prescribed by the Secretary.

(5) Acceptance of an offer to compromise will conclusively settle the liability of the taxpayer specified in the offer. Compromise with one taxpayer does not extinguish the liability of, nor prevent the IRS from taking action to collect from, any person not named in the offer who is also liable for the tax to which the compromise relates. Neither the taxpayer nor the Government will, following acceptance of an offer to compromise, be permitted to reopen the case except in instances where –

(i) False information or documents are supplied in conjunction with the offer;

(ii) The ability to pay or the assets of the taxpayer are concealed; or

(iii) A mutual mistake of material fact sufficient to cause the offer agreement to be reformed or set aside is discovered.

(6) Opinion of Chief Counsel. Except as otherwise provided in this paragraph (e)(6), if an offer to compromise is accepted, there will be placed on file the opinion of the Chief Counsel for the IRS with respect to such compromise, along with the reasons therefor. However, no such opinion will be required with respect to the compromise of any civil case in which the unpaid amount of tax assessed (including any interest, additional amount, addition to the tax, or assessable penalty) is less than $50,000. Also placed on file will be a statement of –

(i) The amount of tax assessed;

(ii) The amount of interest, additional amount, addition to the tax, or assessable penalty, imposed by law on the personagainst whom the tax is assessed; and

(iii) The amount actually paid in accordance with the terms of the compromise.

(f) Rejection of an offer to compromise.

(1) An offer to compromise has not been rejected until the IRS issues a written notice to the taxpayer or his representative, advising of the rejection, the reason(s) for rejection, and the right to an appeal.

(2) The IRS may not notify a taxpayer or taxpayer‘s representative of the rejection of an offer to compromise until an independent administrative review of the proposed rejection is completed.

(3) No offer to compromise may be rejected solely on the basis of the amount of the offer without evaluating that offer under the provisions of this section and the Secretary’s policies and procedures regarding the compromise of cases.

(4) Offers based upon doubt as to liability. Offers submitted on the basis of doubt as to liability cannot be rejected solely because the IRS is unable to locate the taxpayer‘s return or return information for verification of the liability.

(5) Appeal of rejection of an offer to compromise –

(i) In general. The taxpayer may administratively appeal a rejection of an offer to compromise to the IRS Office of Appeals (Appeals) if, within the 30-day period commencing the day after the date on the letter of rejection, the taxpayer requests such an administrative review in the manner provided by the Secretary.

(ii) Offer to compromise returned following a determination that the offer was nonprocessable, a failure by the taxpayer to provide requested information, or a determination that the offer was submitted for purposes of delay. Where a determination is made to return offer documents because the offer to compromise was nonprocessable, because the taxpayer failed to provide requested information, or because the IRS determined that the offer to compromise was submitted solely for purposes of delay under paragraph (d)(2) of this section, the return of the offer does not constitute a rejection of the offer for purposes of this provision and does not entitle the taxpayer to appeal the matter to Appeals under the provisions of this paragraph (f)(5). However, if the offer is returned because the taxpayer failed to provide requested financial information, the offer will not be returned until a managerial review of the proposed return is completed.

(g) Effect of offer to compromise on collection activity –

(1) In general. The IRS will not levy against the property or rights to property of a taxpayer who submits an offer to compromise, to collect the liability that is the subject of the offer, during the period the offer is pending, for 30 days immediately following the rejection of the offer, and for any period when a timely filed appeal from the rejection is being considered by Appeals.

(2) Revised offers submitted following rejection. If, following the rejection of an offer to compromise, the taxpayermakes a good faith revision of that offer and submits the revised offer within 30 days after the date of rejection, the IRS will not levy to collect from the taxpayer the liability that is the subject of the revised offer to compromise while that revised offer is pending.

(3) Jeopardy. The IRS may levy to collect the liability that is the subject of an offer to compromise during the period the IRS is evaluating whether that offer will be accepted if it determines that collection of the liability is in jeopardy.

(4) Offers to compromise determined by IRS to be nonprocessable or submitted solely for purposes of delay. If the IRS determines, under paragraph (d)(2) of this section, that a pending offer did not contain sufficient information to permit evaluation of whether the offer should be accepted, that the offer was submitted solely to delay collection, or that the offer was otherwise nonprocessable, then the IRS may levy to collect the liability that is the subject of that offer at any time after it returns the offer to the taxpayer.

(5) Offsets under section 6402. Notwithstanding the evaluation and processing of an offer to compromise, the IRS may, in accordance with section 6402, credit any overpayments made by the taxpayer against a liability that is the subject of an offer to compromise and may offset such overpayments against other liabilities owed by the taxpayer to the extent authorized by section 6402.

(6) Proceedings in court. Except as otherwise provided in this paragraph (g)(6), the IRS will not refer a case to the Department of Justice for the commencement of a proceeding in court, against a person named in a pending offer to compromise, if levy to collect the liability is prohibited by paragraph (g)(1) of this section. Without regard to whether a person is named in a pending offer to compromise, however, the IRS may authorize the Department of Justice to file a counterclaim or third-party complaint in a refund action or to join that person in any other proceeding in which liability for the tax that is the subject of the pending offer to compromise may be established or disputed, including a suit against the United States under 28 U.S.C. 2410. In addition, the United States may file a claim in any bankruptcy proceeding or insolvency action brought by or against such person.

(h) Deposits. Sums submitted with an offer to compromise a liability or during the pendency of an offer to compromise are considered deposits and will not be applied to the liability until the offer is accepted unless the taxpayer provides written authorization for application of the payments. If an offer to compromise is withdrawn, is determined to be nonprocessable, or is submitted solely for purposes of delay and returned to the taxpayer, any amount tendered with the offer, including all installments paid on the offer, will be refunded without interest. If an offer is rejected, any amount tendered with the offer, including all installments paid on the offer, will be refunded, without interest, after the conclusion of any review sought by the taxpayer with Appeals. Refund will not be required if the taxpayer has agreed in writing that amounts tendered pursuant to the offer may be applied to the liability for which the offer was submitted.

(i) Statute of limitations –

(1) Suspension of the statute of limitations on collection. The statute of limitations on collection will be suspended while levy is prohibited under paragraph (g)(1) of this section.

(2) Extension of the statute of limitations on assessment. For any offer to compromise, the IRS may require, where appropriate, the extension of the statute of limitations on assessment. However, in any case where waiver of the running of the statutory period of limitations on assessment is sought, the taxpayer must be notified of the right to refuse to extend the period of limitations or to limit the extension to particular issues or particular periods of time.

(j) Inspection with respect to accepted offers to compromise. For provisions relating to the inspection of returns and accepted offers to compromise, see section 6103(k)(1).

(k) Effective date. This section applies to offers to compromise pending on or submitted on or after July 18, 2002.

[T.D. 9007, 67 FR 48029, July 23, 2002; 67 FR 53879, Aug. 20, 2002]

[1] An accepted offer in compromise is properly analyzed as a contract between the parties. United States v. Donovan, 348 F.3d 509, 512-13 (6th Cir. 2003); Roberts v. United States , 242 F.3d 1065 (Fed. Cir. 2001); Timms v. United States, supra at 833-36; United States v. Lane, 303 F.2d 1,4 (5th Cir. 1962); Robbins Tire & Rubber Co. Inc. v. Commissioner, 52 T.C. 420, 436 (1969). Consequently, an OIC, like certain other agreements between the Commissioner and taxpayers, is governed by general principles of contract law. Cf. Duncan v. Commissioner , 121 T.C. 293, 296, (2003) (contract law applied to stipulated arbitration agreement); Bankamerica Corp. v. Commissioner, 109 T.C. 1, 12 (1997) (contract law applied to stipulations of fact); Dorchester Indus., Inc. v. Commissioner, 108 T.C. 320, 330 (1997) (contract law applied to settlement agreement), aff’d without published opinion, 208 F.3d 205 (3d Cir. 2000); Woods v. Commissioner, 92 T.C. 776,780 (1989) (contract law applied to agreement to extend the period for making assessments). Courts have routinely held that OICs are valid and binding contracts. See Timms v. United States, supra at 492; Waller v. United States, 767 F. Supp. 1042, 1044-45 (E.D. Cal. 1991); Seattle-First Nat’l Bank v. United States, 44 F.Supp. 603, 610 (E.D. Wash. 1942), aff’d , 136 F.2d 676 (9th Cir. 1943), aff’d, 321 U.S. 583 (1944); Lang-Kidde Co. v. United States, 2 F. Supp 768,769 (Ct. CI. 1933).

[2] Generally, an acceptance of an OIC will conclusively settle the liability of the taxpayer specified in the OIC, absent fraud or mutual mistake. Dutton v. Commissioner, 122 T.C. 133, 138 (2004); Treas. Reg. § 301-7122-1(e)(5). See also Estate of Jones v. Commissioner, 795 F.2d 566, 573-74 (6th Cir. 1986), aff’g, T.C. Memo. 1984-53; Timms v. United States, 678 F.2d 831,833 (9th Cir. 1982). CCA LEG-142031-08, 11/17/2008

[3] Murphy v. Comm’r of Internal Revenue, 469 F.3d 27, 33 (1st Cir. 2006)

[4] Generally, the total number of persons allowed for national standard expenses should be the same as those allowed as dependents on the taxpayer’s current year income tax return. There may be reasonable exceptions.

Tax Litigation Attorneys

Need assistance in managing the Tax Compliance process? With our unique substantive and procedural knowledge, we can provide a comprehensive approach to the tax dispute resolution process, often collaborating with clients’ existing tax professionals to formulate creative solutions to the most complex tax problems. Freeman Law offers value-driven legal services and provides practical solutions to complex tax issues. Schedule a consultation now or call (214) 984-3000 to discuss your tax concerns and questions.

International Students and Their Dependents | F-2 Visas and Work and Study Authorization

On April 30, 2022, Freeman Law posted my blog that provided a brief overview of international students in the U.S. pursuant to an F-1 visa and the limited circumstances under which those visa-holders may work in the U.S. See International Students, F-1 Visas, Graduation an . . . Work in the U.S.? Since that blog hit the Freeman Law webpage, I was accosted with questions about dependents of the F-1 student visa holder. This blog serves to supplement that previous blog, with a focus on the F-2 visa holder.

Dependents of an F-1 visa holder are within the scope of the definition of “immigrant” contained in 8 U.S.C. § 1101(a)(15)(F), which defines “immigrant” to include “the alien spouse and minor children of any alien” having a residence in a foreign country which he or she has no intention of abandoning, who is a bona fide student qualified to pursue a full course of study at an established academic institution (i.e., the F-1 student), if such spouse or minor children are accompanying or following to join such F-1 student. See also 26 U.S.C. § 1201 (Issuance of visas).

The relevant regulation—8 C.F.R. § 214.2(f)(3)—provides, in part: “The spouse and minor children accompanying an F-1 student are eligible for admission in F-2 status if the student is admitted in F-1 status. The spouse and minor children following-to-join an F-1 student are eligible for admission to the United States in F-2 status if they are able to demonstrate that the F-1 student has been admitted and is, or will be within 30 days, enrolled in a full course of study, or engaged in approved practical training following completion of studies.”

At the time the spouse or minor children of an F-1 student seek admission, the eligible spouse and minor children of an F-1 student with a Student and Exchange Visitor Information System (SEVIS) Form I-20 must individually present an original SEVIS Form I-20 issued in the name of each F-2 dependent issued by a school authorized by the government for attendance by F-1 foreign students. Id.

As reported in the earlier blog, an F-1 student is allowed to engage in qualified curricular practical training and employment through the Non-SEVIS Form process or through a SEVIS Form I-20 process, provided that the employment is directly related to his or her major area of study. See 8 C.F.R. § 214.2(f)(10)(i)(A)-(B). After completion of the course study, the F-1 student may engage in qualified optional practical training. See id. at § 214.2(f)(10)(ii).

However, the F-2 spouse and minor children of an F-1 student—each of whom were issued an individual SEVIS Form I-20—may not accept employment and, with limited exceptions, the F-2 dependent may engage only less than a full course of study, as defined by the regulations. See 8 C.F.R. § 214.2(f)(15)(i) (“The F-2 spouse and children of an F-1 student may not accept employment.”), (ii) (authorization for qualified study for the F-2 dependent of an F-1 student).

The prohibition of employment for an F-2 spouse of F-1 student applies during the F-1 student’s authorized practical training as well as any authorized optimal practical training period. For authorization to work or to take on a full course of study, the F-2 spouse or dependent must apply for and receive alternate authorization, such as the F-1, M-1, or J-1 nonimmigrant status. See id. at § 214.2(f)(15)(ii)(A)(1)-(2). However, “[a]n F-2 child may engage in full-time study, including any full course of study, in any elementary or secondary school (kindergarten through twelfth grade).” See id. at § 214.2(f)(15)(ii)(B). “An F-2 spouse and child violates his or her nonimmigrant status by enrolling in any study except as provided in” 8 C.F.R. § 214.2(f)(15)(ii)(A) or (B).

International and Offshore Tax Compliance Attorneys

Need help with tax issues? Contact us as soon as possible to discuss your rights and the ways we can assist in your defense. We handle all types of cases, including complex international & offshore tax compliance. Schedule a consultation or call (214) 984-3000 to discuss your international tax concerns or questions.

See Sample Form I-20

Department of Homeland Security’s Students and The Form I-20

Department of Homeland Security’s Bringing Dependents to the United States

U.S. Immigration and Customs Enforcement’s SEVP’s Governing Regulations for Students and Schools

Federal Court Imposes Willful FBAR Penalties on Long-Time CPA

In a recent decision, a federal district court found that a long-time CPA/tax-return preparer recklessly failed to file FBARs to disclose several foreign financial accounts. As avid readers of our Insights are aware, many federal courts have found that reckless reporting failures are sufficient to impose “willful” FBAR penalties—and those penalties can be quite significant.

The case was United States v. Kronowitz. And it is yet another reminder that courts addressing FBAR reporting failures tend to look critically at the account holder’s background, including educational and professional. Account holders with tax-related backgrounds or professionals with substantial business experience are often held to a higher standard.

The Foreign Accounts

After hearing a rumor that a former client was considering sueing him for fraud, the CPA (Kronowitz) moved assets offshore for protection, opening two bank accounts in the Cayman Islands. His purpose in opening the Cayman accounts was to keep funds out of reach from potential creditors.

Kronowitz also signed a document titled “Management and Administration Agreement” between himself and an entity named Consista Treuunternehmen (“Consista”), a company in Liechtenstein regarding the management of an entity name Cramo Stiftung/Foundation (“Cramo”). The Agreement empowered Consista to manage Cramo (a sifting/foundation in Liechtenstein) on behalf of Kronowitz.

Cramo opened an account at United Bank of Switzerland (“UBS”). Kronowitz was listed as the beneficial owner. Kronowitz later created a trust to hold proceeds from the investments. And still later, funds held at UBS were transferred to an account at Basler Kantonalbank (“BKB”), which was also opened for Kronowitz’s benefit.

The Reporting Failures

Kronowitz prepared his own tax returns for tax years 2005 through 2010. Schedule B is an attachment to the individual federal income tax return (Form 1040) that is used for reporting interest and dividend income, as well as any financial interest in, or signature authority over, financial accounts located in foreign countries. Although he was required to file a Schedule B in conjunction with his 2005 through 2010 individual income tax returns, Kronowitz did not disclose his financial interest in foreign accounts in a Schedule B for his 2005 through 2010 individual tax returns—nor did he file an FBAR.

Instead, on the Schedule B form filed with his 2008 tax return, in response to the question asking “[a]t any time during 2008, did you have an interest in or signature or other authority over a financial account in a foreign country, such as a bank account, securities account or other financial account?” Kronowitz marked “no.” There were no Schedule B forms attached to the 2005, 2006, 2009, or 2010 individual tax returns.

Kronowitz also prepared the tax returns for the Trust for tax years 2008, 2009, and 2010. He marked “no” in response to the question asking, “[a]t any time during [the] calendar year [], did the estate or trust have an interest in or a signature or other authority over a bank, securities, or other financial account in a foreign country?”

Based on these essential facts, the IRS Examiner assessed the following FBAR penalties:

————————————————————-

Calendar Year FBAR Penalty

————————————————————-

2005 $141,667.00

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2006 $140,066.00

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2007 $145,063.00

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2008 $76,781.00

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2009 $82,504.00

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2010 $77,960.00

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Total Penalties Assessed: $663,771.00

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The FBAR Laws

In 1970, Congress enacted the Currency and Foreign Transactions Reporting Act, referred to as the Bank Secrecy Act (BSA), 31 U.S.C. §§ 5311, et seq.. See Pub. L. No. 91-508, 84 Stat. 1114 (1970). The primary purpose of the BSA is to require certain reports that “have a high degree of usefulness in criminal, tax, or regulatory investigations or proceedings.” Id. § 202.

The regulations require “each United States person having a financial interest in, or signature or other authority over, a bank, securities, or other financial account in a foreign country” to file a FBAR. See 31 C.F.R. § 1010.350(a). The FBAR is required “with respect to foreign financial accounts exceeding $10,000 maintained during the previous calendar year.” See 31 C.F.R. § 1010.306(c).

The authority to assess and collect civil penalties for FBAR requirement non-compliance rests with the IRS. See Delegation of Enforcement Authority Regarding the Foreign Bank Account Report Requirements, 68 Fed. Reg. 26489 (May 16, 2003). The BSA did not originally contain a civil penalty provision for failing to comply with the FBAR requirements, see Pub. L. No. 91-508, 84 Stat. 1114 (1970), but Congress added one in 1986. See Money Laundering Control Act of 1986, Pub. L. No. 99-570, Subtitle H, 100 Stat. 3207, § 1357 (October 27, 1986). FBAR penalties may be either willful or non-willful. See 31 U.S.C. § 5321(a)(5).

In Kronowitz, the Government assessed a willful penalty, in addition to late payment penalties and accrued interest. A willful FBAR penalty requires the following elements: (1) the person must be a U.S. citizen; (2) the person must have or had an interest in, or authority over a foreign financial account; (3) the account had a balance exceeding $10,000.00 at some point during the reporting period; and (4) the person must have willfully failed to disclose the account and file a FBAR. 31 U.S.C. § 5314; 31 C.F.R. § 1010.350(a).

The statutes and regulations at issue do not define the term willful; however, the BSA identifies the applicable penalty as a “civil money penalty.” 31 U.S.C. § 5321(a)(5)(A).

Confronted with this lack of definitional guidance, the Court turned to precedent:

“[W]here willfulness is a statutory condition of civil liability, we have generally taken it to cover not only knowing violations of a standard, but reckless ones as well.” Safeco Ins. Co. of Am. v. Burr , 551 U.S. 47, 57 (2007). “While the term recklessness is not self-defining, the common law has generally understood it in the sphere of civil liability as conduct violating an objective standard: action entailing an unjustifiably high risk of harm that is either known or so obvious that it should be known.” Id. at 68 (quoting Farmer v. Brennan, 511 U.S. 825, 836, 114 S. Ct. 1970, 128 L. Ed 2d 811 (1994)) (internal quotations omitted). In the FBAR context, the United States Court of Appeals for the Eleventh Circuit recently held that “willfulness in the § 5321 includes reckless disregard of a known or obvious risk.” United States v. Rum , —F.3d—, 2021 WL 1589153, at *6 (11th Cir. Apr. 23, 2021).

Under this authority, “when imposing a civil penalty for an FBAR violation, willfulness based on recklessness is established if the defendant (1) clearly ought to have known that (2) there was a grave risk that an accurate FBAR was not being filed and if (3) he was in a position to find out for certain very easily.” Id. (citing United States v. Horowitz, 978 F.3d 80, 89 [126 AFTR 2d 2020-6551] (4th Cir. 2020) (quotations and citation omitted)).

Evidence of Recklessness

The Court then set out the basic and relatively sparse facts leading to its conclusion that the willful penalties were appropriate. Boiled down, they were:

Kronowitz was professional tax return preparer for nearly sixty years
Kronowitz probably did not read the instructions
Kronowitz affirmatively answered “no” to questions regarding interests in foreign accounts on both his individual tax returns and on the Trust tax returns he prepared. He simply and incorrectly assumed that reporting the gains from his Levy investments would be sufficient to satisfy tax reporting obligations.

The Court’s Conclusion

Against this background, the district court found willful penalties applied:

Based upon Kronowitz’s background and experiences as a CPA and tax preparer, and the totality of his actions in this case, the Court finds that he clearly ought to have known that there was a grave risk that he was failing to comply with the FBAR requirements with respect to his foreign accounts. Furthermore, he was in a position to find out for certain very easily, had he taken the time to either conduct independent research, or consult with another person more knowledgeable on tax law as to whether any additional reporting requirements might apply to him.

Accordingly, the Court finds that Kronowitz’s FBAR violations for tax years 2006, 2007, 2008, 2009, and 2010 were willful, and that the Government is entitled to recover willful FBAR penalties for those years

FBAR Penalty Defense Attorneys

Failing to file an FBAR can give rise to significant penalties, including a non-willful penalty and willful FBAR penalty. The risks of tax and reporting non-compliance have never been more real and the threat of international penalties, particularly FBAR penalties, has never been more clear. Schedule a consultation or call (214) 984-3000 to discuss your FBAR penalty concerns or questions.

Everything That You Need to Know About Federal Tax Liens

When an IRS Tax Lien Arises

The Internal Revenue Code (IRC) governs when and how a federal tax lien arises. The federal tax lien—sometimes referred to as a “statutory lien” or “silent lien”—is often confused with the notice of the lien’s existence, which is generally filed by the IRS at a later date (i.e. a Notice of Federal Tax Lien or NFTL).

A Notice of Federal Tax Lien is a document that is publicly filed with state and local jurisdictions in order to put other creditors on notice of the IRS’s lien interest. As a result, the NFTL itself does not actually create the lien—it merely informs others of a lien that already exists by statute. However, the date of the NFTL filing is important for determining the IRS’s priority against other creditors.

Tax liens are one of the primary tools that the IRS uses to collect outstanding taxes. The IRS also uses the levy process or seizures to collect taxes where available. See our separate post on IRS Seizures: The Good, the Bad, and The Ugly for more on topics related to levies and seizures.

What is a Tax Lien?

The law generally defines a lien as a charge or encumbrance on the property of another as security for a debt or obligation. A lien does not change the ownership of the property; it merely identifies the property as having a claim against it.

Liens can be divided into three general categories: common-law liens, consensual liens, and statutory liens. The tax lien created under the Internal Revenue Code is a statutory lien.

The primary federal tax lien is the “general” tax lien, sometimes referred to as the “secret” or “silent” lien. The federal tax lien arises automatically—that is, by operation of law—when a taxpayer fails or refuses to pay tax after notice and demand. I.R.C. § 6321.

The general tax lien under Section 6321 is broad; it generally encompasses all of the taxpayer’s property or rights to property to secure payment of tax liability. Section 6321 provides that if any person liable to pay any tax neglects or refuses to pay the tax after demand, the amount (including any interest, additional amount, addition to tax, or assessable penalty, together with any costs that may accrue in addition thereto) shall be a lien in favor of the United States upon all property and rights to property belonging to such person. However, the Government’s lien under §6321 cannot extend beyond the property interests held by the delinquent taxpayer.

Under I.R.C. section 6321, a federal tax lien attaches to all of a taxpayer’s property or rights to property. The Supreme Court has held that state law controls the determination of the existence of any legal interest that a taxpayer has in a property. Aquilino v. United States, 363 U.S. 509 (1960). However, whether the state-created interest constitutes property or rights to property to which the federal tax lien attaches is a matter of federal law. United States v. Bess, 357 U.S. 51 (1958).

In addition to the general federal tax lien, there are also special liens for estate and gift taxes that arise at the date of death or the date of the gift, respectively. These liens are provided for by IRC § 6324. IRC § 6324A and IRC § 6324B also provides for special estate tax liens applicable to certain closely held business or farm or qualified family-owned business property.

How the Tax Lien Arises

A federal tax lien arises when any “person” liable for any federal tax fails to pay the tax after a demand by the Government for payment. IRC § 6321. For federal tax law purposes, a “person” includes individuals, trusts, estates, partnerships, associations, companies, and corporations. IRC § 7701(a)(1).

The lien is effective from the date that the Government assesses the tax. Thus, if the taxpayer neglects or refuses to pay the assessed tax, then the lien is deemed to “relate back” to the assessment date. IRC § 6322. The IRS is not required to file a Notice of Federal Tax Lien (“NFTL”) in order for the tax lien to attach. However, filing a NFTL may be necessary for the IRS to have priority over other creditors.

The Span of a Federal Tax Lien

The federal tax lien continues until the assessed tax liability is satisfied or becomes unenforceable by reason of lapse of time, i.e., passing of the collection statute expiration date (“CSED”). IRC § 6322. Generally, after assessment, the IRS has ten years to collect the tax liability. IRC § 6502. However, there are some circumstances that may extend or suspend the ten-year collection period.

IRC § 6502 provides for an extension of the collection period in two situations:

The statute of limitations was extended at the same time an installment agreement was entered into. In this case, collection action may be taken until the 89th day after expiration of the installment agreement. IRC § 6502(a)(2)(A).[1]
Release of a levy under IRC § 6343 is accompanied by an agreement to extend the statute of limitations to a specific date and that date has not yet passed. IRC § 6502(a)(2)(B); Treas. Reg. § 301.6343-1(b)(2)(ii)(D).

Moreover, IRC § 6503 provides for the suspension of the collection period in several situations. The most common situations are the following:

Issuance of a statutory notice of deficiency, IRC § 6503(a).
Assets of the taxpayer in control or custody of a court, IRC § 6503(b).
Taxpayer is outside of the United States for a continuous period of at least 6 months, IRC § 6503(c).
An extension exists for the payment of an estate tax, IRC § 6503(d).
A wrongful seizure of property or a wrongful lien on property, IRC § 6503(f).
A taxpayer bankruptcy filing triggering the automatic stay, IRC § 6503(h).

Taxpayers should note that there are other IRC sections whose provisions extend the Collection Statute Expiration Date (CSED), including, but not limited to, IRC §§ 6015(e)(2), 6330(e)(1), 6331(i)(5), 6331(k)(3)(B) and 6672(c)(4).

If the United States government files suit and reduces a tax claim to judgment, the collection period generally does not expire until the judgment has been satisfied or other law so provides. United States v. Overman, 424 F.2d 1142 (9th Cir. 1970); United States v. Hodes, 355 F.2d 746 (2nd Cir. 1966).

Taxpayers should be aware that state statutes of limitations do not affect the length or existence of the federal tax lien. Overman, 424 F.2d at 1147.

The Transfer of Property Subject to Lien

After the federal tax lien attaches to property, it remains attached to that property until the lien expires, is released, or the property has been discharged from the lien. The transfer of property after attachment does not affect the lien. United States v. Bess, 357 U.S. 51, 57 (1958). If property is sold by the taxpayer, the lien attaches to whatever is substituted for it, as it reaches all of the taxpayer’s property and rights to property. Phelps v. United States, 421 U.S. 330, 334-35 (1975) (lien attached to the cash proceeds of a sale). However, as a practical matter, it may be difficult for the IRS to enforce a tax lien against certain assets, such as cash sale proceeds.

The Notice of Federal Tax Lien (NFTL)

The federal tax lien arises by law when the IRS satisfies the prerequisites of IRC § 6321: (i) an assessment and (ii) a notice and demand for payment. However, for the federal tax lien to have priority against certain competing lien interests, the IRS must also file a NFTL pursuant to IRC § 6323.

Purpose and Effect of Filing Notice

The filing of a NFTL is not required in order to perfect the IRS’s lien against the taxpayer. Rather, filing a NFTL protects the government’s priority vis. a vis. third parties, such as a purchaser, security interest holder, mechanic’s lienor, or judgment lien creditor. IRC § 6323(a). Generally speaking, unless the IRS properly files a notice of its federal tax lien first, a purchaser will have priority over the federal tax lien. Similarly, unless the IRS files a NFTL first, the holder of a security interest, mechanic’s lienor, and judgment lien creditor will have priority over the federal tax lien.

IRC § 6323(f)(4) requires that in some states a NFTL filed with respect to real property must be indexed in order to be treated as filed. Indexing is required in a state where a deed must be indexed to be valid against a subsequent bona fide purchaser. See Hanafy v. United States, 991 F. Supp. 794 (N.D. Tex. 1998).

Place of Filing

IRC § 6323(f) and state law ultimately determine the correct place to file a NFTL. If the Service files the NFTL in the wrong office, then the lien will not have priority over a later purchaser, holder of a security interest, mechanic’s lienor, or judgment lien creditor.

Note that different filing rules apply for real property and personal property. IRC § 6323(f) provides that states may designate one office for filing the NFTL for real and personal property.

For real property, the NFTL is filed in the one office designated by the State where the property is physically located. That office is generally the county recorder or clerk of the county in which the real property is located.

With respect to personal property, the “situs” of both tangible and intangible property is the residence of the taxpayer at the time the notice of lien is filed. Again, most states generally provide that the one office for filing the NFTL for an individual’s personal property is the county clerk’s office in the county in which the individual resides.

The residence of a corporation or partnership is deemed to be the place at which the principal executive office is located, which is the office at which the major executive decisions are made. S. D’Antoni, Inc. v. Great Atlantic & Pacific Tea Co., Inc., 496 F. 2d 1378 (5th Cir. 1974). For employment tax and certain excise tax purposes, a single-owner unincorporated business entity is classified as a corporation under Treas. Reg. § 301.7701-2(c)(2)(iv) and (v).

For purposes of filing a notice of federal tax lien, a taxpayer who resides abroad is deemed to reside in Washington, D.C. Thus, a notice of federal tax lien filed against personal property is to be filed with the Recorder of Deeds for the District of Columbia.

If a state fails to provide an office or designates more than one office for filing a NFTL, then IRC § 6323(f) provides that the NFTL is to be filed in the office of the clerk of the United States District Court for the judicial district in which the property subject to the lien is situated.

IRC § 6323(f)(5) provides that the filing of a NFTL is governed solely by the Internal Revenue Code and is not subject to any other Federal law establishing a place or places for the filing of liens or encumbrances under a national filing system. For purposes of determining whether a state has designated more than one office for filing a NFTL, state law that merely adopts or reenacts a Federal law establishing a national filing system is not counted. IRC § 6323(f)(1)(A)(ii). See also Treas. Reg. § 301.6323(f)-1(a)(2).

The Revised Uniform Federal Tax Lien Registration Act (1966), which has been adopted by many states, provides, among other things, a clear rule for the personal property of corporations and partnerships: NFTLs should be filed in the Office of the Secretary of State. This rule applies in states that have adopted the Act.

Refiling of Notice

All NFTLs must be refiled within the required refiling period to retain priority as of the initial filing date. If the period expires and the NFTL has not been refiled, most NFTLs will self release thirty days after the date that is ten years after the assessment, regardless of any extension or suspension of the collection statute of limitations.

The NFTL may be refiled during the one-year period ending 30 days after the expiration of ten years after the assessment date of the tax. IRC § 6323(g)(3)(A).

If the collection period continues to be suspended or extended after the initial refiling, the Service may have to refile again. This second refiling must be made in the one-year period ending with the expiration of 10 years after the close of the preceding required refiling period. IRC § 6323(g)(3)(B).

Often, the IRS files the NFTL in multiple offices. When the Service refiles, it must refile in each of the offices in which the prior NFTLs were filed. See IRC § 6323(g)(2)(A) and Treas. Reg. § 301.6323(g)-1(a)(1). If a taxpayer properly notifies the Service of a change of residence, the Service must not only refile in the original offices, but must also file a NFTL in the recording office covering the new residence.

If a self-releasing NFTL is filed in multiple offices with respect to a particular tax assessment, and the Service fails to timely refile in each of those offices, the assessment lien releases and the refiling of any other NFTL is rendered ineffective. Treas. Reg. § 301.6323(g)-1(a)(1). In other words, even if the NFTL is properly refiled in every office except for one, failure to refile in one office causes the underlying assessment lien to be extinguished and the refiled NFTLs to be ineffective.

However, neither the failure to refile before the expiration of the refiling period, nor the release of the lien, alters or impairs any right of the United States to property or its proceeds that is the subject of a levy or judicial proceeding commenced prior to the end of the refiling period or the release of the lien, except to the extent that a person acquires an interest in the property for adequate consideration after the commencement of the proceeding and does not have notice of, and is not bound by, the outcome of the proceeding. Treas. Reg. § 301.6323(g)-1(a)(3).

Contents of Notice of Federal Tax Lien

The Secretary of Treasury prescribes the form and content of the NFTL and the NFTL is valid notwithstanding any other provisions of law regarding the form or content. IRC § 6323(f)(3). State law may not require that the NFTL be in any particular form or contain any particular items to be recordable. United States v. Union Central Life Ins., 368 U.S. 291 (1961).

The NFTL can be either a paper form (the Service uses Form 668(Y)(c)), or a form transmitted electronically, including by fax or e-mail. Regardless of the method used to file the NFTL, it must identify the taxpayer, the tax liability giving rise to the lien, and the date the assessment arose. Treas. Reg. § 301.6323(f)-1(d)(2).

Effect of Errors in Notice of Federal Tax Lien

Errors appearing on the face of the Service’s filed NFTL often create problems not only in evaluating the validity of the NFTL, but also in determining relative priorities between the Service’s claim and other competing lien claimants.

A number of controversies concern errors in the name of the taxpayer as it appears on the NFTL. The general rule is that if the name on the notice is not identical to the correct name of the taxpayer, then the NFTL is still valid if the NFTL is sufficient to put a third party on notice of a lien outstanding against the taxpayer. This is known as the substantial compliance test. United States v. Sirico, 247 F. Supp. 421 (S.D.N.Y. 1965).

In applying the substantial compliance test, some courts have upheld NFTLs even when there was an error in the taxpayer’s name. SeeQuist v. Wiesener, 327 F.Supp.2d 890 (E.D. Tenn. 2004) (“Joint Effort” rather than “Joint Effort Productions, Inc.” ); Whiting-Turner v. P.D.H. Dev. Inc., 184 F.Supp.2d 1368 (M.D.Ga. 2000) (“PDH Development, Inc.” rather than PD Hill Development, Inc.”); Kivel v. United States, 878 F.2d 301 (9th Cir. 1989) (“Bobbie Morgan” rather than “Bobbie Morgan Lane” ); United States v. Polk, 822 F.2d 871 (9th Cir. 1987) (“Roy Bruce Polk” rather than “Bruce Polk” ); Tony Thornton Auction Service, Inc. v. United States, 791 F.2d 635 (8th Cir. 1986) (notice filed against “Davis’s Restaurant,” a partnership, and one partner, “Joe Davis,” was sufficient as notice against the other partner, “Mary Davis” ); Richter’s Loan Co. v. United States , 235 F.2d 753 (5th Cir. 1956) (“Freidlander” rather than “Friedlander”); Brightwell v. United States, 805 F. Supp. 1464 (S.D. Ind. 1992) (“William S. Van Horn” rather than “William B. Van Horn”); and United States v. Sirico, 247 F. Supp. 421 (S.D.N.Y. 1965) (“Sirico, George” and “Sirico, A.” rather than “Assunta Sirico”). ButseeFritschler, Pellino, Schrank & Rosen, S.C. v. United States, 716 F. Supp. 1157 (E.D.Wis. 1988) (“Alan G. Casey” rather than “Alan J. Casey”); Haye v. United States, 461 F. Supp. 1168 (C.D.Cal. 1978) (“Castello” rather than “Castillo”); United States v. Ruby Luggage Corp., 142 F. Supp. 701 (S.D.N.Y. 1954) (“Ruby Luggage Corp.” rather than “S. Ruby Luggage Corp.”); and Continental Invs. v. United States, 142 F. Supp. 542 (W.D. Tenn. 1953) (“W.B. Clark, Sr.” rather than “W.R. Clark, Sr.”).

In re Spearing Tool and Manufacturing Co., Inc., 412 F.3d 653 (6th Cir. 2005), cert. denied sub nom. Crestmark Bank v. United States, 549 U.S. 810 (2006), is the lead case for upholding a NFTL when lien filing records are electronically searched. In Spearing Tool, the Sixth Circuit held that the Service’s identification of a taxpayer in a NFTL was sufficient where the name of the corporation appeared in an abbreviated form of the corporate name registered with the Michigan Secretary of State. A lien search by a secured creditor did not disclose the NFTLs that had been filed against “Spearing Tool & Mfg. Company, Inc.” The proper name under UCC filing rules was “Spearing Tool and Manufacturing Co.”

The 6th Circuit found that the secured creditor challenging the validity of the NFTL had failed to conduct a reasonable and diligent electronic search because its search did not take into consideration the following three factors:

The use of the abbreviation “Mfg.” and the use of an ampersand are common.
The secured creditor knew that Spearing Tool sometimes used these abbreviations.
The Michigan Secretary of State’s office recommended to the secured creditor that it undertake a search using the abbreviations.

The 6th Circuit limited its holding to the facts and specifically expressed no opinion about whether creditors have a general obligation to search name variations.

In summary, when searching for a NFTL in public records, either in a book format or electronic format, the searcher must act reasonably and diligently. The NFTL identifies the taxpayer when it is sufficient to put a third party on notice of a lien outstanding against the taxpayer. Since this is essentially a factual question, however, it is especially important to pay attention to the “details.” Thus, for example, if the IRS suspects that a person uses any aliases or owns property held for him/her by a nominee, agent or trustee, it may prepare an individual NFTL for filing in all such names.

Collection Due Process

IRC § 6320 gives the taxpayer the right to challenge a NFTL filing, request a Collection Due Process (CDP) hearing with Appeals, and seek judicial review of Appeals’ determination with the Tax Court. The Service must generally notify the taxpayer within 5 business days after the date of filing the first NFTL for a tax period. The notice of lien must be given in person, left at the taxpayer’s home or place of business, or sent by certified or registered mail to the person’s last known address. The notice must also inform the taxpayer of the amount of the unpaid tax, the taxpayer’s right to request a hearing, the available administrative appeals procedures, and applicable procedures for releasing the lien. IRC § 6320(a).

Property to Which the Tax Lien Attaches

The federal tax lien attaches to all property and rights to property of the taxpayer. This is a very broad concept and includes not only items which are typically thought of as property, e.g., tangible items and “things,” but also intangible items and “rights” which a taxpayer may have but are not necessarily marketable. The only exception is that the lien does not attach to any interest of a Native American in restricted land held by the United States. Treas. Reg. § 301.6321-1.

The courts have interpreted this very broad language to include property of greatly varying natures, as well as future interests, contingent interests, and executory contracts.

Future interests. The fact that a taxpayer’s enjoyment of a “right to property” may be postponed does not prevent attachment. If a taxpayer has an unqualified fixed right, under trust or a contract, to receive periodic payments or distributions of property, a lien attaches to the taxpayer’s entire right regardless of when the payments or distributions will be made. Rev. Rul. 55-210, 1955-1 C.B. 544.
Contingent interests. These are interests which a party will receive only if certain circumstances or events occur.See Fouts v. United States, 107 F.Supp.2d 815, 817 (W.D. Mich. 2000) (under state law an expectant beneficiary of an inter vivos trust has a present interest in property that is attachable). Butsee Dominion Trust Co. of Tennessee v. United States, 7 F.3d 233 (unpublished table decision) (6th Cir. 1993) (under state law a contingent remainder person did not have an interest in property). An inter vivos trust is sometimes referred to as a “living trust.”
Executory contracts. A lien may attach before performance under a contract.See Seaboard Surety Co. v. United States, 306 F.2d 855, 859 (9th Cir.1962) (a lien attached to the taxpayer’s rights under an executory contract which the taxpayer had assigned and, when the taxpayer performed under the contract, the government had a lien on the proceeds). See also Randall, Sr. v. H. Nakashima & Co., 542 F.2d 270, 274 (5th Cir. 1976) (contract rights under a partially executed contract constituted a right to property because they had a realizable value).

Once the lien has come into existence, it attaches immediately to any property acquired by the taxpayer during the existence of the lien. In other words, unlike a typical mortgage, the federal tax lien attaches to a taxpayer’s after-acquired property.

If the Service files a NFTL, the tax lien will generally have priority to a taxpayer’s after-acquired property. In United States v. McDermott, 507 U.S. 447 (1993), the Supreme Court held that the federal tax lien had priority over a judgment lien on the taxpayer’s after-acquired property, to which the judgment lien and the federal tax lien attached simultaneously, even though the judgment lien was filed ahead of the NFTL.

State Law

State law is very significant when considering the property and rights to property to which the federal tax lien attaches. The Government looks to state law to determine a taxpayer’s rights in a particular piece of property, but federal law determines whether such interests qualify as property or rights to property. “[One] look[s] to state law to determine what rights the taxpayer has in the property the Government seeks to reach, then to federal law to determine whether the taxpayer’s state-delineated rights qualify as ‘property’ or ‘rights to property’ within the compass of federal tax lien legislation.” United States v. Craft , 535 U.S. 274 (2002); Drye v. United States, 528 U.S. 49, 58 (1999).

State law does not determine whether something is property under the Internal Revenue Code. For example, in many states a liquor license is not property. Under the Internal Revenue Code, however, the question is whether the taxpayer has rights under state law. Because the taxpayer does have rights under state law, the liquor license is property under the Internal Revenue Code. SeeDrye, 528 U.S. at 58-59.

The Government must look to state law to determine whether a taxpayer has rights in property by virtue of a civil union, domestic partnership, or similar relationship.

Real Property

Federal tax lien questions relating to the joint ownership of property generally arise when other parties claim an interest in real property otherwise subject to the federal tax lien. This issue typically arises when the Service asserts a tax lien against only one of the parties having an interest in real property which, depending on state law, is held in one of the following forms:

Community property,
Joint tenancy,
Tenancy in common, or
Tenancy by the entirety.

Community Property

The community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. Puerto Rico is also a community property jurisdiction. Spouses in Alaska may elect to have statutory community property rules apply to some or all of their property. Alaska St. § 34.77.010 et seq. Community property includes both real and personal property.

In most community property states, only married couples may own property as part of a community. See Obergefell v. Hodges , 135 S. Ct. 2584 (2015). The community property rules also apply in some states to state-created, formal relationships between non-married couples. For example, California, Nevada and Washington permit domestic partnerships to which each state applies its community property laws.

Community property law presents special problems concerning the force and effect of the federal tax lien.

Joint Tenancy

A joint tenancy may be created when the following conditions are met:

Two or more persons become the owners of property in equal and undivided shares.

The interest of each tenant is created in the same conveyance at the same time and the interests must be equal.

Joint tenants generally have a right of survivorship. Under the right of survivorship, when a joint tenant dies, the surviving joint tenants automatically own a greater portion of the property.

By statute, some states have abolished the survivorship feature of joint tenancy.

Generally, where only one of the joint tenants owes taxes, the lien attaches to the taxpayer’s property interest and the entire property may be sold pursuant to judicial sale under IRC § 7403, although the non-liable joint tenant must be compensated from the sale proceeds. If the Service enforces the tax lien against a taxpayer’s interest in a joint tenancy and sells it, the purchaser acquires the taxpayer’s partial interest in property, but most states then treat the joint tenancy as having been converted to a tenancy in common (discussed below). See generally, United States v. Rodgers, 461 U.S. 677 (1983).

In most states, if the individual, against whose property a federal tax lien attaches, dies before any of the other joint tenants, then the lien ceases to attach to the property. However, if the same individual is the last survivor of the joint tenants, the tax lien then attaches to the entire property. In a few states, however, this is not the rule. Wisconsin is an exception to the general rule: if the federal tax lien has attached to the interest of one joint tenant who then dies, the surviving joint tenant takes the property encumbered with the federal tax lien. United States v. Librizzi , 108 F.3d 136 (7th Cir. 1997). Connecticut is also an exception to the general rule. Conn. Gen. Stat. 47-14f. See also Paternoster v. United States, 640 F.Supp.2d 983 (S.D. Ohio 2009). Accordingly, state law should always be consulted to determine whether there is an exception to the general rule.

Tenancy in Common

A tenancy in common is like a joint tenancy in that it creates an undivided interest in property. However, it is different from a joint tenancy in two important aspects:

First, the interest of a tenant in common may be transferred to a third party without destroying the tenancy in common.
Second, there is no right of survivorship in a tenancy in common.

Applying the above rules to collection, the Service may levy and sell a taxpayer’s interest in a tenancy in common. Alternatively, the Service may ask a court to foreclose the federal tax lien and sell the entire property, although the non-liable tenant in common must be compensated from the sale proceeds. Also, if a tax lien attaches to one tenant’s interest, it will survive the taxpayer’s death and continue to encumber the property in the hands of heirs or legatees.

Tenancy by the Entirety

Only spouses can hold property in a tenancy by the entirety. A tenancy by the entirety is similar to a joint tenancy in having a right of survivorship. But the tenancy by the entirety has a restriction not found with a joint tenancy: one spouse cannot transfer his or her interest without the consent of the other spouse. See Obergefell v. Hodges , 135 S. Ct. 2584 (2015). Some states permit real and personal property to be held as a tenancy by the entirety while others only permit real property to be held in such manner.

For many years there was uncertainty as to whether a federal tax lien could attach to the interest of only one tenant. (If both spouses were liable, the general rule was that a federal tax lien could attach to the tenancy by the entirety.) In United States v. Craft, 535 U.S. 274 (2002), the Supreme Court provided a clear answer, holding that the federal tax lien may attach to the tenancy by the entirety when only one spouse had a federal tax liability. Notice 2003-60, 2003-39 I.R.B. 643 addressed the application of Craft to different situations. In summary, the Notice stated the following:

The federal tax lien attaches to all the property and rights to property of the taxpayer. The Court’s decision confirms that a taxpayer’s property and rights to property have always included any rights that the taxpayer may have in entireties property under state law. The Court’s decision, therefore, does not represent new law and does not affect other law applicable to federal tax liens and federal tax collection. For example, theCraft decision does not change any limitation on the ability of the Service to rescind an accepted offer in compromise or terminate an accepted installment agreement.
As a matter of administrative policy, the Service will, under certain circumstances, not applyCraft, with respect to certain interests created before Craft, to the detriment of third parties who may have reasonably relied on the belief that state law prevents the attachment of the federal tax lien.
The administrative sale of entireties property subject to the federal tax lien presents practical problems that limit the usefulness of the Service’s seizure and sale procedures. Levying on cash and cash equivalents held as entireties property is considerably less problematic and will be used by the Service in appropriate cases.
Because of the potential adverse consequences to the non-liable spouse of the taxpayer, the use of lien foreclosure for entireties property subject to the federal tax lien will be determined on a case-by-case basis.See United States v. Rodgers, 461 U.S. 677 (1983) (IRC § 7403 authorizes foreclosure sale of entire jointly-owned property for separate tax liability of one spouse, but non-liable spouse is entitled to compensation from sale proceeds for loss of her share of the property).
As a general rule, the value of the taxpayer’s interest in entireties property will be deemed to be one-half.Accord Popky v. United States, 419 F.3d 242, 245 (3d Cir. 2005); United States v. Barr, 617 F.3d 370, 373 (6th Cir. 2010), denied, 131 S. Ct. 1678 (2011). Butsee Pletz v. United States, 221 F.3d 1114, 1117-18 (9th Cir. 2000) (using actuarial tables). Craft declined to address the valuation of each spouse’s individual interest in the property. 535 U.S. at 289.
Where there has been a sale or other transfer of entireties property subject to the federal tax lien that does not provide for the discharge of the lien, whether the transfer is to the non-liable spouse or a third party, the lien thereafter encumbers a one-half interest in the property held by the transferee.

Equitable Conversion

Some states recognize the doctrine of equitable conversion, which provides that a purchaser acquires equitable title to property when the unrecorded contract for sale is executed. Although the seller retains bare legal title to the property, the seller’s equity interest is in the right to the balance of the purchase money. The seller holds legal title in trust for the purchaser.

Some states extend the doctrine of equitable conversion to a lender who secures the interest with a mortgage or deed of trust.

Personal Property

Personal property is defined generally as everything that can be owned that is not real property. Tangible property is defined generally as personal property that has physical form and is moveable.

The Service takes collection action against a variety of types of personal property, including automobiles, trucks, boats, goods, bank accounts, wages and benefits, interests in trusts, and partnership interests.

Cash and Rights to Cash

The federal tax lien attaches to a taxpayer’s interest in a bank account, even when the bank account is in the joint names of the taxpayer and others. United States v. National Bank of Commerce, 472 U.S. 713 (1985). This means that the lien reaches a taxpayer’s unqualified right to withdraw all of the money in the account without the consent of the other account holder. However, the right of a taxpayer joint depositor to withdraw funds from a joint bank account is provisional and subject to a later claim by a co-depositor that the money in fact belongs to him or her.

The federal tax lien attaches to a taxpayer’s wages as the wages become his property and rights to property. State laws shielding some portion of a debtor’s wages from collection do not apply to the Service, as the collection of federal taxes is a matter of federal supremacy.

In many situations, the Service loses its federal tax lien on money when a third party acquires the money in exchange for fair value. This occurs under IRC § 6323(b)(1)(A), which provides a superpriority for a purchaser of a security if the purchaser has no actual knowledge of the federal tax lien. Treas. Reg. § 301.6323(h)-1(d) defines a security to include negotiable instruments and money.

Partnership and Other Joint Interests

It is often difficult to determine a partner-taxpayer’s interest in a partnership or other joint interest to which a federal tax lien has attached. Generally speaking, a partner-taxpayer’s interest in either a partnership or a joint venture is only a share in the equity in the assets; that is, the excess of assets over liabilities. United States v. Kaufman, 267 U.S. 408 (1925). Note that a partnership may own both real and personal property in the name of the partnership. If a federal tax lien exists on the partner-taxpayer’s property, the federal tax lien would not attach to the partnership’s property. See Rev. Rul. 73-24, 1973-1 C.B. 602 (addressing whether partnership account is subject to levy to satisfy tax liability of individual partner).

Frequent and regular partnership “draws” which are advances or loans on annual profits are subject to a lien (and may be levied as salary or wages). United States v. Moskowitz, Passman & Edelman, 603 F.3d 162 (2d Cir 2010).

Another issue that arises with respect to partnerships is whether the federal tax lien attaches to a general partner’s individual property in connection with an assessment made against the partnership for a partnership tax liability. In United States v. Galletti, 541 U.S. 114 (2004), the Supreme Court held that a timely assessment of a partnership’s employment tax liability permits the Service to collect the liability from the individual partners. Because the partners are derivatively liable for the taxes under state law, the assessment and notice and demand upon the partnership gave rise to the federal lien both on partnership and partner property.

Trusts and Beneficial Interests

A trust is a state-law created entity where one party holds property for the benefit of another. The following are terms generally used in connection with trusts:

The creator of the trust is referred to as the “grantor” or “settlor.”
The property held by the trust is called the “res,” “corpus,” “principal” or “remainder.” Income generated by the corpus is called income.
The person holding the property for the benefit of the other person is called the “trustee” or “fiduciary.”
The person benefitting from the trust is called the “beneficiary.” A beneficiary may only be entitled to income, principal or both, depending on the provisions of the trust.
A “revocable” trust is one where under the terms of the trust, the grantor/settlor reserves the right to dissolve the trust and take the property back.
An “irrevocable” trust is one that the grantor/settlor cannot dissolve and cannot take the property back.

If the taxpayer is the grantor or settlor of a trust, the validity of the trust must be determined under applicable state law. If the grantor reserves a substantial interest or unrestricted control over the management of the operations that is not for the benefit of the purported beneficiary, the grantor remains the owner of the property and the trust will be ignored. For example, property in a family trust that is a sham – the grantors attempt to reduce their taxes by putting the property in trust, while retaining the use and benefits of the property – is subject to collection action to satisfy the grantors‘ liability. Whitesel Family Estate v. United States, 84-2 U.S. Tax Cas. (CCH) ¶ 9890 (S.D. Ohio 1984); Edwards Family Trust v. United States, 572 F. Supp. 22 (D. N.M. 1983).

If the taxpayer is the beneficiary of a trust, a federal tax lien will attach to the taxpayer’s beneficial interest in the trust. This determination is made by reference to the trust instrument itself, with the appropriate state law governing construction of the terms of the instrument or the resolution of any ambiguities in the instrument. In some cases the lien will attach to the corpus of the trust and the income payable to the beneficiary. In other cases the lien will attach only to the income as it becomes payable to the beneficiary, and in a few cases it may not attach to either the income or the corpus. The latter situation may arise where the trustee has the unrestricted power of disposition of the trust income; i.e., where he/she may legally refuse to make any further distribution to the taxpayer-beneficiary and instead make the distribution to other beneficiaries or simply accumulate the income.

The trust instrument can only determine the property right of the beneficiary (e.g., the taxpayer) in the trust corpus and income; the trust instrument itself cannot determine the effect of the federal tax lien upon that right. Thus, a so-called “spendthrift” trust may by its terms confer certain specific benefits upon a beneficiary and then purport to restrict the rights of creditors to reach those benefits. Such restrictions are not effective to remove those benefits from the reach of the federal tax lien, regardless of whether under the appropriate state law a “spendthrift” trust is regarded as valid in all respects. Bank One Ohio Trust Co. v. United States, 80 F.3d 173 (6th Cir. 1996).

Because the validity of a trust and the taxpayer’s rights to trust property are highly dependent upon the particular facts of the case, the terms of the trust agreement, and applicable state law, Area Counsel should be consulted whenever these issues arise.

Intangible Property

Intangible property is personal property which lacks a physical existence but is represented by physical evidence. Items in this category include certificates of stock, bonds, promissory notes, licenses, goodwill, debts owed to the taxpayer, patents, copyrights, trademarks, franchises and “choses in action.”

A chose in action is a personal right not reduced to possession and recoverable by a suit at law. A plaintiff’s cause of action in tort or contract against a defendant is an example of a chose in action. United States v. Stonehill, 83 F.3d 1156 (9th Cir. 1996), cert. denied, 519 U.S. 992 (1996).

Exempt Property

State laws exempting a debtor’s property from creditors do not affect the reach of the federal tax lien. United States v. Bess, 357 U.S. 51 (1958); Commissioner v. Stern, 357 U.S. 39 (1958). Similarly, while state law may prevent a beneficiary of a spendthrift trust from transferring his or her interest to third parties, the beneficiary’s interest remains property subject to the federal tax lien.

Terminable Interests

Terminable interests are interests that a taxpayer may have that, by definition, terminate upon the death of the party holding the interest. These may include a life estate in property, or a contract right that will terminate at some time ( e.g., an option).

The federal tax lien may attach to such an interest before it terminates. However, once the interest terminates, the federal tax lien on that interest also terminates. United States v. Swan, 467 F.3d 655 (7th Cir. 2006); Rev. Rul. 54-154, 1954-1 C.B. 277.

Similarly, in the case of a life estate, the federal tax lien clearly attaches to the life tenant’s interest and may be enforced against that interest so long as the life tenant lives. However, upon the death of the life tenant, the lien ceases to attach to the property since the Government’s tax lien rights do not exceed the taxpayer’s right to the property.

Property in the Custody of a Court

When a taxpayer’s property is within the jurisdiction of and under the control of a state or federal court, such property is referred to as being in “custodia legis.” This is a judicial doctrine. In most situations, courts recognize that a lien may attach to property held in the court’s custody. See Dragstrem v. Obermeyer 549 F.2d 20 (7th Cir. 1977).

There may be situations, however, when the federal tax lien will not attach to property held in the court’s custody. For example, if an assessment has not been made prior to the transfer of the taxpayer’s property to a state court receiver and the taxpayer has no property interest or rights to property after the transfer, then the federal tax lien will not attach to the property held by the receiver.

Each state decides whether the taxpayer is divested of his interest upon the transfer.

The fact that the Government may not have a lien on property in custodia legis does not prevent the Government from collecting the tax liability in the judicial proceeding that administers the property. The tax lien will attach to any property of the taxpayer not in the custody of the court and will attach to any property returned to the taxpayer upon termination of the court proceedings, such property being in the nature of after-acquired property.

In bankruptcy cases, the discharge of the debtor-taxpayer from a tax liability may prevent the tax lien from attaching to after-acquired property.

Property Held By Third Parties

Attempting to avoid the imminent attachment of the federal tax lien, taxpayers have transferred their assets to legal entities that they or their friends or relatives control. However, the federal tax lien extends to property held by a third party if that third party is either the alter ego or the nominee of the taxpayer. Attempts to improperly use an alter ego or nominee may be factors that increase the risk of criminal exposure. The factors that are relevant in determining whether such a situation exists are similar to the factors which are used in deciding whether a taxpayer has fraudulently conveyed property to keep it from the reach of creditors.

This section outlines some of the most significant elements in determining whether the federal tax lien attaches to property held by a taxpayer’s alter ego or nominee. Note that these two doctrines are legally distinct. Oxford Capital Corp. v. United States, 211 F.3d 280 (5th Cir. 2000).

“Alter egos” connote legally distinct entities which are so intermixed that their affairs (and assets) are not readily separable.
“Nominees” connote readily separable persons or entities, with one holding certain specific property for the exclusive use and enjoyment of the other.

The terms often interchange or overlap, but “alter egos” are usually corporate and business entities controlled by the taxpayer, whereas “nominees” are usually individuals who clearly have a separate physical identity.

Alter Ego

Alter ego essentially means a “second self.” It is a doctrine that allows the law to disregard an entity’s separate legal identity in order to extend liability and prevent abuse. Using an alter ego theory, if an individual is the alter ego of a corporate taxpayer or other legally distinct entity, then that individual’s assets may be used to satisfy the debts of the corporate taxpayer. This is sometimes called “piercing the corporate veil.”

Similarly, if a corporation or other legally distinct entity is the alter ego of a taxpayer, then the assets of that entity may be used to satisfy the debts of the individual taxpayer. This is sometimes called “reverse piercing of the corporate veil.”

An alter ego generally involves a sham corporation used to avoid legal obligations. To establish an alter ego, such that an alter ego Notice of Federal Tax Lien may be filed, it must be shown that the shareholders disregarded the corporate entity and made it an instrumentality for the transactions of their own affairs.

The IRS’s position is that federal common law, rather than state law, governs alter ego status. See Chief Counsel Notice CC-2012-002 (Dec. 2, 2011).

No one factor determines whether an alter ego situation is present, but a number of factors taken together may. The following list is neither exhaustive nor exclusive, but alter ego situations typically involve one or more of the following:

Commingling of corporate and personal finances and use of corporate funds to pay personal expenses.
Unsecured interest-free loans between the corporation and the shareholder.
The taxpayer is a shareholder, director, or officer of the corporation, or otherwise exerts substantial control over the corporation.
The corporation is undercapitalized relative to its reasonable anticipated risks of business.
A failure to observe corporate formalities, e.g. issuance of stock, payment of dividends, director and shareholder meetings, or the maintenance of corporate records.
A failure to disregard the corporate fiction presents an element of injustice or “fundamental unfairness.”

In an alter ego case, a special condition NFTL is used, identifying, in the name line of the NFTL before the taxpayer’s name, the third party as the alter ego. For example, if the taxpayer is TP, and ABC Inc. is TP’s alter ego, then the NFTL name line would read “ABC, Inc., as Alter Ego of TP.”

Generally, the IRS will not assert an alter ego in transactions involving only individuals.

Nominee

A “nominee” is someone designated to act for another. As used in the federal tax lien context, a nominee is generally a third-party individual who holds legal title to property of a taxpayer while the taxpayer enjoys full use and benefit of that property. In other words, the federal tax lien extends to property “actually” owned by the taxpayer even though a third party holds “legal” title to the property as nominee. Generally speaking, the third party in a nominee situation will be either another individual or a trust.

A nominee situation generally involves a fraudulent conveyance or transfer of a taxpayer’s property to avoid legal obligations. To establish a nominee lien situation, it must be shown that while a third party may have legal title to the property, it is really the taxpayer that owns the property and who enjoys its full use and benefit.

No one factor determines whether a nominee situation is present, but a number of factors taken together may. The following list is neither exhaustive nor exclusive, but nominee situations typically involve one or more of the following:

The taxpayer previously owned the property.
The nominee paid little or no consideration for the property.
The taxpayer retains possession or control of the property.
The taxpayer continues to use and enjoy the property conveyed just as the taxpayer had before such conveyance.
The taxpayer pays all or most of the expenses of the property.
The conveyance was for tax avoidance purposes.

The Service’s NFTL in a nominee situation is identical to the standard NFTL, except that the nominee is identified as the name of the taxpayer. For example, if the taxpayer is TP, and My Brother-In-Law or My Trust is TP’s nominee, then the name of the taxpayer on the nominee NFTL would be “My Brother-In-Law or My Trust, Nominee of TP.”

Unlike the alter ego situation, nominee situations usually involve specific pieces of a taxpayer’s property that were conveyed to the nominee. Since the federal tax lien only attaches to property actually “owned” by the taxpayer, it may not reach all property that is, in fact, actually owned by the nominee. Therefore, the NFTL in a nominee situation will usually contain a notation on its face that the lien is filed to attach specifically to certain identified property. This property must be specifically identified and described in the NFTL.

In the nominee lien context, courts have recognized that the language of section 6321 “is broad and reveals on its face that Congress meant to reach every interest in property that a taxpayer might have.” United States v. Natl. Bank of Commerce, 472 U.S. 713, 719-720 [56 AFTR 2d 85-5210] (1985); see also Drye v. United States, 528 U.S. 49, 56 [84 AFTR 2d 99-7160] (1999). Among the property interests reached by section 6321 is an equitable interest owned by or for the benefit of a taxpayer in property titled in the name of a nominee. G.M. Leasing Corp. v. United States, 429 U.S. 338, 350-351 [39 AFTR 2d 77-475] (1977); United States v. Miller Bros. Constr. Co., 505 F.2d 1031 [34 AFTR 2d 74- 6241] (10th Cir. 1974). Section 6321 authorizes the Government, among other things, to file a nominee NFTL against property of a taxpayer in the hands of an alter ego or nominee. G.M. Leasing Corp. v. United States, supra at 351.

A nominee NFTL lien may be used whenever legal title to property is held by a third party but equitable ownership, in whole or in part, resides with the taxpayer. G.M. Leasing Corp. v. United States, supra. It enables the Commissioner to perfect a lien under section 6323 on property in which a taxpayer has an interest that is titled in the name of a third party. Id.; see also Drye v. United States, 528 U.S. 49 [84 AFTR 2d 99-7160] (1999) (holding that a disclaimer by the sole heir of an intestate decedent did not prevent a Federal tax lien with regard to the heir’s unpaid tax liabilities from attaching to his inheritance); Wilkinson v. United States, 770 F. Supp. 1085 (W.D.N.C. 1991); United States v. Drexler, 60 AFTR 2d 87-5091 [60 AFTR 2d 87- 5091], 87-2 USTC par. 9493 [60 AFTR 2d 87-5091] (E.D. Okla. 1985).

Disclaimers and Renunciations

State laws generally provide that a recipient does not have to accept a gift or transfer. Such transfers are generally inheritances, devises, bequests, gifts, and marital interests upon divorce or death of a spouse. To avoid the transfer, state law allows the recipient to “disclaim” or “disavow” or “renounce” such transfers. Typically, the operation of state law can create a legal fiction that the recipient of such transfers never received the property in question by retroactively treating the disclaimer as having occurred prior to the receipt of the property.

The issue is whether a taxpayer-recipient’s disclaimer will prevent the federal tax lien from attaching to the property. In Drye v. United States, 528 U.S. 49 (1999), the Supreme Court held that such a disclaimer will not prevent a federal tax lien from attaching to the property. Similarly, even though a spouse’s renunciation of a marital interest may be treated as retroactive under state law, that state-law disclaimer does not determine the spouse’s liability for federal tax on her share of community income realized before the renunciation. United States v. Mitchell, 403 U.S. 190 (1971).

“Retroactive” or “relation-back” state laws also do not prevent a federal tax lien from attaching to property. Treas. Reg. § 301.6323(h)-1(a)(2)(B); Brent v. Commissioner, 630 F.2d 356 (5th Cir. 1980); Daine v. Commissioner, 168 F.2d 449 (2nd Cir. 1948); Eisenberg v. Commissioner, 161 F.2d 506 (3d Cir. 1947), cert. denied, 332 U.S. 767 (1947).

Same-sex Marriage and Legally-Recognized Relationships

The recognition of same-sex marriage and the creation of formal relationships other than marriage may give taxpayers property rights they previously did not have. Federal tax liens will attach to these property rights and the Service will be able to levy on these rights. Some states allow opposite and same-sex couples to enter into other formal, legal relationships that confer rights and benefits similar to those provided by marriage. These relationships include civil unions, registered domestic partnerships, reciprocal beneficiaries, and designated beneficiaries. Among the rights conferred on members of the state-created legal relationships are:

1.	Inheritance rights. Upon the death of one spouse or member of a legally-recognized relationship, the survivor may be entitled to inherit certain property under the state’s intestacy law. Alternatively, the surviving member may have a right to property as a beneficiary under the decedent’s will. Instead of taking under a will, or in the event of unjustifiable disinheritance or omission from the will, the survivor may be entitled to claim an elective share.
2.	Community property rights.
3.	Tenancy by the entirety.
4.	Tort claims. A member of a legally-recognized relationship may have the right to bring a cause of action in connection with the death or injury of the other member of the legally-recognized relationship. A federal tax lien attaches to tort claims. United States v. Hubbell, 323 F.2d 197 (5th Cir. 1963).
5.	Insurable interest. A member of a legally-recognized relationship may have an insurable interest in the life of the other member of the legally-recognized relationship. A delinquent taxpayer in one of these legally-recognized relationships may be the beneficiary under an insurance policy upon the death or disability of the other member.
6.	Retirement plans. A liable taxpayer may be entitled to receive survivor benefits or the balance of a retirement account from a retirement plan in which his or her deceased spouse or member of a legally-recognized relationship was a participant. If a liable taxpayer has been divorced, he or she may be entitled to benefits or the account balance from a retirement plan in which his or her divorced spouse or member of a legally-recognized relationship is or was a participant.
	a.	ERISA-qualified plans. The Employment Retirement Income Security Act (ERISA) governs most retirement plans and if ERISA-qualified, state law rules do not apply. For a defined benefit plan (plan funded by an employer that pays participants a specific monthly benefit at retirement), the surviving spouse of participant is eligible for a monthly benefit unless the participant and spouse elect against it. For a defined contribution plan (e.g., 401(k), IRA, profit-sharing plan), a spouse is entitled to the balance of the account unless the participant and spouse elect against it. In the absence of a spouse, the named beneficiary may be a registered domestic partner or member of another legally-recognized relationship.
	b.	Non-ERISA plans. Governmental plans, many church plans and section 403(b) plans are not covered by ERISA. These plans may provide for survivor benefits for a spouse or member of a legally-recognized relationship upon the death of the participant.

Priority of Tax Liens: Specially Protected Competing Interests

After notice and demand for payment, the federal tax lien arises and relates back to the assessment date. Congress recognized that it was difficult to conduct business when creditors were unaware of the Service’s assessment lien. Consequently, Congress enacted the forerunner of IRC § 6323(a) to provide that a NFTL must be filed in order to have priority over certain creditors. Today, IRC § 6323(a) provides, in part, that “[the] lien imposed by section 6321 shall not be valid as against any purchaser, holder of a security interest, mechanic’s lienor, or judgment lien creditor until notice thereof … has been filed …”

IRC § 6323(a) applies to the Service in a variety of situations including interpleaders and lien foreclosures. In lien priority disputes, the Service must determine which claims against the taxpayer’s property will be satisfied first, which second, and so on down the order of priority until the value of the property is exhausted. If a purchaser, holder of a security interest, mechanic’s lienor, or judgment lien creditor with a claim to the taxpayer’s property perfects its claim prior to the filing of a NFTL, then that claim is entitled to priority over the tax lien.

The parties listed in IRC § 6323(a) are protected against unfiled NFTLs, notwithstanding actual knowledge of the statutory assessment lien. Rev. Rul. 2003-108, 2003-2 C.B. 963.

Purchasers

If a NFTL has not been filed prior to the sale of a taxpayer’s property, a purchaser takes the property free of the federal tax lien. IRC § 6323(a).

A purchaser is a person who, for adequate and full consideration in money or money’s worth, acquires an interest (other than a lien or security interest) in property which is valid under local law as against subsequent purchasers without actual notice. IRC § 6323(h)(6).

A purchaser must acquire the property pursuant to a sale. The amount paid must bear some reasonable relationship to the value of the property acquired. However, this requirement of full and adequate consideration does not preclude a bona fide bargain purchase or a purchaser who has not completed performance of his/her obligation, such as the completion of installment payments.

A purchaser is also one who has acquired a lease of property, an executory contract to purchase or lease property, one who has an option to purchase or lease property or an interest in it, or one who has an option to renew or extend a lease on property, if the interest acquired is not a lien or security interest.

Some states recognize the doctrine of equitable conversion, which provides that a purchaser acquires equitable title to property when the unrecorded contract for sale is executed. Equitable conversion is only relevant where the contract for sale is executed before the NFTL is filed but recordation occurs after the NFTL is filed or not at all. Even in states that recognize equitable conversion, the purchaser will not take the property free of the federal tax lien unless they qualify as a “purchaser” under IRC 6323(h)(6). Ruggerio v. United States, 2005-2 USTC ¶ 50,645 (4th Cir. 2005), cert. denied, 549 U.S. 811 (2006). In Ruggerio, which is a Maryland case, an assessment lien attached to the taxpayer-seller’s real property. Subsequently, the taxpayer-seller contracted to convey the real property to buyer. The Service filed a NFTL before the closing date on the real property. The Fourth Circuit held that buyer took the real property with the federal tax lien attached to it, because the Service filed a NFTL before the buyer qualified as a purchaser under IRC § 6323(a).

State Law Guides contain information on equitable conversion and its impact on the priority of the federal tax lien in relation to purchasers.

Judgment Lien Creditor

If a NFTL has not been filed prior to a creditor perfecting a judgment lien, the judgment lien has priority over the federal tax lien. In order to be a judgment lien creditor, the creditor must obtain a valid judgment in a court of record and of competent jurisdiction for the recovery of specifically designated property or for a certain sum of money. Treas. Reg. § 301.6323(h)-1(g).

In the case of a judgment for the recovery of a certain sum of money, a claimant must have a perfected lien on the property involved. This requires:

the identity of the lienor,
the property subject to the lien, and
the amount of the lien be established.

If state law requires a recording of the judgment before there is a lien on the real property good against third parties, the creditor does not qualify as a judgment lien creditor until that recordation date. If state law requires a levy or seizure of personal property before there is a lien on the personal property that is good against third parties, then there must be a levy or seizure of the personal property before the notice of federal tax lien is filed in order for a judgment lien creditor to have priority.

Mechanic’s Lienor

If a NFTL has not been filed prior to a creditor perfecting a mechanic’s lien, the mechanic’s lien has priority over the federal tax lien.

IRC § 6323(h)(2) defines a mechanic’s lienor as a person who, under local law, has a lien on real property (or on the proceeds of a contract relating to real property) for services, labor or materials furnished in connection with the construction or improvement of the property.

For priority purposes, the lien arises on the earliest date such lien becomes valid under local law against subsequent purchasers of the property without actual notice of the tax lien but not before the mechanic begins to furnish the services, labor or materials. Thus a mechanic’s lienor, who takes all of the requisite action under local law to perfect and enforce such lien, has a mechanic’s lien from a date no earlier than the day on which the mechanic began to furnish the services, labor or materials on the job to which the lien relates.

Holder of a Security Interest

If a NFTL has not been filed prior to a creditor perfecting a security interest, the security interest has a priority over the federal tax lien. IRC § 6323(h)(1) defines a security interest as any interest acquired by written contract for the purpose of security (payment, performance, indemnity) in existing property for which the holder paid money or money’s worth and which has priority under local law over subsequent judgment liens arising out of unsecured obligations.

If a federal tax lien is invalid against an initial holder of a security interest, it is also invalid against another party that acquires the security interest, whether by purchase or otherwise.

A security interest must be in existence to prime a federal tax lien. A security interest exists at any time –

if, at such time the property is in existence and the security interest has become protected under local law against a subsequent judgment lien and
to the extent that, at such time, the holder has parted with money or money’s worth. See Treas. Reg. § 301.6323(h)-1(a)(1).

Thus, where a creditor fails to perfect its security interest as required by the Uniform Commercial Code, the federal tax lien will attach to the property and will be entitled to priority over the creditor. United States v. Trigg, 465 F. 2d 1264 (8th Cir. 1972), cert. denied sub nom. First State Bank of Crossett, Arkansas v. United States, 410 U.S. 909 (1973).

Local law distinguishes real property from personal property. This is important because the actions required under local law to establish the priority of the security interest against a subsequent judgment lien may differ depending on whether the property involved is real or personal property.

State law permitting relation back to perfect a state lien cannot affect the priority of the lien. Treas. Reg. § 301.6323(h)-1(a)(2)(B).

In some states, equitable conversion provides a lender priority over a NFTL filed before the lender records. Equitable conversion is only relevant where the mortgage instrument or deed of trust is executed before the NFTL is filed, but recordation occurs after the NFTL is filed or not at all. Equitable conversion provides that a lender acquires equitable title when an unrecorded mortgage or deed of trust is executed. In some states, priority is established when the mortgage or deed of trust is executed because the lender’s equitable interest is protected under local law against a subsequent judgment lien arising out of an unsecured obligation. IRC 6323(h)(1); Susquehanna Bank v. United States, 2014-2 USTC ¶ 50492 (4th Cir. 2014). In Susquehanna Bank, the NFTL was filed after the deed of trust securing the loan was executed, but before the deed of trust was recorded. The Fourth Circuit found that the lender’s unrecorded security interests had priority over the federal tax lien, even though the NFTL had been filed, because an equitable security interest is protected under Maryland law against subsequent judgment-lien creditors.

State Law Guides contain information on equitable conversion and its impact on the priority of the federal tax lien in relation to holders of a security interest.

Superpriorities

The Internal Revenue Code provides special protection for limited interests by giving them priority over the federal tax lien even though the interests come into existence after the filing of a NFTL. IRC § 6323(b). These special interests are called “superpriorities.”

There may be some overlapping among categories of “superpriorities” in which event federal law provides protection if any category applies even though another may also be relevant. Should two categories of “superpriorities” apply to an interest, then the Service should use that category which gives the greatest protection to the private interest.

Securities

This “superpriority” protects the purchaser or the holder of a security interest in a “security” who at the time of purchase or at the time the security interest came into existence did not have actual notice or knowledge of the existence of the federal tax lien. IRC § 6323(b)(1). The Code defines securities to include money, stock, bonds, debentures, notes, negotiable instruments, and various other types of interests. IRC § 6323(h)(4).

A subsequent holder of a security interest is also protected if the prior holder did not have actual notice or knowledge at the time the security interest came into existence.

Motor Vehicles

This “superpriority” protects the purchaser of a motor vehicle if, at the time of purchase—

the purchaser did not have actual notice or knowledge of the existence of the federal tax lien; and
before the purchaser has actual notice or knowledge, the purchaser has actual possession of the motor vehicle and has not thereafter relinquished actual possession to the seller or his/her agent. IRC § 6323(b)(2).

Personal Property Purchased at Retail

This “superpriority” protects the purchaser of tangible personal property purchased at a retail sale unless at the time of purchase the purchaser intends the purchase to (or knows the purchase will) hinder, evade or defeat the collection of the federal tax. IRC § 6323(b)(3).

“Retail sale” means a sale made in the ordinary course of the seller’s trade or business of tangible personal property of which the seller is the owner. It includes a sale in the customary retail quantities by a seller who is going out of business but not a bulk sale or an auction sale in which goods are offered in quantities substantially greater than are customary in the ordinary course of the seller’s trade or business or an auction sale where the owner is not in the business of selling such goods. Treas. Reg. § 301.6323(b)-1(c)(2).

Personal Property Purchased in Casual Sale

This “superpriority” protects a purchaser of household goods, personal effects or other tangible personal property exempt from levy under IRC § 6334(a). It encompasses items purchased (other than for resale) in a casual sale for less than $1,590 (as of January 1, 2019). IRC § 6323(b)(4). This amount is adjusted annually for inflation. See Rev. Proc. 2018-57, 2018-49 I.R.B. 827. Rev. Proc. 2018-57, 2018-49 I.R.B. 827. These sales include “garage sales” or “tag sales.”

A casual sale is a sale not made in the ordinary course of the seller’s trade or business. Protection is afforded only if the purchaser does not have actual notice or knowledge of the existence of the federal tax lien or that the sale is one of a series of sales which means that the seller plans to dispose of, in separate transactions, substantially all of his/her household goods, personal effects and other tangible personal property. See Treas. Reg. §301.6323(b)-1(d)(2). This exception applies only to tangible personal property (e.g. household goods, personal effects, wearing apparel, firearms, furniture, etc.) as defined in Treas. Reg. § 301.6334-1.

Personal Property Subject to Possessory Lien

This “superpriority” protects someone in possession of tangible personal property subject to a lien under local law securing the reasonable price of the repair or improvement of that property. IRC § 6323(b)(5).

Thus, for example, if state law gives an automobile mechanic a lien for the repair bill and the right to retain possession of the repaired automobile as security for payment of the repair bill, and the mechanic retains continuous possession of the automobile, a federal tax lien which has attached to the automobile will not be valid to the extent of the repair bill.

Real Property Tax and Special Assessment Liens

This “superpriority” protects certain specified state and local tax liens against real property. IRC § 6323(b)(6) applies if state or local law entitles such liens to priority over security interests in such property which are prior in time, and such lien secures payment of one of the following three types of taxes or charges:

A tax of general application levied by any taxing authority based upon the value of such property. For example, real estate tax.
A special assessment imposed directly upon such property by any taxing authority, if such assessment is imposed for the purpose of defraying the cost of any public improvement. For example, sewers, streets, or sidewalks.
A charge for utilities or public services furnished to such property by the United States, a state or political subdivision thereof, or an instrumentality of any one or more of the foregoing.

If real estate taxes (whenever they accrue) are ahead of mortgages under local law, they will also be ahead of federal tax liens. The result will be the same if a special assessment lien arises after the federal tax lien is in existence. The same priorities apply in the case of charges for utilities or public services.

This superpriority category does not include other state and local tax liens arising for personal property taxes, state or local income taxes, franchise taxes, etc.

Residential Property Subject to a Mechanic’s Lien for Certain Repairs and Improvements

This “superpriority” protects lienors whose liens arise from the repair or improvement of certain real property. IRC § 6323(b)(7).

The property must be a personal residence containing not more than four dwelling units with the owner occupying one of the units and the total contract price being $7,970 or less (as of January 1, 2019). This amount is adjusted annually for inflation See Rev. Proc. 2018-57, 2018-49 I.R.B. 827. Rev. Proc. 2018-57, 2018-49 I.R.B. 827.

Attorney’s Liens

This “superpriority” protects an attorney who, under local law, holds a lien upon, or a contract enforceable with respect to, a judgment or other amount in settlement of a claim or cause of action, to the extent of reasonable compensation for obtaining the judgment or procuring the settlement, even if the attorney has actual notice or knowledge of the filing of the notice of lien. IRC § 6323(b)(8). There is a limitation upon this absolute priority that arises with respect to a judgment or amount in settlement of a claim or a cause of action against the United States, to the extent that the United States sets off such judgment or amount against any liability of the taxpayer to the United States.

Even in those cases where the attorney’s lien enjoys the priority over the federal tax lien, it is limited to reasonable compensation. Generally, reasonable compensation means the amount customarily allowed under local law for an attorney’s services for litigating or settling a similar case or administrative claim. SeeNorth Carolina Joint Underwriting Assn. v. Long, et al., 2008-1 USTC ¶ 50,183 (E.D.N.C. 2008). Nevertheless reasonable compensation shall be determined on the basis of the facts and circumstances of each individual case. The priority does not apply to an attorney’s lien which may arise from the defense of a claim or cause of action against a taxpayer, except to the extent such a lien is held upon a judgment or other amount arising from the adjudication or settlement of a counterclaim in favor of the taxpayer. See Treas. Reg. § 301-6323(b)-1(h)(1).

Certain Insurance Contracts

This “superpriority” protects an insurer in a life insurance, endowment or annuity contract with a taxpayer. IRC § 6323(b)(9).

This “superpriority” applies under the following situations:

If an insurer makes a policy loan on a life insurance policy after a notice of lien has been filed with respect to the property of the insured, the insurer is protected as against the tax lien if such insurer did not have actual notice or knowledge of the existence of the tax lien at the time the policy loan was made.
The insurer, after actual notice or knowledge of a federal tax lien, will still have priority but only with respect to advances (including contractual interest) required to be made under an agreement entered into prior to such actual notice or knowledge.
Thus, although an insurer will not have priority for policy loans made after the insurer has actual notice or knowledge that the policy is subject to a tax lien, the insurer may nevertheless continue to make automatic premium loans to maintain the contract in force and have priority over the federal tax lien with respect to such loans, if the agreement to make the automatic premium loans was entered into before the insurer had actual notice or knowledge.

Deposit Secured Loans

This “superpriority” protects certain institutions, including banks and building and loan associations with regard to a loan, if the loan is secured by an account with the bank. IRC 6323(b)(10). The following requirements apply:

The provisions of IRC § 6323(b)(10) apply to financial institutions described in IRC §§ 581 and 591.

The bank must make the loan without any actual notice or knowledge of the existence of the tax lien.
IRC § 6323(b)(10) requires that the security interest be valid under state law. Under the Uniform Commercial Code (UCC) adopted in all 50 states, a bank cannot obtain a security interest in an account if the loan is made for a consumer transaction, i.e., it is not a business loan. UCC § 9-109(d)(13) (excluding consumer loans from the scope of Article 9).

A superpriority is not a defense to a levy. Therefore, if a bank does qualify for an IRC § 6323(b)(10) superpriority, it should either:

honor the levy and seek a timely return of wrongfully levied property under IRC § 6343(b), or
the bank may promptly request the Service to release the levy.

If the bank timely proves that it has a IRC § 6323(b)(10) superpriority, the Service will generally release the levy. See Rev. Rul. 2006-42, 2006-2 C.B. 337.

Purchase Money Security Interest (PMSI)

A purchase money mortgage or security interest is defined under state law as a mortgage or security device taken to secure the performance of an obligation incurred in the purchase of real or personal property.

While the Internal Revenue Code does not give a PMSI priority status, pursuant to Rev. Rul. 68-57, 1968-1 C.B. 553, the Service recognizes that a PMSI will have priority over the Service’s NFTL if the PMSI is valid under local law.

With respect to personal property, Revised Article 9 of the Uniform Commercial Code defines the creation and perfection of a PMSI.

Creating the PMSI–Pursuant to a security agreement under UCC § 9-103, a PMSI arises when a creditor advances money or credit to enable the debtor-taxpayer to purchase goods (new tangible personal property), and the money loaned is actually used to acquire these specific goods. The newly purchased goods will serve as collateral for the loan. Generally, the PMSI arises in one of the following situations.

Seller advances credit—Buyer obtains possession of the goods, giving seller a security interest in the goods pursuant to a security agreement. Seller has not received full payment.
Bank/finance company advances money—Bank/finance company loans money to purchase goods after debtor-taxpayer signs security agreement with bank/finance company. Seller is fully paid. The burden is on the bank/finance company to prove that the money was actually used to purchase the goods.First Interstate Bank v. IRS, 930 F.2d 1521, 1526 (10th Cir. 1991). Typically, a bank/finance company meets this burden by drafting a check payable to the seller of the goods. If the bank/finance company cannot carry its burden, then it has a regular security interest, not a PMSI.

Perfecting the PMSI – In order to prime a NFTL, a creditor must perfect its PMSI. First National Bank v. Coxson, 76-1 USTC 9450 (D.N.J. 1976). This is generally not a burden for a PMSI in consumer goods: the PMSI is automatically perfected by the security agreement. There is no filing requirement. It’s an entirely different situation for a PMSI in business goods, which must be perfected within a short period from the date that the debtor-taxpayer obtains the collateral. See UCC §§ 9-317(e), 9-324(a) and (b).

Losing a PMSI in consumer goods – Some states have adopted a transformation rule for consumer goods, i.e., a creditor may lose its PMSI in consumer goods if it allows the debtor-taxpayer to refinance or consolidate its debts. The reasoning behind the rule is that the debt restructuring transforms the “old” loan to a “new” loan with a security interest encumbering the debtor-taxpayer’s old assets. The debtor-taxpayer does not acquire any new goods with the new loan. Thus, the new loan could not create a PMSI, because, by definition, a PMSI exists only if the debtor-taxpayer acquires new goods.

Example of transformation rule: Assume NFTL filed on January 2, 2006. Also assume finance company loans debtor-taxpayer funds to purchase a television for his personal use on February 2, 2006, and pursuant to the security agreement, finance company acquires a PMSI in the television. On April 1, 2006, because of debtor-taxpayer’s financial problems, finance company restructures the loan agreement, reducing monthly payments but extending the payment period. In some states, under the transformation rule, this would be a new loan agreement. The debtor-taxpayer did not use the new loan to acquire new consumer goods. Consequently, the creditor’s security interest under the new loan is only a regular security interest, not a PMSI. The PMSI from February 2, 2006 has been extinguished by the new agreement. Accordingly, in a lien priority dispute on June 1, 2006, the NFTL primes the finance company’s regular security agreement on the television.

The transformation rule does not apply to a PMSI in nonconsumer goods under UCC § 9-103(b). Instead, a different rule, the dual status rule, applies. The dual status rule preserves the original PMSI in a restructuring or refinancing for the original PMSI goods. After the restructuring or refinancing, the creditor has both a PMSI in the original goods and a regular security interest in other existing goods.

Example of dual status rule: Using the preceding example with some changes, assume that debtor-taxpayer purchases the television to entertain customers at his restaurant. In this situation, the television is not a consumer good; instead, it is business equipment. When the debtor-taxpayer restructures his loan agreement on April 1, 2006, the new security agreement gives creditor a security interest in the television as well as existing tables and chairs. In a lien priority dispute on June 1, 2006, under the dual status rule, the creditor has a PMSI in the television that primes the NFTL, but the creditor has only a general security interest in the chairs and tables. The NFTL primes the general security interest in the chairs and tables.

Identifying the PMSI property – Even if a creditor establishes that a PMSI was created, in a lien priority fight the creditor must be able to identify the original property encumbered with the PMSI or traceable to the original property. E.g., Citizens Savings Bank v. Miller, 515 N.W.2d 7 (Iowa 1994).

Protected Interests Arising from Certain Financing Agreements

In limited situations, IRC § 6323(c) and (d) provide that certain claims may prime an earlier filed NFTL and act substantially in the same manner as superpriorities.

IRC § 6323(c) has three different subsections that deal with different transactions. There are, however, prerequisites that apply to all three subsections. In order for any creditor to qualify for any of the protections in section 6323(c), the creditor must show the following:

The security interest is in “qualified property.” The definition of qualified property differs in each of the three subsections.
There is a written agreement entered into before tax lien filing, which constitutes a commercial transactions financing agreement, a real property construction or improvement financing agreement, or an obligatory disbursement agreement.
The security interest is protected under local law against a judgment lien arising, as of the time of the tax lien filing, out of an unsecured obligation.

Commercial Transactions Financing Agreements

IRC § 6323(c)(2) provides protection for commercial transactions financing agreements. Generally, these are loans to a taxpayer to operate a business. The creditor and the taxpayer, in the course of trade or business, agree that loans to the taxpayer will be secured by taxpayer’s commercial financing security. Security can include, but is not limited to, accounts receivable, mortgages on real property, and inventory. The agreement must be entered into before the NFTL is filed; however, priority will extend to commercial financing security acquired before the 46th day after the NFTL is filed and to advances made within 45 days of filing (or sooner if the creditor gains knowledge of the NFTL).

Alternatively, a commercial transactions financing agreement could be the purchase of commercial financing security, other than inventory, acquired by the taxpayer in the ordinary course of the taxpayer’s trade or business. Note that both the lender/purchaser and the debtor-taxpayer must have entered into the loan/sale within the ordinary course of business. This protection exists, however, for a limited time period. To be protected, the creditor must loan the funds or purchase the property from the taxpayer within 45 days of the filing of the NFTL, or (if earlier) before the lender or purchaser had actual notice or knowledge of the notice of lien filing.

The term “commercial financing security” is defined as (i) paper of a kind ordinarily arising in commercial transactions, (ii) accounts receivable, (iii) mortgages on real property, and (iv) inventory. General intangibles, such as patents or copyrights, are not included. IRC § 6323(c)(2)(C) . In the case of loans to the taxpayer, commercial financing security also includes inventory. Inventory consists of raw material and goods in process, as well as property held by the taxpayer primarily for sale to customers in the ordinary course of business. Treas. Reg § 301.6323(c)-1(c)(1).

Real Property Construction or Improvement Financing Agreement

IRC § 6323(c)(3) provides protection for interests arising from written real property construction or improvement financing agreements entered into before a NFTL is filed and which interests are given priority under state law against a judgment lien creditor as of the time of the filing of the NFTL. This protection applies to 3 different situations:

the owner’s construction or improvement (including demolition) of real property;
a contractor obtains financing, usually a bank loan, to construct or improve real property; or
the raising or harvesting of a farm crop or the raising of livestock or other animals.

The first subsection addresses a taxpayer’s financing and lien for construction or improvement of the taxpayer’s home or business. IRC § 6323(c)(3)(A)(i). Pursuant to such a financing agreement, the lender takes a mortgage/lien on the taxpayer’s property undergoing construction and agrees to make distributions in the future to finance the construction.

There is no 45-day rule, i.e., disbursements can be made more than 45 days after the filing of the NFTL and the lender’s lien will still prime the NFTL.

Actual knowledge of the NFTL will not disqualify the lender, provided the written agreement predated the filing of the NFTL.

The second subsection addresses a contractor’s financing for a construction project. IRC § 6323(c)(3)(A)(ii).

There is no 45-day rule, i.e., disbursements can be made more than 45 days after the filing of the NFTL and the lender’s lien will still prime the NFTL.

Actual knowledge of the NFTL will not disqualify the lender, provided the written agreement predated the filing of the NFTL. In return for financing on the construction project, the lender acquires a security interest in the contract proceeds, not the real estate.

There is a difference between section 6323(c)(3)(A)(i), a financing agreement for construction on real property, and section 6323(c)(3)(A)(ii), an agreement to finance a construction contract. In the former situation, the lender’s lien is on the real property undergoing construction. In the latter situation, the lender’s lien is on the proceeds of the construction contract only.

The third subsection addresses a farmer’s financing to raise or harvest a crop/livestock. There is no 45-day rule, i.e., disbursements can be made more than 45 days after the filing of the NFTL and the lender’s lien will still prime the NFTL.

Actual knowledge of the NFTL will not disqualify the lender, provided the written agreement predated the filing of the NFTL.

This subsection is relatively generous to the lender because it protects the lender’s interest in not only the crop or livestock raised, but also in any of the taxpayer’s property existing as of the filing date of the NFTL, assuming that property was listed in the security agreement.

Obligatory Disbursement Agreement

IRC § 6323(c)(4) provides protections for interests arising from an obligatory disbursement agreement, which generally requires a lender to make a payment because someone other than a taxpayer has relied on that obligation. The lender must have entered into the obligatory disbursement agreement in the course of his trade or business. A general obligatory disbursement agreement requires that on the filing date of the NFTL, the lender’s security interest must be protected against a hypothetical judgment lien creditor. Also, the taxpayer and the lender’s written agreement must provide that the lender’s duty to pay is triggered by the claim of a third party. In other words, the lender is typically paying a third party for property/services provided to the taxpayer. Under a general obligatory disbursement agreement, the protected security interest covers only two categories:

all of the taxpayer’s property as of the filing date of the NFTL and
after the filing date, any property traceable to the lender’s payment.

A letter of credit is a classic example of an obligatory disbursement agreement. A bank issues a letter of credit (a promise to pay the holder of the letter of credit) to Taxpayer. The Service then files a NFTL. Taxpayer later purchases property by giving the seller the letter of credit. The seller later presents letter of credit to the bank to obtain payment. The bank will have priority over the FTL with respect to all of Taxpayer’s property existing as of the date of the filing of the NFTL and the property purchased with the letter of credit after the filing of the NFTL.

Section 6323(c)(4) provides extra protection to surety agreements. A surety agreement is a special type of obligatory disbursement agreement: The surety agrees to perform a contract if the taxpayer fails to perform. The taxpayer and the surety must meet all of the procedural requirements imposed on a general obligatory disbursement agreement. For example, there must be a written contract; the duty to perform must be triggered by the claim of a third party; and prior to the filing of a NFTL, the security interest must be perfected against the claim of a hypothetical judgment lien creditor.

Sureties receive extra protection because section 6323(c)(4) expands the categories of collateral. Unlike a general obligatory disbursement that creates only two categories of collateral, a surety can look to four categories for collateral:

All of the taxpayer’s property as of the filing of the NFTL (similar category for general obligatory payment).
After the filing date, any of taxpayer’s property traceable to the surety’s payment (similar category for general obligatory payment).
The proceeds of the contract for which performance was insured (an additional category).
If the contract is to construct or improve real property, to produce goods, or to furnish services, any tangible personal property used by the taxpayer in performing the insured contract (an additional category).

IRC § 6323(d)

IRC § 6323(d) protects a creditor’s security interest for disbursements made within 45 days after the filing of the NFTL or before the lender acquires knowledge of the NFTL, if before the 45th day. As discussed below, section 6323(d) is similar to section 6323(c)(2) in some ways, but is different in other ways.

The section 6323(d) and section 6323(c)(2) commercial transaction financing protections are similar in that they both require the following:

Prior to the filing of the NFTL, the taxpayer and the lender must sign a written agreement that creates a security interest in the encumbered property.
As of the filing date of the NFTL, the lender’s security interest must prime a hypothetical judgment lien creditor.
After the filing of the NFTL, the lender must not have any actual knowledge of the NFTL when it makes the loan.
Such loan must be made within 45 days of the filing of the NFTL. If, within the 45 day period, the lender acquires knowledge of the NFTL before making the loan, then the 45 days is shortened to the day on which the knowledge is acquired.

Section 6323(d) and section 6323(c)(2) differ as to the types of property and the time when the taxpayer acquired the property. Specifically, section 6323(d) applies to all of the taxpayer’s property as of the date of the filing of the NFTL. In contrast, section 6323(c)(2) applies to specific property acquired by the taxpayer before the 46th day after the filing of the NFTL. Section 6323(d) applies to a larger pool of property; section 6323(c)(2) may apply to property acquired after the NFTL is filed.

Priority of Interest and Expenses

Interest and certain expenses may enjoy the same priority as the lien or security interest to which they relate. This is the case if under local law they are added to and become a part of the lien or security interest. The types of interest listed in IRC § 6323(e) are the following:

Interest or carrying charges (including finance and service charges) on the obligation secured by a lien or security interest.
Reasonable expenses of an indenture trustee (such as a trustee under a deed of trust) or agent holding a security interest.
Reasonable expenses incurred in collecting by foreclosure and enforcing a secured obligation (including reasonable attorney’s fees).
Reasonable costs of insuring, (fire and casualty insurance for instance) and preserving or repairing the property subject to the lien or security interest.
Reasonable costs of insuring payment of the obligation secured (such as mortgage insurance).
Amounts paid by the holder of a lien or security interest to satisfy another lien on the property where this other lien has priority over the federal tax lien.

An example of this last situation would be if both a security interest and a statutory lien for state sales taxes have priority over a federal tax lien. In that situation, the holder of the protected security interest may discharge the sales tax lien and increase the amount so expended, even though under local law he/she is not subrogated to the rights of the holder of the sales tax lien. However, if the holder of the security interest is, under local law, subrogated to the rights of the holder of the sales tax lien, he/she may also be entitled to any additional protection afforded by IRC § 6323(i)(2). Treas. Reg. § 301.6323(e)-1(d).

Priority of Tax Liens: The Competing Choate Lien

IRC § 6323 does not cover all of the competing lien interests that could attach to a taxpayer’s property, e.g., a state tax lien. To resolve the competing priority claims of these other interests, a court will use the choateness test, which was developed by Supreme Court case law. This test arises under federal law and applies federal rules to determine lien priority, not state rules.

The choateness test follows the general rule for resolving lien priorities: the lien that is “first in time” is “first in right.” The federal tax lien is choate as of the assessment date. (The filing of the NFTL is irrelevant under the choateness test.) However, to be considered first in time, the nonfederal lien must be “choate,” that is, sufficiently specific, when the federal lien arises. A state-created lien is not choate until the following three elements are all established:

the identity of the lienor,
the property subject to the lien, and
the amount of the lien.

United States v. City of New Britain, 347 U.S. 81 (1954). Failure to meet any one of these conditions forecloses priority over the federal lien, even if under state law the nonfederal lien was enforceable for all purposes when the federal lien arose.

In cases involving state and local tax liens, the Supreme Court has indicated that a state or local tax lien that attaches to “all property and rights to property” may be sufficiently choate so as to obtain priority over a later arising federal tax lien. United States v. State of Vermont, 377 U.S. 351 (1964). Therefore, state, county and municipal tax liens may be regarded as choate when: the identity of the lienor is known; the amount of the lien has been finally fixed; and the lien has attached to the taxpayer’s property by virtue of statute or ordinance so as to authorize enforcement by the state or local taxing authority without substantial further administrative remedy being available to the taxpayer. If the state or local tax lien meets these criteria, the rule of first in time, first in right, should then be applied to determine priorities.

Most choateness litigation arises in lien priority disputes with states. In this context, choateness is a federal law test, not a state law test. In re Priest, 712 F.2d 1326 (9th Cir. 1983), mod. 725 F.2d 477 (1984) (holding a state law ineffective which stated that a tax lien arose when the tax return was “due and payable,” or on the date the return was required to be filed). A state-created lien arises when the state takes administrative steps to fix the taxpayer’s liability – mere receipt of a tax return does not make the state tax lien choate. Minnesota v. United States, 184 F.3d 725 (8th Cir. 1999), cert. denied, 528 U.S. 1075 (2000).

Lien Priority Disputes Arranged by Topic

Assignments

An assignment is a transfer of intangible property, frequently an account receivable. An assignee, the party receiving the assigned rights, may meet the requirements of the definition of a purchaser under IRC § 6323(h)(6). Whether an assignee is a purchaser within the meaning of the above subsection is a federal question. SeeUnited States v. Gilbert Associates, 345 U.S. 361 (1953). An assignee who fails to qualify as a purchaser may try to argue that it has a security interest under IRC § 6323(h)(1).

Attachment Liens

An attachment lien, provided for under most state statutes, may arise upon the filing of a creditor’s suit and, under state law, will be taken as of the time the attaching creditor acquired a lien on the debtor’s property. This is done by the doctrine of “relation-back” which relates the subsequently acquired judgment lien back to the date of the attachment lien. This relation back doctrine does not apply to priority disputes with the federal tax lien. United States v. Security Trust and Savings Bank, 340 U.S. 47 (1950).

In cases involving the determination of priority between a federal tax lien and such an attachment lien, the attachment lien is deemed inchoate until perfected by a final judgment.

Circular Priority

Circular priority describes a situation where A’s lien is senior to the federal tax lien; the federal tax lien is senior to B’s lien; but state law makes B’s lien senior to A’s lien.

In United States v. City of New Britain, 347 U.S. 81(1954), the Supreme Court resolved the circular priority problem by providing:

first, that the portion of the fund for which federal law creates a lien superior to that of the Government’s tax lien is set aside;
second, the federal tax claim is paid; and
third, the reserved portion of the fund is distributed among competing claimants according to state law.

Today, circular priority situations generally arise in lien priority disputes with secured creditors under the UCC. Most potential circular priority issues were eliminated when the IRC § 6323(b) superpriority provisions were enacted.

Dower and Curtesy

The wife’s right of dower and the husband’s right of curtesy are limited estates in the real property of the respective spouses which some states still recognize at common law.

Many states have abolished the common law dower and curtesy in favor of a statutory right of dower in either surviving spouse as to both real and personal property.

Some states treat dower and curtesy as creating a property right as of the marriage: a spouse’s dower or curtesy interest or statutory rights cannot be defeated by the other spouse’s conveyances or alienations after the marriage or by a lien in favor of the other spouse’s creditors that becomes effective after the marriage. In these states, if the marriage occurred before the Service assesses the tax liability of one spouse, then the federal tax lien is junior to the non-liable spouse’s dower/curtesy interest. Rev. Rul. 79-399, 1979-2 C.B. 398.

Foreclosure Costs

As discussed in IRM 5.17.2.6.7, if the holder of a security interest or lien has priority over a federal tax lien, then certain expenses also will have priority, provided such expenses are “reasonable” and also would have priority under local law. IRC § 6323(e).

In effect, both direct expenses of sale, such as advertising, auctioneer’s expenses and any other necessary expenses of the sale and items of cost which are included in IRC § 6323(e), which are not normally direct expenses, will have priority over the federal tax lien if the original obligation is a lien or security interest and has priority over the tax lien.

Forfeited Property

Most states have laws providing that property used in connection with the commission of a crime shall be seized; and if the accused is convicted of the criminal charge, the property is to be forfeited. IRC § 6323(i)(3) provides that a forfeiture under local law of property seized by a law enforcement agency of a state, county, or other local governmental subdivision shall relate back to the time of the seizure, except that this paragraph shall not apply to the extent that under local law the holder of an intervening claim or interest would have priority over the interest of the state, county, or other local governmental subdivision in the property.

For example, assume that a state seizes taxpayer’s car in January 2013; the Service makes an assessment against taxpayer in February 2013, and the state obtains an order of forfeiture in August 2013. Also assume that under local law the holder of an intervening claim or interest would not have priority over the state’s interest in the car. In this situation, the forfeiture relates back to the seizure, so essentially the state owned the car as of January 2013 and the car would no longer be property of the taxpayer to which the federal tax lien would attach as of February 2013.

Home Equity Line of Credit or Open-end Mortgage

An “open-end” mortgage or home equity line of credit is different from a typical mortgage. Frequently, these mortgages provide for an initial loan at the time that the parties sign the mortgage, and the borrower has the discretion to request future advances after the mortgage is recorded.

If the Service files a NFTL and the lender makes a future advance within 45 days of the filing of the NFTL, the lender may be entitled to protection under IRC § 6323(d). Bank of America v. Fletcher, 342 F.Supp.2d 1009 (N.D. Okl. 2004).

Insurance and Insurance Loans

Section 6322 of the Code provides that the lien imposed by section 6321 of the Code upon all the property and rights to property of any person liable to pay any tax arises at the time assessment is made.

In UNITED STATES V. BESS, 357 U.S. 51 (1958), the Supreme Court held that the cash surrender value of an insurance policy was property to which a lien attached and that the lien followed the property into the hands of the beneficiary.

In the discussion of superpriorities, it was stated that a lien is not valid against life insurance, endowment or annuity contracts as against the insurer at any time before the insurer had actual notice or knowledge of the lien. Even if the company had such notice or knowledge, it could still make advances for automatic premium loans to maintain the contract if the agreement to make the advances was entered into before the insurer had actual notice or knowledge of the lien. In addition, if a levy had been served on the insurer and the levy was satisfied, the insurer would have priority for subsequent policy loans until a new notice of levy was served on the insurer.

Policy loans are those loans made to an insured by an insurance company without causing the policy to be terminated. Automatic premium loans are loans for the payment of premiums made against the cash surrender value of the insured’s policy, but which the company is required to make by the terms of the contract of insurance itself by reason of the insured’s default in premium payments.

Policy loans will prime the federal tax lien if they are made by the insurance company before the insurer has actual notice or knowledge of the existence of the federal tax lien. IRC § 6323(b)(9)(A).

Automatic premium loans will prime the federal tax lien if the agreement to make advances was entered into before the insurer had actual notice or knowledge of the lien. IRC § 6323(b)(9)(B).

If the Service serves a notice of levy on the insurer and that levy is satisfied by the insurer, then that notice of levy will not constitute a notice of a lien until the Service delivers a new notification of the lien to the insurance company. IRC § 6323(b)(9)(C). The notification may take any form but delivery will only be effective from the time the insurer actually receives the notification.

Landlord’s Liens

State law generally gives landlords and lessors a statutory lien for unpaid rents against their tenant’s or lessee’s property located on the leased premises. When a landlord’s lien competes with a federal tax lien for priority, IRC § 6323(a) generally does not apply. Instead, the priority dispute is resolved under the “choateness test.”

In the case of United States v. Scovil, 348 U.S. 218 (1955), the Supreme Court held that the landlord did not have a choate lien until the landlord recovered a judgment. Prior to obtaining a judgment, the landlord’s lien was inchoate because the amount of the secured debt was not certain, i.e., the secured debt could increase as time progressed and the secured debt could be reduced by the landlord’s breach of contract. To have priority over a federal tax lien, a landlord would have to recover a judgment and then perfect the judgment lien on the personal property prior to the NFTL filing.

Limited Liability Companies (LLCs)

An LLC is a form of business created under state law. LLCs may be either multi-member or single member. Treas. Reg. § 301.7701-3 explains the federal taxation of LLCs. If an LLC is a multi-member, the members may elect to have the LLC taxed as a corporation. If the members do not make the election, then the LLC is treated as a partnership by default. Note, however, that if under state law the members of an LLC are not liable for the debts of the LLC, generally the IRS may not collect the LLC’s federal tax liabilities from the members. Rev. Rul. 2004-41, 2004-1 C.B. 845. A single-member LLC may also elect to be taxed as an association. If the election is not made, then by default the single member LLC will be disregarded, i.e., the single-member owner is the taxpayer.

Treasury regulations affect the treatment of single-owner disregarded LLCs. See Treas. Reg. § 301.7701-3. The single-owner disregarded LLC is liable for excise taxes as of January 1, 2008; the single-owner disregarded LLC is liable for employment taxes as of January 1, 2009. Treas. Reg. §7701-2(c)(2)(iv) and (v).

Maritime Liens

The Federal Maritime Lien Act provides that any person furnishing repairs, supplies, towage or other necessaries for a vessel shall have a lien upon the vessel for payment. Maritime liens arise under 46 USC § 31342. Although the Internal Revenue Code does not provide a priority for maritime liens, courts have generally given maritime liens priority over the federal tax lien.

Maritime liens have, throughout history, enjoyed a peculiar sort of priority because of the very nature of a ship, its usage and needs, and the needs of its crew. For example, taking on provisions in a foreign port will give rise to a lien against the ship, generally entitled to seniority over any non-maritime lien against the ship, whether arising prior to or subsequent to the maritime lien.

The source of problems in this area is that federal law has created both maritime liens and the federal tax liens. Currently, the courts have generally taken the view that the maritime lien should prevail over both prior and subsequent federal tax liens, regardless of whether the Service has filed a NFTL. National Bank of North America v. S.S. Oceanic Ondine, 335 F. Supp. 71 (S.D. Tex. 1971), aff’d, 452 F.2d 1014 (5th Cir.1972); United States v. Flood, 247 F.2d 209 (1st Cir. 1957).

Mechanics’ Liens

All state statutes provide liens for laborers (mechanics) and material suppliers (materialmen) for work performed or materials supplied with respect to real property. Local law governs the method by which such liens are perfected and their duration. Generally, a mechanic’s lien must be enforced within a certain specified time or it will be lost. Generally, a mechanic’s lien attaches to the real property under construction and the proceeds of the construction contract. In determining lien priority disputes under IRC § 6323(a), one must look to the definition of mechanic’s liens in IRC § 6323(h)(2), which limits the relief provided to persons who have a lien on real property under local law for services, labor, or material furnished in construction of the real property. IRC § 6323(h)(2) also provides that a mechanic’s lien arises on the later of –

The date on which the mechanic’s lien first becomes valid under local law against subsequent purchasers of the real property without actual notice, or
The date on which the mechanic’s lienor begins to furnish the services, labor, or materials.

In addition to the above, issues may arise as to whether a payment is the taxpayer’s property. In many cases a subcontractor asserts a mechanic’s lien on construction payments in the main contractor’s possession. A main contractor may fail to pay both his federal tax liability and the subcontractors on a construction project. If the Service and the subcontractors make claims on construction payments, the first step in resolving this priority dispute is determining whether the funds in the general contractor’s possession are the general contractor’s property or rights to property. In many situations the funds will not be the property or rights to property of the general contractor because state law does not give the general contractor any interest in the funds when subcontractors have not been paid.

In two landmark cases, the United States Supreme Court annunciated the now famous “no property” rule. Aquilino v. United States, 363 U.S. 509 (1960), and United States v. Durham Lumber Company, 363 U.S. 522 (1960). The “no property” rule means that in approaching any priority determination, the first question must be: “Does the taxpayer have any property to which the lien will attach?” The fundamental thrust of this inquiry is that if there is no property interest to which the federal tax lien attaches, then there is no need to even consider the question of priorities.

In Aquilino, the Supreme Court remanded the case for a determination of whether the taxpayer-prime contractor, by virtue of a New York statute, held the funds against which the federal tax lien was asserted in trust for the payment of laborers and material suppliers.

In Durham Lumber Company, the prime contractor-taxpayer, by virtue of the law of North Carolina, was held to have no property interest in funds due from the owner except in any surplus that might remain after the payment of the subcontractors.

Miller Act Cases and Sureties

Subcontractors and suppliers who agree to provide labor and materials to a prime contractor take the risk that they will not be paid by the contractor. To protect these subcontractors and suppliers, Congress enacted the Miller Act, codified at 40 USC §§ 3131-3132 in 1935. Specifically, the Miller Act requires that the prime contractor on all federal construction projects purchase both a performance and a payment bond.

The Miller Act, however, does not set forth the priorities as between any claim of the surety and any government claim. In United States v. Munsey Trust Co, 332 U.S. 234, 239 (1947), the Court first held that the government, like any creditor, has the right to setoff amounts owed to a debtor against amounts the debtor owes to the government.

The Court also stated that if the surety completed the job, the surety would be entitled to the “retained moneys in addition to progress payments,” as otherwise a surety would rarely agree to complete a job if it knew that, by doing so, it would lose more money than if it had allowed the government to proceed. Munsey Trust, 332 U.S. at 244.

Subsequently, lower courts have cited Munsey Trust to contrast a surety’s payments made pursuant to a payment bond with payments made pursuant to a performance bond. If the surety makes a payment pursuant to a payment bond, then the government has the right to setoff. Dependable Ins. Co., Inc. v. United States, 846 F.2d 65, 67 (Fed. Cir. 1988); United States Fid. & Guar. Co. v. United States, 475 F.2d 1377, 1383 (Ct. Cl. 1973); Barrett v. United States , 367 F.2d 834 (Ct. Cl. 1966). If a surety makes a payment pursuant to a performance bond, then the government does not have the right to setoff. See Aetna Cas. & Surety Co. v. United States, 845 F.2d 971, 976 (Fed. Cir. 1988); Aetna Cas. & Surety Co. v. United States, 435 F.2d 1082 (5th Cir. 1970); Trinity Universal Ins. Co., v. United States, 382 F.2d 317, 321 (5th Cir. 1967), cert. denied, 390 U.S. 906 (1968).

Receivers

A “receiver” is a disinterested third party (similar to a trustee) appointed by a court to receive and preserve property funds in litigation. In general, in determining the priority of the federal tax lien over court appointed receivers, the threshold consideration is determining the nature of the receiver’s interest in the insolvent’s property. Of course, if the taxpayer is divested of title prior to the time the federal tax lien arises, there is no property belonging to the taxpayer in the hands of the receiver to which a federal tax lien will attach. SEC v. Levine, 881 F.2d 1165 (2d Cir. 1989). If, however, the lien arises prior to the passing of title to the receiver, the property will pass burdened with the lien.

Right of Setoff

Setoff may be defined as the discharge or reduction of one demand by an opposite one. Practically speaking, this question usually arises in the case where a bank has loaned money to a taxpayer who also is the bank’s customer. If the customer/borrower fails to meet the required loan repayments, the bank will often assert a right of setoff against any funds the customer has on deposit.

If the federal tax lien attaches to a taxpayer’s property prior to setoff, then the bank takes funds encumbered with a federal tax lien. The Government may levy on the bank to obtain the encumbered funds. United States v. Donahue Industries, Inc., 905 F.2d 1325 (9th Cir. 1990). Alternatively, the Government may file suit under IRC § 7403 to foreclose the tax lien on the property. United States v. Cache Valley Bank, 866 F.2d 1242 (10th Cir. 1989).

If the bank setoff occurs prior to creation of the assessment lien, then the tax lien will not attach to the funds because the money no longer belongs to the taxpayer.

State and Local Tax Liens

Unlike the property tax, which has a superpriority status under IRC § 6323(b)(6), a state, county, or municipal lien for taxes (e.g., sales taxes, income taxes, franchise taxes, etc.) can achieve priority over the federal tax lien only on the basis that such lien is a choate lien prior in time to the federal tax lien arising, which occurs when the federal tax liability is assessed. Then the doctrine of “first in time, first in right” is applicable. United States v. City of New Britain, 347 U.S. 81 (1954).

State and local liens may not achieve priority over a federal tax lien by being characterized by the local law as some interest in addition to a lien. Thus, the U.S. Supreme Court rejected the characterization by the New Hampshire Supreme Court of a municipal tax lien as constituting a judgment lien, thus bringing the lienor within the protection of IRC § 6323. United States v. Gilbert Associates, Inc., 345 U.S. 361 (1953).

Similarly, a state’s characterization of its lien for taxes as an expense of sale in a mortgage foreclosure action was unavailing and the federal tax lien was held entitled to priority over the subsequent liens of the state on a first in time, first in right basis. United States v. Buffalo Savings Bank, 371 U.S. 228 (1963). Also, in determining the relative priorities of federal tax liens and state and local liens for taxes, the state’s characterization of its liens as choate is not conclusive for federal tax purposes. Illinois v. Campbell, 329 U.S. 362 (1946).

The question of what constitutes “perfection” is particularly significant in this area. States vary in terms of how local tax liens are perfected. Generally speaking, state and local tax liens arise either at the time notice and demand is issued (similar to federal tax liens), or after administrative appeal procedures to contest the lien are exhausted. See Minnesota v. United States, 184 F.3d 725 (8th Cir. 1999) (holding that a state-created lien arises when the state takes administrative steps to fix the taxpayer’s liability); Monica Fuel, Inc. v. IRS, 56 F.3d 508 (3d Cir. 1995), cert. denied, 528 U.S. 1075 (2000) (holding state tax liens to be choate when the time period to administratively appeal the lien expires).

In any event, the principal inquiry in these cases is that of “perfection” of the competing state or local tax lien. If there is “nothing more to be done” in order for the state to enforce its tax lien prior to the attachment of the federal tax lien, which occurs when the federal tax liability is assessed, then the state or local tax lien will have priority. However, if the state must still take administrative action to establish a taxpayer’s liability after the federal tax lien arises, then the federal tax lien will have priority. This means that the state/local lien must be “choate” or “perfected” with respect to the property at issue prior to the time the federal tax liability is assessed.

Subrogation

The doctrine of subrogation involves the substitution of one person in the place of another with respect to a lawful claim or right. IRC § 6323(i)(2) allows creditors to argue subrogation in federal tax lien priority disputes. Specifically, IRC § 6323(i)(2) provides that where, under local law, one person is subrogated to the rights of another with respect to a lien or interest, such person shall be subrogated to such rights for purposes of any lien imposed by IRC § 6321 (relating to lien for taxes) or IRC § 6324 (relating to special liens for estate and gift taxes). In lien priority disputes, subrogation issues arise when a lien that is junior to the federal tax lien pays off a lien that is senior to the federal tax lien.

There is no universal definition of subrogation under state law. Whenever a lienor claims the right of subrogation, state law must be carefully examined to determine if such a claim meets the state definition of subrogation. Consult with Area Counsel on questions regarding applicable state law. State definitions of subrogation may differ. For example, under California law, courts (e.g., United States v. Han, 944 F.2d 526 (9th Cir. 1991)) apply a five-factor guideline for determining equitable subrogation:

Payment was made by the subrogee to protect his own interest.
The subrogee has not acted as a volunteer.
The debt paid was one for which the subrogee was not primarily liable.
The entire debt has been paid.
Subrogation would not work any injustice to the rights of others.

Note: Subordination is the act or process by which one person’s rights or claims are moved voluntarily to a position ranked below those of other claimants. This differs from the principal of subrogation, in which a creditor moves ahead of another claimant by operation of law.

Uniform Commercial Code (UCC) Security Interest

Many lien priority disputes arise between the lien as secured by the NFTL filing and UCC security interest holders. In order to determine priority, you need to understand the creation and perfection of a security interest under Revised Article 9 of the UCC.

Creation of a security interest — Under state law, attachment is the term used to describe the creation of a security interest in the debtor’s collateral. Under UCC § 9-203, attachment generally requires the following three elements:

creditor has given value to the debtor,
the debtor has rights in the collateral, and
an agreement.

The above three elements may occur in any order. Note, however, that a security interest does not exist under the UCC until all three elements have been met. The definition of a security interest in IRC § 6323(h)(1) includes similar requirements to the above three elements. In short, if a debtor fails the state definition of attachment, the creditor will also fail the IRC § 6323(h)(1) definition of a security interest.

Perfection of a financing statement — Under state law, in order to have priority against other lienors, the security interest not only must attach to the collateral but also must be perfected. UCC § 9-301 and the following sections provide that, depending on the facts and type of collateral, steps for perfection may occur under four different methods:

filing a financing statement,
taking possession of the collateral,
for some types of collateral, particularly bank accounts, exercising control over the collateral,
in limited situations, usually a purchase money security interest in consumer goods, automatic perfection exists, i.e., attachment of the security interest automatically perfects it. An example is when a store sells a television for personal use, taking a security interest in the television.

A UCC security interest must have attached and must have been perfected in order to have priority over the Service’s later filed NFTL. Do not assume, however, that a creditor’s security interest is perfected just because a financing statement has been filed. The UCC allows a creditor to file a financing statement before the security interest has attached (come into existence), and creditors frequently do so. UCC § 9-308. The Official Comments to UCC § 9-308, number 2, explain that “If the steps for perfection have been taken in advance, as when the secured party files a financing statement before giving value or before the debtor acquires rights in the collateral, then the security interest is perfected when it attaches.”

For corporations, limited liability companies, and other business entities created under state law (registered organizations) do not assume that a UCC security interest is filed at the same location where the NFTL is filed. IRC § 6323(f)(2)(B) states that the location of personal property is the taxpayer’s residence, and the residence of a corporation is the principal executive office of the business. In contrast, a UCC security interest for a debtor-corporation is filed in the state of incorporation. For example, a UCC security interest on the inventory of a corporation with a principal executive office in California, which was incorporated in Delaware, would be filed in Delaware.

Unrecorded Conveyances

Unrecorded conveyances can interact with the federal tax lien at differing points in time. The interaction could be:

After the accrual of the tax but before the tax is assessed;
After the tax is assessed and the statutory lien arises, but before a Notice of Federal Tax Lien has been filed; or
After a Notice of Federal Tax Lien has been filed.

Prior to assessment, a tax lien does not attach to property the taxpayer has conveyed to a third party through a bona fide conveyance which divests the taxpayer’s interest in the property at issue.

Even where state law provides creditors with certain rights to property if there is an unrecorded conveyance, but all of the taxpayer’s interest in the property was conveyed prior to assessment (i.e. the taxpayer retains no post-conveyance interest), the federal tax lien generally will not attach even if the conveyance is recorded after the lien arises. Filicetti v. United States, 2012-1 USTC ¶ 50,214 (D.Idaho 2012).

In cases involving the determination of priority between a federal tax lien arising after an unrecorded conveyance that extinguishes all of the taxpayer’s interest in the property at issue, generally the federal tax lien does not attach and the lien has no priority position.

The Service’s position on unrecorded conveyances is limited to any bona fide conveyance prior to the assessment and the statutory lien arising that extinguishes all of the taxpayer’s interest in the property at issue. A conveyance is not considered bona fide by the IRS if the taxpayer retains control over the property or enjoys full use and benefit. Thus, the position on unrecorded conveyances does not apply to a transfer to a nominee or alter ego prior to assessment.

Relief from the Federal Tax Lien

The law provides various mechanisms for relief from the federal tax lien.

The most common types of relief from the federal tax lien are a discharge of property from the effect of the tax lien issued by the Service, a foreclosure by a senior competing lienor, and the Service’s release of the tax lien itself.
The less common types of relief from the federal tax lien are a certificate of non-attachment, a certificate of erroneous lien, the subordination of the lien, and withdrawal of the NFTL.

The above types of relief are separate and distinct, as discussed below.

Discharge of Property From the Effect of the Tax Lien

A discharge of the property means that the federal tax lien is removed from a particular piece of property. This occurs only in limited situations listed in IRC § 6325(b). A discharge of the property should not be confused with a release of the federal tax lien. When the Service releases the federal tax lien, the underlying tax lien is extinguished on all of the taxpayer’s property.

The Internal Revenue Code provides that the Service may issue a certificate of discharge of property from the federal tax lien if one of the following conditions is met:

If the fair market value of the taxpayer’s property remaining subject to the lien after the discharge is at least double the sum of the tax liability plus all other encumbrances on that property entitled to priority over the Government’s lien. IRC § 6325(b)(1).
If the Service receives payment of an amount equal to the value of the Government’s interest in the property. IRC § 6325(b)(2)(A).
If the Service’s interest in the property has no value. IRC § 6325(b)(2)(B) .

Note: If there is a short sale, meaning the senior lienholder agrees to accept less than the full amount of its lien, the government’s lien has no value and the Service cannot require payment of a sum that would have been applied to junior real estate taxes as a condition of discharge.

4. If all or part of the taxpayer’s property is sold, and, pursuant to a written agreement with the Service, the proceeds of such sale are to be held as a fund subject to the liens and claims of the United States, in the same manner and with the same priority that such liens and claims had with respect to the discharged property. IRC § 6325(b)(3). This provision often assists in facilitating the sale of property whenever a dispute exists among competing lienors, including the Government, concerning their respective rights in the property.

5. Under IRC § 6325(b)(4), the third-party owner of this property (previously owned by the taxpayer, against which the Service has a lien and has filed an NFTL) may obtain a certificate of discharge with respect to the lien on that property. The Service shall issue such a certificate of discharge of property from the federal tax lien if the third-party owner (but, not the taxpayer) either deposits the amount of the Service’s lien interest in the property (as determined by the Service) or posts an acceptable bond for that amount. IRC § 6325(b)(4). The third party then has 120 days to file a court action to determine the value of the Service’s lien interest in the property. IRC § 7426(a)(4). If the Service determines that the taxpayer’s liability can be satisfied by other sources, or the value of the property is less than the deposit or bond, then the Service will refund the deposit (with interest) and/or release the bond. IRC § 6325(b)(4)(B). If a Court determines the value of property is less than the Service’s determination, it will order the same. IRC § 7426(b)(5). If the third party does not institute proper court proceedings within the 120 days after the Service issues the Certificate of Discharge, then the Service has 60 days within which to apply the amount deposited (or collect on the posted bond) to the amount the Service determined was secured by the lien, and refund (with interest) any remainder to the third party. IRC § 6325(b)(4)(C). See also Treas. Reg. § 301.6325-1(b)(4), for further procedures. Note that any person who co-owned the property with the taxpayer can also avail themselves of this remedy.

In all of the above situations, value means either fair market value or forced sale value in appropriate cases and includes the situation where the interest of the Government in the property sought to be discharged has no monetary value, as in the case of property subject to prior encumbrances in a greater amount than the value of the property.

A certificate of discharge is conclusive that the property covered by the certificate is discharged from the lien. IRC § 6325(f)(1)(B). However, if the taxpayer reacquires the property that has been discharged, the tax lien will again attach. IRC § 6325(f)(3).

Foreclosure by Senior Competing Lienor

When a senior lienholder sells a taxpayer’s property to enforce its lien, this “foreclosure sale” may discharge a federal tax lien in certain situations. Such foreclosure sales can be either a judicial sale (i.e., pursuant to a judicial proceeding) or a nonjudicial sale.

Discharge of Tax Lien in Nonjudicial Sale

Most controversies involving the priority of the federal tax lien involve nonjudicial sales, which are sales made pursuant to one of the following:

An instrument creating a lien on the property sold;
A confession of judgment on the obligation secured by an instrument creating a lien on the property sold; or
A statutory lien on the property sold.

Nonjudicial sales include the divestment of a taxpayer’s interest in property by operation of law, by public or private sale, by forfeiture, or by termination under provisions contained in a contract for deed, land sale contract, or conditional sales contract. Treas. Reg. § 301.7425-2(a). The key point is that a court action is not needed to enforce the creditor’s interest and to sell the property.

The first step in analyzing a nonjudicial sale is determining whether the Service filed a NFTL more than 30 days before the sale. If the Service filed more than 30 days before the sale, then notice of the proposed sale must be given to the Service by the foreclosing party in order for the sale to discharge the federal tax lien. If proper notice is not given to the Service, then the federal tax lien will remain on the property. If the Service filed a NFTL less than 30 days before the sale, then the Service is not entitled to notice of the nonjudicial sale, which will generally discharge the property from the federal tax lien. IRC § 7425(b).

If a senior lienor finds a NFTL and wishes to give notice to the Service of a pending nonjudicial sale, the Internal Revenue Code and regulations provide that notice of a nonjudicial sale shall be given in writing by registered or certified mail or by personal service, not less than 25 days prior to the date of sale, to the IRS official, office and address specified in IRS Publication 786, “Instructions for Preparing a Notice of Nonjudicial Sale of Property and Application for Consent to Sale,” or its successor publication. Treas. Reg. § 301.7425-3(a)(1)). The 25-day period is measured from the time of mailing of the notice and applies to the sale of all real and personal property except perishable goods.

When a scheduled sale for which notice has been given is postponed to a later date, the seller of the property must give notice of the postponement to the appropriate Service official in the same manner as is necessary under local law with respect to other secured creditors. Treas. Reg. § 301.7425-3(a)(2).

The date of the sale is significant in order to compute the requisite notice period that the seller has to provide the Service of any anticipated nonjudicial sale of property encumbered by the federal tax lien. Under Treas. Reg. § 301.7425-2(b), the “date of sale” for purposes of notice to the Service arises in one of the following three situations:

In the case of a public sale which divests junior liens on property, the date of the public sale is controlling.
In the case of a private sale which divests junior liens on property, the date that title to the property is transferred is controlling.
In all other cases (i.e., where there is a divestment of title or interest not resulting from a private or public sale), the date of sale is deemed to be the date on which junior liens in the property are divested under local law.

The Service has authority to consent to a sale of property free and clear of the tax lien or title of the United States in a nonjudicial sale which does not meet the standard notice requirements for such sales. If the Service consents in the manner prescribed by the regulations, then the sale will discharge or divest the property from the federal tax lien notwithstanding a defect in the original notice of sale. Treas. Reg. § 301.7425-3(b).

Special rules apply for the notice of sale requirements for perishable goods. These are set forth in Treas. Reg. § 301.7425-3(c).

Discharge of Tax Lien in Judicial Sale

A judicial sale may discharge property from a federal tax lien. 28 USC § 2410(c). Under IRC §7425(a), if the Service files a NFTL prior to commencement of the suit or civil action, the United States must be named as a party in the suit in order to discharge property from the federal tax lien. If the United States is not named as a party, the judicial sale will not discharge property from the federal tax lien. There may be situations in which the United States is not named as a party in the suit because a NFTL has not been filed prior to the filing of the suit, or the filing of a notice of lien is not provided by the IRC, such as in the case of estate or gift tax liens. In these situations, the judicial sale will discharge the federal tax lien as to the property sold.

Redemption

If either a nonjudicial sale or a judicial sale discharges real property from the federal tax lien, the Service has the right of redemption. This right enables the Service to redeem the real property from the party who purchased it at the foreclosure sale, and then sell it. For both judicial and nonjudicial sales, the Service may redeem the real property within 120 days of the date of sale or the redemption period under state law, whichever is longer. 28 USC § 2410(c) (redemption after judicial sales) and IRC § 7425(d)(1) (redemption after nonjudicial sales).

Release of Lien

There is a fundamental legal distinction between the “release” of a federal tax lien provided for by IRC § 6325(a) and the “discharge” of property from the tax lien provided for by IRC § 6325(b). The release of a lien extinguishes the federal tax lien itself. In other words, a release goes to the very existence of the federal tax lien. In contrast, a discharge will leave only a particular piece of property unencumbered by the federal tax lien.

Before the Service can issue a certificate of release, certain specified conditions must be met. IRC § 6325(a); Treas. Reg. § 301.6325-1. A certificate of release of the federal tax lien is authorized under each of the following conditions:

The amount assessed (plus interest) is paid.
The amount assessed becomes legally unenforceable.
A bond is furnished that is satisfactory in terms and sufficient in amount to secure the payment of the outstanding assessments plus interest.

If either of the first two conditions is met and a Notice of Federal Tax Lien has been filed, a certificate of release must be issued by the IRS. Pursuant to the regulations, a tax lien must be released as soon as practicable, but not later than 30 days, after the IRS Area Director has:

determined that the liability has been fully satisfied,
determined that the liability has become legally unenforceable, or
agreed to accept a bond for the release.

All NFTLs filed since December 1982 contain a self-releasing clause stating that the federal tax lien will automatically be released unless the NFTL is timely refiled. Also, the Service may file a certificate of release prior to the time a NFTL will self-release. In both situations, the release is conclusive that the tax lien referred to in the certificate is extinguished. IRC § 6325(f)(1)(A). To prevent the lien from self-releasing, the Service must refile the NFTL in every office in which a NFTL was originally filed.

If the underlying tax liability has not been satisfied or is not legally unenforceable, the taxpayer is not entitled to release of the lien. See IRC §§ 6322, 6325(a).

The effect of a release is extinguishment of the underlying statutory assessment lien. IRC § 6325(f). The release, in itself, does not extinguish the underlying liability. For example, if a release occurs due to acceptance of a bond or expiration of the collection statute, the liability remains while the assessment lien is extinguished.

Certificate of Nonattachment

The Service may issue a certificate of nonattachment of the federal tax lien if it determines that a person (other than the taxpayer) may be injured by the appearance of the Service’s NFTL. IRC § 6325(e). This situation typically arises when the name of the taxpayer is similar (or identical) to that of a taxpayer identified on a NFTL. The Service files this certificate in the same office where the Service filed the NFTL. It is conclusive that the lien of the Government does not attach to the property of the person referred to in the certificate. The Service may also revoke the certificate in the same manner as a certificate of release of lien. IRC § 6325(f)(2).

The certificate of nonattachment is not related to the discharge of property or the release of a federal tax lien. The certificate of nonattachment is used only when, as a matter of fact and law, the federal tax lien never attached to the property involved because the taxpayer did not own it. The owner of certain property may be subjected to unnecessary hardship because of a lien against a taxpayer with a similar name, thus, perhaps, constituting a cloud on the former’s title to his/her property.

Erroneously Filed NFTL

Treas. Reg. sec. 301.6326-1(b) defines an erroneously filed NFTL as one which is filed during the presence of one of the following conditions:

The tax liability was satisfied prior to the NFTL filing,
The tax liability was assessed in violation of deficiency procedures in IRC sec. 6213,
The tax liability was assessed in violation of the Bankruptcy Code, or
The statute of limitations for collection expired prior to the filing of the NFTL.

In situations where it has been determined that a NFTL was erroneously filed, a specially-worded Form 668(Z), Certificate of Release of Federal Tax Lien, and Letter 544, Letter of Apology – Erroneous Filing of Notice of Federal Tax Lien, will be issued. Pursuant to IRC sec. 6326, the release and letter should be issued within 14 days of the determination, when practical.

Subordination of the Tax Lien

Subordination is the act or process by which one person’s rights or claims are moved voluntarily to a position ranked below those of other claimants. This differs from the principle of subrogation, in which a creditor moves ahead of another claimant by operation of law. Under IRC § 6325(d), the Service may issue certificates subordinating a tax lien to another interest if:

payment is received in an amount equal to the amount with respect to which the tax lien is subordinated , or
the Service believes that the subordination of the tax lien to another interest will ultimately result in an increase in the amount realized by the United States from the property subject to the lien and will aid in the collection of the tax liability.

Subordination provides the Service with flexibility. In subordination by payment, the tax lien is being subordinated only to the extent the United States receives, on a dollar-for-dollar basis, an equivalent amount. The Government’s interest cannot be injured and a new procedure for collecting taxes is made available.

In subordination to ultimately aid in the collection of the tax, there is a risk that the subordination will decrease collection. For example, the federal tax lien could be subordinated to a mortgage that would provide funds to repair a dilapidated building. The assumption is that the real estate market will not go down and that the increased value of the building would both satisfy the mortgage and increase the overall payment of the tax liability. The assumption may be incorrect; the real estate market may go down. After the mortgage is paid, the Service may receive less revenue because of its decision to subordinate.

The Service must exercise good judgment in weighing the risks and deciding whether to subordinate the federal tax lien. The Service’s judgment is similar to the decision that an ordinarily prudent business person would make in deciding whether to subordinate his/her rights in a debtor’s property in order to secure additional long run benefits.

Withdrawal of Notice of Federal Tax Lien

There is an important distinction between “releasing” a federal tax lien and “withdrawing” a filed notice of that lien. The release of a federal tax lien extinguishes the underlying statutory assessment lien. IRC § 6325(f). Not all releases occur after the liability has been satisfied. For example, unless an NFTL is timely refiled, the federal tax lien will self-release because all NFTLs filed since December 1982 contain a self-release clause. The release does not, in itself, extinguish the underlying liability.

The Service has authority to “withdraw” a notice of federal tax lien, in certain circumstances. IRC § 6323(j)(1). The withdrawal of the NFTL only withdraws public notice of the lien; it does not extinguish the underlying liability, nor does it release the underlying federal tax lien.

The Service may withdraw a notice of federal tax lien if the appropriate official determines that one of the following four conditions is met:

The Service’s filing of the NFTL was premature or otherwise not in accordance with administrative procedures.
The taxpayer has entered into an installment agreement to satisfy the tax liability, unless the agreement provides otherwise.
The withdrawal of the NFTL will facilitate collection of the tax liability underlying the NFTL.
The withdrawal of the NFTL would be in the best interest of the taxpayer, as determined by the National Taxpayer Advocate (NTA), and in the best interest of the United States, as determined by the appropriate official.

Note: The Service needs the consent of the taxpayer or the NTA to withdraw a notice of federal tax lien as in the best interests of the United States. A withdrawal for one of the other reasons does not require consent. IRC § 6323(j)(1).

The Service must file its notice of withdrawal of the NFTL at the same office as the withdrawn notice, and must provide a copy of the withdrawal to the taxpayer. Treas. Reg. 301.6323(j)-1. In addition, if requested in writing by the taxpayer, the Service must make reasonable efforts to give notice of withdrawal of the NFTL to creditors, credit reporting agencies, and financial institutions specified by the taxpayer. IRC § 6323(j)(2).

Withdrawal of Notice of Federal Tax Lien after Lien Release

IRC 6323(j) is primarily for situations in which the federal tax lien is still in effect; however, the Service is not legally prohibited from withdrawing the lien’s notice (NFTL) after the lien has been released pursuant to IRC 6325(a). The IRS does not have general authority to withdraw a NFTL outside of the conditions of IRC 6323(j) but whether or not to grant a post-release withdrawal becomes a matter of policy.

Written requests submitted under IRC § 6323(j)(1)(A) (the Service’s filing of the NFTL was premature or otherwise not in accordance with administrative procedures) will generally be granted after lien release if the taxpayer demonstrates the original NFTL filing was improper or not otherwise in accordance with IRS procedures. A withdrawal under this provision may be issued whether a certificate of release was issued or the lien self-released.

Post-release NFTL withdrawals under IRC 6323(j)(1)(D) (best interest test) will generally be granted if the following conditions apply:

The taxpayer requests the withdrawal in writing, and
The taxpayer fully satisfied the liabilities on the NFTL.
The taxpayer is in compliance with filing requirements.

The taxpayer will be considered to be in compliance if the return was, or can be, closed for one of the following reasons:

a. Not liable for the tax period;

b. Income below the filing requirement;

c. Little or no tax due or due a refund;

d. No longer liable for filing.

Liens that self-released in error when the releases are subject to revocation do not qualify for withdrawal under these procedures.

Withdrawal of Notice of Federal Tax Lien When Direct Debit Installment Agreement (DDIA) is in Effect

A request for lien withdrawal under IRC § 6323(j)(1)(B), related to an active DDIA, will generally be approved for certain types of taxpayers if the following conditions are met:

Aggregate unpaid balances of assessment and pre-assessed taxes are $25,000 or less.
Liability will be full paid in 60 months, or prior to collection statute expiration, whichever comes first.
The withdrawal request is in writing.
The taxpayer is in compliance with all other filing and payment requirements.
At least three consecutive payments have been made and there have been no defaults in payment.
The taxpayer has no previous lien withdrawals, excluding withdrawals relating to improper NFTL filing.
If a taxpayer defaults on making payment after the NFTL is withdrawn, a new NFTL may be filed if appropriate.

Note: If a taxpayer does not meet these criteria for withdrawal, the Service must still consider the withdrawal request under the general rule allowing for withdrawal if the taxpayer enters into an installment agreement set forth at IRC 6323(j)(1)(B).

Revocation of Release of Lien and Nonattachment of Lien

If the Service made an error in releasing the federal tax lien or filing a nonattachment of tax lien, that error may be corrected if the collection period is still open. A lien may be found to have been released erroneously or improvidently when the lien self-releases because it was not timely refiled or not timely refiled in all locations where the original NFTL was filed, the Service erroneously files a certificate of release, or when an offer in compromise has been breached. The Service may correct such errors by revoking the certificate of release or nonattachment. IRC § 6325(f)(2).

Because a released lien or a lien released pursuant to self-release language in an NFTL releases the underlying statutory lien, a release in one location invalidates any notice of that statutory lien (NFTL) filed elsewhere. There is only one statutory lien but there can be multiple notices filed for that one statutory lien. The revocation reinstates the statutory lien.

The Service effects the revocation by mailing a notice of the revocation to the taxpayer’s last known address and by filing notice of the revocation in the same office(s) in which the notice of lien to which it relates was filed. If NFTLs or refiled NFTLs were filed in multiple offices, the notices of revocation must also be filed in each of those offices. Any release not cancelled by a revocation filing remains a release of the statutory lien and continues to invalidate any lien notice (NFTL) filed elsewhere.

The effective date of reinstatement will be the date by which the Service has both mailed the notice of revocation to the taxpayer and properly filed the notice of revocation. Revocation does not restore the continuity of the original tax lien from the date of assessment, and there is a gap period between the original release and the revocation of that release within which other liens may arise. Other liens arising during the gap period may have priority over the “reinstated” federal tax lien.

The reinstated lien will have the same force and effect as a general tax lien which arises upon assessment of the tax. IRC § 6321. The reinstated lien will not be in existence for a period longer than the period of limitation on collection after assessment of the tax liability to which it relates. The reinstated lien will not be valid against any holder of a lien or interest described in IRC § 6323(a) that perfected their lien or interest prior to the filing of the reinstated lien. Treas. Reg. § 301.6325-1(f)(2)(iii)(b). The Service must file a new NFTL pursuant to IRC § 6323(a) in every office where it wishes to establish priority.

If the Service seeks to issue a notice of revocation of the certificate of release during a taxpayer’s bankruptcy, it should seek relief from the automatic stay of Bankruptcy Code § 362 to avoid the question of whether the revocation of a certificate of release constitutes a prohibited creation of a new lien interest while the debtor is subject to the automatic stay.

Special Tax Liens Applicable to Estates and Gifts

The Internal Revenue Code provides for a special estate tax lien and a gift tax lien, both of which are separate and independent of the general tax lien. IRC § 6324. The estate tax lien and the gift tax lien may exist simultaneously with the general lien provided for by IRC § 6321 or they may exist independently of the general lien under IRC § 6321. The estate and gift tax liens arise automatically, unlike the general tax lien.

The Estate Tax Lien

When an individual dies, the estate tax lien automatically arises upon death for the estate tax liability. The Government does not have to take any action to create the estate tax lien. This means that the estate tax lien is in existence before the amount of the tax liability it secures is even ascertained. Detroit Bank v. United States, 317 U.S. 329 (1943).

The estate tax lien is a function of the amount of the estate tax a decedent’s estate ultimately owes. The lien attaches to the decedent’s entire “gross estate,” exclusive of property used to pay charges against the estate and administration expenses, for a period of ten years from the date of the decedent’s death. IRC § 6324(a)(1). The majority of courts have held that the ten-year estate tax lien is of absolute duration and thus, lien foreclosure must be completed before expiration of ten years. SeeUnited States v. Davis, 52 F.3d 781 (8th Cir. 1995); United States v. Cleavenger, 517 F.2d 230 (7th Cir. 1975). The Service follows this majority rule. On the other hand, an administrative levy is completed once the notice of levy is served or in the case of tangible property, when the notice of seizure is given. Thus, any suit outside the ten-year period to enforce a levy would not be barred.

The estate tax lien attaches to the “gross estate” of the decedent. The gross estate, arising under federal law, includes certain types of property not included in the probate estate. For example, property held by trusts established by the decedent many years before death may be includible in the gross estate by reason of the trust instrument reserving to the decedent certain “powers,” such as the power to revoke the trust, change beneficiaries, etc.

Under IRC § 6324(a)(2), special rules exist for property included in the “gross estate” but not passing through probate. For nonprobate property, if the estate tax is not paid when due, then the spouse, transferee, trustee, surviving tenant, person in possession, or beneficiary of the estate is generally liable for the payment of the estate tax to the extent of the value of the estate’s property held by, or passing to, such person. IRC § 6324(a)(2). This means that the estate tax lien will encumber such property in the hands of persons within the above classes without regard to any filing of notice of lien or the need for a separate assessment of tax.

If a spouse, transferee, trustee, surviving tenant, person in possession, or beneficiary of the estate transfers nonprobate property to a purchaser or holder of a security interest, then that property is divested from the estate tax lien. IRC § 6324(a)(2). The Service, however, may still collect from the spouse, transferee, trustee, surviving tenant, person in possession, or beneficiary of the estate. IRC § 6324(a)(2) provides that if a transfer of nonprobate property to a purchaser or holder of a security interest removes the estate tax lien, then a “like lien” shall attach to the transferor’s property.

The statute of limitations applicable to the personal liability established by IRC § 6324(a)(2) is not the 10-year period from the date of death set forth in IRC § 6324(a)(1); rather it is 10 years from the date the assessment is made against the estate upon the filing of the estate tax return, in accordance with IRC § 6502(a). The section 6324(a)(2) personal liability arises independently of the estate tax lien; accordingly, it may be collected within the ordinary collection period of 10 years from the date of assessment. A separate assessment against the transferees is not required. SeeEstate of Mangiardi v. Commissioner, T.C.M. 2011-24 aff’d, 442 Fed. Appx. 526 (11th Cir., October 12, 2011); United States v. Bevan, 2008 WL 5179099 (E.D. Cal. 2008); United States v. Degroft, 539 F.Supp.42 (D.Md. 1981).

If property is included in the estate under IRC § 2033 (probate assets), it is divested of the lien upon transfer to a purchaser or holder of a security interest only if the estate’s executor has been discharged from personal liability under IRC § 2204. See IRC § 6324(a)(3); United States v. Vohland, 675 F.2d 1071, 1075 (9th Cir. 1982); United States v. Estate of Young, 592 F.Supp. 1478, 1486 (E.D. Pa. 1984). See also Rev. Rul. 69-23, 1969-1 C.B. 302

As with the general tax lien, there are some exceptions to the special lien for estate taxes. IRC § 6324(c). Thus, the estate tax lien will not be valid as against a mechanic’s lienor and against the superpriorities listed under IRC § 6323(b) if the conditions set forth in that section are satisfied. In addition, if a lien or security interest has priority over the estate tax lien, interest and allowable expenses based on the lien or security interest will have priority based on state or local law. Thus, for example, if A has a valid mortgage on B’s real property, A’s priority over the special lien will include not only the amount of the mortgage debt owed but also the amount of interest and allowable expenses.

IRC § 6324A creates a special lien for estate taxes deferred under IRC § 6166. The executor of the estate makes an election under IRC § 6166 to defer payment of the estate tax for a period of up to 14 years. This period can be extended if the estate requests an extension to make a payment under the deferral election pursuant to IRC § 6161(a)(2)(B). If an estate qualifies and elects to defer the payment of estate tax pursuant to IRC § 6166, the Service must evaluate whether a bond should be required as security for deferral or whether it will require any security at all based on the facts and circumstances of each case. See IRC § 6165; Estate of Roski v. Commissioner, 128 T.C. 113 (2007); IRM 5.5.5.5. The Service’s decision to require a bond can be appealed to the Tax Court. See IRC § 7479(a). See Notice 2007-90, 2007-46 I.R.B. 1003 regarding the factors the Service will consider in deciding to require security. If the Service does require security, the estate may elect to provide an IRC § 6324A special lien in lieu of the bond.

IRC § 6324B creates a special lien for the pending additional estate tax attributable to the estate’s election to use a “special use value” for certain “qualified” property for estate tax calculations. See IRC § 2032A (valuation of farm real property and certain real property used in family business).

The Gift Tax Lien

Under IRC §6324(b), the gift tax lien comes into existence upon the making of a gift by a donor, if the donor is, in fact, liable for a tax in respect to such gift, or any other in the same taxable year. The gift tax lien, like the estate tax lien, arises automatically, and requires no action by the Service. Unless the donor files a gift tax return, there is no statute of limitations on the gift and the Service may examine the gift at any time.

The gift tax lien attaches only to the property which is the subject of the gift. It does not attach to any of the donor’s property. It may attach to the other property of the recipient of the gift in a manner similar to the way an estate tax lien may attach to other property of a decedent’s distributees or transferees. See IRM 5.17.2.9.1. This is because the recipient is made personally liable for any gift tax incurred by the donor on a gift, made during the calendar year, to the extent of the value of the property received if the tax is not paid when due.

A separate assessment against the donee is not required to make the gift tax lien enforceable against the donee’s property. Any part of the property which was the subject of the gift that is transferred by the recipient to a purchaser or holder of a security interest will be divested of the lien and, to the extent of the value of such transfer, the lien will attach to the property of the donee, including after-acquired property.

As was pointed out above, property that comprises the gift or a portion of the gift in issue, which is transferred by the recipient to a purchaser or holder of a security interest is divested of the lien. Likewise the recipient’s own property to which the lien shifts, as explained above, is in turn divested of the lien if it is transferred to a purchaser or holder of a security interest. The exceptions for superpriorities applicable to estate tax liens also apply to gift tax liens.

Note. The following provision govern tax liens:

#	Code Section	Regulation	Description
1	26 USC § 6321:	§301.6321-1	Lien for taxes
2	26 USC § 6322:	no regulation	Period of lien
3	26 USC § 6323:	§301.6323(a)-1, §301.6323(b)-1, §301.6323(c)-1, §301.6323(c)-2, §301.6323(c)-3, §301.6323(d)-1, §301.6323(e)-1, §301.6323(f)-1, §301.6323(g)-1, §301.6323(h)-0, §301.6323(h)-1, §301.6323(i)-1, §301.6323(j)-1	Validity and priority against certain persons
4	26 USC § 6320:	§301.6320-1	Notice and opportunity for hearing upon filing of notice of lien
5	26 USC § 6324:	§301.6324-1	Special liens for estate and gift taxes
6	26 USC § 6324A:	§301.6324A-1	Special lien for estate tax deferred under section 6166
7	26 USC § 6324B:	no regulation	Special lien for additional estate tax attributable to farm, etc., valuation
8	26 USC § 6325	§301.6325-1	Release of lien or discharge of property
9	26 USC § 6326:	§301.6326-1	Administrative appeal of liens
10	26 USC § 6327:	no regulation	Cross References
11	26 USC § 7425:	§301.7425-1, §301.7425-2, §301.7425-3, §301.7425-4	Discharge of Liens
12	26 USC § 7426:	§301.7426-1, §301.7426-2	Civil actions by persons other than taxpayers
13	26 USC § 7432:	§301.7432-1	Civil damages for failure to release lien
14	28 USC § 2410:		Actions affecting property on which United States has lien

The following Policy Statements and Delegation Orders regulate NFTL filing.

#	IRM	Description
1	IRM 1.2.14.1.2	Policy Statement 5-2 – Collecting Principles
2	IRM 1.2.14.1.13	Policy Statement 5-47 – (1) Notices of lien generally filed only after taxpayer is contacted in person, by telephone or by notice; (2) Notice of lien filing in jeopardy assessment cases; (4) Other notice of lien filing requirements
3	IRM 1.2.44.5	Delegation Order 5-4 (Rev 3) – Federal Tax Lien Certificates
4	IRM 1.2.65.3.2 or Functional Delegation Order including authority to foreclose the federal tax lien	Delegation Order SBSE- 1-23-9, Approval of Form 4477, Civil Suit Recommendation

[1] Note that the IRS only secures extensions on partial payment installment agreements and only in limited situations.

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The Collision of Title VII and Religious Freedom —The Aftermath of Bostock v. Clayton County for Religious Organizations

I. Introduction

The contents of this Insights article will be presented at the State Bar of Texas’ 21^st Annual Governance of Nonprofit Organizations (August 31-September 1, 2023). Freeman Law attorney, Cory Halliburton, serves as Course Director for the program and will present this topic for continuing legal education and ethics credits.

The article addresses the aftermath of the monumental U.S. Supreme Court opinion of Bostock v. Clayton County, ––– U.S. ––––, 140 S.Ct. 1731 (June 15, 2020), the ongoing collision of religious freedom enjoyed (or not) by religious organization employers, and the protections afforded individual employees pursuant to Title VII of the Civil Rights Act of 1964.

II. Title VII of the Civil Rights Act of 1964

It is an unlawful employment practice for a covered employer to fail or refuse to hire or terminate any individual, or otherwise discriminate against any individual, because of the individual’s race, color, religion, sex, or national origin. See 42 U.S.C. § 2000e-2(a)(1).

With limited exceptions, a covered employer means a private sector “person engaged in an industry affecting commerce who has fifteen or more employees for each working day in each of twenty or more calendar weeks in the current or preceding calendar year, and any agent of such a person[.]” See id. at § 2000e(b).

Either the EEOC or an affected employee (if the EEOC declines to act) is statutorily authorized to bring an enforcement action. Id. § 2000e-5(f)(1).

III. Bostock v. Clayton County, in Brief

In Bostock, the Supreme Court addressed the legal issue of whether “sex,” as that term is used in 42 U.S.C. § 2000e-2(a)(1), includes an employee’s sexual orientation. Justice Neil Gorsuch began the Bostock opinion as follows:

Sometimes small gestures can have unexpected consequences. Major initiatives practically guarantee them. In our time, few pieces of federal legislation rank in significance with the Civil Rights Act of 1964. There, in Title VII, Congress out-lawed discrimination in the workplace on the basis of race, color, religion, sex, or national origin. Today, we must decide whether an employer can fire someone simply for being homosexual or transgender. The answer is clear. An employer who fires an individual for being homosexual or transgender fires that person for traits or actions it would not have questioned in members of a different sex. Sex plays a necessary and undisguisable role in the decision, exactly what Title VII forbids.

Those who adopted the Civil Rights Act might not have anticipated their work would lead to this particular result. Likely, they weren’t thinking about many of the Act’s consequences that have become apparent over the years, including its prohibition against discrimination on the basis of motherhood or its ban on the sexual harassment of male employees. But the limits of the drafters’ imagination supply no reason to ignore the law’s demands. When the express terms of a statute give us one answer and extratextual considerations suggest another, it’s no contest. Only the written word is the law, and all persons are entitled to its benefit.

Bostock, 140 S.Ct. at 1737.

In line with Justice Gorsuch’s eloquent introduction, a majority of the Court agreed that Title VII’s prohibition of discrimination in employment because of an employee’s “sex” includes a prohibition of discrimination based on the employee’s sexual orientation, including homosexuality or transgender.

“‘Title VII protects every American, regardless of sexual orientation or transgender status. It simply requires proof of sex discrimination.’ That was true before Bostock, and it remains true after Bostock. Under Bostock, transgender discrimination is a form of sex discrimination under Title VII. But a plaintiff claiming transgender discrimination under Bostock must plead and prove just that—discrimination.” Olivarez v. T-Mobile USA, Inc., 997 F.3d 595, 603 (5th Cir. May 14, 2021), cert. denied, 211 L. Ed. 2d 401, 142 S. Ct. 713 (2021) (quoting Wittmer v. Phillips 66 Co., 915 F.3d 328, 340 (5th Cir. 2019) (Ho, J., concurring)).

The Court in Bostock did not, however, address how or when Title VII and the holding of Bostock may be applied to religious organizations.

IV. Title VII’s Exceptions for Religious Organizations

The term “religion,” as used in Title VII, “includes all aspects of religious observance and practice, as well as belief, unless an employer demonstrates that he is unable to reasonably accommodate to an employee’s or prospective employee’s religious observance or practice without undue hardship on the conduct of the employer’s business.” See 42 U.S.C. § 2000e(j).

Notably, no “religious corporation” employer was involved in Bostock.

However, the First Amendment of the United States Constitution provides, in part, that “Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof . . .” U.S. Const. amend. 1. And, Title VII recognizes the religious rights afforded by the First Amendment, and so as not to infringe on that fundamental right, Title VII contains exceptions applicable to religious organizations:

[Title VII’s anti-discrimination provisions] . . . shall not apply . . . to a religious corporation, association, educational institution, or society with respect to the employment of individuals of a particular religion to perform work connected with the carrying on by such corporation, association, educational institution, or society of its activities.

42 U.S.C. § 2000e-1(a) (emphasis added).

Similarly, Title VII provides religious educational institutions an exemption from faith-based employment decisions:

[I]t shall not be an unlawful employment practice for a school, college, university, or other educational institution or institution of learning to hire and employ employees of a particular religion if such school, college, university, or other educational institution or institution of learning is, in whole or in substantial part, owned, supported, controlled, or managed by a particular religion or by a particular religious corporation, association, or society, or if the curriculum of such school, college, university, or other educational institution or institution of learning is directed toward the propagation of a particular religion.

42 U.S.C. § 2000e-2(e)(2) (emphasis added).

In Bostock, the Supreme Court was not faced with the opportunity to address the statutory exception for religious organizations, but the Court noted as follows:

Separately, the employers fear that complying with Title VII’s requirement in cases like ours may require some employers to violate their religious convictions. We are also deeply concerned with preserving the promise of the free exercise of religion enshrined in our Constitution; that guarantee lies at the heart of our pluralistic society. But worries about how Title VII may intersect with religious liberties are nothing new; they even predate the statute’s passage. As a result of its deliberations in adopting the law, Congress included an express statutory exception for religious organizations. § 2000e–1(a). This Court has also recognized that the First Amendment can bar the application of employment discrimination laws “to claims concerning the employment relationship between a religious institution and its ministers. . . .

So while other employers in other cases may raise free exercise arguments that merit careful consideration, none of the employers before us today represent in this Court that compliance with Title VII will infringe their own religious liberties in any way.”

Bostock, 140 S.Ct. at 1753-54 (quoting Hosanna-Tabor Evangelical Lutheran Church and School v. EEOC, 565 U.S. 171, 188, 132 S.Ct. 694, 181 L.Ed.2d 650 (2012)) (emphasis added).

Since Bostock, the Supreme Court has not had the occasion to address the “other employers in other cases” that the Court alluded to in Bostock. Those cases, to the extent they exist, remain in lower courts, and the scope of religious freedom pursuant to section 2000e-1(a) of Title VII remains unsettled.

**V. Aftermath of Bostock – EEOC Guidance**

Following Bostock, the Equal Employment Opportunity Commission published its Protections Against Employment Discrimination Based on Sexual Orientation or Gender Identity, which was in supplement to the EEOC’s earlier-promulgated guidance document, Preventing Employment Discrimination Against Lesbian, Gay, Bisexual or Transgender Workers (Apr. 29, 2014) (https://www.eeoc.gov/laws/guidance/preventing-employment-discrimination-against-lesbian-gay-bisexual-or-transgender).

As of August 22, 2023 the Protections Against Employment Discrimination Based on Sexual Orientation or Gender Identity guidance was available at https://www.eeoc.gov/laws/guidance/protections-against-employment-discrimination-based-sexual-orientation-or-gender.

The EEOC guidance directs employers to recognize same-sex marriage on the same terms as opposite-sex marriage. See U.S. Equal Emp. Opportunity Comm’n, Preventing Employment Discrimination Against Lesbian, Gay, Bisexual or Transgender Workers (Apr. 29, 2014) (https://www.eeoc.gov/laws/guidance/preventing-employment-discrimination-against-lesbian-gay-bisexual-or-transgender) (note, as of August 22, 2023, the website includes the following disclaimer: “As a result of the Supreme Court’s decision in Bostock v. Clayton County, we are currently working on updating this webpage.”). That EEOC guidance document also requires that employers allow employees into restrooms that correspond to the employees’ gender identity, no matter the individual’s biological sex, whether the individual has had a sex-change operation, or whether other employees have raised objections or privacy concerns.

In the Protections Against Employment Discrimination Based on Sexual Orientation or Gender Identity guidance, the EEOC provides the following with respect to the collision of Bostock and religious freedom:

Title VII allows “religious organizations” and “religious educational institutions” . . . to hire and employ people who share their own religion (in other words, it is not unlawful religious discrimination for a qualifying employer to limit hiring in this way). Courts also apply a “ministerial exception” that bars certain employment discrimination claims by the employees of religious institutions because those employees perform vital religious duties at the core of the mission of the religious institution. Courts and the EEOC consider and apply, on a case by case basis, any religious defenses to discrimination claims, under Title VII and other applicable laws. For more information on those defenses and other issues related to religious organizations and discrimination based on religion, see EEOC Compliance Manual, Section 12: Religious Discrimination.

The EEOC Compliance Manual, Section 12: Religious Discrimination (as of August 22, 2023 was available at https://www.eeoc.gov/laws/guidance/section-12-religious-discrimination) provides that the “religious organization” exemption to Title VII’s prohibition to religious discrimination “applies only to those organizations whose ‘purpose and character are primarily religious,’ but to determine whether this statutory exemption applies, courts have looked at ‘all the facts,’ considering and weighing ‘the religious and secular characteristics’ of the entity.” Id. at § C.1 (citing Hall v. Baptist Mem’l Health Care Corp., 215 F.3d 618, 624 (6th Cir. 2000); Garcia v. Salvation Army, 918 F.3d 997, 1003 (9th Cir. 2019); LeBoon v. Lancaster Jewish Cmty. Ctr., 503 F.3d 217, 226 (3d Cir. 2007); Killinger v. Samford Univ., 113 F.3d 196, 198‑99 (11th Cir. 1997)) (emphasis added).

While the EEOC guidance remains available and online, the EEOC “guidance” website for Protections Against Employment Discrimination Based on Sexual Orientation or Gender Identity expressly states: “In October 2022, a federal district court vacated this document in Texas v. EEOC et al., 2:21-CV-194-Z (N.D. Tex.).” See Texas v. Equal Emp. Opportunity Comm’n, No. 2:21-CV-194-Z, 2022 WL 4835346, at *1 (N.D. Tex. Oct. 1, 2022) (vacating the EEOC guidance).

**VI. Aftermath of Bostock – Judicial Opinions**

“The entire Federal Judiciary will be mired for years in disputes about the reach of the Court’s reasoning.”

Bostock, 140 S. Ct. at 1783 (Alito, J., dissenting) (emphasis added).

Indeed, Justice Alito’s foreshadowing proved true.

Following Bostock, “[c]ourts do not agree on the scope of this [Title VII] exemption or on the entities it covers.” Bear Creek Bible Church v. EEOC, 571 F. Supp. 3d 571, 590 (N.D. Tex. 2021), affirmed in part, reversed in part, and remanded by Braidwood Management, Inc. v. EEOC, No. 22-10145, 2023 WL 4073826 (5^th Cir. June 20, 2023); see also Olivarez v. T-mobile USA, Inc., 997 F.3d 595, 598 (5th Cir. May 14, 2021), cert. denied, 211 L. Ed. 2d 401, 142 S. Ct. 713 (2021) (relying on Bostock and noting that “a plaintiff who alleges transgender discrimination is entitled to the same benefits—but also subject to the same burdens—as any other plaintiff who claims sex discrimination under Title VII.”).

Some state courts have expressly rejected the holding in Bostock when applied to state law governing discrimination in employment based on transgender or sexual orientation. Other courts are firm to maintain the confines of Title VII’s laundry list of protected classes. See Stollings v. Texas Tech Univ., No. 5:20-CV-250-H, 2021 WL 3748964, at *11 (N.D. Tex. Aug. 25, 2021) (concluding that the plaintiff “is protected on the basis of sex, which includes sexual orientation in light of Bostock, but sexual orientation does not constitute a distinct class”).

In March 2023, a Louisiana court of appeals refused to apply Bostock’s holding to a claim of sexual orientation brought pursuant to Louisiana’s anti-discrimination-in-employment statute. See Gauthreaux v. City of Gretna, 2023 WL 2674191, No. 22-CA-424 (La. App. 5th Cir. March 29, 2023). In Gauthreax, the court found:

[A]lthough persuasive, our state courts are not bound by Bostock’s interpretation of Title VII in interpreting La. R.S. 23:332. As there is no binding federal or state law or jurisprudence on point, and because the legislature has not seen fit to amend La. R.S. 23:332 to specifically include protection from employment discrimination because of a person’s sexual orientation, we decline to extend Bostock’s reasoning to La. R.S. 23:332 to find that it allows for protection from employment discrimination because of a person’s sexual orientation.

Gauthreaux, 2023 WL 2674191, at *4-5.

In Vroegh v. Iowa Department of Corrections, 972 N.W.2d 686 (Iowa 2022), the plaintiff asserted both sex discrimination and gender identity discrimination for denying plaintiff (born a female and transitioning to male) use of the men’s restrooms and locker rooms and for denying certain healthcare benefit coverage that were provided to non-transgender employees. 972 N.W.2d at 694. The case worked its way to the Iowa Supreme Court, and that court considered whether a lower court erred by submitting a “sex discrimination” instruction to a jury in a case.

The Iowa Civil Rights Act in question prohibited discrimination in employment based on ten specific characteristics, including “sex, sexual orientation, [and] gender identity[.]” Iowa Code § 216.6(1)(a). The Iowa Civil Rights Act did not define “sex,” but it did define “gender identity” as the “gender-related identity of a person, regardless of the person’s assigned sex at birth.” Id. § 216.2(10). Thus, similar to the Supreme Court in Bostock, the Iowa Supreme Court was faced with the question of Does discrimination on the basis of “sex” include discrimination based on a person’s transgender status?

The Iowa Supreme Court answered in the negative. In doing so, the court found Bostock as merely persuasive and expressly rejected its majority opinion:

We disagree with the Bostock majority on this issue and thus reject [plaintiff’s] argument advancing it. Discrimination based on an individual’s gender identity does not equate to discrimination based on the individual’s male or female anatomical characteristics at the time of birth (the definition of “sex”). An employer could discriminate against transgender individuals without even knowing the sex of the individuals adversely affected. But that employer, lacking knowledge of the male or female anatomical characteristics of any of the effected employees, would not (and could not) be engaging in unlawful discrimination based on the individual’s “sex.” We see no reason to jettison the interpretive analysis in [prior Iowa Supreme Court precedent] construing “sex” according to its common usage and to include “transgender” status or other characteristics similarly attenuated from an individual’s male or female anatomical characteristics, particularly considering that the Iowa Civil Rights Act provides separate protections based on gender identity. . . . We effectuate the statute’s “purposes” by giving a fair interpretation to the language the legislature chose; nothing more, nothing less. “Sex” doesn’t expand to “gender identity” (or anything other than “sex”) simply because the statute contains an instruction that it be “construed broadly.” We may not through the judicial metamorphosis of words declare a Hulk where the legislature placed merely Bruce Banner.

Vroegh, 972 N.W.2d at 702 (emphasis added); see also Neese v. Becerra, No. 2:21-CV-163-Z, 2022 WL 16902425, at *8 (N.D. Tex. Nov. 11, 2022) (refusing to apply Bostock’s holding to a claim brought pursuant to Title IX (42 U.S.C. § 18116(a)) and noting, Title IX is not Title VII, and “on the basis of sex” is not “because of sex.”); Mykland v. CommonSpirit Health, No. 3:21-CV-05061-RAJ, 2021 WL 4209429, at *8-9 (W.D. Wash. Sept. 16, 2021) (refusing to apply Bostock to the state of Washington’s Law Against Discrimination due to the state statute’s mutually exclusive definitions of “sex” and “sexual orientation”). But see Maner v. Dignity Health, 9 F.4th 1114, 1122 (9th Cir. 2021), cert. denied, 211 L. Ed. 2d 606, 142 S. Ct. 899 (2022) (refusing to expand the meaning of “sex,” as used in Title VII, to include sexual activity, and finding that a plaintiff’s contention that “sex” means his having sex with a paramour contradicts canons of statutory construction).

Four months after the Bostock opinion was issued, a federal district court in Indiana (which is within the Seventh Circuit Court of Appeals) addressed—in a motion to dismiss procedure (Fed. R. Civ. P. 12(b)(6))—whether a religious school’s decision to not renew an employee’s contract because of her marriage to another woman was actionable under Title VII, Title IX, and Indiana state law, or whether the employer school was exempt from the claims pursuant to 42 U.S.C. § 2000e-1(a). See Starkey v. Roman Cath. Archdiocese of Indianapolis, Inc., 496 F. Supp. 3d 1195, 1198 (S.D. Ind. 2020).

The school asserted that the same-sex marriage violated the school’s religious beliefs. The district court found that, based on the pleadings, the employee could maintain the claims because she asserted a claim for sex discrimination, being a distinct protected class from religion-based discrimination. The religious employer immediately appealed, but the Seventh Circuit Court of Appeals dismissed the appeal for lack of jurisdiction. See Starkey v. Roman Cath. Archdiocese of Indianapolis, Inc., No. 20-3265, 2021 WL 9181051 (7^th Cir. July 22, 2021). In a later appeal, the Seventh Circuit held that, as a matter of law, the employee in issue was a “minister” for employment law purposes and thus, pursuant to Hosanna-Tabor Evangelical Lutheran Church & Sch. v. EEOC, 565 U.S. 171 (2012), the secular courts lacked jurisdiction to adjudicate the employment-related claims. Starkey v. Roman Cath. Archdiocese of Indianapolis, Inc., 41 F.4th 931 (7th Cir. 2022).

A year after the Bostock opinion was issued, a federal district court in North Carolina denied a Catholic school’s motion for summary judgment assertion of First Amendment privileges in terminating the employment of what the court described as a “gay,” male drama teacher. The court noted:

In this case, Charlotte Catholic High School seeks a variety of First Amendment and statutory protections to enable the school to terminate the employment of a substitute drama teacher—Mr. Lonnie Billard (“Plaintiff”). The school claims that he was fired for his support of gay marriage—something the Catholic Church opposes. Plaintiff claims he was fired, or at least suffered a more severe employment action, because of who he is as a gay man. The Court respects the sincerity of the Catholic Church’s opposition to Plaintiff’s actions. With a slightly different set of facts, the Court may have been compelled to protect the church’s employment decision. However, where as here, Plaintiff lost his job because of sex discrimination and where he was working as a substitute teacher of secular subjects without any responsibility for providing religious education to students, the Court must protect Plaintiff’s civil and employment rights.

Billard v. Charlotte Cath. High Sch., No. 3:17-CV-00011, 2021 WL 4037431, at *1 (W.D.N.C. Sept. 3, 2021) (emphasis added). As of June 16, 2023, the Billard district court decision was pending on appeal in the Fourth Circuit Court of Appeals.

In August 2022, a federal district court in Maryland issued an opinion in the case of Doe v. Catholic Relief Services, 618 F.Supp.3d 244 (D. Md. Aug. 3, 2022), on reconsideration in part, No. CV CCB-20-1815, 2023 WL 155243 (D. Md. Jan. 11, 2023). There, Catholic Relief Services asserted that, as a matter of law, its decision to terminate spousal health insurance benefits to an employee was protected by 42 U.S.C. § 2000e-1(a) because the employee was “a gay man married to another man” and that conduct was forbidden by the Catholic faith. In denying Catholic Relief Services request for relief, the court noted:

A plain reading of § 702(a) [42 U.S.C. § 2000e-1(a)] reveals Congress’s intent to protect religious organizations seeking to employ co-religionists, but the reading urged by CRS would cause a relatively narrowly written exception to swallow all of Title VII, effectively exempting religious organizations wholesale. Had Congress wished to exempt religious organizations in this manner, it could have done so, but it “plainly did not.” Accordingly, Title VII § 702(a) does not apply in this case.

Catholic Relief Services, 618 F.Supp.3d at 253.

More recently is the case of Bear Creek Bible Church v. EEOC, 571 F. Supp. 3d 571 (N.D. Tex. 2021), affirmed in part, reversed in part, and remanded by Braidwood Management, Inc. v. EEOC, No. 22-10145, 2023 WL 4073826 (5^th Cir. June 20, 2023). There, two Texas employers—Braidwood Management, Inc. (“Braidwood”) and Bear Creek Bible Church (“Bear Creek”)—asserted that Title VII, as interpreted in the EEOC’s guidance and Bostock, prevented Braidwood and Bear Creek from operating their places of employment in a way compatible with their Christian beliefs.

Braidwood was a management company controlled and owned, essentially, by an individual: Steven Hotze (“Hotze”). Hotze operated his companies as “Christian” businesses. Hotze did not permit his companies to employ individuals who engage in behavior Hotze considered sexually immoral or gender non-conforming, nor did he allow the company to recognize homosexual marriage. Braidwood enforced a sex-specific dress code applied to “biological” men and women. “Cross-dressing” was strictly forbidden. See Bear Creek, 571 F. Supp. 3d at 588-89.

Bear Creek was a nondenominational church whose bylaws state that “marriage is exclusively the union of one genetic male and one genetic female.” Bear Creek required its employees to live according to its professed views on Biblical teaching, and the church refuses to hire individuals who are “practicing homosexuals, bisexuals, crossdressers, or transgender or gender non-conforming individuals.” See id. at 587-88.

Braidwood and Bear Creek asked the court to certify a class of similarly-situated “church-type” employers and “religious-type employers” and to declare those employers’ ability to require their employees to live by the teachings of the Bible on matters of sexuality and gender. 571 F. Supp. 3d 571. The plaintiffs requested a religious exemption from, and a declaration that they do not violate, the anti-discrimination provisions of Title VII and the EEOC’s guidance on same so the employer-plaintiffs may make employment decisions in accordance with sincerely held religious beliefs and employment policies.

Braidwood and Bear Creek asserted the following:

The Religious Freedom Restoration Act (42 U.S.C. § 2000bb-1, et. seq.) compels exemptions to Bostock’s interpretation of Title VII (“RFRA claim”);

[Note: The RFRA provides that the federal government “shall not substantially burden a person’s exercise of religion” unless the burden furthers a “compelling governmental interest” and is “the least restrictive means of furthering” that interest. 42 U.S.C. § 2000bb-1(a)–(b). Additionally, the federal government “must accept the sincerely held . . . objections of religious entities.” See Little Sisters of the Poor Saints Peter & Paul Home v. Pennsylvania, ––– U.S. ––––, 140 S. Ct. 2367, 2383, 207 L.Ed.2d 819 (2020).]

The Free-Exercise Clause of the First Amendment compels exemptions to Bostock’s interpretation of Title VII (“free exercise claim”);
The First Amendment right of expressive association compels exemptions to Bostock’s interpretation of Title VII (“expressive association claim”);
Title VII, as interpreted in Bostock, does not prohibit discrimination against bisexual employees (“bisexual orientation claim”); and
Title VII, as interpreted in Bostock, does not prohibit employers from establishing sex-neutral rules of conduct that exclude practicing homosexuals and transgender people from employment (“sex-neutral rules of conduct claim”).

The EEOC and party-plaintiffs’ moved for summary judgment on various grounds, including standing, ripeness, class-certification, and on the merits.

The district court granted summary judgment in favor of the religious-business-type employer class for claims 1–3, finding that the class was protected under RFRA and the First Amendment. For the RFRA claim, the district court determined that Title VII substantially burdened the class members and that the EEOC did not have a compelling interest in failing to provide a religious exemption to all class members. For the free exercise claim, the district court ruled that strict scrutiny applied and that the EEOC had not shown a compelling interest in light of Title VII’s exemptions or, in the alternative, that Title VII was not sufficiently narrowly tailored. See Bear Creek, 571 F. Supp. 3d at 589-94.

The district court ruled that the members of the religious-business-type-employers class engaged in expressive association and therefore had a right not to associate with persons engaging in homosexual or transgender conduct. The court determined, as a matter of law, that the sex-neutral policies of both classes pertaining to sexual conduct, dress codes, and bathrooms did not violate Title VII. See id. at 607-12.

The court granted summary judgment in the EEOC’s favor on the entirety of claim 4 regarding bisexual orientation and employer policies regulating sex-reassignment surgery and hormone treatment for claim 5.

In its opinion, the district court noted:

The text of the exemption does not provide religious employers a blanket exemption to Title VII’s prohibitions. If it did, the text would simply say it does not apply to religious employers. Instead, it exempts those religious employers who hire employees to perform work connected with the carrying on of its activities or mission. Importantly, the Title VII exemption defines the term “religion” to include “all aspects of religious observance and practice, as well as belief.” Read plainly then, Title VII does not apply to religious employers when they employ individuals based on religious observance, practice, or belief. The plain text of this exemption, therefore, is not limited to religious discrimination claims; rather, it also exempts religious employers from other forms of discrimination under Title VII, so long as the employment decision was rooted in religious belief. In other words, Title VII’s prohibition “shall not apply” to religious employers who desire to “employ only persons whose beliefs and conduct are consistent with the employer’s religious precepts.” Thus, a religious employer is not liable under Title VII when it refuses to employ an individual because of sexual orientation or gender expression, based on religious observance, practice, or belief.

Bear Creek Bible Church, 571 F. Supp. 3d at 590-91 (internal citations omitted; emphasis added). The district court basically held that Braidwood and Bear Creek established a sufficient justiciable interest or “credible fear” of EEOC enforcement, conferring standing, and found that the issues were ripe for adjudication.

Braidwood, Bear Creek, and the EEOC appealed.

On June 20, 2023, the Fifth Circuit Court of Appeals issued its opinion in the case. See Braidwood Management, Inc. v. EEOC, No. 22-10145, 2023 WL 4073826 (5^th Cir. June 20, 2023). The Fifth Circuit court affirmed “in large part,” reversed in part, and remanded. The court found that Braidwood and Bear Creek had standing to seek a declaration of Title VII as applied to the party-plaintiffs, despite no enforcement actions being asserted by the EEOC or any individual affected by the undisputed employment practices. The Fifth Circuit affirmed the district court’s refusal to certify a class of “church-type employers,” but the Fifth Circuit reversed the lower district court’s “religious-business type employers” class certification. See id. at *7-18.

As to the merits, the Fifth Circuit held that RFRA requires that Braidwood be exempted from Title VII because compliance with Title VII post-Bostock would substantially burden Braidwood’s ability to operate per its religious beliefs about homosexual and transgender conduct. The EEOC failed to show a compelling interest in its application of its Guidance and Bostock. The court stated as follows:

Because sincerity is not at issue, Braidwood must show that applying Title VII substantially burdens its ability to practice its religious faith. Braidwood maintains that it has sincere and deeply held religious beliefs that heterosexual marriage is the only form of marriage sanctioned by God, pre-marital sex is wrong, and “men and women are to dress and behave in accordance with distinct and God-ordained, biological sexual identity.” To that end, the EEOC guidance almost assuredly burdens the exercise of Braidwood’s religious practice. . .

As the district court succinctly put it, “[E]mployers are required to choose between two untenable alternatives: either (1) violate Title VII and obey their convictions or (2) obey Title VII and violate their convictions.” We see no reason why that formulation is incorrect. Being forced to employ someone to represent the company who behaves in a manner directly violative of the company’s convictions is a substantial burden and inhibits the practice of Braidwood’s beliefs. . . .

Per EEOC guidance, Braidwood, to comply, must violate its beliefs: No money needs to exchange hands; instead, Braidwood’s employment policies must broadly change, and it must tacitly endorse homosexual and transgender behavior. The EEOC’s euphemistic phrasing that “the only action that Braidwood is required to take under Title VII is to refrain from taking adverse employment actions” is tantamount to saying the only action Braidwood needs to take is to comply wholeheartedly with the guidance it sees as sinful. That is precisely what RFRA is designed to prevent. . . . [The EEOC] does not show a compelling interest in denying Braidwood, individually, an exemption. The agency does not even attempt to argue the point outside of gesturing to a generalized interest in prohibiting all forms of sex discrimination in every potential case. Moreover, even if we accepted the EEOC’s formulation of its compelling interest, refusing to exempt Braidwood, and forcing it to hire and endorse the views of employees with opposing religious and moral views is not the least restrictive means of promoting that interest. We affirm the summary judgment here.

Braidwood Management, Inc., 2023 WL 4073826 at *19; see Bostock, 140 S. Ct. at 1754 (noting that RFRA “might supersede Title VII’s commands in appropriate cases.”).

VII. Determining “Religious Organization” Status for Title VII Exception

As a general rule, it does not violate the First Amendment to apply federal employment discrimination laws to churches and other religious employers. Ference v. Roman Cath. Diocese of Greensburg, No. 2:22-CV-797-NR-MPK, 2023 WL 3300499, at *2 (W.D. Pa. May 8, 2023). Churches, for example, are not generally exempt from federal employment discrimination laws as applied to their non-ministerial employees. But see Hosanna-Tabor Evangelical Lutheran Church & Sch., 565 U.S. at 196 (finding that the First Amendment prohibits courts from adjudicating employment-related claims asserted by a “minister” as defined by judicial opinions for employment law purposes).

Ministers aside (and circling back to the statute), Title VII’s anti-discrimination provisions “shall not apply . . . to a religious corporation, association, educational institution, or society with respect to the employment of individuals of a particular religion to perform work connected with the carrying on by such corporation, association, educational institution, or society of its activities with respect to the employment of individuals of a particular religion to perform work connected with the carrying on by such corporation of its activities.” 42 U.S.C. § 2000e-1(a) (emphasis added). As noted above, certain religious educational institutions enjoy similar exception from Title VII’s anti-discrimination prescriptions. See id. at § 2000e-2(e)(2).

The pivotal questions in cases where Bostock and a Title VII religious organization exception may be applicable are, essentially:

Is the employer a religious corporation, association, educational institution, or society?
Is the employment connected with the carrying on the religious activities of by such corporation, association, educational institution, or society?
And, for religious educational institutions, is the institution, in whole or in substantial part, owned, supported, controlled, or managed by a particular religion or by a particular religious organization, or is the curriculum directed toward the propagation of a particular religion?

So, the question remains: What is a religious organization for these statutory exceptions?

As in most matters that touch on First Amendment principles, Title VII provides no definition of “religious corporation, association, or society,” although the statute provides a definition for “religion”. See 42 U.S.C. § 2000e(j) (defining “religion”).

In Hall v. Baptist Memorial Health Care Corp., 215 F.3D 618 (6th Cir. 2000), the court applied a wholistic review of the educational institution employer in question, including its “atmosphere” that “permeated with religious overtones.” In upholding a lower district court’s finding that the institution in issue was entitled to the exception from Title VII’s religious discrimination prohibition, the Sixth Circuit Court of Appeals stated: “The decision to employ individuals ‘of a particular religion’ under § 2000e-1(a) . . . has been interpreted to include the decision to terminate an employee whose conduct or religious beliefs are inconsistent with those of its employer.” Id. at 625. But see O’Connor v. Lampo Group, LLC, No. 3:20-cv-00628, 2021 WL 4942869, *7 n.8 (M.D. Tenn. Oct. 22, 2021) (noting that the verbiage quoted above from Hall is “regrettably phrased so as to render its meaning obscure.”).

The courts within the Fifth Circuit Court of Appeals likewise offer no specific framework in regard to the exemptions set forth in 42 U.S.C. § 2000e-1(a). See Aguillard v. La. Coll., 341 F. Supp. 3d 642 (W.D. La. 2018) (stating “With regard to the Title VII exemptions, the Fifth Circuit has not offered specific guidance.”).

On the whole, however, the courts consider a non-exclusive number of factors in determining whether an employer entity is a religious organization within section 2000e-1(a) or a religious educational institution within section 2000e-2(e)(2):

whether the entity is supported and controlled by a religious corporation;
whether the entity was founded by sectarian persons or entities;
the atmosphere of the entity;
the nature of the entity;
whether the entity’s facilities are decorated with religious images;
whether regular religious ceremonies and practice are observed;
whether the entity operates for a profit;
whether the entity produces a secular product;
whether the entity’s articles of incorporation or other governing documents state a religious purpose;
whether the entity holds itself out to the public as secular or sectarian.

See EEOC v. Mississippi College, 626 F.2d 477 (5th Cir. 1980), cert. denied, 453 U.S. 912 (1981); Kennedy v. St. Joseph’s Ministries, Inc., 657 F.3d 189, 192- 94 (4th Cir. 2011); LeBoon v. Lancaster Jewish Cmty. Ctr. Ass’n, 503 F.3d 217, 226 (3rd Cir. 2007) (holding that “LJCC was entitled to the protection of [42 U.S.C. § 2000e-1(a)] during the period under scrutiny because its structure and purpose were primarily religious.”); Hall, 215 F.3d at 624 (stating that the court must look at all the facts to decide whether the institution is a religious corporation or educational institution); Ference, 2023 WL 3300499, at *2; Bear Creek Bible Church v. EEOC, 571 F. Supp. 3d at 591; Saeemodarae v. Mercy Health Services-Iowa Corp., 456 F.Supp.2d 1021, 1034-35 (N.D. Iowa 2006).

VIII. Summation

The consequences of the Bostock decision were not unexpected. In fact, Justice Alito’s dissenting opinion in Bostock alluded to the struggles that the lower courts would face. See Bostock, 140 S. Ct. at 1783 (Alito, J., dissenting).

The lower courts are still grappling with the confines of Bostock and its application (if any) to the varying state anti-discrimination statutes and in other statutory regimes that reference “sex” as a protected characteristic, class, or qualifier.

Employers who believe they qualify for a religious organization exemption from Title VII’s prohibition of religious discrimination or exemption as permitted by the RFRA should carefully consider application of the statutory exceptions and Bostock and its progeny. Religious organizations should carefully craft, adopt, evaluate, and honor statements of faith, governing documents, employment policies, employee acknowledgements, job descriptions, mission statements, and other matters that form the foundation of a religious organization’s ability to stand bold behind the exception to Title VII’s prohibition against discrimination based on religion and to exercise, freely, the religious freedom guaranteed by the U.S. Constitution.

Nonprofit and Exempt Organization Attorneys

Every nonprofit is different, that’s why we collaborate with our nonprofit clients to identify and meet their unique needs. Freeman Law represents associations & 501(c)(6) organizations, churches and other religious organizations, foundations, private foundations, 501(c)(3) organizations, and other nonprofit clients. While nonprofits encounter many of the same economic concerns and administrative challenges as any business, they also face many unique challenges. Schedule a consultation or call (214) 984-3000 to discuss your nonprofit concerns or questions.

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Unlawful: FTC Final Rule on Non-Compete Clauses – Update Alert

On July 27, 2024, the below schedule (i.e., the Bits and the Bytes) on the FTC’s Final Rule on Non-Compete Clauses was posted to this Insights blog. On August 20, 2024, the U.S. District Court for the Northern District of Texas, Dallas Division, issued its opinion in the case of Ryan LLC v. Federal Trade Commission. The District Court opined that the FTC’s Non-Compete Rule is unlawful, and the Court set it aside. The Court held, “[t]he Rule shall not be enforced or otherwise take effect” on September 4, 2024, or thereafter.

A copy of the Court’s opinion may be viewed here. Below are excerpts:

“Thus, when considering the text, Section 6(g) specifically, the Court concludes the Commission has exceeded its statutory authority in promulgating the Non-Compete Rule. Having determined the FTC exceeded its statutory authority, the Court pretermits further discussion of statutory bases.”
“In sum, the Court concludes that the FTC lacks statutory authority to promulgate the Non-Compete Rule, and that the Rule is arbitrary and capricious. Thus, the FTC’s promulgation of the Rule is an unlawful agency action. See 5 U.S.C. § 706(2).”
“Thus, the Court hereby holds unlawful and sets aside the Rule. See 16 C.F.R. § 910.1–.6.14 The Rule shall not be enforced or otherwise take effect on its effective date of September 4, 2024, or thereafter.”

This District Court’s ruling is in contrast to other rulings from other courts across the country in that this District Court for the Northern District of Texas, Dallas Division found that the FTC Rule is unlawful and set it aside as to all, not just as to the parties involved in the specific litigation.

This opinion will not be the last word on the subject, so remain vigilant.

Previous Insights Blog – The Bits and the Bytes on FTC Final Rule on Non-Compete Clauses (Rule Later Deemed Unlawful)

LEGAL INFORMATION (NOT LEGAL ADVICE) ON

FTC FINAL RULE ON NON-COMPETE CLAUSES FOR “WORKERS”

16 C.F.R. §§ 910.1 – 910.6

https://www.ftc.gov/legal-library/browse/rules/noncompete-rule

Overview of FTC Final Rule

Bans non-compete clauses applicable to a “worker,” which is defined as any natural person who is or was an employee, contractor, extern, intern, volunteer, apprentice, or sole proprietor. Bans non-compete clauses applicable to a “senior executive,” if the clause was entered into after the Final Rule becomes effective (September 4, 2024, current anticipated effective date).

Businesses with non-compete clauses in place with a worker must notify the worker that the non-compete clause will not be enforced.

Barring any nation-wide injunction, the Rule will take effect September 4, 2024. To date, none of the courts have provided any reliable indication that a nation-wide injunction will be forthcoming.

Remain vigilant of judicial opinions on this subject, especially in regard to pending requests for nation-wide injunction to application of the FTC Final Rule.

Considerations for Business Entities

(1) Identify existing agreements that have non-compete clauses, including agreements for employment, contractor, or other “worker.”

(2) Determine whether the worker is a natural person.

(3) Determine whether the natural person is/was a “senior executive.”

(4) For any worker who is subject to a non-compete clause and is not a senior executive, provide a notice of non-enforcement. Model notice included below. Notice may be delivered by any reasonable means, including mail, email or text message.

(5) After September 4, 2024, do not enter into any non-compete clause with a senior executive.

Definitions and Rules

Non-Compete Clause

§ 910.1

(1) A term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from:

(i) seeking or accepting work in the U.S. where such work would begin after the employment that includes the term or condition; or

(ii) operating a business in the U.S. after the employment that includes the term or condition.

(2) A term or condition of employment includes a contractual term or workplace policy, whether written or oral.

General Rule:

Workers

(Not Senior Executives)

§ 910.2(a)(1)

With respect to a worker other than a senior executive, it is an unfair method of competition for a person:

(i) To enter into or attempt to enter into a non-compete clause;

(ii) To enforce or attempt to enforce a non-compete clause; or

(iii) To represent that the worker is subject to a non-compete clause.

General Rule:

Senior Executive

§ 910.2(a)(2)

For senior executives, it is an unfair method of competition for a person:

(i) To enter into or attempt to enter into a non-compete clause;

(ii) To enforce or attempt to enforce a non-compete clause entered into after the effective date (September 4, 2024, tentative); or

(iii) To represent that the senior executive is subject to a non-compete clause, where the clause was entered into after September 4, 2024.

Worker

§ 910.1

A natural person who works or worked, whether paid or unpaid, without regard to the worker’s title or status under any other law, including an employee, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor who provides a service to a person. The term does not include a franchisee in a franchisee-franchisor relationship.

Senior Executive

§ 910.1

(1) Was in a policy-making position; and

(2) Received from a person for the employment:

(i) Total annual compensation of at least $151,164 in preceding year;

(ii) Total compensation of at least $151,164 when annualized if the worker was employed only part of the preceding year; or

(iii) Total comp of at least $151,164 when annualized in the preceding year before the worker’s departure if the worker departed before the preceding year and the worker is subject to a non-compete clause.

Policy-Making Position

§ 910.1

President, CEO or equivalent, and any officer who has policy-making authority, or any natural person who has policy-making authority for the business similar to an officer with policy-making authority.

An officer of a subsidiary or affiliate that is part of a common enterprise who has policy-making authority for the common enterprise may be deemed to have a policy-making position.

A natural person who does not have policy-making authority over a common enterprise is not in a policy-making position.

Policy-Making Authority

§ 910.1

Final authority to make policy decisions that control significant aspects of a business entity or common enterprise and does not include authority limited to advising or exerting influence over such policy decisions or having final authority to make policy decisions for only a subsidiary.

Model Notice to a Worker Who is Subject to a Non-Compete Clause (§ 910.2(b)(4))

The new rule enforced by the Federal Trade Commission makes it unlawful for EMPLOYER to enforce a non-compete clause as to certain workers. As of September 4, 2024, EMPLOYER will not enforce any non-compete clause against you. This means that as of September 4, 2024: (1) you may seek or accept a job with any company or any person – even if they compete with EMPLOYER; and/or (2) you may run your own business – even if it competes with EMPLOYER. The FTC’s new rule does not affect any other terms or conditions of your employment with EMPLOYER. For mor information about the rule, visit https://www.ftc.gov/legal-library/browse/rules/noncompete-rule and/or https://www.ftc.gov/system/files/ftc_gov/pdf/noncompete-rule.pdf. Complete and accurate translations of the notice in certain languages other than English, including Spanish, Chinese, Arabic, Vietnamese, Tagalog, and Korean, are available at https://www.ftc.gov/legal-library/browse/rules/noncompete-rule.

Exceptions

§ 910.3

(a) A non-compete clause entered into by a person pursuant to a sale of a business, of the person’s ownership interest in a business, or of all or substantially all of a business entity’s operating assets.

(b) Where a cause of action related to a non-compete clause accrued before September 4, 2024.

(c) To enforce, attempt to enforce, or make representations about a non-compete clause where a person has a good-faith basis to believe the Rule is inapplicable.

International Students, F-1 Visas, Graduation and . . . Work in the U.S.?

Many international students present in the U.S. on an F-1 visa are eager to jump out of the classroom into the U.S. workforce. After graduation, those international students—many of whom come from less fortunate circumstances—seek to give back to the local U.S. community that provided so much opportunity, and many of this writer’s nonprofit organization clients—religious organizations, churches, and social service providers—are likewise eager to bring those international students into the workplace fold.

Pause.

An F-1 visa is not likely an appropriate vehicle for an international student’s post-graduation work in the U.S.

Student visas (F-1) are authorized by United States Code (8 U.S.C. § 1101(a)(15)(F)) – “an alien having a residence in a foreign country which he has no intention of abandoning, who is a bona fide student qualified to pursue a full course of study and who seeks to enter the United States temporarily and solely for the purpose of pursuing such a course of study . . . at an established [and qualified and approved] college, university, seminary, conservatory, academic high school, elementary school, or other academic institution or in an accredited language training program in the United States . . .”) (emphasis added).

The Regulations (specifically, 8 C.F.R. 214.2(F)(9)) authorize qualified and limited conditions when an F-1 visa student may work—on campus and off campus—during the student’s course of study. Also, if the student’s spouse is present on an F-2 visa (as the spouse of an F-1 visa holder), “[t]he F-2 spouse and children of an F-1 student may not accept employment.” See 8 C.F.R. 214.2(F)(15)(i).

Thus, an individual who is present in the U.S. on an F-1 visa and has completed the applicable course study is not authorized to work in the U.S., absent appropriate approval.

See authorization information here.

The Regulations governing authorization for F-1 visas allow for qualified “optional practical training” (OPT) for up to 14 months (subject to conditions for extension up to 24 months) following completion of the course of study, but the student must apply for authorization for temporary employment for optional practical training directly related to the student’s major area of study. “The student may not begin optional practical training until the date indicated on his or her employment authorization document, Form I-766.” See 8 C.F.R. 214.2(F)(10)(ii) (providing further that an F-1 student may engage in OPT “[a]fter completion of the course of study . . .”) (emphasis added). See OPT information here; Temporary (Nonimmigrant) Workers | USCIS at footnote 1 (“Only a few nonimmigrant classifications allow you to work in this country without an employer having first filed a petition on your behalf. Such classifications include the nonimmigrant E-1, E-2, E-3 and TN classifications, as well as, in certain instances, the F-1 and M-1 student and J-1 exchange visitor classifications.”).

This is just one high-level area to consider for an F-1 visa student (or the potential employer of same). The U.S. Citizenship and Immigration Services Agency, as well as the Department of State each, provide a wealth of guidance on this subject. But, there are many nuances within the actual Regulations (i.e., the law) that may create legal impediments, or that may provide a legal avenue for an opportunity for the international students in the U.S. on study who wants to give back in the form of employment. With careful attention to the permissions afforded by the Regulations, an international student and a local employer may strategically and lawfully ensure that a potential employer-employee relationship remains within the guardrails constructed by U.S. law.

International and Offshore Tax Compliance Attorneys

The Research & Development Credit | Section 41

Taxpayers are always interested in whether certain expenditures qualify as tax deductions. But many taxpayers often forget that expenditures may alternatively qualify for various tax credits, such as the research and development credit. And all things being equal, taxpayers should generally prefer tax credits over tax deductions as the former are more valuable monetarily than the latter.

Regrettably, many taxpayers are unaware that they qualify for certain tax credits. For this reason, thousands of taxpayers each year fail to file the necessary forms with their tax returns, rendering the credits unclaimed. After a number of years, these credits are gone forever due to the statute of limitations for refund claims.

This article explains one of the more commonly missed tax credits: the research and development credit under Section 41.[i] This article also discusses the IRS’s renewed interest in this credit and its new refund claim procedures applicable to taxpayers who seek to claim the credit after January 10, 2022.

The Research & Development Credit

Section 38 houses many permissible tax credits. Among these is the “qualified research activities credit,” the requirements of which are found in Section 41. Section 41 is not an easy read. Rather, it is full of super-technical statutory definitions (often within other statutory definitions) and various formulas and computations. Indeed, the IRS recently commented on Section 41 as follows:

The research credit (as provided by I.R.C. § 41) is a complex area of law involving the application of a four-part test, numerous exclusions, and significant computation and calculation elements to each research activity claimed by a taxpayer in any given tax year.[ii]

And the Tax Court has further commented on Section 41: “The research credit is one of the most complicated provisions in the Code. Its complexity is evidenced by the fact that it was the most commonly reported uncertain tax position on Schedule UTP, Uncertain Tax Position Statement, for 2010, 2011, and 2012.”[iii]

Credit Amount

Generally, the amount of the qualified research activities credit can be determined through the following formula:

Research Credit Amount = 20 % x [Qualified Research Expenses for Year – Base Amount]

For these purposes, the term “qualified research expenses” means the sum of all amounts paid or incurred during the tax year by the taxpayer in carrying on a trade or business for “in-house research expenses” and “contract research expenses.”[iv]

In-House Research Expenses

“In-house research expenses” is defined by statute to mean all expenses for: (1) wages paid or incurred to an employee for qualified services performed by the employee; (2) any amount paid or incurred for supplies used in the conduct of qualified research; and (3) certain amounts paid or incurred to another person for the right to use computers in the conduct of qualified research.[v]

Qualifying Wages

For purposes of Section 41, the term “wages” has the same meaning as that term is used throughout the Code.[vi] Generally, wages must be separated between those allocable to qualified services and those allocable to other services.[vii] However, there is a taxpayer-friendly rule in the regulations—if substantially all of the services performed by the employee for the taxpayer during the tax year consists of qualified services (i.e., 80% or more), the taxpayer may claim all of the employee’s wages as qualified services.[viii]

“Qualified services” means engaging in either: (1) qualified research; or (2) the direct supervision or direct support of research activities which constitute qualified research.[ix] “Qualified research” is discussed more extensively below. For purposes of (2), however, “direct supervision” means the immediate supervision (i.e., first-line management) of qualified research and not higher-level managers, and “direct support” means services in the support of persons engaging in actual conduct of qualified research, or persons who are directly supervising persons engaging in the actual conduct of qualified research.[x]

Supplies

Section 41 defines “supplies” broadly to mean any tangible property other than land or land improvements and property subject to depreciation.[xi]

Contract Research Expenses

“Contract research expenses” is defined to mean 65% of any amount paid or incurred by the taxpayer to any person (other than an employee of the taxpayer) for qualified research.[xii]

What is Qualified Research?

As shown above, the term “qualified research” is ubiquitous throughout Section 41 and its various statutory definitions. Thus, the heart of Section 41—and a taxpayer’s eligibility for the tax credit—often hinges on whether the activity at issue constitutes a qualified research activity.

Generally, to constitute qualified research, the activity must meet all of the following requirements: (1) the expenditures associated with the activity must be Section 174 expenditures; (2) the activity must be undertaken for the purpose of discovering information which is technological in nature, and the application of which is intended to be useful in the development of a new or improved business component of the taxpayer; and (3) substantially all of the activities must constitute elements of a process of experimentation for purposes of Section 41(d)(3).[xiii] Under Section 41(d)(3), research qualifies if it is conducted for a purpose that relates to a new or improved function, performance, or reliability or quality, unless it also relates to style, taste, cosmetic, or seasonal design factors.

The Section 174 Test

The first requirement to constitute “qualified research” is that the expenditures from the activity must represent Section 174 expenditures. Under the Section 174 regulations, Section 174 expenditures are “expenditures incurred in connection with the taxpayer’s trade or business which represent research and development costs in the experimental or laboratory sense.”[xiv] Generally, this definition hinges on uncertainty—the expenditures for the activity must be intended to discover information that would eliminate uncertainty concerning the development or improvement of a new product.[xv] In turn, uncertainty is present if the information available to the taxpayer does not establish the capability or method in developing or improving the product or the appropriate design of the product.[xvi] Examples in the Regulations provide some additional color on Section 174 expenditures and the uncertainty component.

Example. Company is engaged in the manufacture and sale of custom machines. Company contracts to design and produce a machine to meet a customer’s specifications. Because Company has never designed a machine with these specifications, Company is uncertain regarding the appropriate design of the machine, and particularly whether features desired by the customer can be designed and integrated into a functional machine. Company incurs a total of $31,000 on the project. Of the $31,000, Company incurs $10,000 of costs on materials and labor to produce a model that is used to evaluate and resolve the uncertainty concerning the appropriate design. Company also incurs $1,000 of costs using the model to test whether certain features can be integrated into the design of the machine. This $11,000 of costs represents research and development costs in the experimental or laboratory sense.

After uncertainty is eliminated, Company incurs $20,000 to produce the machine for sale to the customer based on the appropriate design. The model produced and used to evaluate and resolve uncertainty is a pilot model. Therefore, the $10,000 incurred to produce the model and the $1,000 incurred on design testing activities qualifies as research or experimental expenditures under Section 174. However, Section 174 does not apply to the $20,000 that Company incurred to produce the machine for sale to the customer based on the appropriate design.[xvii]

Example: Company is a wine producer. Company is researching and developing a new wine production process that involves the use of a different method of crushing the wine grapes. In order to test the effectiveness of the new method of crushing wine grapes, Company incurs $2,000 in labor and materials to conduct the test on this part of the new manufacturing process. The $2,000 of costs represents research and development costs in the experimental or laboratory sense. Therefore, the $2,000 incurred qualifies as research or experimental expenditures under Section 174 because it is a cost incident to the development or improvement of a component of a process.[xviii]

The Technological Information Test

To be “qualified research,” an activity must be undertaken for the purpose of discovering information that is technological in nature. Information is technological in nature if the process of experimentation used to discover such information fundamentally relies on principles of the physical or biological sciences, engineering, or computer science.[xix]

The Business Component Test

The business component test requires that research undertaken to discover information must be intended to be used to develop a new or improved business component of the taxpayer. For these purposes, a business component is “any product, process, computer software, technique, formula, or invention which is . . . held for sale, lease, or license, or . . . used by the taxpayer in . . . [its trade or business.”[xx]

The Process of Experimentation Test

To be “qualified research,” the activity must also meet the process of experimentation test. For these purposes, a process of experimentation is a process designed to evaluate one or more alternatives to achieve a result where the capability or the method of achieving that result, or the appropriate design of that result, is uncertain as of the beginning of the taxpayer’s research activities.[xxi] Generally, federal courts and the IRS break the process of experimentation test down further into three separate elements: (1) the “substantially all” element; (2) the “process of experimentation” element; and (3) the “qualified purpose” element.[xxii] Each of these elements is tested for each separate business component.

To meet the “substantially all” element, at least 80% of the taxpayer’s research activities for each business component, measured on a cost or other reasonable basis, must constitute a process of experimentation for a qualified purpose.[xxiii]

To meet the “process of experimentation” element, the taxpayer must engage in “a process designed to evaluate one or more alternatives to achieve a result” where the taxpayer is uncertain at the beginning of its research activities regarding the capability or method of achieving the result or an appropriate design.[xxiv] The Section 41 regulations further provide:

A process of experimentation must fundamentally rely on the principles of the physical or biological sciences, engineering, or computer sciences and involves the identification of uncertainty concerning the development or improvement of a business component, the identification of one or more alternatives intended to eliminate that uncertainty, and the identification and the conduct of a process of evaluating the alternatives (through, for example, modeling, simulation, or a systematic trial and error methodology). A process of experimentation must be an evaluative process and generally should be capable of evaluating more than one alternative.[xxv]

To meet the “qualified purpose” element, the research process must relate to a new or improved function, performance, reliability or qualify of the business component.[xxvi] Research activities for style, taste, cosmetic, or seasonal design factors do not qualify. And qualified research specifically does not include the following activities:

Research after Commercial Production. Any research conducted after the beginning of commercial production of a business component.
Adaptation of Existing Business Components. Any research related to the adaptation of an existing business component to a particular customer’s requirement or need.
Duplication of Existing Business Component. Any research related to the reproduction of an existing business component (in whole or in part) from a physical examination of the business component itself or from plans, blueprints, detailed specifications, or publicly available information with respect to such business component.
Surveys, Studies, etc.. Any of the following: (i) efficiency survey; (ii) activity relating to management function or technique; (iii) market research, testing, or development (including advertising or promotions); (iv) routine data collection; or (v) routine or ordinary testing or inspection for quality control.
Computer Software. Unless otherwise exempted by regulations, any research with respect to computer software which is developed by (or for the benefit of) the taxpayer primarily for internal use by the taxpayer, other than for use in: (i) an activity which constitutes qualified research, or (ii) a production process with respect to which the requirements of (i) are met.
Foreign Research. Any research conducted outside the United States, the Commonwealth of Puerto Rico, or any possession of the United States.
Social Sciences, Etc. Any research in the social sciences, arts, or humanities.
Funded Research. Any research to the extent funded by any grant, contract, or otherwise by another person (or government entity).[xxvii]

Examples under the Section 41 regulations are helpful in determining whether an activity meets the qualified purpose element:

Example: Company is engaged in the business of developing and manufacturing blue vehicles. Company wants to change the color of its blue vehicles to green. Company obtains from various suppliers several different shades of green paint. Company paints several sample vehicles, and surveys its customers to determine which shade of green the Company’s customers prefer. In this case, the Company’s activities to change the color of its blue vehicles to green are not qualified research because substantially all of Company’s activities are not undertaken for a qualified purpose. All of Company’s research activities are related to style, taste, cosmetic, or seasonal design factors.[xxviii]

Example: Same example as above, except that Company chooses one of the green paints. Company obtains samples of the green paint from a supplier and determines that Company must modify its painting process to accommodate the green paint because the green paint has different characteristics from other paints that Company has used. Company obtains detailed data on the green paint from Company’s paint supplier. Company also consults with the manufacturer of Company’s paint spraying machines. The manufacturer informs Company that Company must acquire a new nozzle that operates with the green paint Company wants to use. Company tests the nozzles to ensure that they work as specified by the manufacturer of the paint spraying machines. Under these new facts, Company’s activities to modify its painting process are a separate business component, and Company’s activities to modify its painting process to change the color of its blue vehicles to green are not qualified research. Company did not conduct a process of evaluating alternatives in order to eliminate uncertainty regarding the modification of its painting process. Rather, the manufacturer of the paint machine eliminated Company’s uncertainty regarding the modification of its painting process. Company’s activities to test the nozzles to determine if the nozzles work as specified by the manufacturer of the paint spraying machines are in the nature of routine or ordinary testing or inspection for quality control.[xxix]

Base Amount

If a taxpayer has qualified research and otherwise meets the requirements of Section 41, the taxpayer must then compute the “base amount”. For these purposes, the “base amount” is defined as the product of (i) the “fixed-base percentage,” and (ii) the average annual gross receipts of the taxpayer for the four tax years preceding the tax year for which the credit is being claimed (i.e., the “credit year.”).[xxx]

Section 41(c)(3)(A) generally defines the “fixed-base percentage” as the percentage of aggregate qualified research expenses of the taxpayer for the taxable year beginning after December 31, 1983, and before January 1, 1989, to the aggregate gross receipts of the taxpayer for such tax years. If the taxpayer had both gross receipts and qualified research expenses after December 31, 1983, the fixed-based percentage is set by statute, starting with 3% for each of the taxpayer’s first five taxable years beginning after December 31, 1993.[xxxi]

Due in part to the complexity of the “base amount” computations, the Code also permits taxpayers to elect an “alternative simplified method.”[xxxii] Under this method, the credit is equal to 14% of so much of the qualified research expenses for the tax year as exceeds 50% of the average qualified research expenses for the three tax years preceding the tax year for which the credit is being determined.

Claiming the R&D Credit

The Section 41 credit has historically been claimed on IRS Form 6765, Credit for Increasing Research Activities. More recently, however, the IRS has indicated that it intends to make it more difficult for taxpayers to claim the credit, particularly for claims made after January 10, 2022. The IRS’s justification for imposing these new requirements is due to its difficulty in ascertaining whether the taxpayer qualifies and a regulation that provides that taxpayers must generally provide sufficient facts to apprise of the IRS of any refund or claim for credit.

Specifically, by regulation, the IRS is not required to issue a refund or credit unless it receives a claim that sets forth in detail each ground upon which the refund or credit is claimed and facts sufficient to apprise the IRS of the exact basis of the refund or credit.[xxxiii] On October 15, 2021, the IRS issued a Field Attorney Advice (“FAA”) that provided additional requirements taxpayers must meet under this regulation to make a valid claim for credit or refund under Section 41.[xxxiv] If the taxpayer fails to meet the requirements, the IRS has indicated that it will deny the refund or credit claim in its entirety as invalid.

Under the FAA, the taxpayer’s refund claim for a research activity credit is valid if, at a minimum, the taxpayer:

Identifies all the business components to which the Section 41 research credit claim relates for that year;
For each business component, the taxpayer identifies all research activities performed; identifies all individuals who performed each research activity; and identifies all the information each individual sought to discover;
Provides the total qualified employee wage expenses, total qualified supply expenses, and total qualified contract research expenses for the claim year (which may be done through using Form 6765);
Must provide a declaration signed under penalties of perjury verifying that the facts provided in the claim are accurate.

The FAA indicates that if the taxpayer fails to meet these requirements, the IRS will reject the claim as deficient.[xxxv]

Conclusion

Every year, taxpayers who qualify for the Section 41 credit fail to claim it. This is somewhat understandable, particularly in light of the difficulties taxpayers face in determining whether they meet each of Section 41’s various statutory and regulatory requirements. However, business owners who engage in new processes and products should consult with a tax professional to determine whether they are leaving money on the table each year in not claiming the tax credit.

Freeman Law Tax Attorneys

Freeman Law aggressively represents clients in tax litigation at both the state and federal levels. When the stakes are high, clients rely on our experience, knowledge, and talent to help them navigate all levels of the tax dispute lifecycle—from audits and examinations to the courtroom and all levels of appeals. Schedule a consultation or call (214) 984-3000 to discuss your tax needs.

[i] All section references are to the Internal Revenue Code of 1986, as amended (the “Code”).

[ii] IRS FAA 20214101F.

[iii] Suder v. Comm’r, T.C. Memo. 2014-201.

[iv] See I.R.C. § 41(b)(1).

[v] I.R.C. § 41(b)(2).

[vi] I.R.C. § 41(b)(2)(D).

[vii] Treas. Reg. § 1.41-2(d)(1).

[viii] Id. at (d)(2).

[ix] I.R.C. § 41(b)(2)(B).

[x] Id. at (c)(3).

[xi] I.R.C. § 41(b)(2)(C).

[xii] I.R.C. § 41(b)(3).

[xiii] I.R.C. § 41(d).

[xiv] Treas. Reg. § 1.174-2(a)(1).

[xv] Id.

[xvi] Id.

[xvii] Treas. Reg. § 1.174-2(a)(11), Ex. 4.

[xviii] Id., Ex. 10.

[xix] Treas. Reg. § 1.41-4(a)(4); see also Max v. Comm’r, T.C. Memo. 2021-37 (quoting legislative history).

[xx] Sec. 41(d)(2)(B).

[xxi] Treas. Reg. § 1.41-4(a)(5).

[xxii] Union Carbide Corp. & Subs. v. Comm’r, T.C. Memo. 2009-50.

[xxiii] Treas. Reg. § 1.41-4(a)(6).

[xxiv] Treas. Reg. § 1.41-4(a)(5).

[xxv] Id.

[xxvi] Id.

[xxvii] I.R.C. § 41(d)(4).

[xxviii] Treas. Reg. § 1.41-4(a)(8), Ex. 1.

[xxix] Id., Ex. 2.

[xxx] I.R.C. § 41(c)(1).

[xxxi] I.R.C. § 41(c)(3).

[xxxii] I.R.C. § 41(c)(4).

[xxxiii] See Treas. Reg. § 301.6402-2(b)(1).

[xxxiv] See FAA 20214101F.

[xxxv] The AICPA has provided comments and concerns to the IRS regarding its implementation of the change in requirements for a valid refund claim for the R&D credit.

ICO Enforcement Actions – U.S. Federal

Subject

Authority

Date

Action

Description

Blockchain of Things, Inc.

Securities and Exchange Commission (SEC)

12/18/2019

Enforcement Action

Blockchain of Things, Inc. (BCOT) settled charges of conducting an unregistered securities offering from December 2017 through July 2018 that raised over $12 million, agreeing to pay a $250,000 civil penalty.

Cease and Desist Order, Securities Act Release No. 10736

Waiver Order

Block.one

Securities and Exchange Commission (SEC)

9/30/2019

Enforcement Action

Block.one settled charges of conducting an unregistered ICO that raised several billion dollars over approximately one year, agreeing to pay a $24 million civil penalty.

Cease and Desist Order, Release No. 10714

SEC Press Release

ICO Rating

Securities and Exchange Commission (SEC)

8/20/2019

Enforcement Action

ICO Rating, an unincorporated organization formed in September 2016 and based in St. Petersburg, Russia, provided review and rating services for entities conducting ICOs, without being registered with the SEC in any capacity. The SEC ordered ICO Rating to cease and desist from violating Section 17(b) of the Securities Act by touting ICOs involving the sale of securities and to pay disgorgement of $100,572, prejudgment interest of $6,426, and a civil money penalty of $162,000.

Cease and Decease Order, Securities Act Release No. 10673

Kik

Securities and

6/4/2019

Enforcement Action

The SEC sued Kik Interactive Inc. for

Exchange

conducting an illegal $100 million securities

Commission

offering of digital tokens in 2017, charging

(SEC)

that Kik sold the tokens to U.S investors without registering their offer and sale.

U.S. Securities and Exchange Commission
v. Kik Interactive Inc., Docket No. 1:19- cv-05244 (S.D.N.Y. Jun 04, 2019)
SEC Press Release

Gladius

Securities and Exchange Commission (SEC)

2/20/2018

Enforcement Action

The SEC and Gladius Network LLC settled charges that Gladius conducted an unregistered securities offering in an ICO in October 2017-February 2018.
Gladius self-reported its ICO in summer 2018 after evaluating the applicability of federal securities laws and cooperated with the SEC to remedy its registration problems, and as a result, the SEC did not assess any civil money penalties.
Cease and Desist Order SEC Press Release
Securities and Exchange Commission v. AriseBank et al, Docket No. 3:18-cv-00186 (N.D. Tex. Jan 25, 2018)

Bitconnect

Federal Bureau of Investigation (FBI)

2/20/2019

Criminal Investigation

The FBI’s Cleveland field office announced on February 20 that it is seeking victims of the cryptocurrency investment scheme Bitconnect, for its investigation into the alleged Ponzi scheme that collapsed in January 2018.
Press Release Questionnaire

AriseBank

Securities and Exchange Commission (SEC)

12/11/2018

Enforcement Action

Two former executives behind the allegedly fraudulent ICO of AriseBank were ordered to pay nearly $2.7 million and prohibited from serving as officers or directors of public companies or participating in future offerings of digital securities.
Final Judgment as to Defendants Jared Rice Sr. and Stanley Ford
SEC Press Release
Securities and Exchange Commission v. AriseBank et al, Docket No. 3:18-cv-00186 (N.D. Tex. Jan 25, 2018)

CoinAlpha

Securities and Exchange Commission (SEC)

12/7/2018

Enforcement Action

CoinAlpha Advisors LLC, which formed the unregistered digital asset investment fund CoinAlpha Falcon LP in October 2017 and raised approximately $600,000 from 22 investors, then voluntarily unwound the fund in October 2017 after being contacted by

Commission staff, agreed to a cease and desist order and paid a $50,000 civil fine.
In the Matter of CoinAlpha Advisors LLC, ReleaseNo. 33-10582

N/A

Securities and Exchange Commission (SEC)

12/3/2018

Speech

SEC Division of Enforcement Co-Director Steven Peikin stated in a speech on international cooperation and SEC enforcement actions that international cooperation is critical to the SEC’s ability to investigate and recommend that the Commission bring enforcement action, citing the example of the emergency asset freeze to halt the PlexCorps ICO fraud in December 2017, and that the SEC continues to work with international authorities to develop pending ICO investigations.
The Salutary Effects of International Cooperation on SEC Enforcement

Celebrity ICO Touting

Securities and Exchange Commission (SEC)

11/29/2018

Enforcement Action

The SEC concluded its first cases to charge touting violations involving ICOs, reaching settlements with professional boxer Floyd Mayweather Jr. and music producer Khaled Khaled (known as DJ Khaled) for failing to disclose payments they received for promoting investments in ICOs.
Mayweather and Khaled each received individual cease and desist orders and agreed to pay disgorgement, penalties and interest. Mayweather agreed to pay
$300,000 in disgorgement, a $300,000 penalty, and $14,775 in prejudgment interest. Khaled agreed to pay $50,000 in disgorgement, a $100,000 penalty, and
$2,725 in prejudgment interest. In addition, Mayweather agreed not to promote any securities, digital or otherwise, for three years, and Khaled agreed to a similar ban for two years. Mayweather also agreed to continue to cooperate with the investigation.
In the Matter of Floyd Mayweather Jr., Order Instituting Cease-and-Desist Proceedings
In the Matter of Khaled Khaled, Order Instituting Cease-and-Desist Proceedings
SEC Press Release: Two Celebrities Charged With Unlawfully Touting Coin Offerings

Blockvest

United States District Court

11/27/2018

Denial of Motion for Preliminary

Ruling on a motion for preliminary injunction by the SEC in its enforcement action

for the Southern District of California
Securities and Exchange Commission (SEC)

Injunction

against Blockvest LLC and its founder, Reginald Buddy Ringgold, III, Securities and Exchange Commission vs. Blockvest, LLC et al, Docket No. 3:18-cv-02287 (S.D. Cal. Oct. 3, 2018), the U.S. District Court for the Southern District of California denied the motion, holding that whether tokens issued in Blockvest’s ICO were securities could not be determined by the court because there were disputed issues of fact.

Order Denying Plaintiff’s Motion for Preliminary Injunction

Airfox Paragon Coin

Securities and Exchange Commission (SEC)

11/16/2018

Enforcement Action

The SEC imposed its first civil penalties for failures to register ICOs as securities, announcing settled charges against CarrierEQ Inc. (Airfox) and Paragon Coin Inc, two companies that sold digital tokens in ICOs without registering the tokens as securities after the Commission warned that ICOs can be securities offerings in its DAO Report of Investigation.

Airfox Cease and Desist Order

Paragon Coin Cease and Desist Order

SEC Press Release: Two ICO Issuers Settle SEC Registration Charges, Agree to Register Tokens as Securities

Blockvest

Securities and Exchange Commission (SEC)

10/3/2018

Enforcement Action

The SEC obtained an emergency court order that halted a planned ICO which backers falsely claimed was approved by the SEC and also halted ongoing pre-ICO sales by the company, Blockvest LLC and its founder, Reginald Buddy Ringgold, III.

The SEC alleged that the defendants had promoted the ICO with false claims of SEC approval, false claims of approval by a fake agency called the “Blockchain Exchange Commission” that used a graphic similar to the SEC seal and the same address as SEC headquarters, and misrepresentations of connections to a well-known accounting firm, and that they continued their fraudulent conduct even after the National Futures Association (NFA) sent them a cease and desist letter to stop them from using the NFA seal and from making false claims about their status with the NFA.

Securities and Exchange Commission vs. Blockvest, LLC et al, Docket No. 3:18-
cv-02287 (S.D. Cal. Oct. 3, 2018)

Complaint

Press Release: SEC Stops Fraudulent ICO That Falsely Claimed SEC Approval

Diamonds Trading Investment House / First Options Trading

Commodity Futures Trading Commission (CFTC)

9/28/2018

Enforcement Action

The CFTC charged defendants Morgan Hunt, doing business as Diamonds Trading Investment House, and Kim Hecroft, doing business as First Options Trading, with fraudulent solicitation and other fraud. The CFTC alleged that the defendants engaged in a fraudulent scheme to solicit Bitcoin from members of the public, through false or misleading representations or omissions, to invest in trading products including leveraged or margined foreign currency contracts, binary options, and diamonds.
The CFTC alleged that the defendants impersonated a CFTC investigator and forged documents purportedly authored by the CFTC’s General Counsel and bearing the image of the CFTC’s official Seal as part of their fraudulent scheme.
Commodity Futures Trading Commission vs. Doe 1 et al, Docket No. 4:18-cv-00807 (N.D. Tex. Sept. 28, 2018)
Complaint
Press Release: CFTC Charge Two Defendants with Fraudulent Solicitation, Impersonation of a CFTC Investigator, and Forging CFTC Documents, All in Attempt to Steal Bitcoin

My Big Coin

U.S. District Court for the District of Massachusetts

9/26/2018

Court Opinion

The U.S. District Court for the District of Massachusetts denied a motion to dismiss the case brought by the CFTC in Commodity Futures Trading Commission v. My Big Coin Pay, Inc. et al, 1:18-cv-10077- RWZ (D. Mass. Jan. 16, 2018), in part by rejecting the argument that the allegedly fraudulent virtual currency My Big Coin was not a “commodity” within the meaning of the Commodity Exchange Act.
Commodity Futures Trading Commission v. My Big Coin Pay, Inc. et al, 1:18-cv-10077- RWZ, 2018 BL 349103 (D. Mass. Sept. 26,
2018).

TokenLot

Securities and Exchange Commission (SEC)

9/11/2018

Enforcement Action

The SEC and TokenLot LLC, a self- described “ICO Superstore,” and its owners settled charges that they acted as unregistered broker-dealers. This case was the SEC’s first charging unregistered
broker-dealers for selling digital tokens after the SEC issued The DAO Report in 2017, cautioning that those who offer and sell

digital securities must comply with the federal securities laws.
In the Matter of TokenLot, LLC, Lenny Kugel, and Eli L. Lewitt, Release Nos. 33-10543, 34-84075, IC-33221, File No.
3-18739 (September 11, 2018)
Press Release No. 2018-185, SEC Charges ICO Superstore and Owners With Operating As Unregistered Broker-Dealers

REcoin and Diamond Reserve Club

U.S. District Court for the Eastern District of New York

9/11/2018

Judicial Holding

The U.S. District Court for the Eastern District of New York held after “the parties engage[d] in a spirited debate that is undoubtedly premature” that “a reasonable jury could conclude that the facts alleged in the indictment satisfy the Howey test,” and that the question of whether the tokens issued in the ICOs in question were actually securities is a factual issue for a jury.
United States v. Zaslavskiy, No. 17-CR-647 (RJD) (E.D.N.Y. Sep. 11, 2018)

Crypto Asset Management

Securities and Exchange Commission (SEC)

9/11/2018

Enforcement Action

Crypto Asset Management (CAM) and its founder and sole principal consented to a cease and desist order and a civil money penalty of $200,000 in an SEC enforcement action.
CAM and Enneking had formed Crypto Asset Fund, LLC (CAF), a pooled investment vehicle investing in digital assets that had never registered with the SEC. CAM and Enneking had misrepresented to actual and prospective investors that CAF was the “first regulated crypto asset fund in the United States” and had filed a registration statement with the SEC.
In the Matter of Crypto Asset Management, LP and Timothy Enneking, Securities Act Release No. 10544, Investment Advisers Act Release No. 5004, Investment Company Act Release No. 33222, Administrative Proceeding File No. 3-18740

CabbageTech

Commodity Futures Trading Commission (CFTC)

8/23/2018

Enforcement Action

After a four day bench trial, on August 23 the U.S. District Court for the Eastern District of New York ordered Patrick K. McDonnell and Cabbage Tech, Corp. d/b/a Coin Drop Markets (CDM) to pay over $1.1 million in civil monetary penalties and restitution.
The court issued a 139 page memorandum describing CDM’s deceptive and fraudulent virtual currency scheme and relevant law.

CFTC filed the action on January 18, 2018, and the court had previously entered a preliminary injunction against the defendants.
CFTC Wins Trial against Virtual Currency Fraudster

Tomahawkcoin

Securities and Exchange Commission (SEC)

8/14/2018

Enforcement Action

The SEC obtained permanent officer-and- director and penny stock bars against David
T. Laurance, founder of Tomahawk Exploration LLC, for attempting to raise money through the sale of “Tomahawkcoin” tokens.
Promotional materials used inflated projections of oil production that were contradicted by the company’s own internal analysis and misleadingly suggested that Tomahawk possessed leases for drilling sites when it did not, and the materials described Laurance as having a “flawless background” without disclosing his prior criminal conviction for his role in fraudulent securities offerings. Tomahawk claimed that token owners would be able to convert Tomahawkcoins into equity and potentially profit from the anticipated oil production and secondary trading of the tokens. Although the ICO failed to raise money, Tomahawk issued tokens through a “Bounty Program” in exchange for online promotional services.
Without admitting or denying the SEC’s findings, Tomahawk and Laurance consented to a cease and desist order, and Laurance consented to an officer and director bar, penny stock bar, and a
$30,000 penalty.
In the Matter of Tomahawk Exploration LLC and David Thompson Laurance, Securities Act Release No. 10530, Securities Exchange Act Release No. 83839, Administrative Proceeding File No. 3-18641
SEC Bars Perpetrator of Initial Coin Offering Fraud

Titanium Blockchain Infrastructure Services Inc.

Securities and Exchange Commission (SEC)

5/22/2018

Enforcement Action

The SEC filed a complaint charging that Titanium Blockchain Infrastructure Services Inc. and its president Michael Allen Stollery, aka Michael Stollaire, lied about business relationships with the Federal Reserve and dozens of well-known firms in the promotion of an ICO by Titanium Blockchain that raised as much as $21 million from investors in and outside the U.S. The SEC obtained a court order on May 29 halting

the ongoing fraud and approving an emergency asset freeze and appointment of a receiver for Titanium Blockchain.
Securities and Exchange Commission v. Titanium Blockchain Infrastructure Services Inc. et al, Docket No. 2:18-cv-04315 (C.D.Ca. May 22, 2018)
SEC Obtains Emergency Order Halting Fraudulent Coin Offering Scheme

Centra Tech

Department of Justice

4/20/2018

Criminal Charges

The U.S. Attorney for the Southern District of New York unsealed a criminal complaint charging Raymond Trapani, the third co- founder of Central Tech, Inc., with securities fraud and wire fraud offenses in connection with a scheme to induce victims to invest more than $25 million in investments through material misrepresentations and omissions in connection with an ICO. Trapani was arrested and presented before the U.S. District Court for the Southern District of Florida, and the criminal complaint was removed from the Southern District of New York.
USA v. Trapani, Docket No. 0:18-mj-06195 (S.D.Fla. Apr 20, 2018)
Third Co-Founder Of Cryptocurrency Company Charged In Manhattan Federal Court With Scheme To Defraud Investors

Longfin Corp.

Securities and Exchange Commission (SEC)

4/4/2018

Enforcement Action

The SEC alleged violations of Section 5 of the Securities Act by Longfin Corp.; founder and CEO Venkata Meenavalli; Amro Izzelden Altahawi, president of a company operating a Reg A+ offerings platform website; Suresh Tammineedi, an affiliate of Meenavalli; and Dorababu Penumarthi, an affiliate of Meenavalli, by selling unregistered securities without an applicable exemption from December 2017 through March 2018. The complaint sought
(1) an order imposing an asset freeze on Altahawi, Tammineedi, and Penumarthi, directing an accounting and expedited discovery against all defendants, and directing the repatriation of all profits from the illegal stock transactions, (2) an order directing service of the summons and complaint upon the defendants, (3) an order against all defendants imposing a preliminary injunction against future violations of Section 5 of the Securities Act,
(4) an order finding that the defendants violated Section 5 of the Securities Act, (5) an order permanently enjoining the

defendants from future violations of Section 5 of the Securities Act, (6) an order for the defendants to disgorge all of the ill-gotten gains derived from the illegal stock transactions, (7) an order for the defendants to pay civil penalties pursuant to Section 20(d) of the Securities Act, and (8) an order granting such other relief as the court may deem just and proper.
Securities and Exchange Commission v. Longfin Corp. et al, Docket No. 1:18-
cv-02977 (S.D.N.Y. April 4, 2018)
SEC Obtains Emergency Freeze of $27 Million in Stock Sales of Purported Cryptocurrency Company Longfin

Centra Tech

Securities and Exchange Commission (SEC)

4/2/2018

Criminal Charges

The SEC charged two co-founders of a purported financial services start-up with orchestrating a fraudulent ICO that raised more than $32 million from thousands of investors in 2017. The co-founders of Centra Tech Inc., Sohrab Sharma and Robert Farkas, conducted a fraudulent ICO in which Centra offered and sold unregistered investments through a “CTR Token.” The SEC filed a criminal complaint for violations of the anti-fraud and registration provisions of the federal securities laws against Sharma and Farkas, and in a parallel action, the U.S. Attorney’s Office for the Southern District of New York announced criminal charges against them.
USA v. Sharma et al, Docket No. 0:18- mj-06165 (S.D. Fla. Apr 02, 2018)
USA v. Farkas, Docket No. 0:18-mj-06166 (S.D. Fla. Apr 02, 2018)
Two Co-Founders Of Cryptocurrency Company Charged In Manhattan Federal Court With Scheme To Defraud Investors
Securities and Exchange Commission v. Sharma et al, Docket No. 1:18-cv-02909 (S.D.N.Y. Apr 02, 2018)
Press Release: SEC Halts Fraudulent Scheme Involving Unregistered ICO
Press Release: SEC Charges Additional Defendant in Fraudulent ICO Scheme

Three Companies Claiming Cryptocurrency

Securities and Exchange Commission (SEC)

2/16/2018

Trading Suspensions

The SEC suspended trading in three companies amid questions surrounding similar statements they made about the acquisition of cryptocurrency and

and Blockchain Asset Acquisitions

blockchain technology-related assets. The SEC’s trading suspension orders stated that recent press releases issued by Cherubim Interests Inc. (CHIT), PDX Partners Inc. (PDXP), and Victura Construction Group Inc. (VICT) claimed that CHIT, PDXP, and VICT acquired AAA-rated assets from a subsidiary of a private equity investor in cryptocurrency and blockchain technology among other things. According to the SEC order regarding CHIT, it also announced the execution of a financing commitment to launch an ICO.
Trading Suspension Order – Cherubim Interests, Inc.
Trading Suspension Order – PDX Partners Inc.
Trading Suspension Order – Victura Construction Group Inc.
Press Release: SEC Suspends Trading in Three Issuers Claiming Involvement in Cryptocurrency and Blockchain Technology

AriseBank

Securities and Exchange Commission (SEC)

1/25/2018

Court Order Halting ICO

The SEC obtained a court order halting an allegedly fraudulent ICO that targeted retail investors to fund what it claimed to be the world’s first “decentralized bank.” Dallas- based AriseBank used social media, a celebrity endorsement, and other wide dissemination tactics to raise what it claimed to be $600 million of its $1 billion goal in just two months. AriseBank and its co-founders Jared Rice Sr. and Stanley Ford allegedly offered and sold unregistered investments in their purported “AriseCoin” cryptocurrency by depicting AriseBank as a first-of-its-kind decentralized bank offering a variety of consumer-facing banking products and services using more than 700 different virtual currencies. AriseBank’s sales pitch claimed that it developed an algorithmic trading application that automatically trades in various cryptocurrencies. The SEC alleges that AriseBank falsely stated that it purchased an FDIC-insured bank which enabled it to offer customers FDIC-insured accounts and that it also offered customers the ability to obtain an AriseBank-branded VISA card to spend any of the 700-plus cryptocurrencies. AriseBank also allegedly omitted to disclose the criminal background of key executives. The SEC sought the appointment of a receiver in connection with an ICO fraud for the first time.

Securities and Exchange Commission v. AriseBank et al, Docket No. 3:18-cv-00186
Press Release No. 2018-8, SEC Halts Alleged Initial Coin Offering Scam

CabbageTech

Commodity Futures Trading Commission (CFTC)

1/18/2018

Enforcement Action

The CFTC filed a civil enforcement action against Patrick K. McDonnell and CabbageTech, Corp. d/b/a Coin Drop Markets (CDM), charging them with fraud and misappropriation in connection with purchases and trading of Bitcoin and Litecoin.
Commodity Futures Trading Commission v. McDonnell et al 1:18-cv-00361 (E.D.NY Jan. 18, 2018)
Press Release 7675-18, CFTC Charges Patrick K. McDonnell and His Company CabbageTech, Corp. d/b/a Coin Drop Markets with Engaging in Fraudulent Virtual Currency Scheme

My Big Coin

Commodity Futures Trading Commission (CFTC)

1/16/2018

Enforcement Action

The CFTC charged My Big Coin Pay, Inc. and individual defendants in New York, Michigan and Nevada with commodity fraud and misappropriation related to the sale of the virtual currency My Big Coin from at least January through January 2018.
Commodity Futures Trading Commission v. My Big Coin Pay, Inc. et al 1:18-cv-10077- RWZ
Press Release 7678-18, CFTC Charges Randall Crater, Mark Gillespie, and My Big Coin Pay, Inc. with Fraud and Misappropriation in Ongoing Virtual Currency Scam

Munchee, Inc.

Securities and Exchange Commission (SEC)

12/11/2017

Order Finding Unregistered Securities Offer and Sale

A company selling digital tokens to investors halted its ICO after the SEC contacted it and agreed to an order in which the SEC found that its conduct constituted unregistered securities offers and sales.
In the Matter of Munchee Inc., Release No. 33-10445, File No. 3-18304
Press Release No. 2017-227, Company Halts ICO After SEC Raises Registration Concerns

PlexCorps

Securities and Exchange Commission (SEC)

12/4/2017

Enforcement Action

The SEC’s Cyber Unit filed its first charges against a repeated securities law violator in Quebec and his company that were conducting an ICO that had raised up to
$15 million from thousands of investors

since August 2017 by falsely promising a 13-fold profit in less than a month. An emergency court order froze the assets of the company, its owner, and the owner’s partner. The SEC charged them with violation of the anti-fraud provisions and the registration provision of the U.S. federal securities laws.
The Autorité Des Marchés Financiers (AMF) of Quebec assisted the SEC with the investigation and initiated its own action against PlexCorps in August 2017.
SEC v. PlexCorps, E.D.N.Y. 1:17-cv-07007- CBA-RML, 12/1/17
Press Release No. 2017-219, SEC Emergency Action Halts ICO Scam

REcoin Group Foundation, LLC

Department of Justice (DOJ)

10/27/2017

Enforcement Action

DOJ charged Maksim Zaslavskiy with securities fraud conspiracy in connection with engaging in illegal unregistered securities offerings and fraudulent conduct and misstatements designed to deceive investors as part of two ICOs conducted through two of his companies, REcoin Group Foundation, LLC (REcoin) and DRC World, Inc.
USA v. Zaslavskiy, E.D.N.Y., 1:17-cr-00647
Brooklyn Businessman Charged with Fraud in Connection With Two Initial Coin Offerings

REcoin Group Foundation, LLC

Securities and Exchange Commission (SEC)

9/29/2017

Enforcement Action

The SEC alleged that a man in Brooklyn,
N.Y. named Maxim Zaslavskiy and his two companies defrauded investors in ICOs purportedly backed by investments in real estate and diamonds, which were sales of unregistered securities in companies with no real operations.
SEC v. REcoin Group Foundation, LLC, E.D.N.Y., 1:17-cv-5725
Press Release No. 2017-185, SEC Exposes Two Initial Coin Offerings Purportedly Backed by Real Estate and Diamonds

Cryptocurrency Taxation: Frequently Asked Questions

Frequently Asked Questions on Cryptocurrency Taxation

Freeman Law Webinar Archive: Cryptocurrency and Blockchain Taxation and Regulation

Cryptocurrency taxation continues to raise interesting, sometimes intractable questions. But while taxpayers are required to report and pay taxes on income from virtual currency use, the IRS has, to date, issued very limited guidance on tax compliance when it comes to virtual currencies.

Nonetheless, in July of 2019, the IRS began sending out thousands of letters to taxpayers with virtual currency activity informing them that they have potential tax obligations. Authorities have widely viewed this effort as the beginning of a much wider IRS enforcement push.

While there is no statutory definition for virtual currency, IRS guidance has described virtual currency as a digital representation of value that functions as a medium of exchange, a unit of account, or a store of value. A cryptocurrency is a type of virtual currency that employs encryption technology and operates on distributed ledger technology, such as blockchain. Distributed ledger technology allows for users across a computer network to verify the validity of transactions potentially without a central authority. For example, a blockchain is made up of digital information (blocks) recorded in a public or private database in the format of a distributed ledger (chain). The ledger permanently records, in a chain of cryptographically secured blocks, the history of transactions that take place among the participants in the network.

Taxpayers with cryptocurrency activities may have tax-reporting obligations as a result of that activity.

The IRS recently issued guidance in the form of Frequently Asked Questions (“FAQs”) that provide insight into its current positions and thinking with respect to cryptocurrency and its treatment for federal tax purposes. Readers should keep in mind, however, that FAQs are not legally binding on the IRS. They are not, for example, published in the Internal Revenue Bulletin (IRB), and the IRS has stated that only guidance published in the IRB is IRS’s authoritative interpretation of the law. Nonetheless, they provide helpful guideposts for understanding the IRS’s position on virtual currency taxation.

A number of frequent questions and the IRS’s current position are set forth below:

Q1. What is virtual currency?

A1. The IRS describes “virtual currency” as “a digital representation of value, other than a representation of the U.S. dollar or a foreign currency (“real currency”), that functions as a unit of account, a store of value, and a medium of exchange.” The IRS provides that some virtual currencies are convertible, which means that they have an equivalent value in real currency or act as a substitute for real currency. The IRS uses the term “virtual currency” to describe the various types of convertible virtual currency that are used as a medium of exchange, such as digital currency and cryptocurrency. Regardless of the label applied, under the IRS’s interpretation, if a particular asset has the characteristics of virtual currency, it will be treated as virtual currency for Federal income tax purposes.

Q2. How is virtual currency treated for Federal income tax purposes?

A2. Under the IRS’s current guidance, virtual currency is treated as property and general tax principles applicable to property transactions apply to transactions using virtual currency. For more information on the tax treatment of virtual currency, see Notice 2014-21.

Q3. What is cryptocurrency?

A3. Cryptocurrency is a type of virtual currency that uses cryptography to secure transactions that are digitally recorded on a distributed ledger, such as a blockchain. A transaction involving cryptocurrency that is recorded on a distributed ledger is referred to as an “on-chain” transaction; a transaction that is not recorded on the distributed ledger is referred to as an “off-chain” transaction.

Q4. Will I recognize a gain or loss when I sell my virtual currency for real currency?

A4. Yes. When you sell virtual currency, the IRS requires that you recognize any capital gain or loss on the sale, subject to any limitations on the deductibility of capital losses.

Q5. How do I determine if my gain or loss is a short-term or long-term capital gain or loss?

A5. If you held the virtual currency for one year or less before selling or exchanging the virtual currency, assuming that it was a “capital” asset, then you will have a short-term capital gain or loss. If you held the virtual currency for more than one year before selling or exchanging it, then you will have a long-term capital gain or loss. The period during which you held the virtual currency (known as the “holding period”) begins on the day after you acquired the virtual currency and ends on the day you sell or exchange the virtual currency.

Q6. How do I calculate my gain or loss when I sell virtual currency for real currency?

A6. Your gain or loss will be the difference between your adjusted basis in the virtual currency and the amount you received in exchange for the virtual currency, which you should report on your Federal income tax return in U.S. dollars.

Q7. How do I determine my basis in virtual currency I purchased with real currency?

A7. Your basis (also known as your “cost basis”) is the amount you spent to acquire the virtual currency, including fees, commissions, and other acquisition costs in U.S. dollars. Your adjusted basis is your basis increased by certain expenditures and decreased by certain deductions or credits in U.S. dollars.

Q8. Do I have income if I provide someone with a service and that person pays me with virtual currency?

A8. Yes. When you receive property, including virtual currency, in exchange for performing services, whether or not you perform the services as an employee, you recognize ordinary income.

Q9. Does virtual currency received by an independent contractor for performing services constitute self-employment income?

A9. Yes. Generally, self-employment income includes all gross income derived by an individual from any trade or business carried on by the individual as other than an employee. Consequently, the fair market value of virtual currency received for services performed as an independent contractor, measured in U.S. dollars as of the date of receipt, constitutes self-employment income and is subject to the self-employment tax.

Q10. Does virtual currency paid by an employer as remuneration for services constitute wages for employment tax purposes?

A10. Yes. Generally, the medium in which remuneration for services is paid is immaterial to the determination of whether the remuneration constitutes wages for employment tax purposes. Consequently, the fair market value of virtual currency paid as wages, measured in U.S. dollars at the date of receipt, is subject to Federal income tax withholding, Federal Insurance Contributions Act (FICA) tax, and Federal Unemployment Tax Act (FUTA) tax and must be reported on Form W-2, Wage, and Tax Statement.

Q11. How do I calculate my income if I provide a service and receive payment in virtual currency?

A11. The amount of income you must recognize is the fair market value of the virtual currency, in U.S. dollars when received. In an on-chain transaction, you receive the virtual currency on the date and at the time the transaction is recorded on the distributed ledger.

Q12. How do I determine my basis in virtual currency I receive for the services I’ve provided?

A12. If, as part of an arm’s length transaction, you provided someone with services and received virtual currency in exchange, your basis in that virtual currency is the fair market value of the virtual currency, in U.S. dollars, when the virtual currency is received.

Q13. Will I recognize a gain or loss if I pay someone with virtual currency for providing me with a service?

A13. Yes. If you pay for a service using virtual currency that you hold as a capital asset, then you have exchanged a capital asset for that service and will have a capital gain or loss.

Q14. How do I calculate my gain or loss when I pay for services using virtual currency?

A14. Your gain or loss is the difference between the fair market value of the services you received and your adjusted basis in the virtual currency exchanged.

Q15. Will I recognize a gain or loss if I exchange my virtual currency for other property?

A15. Yes. If you exchange virtual currency held as a capital asset for other property, including for goods or for another virtual currency, you will recognize a capital gain or loss.

Q16. How do I calculate my gain or loss when I exchange my virtual currency for other property?

A16. Your gain or loss is the difference between the fair market value of the property you received and your adjusted basis in the virtual currency exchanged.

Q17. How do I determine my basis in property I’ve received in exchange for virtual currency?

A17. If, as part of an arm’s length transaction, you transferred virtual currency to someone and received other property in exchange, your basis in that property is its fair market value at the time of the exchange.

Q18. Will I recognize a gain or loss if I sell or exchange property (other than U.S. dollars) for virtual currency?

A18. Yes. If you transfer property held as a capital asset in exchange for virtual currency, you will recognize a capital gain or loss. If you transfer property that is not a capital asset in exchange for virtual currency, you will recognize an ordinary gain or loss.

Q19. How do I calculate my gain or loss when I exchange property for virtual currency?

A19. Your gain or loss is the difference between the fair market value of the virtual currency when received (in general, when the transaction is recorded on the distributed ledger) and your adjusted basis in the property exchanged.

Q20. How do I determine my basis in virtual currency that I have received in exchange for property?

A20. If, as part of an arm’s length transaction, you transferred property to someone and received virtual currency in exchange, your basis in that virtual currency is the fair market value of the virtual currency, in U.S. dollars, when the virtual currency is received.

Q21. One of my cryptocurrencies went through a hard fork but I did not receive any new cryptocurrency. Do I have income?

A21. A hard fork occurs when a cryptocurrency undergoes a protocol change resulting in a permanent diversion from the legacy distributed ledger. This may result in the creation of a new cryptocurrency on a new distributed ledger in addition to the legacy cryptocurrency on the legacy distributed ledger. According to current IRS guidance, if your cryptocurrency went through a hard fork, but you did not receive any new cryptocurrency, whether by airdrop (a distribution of cryptocurrency to multiple taxpayers’ distributed ledger addresses) or some other kind of transfer, you don’t have taxable income.

Q22. One of my cryptocurrencies went through a hard fork followed by airdrop and I received new cryptocurrency. Do I have income?

A22. According to current IRS guidance, if a hard fork is followed by airdrop and you receive new cryptocurrency, you will have taxable income in the taxable year you receive that cryptocurrency.

Q23. How do I calculate my income from cryptocurrency I received following a hard fork?

A23. According to current IRS guidance, when you receive cryptocurrency from an airdrop following a hard fork, you will have ordinary income equal to the fair market value of the new cryptocurrency when it is received, which is when the transaction is recorded on the distributed ledger, provided you have dominion and control over the cryptocurrency so that you can transfer, sell, exchange, or otherwise dispose of the cryptocurrency.

Q24. How do I determine my basis in cryptocurrency I received following a hard fork?

A24. According to current IRS guidance, if you receive cryptocurrency from an airdrop following a hard fork, your basis in that cryptocurrency is equal to the amount you included in income on your Federal income tax return. The amount included in income is the fair market value of the cryptocurrency when you received it. You have received the cryptocurrency when you can transfer, sell, exchange, or otherwise dispose of it, which is generally the date and time the airdrop is recorded on the distributed ledger. See Rev. Rul. 2019-24 (PDF).

Q25. I received cryptocurrency through a platform for trading cryptocurrency; that is, through a cryptocurrency exchange. How do I determine the cryptocurrency’s fair market value at the time of receipt?

A25. If you receive cryptocurrency in a transaction facilitated by a cryptocurrency exchange, the value of the cryptocurrency is the amount that is recorded by the cryptocurrency exchange for that transaction in U.S. dollars. If the transaction is facilitated by a centralized or decentralized cryptocurrency exchange but is not recorded on a distributed ledger or is otherwise an off-chain transaction, then the fair market value is the amount the cryptocurrency was trading for on the exchange at the date and time the transaction would have been recorded on the ledger if it had been an on-chain transaction.

Q26. I received cryptocurrency in a peer-to-peer transaction or some other type of transaction that did not involve a cryptocurrency exchange. How do I determine the cryptocurrency’s fair market value at the time of receipt?

A26. If you receive cryptocurrency in a peer-to-peer transaction or some other transaction not facilitated by a cryptocurrency exchange, the fair market value of the cryptocurrency is determined as of the date and time the transaction is recorded on the distributed ledger or would have been recorded on the ledger if it had been an on-chain transaction. The IRS will accept as evidence of fair market value the value as determined by a cryptocurrency or blockchain explorer that analyzes worldwide indices of a cryptocurrency and calculates the value of the cryptocurrency at an exact date and time. If you do not use an explorer value, you must establish that the value you used is an accurate representation of the cryptocurrency’s fair market value.

Q27. I received cryptocurrency that does not have a published value in exchange for property or services. How do I determine the cryptocurrency’s fair market value?

A27. When you receive cryptocurrency in exchange for property or services, and that cryptocurrency is not traded on any cryptocurrency exchange and does not have a published value, then the fair market value of the cryptocurrency received is equal to the fair market value of the property or services exchanged for the cryptocurrency when the transaction occurs.

Q28. When does my holding period start for cryptocurrency I receive?

A28. Your holding period begins the day after it is received.

Q29. Do I have income when a soft fork of cryptocurrency I own occurs?

A29. No. A soft fork occurs when a distributed ledger undergoes a protocol change that does not result in a diversion of the ledger and thus does not result in the creation of a new cryptocurrency. Because soft forks do not result in you receiving new cryptocurrency, you will be in the same position you were in prior to the soft fork, meaning that the soft fork will not result in any income to you.

Q30. I received virtual currency as a bona fide gift. Do I have income?

A30. No. If you receive virtual currency as a bona fide gift, you will not recognize income until you sell, exchange, or otherwise dispose of that virtual currency.

Q31. How do I determine my basis in virtual currency that I received as a bona fide gift?

A31. Your basis in virtual currency received as a bona fide gift differs depending on whether you will have a gain or a loss when you sell or dispose of it. For purposes of determining whether you have a gain, your basis is equal to the donor’s basis, plus any gift tax the donor paid on the gift. For purposes of determining whether you have a loss, your basis is equal to the lesser of the donor’s basis or the fair market value of the virtual currency at the time you received the gift. If you do not have any documentation to substantiate the donor’s basis, then your basis is zero.

Q32. What is my holding period for virtual currency that I received as a gift?

A32. Your holding period in virtual currency received as a gift includes the time that the virtual currency was held by the person from whom you received the gift. However, if you do not have documentation substantiating that person’s holding period, then your holding period begins the day after you receive the gift.

Q33. If I donate virtual currency to a charity, will I have to recognize income, gain, or loss?

A33. If you donate virtual currency to a charitable organization described in Internal Revenue Code Section 170(c), you will not recognize income, gain, or loss from the donation.

Q34. How do I calculate my charitable contribution deduction when I donate virtual currency?

A34. Your charitable contribution deduction is generally equal to the fair market value of the virtual currency at the time of the donation if you have held the virtual currency for more than one year. If you have held the virtual currency for one year or less at the time of the donation, your deduction is the lesser of your basis in the virtual currency or the virtual currency’s fair market value at the time of the contribution.

Q35. When my charitable organization accepts virtual currency donations, what are my donor acknowledgment responsibilities? (12/2019)

A35. A charitable organization can assist a donor by providing the contemporaneous written acknowledgment that the donor must obtain if claiming a deduction of $250 or more for the virtual currency donation.

A charitable organization is generally required to sign the donor’s Form 8283, Noncash Charitable Contributions, acknowledging receipt of charitable deduction property if the donor is claiming a deduction of more than $5,000 and if the donor presents the Form 8283 to the organization for the signature to substantiate the tax deduction. The signature of the donee on Form 8283 does not represent concurrence in the appraised value of the contributed property. The signature represents an acknowledgment of receipt of the property described in Form 8283 on the date specified and that the donee understands the information reporting requirements imposed by section 6050L on dispositions of the donated property (see discussion of Form 8282 in FAQ 36).

Q36. When my charitable organization accepts virtual currency donations, what are my IRS reporting requirements? (12/2019)

A36. A charitable organization that receives virtual currency should treat the donation as a noncash contribution. Tax-exempt charity responsibilities include the following:

Charities report non-cash contributions on a Form 990-series annual return and its associated Schedule M, if applicable. Refer to the Form 990 and Schedule M instructions for more information.
Charities must file Form 8282, Donee Information Return, if they sell, exchange or otherwise dispose of charitable deduction property (or any portion thereof) – such as the sale of virtual currency for real currency as described in FAQ #4 – within three years after the date they originally received the property and give the original donor a copy of the form.

Q37. Will I have to recognize income, gain, or loss if I own multiple digital wallets, accounts, or addresses capable of holding virtual currency and transfer my virtual currency from one to another?

A37. No. If you transfer virtual currency from a wallet, address, or account belonging to you, to another wallet, address, or account that also belongs to you, then the transfer is a non-taxable event, even if you receive an information return from an exchange or platform as a result of the transfer.

Q38. I own multiple units of one kind of virtual currency, some of which were acquired at different times and have different basis amounts. If I sell, exchange, or otherwise dispose of some units of that virtual currency, can I choose which units are deemed sold, exchanged, or otherwise disposed of?

A38. Yes. You may choose which units of virtual currency are deemed to be sold, exchanged, or otherwise disposed of if you can specifically identify which unit or units of virtual currency are involved in the transaction and substantiate your basis in those units.

Q39. How do I identify a specific unit of virtual currency?

A39. You may identify a specific unit of virtual currency either by documenting the specific unit’s unique digital identifier such as a private key, public key, and address, or by records showing the transaction information for all units of a specific virtual currency, such as Bitcoin, held in a single account, wallet, or address. This information must show (1) the date and time each unit was acquired, (2) your basis and the fair market value of each unit at the time it was acquired, (3) the date and time each unit was sold, exchanged, or otherwise disposed of, and (4) the fair market value of each unit when sold, exchanged, or disposed of, and the amount of money or the value of property received for each unit.

Q40. How do I account for a sale, exchange, or other disposition of units of virtual currency if I do not specifically identify the units?

A40. If you do not identify specific units of virtual currency, the units are deemed to have been sold, exchanged, or otherwise disposed of in chronological order beginning with the earliest unit of the virtual currency you purchased or acquired; that is, on a first-in, first-out (FIFO) basis.

Q41. If I engage in a transaction involving virtual currency but do not receive a payee statement or information return such as a Form W-2 or Form 1099, when must I report my income, gain, or loss on my Federal income tax return?

A41. You must report income, gain, or loss from all taxable transactions involving virtual currency on your Federal income tax return for the taxable year of the transaction, regardless of the amount or whether you receive a payee statement or information return.

Q42. Where do I report my capital gain or loss from virtual currency?

A42. You must report most sales and other capital transactions and calculate capital gain or loss in accordance with IRS forms and instructions, including on Form 8949, Sales and Other Dispositions of Capital Assets, and then summarize capital gains and deductible capital losses on Form 1040, Schedule D, Capital Gains and Losses.

Q43. Where do I report my ordinary income from virtual currency?

A43. You must report ordinary income from virtual currency on Form 1040, U.S. Individual Tax Return, Form 1040-SS, Form 1040-NR, or Form 1040, Schedule 1, Additional Income and Adjustments to Income (PDF), as applicable.

Q44. Where can I find more information about the tax treatment of virtual currency?

A44. Information on virtual currency is available at Virtual Currencies. Many questions about the tax treatment of virtual currency can be answered by referring to Notice 2014-21 (PDF) and Rev. Rul. 2019-24 (PDF).

Q45. What records do I need to maintain regarding my transactions in virtual currency?

A45. The Internal Revenue Code and regulations require taxpayers to maintain records that are sufficient to establish the positions taken on tax returns. You should, therefore, maintain, for example, records documenting receipts, sales, exchanges, or other dispositions of virtual currency and the fair market value of the virtual currency.

Cryptocurrency and Blockchain Attorneys

Have cryptocurrency or blockchain issues or questions? Freeman Law is an innovative thought leader in the blockchain and cryptocurrency space. Blockchain and virtual currency activities take place in a rapidly evolving regulatory landscape. Freeman Law is dedicated to staying at the forefront as these emerging technologies continue to revolutionize social and economic activities. Schedule a consultation or call (214) 984-3000 to discuss your cryptocurrency and blockchain technology concerns.

The Section 965 Transition Tax

The Tax Cuts and Jobs Act of 2017 enacted a number of important tax-law changes. Few changes are more notable than those contained in the international tax provisions. Perhaps chief among the international tax changes was the Section 965 “transition” tax—a.k.a. the “deemed repatriation” tax.

Section 965 generally requires that shareholders—as defined under section 951(b) of the I.R.C.—pay a “transition” tax on their pro rata share of the untaxed foreign earnings of certain “specified foreign corporations.” The tax is imposed by increasing a specified foreign corporation’s subpart F income for its last tax year beginning before January 1, 2018. The shareholder’s pro rata share of that subpart F income is included in income as if those foreign earnings had been repatriated to the United States—hence the “deemed repatriation” moniker. The mandatory inclusion is subject to tax at an effective tax rate of either 15.5% or 8%, depending upon the extent to which the inclusion is attributable to earnings and profits that are deemed to consist of “cash” or other liquid assets.

A “specified foreign corporation” is generally defined as any Controlled Foreign Corporation under section 957 or a foreign corporation (other than a PFIC) that has a “United States shareholder” (as defined under section 951) that is a domestic corporation. Thus, a shareholder of such a foreign corporation is required to include its share of that foreign corporation’s historic earnings and profits in income as if the amount had been repatriated.

Amounts owed under Section 965 are generally due by the due date or extended due date of the taxpayer’s 2017 tax return. However, the new law provided for an election to pay the tax in installments. There are also special rules applicable to S-Corporations that may effectively allow for the indefinite postponement of such payment.

The IRS recently issued guidance on the section 965 tax in the form of FAQs. Below is a summary of that guidance:

Q1. Who is required to report amounts under section 965 of the Code on a 2017 tax return?

A1. A person that is required to include amounts in income under section 965 of the Code in its 2017 taxable year, whether because, the person is a United States shareholder of a deferred foreign income corporation (as defined under section 965(d) of the Code) or because it is a direct or indirect partner in a domestic partnership, a shareholder in an S corporation, or a beneficiary of another passthrough entity that is a United States shareholder of a deferred foreign income corporation, is required to report amounts under section 965 of the Code on its 2017 tax return.

Q2. How are amounts under section 965 of the Code reported on a 2017 tax return?

A2. Amounts required to be reported on a 2017 tax return should be reported on the return as reflected in the table included in Appendix: Q&A2. The table reflects only how items related to amounts included in income under section 965 of the Code should be reported on a 2017 tax return. It does not address the reporting in other scenarios, including distributions made in 2017, which should be reported consistent with the Code and the current forms and instructions.

Posted: 03/13/2018

Q3. Is there any other reporting in connection with section 965 of the Code required on a 2017 tax return?

A3. Yes. A person that has income under section 965 of the Code for its 2017 taxable year is required to include with its return an IRC 965 Transition Tax Statement, signed under penalties of perjury and, in the case of an electronically filed return, in Portable Document Format (.pdf) with a filename of “965 Tax”. Multiple IRC 965 Transition Tax Statements can be combined into a single .pdf file. The IRC 965 Transition Tax Statement must include the following information:

The person’s total amount required to be included in income under section 965(a) of the Code.
The person’s aggregate foreign cash position, if applicable.
The person’s total deduction under section 965(c) of the Code.
The person’s deemed paid foreign taxes with respect to the total amount required to be included in income by reason of section 965(a).
The person’s disallowed deemed paid foreign taxes pursuant to section 965(g).
The total net tax liability under section 965 (as determined under section 965(h)(6)). _[1]
The amount of the net tax liability under section 965 to be paid in installments (including the current year installment) under section 965(h) of the Code, if applicable, which will be assessed. _[2]
The amount of the net tax liability under section 965, the payment of which has been deferred, under section 965(i) of the Code, if applicable._[3]
A listing of elections under section 965 of the Code or the election provided for in Notice 2018-13 that the taxpayer has made, if applicable.

A model statement is included in Appendix: Q&A3. Adequate records must be kept supporting the section 965(a) inclusion amount, deduction under section 965(c) of the Code, and net tax liability under section 965, as well as the underlying calculations of these amounts. Moreover, additional reporting may be required when filing returns for subsequent tax years, and the manner of reporting may be different. See also Q&A8 concerning Form 5471 filing.

_________________________________

[1] Use section 965(h)(6) to calculate the total net tax liability under section 965 even if an election to pay the net tax liability under section 965 in installments has not been made and even if the person is not a United States shareholder of a deferred foreign income corporation. Do not reduce this amount by any net tax liabilities under section 965 with respect to which section 965(i) is effective. Section 965(h)(6) generally determines a person’s net tax liability under section 965 by starting with (i) the taxpayer’s tax liability with all section 965 amounts included and then subtracting (ii) the tax liability with no section 965 amounts included and with dividends received from deferred foreign income corporations disregarded. See Publication 5292 for instructions to be used in computing the net tax liability under section 965.

[2] If both one or more elections under section 965(i) have been made and an election under section 965(h) has been made, the amount of the net tax liability under section 965 to be paid in installments is: (i) the amount of the total net tax liability under section 965 as determined above less (ii) the aggregate amount of the taxpayer’s net tax liabilities under section 965 with respect to which section 965(i) elections are effective. See Publication 5292 for more information.

[3] See Publication 5292 for more information regarding the calculation of amounts eligible for S corporation shareholder deferral under section 965(i).

Updated: 04/13/2018

Q4. What elections are available with respect to section 965 of the Code on a 2017 tax return?

A4. Section 965 of the Code permits multiple elections related to amounts included in income by reason of section 965 of the Code or the payment of a taxpayer’s net tax liability under section 965 (as determined under section 965(h)(6)). Statutory elections can be found in section 965(h), (i), (m), and (n).

Furthermore, the Treasury Department and the IRS have announced another election that may be made with respect to the determination of the post-1986 earnings and profits of a specified foreign corporation. This election is described in Notice 2018-13, 2018-6 I.R.B. 341, Section 3.02.

Posted: 03/13/2018

Q5. Who can make an election with respect to section 965 of the Code on a 2017 tax return?

A5. The elections under section 965 of the Code are limited to taxpayers with a net tax liability under section 965 (in the case of section 965(h) of the Code), taxpayers that are shareholders of S corporations and that have a net tax liability under section 965 (in the case of section 965(i) of the Code), taxpayers that are REITs (in the case of section 965(m) of the Code), or taxpayers with an NOL (in the case of section 965(n) of the Code). Thus, a domestic partnership or an S corporation that is a United States shareholder of a deferred foreign income corporation may not make any of the elections under section 965 of the Code. The Treasury Department and the IRS provided further guidance concerning the availability of the elections under section 965 of the Code to direct and indirect partners in domestic partnerships, shareholders in S corporations, and beneficiaries in other passthrough entities that are United States shareholders of deferred foreign income corporations. See Section 3.05(b) of Notice 2018-26.

The election under Notice 2018-13, Section 3.02 may be made on behalf of a specified foreign corporation pursuant to the rules of §1.964-1(c)(3).

In the case of a consolidated group (as defined in §1.1502-1(h)), in which one or more members are United States shareholders of a specified foreign corporation, the agent for the group (as defined in §1.1502-77) must make the elections on behalf of its members.

Updated: 04/13/2018

Q6. When must an election with respect to section 965 of the Code be made?

A6. An election with respect to section 965 of the Code must be made by the due date (including extensions) for filing the return for the relevant year. However, even if an election is made under section 965(h) of the Code to pay a net tax liability under section 965 of the Code in installments, the first installment must be paid by the due date (without extensions) for filing the return for the relevant year.

Posted: 03/13/2018

Q7. How is an election with respect to section 965 of the Code made on a 2017 tax return?

A7. A person makes an election under section 965 of the Code or the election provided for in Notice 2018-13, Section 3.02, by attaching to a 2017 tax return a statement signed under penalties of perjury and, in the case of an electronically filed return, in Portable Document Format (.pdf), for each such election. Each such statement must include the person’s name, taxpayer identification number and any other information relevant to the election, such as the net tax liability under section 965 with respect to which the installment election under section 965(h)(1) of the Code applies, the name and taxpayer identification number of the S corporation with respect to which the deferral election under section 965(i)(1) of the Code is made, the section 965(a) inclusion amount with respect to which the election under section 965(m)(1)(B) of the Code applies, the amount described in section 965(n)(2) of the Code to which the election under section 965(n)(1) of the Code applies, and the name and taxpayer identification number, if any, of the specified foreign corporation with respect to which the election under Notice 2018-13, Section 3.02, is made. Model statements are included in Appendix: Q&A7. Each election statement must have the applicable title and, in the case of an attachment in Portable Document Format (.pdf) included with an electronically filed return, the file name reflected in the following table:

Provision Under Which Election is Made	Title	File Name
Section 965(h)(1)	Election to Pay Net Tax Liability Under Section 965 in Installments under Section 965(h)(1)	965(h)
Section 965(i)(1)	S Corporation Shareholder Election to Defer Payment of Net Tax Liability Under Section 965 Under Section 965(i)(1)	965(I)
Section 965(m)(1)(B)	Statement for Real Estate Investment Trusts Electing Deferred Inclusions Under Section 951(a)(1) By Reason of Section 965 Under Section 965(m)(1)(B)	965(m)
Section 965(n)	Election Not to Apply Net Operating Loss Deduction under section 965(n)	965(n)
Notice 2018-13, Section 3.02	Election Under Section 3.02 of Notice 2018-13 to Use Alternative Method to Compute Post-1986 Earnings and Profits	2018-13

Posted: 03/13/2018

Q8. Is a Form 5471 with respect to all specified foreign corporations with respect to which a person is a United States shareholder required to be filed with the person’s 2017 tax return, regardless of whether the specified foreign corporations are CFCs?

A8. Yes. In order to collect information relevant to the calculation of a United States shareholder’s section 965(a) inclusion amount, a person that was a United States Shareholder of a specified foreign corporation during its 2017 taxable year, including on the last day of such year, and owned stock of the specified foreign corporation on the last day of the specified foreign corporation’s year that ended during the person’s year must file a Form 5471 with respect to the specified foreign corporation completed with the identifying information on page 1 of Form 5471 above Schedule A, as well as Schedule J. The exceptions to filing in the instructions to Form 5471 otherwise will continue to apply. United States shareholders not otherwise required to file Form 5471 should consult the instructions to Form 5471 to determine the correct category of filer. Notice 2018-13, Section 5.02 also provides an exception to filing Form 5471 for certain United States shareholders considered to own stock by “downward attribution” from a foreign person. The IRS intends to modify the instructions to the Form 5471 as necessary.

Updated: 04/13/2018

Q9. Are domestic partnerships, S corporations, or other passthrough entities required to report any additional information to their partners, shareholders, or beneficiaries in connection with section 965 of the Code?

A9. Yes. A domestic partnership, S corporation, or other passthrough entity should attach a statement to its Schedule K-1s, if applicable, that includes the following information for each deferred foreign income corporation for which such passthrough entity has a section 965(a) inclusion amount:

The partner’s, shareholder’s, or beneficiary’s share of the partnership’s, S corporation’s, or other passthrough entity’s section 965(a) inclusion amount, if applicable.
The partner’s, shareholder’s, or beneficiary’s share of the partnership’s, S corporation’s, or other passthrough entity’s deduction under section 965(c), if applicable.
Information necessary for a domestic corporate partner, or an individual making an election under section 962, to compute its deemed paid foreign tax credits with respect to its share of the partnership’s, S corporation’s, or passthrough entity’s section 965(a) inclusion amount, if applicable.

For more information concerning the application of section 965 to domestic partnerships, S corporations, or other domestic passthrough entities, see Section 3.05(b) of Notice 2018-26.

Updated: 04/13/2018

Q10. How should a taxpayer pay the tax resulting from section 965 of the Code for a 2017 tax return?

A10. A taxpayer should make two separate payments as follows: one payment reflecting tax owed without regard to section 965 of the Code, and a second, separate payment reflecting tax owed resulting from section 965 of the Code and not otherwise satisfied by another payment or credit as described in Q&A13 and Q&A14 (the 965 Payment). See Q&A13 for information regarding how the IRS will apply 2017 estimated tax payments. Both payments must be paid by the due date of the applicable return (without extensions). But see Notice 2018-26, section 3.05(e), providing that if an individual receives an extension of time to file and pay under §1.6081-5(a)(5) or (6), the individual’s due date for the 965 Payment is also extended.

The 965 Payment must be made either by wire transfer or by check or money order. This may be the first year’s installment of tax owed in connection with a 2017 tax return by a taxpayer making the election under section 965(h) of the Code, or the full net tax liability under section 965 of the Code for a taxpayer who does not make such election and does not make an election under section 965(i) of the Code. For the 965 Payment, there is no penalty for taxpayers electing to use wire transfers as an alternative to otherwise mandated EFTPS payments. Accordingly, taxpayers that would normally be required to pay through EFTPS should submit the 965 Payment via wire transfer or they may be subject to penalties. On a wire payment of tax owed under section 965 of the Code, the taxpayer would use a 5-digit tax type code of 09650 (for more information, see IRS, Same-Day Wire Federal Tax Payments). On a check or money order payment of tax owed resulting from section 965 of the Code, include an appropriate payment voucher (such as Form 1040-V or 1041-V) and along with all other required information write on the front of your payment “2017 965 Tax.”

For the payment owed without regard to section 965, normal payment procedures apply (for more information, see IRS, Pay Online). This payment may be made at the same or different time from the 965 Payment, but must be made by the due date of the return or penalties and interest may apply.

Updated: 04/13/2018

Q11. If not already filed, when should an individual taxpayer electronically file a 2017 tax return?

A11. Individual taxpayers who electronically file their Form 1040 should file on or after April 2, 2018. Individual taxpayers who file a paper Form 1040 can do so at any time.

Posted: 03/13/2018

Q12. If a person has already filed a 2017 tax return, what should the person do?

A12. The person should consider filing an amended return based on the information provided in these FAQs and Appendices. Failure to submit a return in this manner may result in processing difficulties and erroneous notices being issued. Failure to accurately reflect the net tax liability under section 965 of the Code in total tax could result in interest and penalties.

In order to amend a return, a person would file the applicable form for amending the return pursuant to regular instructions and would attach:

amended versions of forms and schedules necessary to follow the instructions in these FAQs,
any election statements, and
the IRC 965 Transition Tax Statement included in Appendix: Q&A3.

Posted: 03/13/2018

Q13. How will the IRS apply 2017 estimated tax payments (including credit elects from 2016) to a taxpayer’s net tax liability under section 965?

A13. The IRS will apply 2017 estimated tax payments first to a taxpayer’s 2017 net income tax liability described under section 965(h)(6)(A)(ii) (its net income tax determined without regard to section 965), and then to its tax liability under section 965, including those amounts that are subject to payment in installments pursuant to an election under section 965(h).

Added: 04/13/2018

Q14. If a taxpayer’s 2017 payments, including estimated tax payments, exceed its 2017 net income tax liability described under section 965(h)(6)(A)(ii) (its net income tax determined without regard to section 965) and the first annual installment (due in 2018) pursuant to an election under section 965(h), may the taxpayer receive a refund of such excess amounts or credit such excess amounts to its 2018 estimated income tax?

A14. No. A taxpayer may not receive a refund or credit of any portion of properly applied 2017 tax payments unless and until the amount of payments exceeds the entire unpaid 2017 income tax liability, including all amounts to be paid in installments under section 965(h) in subsequent years. If a taxpayer’s 2017 tax payments exceed the 2017 net income tax liability described under section 965(h)(6)(A)(ii) (net income tax determined without regard to section 965) and the first annual installment (due in 2018) pursuant to an election under section 965(h), the excess will be applied to the next successive annual installment (due in 2019) (and to the extent such excess exceeds the amount of such next successive annual installment due, then to the next such successive annual installment (due in 2020), etc.) pursuant to an election under section 965(h).

Added: 04/13/2018

Appendix: Q&A2

Individual Taxpayer
Follow these reporting instructions along with attaching the IRC 965 Transition Tax Statement
Form	965(a) Amount _[4]	965(c) Deduction _[5]	Foreign Tax Credit (FTC) _[6]	Reporting of Net Tax Liability Under Section 965_[7] and Amounts to Be Paid in Installments Under Section 965(h) or Deferred Under Section 965(i), If Applicable
1040	Include a net section 965 amount (section 965(a) amount less section 965(c) deduction) on Page 1, Line 21, Other Income. Write SEC 965 on the dotted line to the left of Line 21. If, however, an IRC 962 election is made, consult the Instructions to Form 1040.	See 965(a) amount column.	Report the relevant section 965(a) amount and the relevant section 965(c) deduction on Form 1116. If an IRC 962 election is made, report the relevant section 965(a) amount, the relevant section 965(c) deduction, the deemed paid foreign taxes with respect to the relevant section 965(a) amount, and the disallowed foreign taxes under section 965(g) on Form 1118.	Reduce on Page 2, Line 44, Tax the amount of net tax liability deferred under section 965(i), if applicable. Check box ‘c’ on Line 44 and write 965 to the right of the box_.[8] Include in total on Page 2, Line 73 the amount to be paid in installments for years beyond the 2017 year, if applicable. Check box ‘d’ on Line 73 and write TAX to the right of the box.

Updated: 04/13/2018

_________________________________

[4] This includes section 965(a) inclusion amounts of a United States shareholder of a deferred foreign income corporation and distributive shares and pro rata shares of section 965(a) inclusion amounts of domestic partnerships, S corporations, and other passthrough entities.
[5] This includes deductions under section 965(c) of a United States shareholder of a deferred foreign income corporation and distributive shares and pro rata shares of deductions under section 965(c) of domestic partnerships, S corporations, and other passthrough entities.
[6] See section 965(g).
[7] See section 965(h)(6) and Q&A3.
[8] To make the 965(i) election, the taxpayer will have to file a paper Form 1040.

S corporation or Partnership Taxpayer
Follow these reporting instructions along with attaching the IRC 965 Transition Tax Statement
Form	965(a) Amount	965(c) Deduction	Foreign Tax Credit (FTC)	Reporting of Net Tax Liability Under Section 965
1120 S _{[9], [10]}	Page 3, Schedule K, Line 10	Page 3, Schedule K, Line 12d	N/A	N/A
1065 _{[11], [12]}	Page 4, Schedule K, Line 11	Page 4, Schedule K, Line 13d	N/A	N/A[9]

Updated: 04/13/2018

_________________________________

[9] See also Q&A9.
[10] See section 965(f)(2) concerning the treatment of the income inclusion offset by the section 965(c) deduction for the purposes of computing adjustments to shareholder basis under section 1367(a)(1)(A) and calculating the accumulated adjustments account under section 1368(e)(1)(A).
[11] See also Q&A9.
[12]See section 965(f)(2) concerning the treatment of the income inclusion offset by the section 965(c) deduction for the purpose of computing adjustments to the basis of a partner’s interest in a partnership under section 705(a)(1)(B)

Estate or Trust Taxpayer
Follow these reporting instructions along with attaching the IRC 965 Transition Tax Statement
Form	965(a) Amount	965(c) Deduction	Foreign Tax Credit (FTC)	Reporting of Net Tax Liability Under Section 965 and Amounts to Be Paid in Installments Under Section 965(h) or Deferred Under Section 965(i), If Applicable
1041 _[13] – Net 965 amount distributed to beneficiary *posted:3/13/18*	Include the net 965 amount (section 965(a) amount less section965(c) deduction) to the extent distributed. Include on Page 1, Line 8, Other Income.	See 965(a) amount column.	N/A	N/A
1041 – Net 965 amount not distributed to beneficiary *Updated: 04/13/2018*	Do not enter the amount on Form 1041 but rather report on IRC 965 Transition Tax Statement, Line 1.	Do not enter an amount on Form 1041 but rather report on IRC 965 Transition Tax Statement, Line 3.	Do not report the relevant section 965(a) amount and the relevant section 965(c) deduction on Form 1116. If an IRC 962 election is made, do not report the relevant section 965(a) amount, the relevant section 965(c) deduction, the deemed paid foreign taxes with respect to the relevant section 965(a) amount, and the disallowed foreign taxes under section 965(g) on Form 1118. Report the deemed paid foreign taxes with respect to the section 965(a) amount and the foreign taxes disallowed under section 965(g) on IRC 965 Transition Tax Statement, Lines 4a and 4b.	Include in total on Page 2, Schedule G, Line 7 the net tax liability under section 965. Include in amount on Page 1, Line 24a the amount to be paid in installments for years beyond the 2017 year, if applicable.

_________________________________

[13] See also Q&A9.

Form 1120 Corporate Taxpayer
Follow these reporting instructions along with attaching the IRC 965 Transition Tax Statement
Form	965(a) Amount	965(c) Deduction	Foreign Tax Credit (FTC)	Reporting of Net Tax Liability Under Section 965 and Amounts to Be Paid in Installments Under Section 965(h), If Applicable
1120	Do not enter an amount on Form 1120 but rather report on IRC 965 Transition Tax Statement, Line 1.	Do not enter an amount on Form 1120 but rather report on IRC 965 Transition Tax Statement, Line 3.	Do not enter the relevant section 965(a) amount, the relevant section 965(c) deduction, the deemed paid foreign taxes with respect to the relevant section 965(a) amount, and the foreign taxes disallowed under section 965(g) on Form 1118. Report the deemed paid foreign taxes with respect to the section 965(a) amount and the foreign taxes disallowed under section 965(g) on IRC 965 Transition Tax Statement, Lines 4a and 4b.	Include in total on Page 3, Schedule J, Part I, Line 11 net tax liability under section 965. Include in total on Page 3, Schedule J, Part II, Line 19d the amount to be paid in installments for years beyond the 2017 year, if applicable.
1120 PC	Do not enter an amount on Form 1120-PC but rather report on IRC 965 Transition Tax Statement, Line 1.	Do not enter an amount on Form 1120-PC but rather report on IRC 965 Transition Tax Statement, Line 3.	Do not enter the relevant section 965(a) amount, the relevant section 965(c) deduction, the deemed paid foreign taxes with respect to the relevant section 965(a) amount, and the foreign taxes disallowed under section 965(g) on Form 1118. Report the deemed paid foreign taxes with respect to the section 965(a) amount and the foreign taxes disallowed under section 965(g) on IRC 965 Transition Tax Statement, Lines 4a and 4b.	Include in total on Page 1, Line 13 the net tax liability under section 965. Include in total on Page 1, Line 14k the amount to be paid in installments for years beyond the 2017 taxable year, if applicable. Write ‘965’ on the dotted line to the left of Line 14k.

Posted: 03/13/2018

Follow these reporting instructions along with attaching the IRC 965 Transition Tax Statement

Form

965(a) Amount

965(c) Deduction

Foreign Tax Credit (FTC)

Reporting of Net Tax Liability Under Section 965 and Amounts to Be Paid in Installments Under Section 965(h), If Applicable

1120 L

Do not enter an amount on Form 1120-L but rather report on IRC 965 Transition Tax Statement, Line 1.

Do not enter an amount on Form 1120-L but rather report on IRC 965 Transition Tax Statement, Line 3.

Do not enter the relevant section 965(a) amount, the relevant section 965(c) deduction, the deemed paid foreign taxes with respect to the relevant section 965(a) amount, and the foreign taxes disallowed under section 965(g) on Form 1118. Report the deemed paid foreign taxes with respect to the section 965(a) amount and the foreign taxes disallowed under section 965(g) on IRC 965 Transition Tax Statement, Lines 4a and 4b

Include in total on Page 6, Schedule K, Line 10 the net tax liability under section 965.

Include in total on Page 1, Line 29k the amount to be paid in installments for years beyond the 2017 year, if applicable. Write ‘965’ on the dotted line to the left of Line 29k.

Posted: 03/13/2018

Follow these reporting instructions along with attaching the IRC 965 Transition Tax Statement

Form

965(a) Amount

965(c) Deduction

Foreign Tax Credit (FTC)

Reporting of Net Tax Liability Under Section 965 and Amounts to Be Paid in Installments Under Section 965(h), If Applicable

1120 REIT that makes Section 965(m)(1)(B) election

Include the 8% portion of the net 965 amount (section 965(a) amount less section 965(c) deduction) on page 1, Part I, Line 7, “Other Income.” Write SEC 965 on the dotted line to the left of Line 7.

So as not to include the 8% portion of the net 965 amount in the REIT’s gross income tests (see section 965(m)(1)(A)), include it on page 2, Part III, Lines 2(c) and 5(c). With regard to those lines, the Instructions for Form 1120-REIT require the taxpayer to attach a copy of the Secretary’s determination allowing an exclusion pursuant to section 856(c)(5)(J)(i) to its tax return. The attachment of IRC 965 Transition Tax Statement to the taxpayer’s return satisfies this requirement.

See 965(a) amount column.

If applicable, enter the relevant section 965(a) amount, the relevant section 965(c) deduction, the deemed paid foreign taxes with respect to the relevant section 965(a) amount, and the foreign taxes disallowed under section 965(g) on Form 1118.

N/A

Posted: 03/13/2018

Follow these reporting instructions along with attaching the IRC 965 Transition Tax Statement

Form

965(a) Amount

965(c) Deduction

Foreign Tax Credit (FTC)

Reporting of Net Tax Liability Under Section 965 and Amounts to Be Paid in Installments Under Section 965(h)), If Applicable

1120 REIT that makes neither Section 965(m)(1)(B) election nor Section 965(h) election

Include the net 965 amount (section 965(a) amount less section 965(c) deduction) on page 1, Part I, Line 7, “Other Income.” Write SEC 965 on the dotted line to the left of Line 7.

So as not to include the net 965 amount in the REIT’s gross income tests (see section 965(m)(1)(A)), include it on page 2, Part III, Lines 2(c) and 5(c). With regard to those lines, the Instructions for Form 1120-REIT require the taxpayer to attach a copy of the Secretary’s determination allowing an exclusion pursuant to section 856(c)(5)(J)(i) to its tax return. The attachment of IRC 965 Transition Tax Statement to the taxpayer’s return satisfies this requirement.

See 965(a) amount column.

N/A

Posted: 03/13/2018

Follow these reporting instructions along with attaching the IRC 965 Transition Tax Statement

Form

965(a) Amount

965(c) Deduction

Foreign Tax Credit (FTC)

Reporting of Net Tax Liability Under Section 965 and Amounts to Be Paid in Installments Under Section 965(h)), If Applicable

1120 REIT that makes Section 965(h) election

Include the net 965 amount (section 965(a) amount less section 965(c) deduction) on page 1, Part I, Line 7, “Other Income.” Write SEC 965 on the dotted line to the left of Line 7.

See 965(a) amount column.

Include in total on Page 1, Line 24h the amount to be paid in installments for years beyond the 2017 taxable year. Write ‘965’ in the space above Line 24h

Posted: 03/13/2018

Follow these reporting instructions along with attaching the IRC 965 Transition Tax Statement
Form	965(a) Amount	965(c) Deduction	Foreign Tax Credit (FTC)	Reporting of Net Tax Liability Under Section 965 and Amounts to Be Paid in Installments Under Section 965(h), If Applicable
1120 RIC	Include a net 965 amount (section 965(a) amount less section 965(c) deduction) on page 1, Part I, Line 7, “Other Income”. Write SEC 965 on the dotted line to the left of Line 7.	See 965(a) amount column.	If applicable, enter the relevant section 965(a) amount, the relevant section 965(c) deduction, the deemed paid foreign taxes with respect to the relevant section 965(a) amount, and the foreign taxes disallowed under section 965(g) on Form 1118. .	Include in total on Page 2, Part I, Line 28i the amount to be paid in installments for years beyond the 2017 taxable year, if applicable. Write ‘965’ in the space above Line 28i.

Posted: 03/13/2018

Exempt Organization Taxpayer
Follow these reporting instructions along with attaching the IRC 965 Transition Tax Statement
Form	965(a) Amount	965(c) Deduction	Foreign Tax Credit (FTC)	Reporting of Net Tax Liability Under Section 965 and Amounts to Be Paid in Installments Under Section 965(h), If Applicable
990T	Do not enter an amount on Form 990-T but rather report on IRC 965 Transition Tax Statement, Line 1.	Do not enter an amount on Form 990-T but rather report on IRC 965 Transition Tax Statement, Line 3.	Do not enter the relevant section 965(a) amount, the relevant section 965(c) deduction, the deemed paid foreign taxes with respect to the relevant section 965(a) amount, and the foreign taxes disallowed under section 965(g) on Form 1118. Report the deemed paid foreign taxes with respect to the section 965(a) amount and the foreign taxes disallowed under section 965(g) on IRC 965 Transition Tax Statement, Lines 4a and 4b.	Include in total on Page 2, Part IV, Line 44 the net tax liability under section 965. Include in total on Page 2, Part IV, Line 45g the amount to be paid in installments for years beyond the 2017 year, if applicable. Check the “Other” box on Line 45g and write “965” to the right of the box.

Expert Tax Defense Attorneys

Need help with tax issues? Contact us as soon as possible to discuss your rights and the ways we can assist in your defense. We handle all types of cases, including complex international & offshore tax compliance. Schedule a consultation or call (214) 984-3000 to discuss your tax issues or questions.

U.S. Department of Labor Issues Guidance on Families First Coronavirus Response Act

On March 18, 2020, the Families First Coronavirus Response Act became law. It is effective for paid sick leave or expanded family and medical leave taken between April 1, 2020, and December 31, 2020. Freeman Law first wrote on this legislation here.

Recently, the U.S. Department of Labor has issued helpful guidance via frequently asked questions and answers. Those can be found here and are also reproduced below for the reader’s convenience.

DEFINITIONS

“Paid sick leave” – means paid leave under the Emergency Paid Sick Leave Act.

“Expanded family and medical leave” – means paid leave under the Emergency Family and Medical Leave Expansion Act.

QUESTIONS & ANSWERS

1. What is the effective date of the Families First Coronavirus Response Act (FFCRA), which includes the Emergency Paid Sick Leave Act and the Emergency Family and Medical Leave Expansion Act?

The FFCRA’s paid leave provisions are effective on April 1, 2020, and apply to leave taken between April 1, 2020, and December 31, 2020.

2. As an employer, how do I know if my business is under the 500-employee threshold and therefore must provide paid sick leave or expanded family and medical leave?

You have fewer than 500 employees if, at the time your employee’s leave is to be taken, you employ fewer than 500 full-time and part-time employees within the United States, which includes any State of the United States, the District of Columbia, or any Territory or possession of the United States. In making this determination, you should include employees on leave; temporary employees who are jointly employed by you and another employer (regardless of whether the  jointly-employed employees  are maintained on only your or another employer’s payroll); and day laborers supplied by a temporary agency (regardless of whether you are the temporary agency or the client firm if there is a continuing employment relationship). Workers who are independent contractors under the Fair Labor Standards Act (FLSA), rather than  employees, are not considered employees for purposes of the 500-employee threshold.

Typically, a corporation (including its separate establishments or divisions) is considered to be a single employer and its employees must each be counted towards the 500-employee threshold. Where a corporation has an ownership interest in another corporation, the two corporations are separate employers unless they are  joint employers under the FLSA  with respect to certain employees. If two entities are found to be joint employers, all of their common employees must be counted in determining whether paid sick leave must be provided under the Emergency Paid Sick Leave Act and expanded family and medical leave must be provided under the Emergency Family and Medical Leave Expansion Act.

In general, two or more entities are separate employers unless they meet the  integrated employer test  under the Family and Medical Leave Act of 1993 (FMLA). If two entities are an integrated employer under the FMLA, then employees of all entities making up the integrated employer will be counted in determining employer coverage for purposes of expanded family and medical leave under the Emergency Family and Medical Leave Expansion Act.

3. If I am a private sector employer and have 500 or more employees, do the Acts apply to me?

No. Private sector employers are only required to comply with the Acts if they have fewer than 500 employees.[1]

4. If providing child care-related paid sick leave and expanded family and medical leave at my business with fewer than 50 employees would jeopardize the viability of my business as a going concern, how do I take advantage of the small business exemption?

To elect this small business exemption, you should document why your business with fewer than 50 employees meets the criteria set forth by the Department, which will be addressed in more detail in forthcoming regulations.

You should not send any materials to the Department of Labor when seeking a small business exemption for paid sick leave and expanded family and medical leave.

5. How do I count hours worked by a part-time employee for purposes of paid sick leave or expanded family and medical leave?A part-time employee is entitled to leave for his or her average number of work hours in a two-week period. Therefore, you calculate hours of leave based on the number of hours the employee is normally scheduled to work. If the normal hours scheduled are unknown, or if the part-time employee’s schedule varies, you may use a six-month average to calculate the average daily hours. Such a part-time employee may take paid sick leave for this number of hours per day for up to a two-week period, and may take expanded family and medical leave for the same number of hours per day up to ten weeks after that.

If this calculation cannot be made because the employee has not been employed for at least six months, use the number of hours that you and your employee agreed that the employee would work upon hiring. And if there is no such agreement, you may calculate the appropriate number of hours of leave based on the average hours per day the employee was scheduled to work over the entire term of his or her employment.

6. When calculating pay due to employees, must overtime hours be included?

Yes. The Emergency Family and Medical Leave Expansion Act requires you to pay an employee for hours the employee would have been normally scheduled to work even if that is more than 40 hours in a week. 

However, the Emergency Paid Sick Leave Act requires that paid sick leave be paid only up to 80 hours over a two-week period. For example, an employee who is scheduled to work 50 hours a week may take 50 hours of paid sick leave in the first week and 30 hours of paid sick leave in the second week. In any event, the total number of hours paid under the Emergency Paid Sick Leave Act is capped at 80.

If the employee’s schedule varies from week to week, please see the answer to  Question 5, because the calculation of hours for a full-time employee with a varying schedule is the same as that for a part-time employee.

Please keep in mind the daily and aggregate caps placed on any pay for paid sick leave and expanded family and medical leave as described in the answer to Question 7.

Please note that pay does not need to include a premium for overtime hours under either the Emergency Paid Sick Leave Act or the Emergency Family and Medical Leave Expansion Act.

7. As an employee, how much will I be paid while taking paid sick leave or expanded family and medical leave under the FFCRA?

It depends on your normal schedule as well as why you are taking leave.

If you are taking paid sick leave because you are unable to work or telework due to a need for leave because you (1) are subject to a Federal, State, or local quarantine or isolation order related to COVID-19; (2) have been advised by a health care provider to self-quarantine due to concerns related to COVID-19; or (3) are experiencing symptoms of COVID-19 and are seeking medical diagnosis, you will receive for each applicable hour the greater of:

your  regular rate of pay,
the federal minimum wage in effect under the FLSA, or
the applicable State or local minimum wage.

In these circumstances, you are entitled to a maximum of $511 per day, or $5,110 total over the entire paid sick leave period.

If you are taking paid sick leave because you are: (1) caring for an individual who is subject to a Federal, State, or local quarantine or isolation order related to COVID-19 or an individual who has been advised by a health care provider to self-quarantine due to concerns related to COVID-19; (2) caring for your child whose school or place of care is closed, or child care provider is unavailable, due to COVID-19 related reasons; or (3) experiencing any other substantially-similar condition that may arise, as specified by the Secretary of Health and Human Services, you are entitled to compensation at 2/3 of the greater of the amounts above.

Under these circumstances, you are subject to a maximum of $200 per day, or $2,000 over the entire two week period.

If you are taking expanded family and medical leave, you may take paid sick leave for the first ten days of that leave period, or you may substitute any accrued vacation leave, personal leave, or medical or sick leave you have under your employer’s policy. For the following ten weeks, you will be paid for your leave at an amount no less than 2/3 of your  regular rate of pay  for the hours you would be normally scheduled to work. The  regular rate of pay  used to calculate this amount must be at or above the federal minimum wage, or the applicable state or local minimum wage. However, you will not receive more than $200 per day or $12,000 for the twelve weeks that include both paid sick leave and expanded family and medical leave when you are on leave to care for your child whose school or place of care is closed, or child care provider is unavailable, due to COVID-19 related reasons.

To calculate the number of hours for which you are entitled to paid leave, please see the answers to Questions 5-6 that are provided in this guidance.

8. What is my regular rate of pay for purposes of the FFCRA?

For purposes of the FFCRA, the regular rate of pay used to calculate your paid leave is the average of your  regular rate  over a period of up to six months prior to the date on which you take leave.[2] If you have not worked for your current employer for six months, the regular rate used to calculate your paid leave is the average of your regular rate of pay for each week you have worked for your current employer.

If you are paid with commissions, tips, or piece rates, these amounts will be incorporated into the above calculation to the same extent they are included in the calculation of the regular rate under the FLSA.

You can also compute this amount for each employee by adding all compensation that is part of the regular rate over the above period and divide that sum by all hours actually worked in the same period.

9. May I take 80 hours of paid sick leave for my self-quarantine and then another amount of paid sick leave for another reason provided under the Emergency Paid Sick Leave Act?

No. You may take up to two weeks—or ten days—(80 hours for a full-time employee, or for a part-time employee, the number of hours equal to the average number of hours that the employee works over a typical two-week period) of paid sick leave for any combination of qualifying reasons. However, the total number of hours for which you receive paid sick leave is capped at 80 hours under the Emergency Paid Sick Leave Act. 

10. If I am home with my child because his or her school or place of care is closed, or child care provider is unavailable, do I get paid sick leave, expanded family and medical leave, or both—how do they interact?

You may be eligible for both types of leave, but only for a total of twelve weeks of paid leave. You may take both paid sick leave and expanded family and medical leave to care for your child whose school or place of care is closed, or child care provider is unavailable, due to COVID-19 related reasons. The Emergency Paid Sick Leave Act provides for an initial two weeks of paid leave. This period thus covers the first ten workdays of expanded family and medical leave, which are otherwise unpaid under the Emergency and Family Medical Leave Expansion Act unless you elect to use existing vacation, personal, or medical or sick leave under your employer’s policy. After the first ten workdays have elapsed, you will receive 2/3 of your  regular rate of pay  for the hours you would have been scheduled to work in the subsequent ten weeks under the Emergency and Family Medical Leave Expansion Act.

Please note that you can only receive the additional ten weeks of expanded family and medical leave under the Emergency Family and Medical Leave Expansion Act for leave to care for your child whose school or place of care is closed, or child care provider is unavailable, due to COVID-19 related reasons.

11. Can my employer deny me paid sick leave if my employer gave me paid leave for a reason identified in the Emergency Paid Sick Leave Act prior to the Act going into effect?

No. The Emergency Paid Sick Leave Act imposes a new leave requirement on employers that is effective beginning on April 1, 2020.

12. Is all leave under the FMLA now paid leave?

No. The only type of family and medical leave that is paid leave is expanded family and medical leave under the Emergency Family and Medical Leave Expansion Act when such leave exceeds ten days. This includes only leave taken because the employee must care for a child whose school or place of care is closed, or child care provider is unavailable, due to COVID-19 related reasons.

13.  Are the paid sick leave and expanded family and medical leave requirements retroactive?

No.

14. How do I know whether I have “been employed for at least 30 calendar days by the employer” for purposes of expanded family and medical leave?

You are considered to have been employed by your employer for at least 30 calendar days if your employer had you on its payroll for the 30 calendar days immediately prior to the day your leave would begin. For example, if you want to take leave on April 1, 2020, you would need to have been on your employer’s payroll as of March 2, 2020.

If you have been working for a company as a temporary employee, and the company subsequently hires you on a full-time basis, you may count any days you previously worked as a temporary employee toward this 30-day eligibility period.  

15. What records do I need to keep when my employee takes paid sick leave or expanded family and medical leave?

Private sector employers that provide paid sick leave and expanded family and medical leave required by the FFCRA are eligible for reimbursement of the costs of that leave through refundable tax credits.  If you intend to claim a tax credit under the FFCRA for your payment of the sick leave or expanded family and medical leave wages, you should retain appropriate documentation in your records. You should consult Internal Revenue Service (IRS) applicable forms, instructions, and information for the procedures that must be followed to claim a tax credit, including any needed substantiation to be retained to support the credit. You are not required to provide leave if materials sufficient to support the applicable tax credit have not been provided.

If one of your employees takes expanded family and medical leave to care for his or her child whose school or place of care is closed, or child care provider is unavailable, due to COVID-19, you may also require your employee to provide you with any additional documentation in support of such leave, to the extent permitted under the certification rules for conventional FMLA leave requests. For example, this could include a notice that has been posted on a government, school, or day care website, or published in a newspaper, or an email from an employee or official of the school, place of care, or child care provider. 

16. What documents do I need to give my employer to get paid sick leave or expanded family and medical leave?

You must provide to your employer documentation in support of your paid sick leave as specified in applicable IRS forms, instructions, and information. 

Your employer may also require you to provide additional in support of your expanded family and medical leave taken to care for your child whose school or place of care is closed, or child care provider is unavailable, due to COVID-19-related reasons. For example, this may include a notice of closure or unavailability from your child’s school, place of care, or child care provider, including a notice that may have been posted on a government, school, or day care website, published in a newspaper, or emailed to you from an employee or official of the school, place of care, or child care provider. Your employer must retain this notice or documentation in support of expanded family and medical leave, including while you may be taking unpaid leave that runs concurrently with paid sick leave if taken for the same reason.

Please also note that all existing certification requirements under the FMLA remain in effect if you are taking leave for one of the existing qualifying reasons under the FMLA. For example, if you are taking leave beyond the two weeks of emergency paid sick leave because your medical condition for COVID-19-related reasons rises to the level of a serious health condition, you must continue to  provide medical certifications  under the FMLA if required by your employer.

17. When am I able to telework under the FFCRA?

You may telework when your employer permits or allows you to perform work while you are at home or at a location other than your normal workplace. Telework is work for which normal wages must be paid and is not compensated under the paid leave provisions of the FFCRA.

18. What does it mean to be unable to work, including telework for COVID-19 related reasons?

You are unable to work if your employer has work for you and one of the COVID-19 qualifying reasons set forth in the FFCRA prevents you from being able to perform that work, either under normal circumstances at your normal worksite or by means of telework.

If you and your employer agree that you will work your normal number of hours, but outside of your normally scheduled hours (for instance early in the morning or late at night), then you are able to work and leave is not necessary unless a COVID-19 qualifying reason prevents you from working that schedule.

19. If I am or become unable to telework, am I entitled to paid sick leave or expanded family and medical leave?

If your employer permits teleworking—for example, allows you to perform certain tasks or work a certain number of hours from home or at a location other than your normal workplace—and you are unable to perform those tasks or work the required hours because of one of the qualifying reasons for paid sick leave, then you are entitled to take paid sick leave. 

Similarly, if you are unable to perform those teleworking tasks or work the required teleworking hours because you need to care for your child whose school or place of care is closed, or child care provider is unavailable, because of COVID-19 related reasons, then you are entitled to take expanded family and medical leave. Of course, to the extent you are able to telework while caring for your child, paid sick leave and expanded family and medical leave is not available.

20. May I take my paid sick leave or expanded family and medical leave intermittently while teleworking?

Yes, if your employer allows it and if you are unable to telework your normal schedule of hours due to one of the qualifying reasons in the Emergency Paid Sick Leave Act. In that situation, you and your employer may agree that you may take paid sick leave intermittently while teleworking. Similarly, if you are prevented from teleworking your normal schedule of hours because you need to care for your child whose school or place of care is closed, or child care provider is unavailable, because of COVID-19 related reasons, you and your employer may agree that you can take expanded family medical leave intermittently while teleworking.

You may take intermittent leave in any increment, provided that you and your employer agree. For example, if you agree on a 90-minute increment, you could telework from 1:00 PM to 2:30 PM, take leave from 2:30 PM to 4:00 PM, and then return to teleworking.

The Department encourages employers and employees to collaborate to achieve flexibility and meet mutual needs, and the Department is supportive of such voluntary arrangements that combine telework and intermittent leave.

21. May I take my paid sick leave intermittently while working at my usual worksite (as opposed to teleworking)?

It depends on why you are taking paid sick leave and whether your employer agrees. Unless you are teleworking, paid sick leave for qualifying reasons related to COVID-19 must be taken in full-day increments. It cannot be taken intermittently if the leave is being taken because:

You are subject to a Federal, State, or local quarantine or isolation order related to COVID-19;
You have been advised by a health care provider to self-quarantine due to concerns related to COVID-19;
You are experiencing symptoms of COVID-19 and seeking a medical diagnosis;
You are caring for an individual who either is subject to a quarantine or isolation order related to COVID-19 or has been advised by a health care provider to self-quarantine due to concerns related to COVID-19; or
You are experiencing any other substantially similar condition specified by the Secretary of Health and Human Services.

Unless you are teleworking, once you begin taking paid sick leave for one or more of these qualifying reasons, you must continue to take paid sick leave each day until you either (1) use the full amount of paid sick leave or (2) no longer have a qualifying reason for taking paid sick leave. This limit is imposed because if you are sick or possibly sick with COVID-19, or caring for an individual who is sick or possibly sick with COVID-19, the intent of FFCRA is to provide such paid sick leave as necessary to keep you from spreading the virus to others. 

If you no longer have a qualifying reason for taking paid sick leave before you exhaust your paid sick leave, you may take any remaining paid sick leave at a later time, until December 31, 2020, if another qualifying reason occurs.

In contrast, if you and your employer agree, you may take paid sick leave intermittently if you are taking paid sick leave to care for your child whose school or place of care is closed, or whose child care provider is unavailable, because of COVID-19 related reasons. For example, if your child is at home because his or her school or place of care is closed, or child care provider is unavailable, because of COVID-19 related reasons, you may take paid sick leave on Mondays, Wednesdays, and Fridays to care for your child, but work at your normal worksite on Tuesdays and Thursdays.

The Department encourages employers and employees to collaborate to achieve maximum flexibility. Therefore, if employers and employees agree to intermittent leave on less than a full work day for employees taking paid sick leave to care for their child whose school or place of care is closed, or child care provider is unavailable, because of COVID-19-related reasons, the Department is supportive of such voluntary arrangements.

22. May I take my expanded family and medical leave intermittently while my child’s school or place of care is closed, or child care provider is unavailable, due to COVID-19 related reasons, if I am not teleworking?

Yes, but only with your employer’s permission. Intermittent expanded family and medical leave should be permitted only when you and your employer agree upon such a schedule. For example, if your employer and you agree, you may take expanded family and medical leave on Mondays, Wednesdays, and Fridays, but work Tuesdays and Thursdays, while your child is at home because your child’s school or place of care is closed, or child care provider is unavailable, due to COVID-19 related reasons, for the duration of your leave.

The Department encourages employers and employees to collaborate to achieve flexibility. Therefore, if employers and employees agree to intermittent leave on a day-by-day basis, the Department supports such voluntary arrangements.

23. If my employer closed my worksite before April 1, 2020 (the effective date of the FFCRA), can I still get paid sick leave or expanded family and medical leave?  

No. If, prior to the FFCRA’s effective date, your employer sent you home and stops paying you because it does not have work for you to do, you will not get paid sick leave or expanded family and medical leave but you may be eligible for unemployment insurance benefits. This is true whether your employer closes your worksite for lack of business or because it is required to close pursuant to a Federal, State, or local directive. You should contact your State workforce agency or State unemployment insurance office for specific questions about your eligibility. For additional information, please refer to this link.

It should be noted, however, that if your employer is paying you pursuant to a paid leave policy or State or local requirements, you are not eligible for unemployment insurance.

24. If my employer closes my worksite on or after April 1, 2020 (the effective date of the FFCRA), but before I go out on leave, can I still get paid sick leave and/or expanded family and medical leave?

No. If your employer closes after the FFCRA’s effective date (even if you requested leave prior to the closure), you will not get paid sick leave or expanded family and medical leave but you may be eligible for unemployment insurance benefits. This is true whether your employer closes your worksite for lack of business or because it was required to close pursuant to a Federal, State or local directive. You should contact your State workforce agency or State unemployment insurance office for specific questions about your eligibility. For additional information, please refer to this link.

25. If my employer closes my worksite while I am on paid sick leave or expanded family and medical leave, what happens?

If your employer closes while you are on paid sick leave or expanded family and medical leave, your employer must pay for any paid sick leave or expanded family and medical leave you used before the employer closed. As of the date your employer closes your worksite, you are no longer entitled to paid sick leave or expanded family and medical leave, but you may be eligible for unemployment insurance benefits. This is true whether your employer closes your worksite for lack of business or because the employer was required to close pursuant to a Federal, State or local directive. You should contact your State workforce agency or State unemployment insurance office for specific questions about your eligibility. For additional information, please refer to this link.

26. If my employer is open, but furloughs me on or after April 1, 2020 (the effective date of the FFCRA), can I receive paid sick leave or expanded family and medical leave?

No. If your employer furloughs you because it does not have enough work or business for you, you are not entitled to then take paid sick leave or expanded family and medical leave. However, you may be eligible for unemployment insurance benefits. You should contact your State workforce agency or State unemployment insurance office for specific questions about your eligibility. For additional information, please refer to this link.

27. If my employer closes my worksite on or after April 1, 2020 (the effective date of the FFCRA), but tells me that it will reopen at some time in the future, can I receive paid sick leave or expanded family and medical leave?

No, not while your worksite is closed. If your employer closes your worksite, even for a short period of time, you are not entitled to take paid sick leave or expanded family and medical leave. However, you may be eligible for unemployment insurance benefits. This is true whether your employer closes your worksite for lack of business or because it was required to close pursuant to a Federal, State, or local directive. You should contact your State workforce agency or State unemployment insurance office for specific questions about your eligibility. For additional information, please refer to this link. If your employer reopens and you resume work, you would then be eligible for paid sick leave or expanded family and medical leave as warranted.

28. If my employer reduces my scheduled work hours, can I use paid sick leave or expanded family and medical leave for the hours that I am no longer scheduled to work? 

No. If your employer reduces your work hours because it does not have work for you to perform, you may not use paid sick leave or expanded family and medical leave for the hours that you are no longer scheduled to work. This is because you are not prevented from working those hours due to a COVID-19 qualifying reason, even if your reduction in hours was somehow related to COVID-19.

You may, however, take paid sick leave or expanded family and medical leave if a COVID-19 qualifying reason prevents you from working your full schedule. If you do, the amount of leave to which you are entitled is computed based on your work schedule before it was reduced (see  Question 5).

29. May I collect unemployment insurance benefits for time in which I receive pay for paid sick leave and/or expanded family and medical leave?

No. If your employer provides you paid sick leave or expanded family and medical leave, you are not eligible for unemployment insurance. However, each State has its own unique set of rules; and  DOL recently clarified additional flexibility to the States  (UIPL 20-10) to extend partial unemployment benefits to workers whose hours or pay have been reduced. Therefore, individuals should contact their State workforce agency or State unemployment insurance office for specific questions about eligibility. For additional information, please refer to this link. 

 30. If I elect to take paid sick leave or expanded family and medical leave, must my employer continue my health coverage? If I remain on leave beyond the maximum period of expanded family and medical leave, do I have a right to keep my health coverage?

If your employer provides group health coverage that you’ve elected, you are entitled to continued group health coverage during your expanded family and medical leave on the same terms as if you continued to work. If you are enrolled in family coverage, your employer must maintain coverage during your expanded family and medical leave. You generally must continue to make any normal contributions to the cost of your health coverage. See WHD Fact Sheet 28A.

If you do not return to work at the end of your expanded family and medical leave, check with your employer to determine whether you are eligible to keep your health coverage on the same terms (including contribution rates). If you are no longer eligible, you may be able to continue your coverage under the Consolidated Omnibus Budget Reconciliation Act (COBRA). COBRA, which generally applies to employers with 20 or more employees, allows you and your family to continue the same group health coverage at group rates. Your share of that cost may be higher than what you were paying before but may be lower than what you would pay for private individual health insurance coverage. (If your employer has fewer than 20 employees, you may be eligible to continue your health insurance under State laws that are similar to COBRA. These laws are sometimes referred to as “mini COBRA” and vary from State to State). Contact the Employee Benefits Security Administration to learn about health and retirement benefit protections for dislocated workers. 

If you elect to take paid sick leave, your employer must continue your health coverage. Under the Health Insurance Portability and Accountability Act (HIPAA), an employer cannot establish a rule for eligibility or set any individual’s premium or contribution rate based on whether an individual is actively at work (including whether an individual is continuously employed), unless absence from work due to any health factor (such as being absent from work on sick leave) is treated, for purposes of the plan or health insurance coverage, as being actively at work.

31. As an employee, may I use my employer’s preexisting leave entitlements and my FFCRA paid sick leave and expanded family and medical leave concurrently for the same hours?

No. If you are eligible to take paid sick leave or expanded family and medical leave under the FFCRA, as well as paid leave that is already provided by your employer, unless your employer agrees you must choose one type of leave to take. You may not simultaneously take both, unless your employer agrees to allow you to supplement the amount you receive from paid sick leave or expanded family and medical leave under the FFCRA, up to your normal earnings, with preexisting leave. For example, if you are receiving 2/3 of your normal earnings from paid sick leave or expanded family and medical leave under the FFCRA and your employer permits, you may use your preexisting employer-provided paid leave to get the additional 1/3 of your normal earnings so that you receive your full normal earnings for each hour.

32. If I am an employer, may I supplement or adjust the pay mandated under the FFCRA with paid leave that the employee may have under my paid leave policy?

If your employee chooses to use existing leave you have provided, yes; otherwise, no. Paid sick leave and expanded family medical leave under the FFCRA is in addition to employees’ preexisting leave entitlements, including Federal employees. Under the FFCRA, the employee may choose to use existing paid vacation, personal, medical, or sick leave from your paid leave policy to supplement the amount your employee receives from paid sick leave or expanded family and medical leave, up to the employee’s normal earnings. Note, however, that you are not entitled to a tax credit for any paid sick leave or expanded family and medical leave that is not required to be paid or exceeds the limits set forth under Emergency Paid Sick Leave Act and the Emergency Family and Medical Leave Expansion Act. 

However, you are not required to permit an employee to use existing paid leave to supplement the amount your employee receives from paid sick leave or expanded family and medical leave. Further, you may not claim, and will not receive tax credit, for such supplemental amounts.

33. If I am an employer, may I require an employee to supplement or adjust the pay mandated under the FFCRA with paid leave that the employee may have under my paid leave policy?

No. Under the FFCRA, only the employee may decide whether to use existing paid vacation, personal, medical, or sick leave from your paid leave policy to supplement the amount your employee receives from paid sick leave or expanded family and medical leave. The employee would have to agree to use existing paid leave under your paid leave policy to supplement or adjust the paid leave under the FFCRA.

34. If I want to pay my employees more than they are entitled to receive for paid sick leave or expanded family and medical leave, can I do so and claim a tax credit for the entire amount paid to them?

You may pay your employees in excess of FFCRA requirements. But you cannot claim, and will not receive tax credit for, those amounts in excess of the FFCRA’s statutory limits. 

35. I am an employer that is part of a multiemployer collective bargaining agreement, may I satisfy my obligations under the Emergency Family and Medical Leave Expansion Act through contributions to a multiemployer fund, plan, or program?

You may satisfy your obligations under the Emergency Family and Medical Leave Expansion Act by making contributions to a multiemployer fund, plan, or other program in accordance with your existing collective bargaining obligations. These contributions must be based on the amount of paid family and medical leave to which each of your employees is entitled under the Act based on each employee’s work under the multiemployer collective bargaining agreement. Such a fund, plan, or other program must allow employees to secure or obtain their pay for the related leave they take under the Act. Alternatively, you may also choose to satisfy your obligations under the Act by other means, provided they are consistent with your bargaining obligations and collective bargaining agreement.

36. I am an employer that is part of a multiemployer collective bargaining agreement, may I satisfy my obligations under the Emergency Paid Sick Leave Act through contributions to a multiemployer fund, plan, or program?

You may satisfy your obligations under the Emergency Paid Sick Leave Act by making contributions to a multiemployer fund, plan, or other program in accordance with your existing collective bargaining obligations. These contributions must be based on the hours of paid sick leave to which each of your employees is entitled under the Act based on each employee’s work under the multiemployer collective bargaining agreement. Such a fund, plan, or other program must allow employees to secure or obtain their pay for the related leave they take under the Act. Alternatively, you may also choose to satisfy your obligations under the Act by other means, provided they are consistent with your bargaining obligations and collective bargaining agreement.

37. Are contributions to a multiemployer fund, plan, or other program the only way an employer that is part of a multiemployer collective bargaining agreement may comply with the paid leave requirements of the FFCRA?

No. Both the Emergency Paid Sick Leave Act and the Emergency Family and Medical Leave Expansion Act provide that, consistent with its bargaining obligations and collective bargaining agreement, an employer may satisfy its legal obligations under both Acts by making appropriate contributions to such a fund, plan, or other program based on the paid leave owed to each employee. However, the employer may satisfy its obligations under both Acts by other means, provided they are consistent with its bargaining obligations and collective bargaining agreement.

38. Assuming I am a covered employer, which of my employees are eligible for paid sick leave and expanded family and medical leave?

Both of these new provisions use the  employee definition  as provided by the Fair Labor Standards Act, thus all of your U.S. (including Territorial) employees who meet this definition are eligible including full-time and part-time employees, and “joint employees” working on your site temporarily and/or through a temp agency. However, if you employ a health care provider or an emergency responder you are not required to pay such employee paid sick leave or expanded family and medical leave on a case-by-case basis. And certain small businesses may exempt employees if the leave would jeopardize the company’s viability as a going concern. See  Question 58  below.

There is one difference regarding an employee’s eligibility for paid sick leave versus expanded family and medical leave. While your employee is eligible for paid sick leave regardless of length of employment, your employee must have been employed for 30 calendar days in order to qualify for expanded family and medical leave. For example, if your employee requests expanded family and medical leave on April 10, 2020, he or she must have been your employee since March 11, 2020.

39. Who is a covered employer that must provide paid sick leave and expanded family and medical leave under the FFCRA?

Generally, if you employ fewer than 500 employees you are a covered employer that must provide paid sick leave and expanded family and medical leave. For additional information on the 500 employee threshold, see  Question 2. Certain employers with fewer than 50 employees may be exempt from the Act’s requirements to provide certain paid sick leave and expanded family and medical leave. For additional information regarding this small business exemption, see  Question 4  and  Questions 58 and 59  below.

Certain public employers are also covered under the Act and must provide paid sick leave and expanded family and medical leave. For additional information regarding coverage of public employers, see  Questions 52-54  below.

40. Who is a son or daughter?

Under the FFCRA, a “son or daughter” is your own child, which includes your biological, adopted, or foster child, your stepchild, a legal ward, or a child for whom you are standing in loco parentis—someone with day-to-day responsibilities to care for or financially support a child. For additional information about in loco parentis, see  Fact Sheet #28B: Family and Medical Leave Act (FMLA) leave for birth, placement, bonding or to care for a child with a serious health condition on the basis of an “in loco parentis” relationship.

In light of Congressional direction to interpret definitions consistently, WHD clarifies that under the FFCRA a “son or daughter” is also an adult son or daughter (i.e., one who is 18 years of age or older), who (1) has a mental or physical disability, and (2) is incapable of self-care because of that disability. For additional information on requirements relating to an adult son or daughter, see  Fact Sheet #28K  and/or call our toll free information and help line available 8 am–5 pm in your time zone, 1-866-4US-WAGE (1-866-487-9243).

41. What do I do if my employer, who I believe to be covered, refuses to provide me paid sick leave?

If you believe that your employer is covered and is improperly refusing you paid sick leave under the Emergency Paid Sick Leave Act, the Department encourages you to raise and try to resolve your concerns with your employer. Regardless of whether you discuss your concerns with your employer, if you believe your employer is improperly refusing you paid sick leave, you may call 1-866-4US-WAGE (1-866-487-9243). WHD is responsible for administering and enforcing these provisions. If you have questions or concerns, you can contact WHD by phone or visit their website.  Your call will be directed to the  nearest WHD office  for assistance to have your questions answered or to file a complaint. In most cases, you can also file a lawsuit against your employer directly without contacting WHD. If you are a public sector employee, please see the answer to  Question 54.

42. What do I do if my employer, who I believe to be covered, refuses to provide me expanded family and medical leave to care for my own son or daughter whose school or place of care has closed, or whose child care provider is unavailable, for COVID-19 related reasons?

If you believe that your employer is covered and is improperly refusing you expanded family and medical leave or otherwise violating your rights under the Emergency Family and Medical Leave Expansion Act, the Department encourages you to raise and try to resolve your concerns with your employer. Regardless whether you discuss your concerns with your employer, if you believe your employer is improperly refusing you expanded family and medical leave, you may call WHD at 1-866-4US-WAGE (1-866-487-9243) or visit their website. Your call will be directed to the  nearest WHD office  for assistance to have your questions answered or to file a complaint. If your employer employs 50 or more employees, you also may file a lawsuit against your employer directly without contacting WHD. If you are a public sector employee, please see the answer to  Question 54.

43. Do I have a right to return to work if I am taking paid sick leave or expanded family and medical leave under the Emergency Paid Sick Leave Act or the Emergency Family and Medical Leave Expansion Act?

Generally, yes. In light of Congressional direction to interpret requirements among the Acts consistently, WHD clarifies that the Acts require employers to provide the same (or a nearly equivalent) job to an employee who returns to work following leave.

In most instances, you are entitled to be restored to the same or an equivalent position upon return from paid sick leave or expanded family and medical leave. Thus, your employer is prohibited from firing, disciplining, or otherwise discriminating against you because you take paid sick leave or expanded family and medical leave. Nor can your employer fire, discipline, or otherwise discriminate against you because you filed any type of complaint or proceeding relating to these Acts, or have or intend to testify in any such proceeding.

However, you are not protected from employment actions, such as layoffs, that would have affected you regardless of whether you took leave. This means your employer can lay you off for legitimate business reasons, such as the  closure of your worksite. Your employer must be able to demonstrate that you would have been laid off even if you had not taken leave.

Your employer may also refuse to return you to work in your same position if you are a highly compensated  “key” employee  as defined under the FMLA, or if your employer has fewer than 25 employees, and you took leave to care for your own son or daughter whose school or place of care was closed, or whose child care provider was unavailable, and all four of the following hardship conditions exist: 

your position no longer exists due to economic or operating conditions that affect employment and due to COVID-19 related reasons during the period of your leave;
your employer made reasonable efforts to restore you to the same or an equivalent position;
your employer makes reasonable efforts to contact you if an equivalent position becomes available; and
your employer continues to make reasonable efforts to contact you for one year beginning either on the date the leave related to COVID-19 reasons concludes or the date 12 weeks after your leave began, whichever is earlier.

44. Do I qualify for leave for a COVID-19 related reason even if I have already used some or all of my leave under the Family and Medical Leave Act (FMLA)?

If you are an eligible employee, you are entitled to paid sick leave under the Emergency Paid Sick Leave Act regardless of how much leave you have taken under the FMLA.

However, if your employer was covered by the FMLA prior to April 1, 2020, your eligibility for expanded family and medical leave depends on how much leave you have already taken during the 12-month period that your employer uses for FMLA leave. You may take a total of 12 workweeks for FMLA or expanded family and medical leave reasons during a 12-month period. If you have taken some, but not all, 12 workweeks of your leave under FMLA during the current  12-month period determined by your employer, you may take the remaining portion of leave available. If you have already taken 12 workweeks of  FMLA  leave during this 12-month period, you may not take additional expanded family and medical leave. 

For example, assume you are eligible for preexisting FMLA leave and took two weeks of such leave in January 2020 to undergo and recover from a surgical procedure. You therefore have 10 weeks of FMLA leave remaining. Because expanded family and medical leave is a type of FMLA leave, you would be entitled to take up to 10 weeks of expanded family and medical leave, rather than 12 weeks. And any expanded family and medical leave you take would count against your entitlement to preexisting FMLA leave.

If your employer only becomes covered under the FMLA on April 1, 2020, this analysis does not apply.

45. May I take leave under the Family and Medical Leave Act over the next 12 months if I used some or all of my expanded family and medical leave under the Emergency Family and Medical Leave Expansion Act?

It depends. You may take a total of 12 workweeks of leave during a 12-month period under the FMLA, including the Emergency Family and Medical Leave Expansion Act. If you take some, but not all 12, workweeks of your expanded family and medical leave by December 31, 2020, you may take the remaining portion of FMLA leave for a serious medical condition, as long as the total time taken does not exceed  12 workweeks in the 12-month period. Please note that expanded family and medical leave is available only until December 31, 2020; after that, you may only take FMLA leave.

For example, assume you take four weeks of Expanded Family and Medical Leave in April 2020 to care for your child whose school is closed due to a COVID-19 related reason. These four weeks count against your entitlement to 12 weeks of FMLA leave in a 12-month period. If you are eligible for preexisting FMLA leave and need to take such leave in August 2020 because you need surgery, you would be entitled to take up to eight weeks of FMLA leave.

However, you are entitled to paid sick leave under the Emergency Paid Sick Leave Act regardless of how much leave you have taken under the FMLA. Paid sick leave is not a form of FMLA leave and therefore does not count toward the 12 workweeks in the 12-month period cap. But please note that if you take paid sick leave concurrently with the first two weeks of expanded family and medical leave, which may otherwise be unpaid, then those two weeks do count towards the 12 workweeks in the 12-month period.

46. If I take paid sick leave under the Emergency Paid Sick Leave Act, does that count against other types of paid sick leave to which I am entitled under State or local law, or my employer’s policy?

No. Paid sick leave under the Emergency Paid Sick Leave Act is in addition to other leave provided under Federal, State, or local law; an applicable collective bargaining agreement; or your employer’s existing company policy.

47. May I use paid sick leave and expanded family and medical leave together for any COVID-19 related reasons?  

No. The Emergency Family and Medical Leave Expansion Act applies only when you are on leave to care for your child whose school or place of care is closed, or whose child care provider is unavailable, due to COVID-19 related reasons. However, you can take paid sick leave under the Emergency Paid Sick Leave Act for numerous other reasons.

48. What is a full-time employee under the Emergency Paid Sick Leave Act? 

For purposes of the Emergency Paid Sick Leave Act, a full-time employee is an employee who is normally scheduled to work 40 or more hours per week.

In contrast, the Emergency Family and Medical Leave Expansion Act does not distinguish between full- and part-time employees, but the number of hours an employee normally works each week will affect the amount of pay the employee is eligible to receive.

49. What is a part-time employee under the Emergency Paid Sick Leave Act? 

For purposes of the Emergency Paid Sick Leave Act, a part-time employee is an employee who is normally scheduled to work fewer than 40 hours per week.

In contrast, the Emergency Family and Medical Leave Expansion Act does not distinguish between full- and part-time employees, but the number of hours an employee normally works each week affects the amount of pay the employee is eligible to receive.

50. How does the “for each working day during each of the 20 or more calendar workweeks in the current or preceding calendar” language in the FMLA definition of “employer” work under the Emergency Family and Medical Leave Expansion Act?

The language about counting employees over calendar workweeks is only in the FMLA’s definition for employer. This language does not apply to the Emergency Family and Medical Leave Expansion Act for purposes of expanded family and medical leave. Employers should use the number of employees on the day the employee’s leave would start to determine whether the employer has fewer than 500 employees for purposes of providing expanded family and medical leave and paid sick leave. See  Question 2  for more information.

51. I’ve elected to take paid sick leave and I am currently in a waiting period for my employer’s health coverage. If I am absent from work on paid sick leave during the waiting period, will my health coverage still take effect after I complete the waiting period on the same day that the coverage would otherwise take effect?

Yes. If you are on employer-provided group health coverage, you are entitled to group health coverage during your paid sick leave on the same terms as if you continued to work. Therefore, the requirements for eligibility, including any requirement to complete a waiting period, would apply in the same way as if you continued to work, including that the days you are on paid sick leave count towards completion of the waiting period. If, under the terms of the plan, an individual can elect coverage that becomes effective after completing the waiting period, the health coverage must take effect once the waiting period is complete. 

52. I am a public sector employee. May I take paid sick leave under the Emergency Paid Sick Leave Act?

Generally, yes. You are entitled to paid sick leave if you work for a public agency or other unit of government, with the exceptions below. Therefore, you are probably entitled to paid sick leave if, for example, you work for the government of the United States, a State, the District of Columbia, a Territory or possession of the United States, a city, a municipality, a township, a county, a parish, or a similar government entity subject to the exceptions below. The Office of Management and Budget (OMB) has the authority to exclude some categories of U.S. Government Executive Branch employees from taking certain kinds of paid sick leave. If you are a Federal employee, the Department encourages you to seek guidance from your respective employers as to your eligibility to take paid sick leave.

Further, health care providers and emergency responders may be excluded by their employer from being able to take paid sick leave under the Act. See  Questions 56-57  below. These coverage limits also apply to public-sector health care providers and emergency responders.

53. I am a public sector employee. May I take paid family and medical leave under the Emergency Family and Medical Leave Expansion Act?

It depends. In general, you are entitled to expanded family and medical leave if you are an employee of a non-federal public agency. Therefore, you are probably entitled to paid sick leave if, for example, you work for the government of a State, the District of Columbia, a Territory or possession of the United States, a city, a municipality, a township, a county, a parish, or a similar entity.

But if you are a Federal employee, you likely are not entitled to expanded family and medical leave. The Act only amended Title I of the FMLA; most Federal employees are covered instead by Title II of the FMLA. As a result, only some Federal employees are covered, and the vast majority are not. In addition, the Office of Management and Budget (OMB) has the authority to exclude some categories of U.S. Government Executive Branch employees with respect to expanded and family medical leave. If you are a Federal employee, the Department encourages you to seek guidance from your respective employers as to your eligibility to take expanded family and medical leave.

Further, health care providers and emergency responders may be excluded by their employer from being able to take expanded family and medical leave under the Act. See  Questions 56-57  below. These coverage limits also apply to public-sector health care providers and emergency responders.

54. What do I do if my public sector employer, who I believe to be covered, refuses to provide me paid sick leave or expanded family and medical leave?

If you believe that your public sector employer is covered and is improperly refusing you paid sick leave under the Emergency Paid Sick Leave Act or expanded family and medical leave under the Emergency Family and Medical Leave Expansion Act, the Department encourages you to raise your concerns with your employer in an attempt to resolve them. Regardless whether you discuss your concerns with your employer, if you believe your employer is improperly refusing you paid sick leave or expanded family and medical leave, you may call WHD at 1-866-4US-WAGE (1-866-487-9243) or visit their website. Your call will be directed to the  nearest WHD office  for assistance to have your questions answered or to file a complaint.   

In some cases, you may also be able to file a lawsuit against your employer directly without contacting WHD. Some State and local employees may not be able to pursue direct lawsuits because their employers are immune from such lawsuits. For additional information, see the WHD website and/or call WHD’s toll free information and help line available 8am–5pm in your time zone, 1-866-4-US-WAGE (1-866-487-9243).

55. Who is a “health care provider” for purposes of determining individuals whose advice to self-quarantine due to concerns related to COVID-19 can be relied on as a qualifying reason for paid sick leave?

The term “health care provider,” as used to determine individuals whose advice to self-quarantine due to concerns related to COVID-19 can be relied on as a qualifying reason for paid sick leave, means a licensed doctor of medicine, nurse practitioner, or other health care provider permitted to issue a certification for purposes of the FMLA.

56. Who is a “health care provider” who may be excluded by their employer from paid sick leave and/or expanded family and medical leave?

For the purposes of employees who may be exempted from paid sick leave or expanded family and medical leave by their employer under the FFCRA, a health care provider is anyone employed at any doctor’s office, hospital, health care center, clinic, post-secondary educational institution offering health care instruction, medical school, local health department or agency, nursing facility, retirement facility, nursing home, home health care provider, any facility that performs laboratory or medical testing, pharmacy, or any similar institution, employer, or entity. This includes any permanent or temporary institution, facility, location, or site where medical services are provided that are similar to such institutions. 

This definition includes any individual employed by an entity that contracts with any of the above institutions, employers, or entities institutions to provide services or to maintain the operation of the facility. This also includes anyone employed by any entity that provides medical services, produces medical products, or is otherwise involved in the making of COVID-19 related medical equipment, tests, drugs, vaccines, diagnostic vehicles, or treatments. This also includes any individual that the highest official of a state or territory, including the District of Columbia, determines is a health care provider necessary for that state’s or territory’s or the District of Columbia’s response to COVID-19.

To minimize the spread of the virus associated with COVID-19, the Department encourages employers to be judicious when using this definition to exempt health care providers from the provisions of the FFCRA.

57. Who is an emergency responder?

For the purposes of employees who may be excluded from paid sick leave or expanded family and medical leave by their employer under the FFCRA, an emergency responder is an employee who is necessary for the provision of transport, care, health care, comfort, and nutrition of such patients, or whose services are otherwise needed to limit the spread of COVID-19. This includes but is not limited to military or national guard, law enforcement officers, correctional institution personnel, fire fighters, emergency medical services personnel, physicians, nurses, public health personnel, emergency medical technicians, paramedics, emergency management personnel, 911 operators, public works personnel, and persons with skills or training in operating specialized equipment or other skills needed to provide aid in a declared emergency as well as individuals who work for such facilities employing these individuals and whose work is necessary to maintain the operation of the facility. This also includes any individual that the highest official of a state or territory, including the District of Columbia, determines is an emergency responder necessary for that state’s or territory’s or the District of Columbia’s response to COVID-19.

To minimize the spread of the virus associated with COVID-19, the Department encourages employers to be judicious when using this definition to exempt emergency responders from the provisions of the FFCRA.

58. When does the small business exemption apply to exclude a small business from the provisions of the Emergency Paid Sick Leave Act and Emergency Family and Medical Leave Expansion Act?

An employer, including a religious or nonprofit organization, with fewer than 50 employees (small business) is exempt from providing paid sick leave and expanded family and medical leave due to school or place of care closures or child care provider unavailability for COVID-19 related reasons when doing so would jeopardize the viability of the small business as a going concern.  A small business may claim this exemption if an authorized officer of the business has determined that:

The provision of paid sick leave or expanded family and medical leave would result in the small business’s expenses and financial obligations exceeding available business revenues and cause the small business to cease operating at a minimal capacity;  
The absence of the employee or employees requesting paid sick leave or expanded family and medical leave would entail a substantial risk to the financial health or operational capabilities of the small business because of their specialized skills, knowledge of the business, or responsibilities; or
There are not sufficient workers who are able, willing, and qualified, and who will be available at the time and place needed, to perform the labor or services provided by the employee or employees requesting paid sick leave or expanded family and medical leave, and these labor or services are needed for the small business to operate at a minimal capacity.

59. If I am a small business with fewer than 50 employees, am I exempt from the requirements to provide paid sick leave or expanded family and medical leave?

A small business is exempt from certain paid sick leave and expanded family and medical leave requirements if providing an employee such leave would jeopardize the viability of the business as a going concern. This means a small business is exempt from mandated paid sick leave or expanded family and medical leave requirements only if the:

employer employs fewer than 50 employees;
leave is requested because the child’s school or place of care is closed, or child care provider is unavailable, due to COVID-19 related reasons; and
an authorized officer of the business has determined that at least one of the three conditions described in Question 58 is satisfied.

The Department encourages employers and employees to collaborate to reach the best solution for maintaining the business and ensuring employee safety. 

[1] If you are a Federal employee, you are eligible to take paid sick leave under the Emergency Paid Sick Leave Act.  But only some Federal employees are eligible to take expanded family and medical leave under the Emergency Family and Medical Leave Expansion Act. Your eligibility will depend on whether you are covered under Title I or Title II of the Family Medical Leave Act. Federal employees should consult with their agency regarding their eligibility for expanded family and medical leave. The Office of Personnel and Management will provide information on federal employee coverage. Additional FAQs regarding public sector employers will be forthcoming.

[2] If you are a Federal employee, the State or local minimum wage would be used to calculate the wages owed to you only if the Federal agency that employs you has broad authority to set your compensation and has decided to use the State or local minimum wage.

Business Tax Planning Lawyer

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Tax Court in Brief | Johnson v. Comm’r | Section 179D Energy Efficient Building Property Deduction

The Tax Court in Brief – January 23rd – January 27th, 2023

Freeman Law’s “The Tax Court in Brief” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.

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Tax Litigation: The Week of January 23rd, 2022, through January 27th, 2023

Johnson v. Comm’r, 160 T.C. No. 2| January 25, 2023 |Nega, J. | Dkt. No. (Consolidated) 19973-18, 19975-18, 19978-18, 20001-18

Summary: In this 32-page, consolidated opinion, the Tax Court addresses deficiencies from disallowance of a 26 U.S.C. § 179D energy efficient building property deduction claimed by Edwards 4 Engineering, Inc. (Edwards), an S corporation, for the 2013 taxable year. Petitioners (6 total) are shareholders of Edwards and reported their proportionate shares of the claimed deduction on their individual tax returns.

Edwards contracted with a federal government entity, the VA, to supply and install components of a federal building’s HVAC system. The VA signed a letter that agreed, pursuant to I.R.C. § 179D(d)(4), to allocate to Edwards the full amount of the I.R.C. § 179D deduction to which the VA would otherwise be entitled for the installation of the property. Edwards maintained a full-time staff at the VA to perform the services. Edwards presented evidence of hours logged, invoices submitted, and payments received for the various projects involved in the overall service arrangement. Edwards also presented evidence of subcontractors engaged and paid. Edwards also engaged Alliantgroup, LP (Alliantgroup), to conduct an Energy Efficient Commercial Building Tax Deduction Study (study) for the 2013 taxable year with respect to a certain Building 200. An allocation letter was presented to Edwards, and a VA representative signed off on the letter. The allocation letter stated, in relevant part, that “the owner of the Building allocates the full federal income tax deduction available under Section 179D attributable to the HVAC . . . to Edwards . . . for their work on the Building.” Attached to the allocation letter was a table which stated the placed in service date and the cost of the property installed in Building 200 with respect to the projects at issue. Alliantgroup then proceeded with conducting the study. A certificate of compliance related to Building 200 was issued, stating, among other things, that the total annual energy and power costs of this building had been reduced by more than 50 percent due to the installation of the systems, among other qualifying and compliance conclusions regarding Edwards’ work and services performed on the building. The study was performed in accordance with section 179D(d)(6)(C) and Notice 2006-52, section 5.05, 2006-1 C.B. at 1179. See Key Points of Law below for further reference to Notice 2006-52. Alliantgroup informed the VA that Alliantgroup had completed the study for Building 200 and determined that Edwards had been allocated a section 179D deduction in the amount of $1,037,237. The letter provided the projected annual energy costs for Building 200 and a list of the energy efficient features installed in Building 200.

Edwards filed a Form 1120S, U.S. Income Tax Return for an S Corporation, for the 2013 taxable year, claiming a section 179D deduction of $1,073,237. Petitioners, as direct or indirect shareholders of Edwards, reported their proportionate shares of the claimed section 179D deduction on their Forms 1040 for the 2013 taxable year. By notices of deficiency, the IRS disallowed the section 179D deduction claimed by each Petitioner. Petitioners each petitions challenging the disallowance, and the cases were consolidated.

Key Issue: Whether Edwards is entitled to a deduction of $1,073,237 under section 179D for the 2013 taxable year?

Primary Holdings: The installed property was EECBP within the meaning of I.R.C. § 179D(c)(1). The property: (A) was depreciable; (B) was located in or on property in the U.S.; (C) was installed as part of a plan to achieve the energy savings target; (D) installed resulted in computed energy savings; and (E) the certification and notice to building owner required by section 179D(d)(5) and (6) were sufficient. And, Edwards was primarily responsible for designing the EECB installed. The VA properly allocated the available amount of an I.R.C. § 179D deduction to Edwards as the person primarily responsible for designing the EECBP. The installed property was placed in service in tax year 2013. However, based on the limitations for deduction allowed by section 179D(b), Edwards was entitled to an I.R.C. § 179D deduction of $304,640.

Key Points of Law:

Jurisdiction and Burden of Proof. Where a notice of deficiency issued to an S corporation shareholder includes adjustments to both S corporation items and other items unrelated to the S corporation, the Tax Court has jurisdiction to determine the correctness of all adjustments in the shareholder-level deficiency proceeding. See Winter v. Commissioner, 135 T.C. 238, 245–46 (2010). In general, the IRS’s determinations set forth in a notice of deficiency are presumed correct, and the taxpayer bears the burden of proving them erroneous. Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933). Deductions are a matter of legislative grace, and the taxpayer generally bears the burden of proving entitlement to any deduction claimed. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). A taxpayer claiming a deduction on a federal income tax return must demonstrate that the deduction is allowable pursuant to some statutory provision and must substantiate the deduction by maintaining and producing records sufficient to enable the IRS to determine the taxpayer’s correct tax liability. 26 U.S.C. § 6001; Treas. Reg. § 1.6001- 1(a); Higbee v. Commissioner, 116 T.C. 438, 440 (2001).

Section 179D Deduction. Section 179D provides a deduction with respect to energy efficient commercial buildings. Ordinarily, when a taxpayer incurs expenses for improvements to buildings or other property, the taxpayer is required to capitalize the expenditures and may recover the costs over time through deductions for depreciation or amortization. See 26 U.S.C. §§ 167, 168, 263. Section 179D, however, allows taxpayers an immediate deduction with respect to energy efficient commercial building property. “There shall be allowed as a deduction an amount equal to the cost of energy efficient commercial building property placed in service during the taxable year.” Id. at 179D(a).

EECBP. “Energy efficient commercial building property” (EECBP) is defined in 26 U.S.C. § 179D(c)(1) as property:

(A) with respect to which depreciation (or amortization in lieu of depreciation) is allowable,

(B) which is installed on or in any building which is— (i) located in the United States, and (ii) within the scope of Standard 90.1-2001,

(C) which is installed as part of— (i) the interior lighting systems, (ii) the heating, cooling, ventilation, and hot water systems, or (iii) the building envelope, and

(D) which is certified in accordance with subsection (d)(6) as being installed as part of a plan designed to reduce the total annual energy and power costs with respect to the interior lighting systems, heating, cooling, ventilation, and hot water systems of the building by 50 percent or more in comparison to a reference building which meets the minimum requirements of Standard 90.1-2001 using methods of calculation under subsection (d)(2).

EECBP Energy Costs and IRS Interim Guidance. The statute directs the IRS (Secretary of Treasury) to consult with the Secretary of Energy to promulgate regulations which describe in detail methods for calculating and verifying energy and power consumption and cost, based on the provisions of the 2005 California Nonresidential Alternative Calculation Method Approval Manual. Id. at § 179D(d)(2). Section 179D(d)(3)(A) requires that any such calculation be prepared by qualified computer software. See IRS Notice 2006-52, 2006-1 C.B. 1175 (interim guidance); IRS Notice 2008-40, 2008-1 C.B. 725 (interim guidance); IRS Notice 2012-26 (modifying Notice 2006-52 and Notice 2008-40, the latter of which clarified and amplified Notice 2006-52). The Secretary has not promulgated regulations on the methods of calculation. Notice 2006-52, however, sets forth interim guidance on the methods for calculating and verifying energy and power consumption and cost. See Notice 2006-52, § 3.

Among other things, Notice 2006-52 broadly defines the proposed building as containing the relevant systems “that have been incorporated, or that the taxpayer plans to incorporate,” into the building. Notice 2006-52, § 3.04(1). Under this definition, the systems and components included in the proposed building are not limited to those incorporated into the building within a specific timeframe or by a specific contractor.

EECBP Certifications and “Person Primarily Responsible for Design”. Section 179D(d)(5) provides that each certification required under this section 179D must include an explanation to the building owner regarding the energy efficiency features of the building and its projected annual energy costs as provided in the notice under paragraph (3)(B)(iii). In the case of EECBP installed on or in property owned by arm of the government or a political division, section 179D(d)(4) provides that “the Secretary shall promulgate a regulation to allow the allocation of the deduction to the person primarily responsible for designing the property in lieu of the owner of such property.”

The person primarily responsible for designing the property “shall be treated as the taxpayer for purposes of this section.” Id. at 179D(d)(4). If the requirements of section 179D(c)(1) are satisfied, the amount of the section 179D deduction allowed is equal to the cost of the EECBP placed in service during the taxable year. Id. at § 179D(a). However, the deduction allowed is not to exceed the excess of the product of $1.80 and the square footage of the building, over the aggregate amount of the section 179D deductions taken with respect to the building for all prior taxable years. To the extent that a section 179D deduction is allowed with respect to any EECBP, the building owner is required to reduce the basis of the property by the amount of the deduction so allowed. Id. at § 179D(b), (e).

Section 179D does not define the “person primarily responsible for designing the property.” Notice 2008-40, section 3.02, however, defines a “designer” as “a person that creates the technical specifications for installation of [EECBP]” and may include, for example, an architect, engineer, contractor, environmental consultant or energy services provider who creates the technical specifications for a new building or any addition to an existing building that incorporates energy efficient commercial building property. Notice 2008-40, § 3.02. Section 3.02 clarifies that “[a] person that merely installs, repairs, or maintains the property is not a designer.” Id.

Certifications and Notice to Building Owner. Before a taxpayer may claim a section 179D deduction with respect to property installed on or in a commercial building, the taxpayer must obtain a certification with respect to the property. Notice 2006-52, § 4, 2006-1 C.B. at 1177. Section 179D(c)(1)(D) requires that EECBP be “certified in accordance with subsection (d)(6).” Section 179D(d)(5) requires each certification to include an explanation to the building owner regarding the energy efficiency features of the building and its projected annual energy costs. Notice 2006-52, section 4 prescribes the manner and method for the making of certifications in accordance with section 179D(c)(1) and (d)(6).

Form of Allocation. Section 179D does not prescribe any particular formal requirements for the allocation of the deduction. Notice 2008-40, section 3.05, 2008-1 C.B. at 726, states that “[b]efore a designer may claim the § 179D deduction with respect to property installed on or in a government-owned building, the designer must obtain the written allocation described in section 3.04.” Notice 2008-40, section 3.04 contains the elements that are evaluated for determining the allocation of the section 179D deduction. Notice 2008-40, section 3.04, requires the allocation letter to state only the “amount” (such as a percentage and not necessarily the dollar amount) of the section 179D deduction allocated to the designer.

“Placed in Service.” Section 179D allows a deduction for “the cost of energy efficient commercial building property placed in service during the taxable year.” 26 U.S.C. § 179D(a). Notice 2008-40, section 3.01 states that “[t]he deduction will be allowed to the designer for the taxable year that includes the date on which the property is placed in service.” Section 179D does not define when EECBP is “placed in service.” Because EECBP is property “with respect to which depreciation . . . is allowable,” the statutes and rules governing depreciable property are relevant to determine when property is “placed in service” for section 179D purposes. See 26 U.S.C. §§ 179D(c)(1)(A), 179(a), 167. Section 167 allows a depreciation deduction for the exhaustion, wear and tear, or obsolescence of property used in a trade or business. Treasury Regulation § 1.167(a)-10(b) provides that “[t]he period for depreciation of an asset shall begin when the asset is placed in service.” In general, property is placed in service when it is “first placed in a condition or state of readiness and availability for a specifically assigned function, whether in a trade or business, in the production of income, in a tax-exempt activity, or in a personal activity.” Treas. Reg. §§ 1.167(a)- 11(e)(1)(i), 1.179-4(e). Property is thus deemed to have been placed in service at the time when it functionally could have been used, rather than when it was actually used. See Waddell v. Commissioner, 86 T.C. 848, 897 (1986), aff’d, 841 F.2d 264 (9th Cir. 1988); Piggly Wiggly S., Inc. v. Commissioner, 84 T.C. 739, 746–47 (1985), aff’d, 803 F.2d 1572 (11th Cir. 1986).

Amount of the Section 179D Deduction. Under section 179D(a) the amount of the deduction allowed is “equal to the cost of energy efficient commercial building property placed in service during the taxable year.” Section 179D(b), however, limits the deduction allowed with respect to any building for any taxable year to the excess (if any) of the product of $1.80 and the square footage of the building, over the aggregate amount of section 179D deductions taken with respect to the building for all prior taxable years. Thus, the amount of the section 179D deduction allowed is equal to the lesser of (1) the cost of EECBP placed in service during the taxable year and (2) the maximum amount of deduction determined under section 179D(b). See Notice 2008-40, § 3.06.

Insights: To say that an EECBP deduction is complex is an understatement. And, the lack of statutorily-required regulations is not helpful. Much thought and preparation should go into a qualified building project before it begins to ensure the design is right for EECBP deduction and qualified experts are in place to provide the required evaluation, certification, and notices required by section 179D and the interim guidance provided by the IRS. Consultation of Johnson, section 179D, and the IRS Notices referenced above is advisable.

The FBAR (Report of Foreign Bank and Financial Accounts): Everything You Need to Know

What is the Report of Foreign Bank and Financial Accounts (FBAR)?

Congress enacted the statutory basis for the requirement to report foreign bank and financial accounts in 1970 as part of the “Currency and Foreign Transactions Reporting Act of 1970,” which came to be known as the “Bank Secrecy Act” or “BSA.” These anti-money laundering and currency reporting provisions, as amended, were codified at 31 USC 5311 – 5332, excluding section 5315.

The Secretary of the Treasury subsequently delegated the authority to administer civil compliance with Title II of the BSA to the Director of FinCEN. IRS Criminal Investigation (CI), however, maintains authority to enforce the criminal provisions of the BSA.

While FinCEN retains rule-making authority with respect to FBAR reporting, FinCEN redelegated civil FBAR enforcement authority to the IRS.

The FBAR regulations require that a United States person, including a citizen, resident, corporation, partnership, limited liability company, trust and estate, file an FBAR to report:

a financial interest in or signature or other authority over at least one financial account located outside the United States if
the aggregate value of those foreign financial accounts exceeded $10,000 at any time during the calendar year reported.

Penalties

A failure to file an FBAR report may result in criminal exposure—that is, the possibility of a criminal indictment or investigation. For several years, the IRS has publicly touted its intention to strongly enforce the FBAR reporting requirements.

In addition, a failure to file a FBAR report may result in exposure to civil penalties, including up to half of the balance in all unreported accounts if the government determines that the failure to report was willful or reckless.

Current penalties (adjusted for inflation) are as follows:

U.S. Code citation	Civil Monetary Penalty Description	Current Maximum
31 U.S.C. 5321(a)(5)(B)(i)	Foreign Financial Agency Transaction – Non-Willful Violation of Transaction	$12,921
31 U.S.C. 5321(a)(5)(C)	Foreign Financial Agency Transaction – Willful Violation of Transaction	Greater of $129,210, or 50% of the amount per 31 U.S.C.5321(a)(5)(D)
31 U.S.C. 5321(a)(6)(A)	Negligent Violation by Financial Institution or Non-Financial Trade or Business	$1,118
31 U.S.C. 5321(a)(6)(B)	Pattern of Negligent Activity by Financial Institution or Non-Financial Trade or Business	$86,976

FBAR Statutory Authority

The statutory authority for the FBAR is found under 31 USC § 5314. Section 5314 directs the Secretary of the Treasury to require a resident or citizen of the United States to keep records and/or file reports when making transactions or maintaining a relationship with a foreign financial agency.

31 USC § 5321(a)(5) and (a)(6) establish civil penalties for violations of the FBAR reporting and recordkeeping requirements.

FBAR Regulatory Authority

31 CFR § 1010.350 sets forth the FBAR definitions and requirements. Section 1010.350 requires that “each United States person having a financial interest in, or signature or other authority over, a bank, securities, or other financial account in a foreign country shall report such relationship to the Commissioner of Internal Revenue for each year in which such relationship exists and shall provide such information as shall be specified in a reporting form prescribed under 31 USC § 5314 to be filed by such persons.”

The report is required to be electronically filed with FinCEN on FinCEN Report 114, Report of Foreign Bank and Financial Accounts (FBAR).

Recordkeeping Requirements

31 CFR § 1010.420 requires maintenance and retention of FBAR records for a period of five years. 31 CFR 1010.810(g) references a Memorandum of Agreement between FinCEN and the IRS, which redelegates, to the IRS, FinCEN’s authority to enforce the provisions of 31 USC 5314 and 31 CFR 1010.350 and 1010.420. This includes the authority to:

Assess and collect civil FBAR penalties.
Investigate possible civil violations of these provisions.
Employ the summons power of subpart I of Chapter X.
Issue administrative rulings under subpart G of Chapter X.
Take any other action reasonably necessary for the enforcement of these and related provisions, including pursuit of injunctions.

FBAR Filing Criteria

An FBAR is required if all of the following apply:

The filer is a U.S. person.
The U.S. person has a financial interest in a financial account or signature or other authority over a financial account.
The financial account is in a foreign country.
The aggregate amount(s) in the account(s) valued in dollars exceed $10,000 at any time during the calendar year.

United States Person

A “United States person” is defined by 31 CFR § 1010.350(b) to include:

A citizen of the United States.
A resident of the United States.
An entity formed under the laws of the United States, any state, the District of Columbia, any territory or possession of the United States, or an Indian tribe.

Notably, the federal tax treatment of a United States person does not determine whether the person has an FBAR filing requirement.

Example: Single-member Limited Liability Companies (LLCs) are disregarded for federal tax purposes, but would have to file the FBAR if otherwise required to do so.

Example: Some trusts may not file tax returns but may have an FBAR filing requirement.

The definition of “United States” for this purpose is found in 31 CFR § 1010.100(hhh). For FBAR and other Title 31 purposes, a “United States” includes:

The States of the United States.
The District of Columbia.
The Indian lands (as defined in the Indian Gaming Regulatory Act).
The territories and insular possessions of the United States.

U.S. territories and insular possessions currently include:

Puerto Rico
Guam
American Samoa
S. Virgin Islands
Northern Mariana Islands

U.S. Citizen

A citizen of the U.S. has a U.S. birth certificate or naturalization papers.

U.S. citizenship is not defined by residency. A citizen of the U.S. may reside outside the U.S.

Example:

Children born of U.S. citizens living abroad are U.S. citizens despite the fact that they may never have been to the U.S.

U.S. Resident

Prior to February 24, 2011, when revised regulations were issued, the FBAR regulations did not define the term “U.S. resident.”

For FBARs required to be filed by June 30, 2011, or later, 31 CFR 1010.350(b) defines “United States resident” using the definition of resident alien in IRC 7701(b), but using the Title 31 definition of “United States.” The major tests of residency found in section 7701(b) are:

The green-card test. Individuals who at any time during the calendar year have been lawfully granted the privilege of residing permanently in the U.S. under the immigration laws automatically meet the definition of resident alien under the green-card test.
The substantial-presence test. Individuals are defined as resident aliens under the substantial-presence test if they are physically present in the U.S. for at least 183 days during the current year, or they are physically present in the U.S. for at least 31 days during the current year and meet the specifications contained in IRC 7701(b)(3).
The individual files a first-year election on his income tax return to be treated as a resident alien under IRC 7701(b)(4).
The individual is considered a resident under the special rules in section 7701(b)(2) for first-year or last-year residency.

Individuals residing in the U.S. who do not meet one of these residency tests are not considered U.S. residents for FBAR purposes. This includes individuals in the U.S. under a work visa who do not meet the substantial-presence test.

Using these rules of residency can result in a non-resident being considered a U.S. resident for FBAR purposes. This would occur when a green-card holder actually resides outside the U.S.

FinCEN clarified in the preamble to the regulations that an election under IRC 6013(g) or (h) is not considered when determining residency status for FBAR purposes.

U.S. tax treaty provisions do not affect residency status for FBAR purposes. A treaty provision which allows a resident of the U.S. to file tax returns as a non-resident does not affect residency status for FBAR purposes if one of the tests of residency in IRC 7701(b) is met.

Diplomats residing at foreign embassies in the U.S. are not generally considered U.S. residents since foreign embassies are generally considered part of the sovereign nation they represent.

U.S. Entity

A U.S. entity is a legal entity formed under the laws of the U.S., any state, the District of Columbia, any territory or possession of the U.S., or an Indian tribe.

31 CFR 1010.350(b) specifically names, but does not limit these types of entities to:

Corporations
Partnerships
Trusts
Limited Liability Companies

The preamble to the regulations clarifies that pension plans and welfare benefit plans are included as U.S. entities.

The definition of entities allows for new types of legal entities to be included in the future.

Financial Account

A reportable financial account includes a:
- Bank account, such as a savings deposit, demand deposit, checking, time deposit (CD), or any other account maintained with a financial institution or other person engaged in the business of banking.
- Securities account, securities derivatives account, or other financial instruments account held with a person engaged in the business of buying, selling, holding or trading stock or other securities.
- Other financial account, as defined in (2) below.
“Other Financial Account” is defined by the regulations to include:
- An account with a person in the business of accepting deposits as a financial agency.
- An insurance or annuity policy that has a cash value.

Note:

The preamble to the regulations clarifies that there need be no current payment of an income stream to trigger reporting. The cash value of the policy is considered the account value.

An account with a person that acts as a broker or dealer for futures or options transactions in any commodity on or subject to the rules of a commodity exchange or association.* A mutual fund or similar pooled fund defined as “a fund which issues shares available to the general public that have a regular net asset value determination and regular redemptions.”
The following are not considered financial accounts:
- Stocks, bonds, or similar financial instruments held directly by the person.
- Real estate or an account holding solely real estate (e.g., Mexican “fideicomiso” ).
- A safety deposit box.

Note:

A reportable account may exist where the financial institution providing the safety deposit box has access to the contents and can dispose of the contents upon instruction from, or prearrangement with, the person.

Precious metals, precious stones, or jewels held directly by the person.

Note:

31 USC 5314 defines “foreign financial agency” as “a person acting for a person as a financial institution, bailee, depository trustee, or agent, or acting in a similar way related to money, credit, securities, gold, or a transaction in money, credit, securities, or gold.” Therefore, a reportable account relationship may exist where a foreign agency holds precious metals on deposit or provides insurance or other services as an agent of the person owning the precious metals.

Financial Account Exceptions

The following are not considered reportable financial accounts for FBAR purposes:

- An account of a department or agency of the U.S., an Indian tribe, any state or any political subdivision of a state, any territory or insular possession of the U.S., or a wholly-owned entity, agency or instrumentality of any of the foregoing.
- An account of an international financial institution of which the U.S. government is a member. (e.g., the International Monetary Fund (IMF) and the World Bank.)
- An account in an institution known as a “United States military banking facility,” that is, a facility designated to serve U.S. military installations abroad.
- Correspondent or “nostro” accounts that are maintained by banks and used solely for bank-to-bank settlements.
- Custodial or “omnibus” accounts held for the person by a U.S. institution acting as a global custodian, as long as the person cannot directly access the foreign custodial account.

Accounts not reported on FBAR

Individuals don’t report individual retirement accounts and tax-qualified retirement plans described in Internal Revenue Code Sections 401(a), 403(a) or 403(b) on the FBAR. The FBAR instructions list other exceptions.

Account Valuation

The FBAR is required for each calendar year during which the aggregate amount(s) in the foreign account(s) exceeded $10,000, valued in U.S. dollars, at any time during that calendar year. To determine the account value to report on the FBAR follow these steps:

Determine the maximum value in locally denominated currency. The maximum value of an account is the largest amount of currency and non-monetary assets that appear on any quarterly or more frequent account statement issued for the applicable year.

Example:

If the statement closing balance is $9,000 but at any time during the year a balance of $15,000 appears on a statement, the maximum value reportable on an FBAR is $15,000.

Note:

If periodic account statements are not issued, the maximum account asset value is the largest amount of currency and non-monetary assets in the account at any time during the year.

Convert the maximum value into U.S. dollars by using the official exchange rate in effect at the end of the year at issue for converting the foreign currency into U.S. dollars. The official Treasury Reporting Rates of Exchange for recent years are posted on the FBAR home page of the IRS website. Search for the keyword “FBAR” to find the FBAR home page. Current and recent quarterly rates are also posted on the Bureau of the Fiscal Service website.

If the filer has more than one account to report on the FBAR, each account is valued separately in accordance with the previous paragraphs.

If a person has one or more but fewer than 25 reportable accounts and is unable to determine whether the maximum value of these accounts exceeded $10,000 at any time during the calendar year, the FBAR instructions state that the person is to complete the applicable parts of the FBAR for each of these accounts and enter “value unknown” in Item 15.

Financial Interest

Direct Financial Interest:

A U.S. person has a financial interest in each account for which such person is the owner of record or has legal title, whether the account is maintained for his own benefit or for the benefit of others including non-U.S. persons.
If an account is maintained in the name of two persons jointly, or if several persons each own a partial interest in an account, each of those U.S. persons has a financial interest in that account and, generally, each person must file the FBAR. However, see special rules for spousal filing in IRM 4.26.16.4.4, below.

Note:

Because the FBAR is a report of foreign financial accounts, the entire account value for jointly-owned accounts is reported on each FBAR. Accounts are not prorated for a person’s percentage of ownership interest.

Indirect financial interest: A U.S. person has an “other financial interest” in each bank, securities, or other financial account in a foreign country for which the owner of record or holder of legal title is:

A person acting as an agent, nominee, attorney, or in some other capacity on behalf of the U.S. person.
A corporation, whether foreign or domestic, in which the U.S. person owns directly or indirectly more than 50 percent of the total value of shares of stock or more than 50 percent of the voting power for all shares of stock.
A partnership, whether foreign or domestic, in which the United States person owns an interest in more than 50 percent of the profits (distributive share of income, taking into account any special allocation agreement) or more than 50 percent of the capital of the partnership.
Any other entity in which the U.S. person owns directly or indirectly more than 50 percent of the voting power, total value of the equity interest or assets, or interest in profits.
A trust, if the U.S. person is the trust grantor and has an ownership interest in the trust for U.S. federal tax purposes under 26 USC 671–679 and the regulations thereunder.
A trust, whether foreign or domestic, in which the U.S. person either has a present beneficial interest, either directly or indirectly, in more than 50 percent of the assets of the trust or from which such person receives more than 50 percent of the trust’s current income.

The family attribution rules under Title 26 do not apply to FBAR reporting.

Anti-avoidance rule: A U.S. person that causes an entity including, but not limited to, a corporation, partnership, or trust, to be created for the purpose of evading the FBAR reporting and/or recordkeeping requirements shall have a financial interest in any bank, securities, or other financial account in a foreign country for which the entity is the owner of record or holder of legal title. 31 CFR 1010.350(e)(3).

Signature or Other Authority Over an Account

An individual has signature or other authority over an account if that individual (alone or in conjunction with another) can control the disposition of money, funds or other assets held in a financial account by direct communication (whether in writing or otherwise) to the person with whom the financial account is maintained.

Individuals not considered as having signature authority:

Individuals with only the authority to buy or sell investments within the account, but no authority to disburse assets from the account.
Individuals with supervisory authority over the individuals who actually communicate with the person with whom the account is maintained. FinCEN clarified, in the preamble to the regulations at 31 CFR 1010.350, that approving a disbursement that a subordinate actually orders is not considered signature authority.

Only individuals can have signature authority. Signature authority attributed to entities must be exercised by individuals.

Signature Authority Exceptions

An officer or employee of the following institutions need not report signature or other authority over a foreign financial account owned or maintained by the institution if the officer or employee has no financial interest in the account:

A bank that is examined by the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, or the National Credit Union Administration.
A financial institution that is registered with and examined by the Securities and Exchange Commission or Commodity Futures Trading Commission.
An Authorized Service Provider for a foreign financial account owned or maintained by an investment company that is registered with the Securities and Exchange Commission.

Note:

Authorized Service Provider is an entity that is registered with and examined by the Securities and Exchange Commission and that provides services to an investment company registered under the Investment Company Act of 1940.

An entity with a class of equity securities listed (or American depository receipts listed) on any U.S. national securities exchange.

Note:

Previously, instructions to the form allowed a “large corporation” exception for listed corporations. That exception was expanded to include all listed entities.

An entity that has a class of equity securities registered (or American depository receipts registered) under section 12(g) of the Securities Exchange Act.
An officer or employee of a U.S. subsidiary of an entity described above above need not report signature authority over accounts of the subsidiary if the entity files a consolidated FBAR listing the accounts of the subsidiary.

Foreign Country

A foreign country includes all geographical areas located outside of the United States as defined in 31 CFR 1010.100(hhh). An account is “foreign” for FBAR purposes if it is located outside:

the States of the United States.
The District of Columbia.
The Indian lands (as defined in the Indian Gaming Regulatory Act).
The territories and insular possessions of the United States. See IRM 4.26.16.3.1(4) above.

It is the location of an account, not the nationality of the financial institution, that determines whether an account is “foreign” for FBAR purposes. Accounts of foreign financial institutions located in the U.S. are not considered foreign accounts for FBAR; conversely, accounts of U.S. financial institutions located outside the U.S. are considered foreign accounts. Examples are:

An account with a Hong Kong branch of a U.S.-based bank is a foreign financial account for FBAR purposes.
An account with a New York City branch of a foreign-based bank is not a foreign financial account for FBAR purposes.

Aggregate Value Over $10,000

The final criterion triggering the FBAR filing requirement is the aggregate value of all foreign financial accounts in which the person has a financial interest, or over which the individual has signature or other authority, must be greater than $10,000, valued in U.S. dollars, at any time (on a particular day) during the calendar year.

Steps to aggregate account values:

Each account should be separately valued according to the steps outlined in IRM 4.26.16.3.2.2 to determine its highest valuation during the year in the foreign denominated currency.

Exception:

Money moved from one foreign account to another foreign account during the year must only be counted once.

Each account should be converted from foreign denominated value to U.S. dollars using the FMS conversion rate for December 31st of the calendar year being reported. See IRM 4.26.16.3.2.2, Account Valuation, above.

All reportable accounts should be aggregated, including:

Solely-owned accounts.
Jointly-owned accounts.
Direct financial interest accounts.
Indirect financial interest accounts.
Signature authority accounts.

FBAR Filing Procedures

The determination to file the FBAR is made annually. For example, a person may be required to file an FBAR for one calendar year but not for a subsequent year if the person’s aggregate foreign account balance does not exceed $10,000 at any time during the year.

An FBAR must be filed for each calendar year that the person has a financial interest in, or signature authority over, foreign financial account(s) whose aggregate balance exceeds the $10,000 threshold at any time during the year.

General FBAR Filing

The FBAR must be filed on or before June 30 each year for the previous calendar year.

All FBARs filed after June 30, 2013, must be filed electronically through the FinCEN BSA E-Filing website unless the filer requested, and was granted, an exception to e-filing by FinCEN.

The FBAR should not be filed with the filer’s federal income tax return or information return.

FBAR Filing Exceptions

Individual Retirement Account (IRA) owners and beneficiaries, and participants in and beneficiaries of U.S. tax-qualified retirement plans, are not required to report a foreign financial account held by or on behalf of the IRA or retirement plan.

Caution:

This exception is for U.S. plans only. Foreign plans (e.g., a Canadian Registered Retirement Savings Plan (RRSP) and accounts managed by Mexico’s Administrators of Retirement Funds (AFORES) are normally reportable on an FBAR.

A trust beneficiary with a financial interest is not required to report the trust’s foreign financial accounts on an FBAR if the trust, trustee of the trust, or agent of the trust:

Is a U.S. person, and
Files an FBAR disclosing the trust’s foreign financial accounts.

FBAR Filing by Married Couples

Accounts owned jointly by spouses may be filed on one FBAR. The spouse of an individual who files an FBAR is not required to file a separate FBAR if the following conditions are met:

All the financial accounts that the non-filing spouse is required to report are jointly owned with the filing spouse.
The filing spouse reports the jointly owned accounts on a timely, electronically filed FBAR.
Both spouses complete and sign Part I of FinCEN Form 114a, Record of Authorization to Electronically File FBARs. The filing spouse completes Part II of Form 114a in its entirety.

Note:

The completed Form 114a is not filed but must be retained for five years. It must be provided to IRS or FinCEN upon request.

If these conditions are not met (as when both spouses have individual accounts in addition to the jointly-owned accounts), both spouses are required to file separate FBARs, and each spouse must report the entire value of the jointly-owned accounts.

For calendar years prior to 2014, use the instructions for spousal filing current for that filing year.

Electronic FBAR Filing by a Third Party

FBAR filers may authorize a paid preparer or other third party to electronically file the FBAR for them.

The person reporting financial interest in, or signature authority over, foreign accounts must complete and sign Part I of FinCEN Form 114a.

The preparer or other third-party filer must complete Part II of Form 114a.

Form 114a is not filed. Both parties must retain the form for five years. It must be provided to IRS or FinCEN upon request.

It remains the responsibility of the filer to ensure that filing takes place timely and the report is accurate. Form 114a contains a disclaimer that states: “…it is my/our legal responsibility, not that of the preparer listed in Part II, to timely file an FBAR if required by law to do so.”

FBAR Filing for Financial Interest in 25 or More Accounts

31 CFR 1010.350(g) provides that a United States person that has a financial interest in 25 or more foreign financial accounts only needs to provide the number of financial accounts and certain other basic information on the report, but will be required to provide detailed information concerning each account if the IRS or FinCEN requests it.

Filers must comply with FBAR record-keeping requirements.

FBAR Filing for Signature Authority for 25 or More Accounts

31 CFR 1010.350(g) provides that A United States person that has signature or other authority over 25 or more foreign financial accounts only needs to provide the number of financial accounts and certain other basic information on the report, but will be required to provide detailed information concerning each account if the IRS or FinCEN requests it.

Filers must comply with FBAR record-keeping requirements.

FBAR Filing for U.S. Persons Residing and Employed Outside the United States

The FBAR filing instructions allow for modified reporting by a U.S. person who meets all three of the following criteria:

Resides outside the U.S.
Is an officer or employee of an employer located outside the U.S.
Has signature authority over a foreign financial account(s) of that employer.

In such cases, the U.S. Person should file the FBAR by:

Completing filer information.
Omitting account information.
Completing employer information one time only.

Filing A Consolidated FBAR

31 CFR 1010.350(g) allows an entity that is a U.S. person that owns directly or indirectly a greater than 50 percent interest in another entity that is required to file an FBAR to file a consolidated FBAR on behalf of itself and such other entity.

Each controlled entity that has an FBAR filing obligation must be listed in Part V, even if that entity owns foreign accounts only indirectly.

No FBAR Filing Extension

There is no statutory authority to extend the time for filing an FBAR, and any request for such an extension will be denied.

Extensions of time to file federal income tax returns or information returns do not extend the time for filing FBARs.

IRC section 7508 “Time for performing certain acts postponed by reason of service in combat zone or contingency operation” does not grant U.S. persons that are U.S. Armed Forces members an extension to file the FBAR.

This is not to be confused with extension of the statute of limitations on assessment or collection of penalties, which is possible.

Delinquent FBAR Filing Procedures

Delinquent FBARs should be filed using the current electronic report, but using the instructions for the year being reported to determine if an FBAR filing requirement exists.

On page one of FinCEN Report 114, explain the reason the FBAR was not filed timely. Select a common reason from the drop-down box or select Other, and a 750-character text box appears to allow an explanation.

Keep a copy of the FBAR for recordkeeping purposes.

No penalty will be asserted if the IRS determines that the failure to timely file an FBAR was not willful and was due to reasonable cause.

Amending a Filed FBAR

To amend a filed FBAR, filers should:

Check the “Amended” box in Item 1 at the top of page two and fill in the “Prior Report BSA Identifier” for the original filing in the block provided.
Complete the report in its entirety using the amended information.

FBAR Recordkeeping

If the FBAR is required, certain records must be retained by the filer. 31 CFR 1010.420. Each person having a financial interest in or signature or other authority over any such account must keep the following records:

Name in which the account is maintained.
Number or other designation identifying the account.
Name and address of the foreign financial institution or other person with whom the account is maintained.
Type of account.
Maximum value of each account during the reporting period.

The records must be kept for five years from the June 30 due date for filing the FBAR for that calendar year and be available at all times for inspection as provided by law.

Note that persons are not required to keep copies of FBARs filed, only the records that underlie the filing.

An officer or employee who files an FBAR to report signature authority over an employer’s foreign financial account is not required to personally retain records regarding that account.

FBAR Recordkeeping For Filers Having 25 Or More Accounts

A filer who has financial interest in or signature authority over 25 or more foreign financial accounts must also comply with the record keeping requirements.

Filers will be required to provide detailed information concerning each account if the IRS or FinCEN requests it.

FBAR Penalties

The IRS has been delegated authority to assess civil FBAR penalties.

When there is an FBAR violation, the examiner will either issue the FBAR warning letter, Letter 3800, Warning Letter Respecting Foreign Bank and Financial Accounts Report Apparent Violations, or determine a penalty. However, when multiple years are under examination and a monetary penalty is imposed for some but not all of the years under examination, a Letter 3800 will not be issued for the year(s) for which a monetary penalty is not imposed.

Penalties should be determined to promote compliance with the FBAR reporting and recordkeeping requirements. In exercising discretion, examiners must consider whether the issuance of a warning letter and the securing of delinquent FBARs, rather than the determination of a penalty, will achieve the desired result of improving compliance in the future.

Example:

An individual failed to report the existence of five small foreign accounts with a combined balance of $20,000 for all five accounts, but properly reported the income from each account and made no attempt to conceal the existence of the accounts. The examiner must consider all the facts and circumstances of this case to determine if a warning letter is appropriate in this case or if it would be appropriate to determine civil FBAR penalties.

Civil FBAR penalties have varying upper limits, but no floor. The examiner has discretion in determining the amount of the penalty, if any.
The IRS developed mitigation guidelines to assist examiners in determining the amount of civil FBAR penalties.
There may be multiple civil FBAR penalties if there is more than one account owner, or if a person other than the account owner has signature or other authority over the foreign account. Each person can be liable for the full amount of the penalty.
Managers must perform a meaningful review of the employee’s penalty determination prior to assessment.

FBAR Penalty Authority

IRS was delegated the authority to assess and collect civil FBAR penalties. 31 CFR 1010.810(g). The delegation includes the authority to investigate possible civil FBAR violations, provided in Treasury Directive No. 15-41 (December 1, 1992), and the authority to assess and collect the penalties for violations of the reporting and recordkeeping requirements.

When performing these functions, IRS is not acting under Title 26 but, instead, is acting under the authority of Title 31. Provisions of the Internal Revenue Code generally do not apply to FBARs.

Criminal Investigation was delegated the authority to investigate possible criminal violations of the Bank Secrecy Act. 31 CFR 1010.810(c)(2).

FBAR Penalty Structure

There are four civil penalties available for FBAR violations:

31 USC 5321(a)(6)(A).
Pattern of negligent activity. 31 USC 5321(a)(6)(B).
Penalty for non-willful violation. 31 USC 5321(a)(5)(A) and (B).

Note:

Although the term “non-willful” is not used in the statute, it is used to distinguish this penalty from the penalty for willful violations.

Penalty for willful violations. 31 USC 5321(a)(5)(C).

A filing violation occurs at the end of the day on June 30th of the year following the calendar year to be reported (the due date for filing the FBAR).

A recordkeeping violation occurs on the date when the records are requested by the IRS examiner if the records are not provided.

A civil money penalty may be imposed for an FBAR violation even if a criminal penalty is imposed for the same violation. 31 USC 5321(d).

BSA Negligence Penalties

There are two negligence penalties that apply generally to all BSA provisions. 31 USC 5321(a)(6)

A negligence penalty up to $500 may be assessed against a financial institution or non-financial trade or business for any negligent violation of the BSA, including FBAR violations.
An additional penalty up to $50,000 may be assessed for a pattern of negligent violations.

These two negligence penalties apply only to trades or businesses, and not to individuals.

The FBAR penalties under section 5321(a)(5) and the FBAR warning letter, Letter 3800, adequately address most FBAR violations identified. The FBAR warning letter may be issued in the cases where the revenue agent determines none of the 5321(a)(5) FBAR penalties are warranted. If the revenue agent believes, however, that assertion of a section 5321(a)(6) negligence penalty is warranted in a particular case, the revenue agent should contact a Bank Secrecy Act FBAR program analyst for guidance.

Negligence Defined

Actual knowledge of the reporting requirement is not required to find negligence. For example, if a financial institution or nonfinancial trade or business exercising ordinary business care and prudence for its particular industry should have known about the FBAR filing and record keeping requirements, failure to file or maintain records is negligent. Therefore, standards of practice for a particular industry are relevant in determining whether a negligent violation of 31 USC 5314 occurred. If the failure to file the FBAR or to keep records is due to reasonable cause, and not due to the negligence of the person who had the obligation to file or keep records, the negligence penalty should not be asserted.

Negligent failure to file does NOT exist when, despite the exercise of ordinary business care and prudence, the person was unable to file the FBAR or keep the required records.

Use general negligence principles in determining whether or not to apply the negligence penalty. Treas. Reg. 1.6664-4, Reasonable Cause and Good Faith Exception to section 6662 penalties, may serve as useful guidance in determining the factors to consider.

BSA Simple Negligence Penalty

A negligence penalty up to $500 may be assessed against a business for any negligent violation of the BSA, including FBAR violations.

The simple negligence penalty applies only to businesses, not individuals.

BSA Simple Negligence Penalty Amount

For each negligent violation of any requirement of the Bank Secrecy Act committed after October 27, 1986, a civil penalty may be assessed not to exceed $500.

Generally, the full amount of this $500 penalty is assessed. Although 31 USC 5321(a)(6) permits discretion to assert a lower amount, there are no mitigation guidelines for this penalty.

BSA Pattern of Negligence Penalty

31 USC 5321(a)(6)(B) provides for a civil money penalty of not more than $50,000 on a business that engages in a pattern of negligent BSA violations including violations of the FBAR rules. This penalty is in addition to any $500 negligence penalty.

The pattern of negligence penalty has applied to financial institutions since 1986. For violations occurring after October 26, 2001, the penalty applies to all trades or businesses. This penalty does not apply to individuals.

BSA Pattern of Negligence Penalty Amount

If any trade or business engages in a pattern of negligent violations of any provision (including the FBAR requirements)] of the BSA, a civil penalty of not more than $50,000 may be imposed. This is in addition to the simple negligence $500 penalty. 31 USC 5321(a)(6)(B). The examiner is given discretion to determine the penalty amount up to the $50,000 ceiling.

There are no mitigation guidelines for this penalty. The pattern of negligence penalty should be asserted only in egregious cases.

Penalty for Nonwillful FBAR Violations

For violations occurring after October 22, 2004, a penalty, not to exceed $10,000 per violation, may be imposed on any person who violates or causes any violation of the FBAR filing and recordkeeping requirements. 31 USC 5321(a)(5)(B).

The penalty should not be imposed if:

The violation was due to reasonable cause, and
The person files any delinquent FBARs and properly reports the previously unreported account.

Penalty for Nonwillful Violations – Calculation

After May 12, 2015, in most cases, examiners will recommend one penalty per open year, regardless of the number of unreported foreign accounts. The penalty for each year is limited to $10,000. Examiners should still use the mitigation guidelines and their discretion in each case to determine whether a lesser penalty amount is appropriate.

For multiple years with nonwillful violations, examiners may determine that asserting nonwillful penalties for each year is not warranted. In those cases, examiners, with the group manager’s approval after consultation with an Operating Division FBAR Coordinator, may assert a single penalty, not to exceed $10,000, for one year only.

For other cases, the facts and circumstances (considering the conduct of the person required to file and the aggregate balance of the unreported foreign financial accounts) may indicate that asserting a separate nonwillful penalty for each unreported foreign financial account, and for each year, is warranted. In those cases, examiners, with the group manager’s approval after consultation with an Operating Division FBAR Coordinator, may assert a separate penalty for each account and for each year. The examiner’s workpapers must support such a penalty determination and document the group manager’s approval.

In no event will the total amount of the penalties for nonwillful violations exceed 50 percent of the highest aggregate balance of all unreported foreign financial accounts for the years under examination.

Penalty for Willful FBAR Violations

The penalty for willful FBAR violations may be imposed on any person who willfully violates or causes any violation of any provisions of 31 USC 5314 (the FBAR filing and recordkeeping requirements). 31 USC 5321(a)(5)(C).

The penalty applies to individuals as well as financial institutions and nonfinancial trades or businesses for all years.

For violations occurring after October 22, 2004, the statutory ceiling is the greater of $100,000 or 50% of the balance in the account at the time of the violation.

There may be both a reporting and a recordkeeping violation regarding each account.

The date of a violation for failure to timely file an FBAR is the end of the day on June 30th of the year following the calendar year for which the accounts are being reported. This date is the last possible day for filing the FBAR so that the close of the day with no filed FBAR represents the first time that a violation occurred. The balance in the account at the close of June 30th is the amount to use in calculating the filing violation.

The date of a violation for failure to keep records is the date the examiner first requests records. The balance in the account at the close of the day that the records are first requested is the amount used in calculating the recordkeeping violation penalty. The date of the violation is tied to the date of the request, and not a later date, to assure the taxpayer is unable to manipulate the amount in the account after receiving a request for records. The balance in the account at the close of the day on which the records are first requested is the amount to use in calculating the penalty for failing to keep records as required by statute.

IRS developed guidelines for the exercise of the examiner’s discretion in arriving at the amount of a penalty for a willful violation. See discussion of mitigation, below.

Willful FBAR Violations – Defining Willfulness

The test for willfulness is whether there was a voluntary, intentional violation of a known legal duty.

A finding of willfulness under the BSA must be supported by evidence of willfulness.

The burden of establishing willfulness is on the Service.

Willfulness is shown by the person’s knowledge of the reporting requirements and the person’s conscious choice not to comply with the requirements. In the FBAR situation, the person only need know that a reporting requirement exists. If a person has that knowledge, the only intent needed to constitute a willful violation of the requirement is a conscious choice not to file the FBAR.

Under the concept of “willful blindness,” willfulness is attributed to a person who made a conscious effort to avoid learning about the FBAR reporting and recordkeeping requirements.

Example:

Willful blindness may be present when a person admits knowledge of, and fails to answer questions concerning, his interest in or signature or other authority over financial accounts at foreign banks on Schedule B of his Federal income tax return. This section of the income tax return refers taxpayers to the instructions for Schedule B, which provides guidance on their responsibilities for reporting foreign bank accounts and discusses the duty to file the FBAR. These resources indicate that the person could have learned of the filing and recordkeeping requirements quite easily. It is reasonable to assume that a person who has foreign bank accounts should read the information specified by the government in tax forms. The failure to act on this information and learn of the further reporting requirement, as suggested on Schedule B, may provide evidence of willful blindness on the part of the person.

Note:

The failure to learn of the filing requirements coupled with other factors, such as the efforts taken to conceal the existence of the accounts and the amounts involved, may lead to a conclusion that the violation was due to willful blindness. The mere fact that a person checked the wrong box, or no box, on a Schedule B is not sufficient, in itself, to establish that the FBAR violation was attributable to willful blindness.

The following examples illustrate situations in which willfulness may be present:

A person files the FBAR, but omits one of three foreign bank accounts. The person had previously closed the omitted account at the time of filing the FBAR. The person explains that the omission was due to unintentional oversight. During the examination, the person provides all information requested with respect to the omitted account. The information provided does not disclose anything suspicious about the account, and the person reported all income associated with the account on his tax return. The penalty for a willful violation should not apply absent other evidence that may indicate willfulness.
A person filed the FBAR in earlier years but failed to file the FBAR in subsequent years when required to do so. When asked, the person does not provide a reasonable explanation for failing to file the FBAR. In addition, the person may have failed to report income associated with foreign bank accounts for the years that FBARs were not filed. A determination that the violation was willful would likely be appropriate in this case.
A person received a warning letter informing him of the FBAR filing requirement, but the person continues to fail to file the FBAR in subsequent years. When asked, the person does not provide a reasonable explanation for failing to file the FBAR. In addition, the person may have failed to report income associated with the foreign bank accounts. A determination that the violation was willful would likely be appropriate in this case.

Willful FBAR Violations – Evidence

Willfulness can rarely be proven by direct evidence, since it is a state of mind. It is usually established by drawing a reasonable inference from the available facts. The government may base a determination of willfulness on inference from conduct meant to conceal sources of income or other financial information. For FBAR purposes, this could include concealing signature authority, interests in various transactions, and interests in entities transferring cash to foreign banks.

Documents that may be helpful in establishing willfulness include:

Copies of statements for the foreign bank account.
Notes of the examiner’s interview with the foreign account holder/taxpayer about the foreign account.
Correspondence with the account holder’s tax return preparer that may address the FBAR filing requirement.
Documents showing criminal activity related to the non-filing of the FBAR (or non-compliance with other BSA provisions).
Promotional material (from a promoter or offshore bank).
Statements for debit or credit cards from the offshore bank that, for example, reveal the account holder used funds from the offshore account to cover everyday living expenses in a manner that conceals the source of the funds.
Copies of any FBARs filed previously by the account holder (or FinCEN Query printouts of FBARs).
Copies of Information Document Requests with requested items that were not provided highlighted along with explanations as to why the requested information was not provided.
Copies of debit or credit card agreements and fee schedules with the foreign bank, which may show a significantly higher cost than typically associated with cards from domestic banks.
Copies of any investment management or broker’s agreement and fee schedules with the foreign bank, which may show significantly higher costs than costs associated with domestic investment management firms or brokers.
The written explanation of why the FBAR was not filed, if such a statement is provided. Otherwise, note in the workpapers whether there was an opportunity to provide such a statement.
Copies of any previous warning letters issued or certifications of prior FBAR penalty assessments.
An explanation, in the workpapers, as to why the examiner believes the failure to file the FBAR was willful.

Documents available in an FBAR case worked under a Related Statute Determination under Title 26 that may be helpful in establishing willfulness include:

Copies of documents from the administrative case file (including the Revenue Agent Report) for the income tax examination that show income related to funds in a foreign bank account was not reported.
A copy of the signed income tax return with Schedule B attached, showing whether or not the box pertaining to foreign accounts is checked or unchecked.
Copies of tax returns (or RTVUEs or BRTVUs) for at least three years prior to the opening of the offshore account and for all years after the account was opened, to show if a significant drop in reportable income occurred after the account was opened. (Review of the three years’ returns prior to the opening of the account would give the examiner a better idea of what the taxpayer might have typically reported as income prior to opening the foreign account).
Copies of any prior Revenue Agent Reports that may show a history of noncompliance.
Two sets of cash T accounts (a reconciliation of the taxpayer’s sources and uses of funds) with one set showing any unreported income in foreign accounts that was identified during the examination and the second set excluding the unreported income in foreign accounts.
Any documents that would support fraud (see IRM 4.10.6.2.2 for a list of items to consider in asserting the fraud penalty).

Penalty for Willful FBAR Violations – Calculation

For violations occurring after October 22, 2004, a penalty for a willful FBAR violation may be imposed up to the greater of $100,000 or 50% of the amount in the account at the time of the violation, 31 USC 5321(a)(5)(C). For cases involving willful violations over multiple years, examiners may recommend a penalty for each year for which the FBAR violation was willful.

After May 12, 2015, in most cases, the total penalty amount for all years under examination will be limited to 50 percent of the highest aggregate balance of all unreported foreign financial accounts during the years under examination. In such cases, the penalty for each year will be determined by allocating the total penalty amount to all years for which the FBAR violations were willful based upon the ratio of the highest aggregate balance for each year to the total of the highest aggregate balances for all years combined, subject to the maximum penalty limitation in 31 USC 5321(a)(5)(C) for each year.

Note: Examiners should still use the mitigation guidelines and their discretion in each case to determine whether a lesser penalty amount is appropriate

Examiners may recommend a penalty that is higher or lower than 50 percent of the highest aggregate account balance of all unreported foreign financial accounts based on the facts and circumstances. In no event will the total penalty amount exceed 100 percent of the highest aggregate balance of all unreported foreign financial accounts during the years under examination.

If an account is co-owned by more than one person, a penalty determination must be made separately for each co-owner. The penalty against each co-owner will be based on his her percentage of ownership of the highest balance in the account. If the examiner cannot determine each owner’s percentage of ownership, the highest balance will be divided equally among each of the co-owners.

Mitigation

The statutory penalty computation provides a ceiling on the FBAR penalty. The actual amount of the penalty is left to the discretion of the examiner.

IRS has adopted mitigation guidelines to promote consistency by IRS employees in exercising this discretion for similarly situated persons. Exhibit 4.26.16-1.

Mitigation Threshold Conditions

For most FBAR cases, if IRS has determined that if a person meets four threshold conditions, then that person may be subject to less than the maximum FBAR penalty depending on the amounts in the accounts.

For violations occurring after October 22, 2004, the four threshold conditions are:

The person has no history of criminal tax or BSA convictions for the preceding 10 years, as well as no history of past FBAR penalty assessments.
No money passing through any of the foreign accounts associated with the person was from an illegal source or used to further a criminal purpose.
The person cooperated during the examination (i.e., IRS did not have to resort to a summons to obtain non-privileged information; the taxpayer responded to reasonable requests for documents, meetings, and interviews; and the taxpayer back-filed correct reports).
IRS did not sustain a civil fraud penalty against the person for an underpayment for the year in question due to the failure to report income related to any amount in a foreign account.

FBAR Penalties – Examiner Discretion

The examiner may determine that the facts and circumstances of a particular case do not justify asserting a penalty.

When a penalty is appropriate, IRS penalty mitigation guidelines aid the examiner in applying penalties in a uniform manner. The examiner may determine that a penalty under these guidelines is not appropriate or that a lesser penalty amount than the guidelines would otherwise provide is appropriate or that the penalty should be increased (up to the statutory maximum). The examiner must make such a determination with the written approval of the examiner’s manager and document the decision in the workpapers.

Factors to consider when applying examiner discretion may include, but are not limited to, the following:

Whether compliance objectives would be achieved by issuance of a warning letter.
Whether the person who committed the violation had been previously issued a warning letter or assessed an FBAR penalty.
The nature of the violation and the amounts involved.
The cooperation of the taxpayer during the examination.

Given the magnitude of the maximum penalties permitted for each violation, the assertion of multiple penalties and the assertion of separate penalties for multiple violations with respect to a single FBAR, should be carefully considered and calculated to ensure the amount of the penalty is commensurate to the harm caused by the FBAR violation.

Managerial Involvement and Approval of FBAR Penalties

Managers must perform a meaningful review of the examiner’s penalty determination prior to assessment.

The manager must verify that the penalties were fairly imposed and accurately computed; that the examiner did not improperly assert the penalties in the first instance; and that the conclusions regarding “reasonable cause” (or the lack thereof) were proper.

For BSA cases, written managerial approval must be documented on the Violations Summary Form – Title 31, workpaper 400-1.1.

For SB/SE examination cases, written managerial approval must be documented on the Penalty Approval Form, workpaper 300.

For LB&I cases, managerial approval must be documented on the penalty leadsheets.

For SB/SE campus cases, written managerial approval must be documented on Form 4700, Examination Workpapers.

FBAR Penalty Mitigation Guidelines for Violations Occurring After October 22, 2004

The Bank Secrecy Act (BSA) allows the Secretary of the Treasury some discretion in determining the amount of penalties for violations of the FBAR reporting and record keeping requirements. There is a penalty ceiling but no minimum amount. This discretion has been delegated to the FBAR examiner.

The examiner may determine that the facts and circumstances of a particular case do not justify a penalty.

If there was an FBAR violation but no penalty is appropriate, the examiner must issue the FBAR warning letter, Letter 3800.

When a penalty is appropriate, IRS established penalty mitigation guidelines to ensure the penalties determined by the examiner’s discretion are uniform. The examiner may determine that:

A penalty under these guidelines is not appropriate, or
A lesser amount than the guidelines otherwise provide is appropriate.

The examiner must make this determination with the written approval of that examiner’s manager. The examiner’s workpapers must document the circumstances that make mitigation of the penalty under these guidelines appropriate. When determining the proper penalty amount, the examiner should keep in mind that manager approval is required to assert more than one $10,000 non-willful penalty per year, and in no event can the aggregate non-willful penalties asserted exceed 50% of the highest aggregate balance of all accounts to which the violations relate during the years at issue. Similarly, manager approval is required to assert willful penalties that, in the aggregate, exceed 50% of the highest aggregate balance of all accounts to which the violations relate during the years at issue, and in no event can the aggregate willful penalties exceed 100% of the highest aggregate balance of all accounts to which the violations relate during the years at issue.

To qualify for mitigation, the person must meet four criteria:

The person has no history of criminal tax or BSA convictions for the preceding 10 years and has no history of prior FBAR penalty assessments.
No money passing through any of the foreign accounts associated with the person was from an illegal source or used to further a criminal purpose.
The person cooperated during the examination.
IRS did not determine a fraud penalty against the person for an underpayment of income tax for the year in question due to the failure to report income related to any amount in a foreign account.

FBAR Penalty Mitigation Guidelines – Per Person Per Year
Non-Willful (NW) Penalties
To Qualify for Level I-NW – Determine Aggregate Balance	If the maximum aggregate balance for all accounts to which the violations relate did not exceed $50,000 at any time during the calendar year, Level I – NW applies to all violations. See IRM 4.26.16.3.6, Aggregate Value Over $10,000, above for instruction on determining the maximum aggregate balance.
The Level I-NW Penalty is	$500 per violation, not to exceed a total of $5,000 per year.
To Qualify for Level II-NW – Determine Aggregate Balance	If the maximum aggregate balance of all accounts to which the violations relate exceeds $50,000, but does not exceed $250,000, Level II-NW applies to all violations.
The Level II-NW Penalty is	$5,000 per violation.
To Qualify for Level III-NW – Determine Aggregate Balance	If the maximum aggregate balance of all accounts to which the violations apply exceeds $250,000, Level III-NW applies to all violations.
The Level III-NW Penalty is	$10,000 per violation, the statutory maximum penalty for non-willful violations.
Penalties for Willful Violation
To Qualify for Level I-Willful – Determine Aggregate Balance		If the maximum aggregate balance for all accounts to which the violations relate did not exceed $50,000 during the calendar year, Level I-Willful mitigation applies to all violations. See IRM 4.26.16.3.6, Aggregate Value Over $10,000, above for instruction on determining the maximum aggregate balance.
The Level I Willful Penalty is		The greater of $1,000 per year or 5% of the maximum aggregate balance of the accounts during the year to which the violations relate.
To Qualify for Level II-Willful – Determine Aggregate Balance		If the maximum aggregate balance for all accounts to which the violations relate exceeds $50,000 but does not exceed $250,000, Level II-Willful mitigation applies to all violations. Level II-Willful penalties are computed on a per account basis.
The Level II-Willful Penalty is		For each account for which there was a violation, the greater of $5,000 or 10% of the maximum account balance during the calendar year at issue.
To Qualify for Level III-Willful – Determine Aggregate Balance		If the maximum aggregate balance for all accounts to which the violations relate exceeds $250,000 but does not exceed $1,000,000, Level III-Willful mitigation applies to all violations. Level III-Willful penalties are computed on a per account basis..
The Level III-Willful Penalty is		For each account for which there was a violation, the greater of 10% of the maximum account balance during the calendar year at issue or 50% of the account balance on the day of the violation.
To Qualify for Level IV-Willful – Determine Aggregate Balance		If the maximum aggregate balance for all accounts to which the violations relate exceeds $1,000,000, Level IV-Willful mitigation applies to all violations. Level IV-Willful penalties are computed on a per account basis..
The Level IV-Willful Penalty is		For each account for which there was a violation, the greater of 50% of the balance in the account at the time of the violation or $100,000 (i.e., the statutory maximum penalty).

Money Transmitter FBAR Filing Requirements
Money transmitters in the U.S. send money overseas generally through the use of foreign banks or non-bank agents located in foreign countries. The arrangement permits the money transmitter to readily send payments, in the currency of the foreign country, to the recipient. The U.S. money transmitter wires funds to the foreign bank or non-bank agent and provides instructions to make payments to the recipient located in the foreign country. The money transmitter typically does not have signature or other authority over the agent’s bank account. In this situation, the money transmitter is not required to file an FBAR for the agent’s bank account.

However, if the money transmitter has a direct financial interest in the foreign financial account, has signature authority, or other authority, over the foreign financial account and the aggregate value is in excess of $10,000 at any time during the year in question, the money transmitter is required to file an FBAR. Another person holding the foreign account on behalf of the money transmitter does not negate the FBAR filing requirement.

Frequently Asked Questions (FAQ’s):

Is there an FBAR filing requirement when the money transmitter wires funds to a foreign bank account or has a business relationship with someone located in a foreign country?

Answer: No. Merely wiring funds to a foreign bank account or having a business relationship with someone located in a foreign country does not create an FBAR filing requirement.

Is there an FBAR filing requirement where the money transmitter owns a bank account located in a foreign country or has signature authority over someone else’s bank account located in a foreign country?

Answer: Yes, if the account exceeded $10,000 at any time during the calendar year and the money transmitter was a United States person for FBAR purposes.

Is an FBAR required to be filed by a money transmitter engaged in Informal Value Transfer System (IVTS)/Hawala transactions?

Answer: There would be no FBAR filing requirement if there is no foreign bank or other foreign financial accounts involved. The money transmitter’s relationship with a foreign affiliate, by itself, does not create an FBAR filing requirement. However, if the money transmitter owned a bank account located in a foreign country or had signature authority over someone else’s bank account located in a foreign country, was a United States person, and the account value exceeded $10,000 at any time, the money transmitter would be required to file an FBAR.

What constitutes “other authority” for FBAR reporting purposes?

Answer: “Other authority” is comparable to signature authority in that a person exercising “other authority” can through communication to the bank or other person with whom the account is maintained exercise power over the account. A distinction, however, must be drawn between having authority over a bank account of a non-bank foreign agent and having authority over a foreign agent who owns a foreign bank account. Having authority over a person who owns a foreign bank account is not the same as having authority over a foreign bank account.

Does a money transmitter who has a business relationship with a person located in a foreign country have a financial interest in a foreign financial account if the person in the foreign country is providing services of a financial institution (such as money transmission services) and both parties maintain books and records of their business transactions (including books and records of offsetting transactions or trade accounts receivable or payable)?

Answer: No. The money transmitter does not have a financial interest in a foreign financial account. A “financial account” for FBAR filing purposes includes bank accounts, investment accounts, savings accounts, demand checking, deposit accounts, time deposits, or any other account maintained with a financial institution or other person engaged in the business of a financial institution. “Accounts” as used to describe or identify the books and records of ordinary business transactions between businessmen are not “financial accounts” for FBAR reporting purposes.

Do receivables accounts maintained by foreign non-bank agents which net out the US money transmitter settlement obligations to the foreign agent constitute a financial account for FBAR filing purposes?

Answer: No. Such receivables in accounting records are not financial accounts for FBAR reporting purposes.

Do the FBAR filing requirements apply when a money transmitter maintains a bank account with a foreign bank for the purpose of settling money transmission transactions with a foreign bank?

Answer: Yes. If a money transmitter owns the account maintained with the foreign bank or has signature or other authority over it, the money transmitter may be required to file an FBAR.

FBAR Penalty Defense Attorneys

FBAR penalty defense requires a proactive representation and a deep knowledge of the nuances of FBAR compliance and its defenses. Freeman Law represents clients with offshore tax compliance disputes involving FBAR penalties and international information return penalties. Failing to file an FBAR can give rise to significant penalties, including a non-willful penalty and willful FBAR penalty. The risks of tax and reporting non-compliance have never been more real and the threat of international penalties, particularly FBAR penalties, has never been more clear. Schedule a consultation or call (214) 984-3000 to discuss your FBAR penalty concerns or questions.

The Tax Court in Brief July 12 – July 17, 2020

Freeman Law’s “The Tax Court in Brief” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.

For a link to our podcast covering the Tax Court in Brief, download here or check out other episodes of The Freeman Law Project.

Tax Court: The Week of July 12 – July 17, 2020

Duffy v. Comm’r, T.C. Memo. 2020-108
Smith Lake, LLC, David Hewitt, TMP v. Comm’r, T.C. Memo. 2020-84
Weiderman v. Comm’r, T.C. Memo. 2020-109
Robert Elkins v. Comm’r, T.C. Memo. 2020-110

Duffy v. Comm’r, T.C. Memo. 2020-108

July 13, 2020 | Halpern, J. | Dkt. No. 8711-16

Tax Case Short Summary: The taxpayers purchased property in Gearhart, Oregon for $2 million in 2006. The purchase was seller financed, but the taxpayers later borrowed $1.4 million from JPMorgan Chase and used the proceeds to pay the seller. In 2009 and 2010, the taxpayers rented the Gearhart property to family and acquaintances—prior to, they had used the property as a vacation home. They sold the Gearhart property in 2011 for $800,000 with JPMorgan Chase agreeing to accept $750,841 of the proceeds in full satisfaction of the mortgage loan that encumbered the property.

In February 2011, Mr. Duffy organized Impact Medical, LLC (Impact Medical), which was formed to design and manufacture equipment to alleviate a medical condition known as deep vein thrombosis. Later, additional investors became members of Impact Medical. Mr. Duffy ran the day-to-day operations of Impact Medical.

In 2013, Wells Fargo Bank N.A. forgave $391,532 of debt the taxpayers owed on a home equity line of credit secured by their residence in Portland, Oregon.

The taxpayers filed joint returns for 2009 through 2014. On those returns, the taxpayers reported: (1) for 2009 and 2010, a Schedule E loss related to their rental of the Gearhart property, which was treated as nondeductible passive activity losses; (2) for 2011, a loss from their sale of the Gearhart property, cancellation of debt income related to the JPMorgan Chase loan, and a net operating loss which was carried back to 2009 and 2010, (3) for 2012, Schedule E income which reported Mr. Duffy’s guaranteed payments from Impact Medical as not subject to self-employment tax, and a nonpassive loss for unreimbursed partnership expenses, (4) for 2013, a Schedule E nonpassive loss from Impact Medical, and a nonpassive loss for unreimbursed partnership expenses, and none of the Impact Medical guaranteed payment as subject to self-employment tax; and (5) for 2014, nonpassive loss for unreimbursed partnership expenses, and none of the Impact Medical guaranteed payments as subject to self-employment tax.

Key Tax Dispute Issue: Whether the taxpayers: (1) are entitled to deduct an ordinary loss from their sale in 2011 of residential property in Oregon; (2) must include in their 2011 taxable income, in connection with the sale of the Oregon property, COD income due to discharge of debt that the property secured; (3) are entitled to deduct losses they reported from their rental of the Oregon property; (4) must include in their taxable income for 2013 COD income from the discharge of a home equity line of credit secured by their property in Portland; (5) are entitled to deduct all or a portion of the losses allocated to Mr. Duffy by Impact Medical; (6) are entitled to deduct other losses reported on Schedules E for their 2012 through 2014 tax years; (7) must pay self-employment tax on Mr. Duff’s guaranteed payments he received from Impact Medical; and (8) are liable for accuracy-related penalties.

Primary Holdings:

The taxpayers are: (1) not entitled to deduct an ordinary loss from their sale of the Oregon property in 2011 because they have not established that the adjusted basis of the property at the time of the sale exceeded the amount realized on the sale; (2) required to report the amount of the JPMorgan Chase loan from which they were discharged in their amount realized from the sale of the Gearhart property; (3) not entitled to deduct losses form the Oregon property for 2009, 2010, and 2011 because the taxpayers failed to advance the argument on brief and therefore the issue is deemed conceded; (4) taxable on $117,128 of the COD income related to the Wells Fargo debt because they were insolvent, immediately before the discharge, by $274,404; (5) not entitled to deduct any ordinary loss from Impact Medical for 2012 but are entitled to deduct the loss the partnership allocated to Mr. Duffy for 2013; (6) not entitled to deduct losses for unreimbursed partnership expenses because taxpayers have provided no substantiation for the losses; (7) are subject to self-employment tax for 2012 but are not subject to self-employment tax for 2013 or 2014 because Mr. Duffy had no net earnings from self-employment for those years; and (8) are not liable for the accuracy-related penalties because the IRS failed to meet its burden of production in showing that it obtained written managerial approval of the penalties under Section 6751(b).

Key Points of the Tax Laws:

Section 165(a) allows a deduction for “any loss sustained during the taxable year and not compensated for by insurance or otherwise.” Losses of individual taxpayers, however, are deductible only if they were incurred in a trade or business or transaction entered into for profit or arising from a casualty or theft. 165(c).
Although losses from sales of personal residences are generally nondeductible under section 165(c), Treas. Reg. § 1.165-9(b)(1) provides: “If a property purchased or constructed by the taxpayer for use as his personal residence is, prior to its sale, rented or otherwise appropriated to income-producing purposes and is used for such purposes up to the time of its sale, a loss sustained on the sale of the property shall be allowed as a deduction.” In general, the allowable loss is the excess of the property’s adjusted basis over the amount realized from the sale. Reg. § 1.165-9(b)(2). For that purpose, however, the property’s adjusted basis upon conversion cannot exceed its fair market value at that time. Id. Basis is further reduced by any depreciation allowed between the conversion of the property and its sale. Sec. 1016(a)(2); Treas. Reg. § 1.167(g)-1; Treas. Reg. § 1.1011-1.
Section 61(a) defines gross income to mean “all income from whatever source derived.” That section includes as a specifically listed item “income from discharge of indebtedness.” 61(a)(12).
Section 108(a)(1)(B) excludes from a taxpayer’s gross income amounts otherwise includible as a result of the discharge of indebtedness if “the discharge occurs when the taxpayer is insolvent.” In addition, section 108(e)(2) provides: “No income shall be realized from the discharge of indebtedness to the extent that payment of the liability would have given rise to a deduction.”
When a creditor forgives debt in connection with the sale or exchange of property that secures the debt, the discharge of debt can either result in the taxpayer’s amount realized from the sale, thereby increasing the taxpayer’s gain or reducing the taxpayer’s loss on the sale. The varying treatment of the debt discharge turns on whether the indebtedness was recourse or nonrecourse—that is, whether the creditor’s remedies were limited to the transferred property. Reg. § 1.1001-2(a)(1) provides a general rule that “the amount realized from a sale or other disposition of property includes the amount of liabilities from which the transferor discharged as a result of the sale or disposition.” However, Treas. Reg. § 1.1001-2(a)(2) provides: “The amount realized on a sale or other disposition of property that secures a recourse liability does not include amounts that are (or would be realized and recognized) income from the discharge of indebtedness under section 61(a)(12).”
The adjusted basis of a personal residence converted to business use is stepped down to fair market value for purposes of determining a loss on a subsequent sale of the property but not for purposes of determining gain on such sale. Simonsen v. Comm’r, 150 T.C. 201, 214 (2018).
Section 469 prohibits specified taxpayers, including individuals, from deducting losses from passive activities against other income. In general, passive activities are trade or business activities in which the investor does not materially participate. 469(c)(1). Rental activities are generally considered passive activities regardless of the extent of the investor’s participation. Sec. 469(c)(2). But an individual who actively participates in rental of real estate can deduct up to $25,000 of annual losses from the activity. Sec. 469(i)(1) and (2). This exclusion is phased out for a taxpayer whose adjusted gross income exceeds $100,000 and is eliminated entirely if the taxpayer’s adjusted gross income exceeds $150,000. Sec. 469(i)(3)(A).
Losses disallowed under the passive activity loss rules can be carried forward and used to offset income from passive activities or when the taxpayer, in a taxable transaction, disposes of his interest in the activity that generated the loss. 469(b), (g)(1)(A).
Under Section 172, when an individual taxpayer incurs a net loss for a year from business activities, the loss is carried back to offset income of the taxpayer for the two prior years. 172. Any NOL remaining after carryback is then carried forward to offset the taxpayer’s income in future years. Sec. 172(b)(1)(A). Section 172(b)(3) allows the taxpayer to waive the carryback and simply carry the NOL forward.
An issue raised by the pleadings may be conceded if a party fails to advance on brief an argument regarding that issue. Bradley v. Comm’r, 100 T.C. 367, 370 (1993); Ashkouri v. Comm’r, T.C. Memo. 2019-95.
Section 108(a)(1)(E) excludes from income the discharge before January 1, 2014, of “qualified principal residence indebtedness.” Indebtedness qualifies for the Section 108(a)(1)(E) exclusion only if it was incurred to acquire, construct, or improve a taxpayer’s principal residence.
A partner can deduct his share of a partnership’s loss for a tax year only to the extent of the adjusted basis of his partnership interest at the end of the year. 704(d). Any excess of the loss allocated to the partner over his outside basis carries forward to the following year.
When a partner acquires his interest in a partnership by contributing property to the partnership, the partner’s initial outside basis equals the amount of any money and the adjusted basis of any other property contributed. 722. The partner’s initial outside basis if adjusted over time to reflect partnership activity. In particular, his outside basis is increased by his share of partnership income and decreased by distributions made by the partnership to the partner and by the partner’s share of partnership losses and nondeductible expenditures. Secs. 705, 733. A partner’s outside basis also includes the partner’s share of partnership liabilities. Section 752 achieves that result by treating increases in the partner’s share of partnership liabilities as cash contributions and decreases as cash distributions.
Section 6222 requires a partner to report partnership items on an individual return in a manner consistent with the partnership’s reporting. If the partner reports inconsistently and fails to notify the Commissioner of the inconsistency, Section 6222(c) authorizes the Commissioner to make a computational adjustment to conform the partner’s treatment of the relevant items to the partnership’s treatment of those items and collect any additional tax without deficiency procedures.
When a partner pays expenses of a partnership, an issue can arise regarding the proportion of those expenses the paying partner is entitled to deduct. See Cropland Chem. Corp. v. Comm’r, 75 T.C. 288, 294-97 (1980), aff’d without published opinion, 665 F.2d 1050 (7th Cir. 1981). A partner generally cannot deduct partnership expenses as such. But a partner’s payment of partnership expenses can be treated as a contribution to the partnership, with the paying partner then entitled to deduct his allocable share of the expense. By express agreement or course of conduct, however, the entire expense can be specifically allocated to the partner who paid it.
Section 1401(a) imposes a tax “on the self-employment income of every individual.” An individual’s “net earnings from self-employment” are included in his self-employment income unless specifically excluded. 1402(b). Subject to specified exception, Section 1402(a) provides that the term “net earnings from self-employment” means the gross income derived by an individual from any trade or business carried on by such individual, less the deductions allowed by this subtitle which are attributable to such trade or business, plus his distributive share (whether or not distributed) of income or loss described in section 702(a)(8) from any trade or business carried on by a partnership of which he is a member.
Reg. § 1.1402(a)-1(a)(2) defines “net earnings from self-employment” to include two components, the second of which is an individual’s “distributive share (whether or not distributed), as determined under section 704, of the income (or minus the loss), described in section 702(a)(* * * [8]) and as computed under section 703, from any trade or business carried on by any partnership of which he is a member.”
Section 6662(a) and (b)(1) provides for an accuracy-related penalty of 20% on the portion of an underpayment of tax attributable to negligence or disregard of rules and regulations. Section 6662(a) and (b)(2) provides for the same penalty on the portion of an underpayment of tax attributable to “[a]ny substantial understatement of income tax.”
Section 6662(d)(2)(A) generally defines the term “understatement” as the excess of the tax required to be shown on the return over the amount shown on the return as filed. In the case of an individual, an understatement is “substantial” if it exceeds the greater of 10% of the tax required to be shown on the return or $5,000. 6662(d)(1)(A). An understatement is reduced, however, by the potion attributable to the treatment of an item for which the taxpayer had “substantial authority” or, in the case of items adequately disclosed, a “reasonable basis.” Sec. 6662(d)(2)(B). Moreover, Section 6664(c)(1) provides an exception to the imposition of the Section 6662(a) accuracy-related penalty if it is shown that there was reasonable cause for the underpayment and the taxpayer acted in good faith.
The burden of production that Section 7491(c) imposes on the Commissioner requires him to establish compliance with the supervisory approval requirement of Section 6751(b). Graev v. Comm’r, 149 T.C. 485, 493 (2017), supplementing and overruling in part 147 T.C. 460 (2016). Section 6751(b)(1) provides: “No penalty under this title shall be assessed unless the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination or such higher-level official as the Secretary may designate.”

Tax Court Motion: Mr. and Mrs. Duffy may have lost on some major issues in Duffy, but they obtained a major win on the penalty issue. Interestingly, the IRS sought to satisfy its burden of production under Section 6751(b) via a civil penalty form and a stipulation which provided that the signer “was the manager or supervisor of one or more of the auditing agents.” On this basis, the Tax Court concluded that the stipulation alone did not establish that the signer was the immediate supervisor of the person who made the initial determination to assess the penalties in issue. Thus, the Duffy decision demonstrates that proper wording via the stipulation process in Tax Court matters considerably.

Smith Lake, LLC, David Hewitt, TMP v. Comm’r, T.C. Memo. 2020-84

July 13, 2020 | Kerrigan, J. | Dkt. No. 4980-17

Tax Dispute Short Summary: On July 29, 2008, Rockefeller Holdings, LLC (Rockefeller), owned in part by David Hewitt, purchased 21.89 acres of property on Lewis Smith Lake in Alabama for $200,000. Rockefeller transferred the property to Smith Lake, LLC (Smith Lake). Mr. Hewitt and his wife each owned a 50% interest in Smith Lake at the time of the transfer.

On December 20, 2013, Mr. and Mrs. Hewitt each sold and assigned 49.75% of their interests in Smith Lake to Smith Lake Investment Partners, LLC (Smith Lake Investments). On December 23, 2013, Smith Lake conveyed a deed of easement for the 21.89 acres to the Pelican Coast Conservancy, LLC, by and through its sole member, Atlantic Coast Conservancy, Inc., a Georgia nonprofit corporation.

For the conservation easement, Smith Lake claimed a $6,524,000 noncash charitable contribution deduction.

Tax Litigation Key Issue: Whether the taxpayer satisfied the perpetuity requirement of Section 170(h)(5)(A), and whether Treas. Reg. § 1.170A-14(g)(6) is valid under Chevron.

Primary Holdings:

The taxpayer has failed to satisfy the perpetuity requirement of Section 170(h)(5)(A) because the deed granting the conservation easement reduces the donee’s share of the proceeds in the event of extinguishment by the value of improvements (if any) made by the donor. In addition, the proceeds regulation of Treas. Reg. § 1.170A-14(g)(6) is valid under Chevron.

Key Points of the Tax Laws:

Section 170(a)(1) allows a deduction for any charitable contribution made within the tax year. If the taxpayer makes a charitable contribution of property other than money, the amount of the contribution is generally equal to the FMV of the property at the time the gift is made. Reg. § 1.170A-1(c)(1).
The Code generally restricts a taxpayer’s charitable contribution deduction for the donation of “an interest in property which consists of less than the taxpayer’s entire interest in such property.” 170(f)(3)(A). However, there is an exception to this rule for a “qualified conservation contribution.” Sec. 170(f)(3)(B)(iii). This exception applies to a “qualified conservation contribution”, which is a contribution of a qualified real property interest to a qualified organization exclusively for conservation purposes. Sec. 170(h)(1).
Section 170(h)(5)(A) provides that a contribution will not be treated as being made exclusively for conservation purposes “unless the conservation purpose is protected in perpetuity.” To meet the requirements of Treas. Reg. § 1.170A-14(g)(6)(ii), the deed must guarantee that the donee will receive “a proportionate share of extinguishment proceeds.” Carroll v. Comm’r, 146 T.C. 196, 219 (2016).
When considering whether a regulation is arbitrary and capricious, the Tax Court generally employs the two-part inquiry established by Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837 (1984). The first part is to inquire “whether Congress has directly spoken to the precise question at issue.” at 842. If the intent of Congress is clear, there is no further inquiry. Id. The next part is to consider whether the regulation “is based on a permissible construction of the statute.” Chevron, 467 U.S. at 843. If the statute is silent, the Tax Court gives deference to the interpretation embodied in the agency’s regulation unless it is “arbitrary, capricious, or manifestly contrary to the statute.” U.S. v. Mead Corp., 533 U.S. 218, 227 (2001); Chevron, 467 U.S. at 844. The Tax Court will uphold the regulation if it represents a “reasonable interpretation” of the law Congress enacted. Chevron, 467 U.S. at 844.
In Oakbrook Land Holdings, LLC v. Comm’r, 154 T.C. at ___ (slip op. at 29), the Tax Court reasoned that Treasury’s goal in prescribing the proceeds regulation was to ensure satisfaction of the statute’s “protected in perpetuity” requirement. In that case, the Tax Court also concluded that the proceeds regulation’s “proportionate value” approach is not “arbitrary, capricious, or manifestly contrary to the statute” as examined under the two-part Chevron
The doctrine of judicial estoppel focuses on the relationship between a party and the courts, and it seeks to protect the integrity of the judicial process by preventing a party from successfully asserting one position before a court and thereafter asserting a completely contradictory position before the same or another court merely because it is now in that party’s interest to do so.” Huddleston v. Comm’r, 100 T.C. 17, 26 (1993). Although judicial estoppel requires a court’s acceptance of a party’s prior position, acceptance “does not mean that the party being estopped prevailed in the in the prior proceeding . . . but rather only that a particular position or argument asserted by the party . . . was accepted by the court.” The Court in Huddleston, 100 T.C. at 26, further stated that, in cases that settle, “an argument can be made that the court did not affirmatively accept any of the underlying positions reflected in the settlement and that judicial estoppel should not apply.”

Tax Court Motion: The IRS is on a hot streak on the conservation easement front, and the decision in Smith Lake is another notch in its belt. Taxpayers with docketed Tax Court cases who are able to settle with the IRS under the IRS’ new settlement program should carefully consider their defenses and whether to accept the settlement terms. Next moves may be extremely important.

Weiderman v. Comm’r, T.C. Memo. 2020-109

July 15, 2020 | Ashford, J. | Dkt. No. 14432-14

Tax Dispute Short Summary: Mrs. Weiderman accepted an executive marketing position with K-Swiss in 2006. Under the terms of her employment offer, K-Swiss agreed to assist the Wediermans in their relocation to California, providing them with a $500,000 interest-free loan to help finance the purchase of a new residence. K-Swiss and Mrs. Weiderman later executed a promissory note, dated February 15, 2007, which discussed the terms and conditions of the loan including that the loan was due and payable in full in one lump-sum payment on the earlier of February 15, 2017, or the effective date of her termination (whether voluntary or non-voluntary). After the loan disbursement, the Weidermans used the loan proceeds to purchase a residence in California.

But on December 1, 2008, K-Swiss terminated Mrs. Weiderman’s employment. Accordingly, K-Swiss demanded full payment of the $500,000 loan. Ultimately, Mrs. Weiderman and K-Swiss agreed (through various settlement negotiations) that K-Swiss would cancel $285,000 of the loan with proceeds from the sale of the California residence satisfying the remaining loan balance.

In 2009 and 2010, Mr. and Mrs. Weiderman also claimed various business deductions on Schedules C.

Tax Litigation Key Issue: Whether the taxpayers: (1) must include in gross income COD income of $255,000 and $30,000 for 2009 and 2010, respectively; (2) are entitled to deduct certain expenses they reported on their 2009 and 2010 Schedules C, Profit or Loss From Business; and (3) are liable for accuracy-related penalties.

Primary Holdings:

The taxpayers (1) must include in gross income COD income of $255,000 and $30,000 for 2009 and 2010 because the COD income was not excludible under Section 108(e)(1)(A); (2) are not entitled to deductions on Schedule C because Mrs. Weiderman was not engaged in carrying on a separate trade or business for profit under Section 162 and, in any event, she did not provide substantiation for the expenses, and the Schedule C deductions claimed with respect to Mr. Weiderman’s business were deemed conceded during trial; and (3) are liable for the accuracy-related penalty because they did not satisfy all of the factors under Neonatology Assocs. in asserting that they relied on the professional tax advice of a tax preparer.

Key Points of the Tax Laws:

Generally, the Commissioner’s determinations set forth in a notice of deficiency are presumed correct, and the taxpayer bears the burden of proving otherwise. Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933). In the Ninth Circuit, and with respect to unreported income cases, the Commissioner must provide some reasonable foundation connecting the taxpayer with the income-producing activity, see Weimerskirch v. Comm’r, 596 F.2d 358, 360-61 (9^th 1979), rev’g 67 T.C. 672 (1977), or demonstrate that the taxpayer received unreported income, see Hardy v. Comm’r, 181 F.3d 1002, 1004 (9^th Cir. 1999), aff’g T.C. Memo. 1997-97. Once the Commissioner has done this, the burden of proof shifts to the taxpayer to prove by a preponderance of the evidence that the Commissioner’s determinations are arbitrary and capricious. Helvering v. Taylor, 293 U.S. 507, 515 (1935). Similarly, under section 6201(d), if a taxpayer in any court proceeding asserts a reasonable dispute with respect to any item of income reported on an information return, the Commissioner shall have the burden of producing reasonable and probative information concerning such deficiency, in addition to such information return.
Tax deductions are a matter of legislative grace, and the taxpayer bears the burden of proving entitlement to any deduction claimed. Rule 142(a); INDOPCO, Inc. v. Comm’r, 503 U.S. 79, 84 (1992); Segel v. Comm’r, 89 T.C. 816, 842 (1987). This burden generally requires the taxpayer to demonstrate that the claimed deductions are allowable pursuant to some statutory provision and to substantiate the expenses giving rise to the claimed deductions by maintaining and producing adequate records that enable the Commissioner to determine the taxpayer’s correct liability. 6001; Higbee v. Comm’r, 116 T.C. 438, 440 (2001).
The Commissioner bears the burden of production with respect to accuracy-related penalties under section 6662(a), see 7491(c), but the taxpayer bears the burden of proving that the Commissioner’s determinations with respect to the accuracy-related penalties are incorrect, see Rule 142(a); Welch v. Helvering, 290 U.S. at 115; Higbee v. Comm’r, 116 T.C. at 447.
A taxpayer’s gross income includes “all income from whatever source derived,” including COD income. 61(a)(12). “The underlying rationale for the inclusion of canceled debt as income is that the release from a debt obligation the taxpayer would otherwise have to pay frees up assets previously offset by the obligation and acts as an accession to wealth—i.e., income.” Bui v. Comm’r, T.C. Memo. 2019-54 (citing U.S. v. Kirby Lumber Co., 284 U.S. 1, 2 (1931)).
Generally, the amount of COD income that is includible in a taxpayer’s gross income is equal to the face value of the canceled debt minus any amount paid in satisfaction of the debt. Rios v. Comm’r, T.C. Memo. 2012-128, aff’d, 586 F. App’x 268 (9^th 2014). The income is recognized for the year in which the debt is canceled, Bui v. Comm’r, T.C. Memo. 2019-54, and is taxed at ordinary rates, Callahan v. Comm’r, T.C. Memo. 2013-131.
“[C]ertain accessions to wealth that would ordinarily constitute income may be excluded by statute or other operation of law.” Comm’r v. Dunkin, 500 F.3d 1065, 1069 (9^th 2007). But “given the clear Congressional intent to exert the full measure of its taxing power, exclusions from gross income are construed narrowly in favor of taxation.” Id. (quoting Comm’r v. Glenshaw Glass Co., 348 U.S. 426, 429 (1955).
Section 108(a)(1)(E) provides that gross income does not include amounts that would be includible as COD income if “the indebtedness discharged is qualified principal residence indebtedness.” The term “qualified principal residence indebtedness” is defined as acquisition indebtedness with respect to the taxpayer’s principal residence. 108(h)(2), (5). Section 168(h)(3)(B)(i) provides that acquisition indebtedness is any indebtedness which is: (1) incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer, and (2) secured by that residence. For these purposes, secured debt is any debt that is on the security of an instrument (such as a mortgage, deed of trust, or land contract) that makes the debtor’s interest in the qualified residence specific security for the payment of the debt (1) under which, in the event of default, the residence could be subjected to the same priority as a mortgage or deed of trust in the jurisdiction in which the property is situated and (2) is recorded or otherwise perfected in accordance with the applicable State law. Temp. Treas. Reg. § 1.163-10T(o)(1).
Section 162 allows a taxpayer to deduct all ordinary and necessary expenses paid or incurred during the tax year in carrying on a trade or business. 162(a); Treas. Reg. § 1.162-1(a). An expense is “ordinary” if it is “normal, usual, or customary” in the taxpayer’s trade or business or arises from a transaction “of common or frequent occurrence in the type of business involved.” Deputy v. du Pont, 308 U.S. 488, 495 (1940). An expense is “necessary” if it is “appropriate and helpful” to the taxpayer’s business, but it need not be absolutely essential. Comm’r v. Tellier, 383 U.S. 687, 689 (1966). Additionally, a taxpayer may not deduct a personal, living, or family expense unless the Code expressly provides otherwise. Sec. 262(a). The determination of whether an expense satisfies the requirements of section 162 is a question of fact. Cloud v. Comm’r, 97 T.C. 613, 618 (1991).
Whether a taxpayer is engaged in a trade or business is a question of fact to be decided on the basis of all the relevant facts and circumstances. Stanton v. Comm’r, T.C. Memo. 1967-137, aff’d, 399 F.2d 326 (5^th 1968). Applying this facts and circumstances test, courts have focused on the following three factors indicative of whether a trade or business exists: (1) whether the taxpayer’s primary purpose in undertaking the activity was for income or profit; (2) whether the taxpayer is regularly and actively involved in the activity; and (3) whether the taxpayer’s activity has actually commenced. Jafarpour v. Comm’r, T.C. Memo. 2012-165.
Under the Cohan rule, if a taxpayer establishes that an expense is deductible but is unable to substantiate the precise amount, the Court may estimate the amount of the deductible expense, bearing heavily against the taxpayer whose inexactitude is of his or her own making. See Cohan v. Comm’r, 39 F.2d 540, 543-44 (2d Cir. 1930). In order for the Court to estimate the amount of a deductible expense, the taxpayer must establish some basis upon which an estimate may be made. Norgaard v. Comm’r, 939 F.2d 874, 879 (9^th 1991). Otherwise an allowance would amount to “unguided largesse.” Norgaard v. Comm’r, 939 F.2d at 879.
The Cohan rule, however, is superseded—that is, estimates are not permitted—for certain expenses specified in section 274; to wit, traveling expenses (including meals and lodging while away from home), entertainment expenses, and “listed property” (including passenger automobiles, computers, and, as relevant here, 2009 phone) expenses. 274(d); Sec. 280F(d)(4)(A); Temp. Treas. Reg. § 1.274-5T(a). Instead, these types of expenses are subject to strict substantiation rules. Sanford v. Comm’r, 50 T.C. 823, 827 (1968), aff’d per curiam, 412 F.2d 201 (2d Cir. 1969). These strict substantiation rules generally require the taxpayer to substantiate with adequate records or by sufficient evidence corroborating the taxpayer’s own statement (1) the amount of the expense; (2) the time and place the expense was incurred; (3) the business purpose of the expense; and (4) in the case of entertainment expenses, the business relationship between the person entertained and the taxpayer. Balyan v. Comm’r, T.C. Memo. 2017-140.
For “listed property” expenses, in addition to the time such expenses were incurred and their business purpose, the taxpayer must establish the amount of business use and the total use of such property. Balyan v. Comm’r, T.C. Memo. 2017-140. Generally, deductions for meals and entertainment expenses are subject to the 50% limitation imposed by section 274(n).
Substantiation by adequate records requires the taxpayer to maintain (1) an account book, diary, log, statement of expense, trip sheets, or similar record prepared contemporaneously with the expenditure and (2) documentary evidence, such as receipts or paid bills, which together prove each element of an expenditure. Balyan v. Comm’r, T.C. Memo. 2017-140.
Section 6662(a) imposes a 20% accuracy-related penalty on any portion of an underpayment of tax required to be shown on a return if, as provided by section 6662(b)(1) and (2), the underpayment is attributable to negligence or disregard of rules or regulations and/or a substantial understatement of income tax. For these purposes, negligence includes any failure to make a reasonable attempt to comply with the internal revenue laws, disregard includes any careless, reckless, or intentional disregard, and an understatement of income tax is substantial if it exceeds the greater of 10% of the tax required to be shown on the return for that tax year or $5,000. 6662(c) and (d)(1)(A).
Reasonable cause may exist where the taxpayer relies on professional advice if the taxpayer proves by a preponderance of the evidence that: (1) the adviser was a competent professional who had sufficient expertise to justify the taxpayer’s reliance on him or her; (2) the taxpayer provided necessary and accurate information to the adviser; and (3) the taxpayer actually relied in good faith on the adviser’s judgment. Neonatology Assocs., P.A. v. Comm’r, 115 T.C. 43, 99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002).

Tax Court Motion: The Weiderman decision is a good illustration of the difficulties a taxpayer may face in attempting to fall within an exclusion to COD income under Section 108. Taxpayers should be aware that in many instances (as in this case), the lender will issue a Form 1099 alerting the IRS that the debt has been cancelled. In such a case, the IRS will often look to the debtor’s tax return to determine whether the COD income has been properly reported. In many cases, with proper tax planning, taxpayers can provide better arguments and documentary proof to meet an exception under Section 108.

Robert Elkins v. Comm’r, T.C. Memo. 2020-110

July 16, 2020 | Urda, J. | Dkt. No. 12315-17L

Tax Dispute Short Summary: The case involved the rejection of an offer-in-compromise (OIC) based on the abuse of discretion by the Office of Appeals of the Internal Revenue Service (IRS).

Dr. Elkins (the “taxpayer”), a prominent businessman and a partner at Delta Trading Partners IV, LP, entered a joint stipulation with the IRS to settle adjustments to certain amount of income and deductions reported by the partnership during 1998 and 1999. The Tax Court entered a decision consistent with the stipulation of the settled issues. Consequently, the IRS made computational adjustments to Dr. Elkins 1998, 2000 and 2001 Federal income tax returns consistent with the Tax Court’s decision and assessed more than $10 million in income tax deficiencies, accuracy-related penalties and interest.

The taxpayer submitted an OIC proposing to settle his tax debt for $17,500. To support his OIC premised on doubt as to collectibility, he argued that he was 71 years old, divorced, unemployed, and did not had any substantial assets and that his reasonable collection potential (RCP) was limited to $15,500 (He later increased his OIC to $33,000 and $71,500).

The IRS rejected the OIC and sustained the Notice of Federal Tax Lien (NFTL) on the ground that the offer was not in the best interest of the Government, considering public policy and tax administration concerns. The main points to sustain such rejection were: (i) that the taxpayer’s increases to his OIC did not shown good faith, (ii) that the taxpayer did not make voluntary payments during the years the OIC had been pending, and (ii) the taxpayer’s negative history with use of company funds. These elements show that the IRS did not abused its discretion in sustaining the OIC’s rejection as not in the best interest of the Government.

Tax Litigation Key Issues: Whether the IRS abused its discretion to reject an OIC because it was not in the best interest of the Government.

Primary Holdings: The IRS does not abuse its discretion when rejecting an OIC, when (i) the requirements of applicable law or administrative procedure met by the taxpayer have been properly verified, (ii) the IRS considers any relevant issues raised by the taxpayer, such as good faith and previous negative history, and (iii) the proposed collection action balances the need for efficient collection with the taxpayer’s concern that such action is no more intrusive than necessary.

Key Points of the Tax Laws:

The Court argued that to determine an abuse of discretion by the IRS when rejecting an OIC because it is not in the best interest of the Government, the following elements must be analyzed:

The decision to accept or reject an OIC is in the Secretary’s discretion. Sec. 301.7122-1(c)(1).
An OIC may be rejected if acceptance would not be in the best interest of the Government and the IRS takes into account public policy and tax administration concerns. Rev. Proc. 2003-71, sec. 6.03, 2003-2 C.B. at 519.
The Internal Revenue Manual (IRM) provides that such rejection should be fully supported by the facts outlined in the rejection narrative and should not be routine.
When reviewing for abuse of discretion, the Court uphold the IRS’ determination unless it is arbitrary, capricious or without sound bases in fact or law. Murphy v. Commissioner, 125 T.C. 301, 320 (2005), aff’d, 469 F.3d 27 (1st Cir. 2006); Taylor v. Commissioner, T.C. Memo. 2009-27, 97 T.C.M. (CCH) 1109, 1116 (2009).
The Court has determined that to uphold a notice of determination, it requires that the basis for the determination is reasonably discerned. Bowman Transp., Inc. v. Ark.-Best Freight Sys., Inc., 419 U.S. 281, 285-286 (1974) Melasky v. Commissioner, 151 T.C. 93, 106 (2018), aff’d, 803 F. App’x 732 (5th Cir. 2020); cf. Kasper v. Commissioner, 150 T.C. 8, 24-25 (2018).
Additionally, the Court may consider any “contemporaneous explanation of the agency decision’ contained in the record.” (quoting Tourus Records, Inc. v. Drug Enf’t Admin., 259 F.3d 731, 738 (D.C. Cir. 2001)
Based on the above, the Court determined that the analysis made by the IRS where it considered the bad faith of the taxpayer when making his OIC, the lack of payments made by the taxpayer and the negative history of the taxpayer constituted a sound basis for the OIC rejection.
Finally, in cases where the OIC is rejected and the taxpayer does not offer a viable collection alternative, a NFTL is the least intrusive mean of collecting an outstanding liability.

Tax Court Motion: The question presented in this case provides some elements that may be helpful to determine whether an OIC can be rejected by the Government because it is not in its best interest. Factors such as the good faith of the taxpayer, his real reasonable collection potential and background financial history are elements that can support a favorable narrative when filing an OIC.

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(1) Doubt as to liability

(2) Doubt as to collectability

(3) Promotion of effective tax administration

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When an IRS Tax Lien Arises

What is a Tax Lien?

How the Tax Lien Arises

The Span of a Federal Tax Lien

The Transfer of Property Subject to Lien

The Notice of Federal Tax Lien (NFTL)

Purpose and Effect of Filing Notice

Place of Filing

Refiling of Notice

Contents of Notice of Federal Tax Lien

Effect of Errors in Notice of Federal Tax Lien

Collection Due Process

Property to Which the Tax Lien Attaches

State Law

Real Property

Community Property

Joint Tenancy

Tenancy in Common

Tenancy by the Entirety

Equitable Conversion

Personal Property

Cash and Rights to Cash

Partnership and Other Joint Interests

Trusts and Beneficial Interests

Intangible Property

Exempt Property

Terminable Interests

Property in the Custody of a Court

Property Held By Third Parties

Alter Ego

Nominee

Disclaimers and Renunciations

Same-sex Marriage and Legally-Recognized Relationships

Priority of Tax Liens: Specially Protected Competing Interests

Purchasers

Judgment Lien Creditor

Mechanic’s Lienor

Holder of a Security Interest

Superpriorities

Securities

Motor Vehicles

Personal Property Purchased at Retail

Personal Property Purchased in Casual Sale

Personal Property Subject to Possessory Lien

Real Property Tax and Special Assessment Liens

Residential Property Subject to a Mechanic’s Lien for Certain Repairs and Improvements

Attorney’s Liens

Certain Insurance Contracts

Deposit Secured Loans

Purchase Money Security Interest (PMSI)

Protected Interests Arising from Certain Financing Agreements

Commercial Transactions Financing Agreements

Real Property Construction or Improvement Financing Agreement

Obligatory Disbursement Agreement

IRC § 6323(d)

Priority of Interest and Expenses

Priority of Tax Liens: The Competing Choate Lien

Lien Priority Disputes Arranged by Topic

Assignments

Attachment Liens

Dower and Curtesy

Foreclosure Costs

Forfeited Property

Home Equity Line of Credit or Open-end Mortgage

Insurance and Insurance Loans

Landlord’s Liens

Limited Liability Companies (LLCs)

**V. Aftermath of Bostock – EEOC Guidance**

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