Astrid Omohundro appealed a district court decision that held her refund claim was not timely based on the Ninth Circuit decision in Miller , 38 F3d 473 (1994). The taxpayer argued Miller was incorrect and a refund claim was timely as long as it was filed within three years after the return, regardless of the timeliness of the return itself.

Result. For the taxpayer. Section 6511 requires that taxpayers file refund claims within three years of filing a tax return or two years from the time they pay the tax, whichever is later. A taxpayer who does not file a return must file a refund claim within two years of paying the tax. In Miller , the Ninth Circuit had concluded that if a taxpayer did not file a return within the two-year payment period, the two-year period, not the three-year period, limited refund claims.

In an interesting switch, both the taxpayer and the IRS said the lower court had decided Miller incorrectly, arguing that revenue ruling 76-511 (which was outstanding at the time) was on point and the lower court had not considered it.

In this case the Ninth Circuit decided revenue ruling 76-511 was, in fact, on point and the district court should have considered it. Under this ruling, a refund claim is timely as long as a taxpayer files it within three years after filing a tax returneven if the return is filed more than two years after payment. The Ninth Circuit concluded the revenue ruling was consistent with congressional intent and the lower court should have used it to decide the issue. Under this ruling the taxpayers claim was timely. Therefore, the Ninth Circuit remanded the case to the district court to determine the merits of the taxpayers refund claim.

In deciding to apply the revenue ruling, the Ninth Circuit interpreted the U.S. Supreme Court decision in Mead as requiring courts to apply the so-called Skidmore deference to revenue rulings. (Thus the Ninth Circuit examined the reasonableness of revenue ruling 76-511 in light of congressional intent, the IRS position on the issue and the like.) If other courts interpret Mead in the same way they would have to follow all IRS revenue rulings as long as they are consistent with the statute and reasonable.

However, the Ninth Circuit decision that revenue rulings deserve Skidmore deference is not uniformly accepted. In fact, the Tax Court had previously said revenue rulings were entitled to no deference. In the Omohundro case, it was reasonable for the court to follow the revenue ruling given that all the other courts that had considered itand this same issuehad said the ruling was a correct and reasonable interpretation of the law. When a less certain revenue ruling is at issue, the court should examine the application of deference more closely.

Astrid E.A. Omohundro v. United States (CA-9, 2002)

Prepared by Edward J. Schnee, CPA, PhD, Culverhouse Professor of Accounting and director, MTA program, Culverhouse School of Accountancy, University of Alabama, Tuscaloosa.

An IRA Distribution or Not ?
W hen a taxpayer takes a cash distribution from a regular individual retirement account (IRA), the entire amount is gross income unless part of the distribution represents a return of his or her nondeductible contributions. Suppose the IRA custodian sends a taxpayer a check payable to a third party, the taxpayer then sends the check to the third party to buy stock in the IRAs name. Has the taxpayer received a distribution? Neither the Internal Revenue Code nor the related regulations provide a definitive answer.

Robert Ancira was the owner of a self-directed IRA. The assets were held by Pershing, the IRAs custodian. The taxpayer asked Pershing to buy $40,000 of stock in S.K., a nonpublicly-traded corporation, using existing IRA assets. Company policy prohibited Pershing from buying non-publicly-traded stock, so it arranged an indirect purchase by sending to Ancira a $40,000 check payable to S.K. The taxpayer then sent the check to S.K. to complete the purchase.

S.K. issued a stock certificate listing the IRA as owner of the shares. At a much later date, S.K. mailed the certificate to Ancira, who delivered it to Pershing. The taxpayer received a 1099-R for 1998 from Pershing in the amount of $40,000; he did not report the amount on his 1998 tax return. The IRS assessed a $17,383 deficiency, which included the 10% penalty tax under IRC section 72(t). Ancira petitioned the Tax Court for relief.

Result. For the taxpayer. The Tax Court concluded no distribution had occurred since the taxpayers only role in the transaction was that of a conduit. It based this finding on the following facts: The check was payable to S.K., it negotiated the check, the IRA was the owner of the stock and the taxpayers only action was to deliver the stock to Pershing.

The court could not find any legal, administrative or judicial authority prohibiting a taxpayer from being a conduit for IRA transactions. Furthermore, the court held the taxpayer was not in constructive receipt of the $40,000 since he was not a holder of the check nor could he negotiate it under state law. The Tax Court also distinguished the facts of this case from those of Lemishaw v. Commissioner, 110 TC 110, which determined that a distribution from an IRA to the taxpayer had occurred. In Lemishaw the taxpayer withdrew money from his IRA, used it to buy stock and then contributed the stock to the IRA. The Tax Court differentiated Lemishaw from this case since Ancira never received any cash.

In addition the court concluded the delay in delivering the stock certificate to Pershing did not constitute a transfer of ownership to the taxpayer since the delay did not change the underlying nature of the transaction. Previously, the court had held that a bookkeeping error by an IRA trustee did not change the nature of an IRA transaction (see Wood v. Commissioner, 93 TC 114). The Tax Court said the rationale of the two situations was similar. Also, the court noted that the 60-day limitation on rollovers of IRA distributions did not apply since there was no distribution to Ancira.

With this case it appears the court has extended the concept in Wood that errors by IRA trustees do not affect the substance of a transaction to mistakes made by third parties.

Robert Ancira v. Commissioner, 119 TC no. 6.

Prepared by Charles J. Reichert, CPA, CIA, professor of accounting at the University of Wisconsin, Superior.

In LTR 200236028, a taxpayer in the business of marketing and distributing music industry-related products purchased ERP software and entered into consulting agreements to customize the software to fit the company’s needs. In addition to the hardware and the software license fee, the company incurred costs for

Functional consulting.
Maintenance.
Outside training.
Technical consulting.

While the letter ruling did not include exact amounts, the total cost of ERP systems could range from $2 million to $200 million depending on the company’s size.

The IRS allowed the company to currently deduct the functional consulting, maintenance and training costs. Two observations are crucial here. First, in revenue ruling 96-62 (1996-2 CB 9) the IRS said the Indopco decision (503 US 79) would not cause training costs to be capitalized. Therefore, training is deductible only if a company categorizes it as such. Second, the costs at issue in this ruling did not include any “reorganization expenditures.” This is another way of saying the company did not undertake any business process reengineering. The IRS requires businesses to capitalize reengineering costs (see TAM 9544001 on reengineering in a conversion to just-in-time manufacturing). When a company engages in reengineering and capitalizes the expense of doing so, it ends up including a good deal of training costs because the essence of reengineering is training employees to accomplish a task in a different way. Taxpayers should isolate as many training costs as possible in the spreadsheets they use to track ERP costs.

Technical consulting costs include modeling and designing additional software, writing machine-readable code and implementing existing imbedded ERP software templates. Taxpayers can deduct these costs only if they can categorize them as software development costs under section 5 of revenue procedure 2000-50. The IRS allowed companies to deduct self-developed software for many years but insisted costs included in this category resemble research and development expenditures. Thus, implementing purchased software templates is definitely not internal software development. On the other hand, writing machine-readable code clearly qualifies.

What about modeling and design costs? Recent signals from the IRS indicate that only the costs of writing code would qualify. This letter ruling, however, contains a hopeful sign that at least a portion of design costs may be eligible for a current deduction as software development. The Office of Associate Chief Counsel, at least here, took the position the taxpayer should allocate modeling and design costs to “the activities of writing machine-readable code and the option selection and implementation of existing embedded software templates.” The portion allocated to code writing is deductible, however the company should capitalize the remaining expenses.

The deductibility of technical consulting costs depends not only on the nature of the work but also on who is responsible for development. Who is at risk for the software’s functional utility? In LTR 200236028, the taxpayer was solely responsible for adapting and customizing the ERP software. The consultants performed their technical activities under a time-plus-expense contract. The taxpayer had to correct any problems relating to the system’s functionality. The consultant contracts provided no guarantees or warranties. Thus, if the taxpayer is the responsible party, it may deduct the consulting costs for writing code and related modeling and design as software development under revenue procedure 2000-50.

Planning for an ERP deduction. CPAs may want to consider the following suggestions in light of LTR 200236028 as they seek to justify a current deduction for ERP costs for a client or employer.

Carefully isolate deductible training and maintenance costs regardless of whether software development is taking place.

Document and isolate any reengineering costs. Conceptually, these are costs of adapting the company to the software rather than adapting the software to the company. Without the proper recordkeeping, IRS agents may assume, by default, that the costs of consultants who are not programmers fall into capitalizable reengineering.

Leave a trail for all the time consultants spend on modeling and design and source code writing. Remember source code writing is directly deductible (assuming the taxpayer is functionally at risk on the project) and part of the time spent on modeling and design should be allocated to code writing.

— Larry Maples, CPA, DBA, COBAF Professor of Accounting at Tennessee Technological University, Cookeville.