Tax Matters

Tax Matters

IRS Reinvents National Advocate Organization

N o doubt W. Val Oveson is sighing with relief as 1999 comes to a close. As National Taxpayer Advocate—the voice for taxpayers within the IRS—he is putting some finishing touches on a reorganization that has already brought sweeping changes to his office.

“The plan for 2000 is to get better at what we’re doing and be more effective in helping taxpayers,” Oveson said.

The remodeled Office of the Taxpayer Advocate now has increased independence from local IRS offices and improved local representation for taxpayers. It features 74 local advocates—at least one in each state. An advocate also will serve taxpayers in each of the IRS’s new service centers.

The reorganization of the advocate’s office was designed to comply with provisions in the IRS Restructuring and Reform Act of 1998 that called for a stronger role for the national advocate’s office and for an advocate in each state. The job of realizing those changes fell on the shoulders of Oveson, a CPA and former tax commissioner for Utah. The modernized organization will meet the requirements of the statute, and advocates will have a more defined role and mission, Oveson said.

“With all that has been going on, we’ve still been out there servicing taxpayers, handling their concerns and complaints,” he added. However, according to figures from the IRS, the advocate’s office processed significantly fewer cases this year. It opened approximately 283,000 cases in 1999: The comparable figure from 1998 was 348,000 cases. Oveson said the drop in cases probably resulted from the decreased number of IRS taxpayer audits in 1999.

In the past, taxpayer advocates outside Washington, D.C., reported to the heads of local IRS offices. Now each taxpayer advocate reports directly to the National Taxpayer Advocate. In keeping with its dual mission (see the new mission statement below) of helping taxpayers directly and lobbying Congress to improve tax policies and processes at the IRS, the organization has been divided into two units:

• The casework unit, which is organized geographically, is responsible for assisting taxpayers with their problems.
• The systemic analysis and advocacy unit works with the operating divisions of the IRS to identify problems and implement solutions for existing or new systems and procedures within the service.

The casework unit

Roughly 2,000 of the organization’s staff of 2,400 employees are assigned to the casework unit.

As a result of the reorganization, nine area advocates now manage the local advocates. In addition, three new positions were created to improve the work performed by local advocates in the casework unit.

Associate advocates (AA) and senior associate advocates (SAA) are generalists who will handle problems from taxpayers in all four of the IRS’s new business units. Technical advisers will serve on cross-functional teams and will be able to help taxpayers with complex cases.

As part of the reorganization process, desk guides and the criteria for taxpayer advocate cases were rewritten. With the new guides and upgraded expertise of its employees, the casework unit can better handle tough cases, Oveson said.

Challenges ahead

According to Oveson, notwithstanding all the changes, meeting taxpayers’ expectations continues to be his biggest challenge. His primary goal remains “serving the taxpayers and providing them with the assistance they need while staying within the law.”

INDIVIDUAL

A House Is Not Necessarily a (Tax) Home

T o deduct temporary lodging and travel expenses, a taxpayer must show that they relate to travel away from his or her “tax home” (the geographical area of the taxpayer’s principal place of business) and that the employment was completed within one year.

IRC section 162(a) provides that a taxpayer will not be considered temporarily away from home during any employment (or assignment) that exceeds one year. (For more, see “Defining the Temporary Workplace,” JofA , May99, page 117.)

The IRS issued further guidance in revenue ruling 93-86, which said that assignments characterized at the outset as indefinite were not considered temporary regardless of the length of time required to complete them. As long as the one-year limit was not exceeded, the initial characterization of the length of the assignment determined whether or not the expenses were deductible.

In Thomas J. Mitchell and Janice M. Mitchell v . Commissioner (TC Memo 1999-283), a Los Angeles publisher retained a self-employed publishing consultant working out of his home. The publisher first engaged Mitchell in 1991 for an assignment expected to last four months. However, due to unexpected events at the publishing company (mostly personnel turnover), Mitchell’s services were retained for a series of separate assignments, each lasting less than one year, until the assignments ended in 1996.

During 1994 and 1995, the years in question, Mitchell spent 155 days and 113 days, respectively, in California. He also rented an apartment near the publisher’s office because it was cheaper than staying in a hotel.

The IRS disallowed the travel and lodging expense deductions Mitchell filed on his 1994 and 1995 returns, arguing that his tax home had moved to California.

The Tax Court sided with Mitchell. According to the court, Mitchell’s tax home remained in Illinois because

• The taxpayer’s consulting business and his personal residence were based in Illinois.
• Living in California was not his choice but was dictated by the exigencies of his work for the client.
• He spent more time in Illinois than California during each of the years in question.
• The taxpayer’s connection to California was to provide services on an as-needed basis.
• He sought consulting work from other, unrelated clients from his Illinois office.
• His work in California was not indefinite, but temporary due to “unexpected happenings” at the client’s office.

The court held that “merely because an independent contractor may return to the same general location in more than one year does not mean that the independent contractor is employed in that general location on an indefinite basis.”

Observation: Where consecutive, separate and short-term (less than one year) assignments are a possibility, tax advisers should recommend to clients seeking to deduct temporary lodging and travel that they contract for and document each assignment separately.

—Vinay S. Navani, CPA, tax manager, Wilkin & Guttenplan, PC, East Brunswick, New Jersey.

Deductibility of Expenditures

T he IRS permits taxpayers to use the cash method of accounting even though that method does not perfectly match revenues with expenses. When they are too far out of line, however, the IRS can require a taxpayer to switch to the accrual method of accounting.

Most companies incur professional services expenses on a regular basis. As a result, many choose to hire attorneys, accountants and others on retainer. The deductibility of retainer fees has long been the subject of disagreement between taxpayers and the IRS. Recently, one taxpayer litigated both of these issues.

Accounting method. Dana Corp. and all but one of its subsidiaries used the accrual method of accounting. Leverage Leasing used the cash method. It received its rents in arrears and paid its interest expense in the same manner. In 1984, the company decided to pay the interest expense for the year in December, rather than in January 1985, when it was due. The IRS determined that the cash method did not clearly reflect income and required Leverage Leasing to switch to the accrual method.

Legal retainer. Dana Corp. hired the law firm of Wachtell, Lipton, Rosen and Katz. They paid Wachtell an annual retainer, primarily to prevent the firm from representing a company interested in acquiring Dana. The retainer agreement permitted Dana to reduce any actual legal fees by the amount of the retainer. Dana used Wachtell, Lipton for legal advice only occasionally, but in all cases deducted the retainer in the year it was paid. In 1984, Dana acquired another company and offset Wachtell, Lipton’s legal fees in part with the retainer. The IRS denied a deduction for the retainer.

Result. Split decision: For the taxpayer on the accounting method issue and for the IRS on the capitalization of the legal retainer. Typically, the courts will uphold an IRS determination that a taxpayer’s accounting method does not clearly reflect income. In this case, however, the Federal Circuit Court of Appeals decided that IRC section 461(g) specifically permitted a deduction for advance payment of accrued interest. The same section denies a cash method taxpayer a deduction for interest paid for periods after the close of the tax year. According to the court, by denying a deduction for prepaid interest, the code authorizes a deduction for all interest paid for the tax year—even if it is paid in advance. Therefore, the IRS does not have the authority to require a taxpayer to switch to the accrual method, even if the interest deduction is not properly matched with revenue under the cash method.

Congress enacted section 461(g) to prevent a cash method taxpayer from prepaying interest expense. Most other expenditures do not have comparable code sections. Therefore, other cash method taxpayers must be careful that in prepaying expenses they do not distort their income or the IRS could put them on the accrual method of accounting.

The Court of Federal Claims had held the legal retainer to be deductible based on the origin of the claim doctrine. The appellate court applied this doctrine differently, concluding that the right of offset in the retainer agreement made the origin of the payment the specific legal bill, not the annual retainer, as the earlier court had stated. Since the bill was for an acquisition, a capitalizable event, the company had to capitalize the retainer fee.

The result is that retainer payments are deductible or capitalizable based on the nature of the legal fees a company incurs. As the court pointed out, the company could deduct the retainer each year that it did not offset actual legal bills. Since most retainers have a right of offset, deductibility will depend on the services rendered each year, with any excess retainer deductible currently.

• Dana Corp. v . United States, 74 F.3d 1344, 99-1, USTC P50, 411 (CA-Fed. Cir.).

Calculating Gain on Corporate Distributions

I n 1986, Congress repealed the last element of the General Utilitie s doctrine. As a result, corporations must recognize gain when they distribute appreciated assets to stockholders, regardless of whether they structure the transaction as a property dividend or as a stock redemption. Recently, the Ninth Circuit Court of Appeals addressed how to calculate the gain on distribution.

Pope & Talbot, a publicly held corporation, owned properties in the state of Washington. The company believed the market price of its shares did not properly reflect the value of these properties so it transferred them to a limited partnership and distributed the partnership interests to company shareholders. Between the time the properties were transferred to the limited partnership and the interests distributed to shareholders, the partnership interests began to trade on the Pacific Stock Exchange on a “when-issued” basis.

To calculate the gain on the distribution, Pope & Talbot subtracted the basis of the partnership interests (the carryover basis from the properties transferred to the partnership) from their aggregate value, based on the average price on the exchange. The IRS recalculated the gain based on the higher fair market value of the properties the company transferred to the partnership.

Result. For the IRS, with one dissenting opinion. Pope & Talbot argued that the purpose of the code’s gain recognition requirement is to equate a predistribution sale by the company with a postdistribution sale by the shareholders. However, the Ninth Circuit rejected this argument on the grounds that the wording of IRC section 311 is clear and unambiguous. The corporation must recognize gain as if it had sold the property. The value or gain at the shareholder level is immaterial.

Pope & Talbot also argued that gain should be calculated based on the property distributed—in this case, a limited partnership. The Ninth Circuit rejected this argument as well and accepted the IRS position that the gain must be measured based on a hypothetical sale of the entire property. In this instance, it would be the properties the company contributed to the partnership—not the partnership interests themselves. The lone dissenting opinion accepted the taxpayer’s argument and would have measured the gain based on the value of the partnership interests.

As a result of this decision, there is no symmetry when a company distributes property. The value the company uses to calculate gain at the corporate level is not necessarily the value for purposes of determining how much income shareholders will recognize. The case leaves open the issue of how to determine the exact asset the company distributed. It remains to be seen if other courts will look through the asset distributed to determine an underlying value, as the Ninth Circuit did, or if they follow the dissent and value the exact property distributed.

• Pope & Talbot v . Commissioner, 162 F.3d 1236, 99-1 USTC P50, 158, 83 AFTR.2d 364 (CA-9).

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