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The Service issued proposed regulations implementing changes made last year to the return preparer penalties in IRC §§ 6694 and 6695 and related provisions (REG-129243-07; see also "From The Tax Adviser," page 90). Comments are due by Aug. 18, 2008. Among the many new and expanded provisions are:

Methods of adequately disclosing positions that fall short of the new "more likely than not" standard but nonetheless have a reasonable basis are provided for both signing and nonsigning preparers. The new rules also define good-faith reliance on unverified information received from taxpayers and other preparers.

In contrast to the current "one preparer per firm" rule, each position taken on a return can have a different preparer (Prop. Treas. Reg. § 1.6694-1(b)).

The penalty amount of half the income derived or expected "with respect to" a return or refund claim can be based on compensation for tax advice, including research and consultation. For a preparer not directly compensated by a taxpayer but by a firm, it is compensation that can be reasonably allocated to return preparation or advice that gave rise to the understatement.

A de minimis safe harbor for post-transaction advice is designed to encourage tax professionals to provide follow-up advice requested by a taxpayer without the concern that doing so would make them a return preparer.

Meanwhile, the U.S. House of Representatives passed the Renewable Energy and Job Creation Act of 2008 (HR 6049—commonly referred to as the “extenders bill”), which contained an AICPA-championed measure to harmonize the preparer standard with the “substantial-authority” taxpayer standard of section 6662. The bill, however, may be held up in the Senate for some time because of other provisions.

A district court quashed another IRS summons seeking workpapers that a taxpayer argued were protected by the work product privilege. Despite the setback, the government is trying to use the case to support its argument in the appeal of another work product case it lost in district court last year.

In May, the U.S. District Court for the Northern District of Alabama ruled in favor of the taxpayer in Regions Financial Corp. v. U.S. (101 AFTR2d 2008-2179), concluding that documents sought in the IRS summons were created by Regions “in anticipation of litigation.” Furthermore, Regions did not waive work product protection by supplying the workpapers to a third-party auditor, Ernst & Young. E&Y was neither an adversary nor a third-party conduit to a potential adversary, so the disclosure did not constitute a waiver.

The Regions decision was similar to the ruling of the U.S. District Court for Rhode Island last year in Textron v. U.S. (100 AFTR2d 2007-5848; “Tax Matters: Work Product Stands Up to IRS Summons,” JofA, Nov. 07, page 80). The Textron court also said the disclosure of workpapers to the independent auditor did not waive the privilege.

The IRS has appealed Textron to the U.S. Court of Appeals for the First Circuit. The government subsequently notified the appeals court of the decision in Regions. While the government disagreed with the ultimate decision in Regions, it cited part of the decision that said the court ruled in favor of the taxpaye because the documents it sought to protect “are less broad than those withheld in Textron because Regions has already disclosed the fact and amounts of its reserves.” Among the documents Textron is fighting to protect are those that contain its attorneys’ opinions of the estimated chances of litigation and calculations of tax reserves.

As had been widely expected, the U.S. Supreme Court upheld the constitutionality of the widespread and long-standing practice of states excepting from income tax the interest on bonds they and their political subdivisions issue, while taxing that of other states and local governments. The challenge to Kentucky’s scheme by George W. and Catherine Davis (docket No. 06-666) hinged on the Equal Protection Clause of the U.S. Constitution’s 14th Amendment (originally ratified to prevent former slaves from being treated poorly) as well as the Commerce Clause (Art. I, § 8, cl. 3, “Congress shall have power … to regulate commerce … among the several states”) and its corollary judicial prohibition of discrimination against interstate commerce, commonly known as the “negative commerce clause.” The Court of Appeals of Kentucky had found for the Davises. The Kentucky Supreme Court declined to review, and the state filed for certiorari.

The U.S. Supreme Court ruled 7–2 in favor of Kentucky. The opinion by Justice David Souter noted that Kentucky is among 41 states that employ such differential treatment of public bonds. They have done so since 1919—nearly since they began taxing incomes. Besides the practice’s being deeply ingrained, its constitutionality is supported by cases that distinguish states’ role of regulating markets and—as in issuing bonds—that of participating in them, the court said. The same issue in a different context was similarly resolved last year, the court said, when it ruled that local ordinances in New York state did not discriminate against interstate commerce by requiring private trash collectors to use a public processing plant rather than less expensive out-of-state plants (United Haulers Association Inc. v. Oneida- Herkimer Solid Waste Management Authority, 261 F.3d 245).

The U.S. Supreme Court declined to review the Sixth Circuit’s ruling that a decedent’s bequest to her grandchildren was not entitled to grandfathering provisions of generation-skipping transfer (GST) rules. Both sides agreed in the case, Estate of Gerson v. Commissioner (100 AFTR2d 2007-6593), that GST tax would ordinarily apply. But the estate of Eleanor Gerson, who died in 2000, contended that because the irrevocable trust at issue had not been modified since its creation before 1985, when the GST tax took effect with a grandfather provision, the tax did not apply. The IRS, however, pointed to the fact that the skip transaction wasn’t included in the trust before 1985, only the terms that gave Gerson power to appoint a beneficiary. She exercised that right in a will, naming her grandchildren as beneficiaries. The IRS assessed a deficiency on the estate tax return of $1.14 million.

The relevant provision of the Tax Reform Act of 1986 grandfathered transfers under a trust that was irrevocable as of the GST effective date, “but only to the extent that such transfer is not made out of corpus added to the trust” after that date, it stated. In 1996, the Second Circuit determined that the grandfather clause did not apply where a decedent had full power of appointment over the trust’s assets but did not exercise it to prevent a skip transaction (E. Norman Peterson Marital Trust v. Commissioner, 77 AFTR2d 96-1184). The IRS and Treasury, in response to a decision by the Eighth Circuit more favorable to estates, instituted rules (Treas. Reg. § 26.2601-1(b)(1)(i)) that denied grandfathering to skip transactions made pursuant to an exercise, release or lapse of a decedent’s general power of appointment that is treated as a taxable transfer for gift or estate tax purposes.



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