IRS ISSUES PROPOSED RETURN PREPARER
REGS
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.
WORK PRODUCT STYMIES IRS AGAIN
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.
HIGH COURT APPROVES MUNIS
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).
GRANDMOTHER CAN’T GRANDFATHER
GENERATION SKIP
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.