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Monday, May 28, 2012


For income taxes, the IRS generally has only 3 years to assess any additions to tax from the due date or filing date of a taxpayer’s return. Before assessing tax, the IRS must send a notice of deficiency to the taxpayer. This notice extends the 3 year period for 90 days, during which the taxpayer can file in the Tax Court to contest the proposed tax. Code Section 6213(a) provides that no assessment of tax can be made until the notice of deficiency is sent. A recent case addresses how the IRS must prove it mailed the notice of deficiency when the mailing is disputed.

The burden of proof on mailing is on the IRS. The Internal Revenue Service Manual provides a procedure to the IRS that it should follow. It provides that the record of certified and registered mailing should be kept on PS Form 3877 together with the certified/registered mail numbers, which are supplied by the United States Postal Service. Each PS Form 3877 is to be labeled with, “Notices of Deficiency, for the years indicated, have been sent to the following taxpayers.” Certified/registered mail numbers of each individually mailed notice are recorded on the form, along with the name and address of each addressee. Multiple addresses are separately entered. In the “Remarks” column of PS Form 3877, the tax years to which the notice is applicable are entered. At the Post Office, the postal employee will compare the certified/registered mail number of each notice against the number recorded in PS Form 3877, and subsequently sign and date PS Form 3877. If the IRS produces the above items, it is presumptive proof of proper mailing. Note that the actual receipt of the notice by the taxpayer is not required – just proof of mailing to the proper address.

The failure to prove a PS Form 3877 is not fatal to the IRS – the IRS can attempt to prove mailing by other means. In the current case, the court noted that there is no well-defined precedent of what proof is required. The court went through the applicable cases and came up with the following method of review and analysis:

(1) The IRS has the burden of proving proper mailing of a notice of deficiency by competent and persuasive evidence.

(2) When the IRS has (a) established the existence of a notice of deficiency and (b) produced a properly completed PS Form 3877 certified mail log, it is entitled to a presumption of mailing, and the burden shifts to the taxpayer to rebut that presumption by clear and convincing evidence.

(3) In the absence of a properly completed PS Form 3877, when the existence of a notice of deficiency is not in dispute, the IRS must come forward with evidence corroborating an actual timely mailing of the notice of deficiency

(4) When the parties dispute the existence of the notice of deficiency itself, the IRS bears the burden of establishing both the existence of the notice itself, as well as timely mailing of that specific notice.

The court then applied the facts for 2 tax years to the above analysis. For tax year 1992, the IRS had a copy of the notice of deficiency and also had mail return-receipt cards, but it did not have a PS Form 3877. The IRS also provided testimony that the notices of deficiency was sent by certified mail and that the cards they produced would correspond to the only certified mail sent to the IRS in that year. The court held that these facts came within (3) above and were enough to corroborate timely mailing.

For tax year 1995, the facts fell into (4) above since the IRS could not produce a copy of a notice of deficiency. There was no transmittal letter to the taxpayer’s counsel informing them that a notice had been sent to the taxpayer. The IRS did provide 1) testimonial evidence regarding internal IRS procedure for notice preparation at the Manhattan office, 2) Appeals Case Memorandums indicating that a statutory notice was approved, 3) computer control cards suggesting a 1995 notice existed, and 4) two postal return-receipts. The court rejected this proof as being sufficient because the IRS could not cross-reference the postal receipts to any specific items of correspondence.

The foregoing analysis provides a useful algorithm for analyzing timely mailing cases regarding notices of deficiency.

Welch v. U.S., 109 AFTR 2d 2012-xxxx, 05/18/12 (U.S. Court of Appeals for the Federal Circuit)

Tuesday, May 22, 2012


An accounting firm operated as a C corporation. The firm paid substantial fees to three related entities created by the founding shareholders of the firm. The fees were so high as to reduce the net income of the firm to a  de minimis amount in one year, and a loss in the next.

It is common for C corporations to pay compensation to shareholders to avoid double taxation. C corporation income is taxed twice – first at the corporate level, and then the shareholders are taxed on after-tax dividends. If compensation is paid to a shareholder, there is only one level of tax – the shareholder pays tax on the compensation and the corporation gets a deduction for the payment. Because of this advantage, the IRS and the courts will limit compensation payments to “reasonable compensation,” and characterize payments to shareholders in excess of reasonable compensation as dividends (which generate no deduction for the corporation).

While one cannot tell from the case, the above C corporation may have attempted to disguise unreasonable (and thus nondeductible) payments to shareholders as deductible consulting payments to the entities of the founding shareholders – although there is a suggestion that this arrangement was instead entered into to hide the payments to founders from the employees of the firm. Whatever its rationale, the IRS challenged the payments on the basis that  the consulting firms actually performed no services. That fact alone disqualified the payments as being deductible compensation services. The founders also indicated that the payments were also in payment of services performed by the founders for the accounting firm, but this did not hold up factually. Further,  even if that was the case, the payments were still so high as to flunk the independent-investor test for what qualifies as reasonable compensation. Thus, the trial court found, and the appeals court affirmed, that over $800,000 in payments over the years were disguised dividends and not deductible by the firm. This resulted in substantial income taxes and penalties being imposed on the firm.

The appellate court was puzzled why the accounting firm continued to operate as a C corporation over the years, instead of as an LLC, partnership, or other pass-through entity that would not suffer from these double taxation exposures. But that was not the most remarkable feature of the situation – the court noted:

That an accounting firm should so screw up its taxes is the most remarkable feature of the case.

Mulcahy, Pauritsch, Salvador & Co., Ltd. v. Comm.,  109 AFTR 2d 2012-XXXX (05/17/2012 CA7)

Saturday, May 19, 2012


Taxpayers are requiring to have a taxpayer identification number to file returns and provide to payors, so that their tax data can be adequately tracked and reported. While most U.S. individuals will use their social security number, entities (such as corporations, trusts, partnerships, and LLC’s) have to apply to the IRS for a number (an employer identification number, or EIN) using Forms SS-4.

In recent years, the IRS has helped the process by allowing for the issuance of EINs by fax, telephone, and online, in addition to the traditional mail method. This is helpful since many times a number is needed ASAP to file a return, provide to a payor, or open a bank or brokerage account.

Those businesses or persons who form multiple entities may now suffer the inconvenience of being able to obtain only one EIN per day. When a Form SS-4 is submitted, it requires information on a “responsible party” for the entity. More precisely, a “responsible party” is subject to this once-a-day limit. The responsible party generally is the principal officer, partner, or member as to a business entity or a grantor, owner, or trustee as to a trust.

The IRS notice on this is posted on the IRS website for the instructions for the Form SS-4 and reads:


Limit of one (1) Employer Identification Number (EIN)
Issuance per Business Day

Effective May 21, 2012, to ensure fair and equitable treatment for all taxpayers, the Internal Revenue Service (IRS) will limit Employer Identification Number (EIN) issuance to one per responsible party per day. This limitation is applicable to all requests for EINs whether online or by phone, fax or mail. We apologize for any inconvenience this may cause.

“Fair and equitable?” I am not sure what that means. And what do they mean as to mail? Does it mean I can’t mail them on the same day, or they can’t arrive at the IRS at the same day, or the IRS can’t process them on the same day? What will the IRS do – mail them back without issuing them so I don’t know there is a problem until weeks after I mailed them, or put them in a pile to do one a day? How is the taxpayer to know what is occurring with their mailed in applications? The whole situation is Kafkaesque – the government is requiring entities to get an EIN, but then refusing to issue them.

What happens if multiple entities are formed and a tax return deadline is looming? Or if it is necessary to open and operate bank accounts?

Now perhaps there are multiple responsible parties for the multiple entities  - that could allow for multiple applications on the same day. But if that is not the case, these taxpayers may have some problems.

Note that the “responsible party” is not the same as a Third Party Designee who can apply for a number on behalf of an entity. Those designees can still apply for up to five numbers a day – however, if the entities they are applying for have the same responsible party they presumably will have the same one-a-day limit for those entities.a

Saturday, May 12, 2012


For those of you with a great memory, you will remember that in December 2009 we wrote about the case of Morgens v. Commissioner. For those with a more typical memory, you can read the original post on the case here.

In that case, a QTIP marital trust was terminated during the lifetime of the surviving spouse’s lifetime. §2519 imposed a gift tax on the spouse, but the tax was ultimately paid by trust under §2207A apportionment of tax rules. The surviving spouse then died within three years. The issue was whether the gross estate of the surviving spouse included the amount of gift taxes that were paid under the three year rule of §2035 which draws back gift taxes paid within three years of death. The Tax Court held that the three year rule applies, even though the taxes were not paid by the spouse.

The Ninth Circuit Court of Appeals has sustained the Tax Court, thus adding further authority to this determination and firming up another negative consequences to an early termination of a QTIP trust. The Court analogized the §2519 taxation regime to a net gift scenario, which also results in the application of the three year rule even though the taxes are paid by the gift recipient.

Estate of Anne W. Morgens, 109 AFTR 2d ¶ 2012-736 (CA9 2012)

Sunday, May 06, 2012


If a last Will is lost or destroyed, it can still be offered for probate. Fla.Stats. §733.207 provides that the specific content must be proved by two disinterested witnesses, or if a “correct copy” is provided, by one disinterested witness.

In regard to what is a “correct copy,” Florida case law suggests that the copy has to be a carbon copy or photocopy. In re Estate of Parker, 382 So. 2d 652 (Fla. 1980). However, in a recent Florida case, an unsigned word processor copy taken from the office of the preparing attorney was also found to be a correct copy. The 2nd DCA determined that the term correct copy was not limited to carbon copy or photocopy. This will be good news in many situations since most wills and codicils are prepared on computers and the computer files retained indefinitely.

Even though the court found that the computer copy of a lost codicil was a correct copy, it was not admitted to probate since there was no disinterested witness that could attest to its content. The court  made some interesting pronouncements regarding who is a disinterested witness in reaching its conclusion, including:

     A. The attorney who witnessed the signing was not “disinterested” since he risked malpractice liability if the codicil was not admitted because he was the one who lost the codicil;

     B. The office assistant who prepared the codicil could testify as to the contents, but could not be a “witness” for purposes of the above statute since she did not witness the signing of the codicil (and thus could not be certain that what she prepared on her computer was the same as what was signed by the decedent);

     C. A personal representative is not prevented from serving as a disinterested witness under the above statute, even though he or she is classified as an interested person under the Probate Code. In the case, however, both witnessing personal representatives were deemed to have an interest in the outcome and thus could not be a disinterested witness under the facts; and

     D. A third party witness to the signing without an interest in the outcome will not qualify as a disinterested witness under the above statute if that witness had no knowledge of the actual contents of the will or codicil that was signed.

So who make good witnesses in a law office environment that can be used in a lost or destroyed will situation? One would be an assistant or associate who drafted the document, but only if he or she witnessed the signing. So this may be a good reason to have that person act as one of the witnesses. The attorney who prepared or reviewed the will (if different from the above assistant or associate) should also qualify as a disinterested witness since he or she will have knowledge of the contents if he or she witnesses the signing  - but only if  that attorney was not responsible for the will or codicil being lost.

LANCE SMITH and THOMAS ALLEN, as Co-Personal Representatives of the Estate of Scott P. Smith, Deceased, Appellants, v. ASTRID DePARRY, as Guardian ad Litem for Scott P. Smith, III, 2nd DCA, Case No. 2D11-1851 (May 2, 2012).

Tuesday, May 01, 2012


The Social Security wage base is projected to increase from $110,100 to $113,700 in 2013. Social security taxes are collected on wages up to this maximum - once wages go over the maximum no further taxes are imposed. Normally, those wages are subject to OASDI (social security) taxes of 6.2% imposed on the employer and the same percent imposed on the employee. However, in 2012 the rate on employees was cut to 4.2%. Self-employed persons pay 12.4% (10.4% in 2012).

Therefore, higher earned income persons can expect a double hit in 2013 - an increase in the wage base (that is, more wages subject to tax) and a return to normal OASDI rates. Of course, this is in addition to the major tax hikes set for 2013 per the expiration of the Bush tax cuts.