T.C. M em o . 2 0 2 0 -5 9

UNITED STATES TAX COURT

BRUCE W . LEM AY, Pet it i o n er v . COM M ISSIONER OF INTERNAL REVENUE, Res po n d en t

Do ck etNo . 1 9 3 56 -1 5 L. Fi l edM ay 1 4 , 2 0 2 0
.

Bru ce W . Lem ay , p ro s e. Rach ael J
. Zep ed a, DerekS. Prat t , Al i ci a E. El li o t t , an dTri s ha S. Farro w, fo r res p o n d en t .

M EM ORANDUM FINDINGS OF FACT AND OPINION NEGA, Jud g e: Th is cas e i s b efo re t h e Co u rto n a p et i ti o n fo r rev i ew o f a No t ice o f Det erm i n at i o n Co n cern i ng Co l l ect i o n Act i o n (s ) Un der Sect i o n (s ) 6 3 2 0- 2
-

[* 2 ] an d/o r 6 3 3 0 (n o t i ce o f d et erm i n at i o n ). 1 Aft er co n ces s i on s b y th e p art i es , 2 th e p ri m ary i s s u e fo r d eci s i o n i s wh et h er p et i ti o n er i s l i ab l e fo r p en al t i es t ot al i n g $ 4 6 ,9 8 4 , $ 7 4,6 9 4, an d$ 59 ,3 98 u n d er s ect i o n 6 7 0 0 fo r t ax y ears 2 00 8 , 2 0 0 9 , an d 2 0 1 0 , res p ect i v el y

(y ears ati ss u e).

FINDINGS OF FACT So m e o f t h e fact s are s t i p u l at edan dare s o fo u nd . Th e s t i p u l at io n o f fact s
an d th e at t ach edex h i b i t s are i n co rp o rat edh erei n b y th is referen ce. Pet i t i o n er, Bru ce W . Lem ay , res i d edi n Kan s as wh en th e p et it i o n was fi led . Th is cas e was
co n so l i d at edfo r t ri al al o n g wi th th e cas e o f Dav i s o n v . Co m m i s si on er, d o ck etNo
. 1 4 7 6 5 -1 5 L. Our o p i n i o n i n Dav i s on m ay b e fo un datT.C. M em o . 2 0 20 -5 8
. I. Back g ro u n d Pet i t i o ner g radu at edfro m Bo s to n Co l leg e i n 1 9 7 3 , wh ere h e earn eda b ach el o r’ s d eg ree i n En g l is h . Fro m 1 98 1 t o 1 9 9 6 p et it i on er was a co rp o rat e
ex ecu t i v e i n th e i ns u ran ce i n du s t ry , p ri m ari ly wo rk i n g i n th e fi el d s o f p ro p ert y an d

1 Un l es s o th erwi s e i nd i cat ed , al l s ect i o n referen ces are t o th e In t ern al Rev enu e Co de i n effect fo r t h e y ears ati s s u e. Al l m on et ary am o u n t s are ro u n d ed t o the n eares td ol lar.

2 Res p o n d en tan d pet i t i o ner p ro ceed edas i f t h e qu es ti o n o f p et it i o n er’ s u n d erl y i n g l iab il i ty

i s ap p ro p ri at el y b efo re th i s Co u rt , wi th th e p ri m ary i s su e fo r d eci s i o n b ei n g wh et h er p et it i o n er i s l iab l e fo r p ro m o t er p en al ti es u n d er s ec. 6 7 0 0
. Si n ce b o th p art i es p ro ceed edas th o u g h th e u n d erl y i n g l i ab i l i ty i s i n d i s p u t e, we wi l l fo l l o w th ei r l ead
.- 3
-

[* 3 ] l i ab i l i ty

i n s uran ce. Pet i t i on er fi rs t m ad e th e acq uai n t an ce o f Al l en Dav i s o n i n a p ro fes s i o n al s et t i n g . Th ey b ecam e fri en d s , an dh av e m ai n t ai nedth atfri en d s h i p
s i nce t he earl y

n in et i es . It w as wh i l e wo rk i n g i n th e i n s u ran ce i ndu s try th at p et i t io n er fi rs tcam e t o l earn o f “ t o o l p l an s ”. 3 A fo rm er co l l eag u e h adreq u es t edp et i t i o n er’ s as s is t an ce i n cal cu l at in g , o r o th erwi s e d et erm i n in g , h o w an em p l o y er’ s p art i ci p at i o n i n a t o o l p l an affect edth atem

p l o y er’ s wo rk er’ s co m

p en s at i o n i n s u ran ce p rem i u m s . Pet i t io n er res p on d ed th at h e was u n fam i l i ar wi th t o o l p l an s , b u th e res earch edth i s i s su e an dfo u n d th atan em p l o y er’ s p art i ci p at i o n i n a t o o l p l an h adn o effect o n the cal cu l at io n o f an em

p l oy er’ s wo rk er’ s co m

p en sat i o n p rem i u m s . Pet i t i o ner rep o rt edth es e fi n d in g s t o h i s fo rm er co ll eag u e. Wh i l e res earch i ng t o ol p l an s p et i t i o ner d i s co v ered a t o o l p l an co m p an y cal l edPro Ch eckan db eg an t o fo s t er a rel at i o n s h i p wi th i t s p res i d en t . Pet i t i o n er
an d Pro Ch eck ’ s p res id en td i s cu s s edt o o l p lan s g en eral l y , as wel l as th ei r t ax
as p ect s . Th e p res i d en to f Pro Ch ecko ffered p et i t i o ner t h e o p p ortu n it y t o jo i n Pro Ch eck . Pet i t i o n er s o u gh tthe ad v i ce o f M r. Dav i s o n , as p et i t io n er h el d
res erv at io n s ab o u tPro Ch eck ’ s o p erat i o n s an dth e p urp o rt edb en efi ts i t s t o ol p l an s

3 “ To o l p l an s ” g en eral l y at t em p tt o o p erat e t o rech aract eri ze a p ort i o n o f an em pl o y ee’ s wag es as rei m

b u rs em en to r ren t al ex pen s es refl ect i n g th e co s t o f t h e em pl o y ee’ s t o o l s .- 4
-

[* 4 ] o ffered . Aft er b ei n g ap p ri s edo f t he d et ai l s o f Pro Ch eck , M r. Dav i s o n
v al i d at edp et i t io n er’ s co n cern s , an dad v i sedh i m t o d ecl in e Pro Ch eck ’ s o ffer. Al th o u g h p et i t i o n er d ecl i nedth e o ffer t o jo i n Pro Ch eck , p et i t i o n er an dthe p res i den to f Pro Ch eck ag reedt o fo rm a n ew co m

pan y th atwo u l dp ro m o t e t o o l p l an s , s o l o n g as s u ch p l an s were rev i ewedan dap pro v edb y M r. Dav i s o n an dh is
em pl o y er, Gran t Th o rn t on . II. Org an i zat i o n o f CM S OnSep t em

b er 2 9 , 1 9 9 9 , p et i t io n er, al o n g wi th th e p res id en to f Pro Ch eck
an d two o ther i n d iv i du al s affi l i at edwi th Pro Ch eck , o rg an i zedCas h M an ag em en t Sy s t em s (CM S), an S co rp o rat io n , i n th e St at e o f Vi rg i n ia. Pet i t i o n er atal l rel ev an t t i m es s at o n th atco m p an y ’ s b oardo f d i rect o rs . Fro m 1 99 9 th ro u g h th e
s u m m er o f 2 0 0 2 p et i t i o n er s erv edas th e p res i d en to f CM S. Aft er 2 0 0 2 p et i t i o n er
s erv edas ex ecu t i v e v i ce p res i d en to f CM S. Sh o rt l y aft er o rg an i zat i o n , CM S fo rm al l y en g ag edM r. Dav i s o n , an d th ro u g h h i m Gran t Th orn to n , t o co n s u l twi th an d ad v i s e CM S wi th res p ectt o the t ax b en efi t s o f i t s p ro p o s edt o o l p l an s . M r. Dav i s o n m an ag edth e CM S cl i en t
acco u n t fo r Gran t Th o rn t on . M r. Dav i s o n ’ s fi rs tt as kwas t o rev i ew t h e p ro p o s ed t o o l p l an s ’ co m

p l ian ce wi th l aw.- 5
-

[* 5 ] III. Dev el o p m en to f t h e To o l Pro g ram CM S h ad th ree d i fferen tt o o l p l an s i n i t s To o l Pro g ram : (1 ) t h e ex i s t i n g t o o l p l an , (2 ) t h e n ew t o o l p l an , an d (3 ) t h e t o ol u s e p l an . CM S p l an n edt o o p erat e t h e t o o l p l an s i n s equ en ce i n o rd er t o m ax i m i ze t h e l i fet i m e t ax s av i n gs fo r b o th th e
em pl o y ees an dem

p l o y ers en ro l l edi n i t s p l an s . Inad d it i o n t o th e t o o l p l an s an d p ayro l l ad m i n i s trat io n , CM S wo u l do ffer l eg al res earch an d free au d i t rep res en t at i o n as p arto f an o v eral l em p l oy ee b en efi t s p ack ag e. Th e t o o l p l an s , ad m i n is trat i v e s up po rt , an d au d i trep res en t at i o n co l l ect i v el y co n s t i tu t edth e To o l Pro g ram . CM S d es i g n edi t s t o ol p l an s t o al l o w b o th em p l o y ers an dem

p l o y ees t o cl ai m s ub s t an t i al t ax s av i n g s b y b i fu rcat i n g an em

p l o y ee’ s b as e p ay

i n to a t ax ab l e l ab o r p o rt i o n an da n o nt ax ab le p o rt i o n fo r t o o l rei m bu rs em en t o r u s e. Th i s b i fu rcat io n was b as edup o n a p ro p ri et ary fo rm u l a. 4 Th e CM S To o l Pro gram p u rp ort edt o o ffer t ax s av i n g s b y l i m i ti n g Fed eral i n co m e t ax wi th h o l di n g,
em pl o y m en tt ax es , o r b o th, d ep en d i ng o n th e t o ol p l an . 5 Th e m ax i m um t o o l

4 Des p i t e t h e fact th at CM S m ark et edi t s p ro p ri et ary fo rm ul a as a s el l i n g p o i n to f t h e t o ol p ro g ram , p et i t i o n er was u n aware o f h o w th e fo rm ul a was d et erm i n edatal l rel ev an t t i m es .

5 W e u se t he t erm

“ em p l oym en tt ax es ” t o refer t o t ax es u n d er t he Fed eral In s u ran ce Co n tri b u t i on s Act(FICA) an d th e Fed eral Un em p l o ym en t Tax Act . See

(co n ti n u ed ...)- 6
-

[* 6 ] rei m b u rs em en to r u s e p ay

p er p ay p eri o dwas 3 5 % o f t h e p art i ci pat i ng
em pl o y ees wag es . CM S m ad e m o n ey fro m fees ch arg ed fo r ad m i n is t eri n g th e t o o l p l an s . Up o n en ro l l in g b ot h an em p l oy er an di t s em

p l o y ees , CM S ad m in i s t eredth e
en ro l l edem

p lo y er’ s p ay

ro l l an d i s s u edas s o ci at eds t at em en ts t o p art ici p at in g
em pl o y ees . Th ro ug h tho s e as s o ci at eds t at em en t s , CM S k ep tem p l oy ers an dcl i en t em pl o y ees ab reas t o f t h e cl ai m edt ax s av i ng s fro m CM S t o o l p l an s . A. Th e Ex i s t in g To o l Pl an Un d er th e ex i s t i ng t o ol p l an , an em p l o y er rech aract eri zeda p o rt i o n o f each
em pl o y ee’ s b as e p ay

as a rei m b u rs em en t t o th atem

p l o y ee fo r t h e co s to f t oo l s acq u iredb y

th atem p l o y ee b efo re en ro ll i ng i n the p l an . Th e em p l o y ees were rei m b u rs edi n am o un t s refl ect i n g th e acq u i s i t i o n co s t s o f th ei r t o o ls , rat h er t h an th e rep l acem en tco s t s o r fai r m ark etv al u e co st s , b efo re en ro l l m en ti n th e ex i s t i n g t o o l p l an . 6 CM S cal cu l at edthe ap pro p ri at e t ax wi th h o l d i n g s fo r each em p l o y er’ s l ab o r p ay , b u t n o t t o o l p ay , an d rem i t t edth i s i n fo rm at i o n t o t h e em p l o y er. Th e

5 (...co n t in u ed ) W eb er v . Co m

m i s s i o n er, 1 3 8 T.C. 3 4 8 , 3 5 7 (2 0 1 2 ); St ev en s Tech s ., In c. v . Co m m i s s i o n er, T.C. M em o . 2 0 1 4 -1 3 , at* 2 7 -* 2 9 ; Ot t o ’ s E-Z Cl ean En t ers . , In c. v . Co m m i s s i o n er, T.C. M em o . 2 0 0 8 -5 4 , s l i p o p . at2 n .2
. 6 CM S d et erm i n edth e co s to f anem p l o y ee’ s t o o l i n v en t o ry

b y referen ce t o an es t i m at e o f wh atthe em pl o y ee h ad o ri gi n al l y

p ai dfo r th o s e t oo l s rat h er t h an th e cu rren trep l acem en t co s t s .- 7
-

[* 7 ] em pl o y er wi th hel dth e n eces s ary t ax es fo r t h e l ab o r p ay

p o rt i o n, b u tn o t ax es
wo u l db e wi th h el dfo r t h e t oo l p o rt i on s d et erm i n edb y CM S. CM S cl ai m edth at th e ex i s t i n g t o o l p l an was an acco u n t ab l e p l anu n der s ect i o n 6 2 , wh ereb y rei m b u rs em en tp ai dt o em

p lo y ees fo r t h e co s to f th ei r o wn t oo l s u s edo n a jo b was
n o tco ns i d ered wag es fo r em p lo ym en t t ax p u rp o ses . B. Th e New To o l Pl an Th e n ew t o o l p l an al s o rech aract eri zed a p o rt io n o f each em p l o y ee’ s b as e p ay as a n o n t ax ab l e rei m

b u rs em en t . Th e o n ly

m ean in g fu l d i fferen ce b et ween th e
ex i s t in g t o o l p l an an d t h e n ew t o o l p l an was th at , u n der t h e n ew t o o l p l an , em pl o y ees were rei m

b u rs edo n l y

fo r t o o l s p u rch as edaft er t h ei r en ro l l m en t . Oth erwi s e, t h e b i fu rcat i o n o f an em pl o y ee’ s b as e p ay

o p erat edi n an i den t i cal
m an n er. Th e n ew t o ol p l anal so p u rp o rt edt o b e an acco u n t ab l e p l an u nd er
s ect i on 6 2
. C. Th e To o l Us e Pl an On ce an em

p l o y ee was treat edas rei m b u rs edfo r t h e co s to f h i s o r h er t o o l i n v en t o ry b y way o f t h e ex is t i ng an d/ o r n ew t o o l p l an , CM S t ran s i t i o n edth e cl i en t-em p l o y ee t o th e t o o l u s e p l an . CM S o ffered the t o o l u se p l an as a m et h o dt o al l o w an em

pl o y ee t o ch arg e h i s o r h er em pl o y er a fee fo r th e ren t al o f h i s o r h er t o o l s u s eddu ri n g t h e d ai l y co u rs e o f h i s o r h er l ab o r. Si m il arl y t o th e o ther p l an s ,- 8
-

[* 8 ] th e em

p l o y ee’ s b as e wag es were rech aract eri zedi n t o a t ax ab l e p o rt i o n fo r l ab o r an da t ax -ex em

p tp o rt i o n fo r ren tal fees
. CM S d i dn o tcl ai m th e t o ol u s e p l an was an acco u n t ab l e p l an , th u s ren t al fees p ai du nd er t h e p l an were s ub jectt o Fed eral i nco m e t ax at io n . CM S d i dcl ai m , h o wev er, t h atth e ren t al fees p ai d p u rs u an t t o th e t o ol u s e p l an fel l o u t s i d e t h e em p lo ym en tt ax d efi n i t i o n o f wag es
an d th ereb y

redu cedth e em

p lo ym en tt ax l i ab i l it y o f t h e em p l o y er an dth e
em pl o y ee. Th e t o o l u s e p l an was av ai l ab l e t o an y em p l o y ee en ro l l edi n th e CM S To o l Pro gram , i ncl u d i ng th os e t reat edas fu l l y rei m b u rs edfo r t h e s t at edv al u e o f th ei r t o o l s u n d er t h e ex i s t i n g o r n ew t o o l p l an , o r an y em p l o y ee wh o was treat edas h av in g fu l l y d ep reci at edth e co s to f h i s o r h er t o ol s b efo re en ro l l m en ti n the p l an . CM S cal cu l at ed th e t o o l u s ag e am ou n t fo r each p art i ci pat i n g em p lo y ee an d rep o rt edth e am o u n tt o h i s o r h er em p lo y er s o thatth e em

p l o y ee co u l db e p ai d
acco rd i n g l y . CM S i s s u eda Fo rm 1 0 9 9 -M ISC, M i s cel lan eo u s In co m e, t o each cl i en t-em p l o y ee fo r t o o l p ay

recei v edu n der t he u s e p l an . Al l p aym en t s t o th o s e
em pl o y ees cam e fro m

thei r em p l o y er d irect l y , an dth ey

wo u ldal s o recei v e a Fo rm W -2 , W ag e an dTax St at em en t , fro m th ei r em pl o y er refl ect i ng th ei r l ab o r p ay . IV. In i t i al Rev i ew o f t h e To ol Pl an s M r. Dav i s o n ag reedt o rev i ew th e t o o l p l an s an dth ei r p ro p o s ed ad m i n is trat i o n . M r. Dav i s o n ad v i s edth ats ecu ri n g a p ri v at e l et t er ru li n g fro m th e- 9
-

[* 9 ] In t ern al Rev enu e Serv i ce (IRS) was cri t i cal t o en s u re t h e v i ab i l i ty o f t h e t o o l p l an s . Ino rd er t o b et t er u n ders t an dth e p ro s p ect s o f s ecu ri n g a fav o rab l e p ri v at e l et t er ru l i n g , p et i t io n er an d M r. Dav i s o n s o u g h t th e ad v i ce an dco u n s el o f To m Och sen s ch lag er, a p art n er atGran tTh o rn to n ’ s n at i o n al t ax o ffi ce i n W as h i n g t o n , D.C. Pet i t i o n er an dM r. Dav i s o n p ro v id edM r. Och sen s ch l ag er wi th rel ev an t i n fo rm at i o n o n CM S an dth e t o o l p l an s i ti n t en d edt o o ffer. Th ro u g h a s eri es o f co m

m u n i cat io n s o ccu rri n g i n No v em b er 1 9 9 9 , M r. Och sen s ch lag er i n fo rm edp et i t i o n er an dM r. Dav i s o n thatth ere was l i t t l e ch an ce
o f s ecu ri n g a fav o rab l e p ri vat e l et t er ru l in g fro m th e IRS wi th res p ectt o th e CM S t o o l p l an s . M r. Och s en sch lag er s p o k e wi th at t o rn ey s fro m th e IRS an dad v i s ed p et i t i o n er an dM r. Dav i so n th atth e IRS b el i ev edth atth e t o ol p l an s fai l edt o
co m p l y wi th th e l aw ap p l i cab l e t o acco u n t ab l e p l an s . M r. Och s en s ch l ag er s t at ed th atth e t o o l p l an s al l o wedfo r rei m b u rs em en ts t o em

p l o y ees i n am o u n t s ex ceed i n g th ei r o ut -o f-p o ck etex p en ses , co n trav en i n g th e s t atu t o ry req ui rem en t s fo r
acco u n t ab l e p l an s . Fu rth er, M r. Och s en s ch lag er i n d i cat edth atthe IRS b el i ev ed th e t o o l u s e p l anl ack edeco n o m i c s ub s t an ce, t h at th ere was l i m i t edl eg al au th o ri t y
s up p ort i n g t o o l rei m

b u rs em en tp l an s g en eral l y , an dthatth e IRS h adan i n t eres ti n l i ti g at i n g ag ai ns t tax p ay ers p ro m ot i n g t o o l rei m b u rs em en t p l an s s u ch as th o s e p ro p os edb y CM S.- 1 0 -

[* 1 0 ] Pet i t i o ner an d M r. Dav i s o n s ub s equ en t l y m ett o d et erm i n e h o w b es t t o b ri n g th e CM S To o l Pro g ram t o m ark eti n th e l i g h t o f M r. Och sen s ch l ag er’ s co n cern s . To th aten d , o n Decem

b er 2 , 1 9 9 9 , p et i t i o n er an dM r. Dav i s on m etan dd ev el o p ed th e fo l lo wi n g p l an o f act i on : (1 ) CM S wo u l dag g res s i v el y p ro ceed i n m ark et i n g i t s t h ree s ep arat e t o o l p l an s ; (2 ) M r. Dav is o n wo u l ddraw up a d o cu m en to n b eh al f
o f Gran tTh o rn t o n en d o rs i n g th e To o l Pro g ram (Gran tTh o rn t o n ’ s ju s t i fi cat i o n p ap er); (3 ) M r. Dav i so n , al on g wi th p et i t io n er, wo u l d b e i n cl u dedi n m ark et i n g th e t o o l p l an s t o t arg et edcl i en t s ; (4 ) M r. Dav is on wo u l dtrai n M i k e Eas t , an em p l o y ee
o f p et i ti o n er’ s wh o ll y

o wn edS co rp o rat i o n, Xel l En t erp ri s es , In c. (Xel l ), o n th e t ax as p ect s o f th e To o l Pro g ram , an dM r. Eas two ul dth en trai n CM S’ s al es ag en t s
o n th e t ax as p ect s o f t h e To o l Pro g ram ; an d(5 ) t rai n i ng d at es fo r s al es ag en t s , d at es fo r co m

m en ci n g s al es cal l s , an dth e es t ab l i s hm en to f s al es t arg et s wo u l db e
s et . Du ri n g th atm eet i n g p et i t i o n er an dM r. Dav i s on ag reed th atth e n ew t o o l p l an an dth e ex is t i n g t o o l p l an wo u l db e p ro m o t ed as acco u n t ab l e p l an s b u tth at th e t o o l u s e p l anwas n o t an acco u n t ab l e p l an an dp aym en t s m ad e t h ereu n d er
wo u l di n s t ead b e p ro perl y ch aract eri zedas i n ci d en t al ren tal p aym en ts . Pet i t i o n er
an d M r. Dav i s o n al s o ag reed th atGran tTh o rn t on ’ s ju s t i fi cat i on p ap er s ho u l d
s erv e t o cl earl y

es t ab l i sh th atthe o n l y

ri s k o f en ro l li n g i n th e n ew t oo l p lan an dth e- 1 1 -

[* 1 1 ] t o o l u s e p l an was p aym en to f ad d it i on al t ax an dthatn ei th er p l an carri edth e ri sko f p en al t i es o r p ro secu t i o n . M r. Dav i s o n was aware t h atth e ex i s ti n g t o o l p l an
was ag g res s i v e an db o re t h e ri sko f p en al t i es , an d th i s awaren es s l edh i m t o o m i t th e ex i s t i n g t o o l p l an fro m Gran t Th o rn t o n ’ s ju st ifi cat i o n p ap er. Nev ert h el es s , p et i t i o n er an dM r. Dav i so n res o l v edt o ag g res s iv el y m ark et th e ex is t i n g t o o l p l an . In a l et t er d at ed Decem

b er 6 , 1 9 99 , p et i t i o n er wro t e t o an as so ci at e atGran t Th o rn t on wh o as s i s t ed M r. Dav i s o n wi th CM S m at t ers g en eral l y . Inth atl et t er, fo r p u rp os es o f m em o ri al i zi n g h i s m eet in g wi th M r. Dav i s o n, p et i t i o n er o ffered
s p eci fi c i n s tru ct i o n s ab o u twh ati n fo rm at i o n h e wan t edi n cl ud edi n Gran t Th o rn t on ’ s ju s t i fi cat i o n p ap er. Pet i t i o n er req u es t ed thatGran t Th o rn t o n’ s ju s t ifi cat i o n p ap er ad dres s t h e t ax reg u l at i o n s an dcas es th atd em o ns trat edth e
v al i d i ty an dco m p l i an ce o f th e n ew t o o l p lan wi th acco u n t ab l e p l an ru l es . Ad d i t i o n al l y , p et i t i o n er req ues tedth atGran tTh o rn to n ’ s ju s t i fi cat i o n p ap er d o cu m en tth e t ax cas es an dreg u l at i o n s s up po rt i n g th e p o s i t i o n thatp aym en t s
u n d er t h e t oo l u s e p l an were n o ts ub jectt o em

p l o ym en tt ax es . Fu rt her, p et i t i o n er req u es t edth at Gran tTh o rn to n refrai n fro m d is cu s si n g th e ex i s ti n g t o o l p l an i n i t s ju s t ifi cat i o n p ap er b u ts u g g es t edth ati t s ri s k s b e d is cu s s edwi th p ro s pect i v e cl i en t s i n p ers o n .- 1 2 -

[* 1 2 ] M r. Dav i s o n wro t e an dfi n al i zed Gran t Th o rn t o n ’ s ju s ti fi cat i o n p ap er d at ed Feb ru ary 1 2 , 2 0 0 0 , an d d el iv eredi tt o CM S. Gran tTh o rn t on ’ s ju s t i fi cat i o n p ap er d i dn o t ad dres s th e ex i s t i n g t oo l p l an b u t d i s cu s sedo n ly th e n ew t oo l p lan an dth e t o o l u s e p l an . Gran tTh o rn t o n ’ s ju s t i fi cat i o n p ap er co n cl u d edthatth e n ew t o o l p l an qual i fi edas an acco u n t ab l e p l an an d was th erefo re ex em p tfro m em p l o ym en t t ax es an dthatth e p ot en t i al fo r a p en al ty i m p o s edu n d er s ect io n 6 6 7 2 was l i m i t ed
. Th e p ap er al s o co n cl u dedth atp aym en t s t o em pl o y ees u n d er t h e t oo l u se p l an
wo u l db e u n l i k el y

t o wi th s t an dIRS s cru t i n y fo r an acco u n t ab l e p l an b u tth atth ere
was a “ l o n g l i n e o f au tho ri ty ” t h ats u ch p aym en ts s ho u l db e t reat edas ex em p t fro m s el f-em p lo ym en t t ax . Th e p ap er fu rth er co n cl u d edthati f t h e IRS au d i t ed retu rn s o f an em

p l o y er en ro l ledi n th e t o o l u s e p l an an dp aym en t s m ad e t h ereu n d er were rech aract eri zedas wag es , th e co n s equen ce wo u l d b e p os s i b l e ex am in at i o n , co l l ect i o n , an ds ub m i s s i on o f em p l o ym en t t ax es an di n teres t . M r. Dav i s o n al s o d raft edan ex ecu t i v e s u m m ary o f Gran tTh o rn t o n ’ s ju s t ifi cat i o n p ap er fo r d is tri b u ti o n t o cl i en t s an d p o t en t i al cl i en t s o f CM S. He draft edthe ex ecu ti v e s u m m ary b ecau s e CM S ad v i sedh i m th ati t s cl i en t s l i k el y

d i d
n o twan tt o readth e fu l l o p i n io n b utwo u l dp refer an ab ri d gedv ers i o n . Th e
ex ecu t i v e s u m

m ary co ncl u d edth atth e “ rei m b u rs em en tp l an fo r t he co s to f t h e
em pl o y ee’ s t o o l s qual i fi es as an acco un t ab l e p lan u n d er [s ect i o n ] 6 2 (a)(2 )(A).”- 1 3 -

[* 1 3 ] Th ats u m

m ary al s o co n cl u d edth at“ th ere i s a l o n g l i n e o f au th o ri ty l ead i n g t o the co n cl u si o n t h atth e u s ag e p aym en t s u n d er CM S’ p l an s h o u l db e t reat edas
o th er i nco m e n o ts ub

jectt o th e s el f-em

pl o ym en t t ax .” In b o th Gran tTh o rn t o n ’ s ju st i fi cat i o n p ap er an dM r. Dav i s o n’ s ex ecu t i v e
s u m m ary , M r. Dav i s on em

ph as i zedth atth e l eg al p o s i t i on s t ak eno n th e To o l Pro g ram were s up p o rt edb y

“ s ub s t an ti al au tho ri ty ”. M r. Dav i s o n ’ s ex ecu t i v e
s u m m ary d i dn o t i n cl u d e a d efi n i t i on o f “ sub st an t i al au th o ri ty ” o r d i s cu s s th e l i kel i h o o d t h atth e p l an s wo u l dfai l u n d er IRS s cru ti n y . Nei th er Gran tTh o rn t o n ’ s ju s t ifi cat i o n p ap er n o r t h e ex ecu t i v e s u m m ary em p h as izedth atthe l eg al p o s i t i o n s t ak en i n co n n ect i o n wi th th e p urp o rt edt ax b en efi t s av ai l ab l e u n d er t h e To o l Pro g ram were s up p o rt edb y

“ s ub s t an ti al au tho ri ty ” as th e t erm was u nd ers t o o db y p et i t i o n er an dM r. Dav i so n --t h atth e t o o l p l an s h ada 3 3 .5 % ch an ce o f wi th s t an d i n g an IRS at t ack . Fu rt h er, M r. Dav i s o n ’ s ex ecu t i v e s u m m ary d idn o t ad dres s o r ex p res s co n fi den ce i n th e l awfu l nes s o f t h e ex i st i ng t o o l p l an , d es p i t e th e fact th atCM S m ark et edi t s t h ree t o o l p l an s s im ul tan eo u s l y . Gran tTh o rn t o n ’ s ju s t ifi cat i o n p ap er an dM r. Dav i s o n ’ s ex ecu t i v e s umm ary were d i s tri b u t edt o cl i en ts an dp o t en t i al cl i en t s o f CM S. Fo l l owi n g CM S’ recei p t o f Gran tTh o rn t o n ’ s ju s t i fi cat i o n p ap er, p et i t i o n er d et erm i n edth atth e t o ol p l an s were read y t o m ark etan d d el i v ered a p res en t at i o n t o- 1 4 -

[* 1 4 ] th e CM S b o ardo f d i rect o rs i n d i cat i ng as m u ch . Th e CM S b oardo f d i rect o rs , o n wh i ch p et i t i o n er s at , ap p ro v ed th e t o o l p l an s , s al es s trat eg y , an d
m ark et i n g m at eri al s d ev el o pedb y p et i t io n er an dM r. Dav i so n . CM S b eg an
m ark et i n g an d ad m in i s t eri n g t h e t o ol p l an s i m m ed iat el y th ereaft er. V. M ark et i n g th e To o l Pl an s A. Xel l En t erp ri s es , In c., an dIt s Rel at i o ns h ip W i th CM S CM S u s edth i rd -p art y

ag en t s t o m ark etan ds el l i t s t o ol p l an s, rat h er t h an d i rect l y ex ecu t i ng s al es i ts el f. Pet i t i o n er o rg an i zed Xel l i n th e St at e o f Kan s as o n Ap ri l 2 6 , 1 9 99 . Atal l rel ev an tt i m es , p et i t i on er was th e s o l e s h areh ol d er an d p res i den to f Xel l
. Pet it i on er o ri g i n al l y fo rm edXel l fo r t h e p u rp os e o f o p erat i n g h i s o wns al es -co n s ul t i n g b u s in es s . Aft er CM S was o rg an ized , h o w ev er, Xel l ’ s p ri m ary p u rp o s e b ecam e m ark et i n g an ds el l i n g CM S’ t o o l p l an s . Fro m 1 99 9 t h ro u g h 2 0 1 0 p et i t i o n er o v ers aw t h e m ark et i n g an d s al es o f CM S’ t o o l p l an s i n h i s cap aci ty as p res i d en tan do wn er o f Xel l. Pet i t i o n er’ s du t i es fo r Xel l co n s i s t edo f m an ag i n g an dtrai ni n g s al es ag en t s , 7 co o rd i n at i n g an d

7 Fro m 1 9 99 t o 2 0 0 9 , Xel l al s o h iredi n d ep en d en t co n tract o rs t o s erv e as s al es ag en t s t o i d en t i fy

p o t en ti al cl i en t s an d p i t ch CM S’ t o o l p l an s . CM S wo u l d p ay Xel l s al es co m

m i s s i on s fo r en ro l l i n g cl i en t s , an dXel l wo u l d rem i ta p ercen t ag e o f t h o s e co m

m i s s i on s t o th e i n d ep en d en t co nt ract o rs res p on s i b l e fo r p ro cu ri n g th e en ro l l m en t s . Fu rt h er, i n d ep en den tco n tract o rs wo ul d co n t i n ue t o earn a p o rt io n o f t h e co m m is s i o n s CM S p ai dt o Xel l s o l o n g as cl ien t s th ey (co n ti n u ed ...)- 1 5 -

[* 1 5 ] p art i ci p at i n g i n Xel l ’ s s al es p i t ch es , an d cl os i n g d eal s wi th p ro sp ect i v e cl i en ts . Inh i s cap aci ty

as p res i d en t o f CM S, p et i t i o ner’ s du t i es b len d ed wi th th os e p erfo rm edi n h i s cap aci ty as Xel l ’ s s o l e s h areh ol d er an dp res i d en ti n t h ath e d i rect ed an d p art ici pat edi n the m ark et i ng an ds al es o f t h e To o l Pro g ram . M o re
s p eci fi cal l y , wi th CM S, p et i t i o n er co o rd in at ed , d ev el o p ed , an dm an ag edth e
m ark et i n g as p ect s o f CM S’ t o o l p ro g ram . Pet i t i o n er co n t i n u edt o d i rect the
m ark et i n g as p ect s o f t h e t o o l p ro gram i n h i s cap aci ty

as the o wn er an dp res i d en to f Xel l wh i le al s o s erv i ng as ex ecu t i v e v i ce p res i den to f CM S. Th ro u g h o u tCM S’
ex i s t en ce, Xel l an dp et i t i o n er were res p o ns i b l e fo r p ro cu ri n g al l b u t a few o f CM S’ cl i en t s . CM S d es cri b ed Xel l as i t s “Nat i o n al Di s tri b u t i on Org an izat i o n” i n i t s
m ark et i n g m at eri al s . CM S’ m ark et i n g m at eri al s al s o i n d i cat edth atXel l ’ s o ffi cers were rep res en t at i v e o f CM S’ l ead ers h i p an di n t eg ral t o the s tren g th o f i t s
o p erat i o n s . Xel l an dCM S s h areda web -d o m ai n fro m 2 0 03 t o 2 0 1 1 , an d p et i t i o n er was d irect l y

i n v o l v edi n th e d eci s i o n t o co m b in e t h e web -d o m ai ns . CM S h adkn o w l ed g e o f al l m eet i n g s Xel l ’ s s al es ag en t s an dp et it i on er h adwi t h p ro s p ect i v e cl ien t s . W i th Xel l , p et i ti o n er i n cu rreds ub st an t i al ex p en s es m ark et i ng

7 (...co n t in u ed ) en ro l l edco n t i n u edt o g en erat e rev en ue fo r CM S b y rem ai n i n g i n th e To o l Pro g ram .- 1 6 -

[* 1 6 ] CM S’ To o l Pro g ram an dCM S o ft en rei m

b u rs edp et i t i o n er fo r s u ch
ex p en s es . Wh en p et it i o n er’ s ro l e atCM S ch an g edfro m p res i d en tt o ex ecu t i v e
v i ce p res i d en t , CM S’ b o ardo f d i rect o rs p as s eda res o lu t i o n d ecl ari n g th atCM S
wo u l dg ran t p et i t i o ner ad d i ti on al CM S s t o cki f Xel l ach i ev ed cert ai n s al es
m i l es t o nes , th ereb y

ty i n g h is i n cen t i v e co m

p en s at i o n atCM S t o h i s p erfo rm an ce wi th Xel l. Xel l ’ s p ri m ary s ou rce o f i n co m e was s al es co m m i s s i o n s p ai db y CM S. In 2 0 0 9 , 9 9 % o f Xel l ’ s i n co m e cam e fro m CM S co m m i ss i o ns an d 9 7 % o f t h e
co m m i s s io n s p ai db y

CM S du ri n g th aty ear were p ai dt o Xel l . Fo r 2 0 1 0 , 9 6 % o f al l co m m i s s i o n s p ai d b y

CM S were p ai dt o Xel l, an d9 6 % o f Xel l ’ s i nco m e was fro m CM S co m

m i s s i on s . B. Th e Sal es Pi t ch Becau s e t he t o o l p lan s ai m edt o p ro v i de t ax s av in gs t o em p l oy ers an d
em pl o y ees , CM S n eed edb o th p art i es t o en ro l l i n th e To o l Pro g ram . Th e fi rs ts t ep i n the CM S s trat eg y

was t o en ro l l em

p lo y ers wh o s e em

p l o y ees were req u i redt o fu rn i sh th ei r o wnt o o ls . Ing en eral th i s m ean t m ark et i n g t o em p l oy ers i n the h eat i ng , v en t il at i o n , an dai r co n d i t i o n i n g i ndu s try , as wel l as th e au t o m ot i v e an d tru ck i n g i n du s tri es . On ce CM S s u cces s fu l l y en ro l l edan em

p l o y er (cl i en t -- 1 7 -

[* 1 7 ] em p lo y er), t h e n ex ts t ep was t o en ro l l th atem p l o y er’ s em

p l o y ees (cl i en t em pl o y ees ). 1
. Em

p lo y ers Th e s al es p ro ces s wo u ldty p i cal ly b eg i n wh en s al es ag en t s , wh o were trai n edan dm an ag edb y

p et i t i o n er, i d en t i fi eda p o ten t ial cl i en t -em p lo y er. On ce a p o t en t i al cl i en t-em

pl oy er was i d en t i fi ed , p et i t io n er o r a s al es ag en two u l dm eet wi th th e cl ien t-em

p l o y er an d d el i v er a p res en t at io n o n t h e To o l Pro gram . Duri n g th e p res en t at i o n, p et i t i o ner an dth e s al es ag en t s rel i edo n th e m ark et in g s trat eg y
an d m at eri al s thatp et i t i o ner d ev el o p edal on g s i d e M r. Dav i so n . CM S rel iedo n t h e l eg al p o s i t i o n s M r. Dav i s on ex p res sedi n Gran tTh o rn t on ’ s ju s t i fi cat i o n p ap er t o d ev el o p i t s m ark et i n g m at eri al s . CM S’ m ark et i ng m at eri al s i n cl u d eda s l i de s h o w an d i n fo rm at i o n al fl y ers th atp ro v i d edan o v erv i ew o f t h e p u rp o rt edt ax s av i n g s o f CM S’ three p lan s . As a g en eral m at t er, t h es e m at eri al s em p h as i zed th e To o l Pro g ram ’ s co m p l i an ce wi th rel ev an t l aws . 8 Th e m at eri al s s p eci fi cal l y cl ai m ed thatGran t Th o rn t o n’ s s up p o rt
o f t h e p ro g ram

v i rtual l y el i m i n at edan y

t ax l i ab i li ty

o r ri s ko f p en al ti es , th atCM S

8 Ata p res en t at i o n t o a p ot en t i al cl i en ti n 2 0 08 , p et i t i o n er ad v ert is edth at CM S’ “ u n equ al edex p eri en ce h as res u l tedi n th e s u cces s fu l ex am i n at i o n o f o u r p ro g ram .” At th e t i m e t h is s t at em en twas m ad e, t h e IRS h adn otco m p l et edan au d ito f an y

o f CM S’ cl i en ts ’ retu rn s .- 1 8 -

[* 1 8 ] m ai n t ai n edfu l l co m p l i an ce wi th IRS g u id el i n es , an dth at CM S rei m b u rs em en tp l an s m et th e acco u n t ab l e p l an req u irem en t s u n d er s ect i o n 6 2
. Th es e m at eri al s b ro ad l y

d es cri b edthe t o o l p l an s as a “ no n etco s t ” em pl oy ee b en efi tth atfu n d ed an i n creas e i n em p lo y ee t ak e-h o m e p ay , wh i l e al s o b o o s t i n g an
em pl o y er’ s b o tt o m

l i n e. Th e m ark et i n g m at eri al s fai l edt o cl ari fy t o p o t en t i al cl i en ts h o w p et i t i o n er’ s p o s i t i o n s o n th e p u rp o rt edt ax b en efi t s av ai l ab l e u n d er t h e To o l Pro gram

were s up po rt edb y

“ s ub s t an t i al au th ori ty ” an d wh atex act l y th at t erm m ean t . Pet i t i o ner ro u t i n el y

p ro v i d edp o ten t i al cl i en t s wi th ad d i t io n al m ark et i n g
m at eri al s t o as s u ag e co n cern s reg ard i ng th e l eg al it y o f th e p urp o rt ed t ax b en efi ts
av ai l ab l e u n d er t h e To o l Pro g ram . Su ch m at eri al s i n cl u d edGran tTh o rn to n ’ s ju s t ifi cat i o n p ap er. Oth er m at eri al s i n cl u d ed , s uch as th e ex ecu t i ve s u m m ari es an d

“ co m p ari s o n s ” d raft edb y

M r. Dav i s o n , fu rth er rep res en t edth atGran tTh o rn t o n h ad d et erm i n edth atth e n ew t o o l p l an an d t h e t o o l u s e p l an co m pl i edwi th ap p li cab l e l aw, an dth atth e t ax b en efi t s p urp o rt edt o fl o w th erefro m were
s up p ort edb y

s ubs t an t i al au th o ri t y . Th e m at eri al s p et i t i o ner p ro v i d edt o p ot en t i al cl i en t s rep res en t edth atth e CM S t o o l p l an s an dp ro p ri et ary fo rm ul as h adb een “ t es t edan d accep t ed ”,
u n d erg o n e “ s u cces s fu l ex am i n at i o n ”, an dfo u n dt o co m pl y wi th al l “ t ax- 1 9 -

[* 1 9 ] req u i rem en t s ”. Furt h er, th es e m at eri al s em p has i zedth at Gran tTh o rn t o n
wo u l drep res en tCM S’ cl ien t s du ri n g au d i tatn o co s t . If p ro sp ect iv e o r cu rren t cl i en ts h adqu es t i o ns , M r. Dav i s o n was av ai l ab l e t o s p eak wi th them . M r. Dav i s o n d i di n facts p eakwi th p ro s p ect iv e cl i en t s o n the t ax as p ect s o f t h e To o l Pro g ram , an d th es e co n vers at i o n s o ft enres u l t edi n cl i en ten ro l l m en t .

2
. Em p lo y ees Al th ou g h an em

p lo y ee’ s p art i ci p at i o n i n th e t o ol p l an was v ol u n t ary , th e
em pl o y ee’ s at t en d an ce ata CM S o r Xel l s al es p res en t at i o n was m an d at o ry . Pet i t io n er p res su redcl i en t-em pl o y ers t o m ax i m i ze em

p l o y ee p art i ci p at i o n i n
en ro l l m en to n th e g ro u n d s th ati two u l d fo s t er a b et t er em pl o y ee an d em

p l oy er rel at i o n s h i p an dp ro m o te g reat er s av i n g s fo r t h e em p lo y er. When th e To o l Pro g ram was m etwi th co ncern o r s k ep t i ci s m b y em p l o y ees , p et it i o n er o ft en
reco m m en d eda o n e-o n-o ne m eet i n g wi th them t o ex p l ai n “ wh y

th ei r fear i s n o t
accu rat e.” Duri n g s u ch m eet i n g s , p et i t i o n er o r a s al es ag en tai m edt o p ro v i d e t h e
co n cern edem

p l o y ee wi th a “ m o re accu rat e i n si g h t ” i n t o t h e p ro g ram an di t s b en efi t s . Th e m ark et i n g m at eri al s d i rect edt owardth e p ro sp ect i v e cl i en t -em p l o y ees al s o em p h as i zedth at th e t o o l p l an s o fferedan i n creas e i n an em p l o y ee’ s t ak eh o m e p ay . Th e d eci s i o n t o en ro l l i n th e fu ll s u i t e o f t o o l p lan s was p res en t edas- 2 0 -

[* 2 0 ] s i m p l e as th e d eci si o n t o p i ckup a $ 2 0 b i l l o n th e g ro u n d . Th es e m ark et i n g
m at eri al s , h o wev er, d i dn o td i s cl o s e t h e l ev el o f ri s k i n v o lv edwi th p art i ci p at i n g i n a CM S p l an . Pet i t i on er i n s tru ct edcl i en t -em p lo y ees wh o recei v edco n fl i ct i n g ad v ice fro m

an i n d ep en d en tt ax ad v is er reg ard i n g th e To o l Pro g ram ’ s l eg al
co m p l ian ce t o co n t actCM S i n o rd er t o res o l v e an y d i s crep an ci es . C. Po s t en ro l l m en t Pro cedu re Aft er en ro l l i ng , a cl i en t -em p l o y er ex ecu t edan acco u n tag reem en t an d
au th o ri zat i o n t o d eb i twi th CM S t o p ay CM S fees fo r i t s ad m i ni s trat i on o f t h e To ol Pro g ram . CM S wo ul dthen co o rd i n at e wi th th e cl i en t -em p l oy er t o es t ab l i sh a t i m el i n e fo r en ro l li n g em p l o y ees an di m

p lem en t i ng th e t o ol p ro g ram th ereaft er. On ce a t i m el i n e was s et , CM S wo u l d turn i t s at ten t i o n t o m ark et in g th e To o l Pro g ram t o th e em p l o y ees . Al th ou g h em

pl o y ees co u l den ro ll i n o n e o r m o re o f t h e t h ree t o ol p l an s , ap p ro x i m at el y 9 0 % o f al l cl i en t -em p l o y ees en ro l l edi n al l th ree. If a cl ien t em pl o y ee en ro l l edi n al l th ree t o o l p l an s , th e fi rs t s t ep was the co m p let i o n o f an
en ro l l m en tfo rm

fo r s ub m i s si o n t o CM S. Th e en ro l l m en tfo rm i n cl u d ed a ch art
o rg an i zedb y

d i fferen tcat eg o ri es o f t o o l s wi th co rres p o n d i n g s p aces fo r th e cl i en t em pl o y ee t o fi l l i n th e acqu i s it i o n co s ts o f al l th e t o o l s h e o r s h e o wn edatth e t i m e
o f en ro l l m en t . Cl ien t -em p l o y ees were en co urag edt o i n cl ud e as m an y t o o l s as- 2 1 -

[* 2 1 ] p o s s i b l e i n d et erm i n i n g th e t o t al acq u i s it i o n co s t s o f t h ei r t o ol s , ev en i f s o m e
o f t h o s e t o o l s were n o treq u i redfo r t h ei r em p l o ym en t wi th the cl ien t -em p lo y er. CM S ex p li ci t l y

i n s tru ct edcl i en t -em

p l o y ees n o tt o s t at e t h e rep lacem en t
co s t s o r t h e fai r m ark etv al u es o f t h ei r t o ol s o n t h e en ro l l m en t fo rm . If em pl o y ees d i dn o t h av e reco rd s o f t h e acq u i s i t i o n co s t s o f t h ei r t o o l s, they were i n s tru ct ed t o
es t i m at e th e o ri g i n al co s t s an dwri t e t h o s e am o u n t s o n th e en ro ll m en t fo rm . Th e
en ro l l m en tfo rm s i n s tru ct edcl i en t -em p l o y ees t o en t er t hes e es t i m at edco s ts u n d er
a s p ace fo r “ m is cel l an eo u s ” t o o l s , wi th ou tl i s t i n g each s ep arat e t o o l o r i t s co s t . Th e en ro ll m en tfo rm s al s o i n s tru ct edcl i en t -em pl o y ees t o an s wer a y es o r n o qu es ti o n as t o wh et h er th ey h add ep reci at ed o r ex p en s edan y o f t h ei r t o ol s , an d , i f
s o , h ow m

u ch i n t o t al . Un t il 2 0 0 7 cl i en t -em pl o y ees were n otfo rm al l y req u i redt o p ro v id e recei p ts s upp o rt i n g the acq u i s i t i on co s t s s t at edo n th e en ro l l m en tfo rm s o r t o l is tth e d at es th ey pu rch as edth ei r t o o l s. In 2 0 0 7 CM S as k edp ro s p ect i v e cl i en t s
an d cu rren tcl i en ts t o p ro v i d e recei p t s al o n g wi th th ei r t o o l i n v en t o ri es ; h o wev er, CM S d i dn o ten fo rce t h is req u irem en t . Th e m ark et in g m at eri al s em p h as i zedth e i m p o rt an ce o f accu rat e reco rds ub s t an t i at i o n i n acco rd an ce wi th th e acco u nt ab l e p l an ru l es . Ho wev er, n o o n e fro m CM S o r Xel l was res p o n s i b l e fo r v eri fy i n g th at th e s t at edacq ui si t i on co s t s fo r an em p l o y ee’ s t o o l s were, i n fact , accu rat e.- 2 2 -

[* 2 2 ] Th e s u m

t o tal o f the cl ien t -em

p l o y ee’ s acq ui s i t i o n co s t s fo r t h e t o o l i n v en t o ry was track edas th e em

p l o y ee’ s b as e fo r rei m

b u rs em en tfo r t he du rat i o n
o f h i s o r h er en ro ll m en ti n th e ex i s t i n g t oo l p lan . Un der t he ex i s t i n g t oo l p l an CM S ch aract eri zeda fi x edp ercen t ag e o f each cl i en t -em p l o y ee’ s g ro s s wag es i n each p ay p eri o d as a p art i al rei m

b u rs em en tfo r t he v al u e o f h i s o r h er t o o l i n v en t o ry an dp ai dth atam ou n teach p ay p eri o d u n t i l th e cl i en t -em pl o y ee was fu l l y rei m b u rs edfo r t h e t o o l i n v en t o ry . CM S’ p ract i ce o f en co u rag i n g cl i en t em pl o y ees t o l i stas m an y

t oo l s as p os s i b l e h adth e effect o f g reat l y i n fl at i n g th e
em pl o y ees ’ b as es fo r rei m

b u rs em en tan dth erefo re i n creas ed b ot h th e p u rp o rt ed t ax s av i n g s an dth e fees recei v edb y CM S. CM S o p erat edth e n ew t oo l p lan i n a m an n er s i m i l ar t o the ex i s t i n g t o o l p l an . Un d er t h e n ew t o o l p l an , wh en a cl i en t -em pl o y ee p u rch as eda n ew t o o l , h e
o r s h e wo u l drep o rtth e p u rch as e an dco s t t o CM S, an d th att o o l an di t s v al u e
wo u l db e ad d ed t o th e cl i en t -em p lo y ee’ s t o o l i nv en t o ry

an dtreat edas rei m

b u rs ed i n the s am e m an n er as th e p reex i s t i n g t o o l i n v en t o ry . On ce a cl i en t -em

p l o y ee was rei m

b u rs edfo r t he co s to f h i s o r h er t o o l i n v en t o ry , CM S wo u l dtran si t io n th e cl i en t -em p lo y ee t o the t o o l u se p l an . Un d er th atp l anCM S cat eg o ri zeda p o rt i o n o f t h e cl i en t -em p l o y ee’ s b as e p ay

as t o o l- 2 3 -

[* 2 3 ] ren t al fees , i n a p ro p o rt i o n d et erm in edb y ap p l y in g a CM S-d ev el o p ed fo rm u l a ag ai n s tth e t o tal v al u e o f t he cl ien t -em p l o y ee’ s t o o l i n ven t o ry . VI. Pro fes s i o n al Ad v i ce Reg ard in g th e To o l Pro g ram an dM ark et i n g M at eri al s A. Cro we Ch i zek Aft er M r. Och s en s ch l ag er o f Gran tTh o rn t on ’ s n at io n al o ffi ce co n cl u d ed th atth ere was l i t t l e t o n o ch an ce o f s ecu ri n g a fav o rab l e IRS p ri v at e l et t er ru l i n g wi th res p ect t o th e To o l Pro g ram , p et i t i o n er an d M r. Dav i s o n act i vel y s ou g h ta
s eco n do p i n i o n . Pet i t i on er co nt act ed t o th e acco un t i n g fi rm Cro w e Ch i zek (Cro we) t o i n qu i re ab o u t CM S’ p ro s p ect s o f s ecu ri n g a fav o rab l e p ri v at e l et t er
ru l i n g. Pet i t i o n er p ro v i d edCro we wi th a co p y o f Gran tTh o rn to n ’ s ju s t i fi cat i o n p ap er fo r Cro we’ s ev al u at i o n . OnOct o b er 9 , 2 0 00 , Ro b ertZwi ers o f Cro we wro t e a l et t er (Cro we o p i n i o n ) t o p et i ti o n er wi th Cro we’ s an al y s i s o f Gran tTh o rn t o n ’ s ju s t i fi cat i on p ap er. Gran t Th o rn t on ’ s ju s t i fi cat i o n p ap er d i dn o ti n cl u d e an an al y s i s o f t h e ex i s t i n g t oo l p l an . Acco rd in g ly , th e Cro we o p in i o n d i dn o td i s cu s s th e ex i s ti n g t o o l p l an . Th e Cro we
o p i n i o n s t at edthatGran tTh o rn t o n ’ s ju s t i fi cat i o n p ap er p ro v i d edi n s u ffi ci en t i n fo rm at i o n fo r Cro we t o d et erm i ne wh et h er t h e n ew t o o l p l an m etthe req u i rem en t s fo r anacco u n t ab l e p l an . Th e Cro we o pi n i o n al so s t at ed th atth e IRS h ad recen t l y

wi th drawn a p ri v at e l et t er ru li n g wh ere i th as co n cl ud edth at- 2 4 -

[* 2 4 ] p aym en ts m ad e u n d er an acco un t ab le p l an were n o ts ubjectt o Fed eral
em pl o y m en tt ax es . Th e Cro w e o p i ni o n s tat edth ati twas p o s s i bl e t h atthe
co n cl u s i o n reach edi n th atp ri v at e l et t er ru l i n g co u l d ap p l y t o th e n ew t oo l p l an . As t o th e t o o l u s e p l an th e Cro w e o p i n i o n s t at edth at“ th ere d o es n o tap p ear t o b e
an y au th o ri ty fo r * * * [M r. Dav i s o n an dp et i t i o ner’ s] co ncl u s io n ” t h atp aym en ts
m ad e t h ereu n d er were n ots ub jectt o Fed eral em

p lo y m en tt ax es . Fu rt h er, t h e Cro w e o p i n i on s t at edth atth ere was n o s up po rtfo r t reat i ng p aym en t s t o
em pl o y ees , i n th ei r cap aci ty as em p l o y ees , as ex em

ptfro m Fed eral em

p l o ym en t t ax es u n l es s m ad e u n d er an acco u n t ab l e p l an . Th e Cro we o pi n i o n co n cl ud edth ere ap p earedt o b e l i t t l e s upp o rt , i f an y , fo r t h e p o s i t i o n thatp aym en t s u nd er t h e t o o l
u s e p lan s h o u l db e ex em

p tfro m Fed eral em

p l o ym en tt ax es . Pet i t i o ner d i dn o taccep t th e ad v i ce i n the Cro we o p i n i o n . Rat her, h e as k ed M r. Dav i s o n t o drafta res p on s e t o th e Cro we o p i n i o n o n b eh al f o f Gran t Th o rn t o n i n wh ich h e d i sp u tedthatad v i ce. In a l et t er d at edNo v em b er 1 , 2 00 0 , M r. Dav i s o n
res p o n d ed t o th e Cro w e o p i n io n an ds en tthe res po n se t o p et i t i o n er. M r. Dav is o n ’ s l et t er co n cl u dedth atth e Cro we o pi n i on i n co rrect l y s t at edth atthere was i n s u ffi ci en ti n fo rm at io n t o d et erm i n e wh et h er th e requ irem en ts o f an acco u n t ab l e p l an were m eti n th e New To o l Pl an . M r. Dav is on al s o co n cl u d edth at , al th o u g h th ere was n o tan y

cas el aw s p eci fi cal l y ad dres si n g u s ag e p aym en t s u n d er a p l an- 2 5 -

[* 2 5 ] s i m i l ar t o t h e To o l Us e Pl an , th e u s e p l an was i n co m p l i an ce wi th al l rel ev an t l aw. Pet it i o n er an dM r. Dav i s o n ’ s s up p orto f t h e To o l Pro g ram was
u n affect ed b y

th e Cro we o p i n i o n . CM S m ad e n o ch an g es t o t h e To o l Pro gram aft er recei v i n g the Cro we o p i n i o n . B. M cDerm o t tW il l & Em ery Pet i t i o ner al s o co n t act edth e l aw fi rm o f M cDerm o tt , W i l l & Em ery (M cDerm o t t ) reg ard in g t he To o l Pro g ram . In ad d i t i o n t o th e n ew t o o l p l an an dth e t o o l u s e p l an , p et i t i on er s o u g h tM cDerm ot t ’ s o p i n i o n o n th e ex is ti n g t o o l p l an , wh i ch was n o t ad dres s edi n Gran tTh o rn to n ’ s ju s t i fi cat io n p ap er. M cDerm o t ts en t p et i t i o n er a m em o ran du m d at edJ u n e 1 , 2 00 1 , wri t t en b y t ax at t o rn ey s Dav i d Fu l l er an dJ an i n e Co ok
. In th atm em o ran du m , M cDerm o tts t at edth at t o o l rei m b u rs em en t p l an s were th e s ub jecto f i n creas eds cru t i n y b ecau se t h e IRS h adp l aced em p l o y er rei m b u rs em en tp ro g ram s o n i t s Pri o ri ty Gu i d an ce Pl an . M cDerm o t t ’ s
m em o ran du m

warn edth atth e ex i s ti n g t o o l p l an wo u l dl i k el y fai l the acco u n t ab l e p l an req u i rem en ts . M cDerm ot tex p l ai nedth atth e IRS wo u l dn otal l ow CM S t o rei m b u rs e cl i en t -em

p l o y ees fo r ex p en s es i ncu rredb efo re t he em p l o y ees ’ cu rren t
em pl o y m en t . M cDerm o t tad v i s edth atth e n ew t o ol p l an was “ th e s tro n g es t
co m p o n en to f t h e * * * [To ol Pro g ram ] u n d er t h e acco u nt ab l e p l an ru les ,” b u tal s o- 2 6 -

[* 2 6 ] n o t edthatas p ect s o f t h atp l an n eed edt o b e m o d i fi edi n o rd er t o co m p l y wi t h
acco u n t ab l e p l anru l es . Sp eci fi cal l y , th e n ew t o o l p l an wo u l d l ik el y ru n afo u l o f th e b u si n es s co n n ect i o n co m p on en to f t h e acco u n tab l e p l an ru l es i f CM S o p erat ed a p l an i n wh ich a cl i en t -em p lo y er p ai dth e s am e week l y am ou n twh et h er o r n o tth e
em pl o y ee i n cu rredb u s i n es s ex p en s es . M cDerm o t tco n fi rm edM r. Dav i s o n’ s co n cl u s i o n t h atth e t o o l u s e p l an
wo u l dp ro b ab l y

fai l th e acco u nt ab l e p l an req u i rem en t s . M cDerm o t tco n cl ud edi f th e t o o l u s e p l anfai l edth e acco u n t ab l e p l an ru l es , th ere was n o s up p o rtfo r t h e p o s i t i on th atp aym en t s m ad e u n d er t h e t o o l u s e p l an were ex em p tfro m Fed eral
em pl o y m en tt ax es . M cDerm o ttal s o warn ed p et i t io n er t h ato p erat i n g t h e t h ree t o o l p l an s i n t an d em

g reat l y i n creas edth e ri s ko f l o s i n g i n an IRS au di t . Th i s i s b ecau s e “ an i n dep en den tp art y b arg ai n i n g atarm ’ s l en g th wo u ldn o t ag ree t o b o t h p ay fo r b u y i ng the * * * [em p l o y ee’ s t oo l s an d eq u ip m en t ] an dth en p ay fo r u s i n g th e * * * [t oo l s an dequ i p m en t ] , u n les s th e l at t er p aym en twas o n l y i n t en d edt o
co v er m ai n t en an ce an drel at edco n t i n ui n g co s t s .” M cDerm o t to ffered a n u m b er o f reco m

m en dat i on s fo r b ri n gi n g th e To o l Pro g ram i n t o l eg al co m

pl ian ce. M cDerm o t t reco m m en d at i o n s i n cl u d ed , b u twere
n o tl i m i t edt o , th e fo l l o wi n g : (1 ) t h at CM S o ffer o n l y th e co m b i n edTo o l Pl an s wh ere ex p en s e rei m

b u rs em en t s wo u l d b e fo r t h e v al u e o f t h e u s e o f t oo l s an d- 2 7 -

[* 2 7 ] equi p m en t at tri b u t ab l e t o o n g o i n g m ai n t en an ce, i n s u ran ce an d i n v en t o ry i n g
co s t s ; (2 ) t h atCM S en fo rce a s al ary redu ct i o n i f t h e em

p lo y ee fai l edt o i n cu r o r
s ub s t an t i at e t o ol ex p en s es fo r an y g i v en p ay

ro l l p eri o d ; (3 ) th at , fo r t he ex i s t i n g t o o l p l an , CM S en s u re al l el i gi b l e ex p en s es were i n cu rredwi th i n a y ear; (4 ) t h at
ex p en s es h adn o tb een i n cu rredi n th e cap aci ty o f i nd ep en d en tco n tract or an dh ad
n o tb een p rev io us l y

rei m b u rs ed , d edu ct ed , o r d ep reci at ed ; an d (5 ) t h atex p en s es h av e b een i n cu rred fo r t o o ls th atwi l l b e u s edt o p erfo rm s erv i ces fo r t h e em

p l o y er. Aft er p et i ti on er recei v edM cDerm ot t ’ s m em o ran du m , p et i t i o n er an d M r. Dav is o n s ch edu l eda m eet i n g wi th the M cDerm o t t at t o rn ey s wh o h addraft edi t . Befo re t h atm eet i n g p et i t i on er s en tM r. Dav i s o n an em ai l as k i n g h o w CM S o u g h t t o m o d i fy th e ex i s t in g t o o l p lan i n th e l i gh to f th e factth at M cDerm o t t ’ s
m em o ran du m

ci t eda p ri v at e l et t er ru l i ng i n wh i ch th e IRS h add i s al l o wed rei m b u rs em en to f t h e acq u is i t i o n co s t s o f t o o l s p u rch as ed b efo re an em p l o y ee’ s t en u re wi th h i s o r h er cu rren t em p l o y er. Des pi t e p et i t i o ner’ s kn o w l ed g e t h at M cDerm ot treco m

m en dedch an g es b e m ad e t o th e ex i s t i n g t o o l p l an t o b ri n g i t i n t o co m pl i an ce, CM S m ad e n o ch an g es t o t h e To o l Pro gram as a res u l to f M cDerm ot t ’ s m em o ran du m .- 2 8 -

[* 2 8 ] C. Gran tTh o rn t o n ’ s Di s av o wal o f CM S an dthe To o l Pro g ram OnAp ri l 1 5 , 2 0 0 1, M r. Dav i s o n g av e Gran tTh orn t o n h i s res i g n at i on l et t er, effect i v e Oct o b er 1 5 , 2 0 0 1
. M r. Dav is o n l eftGran t Th orn t o n t o p u rs ue an o th er fu l l -t i m e jo b wi th the Nat i o nal As s o ci at i o n o f In d ep en d en tTru ck ers , wh ich
o ffered h i m

a m o re fl ex i b l e wo rks ch edu l e. M r. Dav is o n co nt i n uedt o wo rkwi th
an d o n b eh al f o f CM S aft er l eav i n g Gran tTh o rn t o n . In a l et t er recei v ed b y

p et i t i o n er d at edJ u n e 2 6 , 2 0 02 , Gran tTh o rn to n d em an d edth atCM S s t o p u s i n g Gran tTh o rn t o n ’ s n am e i n m ark et i n g th e To o l Pro g ram . Th e l et t er was wri t t en b y Ro b ertP. Scal es , as so ci at e g en eral co u n s el fo r Gran tTh o rn t o n . Inth atl et t er M r. Scal es al s o ad v i s edth atCM S d idn o t h av e p erm i s s i o n t o d i s tri bu t e co p i es o f co rres p o n d en ce an dm em o ran da fro m Gran t Th o rn t on fo r p u rp o ses o f m ark et i n g th e To o l Pro g ram . Fu rt h er, M r. Scal es i n s i s tedth atCM S cl ari fy wi th i t s ex i s t i n g an dp o t en t i al cl i en t s th atGran t Th o rn t on d i d n o t en d o rs e t h e To o l Pro g ram . Pet i t i o ner res p on d ed t o Gran t Th o rn t o n wi th a l et t er d at ed J ul y 2 2 , 2 0 0 2
. Pet i t io n er wro te t h e l et t er i n o rd er t o s al vag e t h e rel at i o n s h i p b et ween Gran t Th o rn t on an d CM S. In p et it i o n er’ s l et t er h e d efen dedCM S’ u s e o f Gran t Th o rn t on ’ s n am e i n i t s m ark et i n g m at eri al s o n th e g ro u n dth atthe p o s i t i on s CM S h ad t ak en reg ard i n g th e n ew t o o l p l an an dth e t o o l u s e p l anwere m ad e wi th th e- 2 9 -

[* 2 9 ] kn o wl ed g e an d ag reem en to f M r. Dav i s o n an d M r. Och s en s ch l ag er. 9 Pet i t io n er req u es t edth atGran t Th o rn to n p ro v i d e up dat edfeedb acko n th e t o o l p l an s , o r al t ern at i v es t o b ri n g CM S’ p o s i t i o ns cu rren t . Gran tTh o rn t o n res p on d edt o p et i t i o n er i n a l et t er d at edAu g u s t1 5, 2 0 0 2 , rei t erat i ng th at n o p o s i t i o n o r al t ern at iv e arg u m en tco u l d b e m ad e t o s up p ortth e t o o l u s e p l an . Gran tTh o rn t o n cl ari fi edth ata rei m b u rs em en t p l an i s ei th er
acco u n t ab l e an dth ereb y

ex em p tfro m em p l oym en tt ax es o r n on acco u n t ab l e an d
s ub jectt o b o th i n co m e an dem p l o ym en t t ax es . Gran tTh o rn t o n ag ai n ad v i s edth at CM S s t o p m ark et in g the t o ol u s e p l an as a g en eral m at t er an dd em an dedth atCM S
s t op u s i n g m ark et i n g m at eri al s wi th Gran tTh o rn t on ’ s n am e o n th em . Fu rt h er, Gran tTh o rn t o n ad v i s edth atRev . Ru l. 2 0 0 2 -3 5, 2 0 02 -1 C.B. 1 0 6 7, effect i v el y

9 M r. Och s en s ch l ag er rep u d i at ed p et it i on er’ s as s ert io n th atth e p o s it i o n s CM S h adt ak en reg ard i n g th e t o o l p ro g ram were m ad e wi th h i s kn o wl ed g e an d ag reem en t . M r. Och s en s ch l ag er recal l edth ath is “ co n cl us i o n was n eg at i v e” wi t h res p ectt o t h e n ew t o o l p l an an dth e t oo l u s e p l an . M r. Och s en s ch l ag er co m m en t edth at , o n b o th occas i o n s wh en h e h adm et wi th M r. Dav i s o n an d p et i t i o n er t o d i s cu s s th e To o l Pro g ram , h e ex p res sedn o o p t i m i s m th atth e t o o l u s e p l an wo u l dp as s m

u s t er wi th th e IRS. M r. Och s en s ch l ag er s t at ed th atth e n ew t o o l p l an co u l dp ro b ab l y be s up p ort edi f i tes s en ti al ly ex p en s eds m al l t o o l p u rch as es , b u th e reg ard edth e t o o l u s e p l an as th e “ bread an db u t t er o f CM S.”- 3 0 -

[* 3 0 ] ren d eredm o o t M r. Dav i s o n ’ s arg u m en tth ata t o o l rei m b u rs em en tp l an m ay b e n o n acco u n t ab l e an dn o n et h el es s av o i dem p lo ym en tt ax es . 1 0 Fo l l owi n g recei p t o f Gran tTh o rn t on ’ s l et t er d at edAu g us t1 5 , 2 0 0 2 , p et i t i o n er u n d ers t oo dth atCM S n o l o n g er h ad th e s up p o rto f Gran t Th o rn t o n . Des pi t e p et i ti o ner’ s kn o wl ed ge t h atcl i en t s en ro l l edi n th e To ol Pro g ram u n d er t h e
as s u m pt i o n th ati twas s up po rt edb y Gran tTh o rn t on , CM S fai l edt o n o t i fy an y o f i t s cl i en t -em

p l o y ers o r cl i en t -em

p l oy ees th atGran tTh o rn to n n o l o n ger s up p o rt ed th e To o l Pro g ram . Al th o u gh CM S’ rel at i o n s h i p wi th Gran tTh o rn t o n t erm i n at ed i n 2 0 0 2, s o m e cl i en t s t h aten ro l l edb efo re t h att i m e co n ti nu edt o b el i ev e t h atGran t Th o rn t on was res p o n s i b l e fo r t h ei r au d i t d efen se u n t i l as l at e as 2 0 1 1
. D. M r. Dav i s o n ’ s Res p o n s e t o Gran tTh o rn t o n ’ s Di s av o wal In res p o n s e t o Gran tTh o rn t o n ’ s d i sav o wal o f i t s rel at i on s hi p wi th CM S, p et i t i o n er req u es t edth atM r. Dav i s o n drafta s eri es o f m em o ran d a i n s up p o rto f t h e To o l Pro gram . Fi rs t , M r. Dav i s o n draft eda m em o ran du m d at edJ u l y

2 4 , 2 0 0 2 ,

1 0 Rev
. Ru l . 2 0 0 2 -3 5 , 2 0 02 -1 C.B. 1 0 6 7 , d eal t wi th p i p el i n e wel d ers an d equ ip m en tm ech an i cs . Th e m ech an ics were em p l o y ees wh o al s o p ro vi d ed equ ip m en tt o the em

pl oy er, an dth ey

recei v ed a s ep arat e p aym en tfo r u s e o f t h e equ ip m en t . Th e ru l i ng h el dth atth e p aym en t s were s ubject t o b o th i n co m e an d em pl o y m en tt ax es . Th e ru l i ng al s o s t at ed i n p ert in en tp artth at“ [i ] f an arran g em en td o es n o ts at i sfy o ne o r m o re o f * * * [t h e acco u n t ab l e p l an ] req u i rem en t s ,” al l o f t h e am o u nt s p ai du n d er t h e arran gem en two u l db e p ai du n d er a n o n acco u n t ab l e p lan . Id ., 2 0 0 2 -1 C.B. at1 0 6 8
.- 3 1 -

[* 3 1 ] co ncl u d in g th ata n u m b er o f t ax theo ri es s upp o rt edthe co n cl u si o n thatth e
ex i s t in g t o o l p l an m etth e b us i nes s co n n ect i o n req u i rem en to f t he acco u n t ab l e p l an
ru l es . M r. Dav i s o n al s o s tat edth atcl i en t -em p l o y ees o ug h tt o b e al l o wed d educt i o n s fo r t he co st s o f an y ex i s t i n g t oo l s u s edo n the jo b an dth ats u ch
ex p en s es co ns t i tu tedo rd i n ary an dn eces s ary

b u si n es s ex p en s es . M r. Dav i so n
reas on edth atem

p l o y ees en t eredi n t o a n ew b u s in es s wi th res p ectt o th ei r ex i s t i n g t o o l i n v en t o ry

b y en ro ll i n g i n th e CM S To o l Pro g ram an d t h atth i s co n v ers i o n
o p en edth e d oo rway

t o o rd i n ary

an dn eces s ary b u s i n es s d edu ct i o n s wi th res p ectt o th e co s t s o f t h os e t o o l s. M r. Dav i s o n u n d ers t oo dthatcl i en t -em p l o y ees m i g h th av e p u rch as edth ei r t o o l s s ev eral y ears b efo re p art i ci p at i n g i n th e ex is t in g t o o l p l an . Fu rt h er, M r. Dav i so n u n d ers t o o dth at cl i en t -em p l o y ees d i d n o th o l dth em s el v es
o u tas b ei n g i n a n ew o r d i fferen ttrad e o r b u s i n es s b y v i rtu e o f th ei r en ro l l m en ti n th e CM S To o l Pro g ram . M r. Dav i s o n ’ s m em o ran du m d at edJ u l y

2 4 ,2 0 0 2 , d i d n o tad dres s wh et h er t o o l s u n n eces s ary

fo r a jo b , o r t o o l s u s ed o u t s i de o f wo rk , were el i g i b le fo r rei m b u rs em en tu n d er t h e acco u n t ab l e p l an ru l es . M r. Dav i s on kn ew t h atan
em pl o y ee’ s ex p en s e i n cu rredfo r an u n n eces s ary t o o l “ m urk i es the wat er” as t o wh et h er i tqu al i fi es as an o rd i n ary an dn eces s ary

b u s in es s ex p en s e. Pet i ti o n er- 3 2 -

[* 3 2 ] p ro m o t edM r. Dav i s o n ’ s m em o ran dum d at edJ u l y

2 4 , 2 0 0 2 , i n s el l i n g th e To o l Pro gram . M r. Dav i s o n al s o d raft eda m em o ran du m d at ed Oct o b er 1 0 , 2 0 0 2 , wh i ch d i d
n o td i s cu s s th e ex i s t i n g t o o l p l an . Th i s m em o ran du m co n cl u dedth at“ s ub s t an t i al
au th o ri ty ” s up po rt edthe n ew t o o l p l an ’ s qu al i fi cat i o n as an acco u nt ab l e p l an . M r. Dav is o n ’ s o p i n io n d efi n ed“ sub s t an ti al au th ori ty ” as a 3 3
. 5 % ch an ce o f p rev ai l i n g i f retu rn s were ex am i n edb y th e IRS. Th is m em oran du m al s o co n cl u dedth at p aym en t s m ad e u n d er t h e t o o l u s e p l an were n o ts ub ject t o s el f-em

p l o y m en to r p ayro l l t ax es , b u ti td i dn o td i rect l y co n cl ud e t h ats ub s t an t ial au th ori ty ex i s t edfo r th i s p o s i t i o n . M r. Dav i s o n reas o n edth at s in ce t h e cl i en t -em p l o y ee was n o ti n th e trad e o r b u si n es s o f ren t i n g t o ol s o r eq u i p m en t , ren t al p aym en t s m ad e u n d er th e
u s e p lan were n o ts ubjectt o s el f-em p l o ym en tt ax . M r. Dav i s o n creat edan ex ecu t i v e s umm ary o f h is m em o ran du m d at ed Oct o b er 1 0 , 2 0 0 2 , o n No v em b er 2 2 , 2 0 0 2 . M r. Dav i s o n was as k edt o draftth i s
ex ecu t i v e s u m

m ary fo r m ark et i n g p u rp o s es , an dCM S d i d i n fact u s e i tfo r
m ark et i n g p u rp o s es . In th e ex ecu t i ve s umm ary d at edNo v em

ber 2 2, 2 0 0 2 , th e ex i s ti n g t o o l p l an i s m en t i o n ed o n l y o n ce. M r. Dav i s o n wro t e: “ [A] v ari at i o n o f * * * [t h e n ew t o o l ] p l an m ay al l ow em p l o y ees t o s ub s t an t i at e t he co s to f t h ei r ex i s t i n g t o o ls wh en th ey- 3 3 -

[* 3 3 ] i n i t i al l y

en ro l l i n th e p l an t o t ak e ad van t ag e o f t ax b en efi ts o f rei m b u rs em en t fo r ex i s t i n g t o o l s wi tho u ti n co m e t ax o r em pl o ym en t t ax es . ” Fu rth er, M r. Dav i s on
as s ert ed th atb o th th e n ew t oo l p l an an d t h e t o o l u s e p l an were s up po rt edb y

“ s ub s t an t i al au th o ri ty ”, an dth ati n th e ev en to f an au d it , CM S wo ul dp ro vi d e au di t
s up p ortatn o co s t . Ind irect co n tras t wi th Gran t Th o rn t o n ’ s read i ng o f Rev . Ru l
. 2 0 0 2 -3 5 , s up ra, M r. Dav i s o n d i dn o tb el i ev e t h atthe ru l i n g d i ct at edth at rei m b u rs em en tp l an s m

u s tqu al i fy

as acco u n t ab l e p lan s i n o rd er fo r p aym en t s
m ad e t h ereu n d er t o av o i d em p l o ym en tt ax es . 1 1 Pet i t i o n er u sedth i s ex ecu t i v e
s u m m ary t o h el p s el l the t o ol p l an an dt o trai n CM S an dXel l s al es ag en t s i n
m ark et i n g th e To ol Pro g ram . E. KPM G’ s Op i n i o n o n th e To o l Pro g ram Fo l l owi n g Gran tTh o rn t o n ’ s d i s av o wal o f t h e To o l Pro gram , p et i t i o ner
s o u g htt o b o l s t er t h e rep u t at io n o f CM S an d the To o l Pro g ram b y o bt ai n i n g
s up p ortfro m

an o th er i nd ep en d en tt ax fi rm . Pet i t i o n er al s o wan t edan o th er

1 1 M r. Dav i s o n co n cl u d edth atth e t ech n ical u n d erp i n n i n g s o f t h e CM S t o o l u s ag e p ro g ram

p l anwere n otad dres s edb y Rev . Ru l . 2 0 0 2 -3 5 , s up ra. He th en co n cl u d ed th at th e IRS t aci t l y ackn o wl ed g edth atp aym en t s fo r u s e o f p ro p ert y m i g h tco ns t i tu te ren t. He g ro u n d edth es e co n cl u s io n s o n h i s read i ng o f a 2 0 0 1 fi el d serv i ce ad v i ce, FSA 2 0 0 1 2 7 0 0 4 , wh i ch h e read t o al l ow fo r u s ag e p aym en ts s ep arat e fro m th e em

pl o ym en trel at i o ns h ip th atare n o tco n si d eredwag es fo r em pl o y m en tt ax p u rp o s es , reg ard l es s o f wh et h er s u ch p aym en t s were m ad e u n d er an acco u nt ab l e p lan
.- 3 4 -

[* 3 4 ] o p i n i o n o n th e l ik el i h o o d o f o b t ai n i n g a fav o rab l e IRS p ri v at e l et ter ru l i n g . To th aten d , p et i t i o n er co n t act edKPM G’ s W i ch i t a o ffi ce (KPM G) an dreq u es t ed i t s o p i ni o n o f M r. Dav i s on ’ s m em o ran du m d at edOct o b er 1 0 , 2 0 0 2
. OnAp ri l 3 , 2 0 0 3 , CM S recei v edKPM G’ s o p i n i o n o n the To o l Pro g ram . Th ere was n o d i s cu s s i o n o f t h e ex i s t in g t oo l p l an i n KPM G’ s o p i n i o n. KPM G ad v i s edp et i t i o n er t h atth e t o o l u s e p l anfai l ed th e acco un t ab le p l an
ru l es an dad v i s edth atRev . Ru l . 2 0 0 2 -3 5 , s up ra, d i dn o t p erm i tal t ern at e ch aract eri zat i o n s o f p aym en t s m ad e t o em p lo y ees . Acco rd i n g ly , KPM G ad v i s ed th atp aym en t s m ad e t o em p l o y ees b e ch aract eri zed as wag es fo r s erv i ces ren d ered , acco u n t ab l e p l anrei m

b u rs em en t s , o r n o n acco u n t ab l e p l an rei m bu rs em en t s. Fu rt h er, KPM Gs t at edthatn on acco u n t ab l e p l an p aym en t s were t reat edas ad d it i o n al wag es , an dem p l o y ee p aym en t s n otm ad e u n d er an acco u n t ab l e p l an
were s ub j ectt o i n co m e t ax at i o n an dem p l o ym en tt ax at i on . KPM G n o t edth atth ere
was n o d i rect o r i n d i rect s upp o rtfo r b i fu rcat i n g wag es p l an as co n t em p l at edu n d er th e t o o l u s e p l an . KPM G co n cl u d edth atth e n ew t o o l p lan ap p eared t o m eetth e req u irem en t s
o f an acco u n t ab le p l an b u t n o t edth ateach em p l o y er s h o u l db e en co u rag edt o ad o ptfo rm al , wri t t enp ers o n n el p ol i ci es p ro v i d i n g co nd i ti o ns fo r rei m b u rs em en t
co n si s t en twi th th e acco u n t ab l e p l an req u i rem en t s . Th e reco rdd o es n otrefl ect- 3 5 -

[* 3 5 ] CM S’ h av i n g en co u rag edi t s cl i en t s t o d o t h i s . Fu rt h er, n o ch an g es were
m ad e t o th e To o l Pro g ram i n t h e l i g h t o f KPM G ’ s o p i n i on an dCM S d i dn o t d i s tri b u t e i tt o cl i en t s . F. Fu rt h er Op i n i o n s b y M r. Dav i s o n an dSeco ndTry W i th M cDerm o t t In 2 0 0 5 p et i t i o n er req u es t edth at M r. Dav is o n wri t e an o ther o p i n io n fo r CM S, as wel l as an ex ecu t i v e s u m m ary o f t hato p i ni o n, i n t h e l i g h to f Rev . Ru l
. 2 0 0 5 -5 2 , 2 0 0 5 -2 C.B. 4 2 3 . Th atru l i n g co n cl u d edth at t o o l al lo wan ces p ai dt o
em pl o y ees were n o tp ai du n d er an acco u n tab l e p l an b ecau se t h e s ub s t an t i at i o n an d retu rn o f ex ces s req u i rem en t s were n o tm et . Fu rt h er, t h e ru l i ng co n cl ud edth atal l t o o l al lo wan ce p aym en t s u n d er t h e arran gem en tm u s t b e i n cl u d ed i n t h e
em pl o y ees ’ g ro s s i nco m e an drep o rt edo n the em p l o y ees ’ Fo rm s W -2 an d are
s ub jectt o wi th h ol d i n g an d p aym en to f Fed eral em p l o ym en tt ax es . Id ., 2 0 0 5 -2 , C.B. at4 2 5 . M r. Dav i s o n draft edth e req ues t edo pi n i o n d at ed Sep t em b er 1 4 , 2 0 0 5 , an da rel at ed ex ecu t i v e s u m m ary . Th i s o pi n i on , l i k e earl i er o p in i o n s wri t t en b y M r. Dav i s o n , d i dn o tad dres s th e ex i s t i n g t o o l p l an o r t h e v al u at i on fo rm u l a p ro v id edb y

CM S. Pet i t i o n er u s edth i s o pi n i on t o h el p s el l the CM S t o o l p l an s . Th e Sep t em

b er 1 4 , 2 0 05 , o p i n i o n an di t s ex ecu ti ve s u m m ary s t at ed th at th ere was “ s ub s t an t i al au tho ri ty ” t o co n cl u d e t h atrei m b urs em en tfo r t o o l s acq u iredaft er en ro l l m en t , i .e., th e n ew t o o l p l an , wo u ldb e n on t ax ab l e. As wi th- 3 6 -

[* 3 6 ] p ri o r o pi n i o n s wri t t en b y M r. Dav is o n , “ s ub s t an t i al au th o ri ty ” m ean ta 3 3 .5 % ch an ce t h atth e p l an wo u l d s urv i v e IRS s cru t i n y . W i th res p ectt o the t o o l
u s e p lan , M r. Dav i s o n ag ai n co n cl u dedth atp aym en t s m ad e t o t ech n i ci an s fo r t h e
u s e o f th ei r t o o l s were n o ts ubjectt o s el f-em p l o ym en to r p ayro l l t ax es . M r. Dav is o n reject edKPM G’ s p o s i t i o n th atRev . Ru l . 2 0 02 -3 5 , s up ra, p recl u d ed
n o n t ax ab l e s t atu s fo r u s ag e p aym en t s m ad e u n d er a p l an th atfai l edt o co m p l y wi t h th e acco u n t ab l e p l an ru l es , an dh e i ns t ead as s ert ed th atRev . Ru l
. 2 0 0 2 -3 5 , s up ra,
o p en edal t ern at i v e ch aract eri zat i o n s s u ch as th atp ro m o t edu n d er CM S’ u s e p l an . M r. Dav i s o n ’ s o pi n i o n an dex ecu t i v e s u m m ary ex p lai n edth at , u nd er Rev
. Ru l
. 2 0 0 5 -5 2 , s up ra, “ em p l o y ers u s i n g acco u nt ab l e p l an s t o rei m b urs e em p l o y ees fo r t h e co s t o f p ro v id i n g t o o l s m u sts ubs t an t i at e t h e ex p en s es rei m bu rs ed an d , t o th e ex t en tth e p l an p ro v i d es p aym en t s b efo re ex p en ses are i n cu rred , th e p l an m u s t req u i re t hatthe em

pl o y ee retu rn am o u n t s i n ex ces s o f t h e s ub st an t i at edex p en s es .” M r. Dav i s o n u n d ers t oo dthi s t o m ean th at“ th e ru l i n g cl ari fi es th atan acco u n t ab l e p l an m ay n o t u s e es t i m at es t o s ub s t an t i at e t he am o u nto f t h e ex p en s es .” Th i s
n eg at ed th e v i ab i l i ty

o f CM S’ ex i s t i n g t o o l p lan ; h o w ev er, M r. Dav i s o n ’ s
m em o ran du m

an dex ecu t i v e s u m

m ary d i dn o tad dres s t hi s co n cern . M r. Dav i s o n ’ s
ex ecu t i v e s u m

m ary d i d n o t ad dres s th e ri s k s o f u si n g the t h ree t o o l p l an s i n
co n j u n ct i o n . Fu rt h er, i n the ex ecu t i ve s umm ary M r. Dav i s o n rei t erat edth e- 3 7 -

[* 3 7 ] co ncl u s i o n s an drat i o n al e u s edi n p ri o r o p in i o n s , d es p i t e n ew ru l i n g s an d l eg al ad v i ce t h ati nv al i d at edth es e p o si t i o n s . Pet i t i o ner o n ce ag ai n s o u g h t t o o b tai n a fav o rab l e i n d ep en d en t o pi n io n reg ard i n g th e t o o l p l an s ’ l eg al co m p l i an ce l aw, an d h e co n t act edM cDerm o t t . On Decem b er 1 6 , 2 0 05 , CM S recei v edan o th er o p in i o n fro m M cDerm ot t , wh i ch
warn ed CM S as fo l lo ws : W e b el i ev e y o u s ho u l dan t i ci p at e an au d ito f a cl i en ti n wh i ch the IRS wi l l ch al l en g e t h e n o nt ax ab l e “ acco u n t ab le p l an ” treat m en to f th e rei m b u rs em en t s fo r b o th cu rren tan d n ew i n v en to ry , s ubject i n g al l s u ch p aym en t s t o i n co m e an dFICA t ax es o n th e b as i s th atthe rei m b u rs em en t s are am o u n t s th atwo u l db e p ai dan yw ay (i .e., as a u s ag e p aym en t ), thu s v i o l at i n g th e acco u n t ab l e p lan reg u l at i o n s . Th e IRS i s u nl i k el y

t o res p ectth e rei m

b u rs em en tarran g em en tn o r t o reco gn i ze t he u s ag e p aym en tas s ep arat e fro m th e co m pen s at io n fo r s erv ices , s ub

j ect i n g the u s ag e p aym en t t o FICA t ax es as wel l
. Th e M cDerm o tto p in i o n ad v i s edth at Rev . Ru l . 2 0 0 5 -5 2, s up ra, “ m ak es i t
ev en hard er fo r p ro sp ect i v e CM S cl ien t s t o rel y up o n t h e p o si t io n s b ei n g as s ert ed b y CM S.” M cDerm o t tex p l ai n edth atth e rev en u e ru l i n g req u i redt o o l al l o wan ce p aym en t s t o b e i n cl u d edi n g ro s s i nco m e an d rep ort edas wag es s ubjectt o wi th h o l d i n g an dem

p l o y m en tt ax es i f t h e arran g em en td idn o t req u i re
s ub s t an t i at i o n an dretu rn of ex ces s p aym en t s , as req ui redu n der t h e acco u n t ab l e p l an ru l es . M cDerm o ttn o tedth atCM S’ rei m b urs em en tp ro g ram

ap p eared

“ al m o s ti n d i s t i n gu i s h ab l e” fro m th e p ro g ram

d is cu s s edi n the rev en u e ru l i n g- 3 8 -

[* 3 8 ] n o twi th s tan d i n g CM S’ p ro p ri et ary cal cu l at io n s . Pet i t i o n er d i d n o t d is tri b ut e th i s o p i n i o n t o cl i en ts o r p o t en t i al cl i en t s . Pet i t io n er an dCM S m ad e n o ch an g es t o the t o o l p ro gram as a res u l t o f t h i s o p i n i o n . M r. Dav i s o n wro t e an o ther o p in i on i n s up p o rto f t he To o l Pro g ram d at ed J u l y 1 , 2 0 0 7
. Pet it i o n er d i dn otu s e t hi s o pi n i o n p ri m ari ly fo r t h e p u rp os e o f
s el l i n g th e To o l Pro g ram , b ecau s e CM S an dXel l were n o ts el l i ng th e To ol Pro g ram atthatp o i n t . Nev erth el es s , th e o p i n io n was d is tri bu t edt o ex i s t i n g cl i en ts , an dM r. Dav i s o n wro t e i twi th th e u n d ers tan d i n g th ati two u ldb e u s edt o
m ark etth e To o l Pro gram . M r. Dav i s o n ad dres s edth e ex i s t in g t o o l p l an i n h i s J u l y 1 , 2 0 0 7 , o p in i o n . He co n cl u d edth at “ sub st an t i al au th o ri ty ” s up p o rt edth e p o s i t i on th atrei m

b u rs em en t s fo r t o o l s acq ui redb efo re an daft er th e i n it i at i o n o f CM S’ t o o l rei m

b u rs em en tp l an were n o nt ax ab le u n d er t h e acco u n t ab l e p l an ru l es . Aro u n d Oct o b er 2 0 0 7 CM S m ad e i t s fi rs ts ub s t an ti v e ch an g e t o the t o o l p ro g ram . Atth att i m e, CM S b eg an t o req u i re recei p t s fo r p u rp o ses o f
s ub s t an t i at i n g p aym en ts m ad e u n d er t h e rei m b u rs em en t p l an s . Al tho u gh th i s was a ch an g e t o th e To o l Pro g ram th atap p eared t o b e req u i redi n th e l i g hto f Rev . Ru l. 2 0 0 5 -5 2 , s up ra, an dwas ad v is edb y M cDerm o t ti n i t s 2 00 5 m em oran du m , CM S wai t edo ver t wo y ears t o m ak e t h i s ch an g e. CM S d i dn o td is co n t i n u e t h e ex i s t i n g t o o l p l an fo r t h o s e al read y en ro l l edan dm ad e n o o th er s ub st an t i v e ch an g es t o th e- 3 9 -

[* 3 9 ] To ol Pro g ram . Th erefo re, t h o s e al read y en ro l l edi n th e ex i s t i n g t o o l p l an d i dn o t h av e t o p ro vi d e recei p t s . M r. Dav i s o n wro t e o n e m o re m em o ran du m t o CM S d at edNo v em b er 2 8 , 2 0 0 7 , i n res p o n s e t o a Ch i ef Co u n s el Adv i ce (CCA) i n wh i ch th e IRS an n o u n ced i n creas edau di t at t en t i o n wo u l db e p ai dt o t o ol rei m b urs em en tp l an s, s uch as th o s e ad m i n is t eredb y CM S. M r. Dav i so n d es cri bedth e recen tCCA as fo l l o ws : Th i s CCA rai s es s o m e s eri o u s co ncern s reg ard i n g the CM S ex i s t i n g t o o l p l an * * * I am

co ncern ed th atCM S cl i en t s n eedt o ackn o w l ed g e an du n d ers t an d a “ s ub s t an t i al au th o ri ty ” co n cl u s i o n o nl y av o i d s t ax p en al t i es ; n otactu al t ax an di n t eres t . Atthi s p o i n t , I am n o t read y

t o reco m m en da Draco n i an ap p ro ach o f s u s p en d i n g th e ex i s ti n g t o o l p l an an ds eek in g a l eg i s l at i v e rem ed y , b uti ts h o u l db e i n t h e b acko f o u r co l l ect i ve m i n d s . M r. Dav i s o n kn ew t h atCM S d i dn o t at t em p tt o v eri fy

cl ien t -em

p l o y ees ’
s t at em en t s reg ard i n g th e co s ts , b u s i n es s u s e, d ep reci at i on , an d p ri o r rei m b u rs em en t s fo r t h ei r t o o l s . He reco m m en d ed thatCM S s t artreq u i ri n g cl i en t em pl o y ees t o rei m

b u rs e th ei r em

p l o y ers fo r ex ces s rei m

b u rs em en t s . M r. Dav i s o n ack n owl ed gedth atth e ex i s t i n g t o o l p l an was th e “ Ach i l les h eel ” o f t he To o l Pro g ram an d th at n o m at t er wh atCM S d i dt o ch an g e t h e ex i s t i n g t o o l p l an , i t
m i g h tn o t b e en o u g h t o bri n g i ti n t o co m pl i an ce. Des pi t e rep eat ed ad v i ce t o th e
co n trary , M r. Dav i so n s t at edh is co n fi d en ce t h atth e t o o l u s e p l an wo u l dp as s IRS- 4 0 -

[* 4 0 ] m us t er an dco m

p l i edwi th th e rel ev an tru l es an d reg u lat i on s . As t o th e n ew t o o l p l an , M r. Dav i so n s t at edi t s h o u ldeas il y p as s IRS m

u s t er. OnAu gu s t2 2 , 2 0 0 8, p et i t i o n er em ai l edM r. Dav i s o n an dth e o th er CM S b o ardm em

b ers i n d icat i n g t h ata cl i en t o f CM S h adn o t i fi edp et i ti o n er t hatth e IRS i s su eda co o rd i n at edp ap er d at edJ u l y 2 , 2 0 0 8 , i n wh ich i t co ncl u d edth atth e t o o l
an d equ i p m en tp l an s i t h ads een t o d at e fai ledt o m eetth e acco u n t ab l e p l an req u i rem en t s . Pet i ti o n er s ub s equ en t l y fo rward edt o M r. Dav i s o n an do th er CM S b o ardm em

b ers an art i cl e p ub l i s h edi n th e Au g u s t2 2 , 2 0 0 8 , i s s u e o f Payro l l Cu rren tl y en t i t l ed“ To o l Pl an Paym en t s M u s tBe In cl u d edi n Em p l o y ees ’ Gro s s In co m e, IRS Say s ”, wh i ch d i s cu s s edth e IRS co o rd i n at edp ap er referen cedi n th e
em ai l d at edAu gu st2 2 , 2 0 0 8
. Th at art i cl e u l t i m at el y co n cl u d edth at“ th e ro u t i n e rei m b u rs em en to f u n s ub s t an t i at edex p en s es an dth e p ract i ce o f rech aract eri zi n g wag es as rei m

b u rs em en t s u n t i l th e em

p l oy ee’ s t o o l i n v en t o ry

v al u e i s zero edo u t , o n l y t o rei n s t at e t he o ri gi nal wag e am o u n tatth atp o i n t , ‘ ev id en ce a p at t ern o f ab u se o f t h e acco u n t ab l e p l an ru l es .’ ” VII. Cl i en tAu d it s , In

jun ct i o n, an dPen al t i es A. Cl i en tAu d it s an dIn jun ct i o n s Ag ai n s tCM S, Pet i t i o n er, an d Dav i s o n Sev eral CM S cl i en t s ’ retu rn s were au di t edb y th e IRS i n co nn ect i o n wi th th ei r p art i ci p at io n i n t h e CM S To o l Pro g ram b eg i n n in g i n 2 0 0 8 . Int ot al 2 4 CM S- 4 1 -

[* 4 1 ] cl i en t -em

p l o y ers h adretu rn s au d i t edb y th e IRS. Pet i t i o n er recei v edcal l s fro m m an y o f t h es e cl i en t s reg ard i n g au di trep res en t at i o n , an dp et i t io n er p ro v i d ed th es e cl i en t s wi th a p ro t es t l et t er draft ed b y M r. Dav i s o n d efen d i ng th e CM S t o o l p l an s . Each o f CM S’ cl i en ts wh o s e ret urn s were au di t edwas req u iredt o rem i t ad d it i o n al em

p l oym en tt ax es . Th e t o t al res u l t in g t ax du e was $ 4 ,5 9 1 ,1 0 6
. In Feb ru ary

2 0 0 8 th e Un i t edSt at es i n i t i at edan act io n ag ai n s tM r. Dav i s on t o en jo i n h im fro m p ro m o t i n g t ax s h el t ers . Pet i t i o ner was aware o f t he s u i twh en i t w as i ni t i at ed . CM S t o o kn o act i o n ag ai ns tM r. Dav is o n o n th e b as i s o f t he i n jun ct i o n act i o n . Pet it i o n er co n t i n u edt o d i s tri b u t e p ro t es t l et ters p rep aredb y M r. Dav is o n t o CM S cl ien t s wi th retu rn s u n der au d i t . Pet i ti o n er fai l edt o n o t i fy CM S cl i en ts th atM r. Dav i s o n was b ei n g s u edfo r t h e p ro m o ti o n o f t ax s h el t ers . OnM ay 1 1 , 2 0 1 0 , th e U.S. Di s tri ctCo u rtfo r t h e W es tern Di s tri cto f M i s s ou ri fo u n d t h atM r. Dav i s on h ad“ ro u t i n el y fal sel y an dfrau du l en t ly

ad v i s ed cl i en ts th ath i s t ax arran g em en t s were l eg al .” Th e Di s tri ctCo u rtco n cl u d edth at M r. Dav i s o n ’ s “ reco rdes t ab li s h es th at th i s cy cl e wi l l co n ti n u e u n l es s h e i s b arred fro m p ro v i d i n g t ax ad vi ce wi tho u ts i g n i fi can t res trai n t .” Th erefo re, t h e Di s tri ct Co u rten jo i n edM r. Dav i s o n fro m o rg an i zi n g , es t ab l i s h i n g , p ro m o t i n g , s el l i n g , o r
o fferi n g fo r s al e o r h el p i n g t o o rg an i ze, es t ab l i s h , p ro m o t e, s el l, o r o ffer fo r s al e- 4 2 -

[* 4 2 ] an y t ax p l an . As a res u l to f t h e i n j u n ct io n , M r. Dav i s o n ’ s C.P.A. l i cen s es
were s u s pen dedi n 2 0 11
. Th e Di s tri ctCo u rtreq u i redM r. Dav i s o n t o p ro v i de a co p y o f i t s o rd er wi th i n 6 0 d ay s t o each cl i en tfo r wh o m p et i t i on er h adp ro v i dedan y ty p e o f t ax rel at ed ad v i ce wi th in th e l as tfi v e y ears . M r. Dav i so n d i dn o t p ro v i d e a co py o f th e i n jun ct i o n t o an y o f CM S’ cl i en t -em pl o y ers o r cl ien t -em

p l o y ees . M r. Dav i s o n d i dn o ti fy CM S an dp et i t i o n er o f t h e i n junct i on . Nev erth el es s , CM S co n t i n u edt o d i s tri b u t e p ro t es tl et t ers p rep aredb y M r. Dav i s o n t o CM S cl i en t s wi th retu rn u n d er
au d it . Pet i t i o n er d i dn o tn o t i fy CM S cl i en t s t h atM r. Dav i s o n was s u edfo r t h e p ro m o t io n o f t ax s h el t ers . OnDecem b er 1 7 , 2 01 0 , M r. Dav i s o n was o ffi ci al l y
s u s p en d edi n d efi n i t el y

fro m rep res en t i n g an y o n e i n fro n t o f t h e IRS; h owev er, CM S co n t i n uedt o d i st ri b u te an u n s i g n edv ers i o n o f M r. Dav i so n ’ s p ro t es tl et t er t o i t s cl i en t s . B. Sect io n 6 7 0 0 Pen al t y Ex am i n at i o n In 2 0 0 8 th e IRS o p en eda s ect i on 6 7 0 0 p en al ty ex am in at i o n ag ai n s t CM S, p et i t i o n er, an dM r. Dav i s on reg ard i n g th e To o l Pro g ram . Th e m at t er was as s i g ned t o an IRS rev en u e ag en t (RA). Th e RA co n cl u d edth atCM S an d i t s p ri n ci p al s , i n cl u d i n g p et i ti o n er, m ad e a n u m b er o f fal s e o r frau du l en ts t at em en t s co n cern i n g th e To o l Pro g ram , th atp et i t i o n er kn ew o r h ada reas o n t o kno w th es e s t at em en t s- 4 3 -

[* 4 3 ] were fal se o r frau du l en t , an dth atth es e s t at em en ts h ada s ub st an t i al i m p act
o n th e d eci s i o n -m ak in g p ro ces s o f t h e cl i en t s an dcau s edth em t o av oi dth e p aym en t o f em

p l oym en tt ax es . Th erefo re, i n acco rd an ce wi th s ect i o n 6 7 00 , th e RA d et erm i n edth atth e IRS s h o u l das s es s p en al t i es ag ai n s t CM S, p et i t i o n er, an d M r. Dav i s o n . To cal cu l at e t h e p en al ti es ag ai n s tp et i t i o n er, t h e RA rev i ewedCM S’ cl i en t l i st . CM S h ad 9 1 cl i en t -em p l o y ers fo r wh om

i twas ad m i n i s t eri n g a t o o l p l an du ri n g th e p eri o db et ween J an u ary 1 , 2 00 6 , an dDecem

b er 3 1 , 2 00 8 . Of tho s e 9 1 cl i en ts , o n ly

6 3 were s t i l l p art i ci p at i n g as o f t h e en do f 2 0 0 8 . Th e RA i d en t i fi ed CM S’ g ro s s recei p t s fo r each t ax y ear at i s s u e. Fo r 2 0 0 8 CM S earn edg ro s s recei p t s o f $ 5 87 , 2 9 8
. 1 2 Fo r 2 0 0 9 CM S earn ed g ro s s recei pt s o f $ 9 33 ,6 7 4
. Fo r 2 0 1 0 CM S earn edg ro s s recei p t s o f $ 74 2 ,4 7 3 . Th e RA t h enm u l t i p li ed thes e
am ou n tb y p et it i o n er’ s o wn ers h i p o f s h ares i n CM S, 1 6 % , fo r t ax y ears 2 0 0 8 , 2 0 0 9 , an d2 0 1 0 . Th e RA t h en m u l t i p li edp et it i on er’ s p ro p ort i o n at e s h are o f t h e g ro s s recei p ts b y

5 0% as req ui redb y

s ect io n 6 70 0 (a). Th e RA p rep aredan ds ub m i t t edfo r s up erv is ory ap p ro v al Fo rm s 8 2 7 8 , As s es s m en tan dAb at em en to f M i s cel l an eo u s Ci v i l Pen al t i es , d at edJ an u ary 2 3 ,

1 2 Fo r 2 0 0 8 t h e RA i n cl u d edo n l y h al f t h e g ro ss recei p t s i n t h e p en al ty b as e t o b e co ns erv at i v e.- 4 4 -

[* 4 4 ] 2 0 1 4 , fo r th e y ears ati ss u e. Th e RA’ s i m m ed i at e s up erv i s or s i g n edan d d at edth e Fo rm s 8 2 7 8 o n M arch 2 6 , 2 0 1 4 . OnJ u n e 2 4 , 2 0 1 4 , res p o n den tas s es s ed p en al t i es ag ai n s tp et i t i o n er p urs u an tt o s ect io n 6 7 0 0 fo r t ax y ears en d i n g Decem b er 3 1 , 2 0 08 , 2 0 0 9 , an d2 0 1 0 , o f $ 4 6 ,9 8 4 , $ 74 ,6 9 4 , an d$ 5 9,3 9 8 , res p ect i vel y . Onth ats am e d ay , res p o n d en ti ss u edp et i t i o n er No t ice CP1 5 , No t i ce
o f Pen al ty

Ch arg e, fo r each o f t h e t ax y ears ati s su e fo rm al l y co m m u n icat i n g t o p et i t i o n er fo r t h e fi rs tt i m e res p o n d en t ’ s d et erm i n at io n o f t h os e p en al t i es . OnJ u l y 1 5 , 2 0 1 4 , p et i t i o n er s ub m i t t ed Fo rm s 6 11 8 , Cl ai m fo r Refu n do f Tax Retu rn Prep arer an dPro m ot er Pen al t i es , t o res po n d en t fo r t h e y ears ati s s u e. Pet i t i o ner p ai d $ 1 5 0 t o wardh i s p en al ty l i ab i l i ty fo r each o f t h e y ears at i s su e i n co n

jun ct i o n wi th h i s s ub m i s s io n o f th e Fo rm s 6 1 1 8
. 1 3 Res p on d en th ad n o t act edo n p et i ti o n er’ s Fo rm 6 1 1 8 b y th e t i m e t h e n o t i ce o f d et erm in at i o n was i s s u ed
o n J u l y 2 , 2 0 1 5
. Befo re res p o nd en t co n cl u d edth e s ect i o n 6 7 0 0 p en al ty ex am i n at i o n , p et i t i o n er an dth e U.S. Dep art m en to f J us t i ce ag reedth atp et i t i o n er wo u l dex ecu t e
a s t i p u l at edo rd er fo r p erm an en ti nju nct i o n u n d er s ect i on s 7 4 02 , 7 4 0 7 , an d7 4 0 8
. Th i s s t i p u l at edo rd er was s i g n edb y p et i t i o n er o n J an uary 4 , 2 01 3 , an dwas fi l ed

1 3 Th e No t i ce CP1 5 s tat edco n s i s t en tl y wi th s ec. 6 70 3 (c)(1 ) t h atp et i t i o n er co u ldp ay n o tl es s th an 1 5% o f th e p en al ty an dfi l e a cl ai m

fo r refu n do n Fo rm 6 1 1 8 fo r t h e am o u n tp ai d wi th i n 3 0 d ay s aft er t h e d at e o f t h e No t i ce CP1 5
.- 4 5 -

[* 4 5 ] o n J an u ary

1 4 , 2 0 1 3, wi th th e Di s tri ctCo u rt i n wh i ch th e i n jun ct i o n act i o n
was p en d i n g . Th i s s t i p u l at edo rd er en jo i n edp et i t i o n er fro m

fu rt h er p ro m o t i n g
u n l awfu l t o o l rei m

b u rs em en t , t o o l ren t al , o r t o ol u s e t ax av o i d an ce s ch em es th at
co u ldi m pl i cat e s ect i o n s 6 7 00 an d6 7 0 1. Th e s t ip u l at edo rd er al s o en jo i n ed p et i t i o n er fro m

ad v i s i n g cu st o m ers th atth e t o o l rei m b u rs em en tan dt o o l rei m b u rs em en tp l an s , o r an y o th er s i m i l ar p l an , are co n si st en twi th th e i n t ern al
rev en u e l aws . Pet i t i on er al s o ex ecu t edth e s am e s t i p u l at edo rd er o n b eh al f o f Xel l , wh i ch was s i g n edb y

p et i t i on er o n J an u ary

4 , 2 0 1 3 , an d fi l ed o n J an uary1 4 , 2 0 1 3
. Pet i t io n er, al on g wi th M r. Dav i s o n , ex ecu t edth e s am e s ti p u lat ed o rd er o n b eh al f
o f CM S, wh i ch was s i g n edo n J an u ary 4 , 2 0 1 3, an dfi ledo n J an u ary 1 5 , 2 01 3
. VIII. CDP Pro ces s OnOct o b er 2 7 , 2 01 4 , res p o nd en ts en tp et i t i o ner a Fi n al No t i ce o f In t en tt o Lev y an d No t i ce o f Yo u r Ri g h tt o a Heari n g (l ev y n o t i ce) wi th res p ect t o p et i t i o n er’ s u npai ds ect i o n 6 7 0 0 p en al t i es fo r t h e t ax y ears ati s s u e. Pet i t i o n er t i m el y sub m i t t eda Fo rm

1 2 1 5 3 , Requ es tfo r a Co l l ect io n Du e Pro ces s o r Equ iv al en tHeari n g , d at edNo vem b er 2 0 , 2 0 1 4 (CDP req u es t1 ), i n res p o ns e t o h is recei p t o f t he l ev y

n o t i ce. Pet i t i o n er s ub m i tt ed a d o cu m en t wi th h i s CDP req u es t1 , t i t l ed“ Ex p l an at i on o f Tax p ay er Po s i t i o n”, d at edNo vem b er 2 0 , 2 0 1 4
. In th i s d o cu m en t , p et i t i on er ex p l ai n edth at“ h e h a[d ] p ai d t ax an dfi l edFo rm s 6 1 1 8- 4 6 -

[* 4 6 ] s eek i n g refu n d s o f the t ax p ai d ,” an d t h ath e “ d i rect s * * * [res p on d en t ] t o
s u s p en dal l co l l ect i on act i v i t i es wh en * * * [h i s ] cl ai m fo r a refu n d i n a s ect i o n 6 7 0 0 cas e i s p en d in g .” Wh i l e p et i t i o n er’ s CDP l ev y h eari n g was p en di n g, res p on d en ti s s u eda No t ice o f Fed eral Tax Li en Fi l i n g an dYo u r Ri g htt o a Heari ng Un der Sect i o n 6 3 2 0 (l i en n o t i ce) d at ed Decem b er 9 , 2 0 1 4, t o p et i t i o n er fo r t h e t ax y ears ati s s u e. Pet i t io n er t i m el y

s ub m i t t ed a s eco n dFo rm 1 2 1 5 3 , d at ed J anu ary

9 , 2 0 15 (CDP req u es t2 ), i n res p o ns e t o th e l ien n o t i ce. Pet i t i o n er al s o s ub m i tt eda d o cu m en t wi th CDP req u es t2 , t i tl ed“ Ex p l an at i o n o f Tax p ay er Po s i t i o n ”, d at edJ an u ary 9 , 2 0 1 5 . Inth i s d o cu m en tp et i t io n er rei t erat edth at“ h e h a[d ] p ai dt ax an dfi l ed Fo rm s 6 1 1 8 s eek i n g refu n d s o f t h e t ax p ai d” an dth ath e “ d i rect s * * * [res po n d en t ] t o su s p en d al l co l l ect i o n act i v i t i es wh en* * * [h i s] cl ai m fo r a refu n d i n a s ect i o n 6 7 00 cas e i s p en di n g .” Pet i t i o ner’ s CDP req u es t1 an d CDP req u es t2 were as s i g nedt o a s et t l em en t
o ffi cer (SO) wi th n o p ri or i n v o l v em en twi th th e l i ab i l i t i es ati s su e. OnFeb ru ary 2 , 2 0 1 5 , th e SO s en t p et i t i on er an ap p oi n tm en tl et t er s ch edu l i n g a face-t o -face CDP h eari n g fo r Feb ru ary

1 9, 2 0 1 5 , requ es t i n g th atp et i t io n er p ro v i d e t h e SO wi th a
co m p l et edFo rm

4 3 3 -A, Co l l ect i o n In fo rm at i o n St at em en tfo r W ag e Earn ers an d Sel f-Em p l o y edIn d i v i du al s . Atp et i t i o ner’ s req u es t the CDP h eari n g was- 4 7 -

[* 4 7 ] res ch edu l edt o Feb ru ary 2 0 , 2 0 1 5 . Pet i ti o n er an d th e SO h el da face-t o -face CDP h eari n g o n Feb ru ary 2 0 , 2 0 1 5 , atthe Kan s as Ci ty Ap p eal s Offi ce. Th e SO s en tp et i t i o n er a l et t er d at edM arch , 2 7 , 2 0 1 5 , s ch edu l i n g a s eco n d face-t o -face CDP co n feren ce fo r Ap ri l 1 0, 2 0 1 5 , an dreq u es t i n g th atp et i ti o n er p ro v id e t h e SO wi th a co m pl et edFo rm

4 3 3 -A. Atp et i t i o ner’ s req ues t , th e s eco n d CDP h eari n g was res ch edul edt o Ap ri l 1 3 , 2 0 1 5, an dwas h el do n th atd at e atth e Kan sas Ci ty

Ap p eal s Offi ce. Du ri n g th e Feb ru ary 2 0 , 2 0 15 , CDP h eari n g , p et i t i o n er t o l d t h e SO t h ath e

“ wan tedh i s d ay i n co u rt ” reg ard i n g t h e u nd erl y i n g l i ab i li t i es fo r t h e p ro m o t er p en al t i es . Th e SO ex p lai n ed t o p et i t i o ner t hatp et i t i o n er’ s refu n dcl ai m ap p eared i n v al i db ecau s e p et i t i o n er fai l edt o p ay 1 5 % o f t h e p en al ty , b u th e n ot i fi ed p et i t i o n er t h ath e wo u l d i n qu i re i n t o th e s t atu s o f th e refu n d
. 1 4 Pet i t i o n er d i dn o t rai s e an y co ll ect i o n al tern at i v es o r s ub m i tan y o f t h e fi n an ci al i n fo rm at io n req u es t edb y

th e SO. Pet it i on er rai s ed n o o th er i s s u es du ri n g the Feb ru ary 2 0 , 2 0 1 5 , CDP h eari n g . Du ri n g t h e Ap ri l 1 3 , 2 0 1 5 , CDP h eari ng , p et i t i o ner rei t erat ed th atth e u n d erl y i n g l i ab i l i ty was fl awed . Pet i t i o n er ag ai n s t at edh is d es i re t o d i s p u t e t h e u n d erl y in g l iab i l i ty fo r t h e p ro m o t er p en al ty i n co urt , an d t h ath e was

1 4 Th e SO h adn o juri s d i ct i o n o ver t he refu n d cl ai m , b u twas m ak i n g t h i s s t at em en tas an ex p res s i o n o f h i s o p i n i o n o n th e m at t er.- 4 8 -

[* 4 8 ] n o ti n t eres t edi n co l l ect i on al t ern at i ves atth at t im e. At the t im e o f t h e CDP h eari n g s , res p o n d en th adn o t ru l edo n p et i t i o ner’ s Fo rm 6 11 8 cl ai m fo r refu n d
. Fu rt h er, p et i t i o n er h adn o tfi l eds u i ti n Di s tri ctCo u rt reg ard i ng h i s cl ai m s fo r refu nd , d es p i t e t h e ex p i rat i o n o f t he s ix -m o n th p eri o d wi th o u t a d eci s io n o n th o se refu ndcl ai m s b y

res po n d en t . OnJ u ly 2 , 2 0 1 5, the Ap p eal s Offi ce i ss u ed a n o t i ce o f d et erm i n at i on
s u s t ai n i n g t h e l ev y n o t i ce an d t h e l i en n o t i ce. Th e n o t i ce o f d et erm i nat i o n i n d i cat edth atres p o n d en t co u l dn o t m o v e fo rwardwi th th e co l lect i o n act io n wh il e p et i t i o n er’ s cl ai m s were u n d er co n s i d erat i o n , o r duri n g an y s ub s equ en t l i t i g at i o n rel at ed t o d en ial o f t h o se cl ai m s . Th e s u s p en si o n o f t h e l ev y act i o n d o es n ot i n v al i d at e th e i s su an ce o f t h e l ev y n o t i ce. Fu rt h er, th e fi l i n g o f t h e l i en n o t i ce b y
res p o n d en t i s n o ts i m i l arl y res tri ct edu n der s ect i o n 6 7 0 3
. OnJ u ly 3 0 , 2 0 15 , p et i t i on er t i m el y fi l eda p et it i on wi th th i s Co urt . OPINION I. St an dardo f Rev i ew Sect io n s 6 3 2 0 an d6 3 3 0 req u i re t h e Co m m i s s i o n er t o n o t i fy a t ax p ay er i f h e h as fi l eda l i eno r i n t en d s t o l ev y o n th att ax p ay er’ s p ro p ert y . Th e n ot i ce m u s t i n fo rm th e t ax pay er o f h i s o r h er ri g h t t o a CDP h eari n g reg ard i n g th e fi l i n g o f a l i eno r t he p ro p o s edco l l ect i o n act i o n . Secs . 6 3 3 0 (a), 6 3 2 0 (a). In a CDP h eari ng- 4 9 -

[* 4 9 ] t ax p ay ers m ay

rai s e an y rel ev an t i s s u e o r req u es tth e co n s i d erat i o n o f a
co l l ect i o n al t ern at i v e. Sec. 6 3 3 0 (c)(2 )(A). Tax p ay ers m ay n o tch al l en g e t he
u n d erl y i n g t ax l iab i l i ty

u nl es s th ey

d i dn o trecei v e a s t atu to ry n ot i ce o f d efi ci en cy
o r o th erwi s e h av e an o p p o rtu n i ty t o d i s p u t e t he l iab i l i ty . Sec. 6 3 3 0 (c)(2 )(B). On ce t h e Co m

m i s s io n er i s s u es a n o t i ce o f d et erm i n at i o n atth e co n cl u si o n o f t h e CDP h eari n g , th e t ax p ay er m ay s eekju d i ci al rev i ew b y

t i m el y fi l in g a p et i t i o n wi th th i s Co u rt . Sec. 6 3 3 0 (d ). Wh en th e u nd erl y i n g t ax l i ab i l i ty i s p ro p erl y ati s s u e, we rev i ew t h at d et erm i n at i o n d e n o v o . Seg o v . Co m m i s s i o n er, 1 1 4 T.C. 6 0 4 , 6 1 0 (2 0 00 ). In the i n s t an tcas e, t h e u n d erl y i n g l i ab i l i t i es are t he s ect i o n 6 7 0 0 p en al t i es i m p o s edo n p et i t i o n er fo r p ro m o ti n g ab us i ve t ax s h el t ers . Th i s Co u rth as juri s di ct i o n t o
rev i ew t h e Co m

m i s si o ner’ s d et erm i n at i o n wh en the u n d erl y i n g t ax l i ab i l i t i es s t em fro m s ect i o n 6 7 0 0 p en al t i es . Gardn er v . Co m m i s si on er, 1 4 5 T.C. 1 6 1 , 1 7 4 (2 0 1 5 ), aff’ d , 7 0 4 F. Ap p ’ x 7 2 0 (9 th Ci r. 2 0 17 ). Sect io n 6 70 0 p en al t i es are n o ts ubjectt o d efi ci en cy

p ro cedu res . Sec. 6 7 0 3 (b ). Res p o n d en t co n ced es th at p et i t io n er d i dn o t h av e ano p po rtu ni ty to d i sp u te h i s l i ab i l i t i es fo r t h e s ect i o n 6 7 0 0 p en al t i es wi th th e Ap p eal s Offi ce b efo re h i s ad m i n i s trat i v e CDP h eari ng . Fu rt h er, t h e p art i es p ro ceed edas i f p et it i on er’ s u n d erl y i n g l i ab i l i t i es were ap p ro p ri at el y ch al l en g ed- 5 0 -

[* 5 0 ] an d p ro perl y

ati s su e i n th i s cas e. W e fo l l ow t h e l eado f t h e p art ies an d
rev i ew d e n o v o th e qu es t i on o f p et i t i o n er’ s l i ab i l i t i es u n d er s ect i on 6 7 0 0. II. Sect io n 6 7 0 0 Pen al ty A. Bu rd en o f Pro o f Sect io n 6 7 0 0 p en al t i es are s ub jectt o th e p ro cedu ral ru l es o f s ect i o n 6 7 0 3
. Sect i o n 6 7 0 3(a) p ro v i d es th atth e Secret ary b ears th e b u rd en o f p ro v i n g a t ax p ay er’ s l i ab i l i ty wi th res p ectt o p en al t i es as s es s edu n d er s ect io n 6 70 0
. Al th o u g h th i s Co u rth as n o td eci d edth e ap p ro p ri at e s t an d ardo f p ro o f i n d et erm i n i n g l i ab i l i ty

fo r s ect i o n 6 7 0 0 p en al t i es , th is Co u rt i n Gard ner v . Co m m i s s i o n er, 1 4 5 T.C. at1 7 5 n .1 0 , ci t eda Co urto f Ap p eal s fo r t he Ni n th Ci rcu i td eci s i o n affi rm i ng a Di s tri ctCo u rt ’ s ap pl i cat i o n o f th e p rep on d eran ce o f th e ev i d en ce s t an d ardi n a s ect io n 6 7 0 0 cas e. Ad d i ti o n al l y , the Co u rto f Ap p eal s fo r t h e Ten th Ci rcu it ap pl iedthe p rep on d eran ce o f th e ev i d en ce s t an d ard i n a cas e fo r i n jun ct i v e rel ief u n d er s ect i o n 7 4 0 8 b as edo n a v i o l at i o n o f s ect io n 6 70 0
. Un i ted St at es v . Hart s h o rn , 7 5 1 F.3 d1 1 9 4, 1 1 98 (1 0 th Ci r. 2 01 4 ). W e wi l l fo l l o w th e Co u rto f Ap p eal s fo r th e Ten th Ci rcu it , th e l i k el y ap p el l at e v en u e, an dap p l y a- 5 1 -

[* 5 1 ] p rep o n d eran ce o f t he ev i d en ce s t an dard . See Go ls en v . Co m m is s i o n er, 5 4 T.C. 7 4 2 , 7 5 7 (1 9 7 0 ), aff’ d , 4 4 5 F.2 d 9 8 5 (1 0 th Ci r. 1 9 7 1 ). 1 5 B. El em en t s an dAp p l i cat i o n To s at i s fy th e b u rd en o f p ro o f wi th res p ectt o s ect i o n 6 7 0 0 , res p o nd en tm u s t p ro v e b y a p rep on d eran ce o f t h e ev id en ce t h atp et it i o n er: (1 ) o rg an i zed(o r
as s i s ted i n th e o rg an i zat io n o f) o r p art i ci p at ed(d i rect l y o r i n d i rect l y ) i n th e s al e o f
an i n t eres ti n an i n v es t m en t p l an o r arran g em en t , o r an y o th er p l an o r arran g em en t ;
an d (2 ) m ad e m at eri al s t at em en t s co ncern i n g the “ t ax b en efi t s ” 1 6 t o b e d eri v ed fro m th atp l an o r arran g em en tth atp et i t i o ner k new o r h adreas o n t o kn ow were fal s e. See s ec. 6 7 00 (a). W e ad dres s th es e req u i rem en t s i n tu rn .

1 5 Th i s Co u rth as ap p l i eda p rep o nd eran ce o f t he ev i d en ce s t an d ardwi th res p ectt o an al o g o u s p en al ty co n t ex t s , s u ch as p en al t i es as s es s edu n d er s ec. 6 7 0 2 (a) wh en t ax p ay ers fi l e fri v o l ou s retu rn s. See O’ Bri en v . Co m m i s s i o n er, T.C. M em o. 2 0 1 2 -3 2 6
. Ad di t i o n al l y , a n um b er o f Fed eral co u rt s h av e s peci fi cal l y h el d th atp rep o n d eran ce o f t h e ev i d en ce i s th e ap p ro p ri at e s tan d ardo f p ro o f u nd er s ecs . 6 7 0 0 an d6 7 0 1 . See Un it edSt at es v . Es t at e Pres
. Serv s., 2 0 2 F.3 d1 0 9 3 , 1 0 9 8 (9 t h Ci r. 2 0 00 ); Barr v . Un i t edSt at es , 6 7 F.3 d4 6 9 , 4 6 9 (1 1t h Ci r. 1 9 9 5 ).

1 6 Fo r p u rp o s es o f s ec. 6 7 0 0 , “ s t at em en ts co n cern i n g th e t ax b en efi ts ” m ean s : “ a s t at em en twi th res p ectt o th e al l o wab i l i ty o f an y d edu ct i o n o r cred i t , th e ex cl u d ab i l i ty

o f an y i n co m e, o r th e s ecu ri n g o f an y o th er t ax b en efi tb y reas o n o f h o l d i n g an i n t eres t i n th e en t it y o r p art ici p at in g i n the p l an o r arran gem en t ”. Sec. 6 7 0 0 (a)(2 )(A).- 5 2 -

[* 5 2 ] 1
. Org an i zat i o n an dSal e o f a Pl ano r Arran g em en t Pet i t i o ner co n ten d s th ath e d i dn o ts el l a p l an o r arran g em en tt o av o idt ax es . Pet i t io n er d o es n o trefer t o s p eci fi c ev i d en ce i n s up p o rto f th i s co nt en t i o n b u t
as s ert s th atth e reco rdo n th e wh o l e s up p o rt s t h i s p o s it i on . Sect io n 6 7 0 0 d o es n o td efi n e t h e t erm s “ i n v es t m en t p l ano r arran g em en t ” o r

“ an y o ther p lan o r arran g em en t .” Fu rt h er, t h ere are n o reg u l at i o n s d efi n i n g wh at
co n du ct co n s t i tu t es the o rg an i zat i on o f an en ti ty , p lan , o r arran g em en t d es cri b edi n
s ect i on 6 7 0 0 (a)(1 )(A). Nev ert h el es s , Fed eral cas el aw o n th i s i ss u e i n s tru ct s th ata

“p l ano r arran g em en t ” u n d er s ect i o n 6 7 00 s h ou l d b e d efi n edb ro ad l y an dth atth e

“ s al e o f a p l an o r arran g em en t ” co m p on en to f s ect io n 6 7 0 0 “ i s s at i s fi eds i m p l y b y

‘ sel l i n g an i l l eg al m et h o db y wh i ch t o av o i dp ay i n g t ax es .’ ” See Un i t edSt at es v . St o v er, 6 5 0 F.3 d1 0 9 9 , 1 10 7 (8 th Ci r. 2 0 1 1 ) (qu o t i n g Un i t edSt at es v . Ben s o n , 5 6 1 F.3 d7 1 8 , 7 2 2 (7 th Ci r. 2 0 0 9 )). Fo r p u rp os es o f s ect i o n 6 7 0 0 , “ an y ‘ p lan o r
arran g em en t ’ h av i n g s o m e co n n ect io n t o t ax es can s erv e as a ‘ tax s h el t er’ an dwi l l b e an ‘ ab u s i v e’ t ax s hel t er i f t h e * * * [p ro m o ter] m ak es th e requ is i te fal s e o r frau du l en t s tat em en t s co n cern in g th e t ax b en efi t s o f p art i ci p at i o n .” Un i t edSt at es
v . Raym o n d , 2 2 8 F.3 d 8 0 4 , 8 1 1 (7 th Ci r. 2 0 0 0 ). Fed eral co u rt s h av e fo u n dth at
en g ag i n g i n a b ro adran g e o f m ark et i n g act i v i ti es co n s ti tu t es p art ici p at i o n i n th e
s al e o f an y

i n t eres ti n an en t i ty , p l an , o r arran g em en t , fo r p u rp o s es o f s ect i o n 6 7 0 0
.- 5 3 -

[* 5 3 ] See i d .; s ee al s o Un i t edSt at es v . Kau n , 8 2 7 F.2 d1 1 44 , 1 1 4 9 -1 1 5 0 (7 th Ci r. 1 9 8 7 ). W e co ncl u d e t h at res p on d en t h as d em o n s trat ed th atth e CM S To o l Pro g ram i s a p l an o r o ther arran g em en tu n d er s ect i o n 6 7 0 0 an d th atp et i t i on er o rg an i zed
an d as si s t edi n th e s al e o f t h atp l an o r arran g em en t . To th os e en d s , ev i d en ce
s h o ws , an dwe fi n d , th atCM S m ark et ed an ds o ldthe To o l Pro g ram as a m u l t i s t ep b en efi tp l an th ro u g h wh i ch em p l o y ers an dem

p lo y ees co u l d av o i dp ay in g t ax es
an d th atp et i t io n er was a p ri m ary an di n d i s p en s ab le fi g u re i n th e p l an ’ s
o rg an i zat i o n an ds al e. Th e To ol Pro g ram co n s i s t edo f t h ree d i fferen tt oo l p l an s : (1 ) t h e ex i s t i n g t o o l p l an , (2 ) t h e n ew t o o l p l an , an d (3 ) t h e t o o l u se p l an . CM S
o p erat edth e t oo l p l an s i n s equ en ce, t h ereb y at t em p ti n g t o m ax i m i ze t h e p u rp o rt ed l i fet i m e t ax s av i n g s fo r en ro l l edem p lo y ees an d em

p l o y ers . Inad d i t io n t o th e t o o l p l an s an dp ayro l l ad m i n i s trat i o n , CM S p ro m i sedt o o ffer l eg al res earch an dfree
au d itrep res en t at i on as p art o f an o v eral l em pl o y ee b en efi t s p ack ag e. CM S ch arg ed fees fo r ad m i n i s t eri n g th e t o o l p lan s . Al l CM S’ cl ai m s th atth e To o l Pro g ram o ffereda l eg al av en u e t o ach i ev e t ax s av i n g s were u ns up p o rt ed b y l aw. Fu rt h er, al l o f t h e i nd ep en d en tt ax p ro fes s i o n al s wi th wh o m p et i t i on er an d M r. Dav is o n co n s u l t edreject edth e p o s i t i o n thatth e To o l Pro gram p ro v i d edi t s
en ro l l ees a m ean s t o ach i ev e l eg al t ax s av i n g s . W e fi ndth atCM S ad m i ni s t ereda- 5 4 -

[* 5 4 ] b en efi ts p ro g ram , th e To o l Pro g ram , th ath adas i ts p ri m ary p u rp o s e t h e redu ct i o n i n Fed eral i n co m e an dem p l o ym en t t ax es . Th erefo re, t h e To o l Pro g ram
co n st i tu t eda p l an o r arran g em en tu n d er s ect i o n 6 7 0 0 . See Kau n , 8 2 7 F.2 dat 1 1 4 9 -1 1 5 0 ; s ee al s o Un it edSt at es v . Zan fei , No . 0 4 C 2 7 0 3, 2 0 06 W L 2 8 61 0 5 1 , at* 8 (N.D. Il l . Sep t. 2 9, 2 0 0 6 ). W e al s o fi n d t h atres po n d en t h as s h o wn th atp et it i o n er was an o rg an i zer an d
s el l er o f a p l ano r arran g em en tu n d er s ect i o n 6 7 0 0 . CM S ex i s t eds o l el y t o m ark et
an d o p erat e t h e To ol Pro g ram . Pet i t i o n er was a fo un d i n g m em b er o f CM S an dat al l rel ev an tt i m es s ato n i ts b oardo f d irect o rs . Pet i t i o n er s erv ed as p res i d en to f CM S fro m 1 9 9 9 t o 2 00 2 , an das ex ecu t i ve v i ce p res i d en t o f CM S t h ereaft er. Fu rt h er, atal l rel ev an t t i m es , p et i t i o n er, i n h i s cap aci ty as s o l e s h areh ol d er an d p res i den to f Xel l , o v ers aw t h e m ark et i n g an ds al es o f t h e CM S t o o l p l an s . Xel l
was res p on s ib l e fo r s ecu ri n g t h e m ajo ri ty o f CM S’ cl i en t s an d rev en u es . Pet i t io n er’ s du t i es wi th Xel l co n s i s t edo f m an ag i n g an dtrai n in g s al es ag en t s , co o rd i n at i n g an dp art i ci p at in g i n s al es p i t ch es , an d cl os i n g d eal s wi th p ro sp ect i v e cl i en ts . Pet i ti o n er’ s co re du ti es wi th CM S an dXel l were i n d i s t i n gu i s h ab l e, an di n b o th cap aci t i es h e d i rect ly p art i ci p at edi n t h e m ark et i n g an d s al es o f t h e CM S To o l Pro g ram . Ul t i m at el y , p et i t i o n er was i n st ru m en t al i n o rg an izi n g an dfaci l i t at i n g th e
s al es o f t h e CM S To ol Pro g ram .- 5 5 -

[* 5 5 ] 2
. Pet i t i o ner’ s M at eri al St at em en t s He Kn ew o r HadReas on To

Kn o wW ere Fal s e As rel ev an th ere, t h e s ect i o n 6 7 0 0 p en al ty ap p l ies wh en th e o rg an i zer (o r
as s i s tan t th eret o ), o r s el l er o f a s ub ject p l an (o r as si s t an tth eret o ), m ak es o r cau s es t o b e m ad e an y

s t at em en twi th res pect t o t ax b en efi ts ari s i ng fro m p art i ci p at i o n i n
s u ch a p l an th at(a) i s m at eri al an d(b ) h e o r s h e “ kn ows o r h as reas o n t o kn o w i s fal s e”. See s ec. 6 70 0 (a). St at em en ts co v eredb y s ect i o n 6 7 0 0 i n cl ud e fact ual
m at t ers th atare rel ev an tt o th e av ai l ab il i ty o f t ax b en efi t s an dth o se d i rect l y ad dres s i n g th e av ai l ab il i ty o f t ax b en efi t s. See St o v er, 6 5 0 F.3 d at1 1 0 8
. Un qu al i fi eds t at em en t s co n cern i n g th e t ax b en efi t s o f a s ub jectp l anh av e b een fo u n d t o b e fal s e o r frau du l en ts t at em en t s u n d er s ect i o n 6 7 0 0 . See Un i t edSt at es
v . Gl eas o n , 4 3 2 F.3 d 6 7 8 , 6 8 3 -6 8 4 (6 th Ci r. 2 0 0 5 ). Th e qu es ti o n o f m at eri al i ty d o es no treq u i re p ro o f t h atan y o n e act u al l y rel i edo n th e m i s rep res en tat i o n s o r l i es
o f t h e p ro m o t er. Gard n er v . Co m m i s s i o n er, 1 4 5 T.C. at 1 7 6 . Rat h er, a s tat em en t i s m at eri al i f i two u l dh av e a s ub s t an t i al i m pact o n th e d eci s io n -m ak i n g p ro ces s o f
a reas on ab l y

p ru d en t i n v es t o r o r co n cern s m at t ers rel ev an tt o t h e av ai l ab il i ty o f a t ax b en efi t . See Un i t edSt at es v . Cam p bel l , 8 9 7 F.2 d1 31 7 , 1 3 2 0 (5 th Ci r. 1 9 9 0 ). Th e qu es ti o n o f wh et h er an al l eg edp ro m o t er’ s s t at em en ts were kn o wi n g l y fal s e, o r wh et h er h e o r s h e h adreas on t o kn ow t h e s am e, req u i res an ev al u at i o n o f- 5 6 -

[* 5 6 ] wh ata reas o n ab l e p ers o n i n h i s o r h er p o s it i on wo u l dh av e d i s co v ered . See i d . at1 3 2 1 -1 3 22 . To d et erm i n e wh et h er an al l eg ed p ro m o ter k n ew o r h adreas o n t o kn o wth e s t at em en t s h e o r s he m ad e were fal s e, Fed eral co u rt s h av e co ns i d ered : (1 ) t h e ex t en tt o wh i ch h e o r s h e rel i edo n kn o w l ed g eab le p ro fes s i on al s , (2 ) h i s o r h er s o p h i s t i cat i o n an d edu cat i o n , an d(3 ) h is o r h er fam i li ari ty wi th t ax m at t ers . Un i ted St at es v . Es t at e Pres . Serv s ., 2 0 2 F.3 d1 0 9 3 , 1 1 0 3 (9 th Ci r. 2 0 0 0 ); s ee Kau n, 8 2 7 F.2 d at1 1 4 9
. Fu rt h er, i f an al l eg ed p ro m o t er kn ew h i s o r h er
s t at em en t s co n trad ict eds et t l edl aw o r were co n trary t o ex p res s IRS g u i d an ce, h e
o r s h e wo u l db e i s t reat edas i f h e o r s h e h ada reas o n t o kn o wth at s uch s tat em en ts
m i g h tb e an dp ro b ab l y were fal s e. See St o v er, 6 5 0 F.3 dat1 1 1 0 . Ad d i t io n al l y , o m is s i o n o f m at eri al fact s wei g h s as h eav i l y m ak i n g fal s e m at eri al s t at em en t s . See i d . at1 1 0 9 -1 1 11 ; s ee al s o Hart s h o rn , 7 5 1 F.3 d at1 2 0 2 (Co u rto f Ap p eal s fo r t h e Ten th Ci rcu i tap p l y i ng s ect i on 6 7 00 i n the co n tex t o f an i n jun ct i o n u nd er s ect i o n 7 4 0 8 u s edth e reas o n ab l e p ers o n t es t ). Pet i t i o ner d o es n o ts p eci fi cal l y d i s p ut e t h ath e m ad e m at eri al s t at em en t s reg ard i n g th e t ax b en efi t s o f t h e To o l Pro gram . Ho wev er, h e co nt en d s t h ath e d i d
n o tm ak e an y

m at eri al s t at em en t s th ath e kn ew o r h ada reas o n t o kn o wwere fal s e reg ard i n g th e t ax b en efi t s o f t h e To o l Pro gram . Pet i t i o n er arg u es th at h e rel i edo n th e ad v i ce o f h i g h l y

res pect ed t ax p ro fes si o n al s i n o rg an i zi n g an dm ark et i n g th e- 5 7 -

[* 5 7 ] To ol Pro g ram . Fo r s up p o rt , p et i ti o n er p o i n t s o u tth ath e rel iedo n M r. Dav is o n ’ s t ax ad v i ce i n creat i n g an dm ark et i n g the To o l Pro g ram , p art i cu l arl y Gran tTh o rn t o n ’ s ju s t i fi cat io n p ap er. Pet i t io n er as s ert s t h atthe reco rds h o w s h e
was tran s p aren t wi th p ro s p ect i ve cl i en ts reg ard i n g th e ri s k s i n ci den tt o th e To o l Pro g ram , s p eci fi cal l y

th atthe t o o l p lan s wo u ldl ik el y b e u n su cces s fu l o n an IRS
au d it
. a. M at eri al Fal s e St at em en t s Ab o u tth e Ex i s ti n g To o l Pl an ’ s Co m

p l i an ce W i th th e Acco u n t ab l e Pl an Ru l es Res p o n d en targ u es th atp et i ti o n er m ad e m at eri al fal s e s t at em en ts co n cern i n g th e t ax b en efi ts o f the To o l Pro g ram . Sp eci fi cal l y , res p o n d en tco nt en d s th at p et i t i o n er s t at edfal s el y

th atrei m b urs em en tp aym en ts m ad e u n d er t h e ex i s ti n g t o ol p l an were n o n t ax ab l e u n d er t h e acco u n t ab l e p l an ru l es . Fu rth er, res p o nd en t
co n ten d s t h ats u ch s t at em en ts wo u l dh av e a s ub st an t i al i m p act o n a reas o n ab l y p ru d en ti n v es t or’ s d eci s i o n -m ak i n g p ro ces s b ecau s e s u ch s t at em en ts i n cl u d e
m at t ers rel ev an tt o t h e av ai lab i l i ty o f a t ax b en efi t . See Cam p b el l , 8 9 7 F.2 dat 1 3 2 0 ; s ee al s o St o v er, 6 5 0 F.3 dat1 11 1 (“ [St o v er] p ro m i sedt o redu ce h i s cl i en t ’ s t ax ab l e i n co m e b y

h u n dred s o f th o u s an d s o f d o l l ars . An y s u ch p ro m is e wo u l d h av e h ada s ub s t an t i al i m p acto n the d eci si o n m ak in g p ro ces s o f a reas o n ab l y p ru d en ti n v es t or.”). W e ag ree wi th res p o nd en t an dfi ndth at th e CM S To o l- 5 8 -

[* 5 8 ] Pro g ram ’ s ex i s t i n g t o o l p l an d i dn o tqu al i fy as an acco u n tab l e p l an an dth at
s t at em en t s m ad e b y

p et i t i o ner t o th e co n trary wh i l e m ark et i ng th e t o ol p ro g ram
were m at eri al an dfal s e. Un d er s ect i o n 6 2(a)(2 )(A), an em p l o y ee can d edu ctcert ai n b us i n es s
ex p en s es i n cu rredi n co nn ect i o n wi th th e p erfo rm an ce o f s erv i ces fo r an em p l o y er
u n d er a rei m

b u rs em en t o r o ther ex p en s e al l o wan ce arran g em en t . If thes e ex p en s es are rei m b u rs edb y th e em p l o y er p u rs uan tt o an “ acco u n t ab l e p l an ”, t h en th e rei m b u rs edam o u n ti s ex cl ud edfro m g ro s s i nco m e an di s n o tco ns i d eredwag es o r
o th er co m

p en s at i o n . Sec. 1 .6 2 -2 (c)(4 ), In co m e Tax Reg s . Thu s , ex p en s es rei m b u rs edp urs u an tt o an acco u n t ab l e p l an wo ul db e ex em p tfro m wi thh o ld i n g
an d p aym en to f em

p l o ym en tt ax es . See i d . Ho wev er, i f th e rei m b u rs em en ti s n o t
m ad e u n d er an acco u n tab l e p l an , th en th e am ou n t o f t h e rei m b urs em en ti s t reat ed
as wag es an di s i n cl u d edi n th e em p l oy ee’ s t ax ab l e i nco m e. Id . s ub p ara. (5 ) To qu al i fy

as an acco u n t ab l e p l an , th e p l anm u s t: (1 ) h av e a b u si n es s
co n nect io n , (2 ) req u i re s ubs t an t i at i o n o f ex p en s es , an d(3 ) req ui re th e retu rn t o th e
em pl o y er o f am o u n t s ex ceed i n g t h e em p l o y ee’ s actu al ex pen s es . Id . p aras . (c), (d ), (e), an d(f). A rei m

b u rs ed em

p lo y ee ex p en se can b e “ i n co n n ect i o n wi th ” t h e p erfo rm an ce o f s erv i ces as an em p l oy ee, an dex cl u d ab l e fro m g ro s s i n co m e u n d er th e acco u n t ab l e p l an ru l es , o n l y i f i ti s i n cu rredb y

an em p lo y ee o n b eh al f o f t h e- 5 9 -

[* 5 9 ] em p lo y er t h atp ro v i des th e rei m b urs em en t . Id
. p ara. (d )(1 ). Rei m b u rs em en t s fo r ex p en s es i n cu rredb efo re an em p l o y ee’ s em

p lo ym en twi th h i s
o r h er cu rren tem

pl oy er are n o ti n cu rred b y an em p l o y ee i n th e co u rs e o f h is o r h er
cu rren tem

pl o ym en t , an dwo ul dth u s fai l th e b u s i n es s co n n ect i o n req u i rem en t . See Bi eh l v . Co m

m i s s io n er, 1 1 8 T.C. 4 6 7 , 4 7 8 (2 0 0 2 ), aff’ d , 3 5 1 F.3 d9 8 2 (9 th Ci r. 2 0 03 ). Atal l rel ev an tt im es , th e ex i s t i n g t o ol p l an was m ark et edas an acco u n t ab l e p l an . Pro m o ti o n al m at eri al s creat edb y p et i t i o n er em

p h as i zedth e ex is t in g t o o l p l an ’ s co m

p l ian ce wi th th e l aws an dreg u l at i o n s o n acco un t ab l e p l an s . Al th o u g h
an em p l oy er’ s em

p l o y ees h adth e o p t i o n o f en ro l li n g i n o n e o r m o re o f t he t h ree To o l Pl an s , ap p ro x i m at el y 90 % o f al l cl i en t -em p l o y ees en ro l l ed i n th e ex i s t i n g t o o l p l an . A cl i en t -em

pl o y ee was req u i redt o fi l l o utan en ro l l m en t fo rm as th e fi rs ts t ep t o wardfu l l p art i ci p at i o n i n th e ex i s t i n g t oo l p lan . On the en ro l l m en t fo rm , th e cl i en t -em

p l o y ee l i s t edth e acq u i s i t i o n co s t o f al l h i s o r h er t o o l s , i n cl u d i n g t o o l s acq u i redb efo re em p l oym en tan dt o o l s u n n eces s ary fo r t he jo b
. Em p l o y ees were i n s tru ct edt o , an dd i di n fact , i ncl u d e o n th ei r en ro l l m en tfo rm s th e acq u is i t i o n co s ts o f t o o l s u n rel at edt o th ei r wo rko r p u rch as edi n y ears b efo re th ei r cu rren t em

p lo ym en t . Th i s p ract i ce i s d i rect l y i nco ns i s t en t wi th th e b u s i n es s
co n nect io n req u i rem en to f t h e acco u n t ab le p l an ru l es . See s ec. 1 .6 2 -2 (d )(1 ),- 6 0 -

[* 6 0 ] In co m e Tax Reg s . ; s ee al s o Bi eh l v . Co m m i s s io n er, 3 5 1 F.3 dat9 8 6-9 8 7 (s t at i n g th ati n o rd er t o m eet th e b u s i n es s co n n ect io n req u i rem en t , rei m b u rs ed
ex p en s es m

u s tb e i n cu rreddu ri n g th e co u rs e o f em p l oym en t ). Th erefo re, t h e
ex i s t in g t o o l p l an d i d n o tm eetth e b u si n es s co n n ect i o n req u i rem en to f t h e
acco u n t ab l e p l anru l es . Fu rt her, t o p ro p erl y

s ub s t an t i at e ex p en s es , em p l o y ees m

u s ts ub m i t i n fo rm at i o n t o th e em

p l o y er s u ffi ci en tt o i d en t ify the s p eci fi c n atu re o f each
ex p en s e an d t o co n cl ud e t hatthe ex p en s e i s at tri b u t ab l e t o th e em p l o y er’ s b u s i n es s act i vi t i es . Sec. 1 .6 2 -2 (e)(3 ), In co m e Tax Reg s . Each o f th e el em en t s o f an
ex p en d i tu re o r u s e m

u stb e s ub s t an t iat edt o th e p ay o r. Nam y s tv . Co m

m i s s i o n er, T.C. M em o . 2 00 4 -2 6 3 , s l i p o p . at4 , aff’ d , 4 3 5 F.3 d9 1 0 (8 th Ci r. 2 0 0 6 ); s ec. 1 .6 2
- 2 (e)(3 ), In co m e Tax Reg s . Inacco rd an ce wi th s ect i o n 1 .6 2 -2 (e)(3 ), In co m e Tax Reg s., i f an em

p l o y ee i s n o t req u i redt o s ubs t an t i at e an ex p en s e t o th e p ay o r fo r rei m b u rs em en t , th en th e rei m

b u rs em en tarran g em en ti s n o t an acco u n t ab l e p l an . Fu rt h er, i f an em

p l o y ee m erel y

ag g reg at es ex p en s es i n to b ro adcat eg o ri es , o r rep o rt s i n d i v i du al ex p en s es thro u g h th e u s e o f v ag u e n o n d es cri pt i v e t erm s (s u ch
as “ m i s cel l an eo u s b u s i n es s ex p en s es ”), t h e s ub s t an t i at io n req u irem en ti s n o t
s at i s fi ed . Id
.- 6 1 -

[* 6 1 ] In d et erm in i n g th e t o t al acq u i s i t io n co s t o f a cl i en t -em p l o y ee’ s t o o l s , CM S i n s tru ct edcl i en t -em

p l o y ees t o l i s tas m an y

t oo l s as p o s s ib l e, ev en u n neces s ary o r p rev i o u s l y acq u i redt o ol s . If t h e em p lo y ee d i d n o th av e reco rd s o f t h e acq u i s i t i o n
co s t s o f t h ei r t o o l s, th e em p l o y ee was i n s tru ct ed t o es ti m at e t h e o ri g i n al co s t s an d wri t e th atam o un to n t h e en ro l l m en tfo rm . Cl i en t -em p l o y ees were n o t req u i red t o p ro v id e ei th er recei p t s s up p o rt i n g th e acq u i s i t i o n co s t s s t at edo n th ei r en ro l l m en t fo rm s o r t o l i stth e d at es th ey p u rch as edth ei r t oo l s . Al th o u g h p et i t i o ner cl ai m ed CM S fo rm al l y

ch an g edth i s ru l e i n 2 0 0 7 t o req u ire recei p t s , CM S d i dn o td em an d recei p t s fro m

i ts cu rren to r fu tu re cl i en t s . Al th ou g h CM S an dXel l ’ s m ark et i n g m at eri al s em p h as i zedth e i m

p o rt an ce
o f accu rat e reco rds ub s t an t i at i on i n acco rd an ce wi th th e acco u n t ab l e p l an ru l es , n o
o n e fro m CM S o r Xel l v eri fi edth atth e s t at edacq u is it i on co s t s fo r t h e t o o l s were
accu rat e o r t h ata g i v en t o o l was n eed edfo r t h e jo b. Fu rt h er, t h e en ro l lm en tfo rm d i dn o t req u i re t h e cl i en t -em p l o y ee t o l i s tth e co s t o f each s ep arat e t o o l b u ti n s t ead d i rect ed th e cl i en t -em

p l o y ee t o cat eg o ri ze t he t o o l co s t s i n t o b ro adcat eg o ri es , s u ch as a “ m i s cel l an eo u s ” cat eg o ry . Th es e b eh av i o rs are d i rect l y i n co n s i s t en twi t h th e s ub s t an t i at io n req u i rem en to f t h e acco u nt ab l e p l an ru l es . See s ec. 1 .6 2 -2 (e)(3 ), In co m e Tax Reg s .- 6 2 -

[* 6 2 ] Becau s e t he ex i s t i n g t o o l p lan d i dn otm eet th e b u s i n es s co n nect i o n req u i rem en to r t h e s ub s t an t i at i on req ui rem en t , i ti s n o tan acco u n t ab l e p lan . Fal s e
s t at em en t s u n d er s ect i o n 6 7 0 0 i n cl u d e rep res en t at io n s th ata p lan qu al i fi es fo r
s p eci al t ax treat m en t wh en th e p l an d o es n o tco m pl y wi th t h e l aw. See Ko res k o v . Un i ted St at es , 1 2 3 F. Sup p . 3 d6 5 4 , 6 8 2 -6 8 9 (E.D. Pa. 2 0 1 5 ). Th e m ark et i n g
m at eri al s creat edan du s edb y p et i ti o n er an ds al es ag en t s i ncl u d eds t at em en t s th at th e ex i s t i n g t o o l p l an was i n co m p l i an ce wi th th e l aw o n acco un t ab le p l an s . Th erefo re, p et it i o n er m ad e an dcau s eds al es ag en t s o f CM S an dXel l t o m ak e fal s e
s t at em en t s co n cern in g the av ai l ab i l it y o f t ax b en efi t s u n der t h e To o l Pro g ram . Fu rt h er, b ecau se s t at em en t s co ncern i n g wh et h er t h e ex i s t i n g t o o l p l an qu al i fi edas
an acco u nt ab l e p lan are s t at em en t s d irect l y rel ev an t t o th e av ai l ab i l i ty o f a t ax b en efi t , s u ch s tat em en ts are m at eri al . See Cam p b el l, 8 97 F.2 d at 1 3 2 0
. 1 7 Th erefo re, p et it i o n er m ad e m at eri al fal s e s t at em en t s co ncern i n g th e av ai l ab i l i ty o f t ax b en efi t s u n d er t h e To o l Pro g ram wi th res pect t o the ex i s t i n g t o o l p l an ’ s qu al i fi cat i o n as an acco un t ab l e p l an .

1 7 Res p o nd en th as s h o wn Th e reco rdes t ab l i s h es th at p et i t i o n er fai ledth e b u s i n es s co n n ect i on an ds ub s t an t i at io n req u irem en ts o f t h e acco u n t ab l e p l an ru l es . Co n s equ en t l y , we n eedn o t ad dres s wh et h er h e fai l edth e ex ces s recei p t s req u i rem en t .- 6 3 -

[* 6 3 ] b
. Fal s e St at em en t s Ab ou tth e Tax Ben efi t s o f t h e To o l Us e Pl an Pro m o t i o n al m at eri al s creat edan d u sedb y p et i t i o n er an dCM S’ s al es ag en t s
m ark et edth e t o o l u s e p l anas a m et h o d t o al l o w a cl i en t -em p l o y ee t o ch arg e h i s o r h er em pl o y er a n o n t ax ab l e fee fo r t h e ren t al o f t h e em p l o y ee’ s t o o l s du ri n g th e d ai l y co u rs e o f t h e em

p l o y ee’ s l ab o r. Pet i t i o ner an d M r. Dav i s on kn ew t hatth e t o o l u s e p l an fai l edth e acco u n t ab l e p l an req u i rem en t s an dd i d n o tat t em p t t o
m ark etth e t oo l u s e p l an as an acco u n t ab l e p l an . In s t ead , CM S cl ai m edth atth e
ren t al fees p ai d u n der t h e t o o l u s e p l an fel l o u t s i d e t h e em p lo ym en tt ax d efi n i t i o n
o f wag es , an dp aym en t s m ad e th ereu n d er, fro m th e em p l o y er’ s p o i n to f v i ew, were
n o ts ub jectt o th e em

p l o y m en tt ax . M ark et in g m at eri al s erro n eo u s l y cl ai m edth at rel ev an t l aw s up p o rt edthe t o ol u s e p l an . Des p i t e cl ai m s i n CM S’ p ro m o t i o n al m at eri al s t h atp aym en t s m ad e u n d er th e t o o l u s e p l anwere n on t ax ab l e, p et i t i o n er was rep eat ed l y i n s tru ct edb y i n d ep en den tt ax p ro fes s i o n al s th at th ere was n o au th o ri ty fo r t h e co n cl u si on th at
s u ch paym en t s were n o t s ub jectt o Fed eral em

p l o y m en t t ax es . Fu rt h er, p et i t i o n er
was aware t h atthe IRS i n Rev
. Ru l . 2 0 0 2 -3 5 , s up ra, i n s tru ct edth ati f a p l an o r
arran g em en td o es n o ts at i sfy o ne o r m o re o f th e acco u nt ab l e p l an req ui rem en t s , al l
am ou n t s p ai du n d er t h atarran gem en tare p ai du nd er a n o n acco u n tab l e p l an an d- 6 4 -

[* 6 4 ] t ax edas wag es . Pet i t i o n er an dM r. Dav i s o n were rep eat ed l y m ad e aware o f th i s g u i d an ce b u tp ers i s tedi n m ark et i n g th e t o o l u s e p lan as res u l ti n g i n
n o n t ax ab l e p aym en t s . Pet i t i o n er u s edM r. Dav i s o n ’ s l eg al o p i ni o n s i n p ro m o t i n g th e t o o l u s e p l and es p i te t h e factth atal l o f t h e o th er t ax p ract i t i o n ers wi th wh o m h e co ns u l t edco m

pl et el y d i s ag reedwi th M r. Dav i s o n an dad v i s edp et it i o n er t o s t o p
m ark et i n g th e t o o l u s e p l an as res u l t i ng i n n o nt ax ab le p aym en t s . Ul t i m at el y , p et i ti o n er’ s m ark et i n g m at eri al s cl ai m edth e t o o l u s e p lan was
s up p ort edb y

l aw, b u tth e ev i d en ce i n th e reco rdd o es n ots up p o rtth atcl ai m . Pet i t io n er fai l edt o i n s tru ct cl i en t -em pl o y ers an dcl ien t -em

p lo y ees as t o t h e ri s k s th atth e t o o l u s e p l an wo u l dfai l i n an au di tb y th e IRS. St at em en ts are fal s e wh en
as s ert i o n s are n o tqu al i fi edan dcu st o m ers are n otn o ti fi ed th atfo l l o wi n g th e ad v ice co u l ds ubjectth em t o IRS s cru t i n y . St o ver, 6 5 0 F.3 dat1 1 0 9 -1 1 10
. Pet i t io n er was rep eat ed l y i n s tru ct edas t o th e ri s k s as so ci at ed wi th en ro l l m en ti n th e t o o l u s e p l anb u tfai l ed t o i n fo rm p ro s pect i ve an d cu rren tcl i en t s o f th atri s k
. Th erefo re, p et it i o n er m ad e fal s e s t at em en t s as t o th e t ax b en efi t s i n ci den tt o p art i ci p at i o n i n th e t oo l u s e p l an , an db y ex t en s i o n , th e To o l Pro g ram . See i d
. Su ch cl ai m s were m at eri al b ecau s e t h ey co n cern edth e av ai l ab i li ty o f t ax b en efi t s
u n d er t h e To o l Pro gram . See Cam p b el l, 8 97 F.2 d at 1 3 2 0
.- 6 5 -

[* 6 5 ] c. Pet i t i o n er’ s Fal s e St at em en t s Co n cern i n g t h e Ri s k s o f En ro ll i n g i n th e To o l Pro g ram St at em en t s are fal s e wh enp ro m o t ers fai l t o qu al i fy as s ert i o ns ab o u tth e
av ai l ab i li ty

o f t ax b en efi t s an dn o t i fy cl ien t s t h atfo l l o wi n g th e s t at em en t s co u l d
s ub jectthem t o IRS s cru t i n y . See St o v er, 6 5 0 F.3 d at1 1 0 9 -1 11 0 . Co u rt s h av e rep eat ed l y

h el dth ata t ax p ro m o t er’ s fai l u re t o ad v is e h i s cl i en t s o f t h e req u i rem en t s t o qual i fy

fo r a t ax b en efi tqu al ify

as a fal s e s t at em en t . See Gl eas o n , 4 3 2 F.3 dat6 8 2 -6 8 3 ; Es tat e Pres . Serv s . , 2 0 2 F.3 dat1 1 0 1. Al th ou g h p et i t i o n er an dM r. Dav i s o n b el i ev edth ere was a m ere 3 3.5 % ch an ce th atth e n ew t o o l p l an an dt o o l u s e p l an wo u l ds u cceed i n an au di tb y th e IRS, t h ey m ark et edth e To o l Pro g ram as i f t h ere were m i n i m al ri s k s i n en ro l l m en t . Fo r ex am p le, p et it i on er d i d n o tm en t i o n th att oo l rei m b u rs em en tp l an s were b ei n g cl o s el y s cru t i n i zedb y

th e IRS wh en h e d is cu s s edth e To o l Pro gram wi th cu rren t
an d p ro s p ect i v e cl i en t s . In st ead , th e m ark et i n g m at eri al s em p h as i zedth atth e t o o l p l an s o ffered an i ncreas e i n an em p l o y ee’ s t ak e-h o m e p ay . Fu rt h er, t h e d eci s i o n t o
en ro l l i n th e fu l l s u it e o f t oo l p l an s was p res en t edas s i m p le as th e d eci si o n t o p i ck
up a $ 2 0 b i l l o n th e g ro u n d . Ex ecu ti v e s u m m ari es draft edb y

M r. Dav i s on rep res en t edth atGran t Th orn t o n h add et erm i n ed th atth e n ew t oo l p l anan dth e t o o l
u s e p lan co m

p l i edwi th ap p l i cab l e l aw an dthatth e t ax b en efi t s p u rp o rt edt o fl o w- 6 6 -

[* 6 6 ] th erefro m

were s up po rt edb y

“ s ub s t an t ial au th o ri ty ”. Th e s u m m ari es d i dn o t d i s cl os e t h atGran t Th o rn t o n, KPM G, M cDerm o t t , an dCro w e reject ed th e p o s i t i o n th atth ere was l eg al au th o ri ty s up p o rt i n g th e t o ol u s e p l an an dth e n ew t o ol p l an as ad m i n is t eredb y CM S. Th es e ex ecu t iv e s u m m ari es al s o fai ledt o ad dres s t he l awfu l n es s o f t h e ex i st i n g t o ol p l an , d es p i t e t he fact th at CM S m ark et ed al l th ree p l an s s i m u l t an eo u s l y . Pet i t i o n er an dM r. Dav i s o n ag g res s i v el y m ark et edth e
ex i s t in g t o o l p l an d es p i t e t h ei r co m m o n u n d ers t an d i n g th atthi s p l an carri eda ri s k
o f p en al t i es an dwas an ag g res s i v e t ax p l an ni n g t act i c. Pet i t i o ner’ s fai l u re t o em p h as i ze th e IRS’ h ei g h t en eds cru t i ny t o wardt o o l rei m b u rs em en tp l an s was a fai l u re t o i n fo rm th e cl i en t s th at fo l l o w i n g h i s ad v i ce
co u lds ub jectth em t o IRS s cru t i n y . See St o v er, 6 5 0 F.3 dat1 1 09 -1 1 1 0. Fu rt h er, p et i t i o n er d i dn o ttru th fu l l y d i s cl o s e t he av ai lab i l i ty

o f t ax b en efi t s u n d er t h e To o l Pro g ram g en eral l y , p art i cu larl y

b en efi t s av ai l ab l e u n d er th e ex i s t i ng t o ol p l an . See i d . To g et h er, t h es e o m i s s i o n s co n s t i tu te t he p ro m u l gat i o n o f ad di t i o n al fal s e
s t at em en t s co n cern in g the t ax b en efi t s av ai l ab l e u n d er t h e To o l Pro g ram . See i d .; Gl eas o n, 4 32 F.3 d at6 8 2 -6 8 3 ; s ee al s o Es t at e Pres . Serv s ., 2 0 2 F.3 dat1 1 0 1 . Su ch
s t at em en t s are m at eri al p reci s el y b ecau s e th ey

co n cern th e av ai l ab il i ty

o f t ax b en efi t s u n d er t he To o l Pro g ram . See Cam p bel l , 8 9 7 F.2 dat 1 3 20
.- 6 7 -

[* 6 7 ] d
. Pet i t i o n er’ s Kn owl ed g e Th at Hi s M at eri al St at em en t s Ab o utth e Tax Ben efi t s o f t h e To o l Pro g ram W ere Fal s e Pet i t i o ner arg u es th ath e d i dn o tv i o lat e s ect i o n 6 7 0 0 b ecau se h e d i dn o t kn o w o r h av e reas o n t o kno w th at h e m ad e m at eri al fal s e s t at em en t s co n cern i n g th e t ax b en efi ts o f the To o l Pro g ram . Pet it i o n er co n t en ds th ath e l ack s t ax an d l eg al ex p ert i s e. Pet i t i o n er arg ues th ath e rel i edo n the t ax g u i dan ce o f M r. Dav is o n . Res p o n d en tco n t en d s th atp et i t i o n er i s n o t en t i t ledt o rel y o n M r. Dav i s o n ’ s ad v ice b ecau s e M r. Dav is o n was n o tan i n d ep en d en tt ax ad v is er an dwas a
co p ro m o t er an d a n eces s ary el em en to f t h e To o l Pro g ram ’ s co m m erci al s u cces s . In s up po rto f t h i s p os i ti o n , res p o n d en t d irect s o u r at t en ti o n t o Es t at e Pres . Serv s ., wh ere t h e Co u rto f Ap p eal s fo r t h e Ni n th Ci rcu i t h el dth ata p ro m o ter h adn o t rel i edo n p ro fes s i o n al ad v i ce wh en h e ch o s e t o i g n o re t ho s e wh o were s kep t i cal as t o the l eg al i ty

o f h i s s tat em en t s an d t o t ak e t h e ad v i ce o f o n l y th o s e wh o
u n qu es t io n i n g ly

ag reedt o fu rt her t h e s ch em e. Es tat e Pres . Serv s ., 2 02 F.3 d at 1 1 0 3 . Th e reco rdi nd i cat es thatM r. Dav i s o n was n o tan i n d ep en den t t ax ad v i s er, b u ti n s t eadwas i n t i m at el y i nv o l v edi n the d ev el o p m en t o f t h e CM S To o l Pro g ram . M r. Dav i s o n s at o n th e CM S b o ardo f d i rect o rs an d was h el d o u tas th e t ax ex p ert b eh in dth e To o l Pro g ram . M r. Dav i s o n was s p eci fi cal l y as s i g n edth e t as k o f- 6 8 -

[* 6 8 ] m ol l i fy i n g s k ep t i cal cl i en t -em p lo y ees ’ co n cern s ab o utthe l eg al i ty o f t h e To o l Pro gram . Pet i t i o n er u n d ers t o o dth atM r. Dav i s o n ’ s “ s ub s t an t i al au th ori ty ”
o p i n i o n s m ean tth e n ew t o o l p lan an dth e t o o l u s e p l an s to o do n l y a 3 3
. 5 % ch an ce
o f s u cces s o n au d it . Pet i t i o n er fai l edt o ad equat el y co m m u n icat e t h i s t o p o t en t i al cl i en t-em p l o y ers an dcl i en t -em

p l o y ees . Duri n g th e IRS au d it s o f CM S’ cl i en t s ’ retu rn s , p et i t i o n er p ro v i d edco p i es o f M r. Dav is o n ’ s p ro t es tl et t er, d es p it e p et i t i o n er’ s kn owl ed g e t h atM r. Dav i s o n was en jo i n edfro m

p ro m o t i n g t ax
s h el t ers . Ad d it i on al l y , p et i t i o n er was aware o f g u i d an ce i ss u ed b y th e IRS i n d i cat i n g i n creas edau di t at t en t i o n t o t oo l rei m b u rs em en tp lan s s u ch as tho s e m ark et edan d ad m i n is t eredb y CM S. Pet it i o n er was rep eat ed l y ad v i s edb y

i n dep en d en tt ax p ract i t i o n ers , i n cl u d i n g Cro we, Gran tTh orn t o n, KPM G, an dM cDerm o t to f t h e ri sk s th atth e t oo l p lan s wo u l dfai l t o p as s m u s t er i f return s were ex am i nedb y th e IRS. Cro we, Gran tTh orn t o n , KPM G, an dM cDerm o tti n fo rm edp et i t i o n er th at th ere was n o l eg al au th o ri ty fo r t h e t o o l u s e p lan . In s teado f rel y i n g o n th e ad v i ce
o f i m p art i al t ax p ro fes si o nal s , p et i t i o n er ch o s e t o fo ll o w M r. Dav is on ’ s ad v i ce. Co u rt s h av e fo u ndth atth e “ kn o w o r reas o n t o kn o ws t an d ard ” m ean s wh at
a reas on ab l e p ers on i n th e t ax p ay er’ s s ub ject i v e p os i t i o n wo u l d h av e d i s co v ered
. See Cam p b el l , 8 9 7 F.2 dat1 3 21 -1 32 2 . W e l o o kat(1 ) t h e ex t en tt o wh i ch th e- 6 9 -

[* 6 9 ] t ax p ay er rel iedo n kn owl ed g eab l e p ro fes s i o n al s, (2 ) t he t ax p ay er’ s
s o p h is t i cat i o n an dedu cat i o n, an d(3 ) t h e t ax p ay er’ s fam i l i ari ty wi th t ax m at t ers . Es t at e Pres . Serv s ., 2 02 F.3 d at1 1 0 3 . A t ax p ay er h as reas o n t o kn ow t h at
s t at em en t s m ay

b e an dp ro b ab l y

are fal s e wh enth o s e s tat em en t s co nt rad i cts et t l ed l aw o r are co nt raryt o ex p res s IRS g u i d an ce. St o v er, 6 50 F.3 d at 1 1 1 0
. It is cl ear t h atp et i t io n er was aware o f IRS g u i d an ce rel ev an tt o th e l eg al i t y
o f t h e To o l Pro g ram . Fu rt h er, p et i t i o n er was aware t hatn o kno wl ed g eab l e p ro fes s i on al wi th wh o m

h e co ns u l t edag reedwi th M r. Dav i s o n ’ s p o s i t i o n reg ard i n g th e t o o l p ro g ram . In s t eado f rel y i n g o n th es e kn o wl ed geab l e p ro fes s i on al s , p et i t i o n er co m p l et el y i gn o redth ei r ad v i ce an dm ad e n o ch an g es t o th e t o o l p ro g ram

as a res u lto f t h ei r reco m m en d at io n s . Fu rt h er, p et i t i o n er kn ew th atM r. Dav i s o n b el i ev edeach o f t h e t o o l p l an s wo u l dp ro b ab ly fai l IRS
ex am i n at i o n , wh i ch res u l t s i n th e d en i al o f t h e t ax b en efi t s u n d er th e To ol Pro g ram . Thu s, p et i ti o n er was aware t h atth es e p ro gram s were n o t d ev o i d o f ri s k, wh i ch was h o w h e p res en t edth e p l an s t o p o ten t i al cl ien t s. Pet i t i o n er h el ped d es i g n th e To ol Pro g ram

al o n g wi th M r. Dav i s o n, an d reg u larl y d i s cu s s edth e t ax ad v ice h e recei v edwi th t h e fi rm s th ati s s u edi t , as wel l as wi th M r. Dav i s o n . To cl ai m p et i t i o n er h adn o t ax kn o wl ed ge wo u l d m ean h e i n g es t edn o t ax i n fo rm at i o n du ri n g th e y ears s p en t d es i g n i n g , m ark et in g , d i scu s s i n g th e To o l Pro g ram --a- 7 0 -

[* 7 0 ] p ro g ram

wh o s e v al ue d ep en d s en t irel y o n th e p u rp o rt edt ax b en efi ti t d el i v eredt o th e cu s t o m er. Ul t i m at el y , we ag ree wi th res p on d en tth atp et i t i o n er kn ew o r s h o u l dh av e kn o wn th ath i s m at eri al s t at em en ts reg ard i n g th e t ax b en efi t s
av ai l ab l e u n d er t h e t oo l p ro g ram were fal se. III. Sup erv i s o ry

Ap pro val an dAm o u n t o f Pen al ti es Res p o n d en tb ears th e b u rd en o f p ro du ct i o n wi th res p ectt o p et i t i o ner’ s l i ab i l i ty fo r s ect io n 6 70 0 p en al t i es . See s ec. 7 4 9 1 (c). As p arto f t h atb u rd en , res p o n d en t m

u s ts h o w th atth e wri t t en s up erv i so ry ap p ro v al req ui rem en t o f s ect i o n 6 7 5 1 (b )(1 ) was t i m el y

co m pl i edwi th . See Graev v . Co m m i s s i o n er, 1 4 9 T.C. 4 8 5 , 4 9 3 (2 01 7 ), s upp l em en t in g an do v erru li n g i n p art1 4 7 T.C. 4 60 (2 0 16 ); s ee al s o Cl ay v . Co m m i s s i o n er, 1 52 T.C. 2 2 3 , 2 4 9 (2 0 1 9). Onth e reco rdb efo re u s we fi n d th atres p o n d en t h as m eth i s b u rd en o f p ro du ct i o n . Th e RA’ s i m m ed i at e s up erv i s o r p ers o n al l y

ap p ro v edth e i n i ti al d et erm i n at i o n o f t h e s ect io n 6 70 0 p en al t i es
as s es s edag ai n stp et i t i on er o n March 2 6 , 2 01 4 , b y s i g n in g th e Fo rm s 8 27 8 fo r each
o f t h e y ears ati s s ue. Th e p en al t i es as s es s edwere fi rs tco m m u n i cat edt o p et i t i o n er b y way of a No t ice CP1 5, d at edJ u n e 2 3 , 2 0 1 4 , fo r each o f t he y ears at i ss u e. Th u s, wri t t en s up erv is o ry ap p ro v al fo r t h e p en al t i es was g iv en b efo re t h e fi rs t fo rm al co m

m u n i cat i o n o f t he p en al t i es t o p et i ti o n er. Bel ai r W oo d s , LLC v
.- 7 1 -

[* 7 1 ] Co m

m i s si o n er, 1 5 4 T.C. _

_ , _

_ (s l i p o p . at 2 3 ) (J an . 6 , 2 0 2 0 ); s ee al s o Cl ay
v . Co m m i s s i o n er, 1 5 2 T.C. at2 4 6 -2 5 0
. Sect io n 6 7 0 0 (a) p ro v i d es th atfo r an y p ro m ot er wh o m ak es o r cau s es t o b e
m ad e an y m at eri al fal s e s t at em en t s rel at i n g t o t ax b en efi t s , th e am o un to f th e p en al ty s hal l b e eq ual t o 5 0 % o f t h e g ro s s i n co m e t h e p ro m o t er d eri vedth erefro m . Th u s, the p en al ty

i s ap p ro p ri at el y

cal cu l at edas 5 0 % o f t h e g ro s s i nco m e p et i t i o ner d eri v edfro m s el l i n g , o r p art i ci p at i n g i n s el l i n g, the To o l Pro g ram . 1 8 Res p o n d en t
as s es s eds ect i o n 6 7 0 0 p en al t ies ag ai n s t p et i t i o n er i n th e t o t al am o un to f $ 1 8 1 ,0 7 6
. In d et erm i ni n g th e s ect i o n 6 7 0 0 p en al ty fo r each o f t h e t ax y ears ati ss u e, t h e RA i d en t i fi edCM S’ g ro ss recei p t s an dth en m u l t i p li edth atam o u n t b y

1 6 %, p et i t i o n er’ s p ro p o rt i o n at e s h are o f t h e g ro s s recei p t s . Th e RA t h en m u l t i pl i ed p et i t i o n er’ s p ro p o rt i o n at e s h are o f CM S’ g ro s s recei pt s b y 5 0 % fo r each o f t h e t ax y ears ati s s u e.

1 8 Pen al t ies u n d er s ec. 6 7 0 0 are n o tas s es s edfo r d i s cret e t ax ab l e y ears , b u t fo r co n ductan dtran s act io n s th ato ccu r o ver o n e o r m o re t ax ab l e y ears , n o to n an an n ual b as i s . Pl an n edIn v s ., In c. v . Un i t edSt at es , 8 8 1 F.2 d3 4 0 , 3 44 (6 th Ci r. 1 9 8 9 ). In Gard n er v . Co m m is s i o n er, 1 4 5 T.C. 1 6 1 , 1 8 2 (2 0 1 5 ), aff’ d , 7 0 4 F. Ap p ’ x 7 2 0 (9 th Ci r. 2 0 1 7 ), thi s Co u rtex p res s l y ag reedwi th th e reas o ni n g i n Pl an n ed In v es t m en ts , co n cl u d i n g th atth e s ec. 6 7 0 0 p en al ty i s n o tn eces s ari l y

t i ed t o act i vi t i es o r am o un t s earn edi n a p art i cu l ar t ax y ear an dcan b e b as edo n act i vi t i es an dam o u n t s earn edi n o th er y ears .- 7 2 -

[* 7 2 ] Fo r 2 0 0 8 CM S earn ed g ro s s recei pt s o f $ 5 87 ,2 9 8
. 1 9 Fo r 2 0 0 9 the RA i d en t i fi edCM S’ g ro ss recei p t s as $ 9 3 3 ,6 7 4 . Fo r 2 0 1 0 th e RA i den t i fi edCM S’ g ro s s recei p ts as $ 7 4 2 ,4 7 3 . Th e RA t h en m u l t ip l i edth es e am o u ntb y p et i t i o n er’ s
o wn ers hi p o f s h ares in CM S, 1 6 %, fo r t ax y ears 2 00 8 , 2 0 0 9, an d2 01 0
. Th e RA th en m u l ti p l ied pet i t i o ner’ s p ro p o rt i o n at e s h are o f t h e g ro s s recei p t s b y 5 0 % as req u i redb y

s ect i o n 6 7 0 0 (a). Res p o n d en t d et erm i n edp en al t i es ag ai n s t p et i t i o n er p u rs u an t t o s ect io n 6 70 0 fo r t ax y ears en d i n g Decem ber 3 1 , 2 0 0 8 , 2 0 0 9 , an d2 0 10 , o f $ 4 6,9 8 4 , $ 7 4 ,6 94 , an d$ 5 9 ,3 9 8 , res p ect i v el y . 2 0 Th e p en al t i es were ap p ro p ri at el y

as ses s ed , accu rat el y

cal cu l at ed , an d res p on d en tfo l l o wedal l ad m i n is trat i v e p ro cedu res . IV. Rem ai n i n g CDP Is su es Wh en th e Co u rtco ndu ct s a d e n ov o rev i ew o f an u n d erl y i n g l i ab i l i ty , we
rev i ew al l d et erm in at i o n s n o ti n v o l v i n g th e u nd erl y i n g l i ab i li ty fo r ab u s e o f

1 9 Fo r 2 0 0 8 t h e RA i n cl u d edo n l y h al f t h e g ro ss recei p t s i n t h e p en al ty b as e fo r p u rp o s es o f b ei n g co n s erv at i v e.

2 0 Ul t i m at el y , res p o nd en tu s eda rat h er co n s erv at i v e fo rm u l a fo r cal cu l at i n g th e b as e am o u n tfo r p et i t i o ner’ s p en al t i es . Pet i t i o n er was th e s o l e s h areh o l d er o f Xel l atal l t i m es , an dn earl y al l o f Xel l ’ s i n co m e was d eri v edfro m s el li ng th e To o l Pro g ram . Th ere i s n o cl ear reas o n wh y th e g ro s s i n co m e d eri v edfro m p art i ci p at i n g i n th e s al e o f t h e CM S To o l Pro g ram s h o u l dn o ti n cl u d e i n co m e p et i t i o n er d eri vedfro m

Xel l . See In re Tax Refu n dLi ti g ., 7 6 6 F. Sup p . 1 24 8 , 1 2 5 8 (E.D.N.Y. 1 9 9 1 ).- 7 3 -

[* 7 3 ] d i s cret i o n. Crai g v . Co m m i s s i o n er, 1 1 9 T.C. 2 5 2 , 2 6 0 (2 00 2 ). Anact i o n
co n st i tu t es an ab u s e o f d i s cret i o n i f i ti s arb i trary , cap ri ci o u s , o r wi th o u t s o u n d b as i s i n fact o r l aw. Gi am el l i v . Co m m i ss i o n er, 1 2 9 T.C. 1 0 7 , 1 11 (2 0 0 7 ). Th i s
rev i ew i s t o en s ure t h at th e Ap p eal s Offi ce v eri fi edth atthe Co m m i ss i o n er
co m p l iedwi th t h e req u i rem en ts o f al l ap p l i cab l e l aw an d ad m i n i s trat i v e p ro cedure, co n s id eredal l rel ev an ti ss u es rai s ed b y th e t ax pay er, an dco n si d ered wh et h er t h e p ro p o s edco l l ect i o n act i o n b al an ces th e n eedfo r t h e effi ci en t
co l l ect i o n o f t ax wi th the t ax p ay er’ s l eg i t i m at e co ncern th atth e co l l ect i o n act i o n b e n o m o re i n tru s i v e t h an n eces s ary . 2 1 See s ec. 6 3 3 0 (c)(3 ). Th e n o t i ce o f d et erm i n at i o n s u s t ai nedth e co ll ect i o n act i on , wi th th e cav eat th atco l l ect i o n m ay

n o tp ro ceedu n t i l p et i t i o n er’ s refu n dcl ai m was cl o s ed
. Th e
o n l y i ss u e t h atp et i t i o n er rai s eddu ri n g h i s CDP h eari n g was h i s u n d erl y in g l i ab i l i ty . Th e SO ad dres s edth i s i ss u e. Fu rt her, t h e SO v eri fi edth atth e
as s es s m en to f t h e s ect i o n 6 7 0 0 p en al ty was t i m el y

an dth atp et i t i o n er recei v edal l ap p ro p ri at e n o ti ces i n th i s res p ect . Acco rd i n gl y , p et i t i on er d o es n o tal l eg e, an dwe

2 1 Pet i t i o ner d i dn o treq u es ta co l l ect i o n al t ern at iv e an dfai l edt o p res en t n eces s ary fi n an ci al i n fo rm at i o n fo r th e SO t o co n s i d er. See s ec. 6 3 3 0 (c)(2 )(A)(i i i ). Th e reco rd s h o ws th e SO v eri fi edth atthe req ui rem en t s o f ap p li cab l e l aw an dad m i n i s trat i v e p ro cedu re were fo l l o w ed
.- 7 4 -

[* 7 4 ] d o n oth o l d , th atth e SO ab u sedh i s d i s cret i o n i n arri v i n g atan y o f t h es e d et erm i n at i o n s. V. Co n cl u si o n W e h av e co n s id eredal l th e o th er arg u m en ts o f t h e p art i es , an d t o t h e ex t en t
n o td i s cu s s edab o v e, fi n dtho s e arg u m en t s t o b e i rrel ev an t , m o o t , o r wi th ou tm eri t. To refl ectthe fo reg o i n g , Deci s i o n wi ll b e en t ered fo r res p o n den t .