Source: http://oicattorney.blogspot.com/2008/04/
Timestamp: 2018-02-18 21:51:11
Document Index: 202799754

Matched Legal Cases: ['§6325', '§301', '§506', '§ 506', '§616', '§1111', '§1123', '§29', '§6321', '§506', '§6321', '§6321', '§6325', '§6325', '§301', '§6321', '§157', '§157', '§1123', '§1322', '§101', '§6325', '§301', '§6330', '§6330', '§6330', '§1', '§1']

IRS Tax Attorney: April 2008
26 U.S.C. §6325(b)(2)(B) . 26 C.F.R. §301.6325-1(b)(2) provides for removal of an IRS lien from an affected property simply upon a showing by the taxpayer that no equity exists in the affected property. The partial discharge provision is discretionary with the Secretary of the IRS, although perhaps a denial of discharge by the Secretary is subject to review under a deferential abuse of discretion standard. See, for example, United States v. Polk 822 F.2d 871, 874 (9 th Cir. 1987).
In re Kirk G. Johnson, Debtor; Kirk G. Johnson, Plaintiff v. The Internal Revenue Service of the Department of the Treasury of the United States of America and the Commonwealth of Pennsylvania, Department of Labor and Industry, Defendants.
U.S. Bankruptcy Court, West. Dist. Pa.; 05-35220 TPA, April 16, 2008.
[ Code Secs. 6321 and 6871]
Bankruptcy: Tax liens: Real and personal property: Avoidance of liens: Strip-off:
Debtor's equity. --
A federal tax lien did not attach to a debtor's real property because higher priority liens exceeded the fair market value of the property. The IRS's argument that its lien attached to all of the debtor's real and personal property and that the debtor could not determine to which property the lien attached was rejected. Debtors possess the authority under the Bankruptcy Code to limit secured claims to the value of the collateral. Moreover, lien stripping is engrained in the reorganization process of a Chapter 11 case and to find that lien stripping is not permitted would ignore the existence of this right. Further, there is nothing in Code Sec. 6321 that would protect the IRS from lien stripping. Under the regulations, the "single lien" created by Code Sec. 6321 can be treated as separate liens on separate properties and discharged as to those properties that are valueless because they are subject to liens with a higher priority. Back references: ¶38,136.34 and ¶40,630.107.
AGRESTI, United States Bankruptcy Judge: Kirk G. Johnson ("Debtor "), who operates a business proprietorship known as "KJ Transit," filed a voluntary Chapter 11 petition on October 10, 2005 . Among the secured creditors listed on Schedule D accompanying the Debtor's Petition are the Internal Revenue Service ("IRS") and the Pennsylvania Department of Labor and Industry ("Labor") based on their statutory lien positions involving a federal tax lien and a lien for state unemployment compensation taxes, respectively.
The Debtor initiated this adversary proceeding on February 20, 2007 by filing a Complaint to Determine Validity, Priority, and Extent of Liens of the Internal Revenue Service and Pennsylvania Department of Labor and Industry Against the Debtor's Assets ("Complaint"), essentially alleging that two higher priority liens, one a purchase money mortgage and the other for county real estate tax, in combination, exceed the fair market value of the Debtor's residence such that there is no equity in the residence to which the IRS and Labor liens can attach. The Debtor seeks relief under 11 U.S.C. §506 to the effect that his residence is free and clear of the IRS and Labor liens. The IRS has filed an answer and the Parties have stipulated to all material factual issues, leaving the case ripe for decision as to the legal issue presented. 1 For the reasons that follow, the Court will grant the Debtor the relief he seeks. 2
The following is gleaned from the Parties' stipulations of fact. The Debtor owns and resides at real property located at 4008 Turnwood Lane, Coraopolis, Pa. ( "the Real Property"). The Real Property possessed a fair market value of $279,000 as of the date the bankruptcy petition was filed. As of that same date, the Real Property was subject to a purchase money first mortgage lien in the amount of $279,440 held by Mortgage Electronic Registration Systems, Inc. ("the MERS Mortgage") and a county real estate tax lien in the amount of $215.61 ("the County Lien"). The MERS Mortgage and the County Lien therefore collectively exceed the fair market value of the Real Property and both of them predate any lien held by the IRS.
The Debtor also owns various items of personal property with a total fair market value of $53,595.83 ("the Personal Property"). Other than the lien of the IRS, the only item of the Personal Property subject to a lien is a 2002 Lincoln Navigator. As of the Petition date, the fair market value of that vehicle was $18,675. At that time the vehicle was subject to a security interest in favor of M.& T. Credit Services, LLC in the amount of $12,221 ("the M&T Lien") superior to the lien of the IRS. Again, leaving aside for the moment the lien of the IRS, the Parties agree that because of the $6,454 of Debtor's equity in this vehicle, as of the Petition date, the Debtor's total equity in all of the Personal Property was $41,374.88.
On February 17, 2006, the IRS filed an Amended Proof of Claim asserting a secured claim in the amount of $178,673.05 against the Debtor and an unsecured priority claim of $2,374.71, for a total claim of $181,047.76. On March 31, 2006, Labor filed a proof of claim asserting a secured claim against the Debtor in the amount of $1,035.59. The Debtor's Amended Chapter 11 Plan was confirmed on May 3, 2007.
Relief Sought by the Debtor
The Debtor seeks a determination that the IRS lien does not attach to the Real Property because there is no equity in that property. The Debtor also asks the Court to find that the IRS possesses a secured claim of only $41,374.88 in the Personal Property (the value of the Personal Property less the amount of the M&T Lien) and that the balance of the IRS claim is unsecured. With respect to the latter request, the matter has been partially resolved. In its portion of the Combined Pre-trial Narrative Statement, the IRS states:
The Internal Revenue Service acknowledges that the amount of its lien exceeds the value of debtor's assets. Accordingly, the Service is willing to stipulate that its claim be allowed as follows: a secured claim of $ 41,374.83, an unsecured priority claim of $ 30,592.52, and a general unsecured claim of $109,079.00.
Combined Pre-Trial Narrative Statement at 3, Document No. 14. The Debtor has accepted this proposed stipulation. See Plaintiff's Brief on Whether a Federal Tax Lien can be Avoided Under Section 506 of the Bankruptcy Code in a Chapter 11 Proceeding at 1, n. 1, Document No. 18. Thus, by voluntary action of the IRS, the IRS lien, and therefore the amount of its secured claim, has been "stripped-down" to $41,374.83 and the Court need not consider that issue further. The remaining question therefore is whether the IRS lien encumbers both the Personal and Real Property, or only the Personal Property.
In the bankruptcy setting, the phrase "lien stripping" refers to the process of reducing a secured claim to reflect the value of the underlying collateral. Variants of this phrase are a "stripdown" wherein an undersecured creditor's lien is reduced to the equity value held by the Debtor in the collateral (after the amount of any superior lien is deducted from the fair market value of the collateral), and, a "strip- off" wherein a wholly-unsecured creditor's lien is removed from collateral in which there is no equity value.
In this case, the Debtor was originally seeking a combination of both forms of lienstripping relief. He asked that the IRS tax lien be stripped off the Real Property because there is no equity in that property, and, that the IRS tax lien be stripped down on the Personal Property to the level of available equity in that property, i.e., $41,374.88. As indicated, the IRS has conceded that its secured claim is reduced to $41,374.88 and therefore the latter request is no longer at issue.
The statutory basis for "stripping off" a lien arises from the combination of 11 U.S.C. §§ 506(a) and (d). 3 First, by operation of Section 506(a) an undersecured creditor's allowed claim is bifurcated into secured and unsecured portions. Then, with certain exceptions not applicable here, pursuant to Section 506(d) the lien securing the claim is voided to the extent that it is not an allowed secured claim, effectively stripping the lien "off" to that extent. Although the lien stripping process seems straightforward based on the statutory language, there are two issues that must be considered in making the determination whether the Debtor should be granted relief. First, does Dewsnup v. Timm, 502 U.S. 410 (1992), preclude the Court from granting the requested relief in this Chapter 11 case? Second, if that hurdle is cleared, is there some reason why an IRS tax lien should be treated any differently than other liens?
Lien Stripping in Ch. 11-Dewsnup
The Court must first consider whether the decision in Dewsnup, the foremost Supreme Court decision on lien stripping, dictates the outcome in this case. 4 In Dewsnup the Court held that a lien on real property could not be stripped-down in a Chapter 7 case. The Dewsnup Court construed the statutory language of Sections 506(a) and (d) in such a manner as to give effect to the pre-Bankruptcy Code rule in liquidation cases that liens pass through a bankruptcy unaffected. The Court did so because it was not convinced that Congress had intended to depart from that rule when it adopted the Bankruptcy Code. See 502 U.S. at 417. Importantly, however, the Dewsnup Court was careful to limit the holding of the case to the situation squarely before it, i.e., an attempt to strip a lien in a Chapter 7 liquidation case. The Court stated:
Hypothetical applications that come to mind and those advanced at oral argument illustrate the difficulty of interpreting the statute in a single opinion that would apply to all possible fact situations. We therefore focus upon the case before us and allow other facts to await their legal resolution on another day.
As a result of this limiting language, it is clear that the Dewsnup Court left open the question as to whether the same result would be reached in different circumstances, for instance, in a case under a different chapter of the Bankruptcy Code. Based on this "opening," courts and commentators have examined whether Dewsnup also establishes the rule on the availability of lien stripping in Chapter 11 and 13 cases. A great majority of the courts that have considered the issue in reorganization cases have concluded that the holding in Dewsnup should be limited to Chapter 7 cases and should not prevent lien stripping in reorganization cases. See 4-506 Collier on Bankruptcy, 15 th ed. Rev. ¶506.06[1][c] (2007); Sapos v. Provident Inst. of Savs. in the Town of Boston, 967 F.2d 918, 925 (3 d Cir. 1992) ( Dewsnup Court's interpretation of Section 506 in a Chapter 7 liquidation does not apply in a Chapter 13 reorganization); Wade v. Bradford, 38 F.3d 1126 (10 th Cir. 1994) (Chapter 11 debtors could strip down lien on residence notwithstanding Dewsnup); Harmon v. U.S. Through Farmers Home Admin., 101 F.3d 574 (8 th Cir. 1996) (allowing lien stripping in Chapter 12); In re Jones, 152 B.R. 155, 173 (Bankr. E.D. Mich. 1998) (categorically prohibiting lien stripping in Chapter 11 would disrupt established pre-Code law).
Many of the courts so limiting the Dewsnup holding have noted that a general prohibition against lien stripping in reorganization cases would be inconsistent with pre-Bankruptcy Code law, and would conflict with key provisions and principles applicable in the reorganization chapters of the Bankruptcy Code. This Court agrees with the majority view and concludes that the holding in Dewsnup does not extend to cases filed under Chapter 11 of the Bankruptcy Code. 5
The Court reaches this conclusion for a number of reasons, all of them related to the significant differences between liquidations and reorganization proceedings. Quite simply, the possibility of lien stripping has been a long-standing aspect of reorganization cases, one that pre-dates the adoption of the current Bankruptcy Code in 1978. See Dewsnup, 502 U.S. at 418-19 (recognizing that pre-Code law permitted involuntary reduction of the amount of the creditor's lien in reorganization proceedings, and citing as examples former 11 U.S.C. §§616(1) and (10) (1976 ed.)) Thus, the Dewsnup Court's stated reluctance to interpret the Bankruptcy Code in such a manner as to effect a major change in pre-Code practice by permitting lien stripping in liquidation cases (without clear evidence of Congressional intent for such a change) is not implicated in a reorganization setting because permitting lien stripping in a reorganization is consistent with pre-Code practice.
Furthermore, the process of lien stripping is ingrained in the reorganization provisions of the Bankruptcy Code to such an extent that any attempt to extend the holding in Dewsnup to Chapter 11 cases would require that numerous provisions of the statute be ignored or construed in a very convoluted manner to achieve that result. For instance, Congress has provided a mechanism under 11 U.S.C. §1111(b) for undersecured creditors to opt out of the claim bifurcation process that would otherwise occur under Section 506(a) and instead be treated as fully secured to the extent of their allowed claims. 6 The very fact that this Section 1111(b) election exists at all presumes that debtors possess the authority under the Bankruptcy Code to limit secured claims to the value of the collateral. To find that lien stripping is not permitted in Chapter 11would thus be to ignore the existence of Section 1111(b) . See In re 680 5 th Ave Assocs., 156 B.R. 726, 731 (Bankr. S.D.N.Y. 1993), decision affirmed 169 B.R. 22 (S.D.N.Y. 1993), judgment affirmed 29 F.3d 95 (2d Cir.1994).
Another example of Congress specifically recognizing and approving the existence of lien stripping in Chapter 11 cases surfaced when it passed the Bankruptcy Reform Act of 1994, Pub. L. No. 103-394. Section 206 of that Act amended the Code by adding current 11 U.S.C. §1123(b)(5) which permits a Chapter 11 plan to "modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor's principal residence." This brought Chapter 11 into conformity with Chapter 13, which includes a similar provision to permit the modification of secured claims generally while preventing the modification of home mortgages. 7 Clearly, Section 1123(b)(5) represents an explicit Congressional approval of lien stripping in Chapter 11 cases, subject only to the home mortgage exception. What is most significant for present purposes is the timing of the enactment of the Bankruptcy Reform Act of 1994 which included this provision when it was passed two years after Dewsnup was decided. To hold that Dewsnup prevents lien stripping in Chapter 11 cases would be to ignore this clear Congressional intent, something the Court cannot do.
It is also instructive to consider the particular feature of liquidations that seemed to cause the Court in Dewsnup to have concerns about whether lien stripping should be permitted in Chapter 7 cases. The Court noted that the "practical effect" of finding that lien stripping was allowed in Chapter 7 would be that a creditor's interest would be frozen at the judicially determined property valuation, leaving the creditor to lose the benefit of any increase in the value of the property that might occur between then and the time of a foreclosure sale. Instead, the debtor would enjoy the benefit of any such increase-a result some might view as a windfall. See 502 U.S. at 417. The Dewsnup case can thus be interpreted to stand for the proposition that there can be no lien stripping without payment of the debt secured by the lien, and upon failure to so provide, allowing the creditor to purchase the property by credit bid and enjoy any appreciation in value. See In re Dever, 164 B.R. 132, 135 (Bankr. C.D. Cal. 1994). By contrast, in reorganization cases any lien stripping is coupled with payments under the plan and ownership of the property being vested in the debtor. This has led courts and commentators to note that creditors in reorganization cases thus receive something in exchange for the voiding of their liens, i.e., payment obligations under a plan of reorganization, so that principle of Dewsnup is not violated. See In re Bowen, 174 B.R. 840, 855 (Bankr. S.D. Ga. 1994); Baxter Dunaway, Law of Distressed Real Estate §29.72 (2007).
To sum up, lien stripping is a fundamental aspect of reorganization proceedings. To bar lien stripping in cases under the reorganization chapters would:
... [I]n essence, gut the sum and substance of the reorganization and rehabilitation of debt concept under the Bankruptcy Code. In such cases, the Debtor would propose a plan for repayment of creditors to the extent of the value of the property securing the creditor's claim, but would still owe the unsecured portion of the claim, post-confirmation, in order to obtain a release of the lien on said property. This would require all plans filed under Chapters 11, 12 and 13 to pay all creditors one hundred percent of their claims in order for the debtor to emerge from bankruptcy with a true "fresh start." Clearly, this has never been the purpose contemplated for Section 506(d).
In re Butler, 139 B.R. 258, 259 (Bankr. E.D. Okl. 1992).
The Court therefore concludes that, in general, lien stripping is permitted in Chapter 11 cases, notwithstanding the decision in Dewsnup. That leads to a question of whether there is something special about an IRS tax lien that would prohibit lien stripping, creating an exception to this process in favor of the IRS. The Court now turns to that issue.
Lien Stripping and the Nature of the IRS Lien
Having concluded that Dewsnup does not preclude lien stripping in a Chapter 11 case, the Court must next consider whether the very nature of an IRS tax lien somehow precludes that from being done in these particular circumstances. In so doing, the Court will operate from the presumption that the IRS lien should be treated the same as any other lien unless there is some contrary statutory law or provision of decisional law requiring different treatment.
The lien of the IRS arises pursuant to a statute which provides:
26 U.S.C. §6321 . There is nothing apparent from this statutory language which would protect an IRS lien from lien stripping treatment. Furthermore, the Debtor has pointed to a number of cases in which courts have permitted IRS liens to be avoided. For instance, in In re Dever, supra, after a long and thoughtful discussion on various aspects of lien stripping, the court noted that Section 506 does not distinguish between voluntary and involuntary liens. It held that if a voluntary lien is avoidable by a strip down in Chapter 11, then so too should an involuntary one, like an IRS lien. 164 B.R. at 144. The Dever court further stated:
Nothing in Sections 506 or 1129 suggests that IRS liens or claims are totally immune from avoidance or modification. Under the Bankruptcy Code, the IRS is the beneficiary of several specific provisions that reflect Congressional desire to protect the federal fisc. For example, Congress required that all tax obligations must be paid under a Chapter 11 plan within six years of assessment date. Section 1129(a)(9)(C). Certain tax obligations are entitled to priority under Section 507(a)(7). Section 523(a)(1) makes some tax debts nondischargeable. Although none of the obligations here are alleged to be nondischargeable, most debtors facing IRS liens would not be able to walk out of bankruptcy court in complete defiance of their tax obligations. The granting of IRS priorities and the nondischargeable nature of many such obligations are strong evidence that Congress provided an alternative method of realizing on such claims. Reading an IRS exception into Section 506 to prevent avoidance of the liens here is unnecessary and inappropriate.
164 B.R. at 145. See also In re Bowen, supra; In re Butler, supra.
The IRS offers precious little in response to convince the Court otherwise. It argues that the nature of its lien is such that it attaches to all of the Debtor's property, real and personal, and that there "is nothing in the Bankruptcy Code, the Internal Revenue Code, or case law which permits the debtor to determine which of his property is subject to the lien, once the value of that lien has been determined." Defendant Internal Revenue Service's Response to Plaintiff's Brief on Whether a Federal Tax Lien can be Avoided Under 11 U.S.C. §506 in a Chapter 11 Proceeding at 2-3, Document No. 21.
The only case cited by the IRS in support of its position is In re Hoekstra, 255 B.R. 285 (E.D. Va. 2000). In that case, the debtors brought an adversary proceeding seeking to avoid junior tax and homeowners' association liens against their townhouse because the two superior liens against the property already exceeded its value. The bankruptcy court had found in favor of the debtors, distinguishing the case from Dewsnup because in that case the property at issue did have some equity, whereas in Hoekstra there was no equity in the townhouse. The bankruptcy court concluded that Dewsnup prohibited only a "strip-down" of an undersecured claim, not a "strip off" of a wholly-unsecured claim. On appeal, the District Court reversed, agreeing with the IRS that Dewsnup governed the outcome of the case, but concluding that the "indivisible" nature of the IRS federal tax lien made what the bankruptcy court had done more analogous to a prohibited strip-down rather than a permitted strip-off . As the Hoekstra court explained:
The bankruptcy court... [ treated] Creditor's federal tax lien as distinct and individual liens as to each component of property underlying the lien. The [bankruptcy] court concluded that "for the purpose of lien avoidance, each item of collateral must be viewed individually... The avoidance of the lien as to that particular parcel does not affect or impair the lien of Creditor as to any other property to which it may have attached." In re Hoekstra 253 B.R. 193, 195. However, the Internal Revenue Code and case law make clear that a federal tax lien is not divisible in this context.
Debtors here seek to avoid a portion of a lien where a component of the collateral has no value but other components of collateral have value. The Dewsnup Court's clear prohibition against "stripping down" liens leads this Court to reverse the bankruptcy court's judgment voiding Creditor's lien against the Townhouse.
255 B.R. at 290, 292.
For a number of reasons, this Court does not find Hoekstra to be particularly relevant or persuasive on the issue presented in the case before it. Perhaps most significantly, Hoekstra was decided in the context of a Chapter 7 liquidation proceeding. As such, the court in Hoekstra was faced with the clearly applicable precedent of Dewsnup and was required to analyze what the debtors were seeking to accomplish in light of that compelling precedent. In sharp contrast, the present case is a reorganization under Chapter 11 and as noted above, the majority view which is now also adopted by this Court, is that Dewsnup does not apply to lien stripping occurring in a reorganization.
The Court is also left unpersuaded by the Hoekstra court's view of the "nature" of the IRS lien. The Hoekstra court stated that the language of 26 U.S.C. §6321 makes clear that there is but a single lien created; not separate liens upon a debtor's real and personal property. 255 B.R. at 290 - 91. It is from this aspect of the Hoekstra decision that the IRS draws its sole decisional support for the position it takes here, that is, because of its "unitary nature", the IRS lien cannot be stripped off the Real Property.
The IRS admits that, other than the Hoekstra decision and the language of Section 6321 itself, it has no other support for its view that the IRS lien is inviolable so long as there is equity value in any of the collateral subject to the lien. In its brief and again at the time of argument, the IRS provided no in depth public policy analysis or Dewsnup-extension argument to support its position under these facts. It simply steadfastly maintained that the language of 28 U.S.C. §6321 required such a result. If this lien inviolability were a consistently held view and practice of the IRS, it might cause the Court pause before ordering relief that runs contrary to such a settled norm. However, the admitted, normal customs of the IRS, carried out pursuant to an enabling statute and regulation, reveals that even the IRS does not treat federal tax liens in the monolithic and indivisible manner that it urges this Court to follow.
26 U.S.C. §6325(b) , which allows for the discharge of property subject to a federal tax lien, provides in relevant part:
(2) Part payment; interest of United States valueless. --Subject to such regulations as the Secretary may prescribe, the Secretary may issue a certificate of discharge of any part of the property subject to the lien if --...
In determining the value of the interest of the United States in the part to be so discharged, the Secretary shall give consideration to the value of such part and to such liens thereon as have priority over the lien of the United States.
26 U.S.C. §6325(b)(2)(B) . The IRS has issued regulations which mirror this provision of the Internal Revenue Code. See 26 C.F.R. §301.6325-1(b)(2) . As admitted by the IRS at the time of argument, this statutory provision provides the mechanism for removal of an IRS lien from an affected property simply upon a showing by the taxpayer that no equity exists in the affected property. The Court understands that the weight of authority holds that this partial discharge provision is discretionary with the Secretary of the IRS, although perhaps a denial of discharge by the Secretary is subject to review under a deferential abuse of discretion standard. See, for example, United States v. Polk 822 F.2d 871, 874 (9 th Cir. 1987). However, the Court finds it highly significant that the statute and accompanying regulations contemplate that the alleged "single lien" created by 26 U.S.C. §6321 can, in effect, be treated as separate liens on separate items of property and discharged as to those items of property which are valueless to the United States because they are subject to other lien(s) with priority. Also at the oral argument, Counsel for the IRS represented that it was common practice for the IRS to actually discharge a federal tax lien as against an item of property that has no value. 8 Given this reality, it would make no sense to deny the Debtor relief in this case based solely on a fiction the IRS itself does not consistently follow, that is, that the IRS lien is so indivisible in nature that a Bankruptcy Court cannot strip it off real property that has no equity value while allowing it to remain on personalty that does have value.
It is axiomatic that a central purpose of the Bankruptcy Code is to provide a procedure by which the debtor can "reorder his affairs, make peace with his creditors, and enjoy 'a new opportunity in life with a clear field for future effort, unhampered by the pressure and discouragement of pre-existing debt'." In re Alston, 297 B.R. 410, 417 (Bankr. E.D. Pa. 2003) (quoting Local Loan Co. v. Hunt, 292 U.S. 234, 244 (1934)). In reorganization cases that central purpose can often only be accomplished by lien stripping. As the court in Dever observed:
Modifying the rights and interests of secured creditors is at the heart of most reorganizations.... very few Chapter 11 plans seek merely to stretch out or reduce payments to unsecured creditors. Most debtors are currently entering Chapter 11 with their assets fully encumbered, which means that their plans must restructure the secured debt in order to make a meaningful difference in their financial well-being.
164 B.R. at 143. That is certainly the case with the Debtor in the present case. Unless the Court removes the IRS lien from his residence, that lien will remain an anchor dragging him down from achieving the fresh start envisioned by the Code.
For the foregoing reasons, the Court finds in favor of the Debtor on the matters set forth in his Complaint and will issue an appropriate order.
Case Administrator to serve:
Phillip Simon, Esq.
Gary W. Short, Esq.
Gerald A. Role
AND NOW, this 16 th day of April, 2008 , upon consideration of the Complaint to Determine Validity, Priority and Extent of Liens of the Internal Revenue Service and Pennsylvania Department of Labor and Industry Against the Debtor's Assets filed by Plaintiff, Kirk G. Johnson t/d/b/a "KJ Transit" at Document No. 1 ("Complaint") and the Answer filed by the Internal Revenue Service of the Department of the Treasury of the United States of America ("Internal Revenue Service") at Document No. 6, for the reasons stated in the foregoing Memorandum Opinion, pursuant to Fed.R.Bankr.P. 7052, after notice and hearing and consideration of the stipulations and argument of Counsel,
It is hereby ORDERED, ADJUDGED and DECREED that the relief requested by the Debtor in his Complaint is GRANTED.
(1) All of the Internal Revenue Service's tax liens against the Debtor's real estate known as 408 Turnwood Lane, Coraopolis, PA 15108 are declared NULL, VOID and REMOVED , the legal description for said real property being found in the Deed recorded in the Office of Recorder of Deeds of Allegheny County at Deed Book Volume 11686, page 585, and more further described as follows:
ALL THAT CERTAIN lot or piece of ground situate in the Township of Moon, County of Allegheny and Commonwealth of Pennsylvania, being Lot No. 915 in the Whispering Woods Plan of Lots, Phase IX, as recorded in the Recorder's Office of Allegheny County, Pennsylvania, in Plan Book Volume 198, pages 63-66. BEING designated as Block 925-G, Lot No. 12 in the Deed Registry Office of Allegheny County, Pennsylvania. UNDER AND SUBJECT to easements, rights of way, oil and gas leases, restrictions, reservations, exceptions, agreements and coal and mining rights as set forth in prior instruments of record. ("Real Property")
(2) The Internal Revenue Service's tax liens against the Debtor's personal property are declared NULL, VOID and REMOVED from said personal property to the extent said liens exceed $41,374.88;
(3) Pursuant to Section 507(a)(8) of the Bankruptcy Code the Internal Revenue Service possesses an allowed unsecured, priority claim in the amount of $30,595.00;
(4) The Internal Revenue Service possesses a general unsecured, nonpriority claim in the amount of $109,079.88; and,
(5) The Commonwealth of Pennsylvania, Department of Labor and Industry's tax liens against the Debtor's assets, both the Real Property and the personal property, are declared NULL, VOID and REMOVED from said property.
1 Labor was properly served with the Complaint but it has not filed an answer or otherwise responded. Counsel for the Debtor has submitted a letter and e-mail from counsel for Labor indicating that Labor has consented to the relief being sought by the Debtor. Based on Labor's default and the further evidence of its consent, the Debtor will be granted the relief he seeks as against Labor and Labor's claim will be deemed wholly unsecured.
2 The Court's jurisdiction under 28 U.S.C. §§157 and 1334 was not at issue. This is a core proceeding pursuant to 28 U.S.C. §§157(b)(2)(K) and (O). This Opinion constitutes the Court's findings of fact and conclusions of law pursuant to Fed.R.Bankr.P. 7052.
3 Section 506(a) provides:
(1) An allowed claim of a creditor secured by a lien on property in which the estate has an interest, or that is subject to setoff under section 553 of this title, is a secured claim to the extent of the value of such creditor's interest in the estate's interest in such property, or to the extent of the amount subject to setoff, as the case may be, and is an unsecured claim to the extent that the value of such creditor's interest or the amount so subject to setoff is less than the amount of such allowed claim. Such value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditor's interest.
(d) To the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void, unless --
4 The willingness of the IRS to stipulate to a substantial reduction of its lien down to the amount of the Debtor's equity value in the Personal Property would seem to signal its acknowledgment that Dewsnup has no application here and does not restrict the Court's ability to act. Indeed, the IRS has not even made the argument that Dewsnup applies. Nevertheless, the Court does not wish to rest solely on that premise but will independently examine the issue.
5 The courts adopting this majority view have not all arrived at their conclusion by the same route. Some have concluded that the Dewsnup court's limiting construction of Sections 506(a) and (d) is applicable only in the Chapter 7 setting, leaving Section 506 available as a vehicle to permit lien stripping in the reorganization chapters. See, e.g., In re Dever, 164 B.R. 132 (Bankr. C.D. Cal. 1994). Other courts, however, conclude that the Dewsnup construction of Section 506 must apply in all bankruptcy settings. In this view, Dewsnup does not hold that Section 506(d) prohibits lien stripping in Chapter 7, it holds only that Section 506(d) does not itself provide the authority for a debtor to strip a lien. See, e.g., In re Virello, 236 B.R. 199, 204 (Bankr. D.S.C. 1999). Thus, in this view, Dewsnup does not prevent lien stripping in reorganization cases because, unlike Chapter 7, those chapters of the Bankruptcy Code do contain provisions that permit lien stripping. See, e.g., 11 U.S.C. §1123(b)(5) , discussed infra. at 9-11.
In the present case, the Debtor has invoked Section 506 as the basis for relief in his Complaint, which is consistent with the first judicial approach discussed above. (It should also be noted that the IRS has never objected that Section 506 is not a proper vehicle to bring the issue before the Court). However, even if this Court were to follow the second judicial approach it would not deny the Debtor the relief he seeks solely because the Complaint refers only to Section 506 because that would elevate form over substance. The Court would instead treat the matter as tried by consent pursuant to Fed.R.Bankr.P. 7015(b)(2) or grant the Debtor leave to file an amended Complaint pursuant to Fed.R.Bankr.P. 7015 (a)(2). Thus, either way, the Debtor should be granted the relief he seeks.
6 In the context of this case, the IRS never exercised that option. In determining whether an 1111(b) election had occurred in this matter, not only did the Court review the docket of the within Adversary Proceeding but also the main case filings as well. During the course of its review of the main case docket, the Court identified a "Stipulation and Agreement" between the Debtor and the IRS dated April 17, 2007 and filed at Document No. 112 ( "Stipulation") and approved by the Court by Order entered on April 23, 2007 at Document No. 115. Paragraph 3 of the Stipulation states in part:
To the extent that any federal tax liens attach to any property owned by the Debtor as of the date of the filing of the Petition in this case, such property shall remain subject to such federal tax liens until such time as the amount of such liens has been fully satisfied.
Neither of the Parties in the Adversary Proceeding has ever referenced the existence of the Stipulation as an impediment to this Court's ability to grant the relief sought by the Debtor. The Court can only conclude that the Parties agree the Stipulation was not intended to have any effect with respect to the pending Adversary Proceeding, and in particular, was not intended to be a defense available to the IRS. This conclusion is further supported by the language of the Confirmed, Amended Plan subsequently approved by the Court which contains language apparently allowing for the filing of the Complaint in this matter and its ultimate resolution by the Court. See Amended Chapter 11 Plan at ¶ 2.02, filed May 1, 2007 at Document No. 125. In the alternative, Fed.R.Bankr.P. 7012(b) requires every defense to a claim for relief in any pleading to be asserted in the responsive pleading if one is required, as was the case here. Affirmative defenses such as res judicata or waiver, must also be affirmatively pled. Fed.R.Bankr.P. 7008(b). The failure to plead a defense means it has been waived. Fed.R.Civ.P. 12(h) made applicable in this proceeding pursuant to Fed.R.Bankr.P. 7012(b); In re Hankerson, 133 B.R. 711, 713, n. 1 (Bankr. E.D. Pa. 1991). The IRS, having failed to raise any defense arising from the Stipulation in any of the pleadings (including its Pretrial Narrative Statement and Consolidated Pretrial Narrative Statement) or brief filed in the Adversary Proceeding, has therefore waived any such defense it may otherwise have had related to the Stipulation.
7 See 11 U.S.C. §1322(b)(2) . Note also that the home mortgage exception does not apply to the present case because a "security interest" does not include a statutory tax lien. See 11 U.S.C. §101(51) ; In re Marfin Ready Mix Corp., 220 B.R. 148, 158 n. 10 (Bankr. E.D.N.Y. 1998).
8 At the oral argument the Court inquired why the IRS would not be willing to voluntarily "discharge" the lien as against the Real Property in this case. Counsel for the IRS admitted it frequently does just that in other, non-bankruptcy contexts. The IRS could offer no compelling response to that rather straightforward question other than to note that it wished a legal ruling on the matter.
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Labels: §6325(b)(2)(B) . 26 C.F.R. §301.6325-1(b)(2)
Offer in Compromise "reasonable collection potential" under section 7122 does not include "special circumstances." The showing by the taxpayer of special circumstances that may cause an offer to be accepted notwithstanding that it is for less than the taxpayer's reasonable collection potential, e.g., the taxpayer is incapable of earning a living because of a long-term illness, and it is reasonably foreseeable that the taxpayer's financial resources will be exhausted providing for care and support during the course of the condition. Sec. 301.7122-1(b)(3), (c)(3), Proced. & Admin. Regs.; 1 Administration, Internal Revenue Manual (CCH), pt. 5.8.11.2.1, at 16,375, sec. 5.8.11.2.2, at 16,377.
William G. Schwartz and Jacqueline R. Schwartz v. Commissioner.
Dkt. No. 12530-06L , TC Memo. 2008-117, April 28, 2008.
Collection: Notice before levy: Offer-in-compromise. --
JACOBS, Judge:1 The petition in this case was filed in response to a Notice of Determination Concerning Collection Action(s) Under Section 6320 and/or 6330 (notice of determination).2 The issue for decision is whether respondent abused his discretion in rejecting as inadequate petitioners' offer-in-compromise to satisfy their unpaid income taxes for tax years 1996, 1997, 1998, 2000, and 2001.
This case was submitted fully stipulated pursuant to Rule 122. The stipulation of facts and the attached exhibits are incorporated herein by this reference. Petitioners resided in Pennsylvania at the time they filed their petition.
Petitioners filed income tax returns for the years at issue as follows:
Return Adjusted
Due Gross Self
(After Date Income Income Employment
Extensions) Return per Tax per Tax per
Year Filed Return Return Return
Oct. Jan. 7,
1996 15, 1997 1999 N/A $136,155 N/A
Oct. Aug. 6,
1997 15, 1998 1999 $185,713 63,354 $ 5,610
1998 15, 1999 28, 1999 117,963 32,906 11,831
Aug. Aug. 7,
2000 15, 2001 2001 55,953 15,193 12,124
2001 15, 2002 17, 2002 104,836 26,569 13,525
Respondent assessed the tax shown on each return. As of November 10, 2003, the date respondent issued a Letter 1058, Final Notice of Intent to Levy and Notice of Your Right to a Hearing (final notice of intent to levy), for tax years 1996 through 2001, the unpaid balance of petitioners' tax liabilities (after taking into account withholding credits, payments, additions to tax, and interest) totaled $287,523.10.3
The final notice of intent to levy was followed on November 17, 2003, by a Notice of Federal Tax Lien with respect to petitioners' outstanding tax liabilities for 1996 through 2001 and a Letter 3172, Notice of Federal Tax Lien Filing and Your Right to a Hearing Under IRC 6320 (notice of tax lien filing), for tax years 1996 through 2001. In response to respondent's final notice of intent to levy and notice of tax lien filing, petitioners, in December of 2003, requested hearings under sections 6320 and 6330. Petitioners' hearing under section 6320 was held in conjunction with their hearing under section 6330 and was conducted by correspondence and telephone conversations with a succession of four officers in respondent's Office of Appeals.
At their hearing petitioners sought to compromise their tax liability. In the course of exploring this collection alternative, the parties disagreed as to the amount of petitioners' reasonable collection potential, which in turn largely depends upon the net amount petitioners could realize from their equity in their home, their main asset.4 This disagreement forms the basis of petitioners' claim that respondent placed a value on petitioners' home greater than that which could be realized and thus abused his discretion in rejecting petitioners' offer-in-compromise.
The Internal Revenue Service (IRS) refused to process petitioners' first ($29,124) offer-in-compromise, claiming that as of the date of the offer-in-compromise (June 2004) petitioners were not current with regard to tax deposits for their business employees. After clarifying that they did not have business employees for the period in question, in September 2004 petitioners resubmitted their $29,124 offer-in-compromise, which was accepted for processing. Before respondent took action on that offer-in-compromise other than to request additional information, petitioners submitted an amended offer-in-compromise for $7,452 on November 17, 2004, followed by a second amended offer-in-compromise for $65,525 on November 26, 2004. Respondent accepted petitioners' $65,525 offer-in-compromise for processing.
In support of their $65,525 offer-in-compromise, petitioners submitted a written appraisal for their home, dated March 10, 2003, which represented that the home had a "quick sale", "as is" value of $400,000.
In evaluating the $65,525 offer-in-compromise, respondent's Appeals officer requested an opinion as to the offer's legal sufficiency from respondent's Office of Chief Counsel. In March 2005 respondent's Office of Chief Counsel responded that the $65,525 offer-in-compromise was legally insufficient because, among other things, (1) the appraisal of petitioners' home was by then more than 2 years old, and (2) because the appraisal was based on comparable sales made on or before the summer of 2002, the appraisal did not accurately reflect the value of the property at the time the $65,525 offer-in-compromise was submitted.
Petitioners claimed that they had little or no equity in their home because it was encumbered by two mortgages, one of which was held by a savings bank in the approximate amount of $280,000. Respondent's Office of Chief Counsel did not contest the bona fides of that mortgage but did question the bona fides of a $125,000 "open end mortgage" held by William G. Schwartz's father which was recorded shortly before the filing of respondent's notice of tax lien.
Upon receiving the response from respondent's Office of Chief Counsel, respondent's Appeals officer requested additional information from petitioners, including a new appraisal of their home. Accordingly, on August 3, 2005, petitioners provided an appraisal as of November 1, 2004, which was prepared by the same appraiser who had prepared the first appraisal. It showed an "as is" value for the home of $400,000. On October 11, 2005, petitioners submitted yet another appraisal as of October 5, 2005. That appraisal was prepared by a different appraiser and showed an "as is" value of $430,000. On October 21, 2005, petitioners provided respondent's Appeals officer with an inspection report, dated July 19, 2005.
Respondent's Appeals officer independently investigated the value of petitioners' home and identified a number of problems with petitioners' appraisals. For example, the Appeals officer discovered that three smaller properties in the same area were for sale for $500,000 to $650,000, but were not reflected in petitioners' appraisals. Additionally, a November 2004 sale of a smaller property in the same area for $780,000 was omitted. Furthermore, it appeared that property values in the area had increased by more than 70 percent in recent years, whereas petitioners' most recent appraisal reflected a much smaller increase, even though it appeared that petitioners had made major improvements on their property. The Appeals officer's report detailed the weaknesses of petitioners' appraisals.5
On November 3, 2005, respondent's Appeals officer advised petitioners that she could recommend acceptance of an amended offer-in-compromise for $129,361. The Appeals officer wrote: "Once you have returned the amended Offer form, I will forward the case to our Chief Counsel office for concurrence." Petitioners duly signed and submitted an amended offer-incompromise.6 Thereafter, the Appeals officer requested an opinion from respondent's Office of Chief Counsel as to the legal sufficiency of petitioners' $129,361 offer.
On March 26, 2006, respondent's Office of Chief Counsel responded to the Appeals officer that it was unable to determine whether petitioners' $129,361 offer-in-compromise was legally sufficient because the reasonable collection potential of petitioners' home had not been adequately determined. The Appeals officer was advised to request assistance from respondent's Engineering Group.7 The Appeals officer then forwarded all three of petitioners' appraisals to respondent's Engineering Group to ascertain whether the valuations were reasonable. On May 1, 2006, a member of respondent's Engineering Group, holding an MAI designation,8 informed the Appeals officer by letter that the current market value of petitioners' home might be 30 to 40 percent greater than that stated in petitioners' appraisals. Before reaching this conclusion, the Engineering Group member had reviewed additional sales in the subject market area.
Respondent's Office of Appeals rejected petitioners' $129,361 offer-in-compromise as inadequate and notified petitioners of this rejection on June 6, 2006. On the same date, respondent issued a notice of determination sustaining both the proposed levy and the filing of a Federal tax lien for the tax years in issue.
Petitioners timely filed their petition seeking our review of respondent's determination. Petitioners contend that: (1) Respondent rejected their $65,525 and $129,351 offers-incompromise "out of hand, without basis or reason" and (2) because petitioners submitted a certified appraisal supporting their valuation, respondent's Engineering Group likewise should have prepared a certified appraisal supporting its conclusions. Petitioners further claim that respondent should have continued to negotiate an acceptable offer-in-compromise, and respondent's failure to do so constituted an abuse of discretion.
Section 6321 imposes a lien in favor of the United States on all property and property rights of a person who is liable for, and fails to pay, taxes after demand for payment has been made. The lien arises when assessment is made and continues until the assessed liability is paid or becomes unenforceable by lapse of time. Sec. 6322. For the lien to be valid against certain third parties, the Secretary must file a notice of Federal tax lien, and within 5 business days thereafter the Secretary must provide written notice to the taxpayer. Secs. 6320(a), 6323(a). The taxpayer may then request an administrative hearing before an Appeals officer. Sec. 6320(b)(1).
Section 6331(a) authorizes the Secretary to levy upon property and property rights of a taxpayer liable for taxes who fails to pay those taxes within 10 days after notice and demand for payment. Section 6331(d) provides that the levy authorized in section 6331(a) may be made with respect to any unpaid tax only after the Secretary has notified the person in writing of his intention to make the levy at least 30 days before any levy action is begun. Section 6330 elaborates on section 6331 and provides that upon a timely request a taxpayer is entitled to a collection hearing before respondent's Office of Appeals. Sec. 6330(a)(3)(B) and (b)(1). A request for a collection hearing must be made within the 30-day period commencing on the day after the date of the section 6330 notice. Sec. 6330(a)(3)(B),(2); sec. 301.6330-1(b)(1), Proced. & Admin. Regs.
If a hearing under section 6320 or 6330 is requested, the hearing is to be conducted by respondent's Office of Appeals, and, at the hearing, the Appeals officer conducting it must verify that the requirements of any applicable law or administrative procedure have been met. Secs. 6320(b)(1), (c), 6330(b)(1),(c)(1). To the extent practicable, a hearing under section 6320 is to be held in conjunction with a hearing under section 6330, and the conduct of the hearing is to be in accordance with the relevant provisions of section 6330. Sec. 6320(b)(4),(c). The taxpayer may raise at the hearing any relevant issue relating to the unpaid tax or the proposed levy. Secs. 6320(c), 6330(c)(2)(A).
At the conclusion of the hearing, the Appeals officer must determine whether and how to proceed with collection and take into account: (i) The relevant issues raised by the taxpayer, (ii) challenges to the underlying tax liability by the taxpayer, where permitted, and (iii) whether any proposed collection action balances the need for the efficient collection of taxes with the legitimate concern of the taxpayer that the collection action be no more intrusive than necessary. Secs. 6320(c), 6330(c)(3).
Section 7122(a) permits the Secretary to compromise any civil case arising under the internal revenue laws. Section 7122(c) requires the Secretary to prescribe guidelines for officers and employees of the IRS to determine whether an offer-in-compromise is adequate and should be accepted to resolve a dispute. Sec. 7122(a),(c)(1). Section 7122(b) provides that if the Secretary makes a compromise exceeding $50,000, an opinion of the General Counsel for the Department of the Treasury or his delegate shall be placed on file in the office of the Secretary. Sec. 301.7122-1(e)(6), Proced. & Admin. Regs.
The contemplated guidelines and schedules pertaining to evaluating offers-in-compromise on the basis of collectibility have been published in the regulations interpreting section 7122. See sec. 301.7122-1(c)(2), Proced. & Admin. Regs.; 1 Administration, Internal Revenue Manual (CCH), pt. 5.8.4.4, at 16,306. Under this administrative guidance, the Secretary will generally compromise a liability on the basis of doubt as to collectibility only if the liability exceeds the taxpayer's reasonable collection potential. Cf. Murphy v. Commissioner, 125 T.C. 301, 308-310 (2005), affd. 469 F.3d 27 (1st Cir. 2006). Furthermore, an offer to compromise based on doubt as to collectibility will be acceptable only if the offer reflects the taxpayer's reasonable collection potential; i.e., that amount, less than the full liability, that the IRS could collect through means such as administrative and judicial collection remedies. Id. at 309; Rev. Proc. 2003-71, sec. 4.02(2), 2003-2 C.B. 517, 517. The Secretary has no duty to negotiate with a taxpayer before rejecting the taxpayer's offer-in-compromise. Fargo v. Commissioner, 447 F.3d 706, 713 (9th Cir. 2006), affg. T.C. Memo. 2004-13; Catlow v. Commissioner, T.C. Memo. 2007-47.
A taxpayer's reasonable collection potential is determined, in part, using the published guidelines for certain national and local allowances for basic living expenses and essentially treating income and assets in excess of those needed for basic living expenses as available to satisfy Federal income tax liabilities. See 2 Administration, Internal Revenue Manual (CCH), exh. 5.15.1-3, at 17,668, exh. 5.15.1-8, at 17,686, exh. 5.15.1-9, at 17,742.
The aforementioned formulaic approach is disregarded, however, upon a showing by the taxpayer of special circumstances that may cause an offer to be accepted notwithstanding that it is for less than the taxpayer's reasonable collection potential, e.g., the taxpayer is incapable of earning a living because of a long-term illness, and it is reasonably foreseeable that the taxpayer's financial resources will be exhausted providing for care and support during the course of the condition. Sec. 301.7122-1(b)(3), (c)(3), Proced. & Admin. Regs.; 1 Administration, Internal Revenue Manual (CCH), pt. 5.8.11.2.1, at 16,375, sec. 5.8.11.2.2, at 16,377. Petitioners do not allege, and it does not appear, that any such special circumstances are present.
Where, as here, the underlying tax liability is not at issue, we review respondent's determination for abuse of discretion.9 Sego v. Commissioner, 114 T.C. 604, 610 (2000). This standard does not require us to decide what we think would be an acceptable offer-in-compromise. Murphy v. Commissioner, supra at 320. Rather, our review is to determine whether respondent's rejection of petitioners' offer-in-compromise was arbitrary, capricious, or without sound basis in fact or law. Id.
Petitioners do not suggest, and it does not appear from this record, that respondent failed to follow his own procedures in evaluating petitioners' offers-in-compromise or that those procedures were defective. Petitioners claim that respondent summarily refused to accept the values shown in the appraisals they submitted and consequently miscalculated their reasonable collection potential. That miscalculation, according to petitioners, led respondent to reject both their $65,525 offer-in-compromise, evaluated by respondent's Office of Chief Counsel in March of 2005, and their $129,361 offer-in-compromise, evaluated by respondent's Engineering Group in May of 2006, and constituted an abuse of discretion.
Respondent's Office of Chief Counsel identified a number of defects in petitioners' $65,525 offer-in-compromise, such as the outdated appraisals submitted in support of the claimed value of petitioners' home, the validity of an encumbrance placed on the mortgage by a member of petitioners' family, and the consequent value of petitioners' equity in the home. The Appeals officer also identified several problems with the more recent appraisals that petitioners then submitted.
Admittedly, the reviewing member of respondent's Engineering Group expressed her opinion concerning the value of petitioners' home in a letter to the Appeals officer, as opposed to a formal appraisal report. However, we do not believe that such an appraisal report was required.
The Engineering Group member reviewing petitioners' appraisals held an MAI designation. Her letter to the Appeals officer makes clear that she reached her conclusion after reviewing petitioners' appraisals10 and by conducting her own investigation with respect to other property sales in the subject market area.
The record shows that from the time petitioners submitted their first offer-in-compromise, a substantial divergence of opinion existed as to the value of petitioners' home. Respondent alerted petitioners to the fact that their appraisals were problematic, beginning with the first appraisal dated March 10, 2003. The bases of respondent's objections to the appraisals were explained.
Upon a review of the record, we cannot say that respondent's objections to petitioners' appraisals were arbitrary, capricious, unreasonable, or without sound basis in fact or law. Nor can we agree with petitioners that respondent's Engineering Group and/or Office of Appeals summarily rejected "out of hand" petitioners' valuation. Moreover, contrary to petitioners' assertion, respondent was under no obligation "to negotiate a new offer-incompromise figure" once respondent determined that petitioners' $129,361 offer-in-compromise was inadequate.
We hold that respondent did not abuse his discretion in rejecting petitioners' offer-in-compromise as inadequate. Consequently, we sustain respondent's determination that the proposed levy and filing of a Federal tax lien were appropriate.
1 This case was submitted to Judge James S. Halpern on Nov. 26, 2007. The Chief Judge reassigned this case to Judge Julian I. Jacobs on Mar. 14, 2008.
2 Unless otherwise indicated, all section references are to the Internal Revenue Code as amended, and all Rule references are to the Tax Court Rules of Practice and Procedure.
3 This amount includes $4,629.93 owed for tax year 1999. Petitioners paid some of the taxes due after respondent issued the final notice of intent to levy. As a consequence, no tax is owed and respondent does not seek to collect any amount with respect to 1999.
4 As discussed infra, the reasonable collection potential with respect to the tax debt of a taxpayer is defined as the amount that can be collected from all available means and is generally calculated using: (1) The values of assets, (2) future income, (3) amounts collectible from third parties, and (4) assets and/or income that are available to the taxpayer but beyond the reach of the Government (e.g., assets to which a lien will not attach because they are outside the country). 1 Administration, Internal Revenue Manual (CCH), pt. 5.8.4.4.1, at 16,307.
5 The Appeals Officer's report identified other items requiring adjustment that are no longer at issue. For example, the Appeals officer adjusted the amount petitioners claimed as equity in their pension plans. In addition, the Appeals officer disregarded the "open end mortgage" held by William G. Schwartz's father, but made a $54,000 allowance for amounts from the father that had been used to pay a portion of petitioners' tax liabilities.
6 At that time petitioners' tax liability approximated $315,930.
7 Respondent's Engineering Group consists of experts who provide technical advice for field investigations.
8 MAI is a designation awarded to qualifying members of the Appraisal Institute (the body that resulted from the merger of the American Institute of Real Estate Appraisers and the Society of Real Estate Appraisers). Within the real estate appraisal community MAI is viewed as the highest regarded appraisal designation. See Estate of Auker v. Commissioner, T.C. Memo. 1998-185.
9 Secs. 301.6320-1(f)(2), A-F5, and 301.6330-1(f)(2), A-F5, Proced. & Admin Regs., provide that in seeking Tax Court review of a notice of determination, the taxpayer can ask the Court to consider only an issue that was raised in the taxpayer's sec. 6320 and/or 6330 hearing. See Giamelli v. Commissioner, 129 T.C. 107, 113 (2007); Magana v. Commissioner, 118 T.C. 488, 493 (2002). Petitioners raised various issues pertaining to their underlying tax liabilities in their requests for a hearing under secs. 6320 and 6330 but did not pursue those claims at the hearing, or at any time thereafter.
10 It is not clear from this record whether petitioners' appraisers held MAI designations. An MAI designation does not appear after their names on their appraisals, although petitioners refer to their "certified MIA appraisals" on brief.
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Labels: 7122 Special Circumstances
Treasury Inspector General for Tax Administration (TIGTA) Report: Fiscal Year 2008 Statutory Review of Compliance With Legal Guidelines When Issuing Levies (Reference Number: 2008-30-097)
Treasury Inspector General for Tax Administration (TIGTA) report : IRS levies : Compliance with IRS Restructuring and Reform Act of 1998 .
Fiscal Year 2008 Statutory Review of Compliance With Legal Guidelines When Issuing Levies
Reference Number: 2008-30-097
Phone Number 202-622-6500
Email Address inquiries@tigta.treas.gov
Web Site http://www.tigta.gov
FROM: (for) Michael R. Phillips /s/ Margaret E. Begg
SUBJECT: Final Audit Report - Fiscal Year 2008 Statutory Review of Compliance With Legal Guidelines When Issuing Levies (Audit # 200830003)
This report presents the results of our review to determine whether the Internal Revenue Service (IRS) has complied with 26 United States Code (U.S.C.) Section (§) 6330, Notice and Opportunity for Hearing Before Levy.1 This audit is statutorily required in each fiscal year.
The IRS Restructuring and Reform Act of 19982 requires the IRS to notify taxpayers at least 30 calendar days before initiating any levy action to give taxpayers an opportunity to formally appeal the proposed levy. We determined the IRS is complying with the legal guidelines and protecting taxpayer rights.
This is the tenth annual report the Treasury Inspector General for Tax Administration has issued in compliance with the IRS Restructuring and Reform Act of 1998 requirement to determine whether the IRS is complying with legal guidelines over the issuance of levies. Our prior reports have recognized that the IRS has implemented tighter controls related to systemically generated levies. This was due primarily to the development of systemic controls in both the Automated Collection System3 and the Integrated Collection System4 to prevent levies from being generated unless there were at least 30 calendar days between the date taxpayers received notice of their appeal rights and the date of the proposed levies. Our reviews for the past 5 years disclosed no weaknesses in the Automated Collection System and the Integrated Collection System systemic levy processes. Based on these results, we considered the systemic controls strong and concentrated this year's audit efforts on manual levies only. We did not test systemic levies.
Since Fiscal Year 2005, we have reported that revenue officers in field offices and Automated Collection System function customer service representatives properly notified taxpayers of their appeal rights when issuing manual levies.5 Our review this year of 30 Integrated Collection System and 30 Automated Collection System manual levies issued between July 1, 2006, and June 30, 2007, showed revenue officers and customer service representatives continued to properly inform taxpayers of their rights at least 30 calendar days prior to issuing the levies.
During last fiscal year's audit, we reported that the IRS did not always contact taxpayers or send reminder notices about potential enforcement actions when more than 180 calendar days had passed since the date of the notification letters. The IRS implemented program changes in the Automated Collection System to correctly address this issue. We tested the effectiveness of these changes and determined that the IRS appropriately sent reminders or had contacted taxpayers within 180 calendar days of levy for all cases in our sample.
We made no recommendations in this report. However, key IRS management officials reviewed it prior to issuance and agreed with the facts and conclusions presented.
Copies of this report are also being sent to the IRS managers affected by this report. Please contact me at (202) 622-6510 if you have questions or Margaret E. Begg, Acting Assistant Inspector General for Audit (Small Business and Corporate Programs), at (202) 622-8510.
Appendix IV - Example of Levy (Form 668-B)
The Treasury Inspector General for Tax Administration is required to annually verify whether the IRS is complying with the IRS Restructuring and Reform Act of 1998 requirement to notify the taxpayer at least 30 calendar days before initiating a levy action.
When taxpayers do not pay delinquent taxes, the Internal Revenue Service (IRS) has the authority to work directly with financial institutions and other third parties to seize taxpayers' assets. This action is commonly referred to as a "levy" (see Appendix IV for an example of a Levy (Form 668-B)). The IRS Restructuring and Reform Act of 19986 requires the IRS to notify the taxpayer at least 30 calendar days before initiating a levy action to give the taxpayer an opportunity to formally appeal the proposed levy.
The IRS Restructuring and Reform Act of 1998 also requires the Treasury Inspector General for Tax Administration to annually verify whether the IRS is complying with the provisions. This is the tenth year in which we have evaluated the controls over levies.
Two operations within the IRS issue levies to collect delinquent taxes:
Ÿ The Automated Collection System (ACS), through which customer service representatives contact delinquent taxpayers by telephone to collect unpaid taxes and secure tax returns.
Ÿ The Collection Field function, where revenue officers contact delinquent taxpayers in person as the final step in the collection process. Field contact becomes necessary when the ACS function does not resolve the tax matter. Delinquent cases assigned to revenue officers in the field offices are controlled and monitored with the automated Integrated Collection System (ICS).
Both operations issue two types of levies: systemically generated levies and manual levies. Virtually all levies issued by customer service representatives are generated through the ACS. To comply with requirements in the IRS Restructuring and Reform Act of 1998, the ACS contains a control that prevents a levy from being generated if there are fewer than 30 calendar days between the date the taxpayer was notified of the pending levy and the date requested for the actual issuance of the levy. This control is designed to ensure that taxpayers have been notified at least 30 calendar days prior to issuance of the levies and have been informed of their appeal rights for any systemically generated levies. In addition, managers approve all levy actions. Even when an employee manually generates the request for a levy (as opposed to the system generating the request), the systemic controls of at least 30 calendar days' notice and managerial approval are in place.
The ICS includes a control-similar to the control in the ACS-that prevents revenue officers from issuing levies unless taxpayers have received 30 calendar days' notice and have been informed of their appeal rights. If fewer than 30 calendar days have elapsed since the final notice date, the ICS will not generate a levy.
Previous Treasury Inspector General for Tax Administration audit reports7 have recognized that the IRS has significantly improved controls over the issuance of systemically generated levies, primarily due to the development of these systemic controls in both the ACS and ICS. Our reviews for the past 5 fiscal years disclosed no weaknesses in the ACS and ICS systemic levy processes. Based on these results, we consider the controls to be strong. Therefore, we concentrated this year's audit efforts on manual levies only and did not test systemic levies.
There is a higher risk when revenue officers issue manual levies because they request these levies outside of the systemic controls that exist and there is no managerial approval required. Treasury Inspector General for Tax Administration audit reports issued prior to Fiscal Year 2005 reported that additional controls were needed over manual levies issued by revenue officers.8 The IRS issued an ICS Alert on March 5, 2004, reminding employees to ensure that taxpayer rights are protected whenever a manual levy is issued. Since our Fiscal Year 2005 report,9 we have reported that revenue officers properly notified taxpayers of their right to a hearing when issuing manual levies. However, we consider the risk higher and continued to test the manual levies.
Because the ICS is not generating the levies, we cannot be assured that there is a complete automated trail for manual levies. Therefore, it is impossible to reliably determine the exact number of manual levies issued by revenue officers during our review period. However, we estimate that customer service representatives manually generated about 22 percent of all levies issued through the ACS during our audit period. We estimate that revenue officer requests for manual levies totaled less than 1 percent of all levies requested by revenue officers.
This review was performed at the Small Business/Self-Employed Division National Headquarters in the Collection office in New Carrollton, Maryland, during the period August 2007 through January 2008. We conducted this performance audit in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objective. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objective. Detailed information on our audit objective, scope, and methodology is presented in Appendix I. Major contributors to the report are listed in Appendix II.
Although the ACS function primarily issues levies systemically, customer service representatives may also request manual levies under certain circumstances, such as levies on Individual Retirement Arrangements and in jeopardy situations.10 Manual levies require the same advance notification to the taxpayer as systemic levies, except in cases involving jeopardy situations. IRS procedures require that manual levies issued by customer service representatives be reviewed and approved by a manager prior to the levies being issued. We consider this managerial review to be an effective control.
We analyzed the case histories for ACS function cases to identify any manual levies issued between July 1, 2006, and June 30, 2007. Because there is no automated audit trail produced for manual levies, we used employee and action codes11 as the basis to identify any potential manual levies issued by ACS function employees. Our review of 30 manual levies issued by customer service representatives showed the IRS adequately protected taxpayers' appeal rights.
Our review of 30 ACS function and 30 ICS manual levies determined the IRS protected taxpayers' appeal rights in these cases.
Revenue officers issue levies systemically through the ICS in most cases. They are also authorized to issue a manual levy on any case as needed. While managerial approval is mandatory for manual levies issued by the ACS function, no review or approval is required when revenue officers issue manual levies. We believe there is a high risk associated with manual levies because no review is required.
We analyzed the ICS case inventory assigned to revenue officers to identify any manual levies issued between July 1, 2006, and June 30, 2007. Because no automated audit trail is produced for manual levies, we analyzed case history comments for any reference to a manual levy. Using this methodology, we identified cases in which a manual levy was issued to seize taxpayers' assets and reviewed a sample of 30 cases. In all 30 cases, taxpayers received proper notification of their rights.
The ACS is sending reminder notices to taxpayers when 180 calendar days have passed since issuance of the notification letters
IRS guidelines state that, if a notice of intent to levy is more than 180 calendar days old, it is legally sufficient to support consequent collection action by levy. However, the IRS has administratively determined that the taxpayer will get a new warning of enforcement action before a notice of levy is issued. This warning can be given orally through contact with the taxpayer or in writing through issuance of an ACS letter. During last fiscal year's audit, we reported that this was not always being done in the ACS function. The IRS implemented programming changes to correct this. During this audit, we followed up to determine if those programming changes were effective.
We evaluated the effectiveness of program changes to the ACS for sending reminder notices to taxpayers about potential enforcement actions when more than 180 calendar days had passed since the date of the notification letters and there had been no taxpayer contact. Our review of 30 manual levies issued more than 180 calendar days after the original notices of intent to levy had been sent showed the ACS function sent appropriate reminder letters if there had been no other contacts with taxpayers within 180 calendar days of the date of the notices.
The overall objective of this review was to determine whether the IRS has complied with 26 United States Code (U.S.C.) Section (§) 6330, Notice and Opportunity for Hearing Before Levy.12 To accomplish our objective, we:
I. Determined whether manual levies issued by both revenue officers and ACS13 function customer service representatives complied with legal guidelines in 26 U.S.C. §6330.
A. Identified any references to manual levies issued between July 1, 2006, and June 30, 2007, by querying the history narrative text field of the ICS14 open case inventories. We identified and reviewed a judgmental sample of 30 manual levies from the open ICS cases. We used judgmental sampling because we could not identify the population of manual levies issued.
B. By using the employee and action codes15 on the ACS, identified 433,523 employee-requested levies on the ACS between July 1, 2006, and June 30, 2007, and randomly selected a sample of 30 manual levies.
C. Requested case history files for all cases containing references to manual levies identified in Steps I.A. and I.B.
E. Analyzed Master File16 transcripts and ACS and ICS history files to determine whether taxpayers were provided at least 30 calendar days' notice prior to any levy actions initiated by the IRS.
F. Validated data from the ACS and ICS by relying on Treasury Inspector General for Tax Administration Data Center Warehouse17 site procedures that ensure that data received from the IRS are valid. The Data Center Warehouse performs various procedures to ensure that it receives all the records in the ACS, ICS, and IRS databases. In addition, we scanned the data for reasonableness and are satisfied that the data are sufficient, complete, and relevant to the review. All the levies identified are in the appropriate period, and the data appear to be logical. This data validation also applied to Step II.
II. Determined the effectiveness of program changes on the ACS for sending reminder notices to taxpayers about potential enforcement actions when more than 180 calendar days have passed since the date of the notification letters and there has been no taxpayer contact.
A. Identified one levy per taxpayer issued more than 180 calendar days from the date of the notification letter between June 1, 2007, and June 30, 2007, by querying the Treasury Inspector General for Tax Administration Data Center Warehouse ACS database using the codes for levies and letters. We selected 1 month of levies due to the large volume of data. We identified a population of 20,037 levies and randomly selected 30 levies.
B. Reviewed Master File, ACS, and Desktop Integration18 histories and action codes to determine whether reminder notices had been sent or contacts with taxpayers had been made within 180 calendar days of the levy.
Pillai Sittampalam, Lead Auditor
Christina Dreyer, Senior Auditor
Director, Campus Compliance Services, Small Business/Self-Employed Division SE:S:CCS
1 26 U.S.C. §6330 (Supp. IV 1998) as amended by the Trade Act of 2002, Pub. L. No. 107-210, 116 Stat. 933; the Job Creation and Worker Assistance Act of 2002, Pub. L. No. 107-147, 116 Stat. 21 (codified in scattered sections of 26 U.S.C., 29 U.S.C., and 42 U.S.C.); the Victims of Terrorism Tax Relief Act of 2001, Pub. L. No. 107-134, 115 Stat. 2427 (2002); and the Community Renewal Tax Relief Act of 2000, Pub. L. No. 106-554, 114 Stat. 2763.
2 Pub. L. No. 105-206, 112 Stat. 685 (codified as amended in scattered sections of 2 U.S.C., 5 U.S.C. app., 16 U.S.C., 19 U.S.C., 22 U.S.C., 23 U.S.C., 26 U.S.C., 31 U.S.C., 38 U.S.C., and 49 U.S.C.).
3 A telephone contact system through which telephone assistors collect unpaid taxes and secure tax returns from delinquent taxpayers who have not complied with previous notices.
4 An automated system used to control and monitor delinquent cases assigned to revenue officers in the field offices.
5 Taxpayer Rights Are Being Protected When Levies Are Issued (Reference Number 2005-30-072, dated June 2005); Fiscal Year 2006 Statutory Review of Compliance With Legal Guidelines When Issuing Levies (Reference Number 2006-30-101, dated August 4, 2006); and Fiscal Year 2007 Statutory Review of Compliance With Legal Guidelines When Issuing Levies (Reference Number 2007-30-070, dated April 20, 2007).
6 Pub. L. No. 105-206, 112 Stat. 685 (codified as amended in scattered sections of 2 U.S.C., 5 U.S.C. app., 16 U.S.C., 19 U.S.C., 22 U.S.C., 23 U.S.C., 26 U.S.C., 31 U.S.C., 38 U.S.C., and 49 U.S.C.).
7 The Internal Revenue Service Does Not Have Controls Over Manual Levies to Protect the Rights of Taxpayers (Reference Number 2003-40-129, dated June 2003); The Internal Revenue Service Has Improved Controls Over the Issuance of Levies, But More Should Be Done (Reference Number 2002-40-176, dated September 2002); The Internal Revenue Service Complied With Levy Requirements (Reference Number 2001-10-113, dated July 2001); and The Internal Revenue Service Has Significantly Improved Its Compliance With Levy Requirements (Reference Number 2000-10-150, dated September 2000).
8 Additional Efforts Are Needed to Ensure Taxpayer Rights Are Protected When Manual Levies Are Issued (Reference Number 2004-30-094, dated April 2004) and The Internal Revenue Service Does Not Have Controls Over Manual Levies to Protect the Rights of Taxpayers (Reference Number 2003-40-129, dated June 2003).
9 Taxpayer Rights Are Being Protected When Levies Are Issued (Reference Number 2005-30-072, dated June 2005); Fiscal Year 2006 Statutory Review of Compliance With Legal Guidelines When Issuing Levies (Reference Number 2006-30-101, dated August 4, 2006); and Fiscal Year 2007 Statutory Review of Compliance With Legal Guidelines When Issuing Levies (Reference Number 2007-30-070, dated April 20, 2007).
10 A jeopardy situation occurs when the IRS is concerned that the taxpayer may attempt to hide or dispose of assets to prevent enforced collection actions.
11 The action code shows what action was taken, such as levy. The employee code shows whether there was a system-generated action or an employee-generated action.
12 26 U.S.C. §6330 (Supp. IV 1998) as amended by the Trade Act of 2002, Pub. L. No. 107-210, 116 Stat. 933; the Job Creation and Worker Assistance Act of 2002, Pub. L. No. 107-147, 116 Stat. 21 (codified in scattered sections of 26 U.S.C., 29 U.S.C., and 42 U.S.C.); the Victims of Terrorism Tax Relief Act of 2001, Pub. L. No. 107-134, 115 Stat. 2427 (2002); and the Community Renewal Tax Relief Act of 2000, Pub. L. No. 106-554, 114 Stat. 2763.
13 A telephone contact system through which telephone assistors collect unpaid taxes and secure tax returns from delinquent taxpayers who have not complied with previous notices.
14 An automated system used to control and monitor delinquent cases assigned to revenue officers in the field offices.
15 The action code shows what action was taken, such as levy. The employee code shows whether there was a system-generated action or an employee-generated action.
16 The IRS database that stores various types of taxpayer account information. This database includes individual, business, and employee plans and exempt organizations data.
17 A centralized storage and administration of files that provides data and data access services of IRS data.
18 The IRS system that provides multiple system interfaces using only one computer terminal. Users can access various IRS data systems through one computer.
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Labels: TIGTA report on tax levies
Section 6694 contact information
Chief Counsel Notice CC-2008-013
Code Sec. 6694
Chief Counsel Notice : Tax return preparer penalties : Understatement of tax liability .
Notice CC-2008-013
Subject: Coordination of Section 6694 Penalty
This Notice instructs Chief Counsel attorneys on how to advise the Internal Revenue Service regarding the tax return preparer penalty provisions under section 6694 of the Internal Revenue Code and the related definitional provisions, as amended by the Small Business and Work Opportunity Tax Act of 2007, Pub. L. No. 110-28, 121 Stat. 190.
COORDINATION OF SECTION 6694 PENALTY
Section 8246 of the Act amended several provisions of the Code to extend the application of the income tax return preparer penalties to all tax return preparers, alter the standards of conduct that must be met to avoid imposition of the section 6694(a) penalty for preparing a return which reflects an understatement of liability, and increase applicable penalties under section 6694(a) and (b). The amendments to section 6694 are effective for tax returns and claims for refund prepared after May 25, 2007. The Department of Treasury and IRS issued Notice 2008-13, which provides interim guidance regarding implementation of the tax return preparer penalty provisions until final regulations are published. Notice 2008-13 also solicited public comments regarding the revision of the regulatory scheme governing tax return preparer penalties. The Treasury Department and the IRS intend to finalize the revision of the tax return preparer regulations by the end of 2008.
Until the revised tax return preparer penalty regulations are issued, Chief Counsel attorneys must consult with the Office of the Associate Chief Counsel (Procedure and Administration) on any issues under section 6694 and the related definitional provisions as amended by the Act.
Questions regarding this Notice should be directed to Procedure & Administration Branch 1 at (202) 622-4910 or Branch 2 at (202) 622-4940.
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Labels: 6694 contact information
The practice of granting options with a discounted exercise price can have adverse tax consequences for the corporation issuing the option. Generally, IRC section 162(m) provides a $1 million annual limit on the deduction allowed for compensation paid to each of the CEO and four other highest compensated officers in a publicly traded corporation. Treasury Regulations section 1.162-27(e)(2)(vi) provides a "qualified performance based compensation" exception to the $1 million deduction limit for compensation attributable to option exercises if the option exercise price equals or exceeds the per share value on the grant date and certain other requirements are met. A failure to satisfy this requirement may cause compensation attributable to the option exercise to be subject to the $1 million deduction limit. Treasury Regulations section 1.162-27(e)(2)(vii), Example 9.
Large and Mid Size Business Division Industry Directive on Backdated Stock Options Directive #2
Code Sec. 422
Internal Revenue Service : Large and Mid Size Business Division : Backdated stock options : Industry directive : Tier II designation .
Industry Director Directive on Backdated Stock Options Directive #2
LMSB Control No. 4-0308-017
MEMORANDUM FOR: INDUSTRY DIRECTORS
FROM: Laura M. Prendergast / s / Laura M. Prendergast
SUBJECT: Tier I Issue - Backdated Stock Options Directive #2
The Backdated Stock Option (BSO) Issue has been removed from Tier I status and will be designated as a Tier II issue.
The BSO issue was originally designated as Tier I due to intense public and Congressional interest. The level of importance for maintaining Tier I status has diminished as field personnel are now better equipped to identify and examine this issue. Based on the progress of BSO examinations, this issue no longer requires Tier I monitoring and has been moved into Tier II status. Tier II will allow the Issue Management Team (IMT) to assist ongoing examinations through completion and continue to provide field support for the issues.
This directive amends the Tier status and reporting requirements outlined in Directive #1.
Issue guidance and support will continue through the LMSB Executive Compensation Technical Advisors and the IMT. Reporting requirements will be eased and no additional BSO Tier I cases will be assigned to the field by the IMT. The following changes will be implemented for the Tier I cases assigned to the field:
1. Monthly reporting by the case agent will be eliminated after submission of the April 10, 2008 report.
2. A closing report continues to be required upon completion of the examination of the issues.
3. Non assertion of penalties continues to require IMT approval prior to any penalty discussion with the taxpayer.
4. UIL, Project and Tracking Codes continue to be mandatory and will conform to those outlined in Directive #1.
These requirements will remain in place until all cases assigned to the field have been completed or such time as the Issue Owner Executive issues a directive eliminating these actions.
If examiners need further assistance, they should contact the Executive Compensation Technical Advisors.
This Directive is not an official pronouncement of law or the position of the Service and can not be used, cited, or relied upon as such.
Director, Performance, Quality, Audit Assistance and Service
2007ARD 135-7 IRS Large and Mid-Size Business Division (LMSB) Industry Directive on Backdated Stock Options July 13, 2007
Backdated stock options: Internal Revenue Service: Large and Mid-Size Business Division.
DIRECTOR, INTERNATONAL COMPLIANCE STRATEGY AND POLICY
SUBJECT: Tier I Issue - Backdated Stock Options Directive # 1
This issue was identified from media reports of a practice among some publicly traded companies to backdate stock option exercise prices to a date that provides a lower cost to acquire the underlying stock. This issue also exists for stock options described as discounted, mis-priced, mis-dated, or in-the-money, and may arise from clerical or other errors in addition to deliberate backdating. Over one hundred companies have confirmed backdating stock options in SEC filings and press releases. Many are the subject of investigations by the Securities and Exchange Commission (SEC) and/or the Department of Justice (DOJ).
Stock options provide the right to purchase company stock on a future date at a set price (the exercise or strike price), and this right is normally exercised when the per share stock value is above the exercise price. Typically, when options are granted, the exercise price is set at the per share value on the grant date so that the option holder will profit from the option only if the stock price increases after the grant date. A backdated option provides the holder with a "built-in" profit on the option at the time of grant, which may result in the company having to accrue a charge against its earnings for financial accounting purposes.
This practice can also have adverse tax consequences for an individual taxpayer. First, such options will not qualify as "incentive stock options" under IRC section 422. As a result, if a discounted option was intended to be an incentive stock option, the issuing corporation may have an obligation to withhold and pay income and employment taxes when the option is exercised and the individual taxpayer may owe additional taxes at the time of exercise. Second, options granted with a discounted exercise price may be subject to IRC section 409A, relating to nonqualified deferred compensation. Section 409A generally does not apply to options granted before January 1, 2005, but it does apply to discounted options that were not earned and vested as of December 31, 2004, and to discounted options that were materially modified after October 3, 2004. Under the transition rules, taxpayers generally may amend options until December 31, 2007 to avoid problems under section 409A. However, for options granted to a person who, as of the date of grant, was subject to the disclosure requirements of section 16(a) of the Securities Exchange Act of 1934, transition relief generally is available only if the option was amended by December 31, 2006. Notice 2005-1, 2005-2 I.R.B. 274, Q&A 4(d); Preamble to Proposed Regulations §1.409A, 70 Fed. Reg. 57956 (October 4, 2005); Notice 2006-79, 2006-43 IRB 763; Notice 2006-100, 2006-51, IRB 1109; T.D. 9321 Final Regulations §1.409A 72 FR 19234 (April 17, 2007). If a taxpayer fails to comply with section 409A, the taxpayer would be required to include the deferred income under the option in taxable income, pay an additional 20% tax, and an additional tax calculated by reference to interest on the taxes the executive saved by not reporting the deferred income in earlier years.
1. On ERCS, Tracking Code 0537 and/or Project Code 0537 is required to be manually input on all Backdated Stock Option issues at the examination level.
2. On IMS, examiners need to accurately identify the proper UIL code.
 UIL Codes used to track issue on IMS for cases input after April 1, 2007:
o 162.40-00 - Compensation Limitation due to the backdating or discounting of Stock options for covered employees (162(m))
o 422.06-00 - Conversion of incentive stock options to nonstatutory options due to backdating or discounting of the option
o 409A.01-00 - Conversion of incentive stock options to nonstatutory options due to backdating or discounting of exercised stock options.
This is a Tier I Compliance Issue and therefore is a mandatory examination item for taxpayers with backdated stock option grant and/or exercise prices. The field should address issues including section 162(m), section 422, section 409A and other relevant issues and challenge arguments by taxpayers who have not complied with the provisions of these Code sections. Examination results should be reported to the Issue Owner Executive.
Section 162(m) Audit Technique Guide
Section 422 Stock Based Compensation Audit Technique Guide
Section 409A - Refer to section 409A guidance noted above for this issue. The Final Regulations and the Notices are available on http://www.irs.gov/.
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Labels: Back dated stock options