Tax Watch: Client-attorney privilege challenged in shelter case

The government recently took unprecedented action against a Dallas-based law firm, seeking the names of taxpayers that the Internal Revenue Service believes participated in abusive tax shelters. Those shelters had shielded at least $2.4 billion from federal income taxes, the IRS said.

According to court documents, at least 600 individuals may have participated in the shelters organized and sold by the law firm. Each of those individuals may have claimed at least $4 million in artificial losses on their tax returns in order to reduce their taxes, the IRS said.

“Promoters of potentially abusive tax-avoidance transactions know the tax code requires them to keep investor lists and to provide those lists to the IRS on request,” IRS Commissioner Mark W. Everson said.

The IRS received approval from U.S. District Court Judge John W. Darrah in Chicago to order Jenkens & Gilchrist to identify taxpayers who may have invested in such shelters that were organized and sold by the firm. It is the first-ever John Doe summons against a law firm to obtain the names of investors in tax shelters.

The law firm said that it would not comply with the summons.

“It has long been the law of this country that Americans have a right to consult with an attorney in confidence, and that only the clients themselves can waive that right,” Petri Darby, a spokesperson for Jenkens & Gilchrist, said in a prepared statement.

The firm said it is prohibited by law and its ethical responsibility from complying with the IRS’ demand to disclose the names of clients who have sought its advice.

This credit promise doesn’t check out

* The IRS has issued an alert warning consumers about a new scam targeting potential recipients of the advance child tax credit. The IRS has reportedly seen isolated instances of this new scheme.

A taxpayer receives a telephone call from a person who promises to speed up the payment of checks for the benefit. The catch is, the taxpayer must agree to a $39.99 charge to a credit card.

The IRS is reminding taxpayers that no person or organization can speed up the payment of tax benefits. According to the agency, taxpayers don’t have to take any action to get the new benefit, which features an advance payment for up to $400 per qualifying child.

The Department of the Treasury and the IRS have issued regulations dealing with a tax shelter commonly referred to as “son of boss.” The regulations pertain to the assumption by a partnership of a partner’s liability.

The rules make clear that non-economic tax losses cannot be created by transferring obligations to partnerships.

In one variation, a taxpayer purchases and writes economically offsetting options and then purports to create a substantial positive basis by transferring those option positions to a partnership.

On the disposition of the partnership interest, the liquidation of the partnership, or the taxpayer’s sale or depreciation of distributed partnership assets, the taxpayer claims a tax loss, even though no corresponding economic loss was incurred.

Cite: JS-493 & T.D. 9062, REG-106736-00

When non-lawyer can act for client

* In a recent legal memorandum, the IRS ruled that disclosures of returns and return information are authorized to a non-lawyer under a valid Form 2848, Power of Attorney.

While the IRS has said disclosing returns and the information on those returns to someone who is not a lawyer may be permissible, the new guidance doesn’t mean that the non-lawyer is authorized to practice before a revenue officer.

An IRS manager group sought advice on the effectiveness of a Form 2848 that lists one lawyer and two non-lawyers from one law firm. The non-lawyers designated themselves as unenrolled return preparers. The IRS said there’s a difference between the disclosure of return information to a designee of the taxpayer and practicing before the IRS.

It advised that any person can qualify, as a taxpayer’s designee, to receive returns or return information. No requirement exists that the person fall into one of the categories listed in Part II of Form 2848.

A non-lawyer working for a law firm is not one of the categories of individuals that may represent a taxpayer before the IRS.

If a non-lawyer working in a law firm is an unenrolled return preparer in connection with a particular return, that person isn’t allowed to represent the taxpayer in the collection process, the IRS concluded.

Cite: Legal Memorandum 200321017

Though illegal, the income’s taxable

* The U.S. Tax Court has upheld the IRS’ determination that an individual is liable for self-employment tax – as well as civil fraud penalties – on unreported income from marijuana sales.

Louis Peyton and his wife filed joint returns for tax years 1990 and 1991, reporting her wages while reporting only the profits from construction activities on a Schedule C. Mr. Peyton was convicted of conspiracy to distribute marijuana and cocaine, and four counts of filing false tax returns.

In 1998, the IRS went after Mr. Peyton, claiming he had unreported income from marijuana sales totaling $85,000 and unreported construction income of $9,171 in 1991.

The IRS determined self-employment tax liabilities and civil fraud penalties. Mr. Peyton petitioned the Tax Court, disputing the IRS’ determination, and the IRS asserted a claim for increased deficiencies for the unreported drug-sales income.

Tax Court Judge Mary Ann Cohen, upholding only the IRS’ original deficiency determination, concluded that Mr. Peyton had failed to report income in 1990 and 1991 from the sale of drugs and from construction activities.

She said the IRS had introduced evidence from Mr. Peyton’s criminal trial that was sufficient to link him to the unreported income, on which self-employment tax is due.

The court also upheld civil fraud penalties, noting Mr. Peyton’s underpayments and finding that the conviction, inadequate records, cash dealings and illegal activities had supported an inference of intent to evade taxes.

Cite: Louis E. Peyton v. Commissioner, T.C. Memo 2003-146

Selling for a bonus is not a business

* The IRS, ever vigilant for home businesses where taxpayers are using the activity to write off expenses rather than make a profit, have encountered yet another Amway Corp. activity that wasn’t a business, at least for tax purposes.

In a recent case before the U.S. Tax Court, the taxpayers operated a distributorship for the Ada, Mich.-based company but incurred losses four years in a row. The Tax Court ruled that the taxpayers did not have a profit motive for the activity.

Rather than trying to make a profit on the products, they sold the products at cost to try to generate a high-enough sales volume to qualify for bonuses.

The court noted that while the taxpayers did keep records, they appeared to do so solely for substantiating their deductions, not as a business tool.

Cite: Jorge N. and Vivian Lopez, T.C. Memo. 2003-142