"Tax Shelter" Exception To The Tax Practitioner- Client Privilege Is Broad Enough To Encompass Any Plan Who Significant Purpose Is To Avoid Taxes

Posted on September 17, 2009 by Michael Rigney

VALERO ENERGY CORPORATION v. UNITED STATES OF AMERICA (June 17, 2009)

Valero Energy Corp., a large U.S. refiner, acquired Ultramar Diamond Shamrock Corporation ("UDS”) in 2001. Prior to the transaction, Valero received relevant tax advice from Arthur Andersen. With Arthur Andersen's help, Valero initiated a complex set of transactions that resulted in tax deductible losses in excess of $100 million. The size of the deduction caught the eye of the IRS, which issued a summons to Arthur Andersen seeking documents relating to its tax analysis for Valero or UDS. Valero moved to quash the summons, in part based on the tax practitioner-client privilege. The government argued that the tax practitioner-client privilege did not apply because of the statutory exception for documents made in connection with the promotion of a tax shelter. The district court originally upheld Valero’s claim of privilege, concluding that the government failed to meet its burden. On a second round of document production, however, the government again challenged the privilege and supported its challenge with a detailed affidavit. This time the district court concluded the government met its burden with respect to some documents and ordered them produced. Valero appeals.

In their opinion, Judges Rovner, Evans and Tinder affirmed. The Court noted that Congress created the tax practitioner-client privilege in 1998 as a limited shield of confidentiality. It is no broader than the attorney-client privilege and does not protect general accounting advice, even if provided by an attorney. The Court first rejected Valero’s arguments that the bulk of the documents were even covered by the privilege. Although some of the documents contained legal analysis, the Court concluded they were not privileged because they contained the type of information generally collected in the process of preparing a return. With respect to the small group of documents that the district court found were protected, the Court agreed with the government that they fell within the exception for communications in connection with the promotion of a tax shelter. Under the statute, a "tax shelter" includes any plan or arrangement a "significant purpose" of which is the avoidance of income tax. Because the privilege is an exception to the broad summons power of the IRS, the Court declined to broaden the privilege through a narrow interpretation of the exception. Given that the Valero documents addressed the structure of the transactions that resulted in a large tax deduction, the Court concluded that they fit within the exception and were not covered by the privilege.

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Subjective Belief Is Insufficient To Establish Potential Value of Business For Tax Purposes Without Objective Evidence That the Belief Was Reasonable

Posted on March 18, 2009 by Michael Rigney

BILTHOUSE v. UNITED STATES (January 15, 2009)

Alan and Patricia Bilthouse bought $500,000 worth of stock in S&E Contractors (“S&E”), a heavy construction contractor in Florida. S&E’s principal business was public works projects, for which it needed to be bonded. S&E came upon hard times beginning in early 1994. It suffered severe losses from cost overruns on a large project, eventually defaulting on the bonds in 1995. Without bonding, S&E had to discontinue its public works projects. It did file a lawsuit in late 1995 to recover its losses from the project. The lawsuit was settled in 1997 with S&E receiving no money. The confluence of the IRS regulations and the Bilthouse personal situation made the S&E losses much more valuable to them if their loss occurred in 1997 rather than 1995. The Bilthouses sought a refund from the IRS from their 1997 tax payment, asserting that their interest in S&E became worthless in 1997 and their shares were, therefore, “disposed of” in that year. The IRS denied their claim. The Bilthouses sued in district court. The court granted summary judgment to the United States. The Bilthouses appeal.

In their opinion, Judges Ripple, Kanne and Williams affirmed. The principal question before the Court was whether the stock became worthless in 1995 or 1997. The parties agreed that, for loss computation purposes, the stock is considered “disposed of” the year it became worthless. The Court noted that “worthless” is not defined by the IRS but is a fact question, taking into account both the liquidating value and the potential for value. It is the Bilthouse’s burden, however, to establish the facts supporting the worthlessness in 1997. The Bilthouses rely on two facts: a) the lawsuit was expected to result in an award in excess of $15 million and b) S&E continued its construction activity on small, private projects through 1997. The Court rejected first basis. Although the plaintiffs presented evidence of the subjective belief of many that the lawsuit would succeed, the Court stated that the proper inquiry requires objective evidence of the reasonableness of those beliefs. The Bilthouses presented no such evidence – nor did they present evidence of the basis for the calculation of damages in the event of success. The Court viewed the continued projects as a closer question. Continued operations of a company can establish the potential for value. The plaintiffs again, however, were unable to demonstrate a sufficient evidentiary basis for their claim. The record was silent on the amount of private work S&E was engaged in, its future prospects, and whether the private projects would have eventually been sufficient to revive the company. The Court concluded that the Bilthouses failed to carry their burden.

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President of Non-Profit's Board of Directors is Personally Liable to IRS as "Responsible Person" Because He Had Significant Involvement in the Organization's Financial Affairs

Posted on October 20, 2008 by Michael Rigney

JEFFERSON v. UNITED STATES  (October 8, 2008)

Charles Jefferson served as the voluntary, uncompensated president of the board of directors of New Zion Day Care Center (“Center”). Velma Hayes was the paid director of the Center and ran its day-to-day operations. Jefferson had authority to direct the financial affairs of the Center. The United Way provided financial support to the Center . In early 1998, the United Way informed Jefferson that the Center was not paying its payroll taxes properly. The board ordered Hayes to pay any taxes due to the IRS. By 2000, the Center was in severe financial trouble. It did not pay income and FICA taxes from early 2000 through mid-2001. Hayes reported to the board at its monthly meetings that the Center was delinquent in its bills and tax liabilities. The United Way ceased its support of the Center, in part because of the tax issue. Jefferson arranged for the Center to borrow money to pay the delinquent taxes. In August, 2000, Jefferson co-signed two checks to the IRS for penalties and interest. In 2002, the IRS made assessments against both Hayes and Jefferson for the delinquent taxes. Jefferson filed suit to recover the $41,432 he paid pursuant to the assessment. The district court granted the United States’ motion for summary judgment. Jefferson appeals.

In their opinion, Judges Bauer, Williams, and Sykes affirmed. The Court addressed each of Jefferson’s arguments in turn: a) that he was not a “responsible person” under the statute, b) that his conduct was not willful, c) that he was exempt as an honorary board member, d) that the IRS was estopped because of its failure to develop explanatory materials as required by statute, and e) that the IRS failed to disclose evidence. The Court stated that a “responsible person” under Section 6672(a) of the Internal Revenue Code is a person who has enough authority over the organization’s finances to determine which debts will be paid. Jefferson had significant involvement in the Center’s financial affairs. The Court found that Jefferson was a “responsible person,” relying on his position on the board, his review of finances at monthly meetings, his securing of the loan to pay IRS penalties and interest, and his direction to Hayes to pay the taxes. On the “willful” issue, the Court observed that a person acts willfully when he acts in reckless disregard of a known risk that taxes are going unpaid. The Court recognized that the board had directed Hayes to pay the taxes but found that Jefferson had taken no steps to make sure that the taxes were, in fact, paid or that effective controls were in place. This made Jefferson’s conduct willful, even if he did not actually know the taxes were still unpaid. The Court rejected Jefferson’s honorary board member argument, noting that the statutory exemption only applied to board members who did not participate in the financial operations of the organization. Jefferson’s estoppel argument is that the government is required by law to develop explanatory materials relating to the circumstances under which a board member of a non-profit organization could be held liable for tax delinquencies. The Court agreed that the materials are required by law and that they were never developed. However, it refused to adopt a blanket rule that would make the assessment invalid as a result. Instead, the Court required a showing of prejudice, which it said Jefferson could not make. The Court rather summarily rejected Jefferson’s evidence argument, citing the substantial evidence of his liability and the fact that the evidence was relevant, if at all, only to collateral issues (e.g., his knowledge of the delinquencies).

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