Corporations

Debt Funded by Family to Purchase Baseball Team Was Not Bona Fide Debt: In Tribune Media Company v. Comm'r, T.C. Memo. 2021-122, the Tax Court held that the formation of a limited liability company by a media company and a wealthy family so that the media company could sell a baseball team to the family was a disguised sale transaction. The court concluded that the debt incurred by the family in financing the deal was not bona fide debt for tax purposes and that resulted in the media company recognizing gain on the sale of the baseball team.

Employment Taxes

Government Can Foreclose on Taxpayer's Property for Failing to Pay Payroll Taxes: In Reddington v. U.S., 2021 PTC 253 (E.D. Pa. 2021), a district court granted a government motion to foreclose on the property of a taxpayer who was convicted under Code Sec. 6672 of willfully failing to pay employment taxes. In granting the government's motion, the court noted that (1) the fact that the taxpayer truthfully accounted for all of the payroll taxes by timely filing all of the required tax returns or subsequently contacting the IRS to attempt to come up with a payment plan was irrelevant in determining if he acted "willfully" for purposes of Code Sec. 6672(a); and (2) the fact that the taxpayer may or may not have engaged with the IRS in an attempt to develop a payment plan after violating federal tax law has no bearing on whether he acted "willfully" at the time he failed to pay the requisite taxes which, the court said, is the only relevant time under Code Sec. 6672.

Foreign Bank Account Reporting

Couple with Joint Bank Account in Costa Rica Liable for $55,000 in Penalties and Interest: In U.S. v. Vega, 2021 PTC 350 (D. N.J. 2021), a district court granted the government's motion for a default judgment against a married couple who refused to respond to government complaints and summonses relating to their failure to file a Foreign Bank Account Report (FBAR) to report their interest in a joint bank account in Costa Rica. The court upheld the government's assessment of FBAR penalties, late-payment penalties, and pre-judgment interest of more than $55,000.

Procedure

Chief Counsel Advised on Overpayment Interest Relating to Form 1120-F: In CCM 202144027, the Office of Chief Counsel advised that, with respect to a question as to when overpayment interest begins to accrue for an overpayment of withholding tax claimed on a taxpayer's Year 1 Form 1120-F, U.S. Income Tax Return of a Foreign Corporation, the original due date of which was June 15 of Year 2 (1) if the corporation knew that its full withholding, at the time it occurred, would result in an overpayment for which it would seek a refund and the corporation timely filed its income tax return, then overpayment interest accrues from June 15 of Year 2; or (2) if the corporation's income tax return was not timely filed, overpayment interest accrues from the date the corporation filed a processible return. The Chief Counsel's Office also advised that if the corporation did not know that its full withholding, at the time it occurred, would result in an overpayment for which it would seek a refund, its overpayment interest would accrue from June 15 of Year 2.

IRS Complied with Supervisory Approval Requirement: In Excelsior Aggregates, LLC v. Comm'r, T.C. Memo. 2021-125, the Tax Court held that the IRS complied with Code Sec. 6751(b)(1) with respect to penalties it assessed against a partnership after disallowing the partnership's deduction for a conservation easement deduction. The court rejected the partnership's argument that the supervisory approval for the penalties came too late and agreed with the IRS's argument that the initial determination of the penalties occurred four months before the final partnership administrative adjustment was issued when the IRS assessed penalties against the partnership's appraiser under Code Sec. 6695A(a).

IRS Form 4549 Did Not Prevent Agency from Assessing Interest: In Goldberg v. Comm'r, 2021 PTC 351 (7th Cir. 2021), the Seventh Circuit affirmed the Tax Court's holding that Form 4549, Income Tax Examination Changes, signed by the taxpayer did not prevent the agency from assessing interest and, to the contrary, the taxpayer had committed himself to paying lawful interest. The court rejected the taxpayer's argument that the IRS had agreed in Form 4549 that it would not collect interest on a tax debt that he owed after noting that the Form 4549 at issue merely reported a proposed tax debt by a tax examiner who lacked authority to bind the government to a contract.

Couple Hit with Taxes and Penalties for Failing to Repay Premium Tax Credit Advance: In Amburgery v. Comm'r, T.C. Memo. 2021-124, the Tax Court held that a couple who filed a joint tax return, on which they reported $181,000 of modified adjusted gross income, was liable for tax deficiencies for failing to repay an advance premium tax credit as required under Code Sec. 36B. The court also upheld the IRS's assessment of penalties after concluding that the couple failed to meet their burden of showing that the provisions of Code Sec. 36B violate the Constitution.

House Sends $1T Infrastructure Package to Biden; Build Back Better Bill on Hold

On November 5, the House of Representatives passed the Infrastructure Investment and Jobs Act, a $1 trillion infrastructure bill previously passed in the Senate. The bipartisan infrastructure bill contains several important tax provisions, such as: (1) the early termination, effective October 1, of the Code Sec. 3134 employee retention credit for employers other than recovery startup businesses; (2) modifications to Tax Court filing and tax-related deadlines; (3) changes to the tax treatment of certain contributions to the capital of a corporation; (4) new information reporting requirements on sales of cryptocurrency and other digital assets; (5) the extension of interest rate stabilization for pension-related purposes; and (6) the inclusion of qualified broadband projects in private activity bonds. H.R. 3684, Infrastructure Investment and Jobs Act.

Background

On November 5, the House passed H.R. 3684, Infrastructure Investment and Jobs Act. H.R. 3684 is a $1 trillion infrastructure package which the Senate passed with bipartisan support on August 10, 2021. H.R. 3684 authorizes roughly $550 billion in new funding for infrastructure, including:

(1) $110 billion of new funds for roads, bridges, and major projects;

(2) $11 billion in transportation safety programs;

(3) $39 billion to modernize public transit;

(4) $66 billion for passenger and freight rail upgrades;

(5) $7.5 billion for a national network of electric vehicle chargers;

(6) $25 billion for airport repair and maintenance, and $17 billion for port infrastructure;

(7) $50 billion for protection against droughts, floods, and wildfires;

(8) $55 billion for clean drinking water;

(9) $65 billion for broadband internet infrastructure; and

(10) $65 billion for power grid improvements.

H.R. 3684 also includes several important tax-related provisions such as: (1) the early termination, effective October 1, of the Code Sec. 3134 employee retention credit for employers other than recovery startup businesses; (2) modifications of filing deadlines for taxpayers experiencing certain disasters; (3) an extension of Tax Court filing deadlines and the temporary postponement of certain other filing deadlines; (4) additional time to file certain tax-related documents when a taxpayer is affected by a significant fire event; (5) a modification of the tax treatment of contributions to the capital of a corporation; (6) new broker information reporting requirements for digital assets; (7) pension interest rate stabilization changes; and (8) the inclusion of qualified broadband projects and qualified carbon dioxide capture facilities in private activity bonds. Finally, of interest to certain qualifying nonprofits, H.R. 3684 authorizes grants of up to $200,000 for energy-efficiency materials installed in a nonprofit building.

Observation: On November 5, the House temporarily put on hold a vote for the Build Back Better (BBB) Bill, an almost $2 trillion social spending package loaded with tax provisions. Instead, the House passed a procedural vote needed to advance the BBB for an eventual vote. In the meantime, the House is waiting on a detailed cost estimate of the BBB from the Congressional Budget Office, which could take up to two weeks.

The following is a summary of the tax provisions included in H.R. 3684.

Early Termination of Employee Retention Credit

Section 2301 of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) enacted the employee retention credit (ERC) which allows eligible employers to take a credit against certain employment taxes. Originally, the credit related to employment taxes paid on a percentage of qualified wages paid after March 12, 2020, and before December 31, 2020. That termination date was later extended to July 1, 2021, by Section 207 of the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Disaster Tax Relief Act), which was enacted as part of the Consolidated Appropriations Act, 2021 (Pub. L. 116-260). Section 207 also made several other changes to the ERC. The American Rescue Plan Act of 2021 (Pub. L. 117-2) subsequently enacted Code Sec. 3134, which extended the ERC to wages paid after June 30, 2021, and before January 1, 2022.

Section 80604 of H.R. 3684 terminates the ERC early so that it does not apply to wages paid after September 30, 2021, unless the employer qualifies as a recovery startup business under Code Sec. 3134(c)(5). For a recovery startup business, the ERC continues to apply to wages paid before January 1, 2022. A recovery startup business refers to any employer that: (1) began carrying on a trade or business after February 15, 2020; (2) for which the average annual gross receipts for the 3-tax-year period ending with the tax year preceding the calendar quarter for which the credit is determined does not exceed $1 million; and (3) with respect to any calendar quarter, was not subject to a government-ordered shutdown or a significant decline in gross receipts.

Practice Tip: Due to the early termination of the ERC, employers (other than recovery startup businesses) that reduced employment tax deposits and/or received an advance payment of the credit by filing Form 7200, Advance Payment of Employer Credits Due to COVID-19, after September 30, 2021, will have to repay those amounts. Under Reg. Sec. 31.3134-1T, any amount of the ERC to which an employer is not entitled is treated as an underpayment of the taxes, which the IRS can assess and collect in the same manner as the taxes.

Modifications to Tax Court Filing and Tax-Related Deadlines

Clarification of Automatic Extension of Certain Deadlines in the Case of Taxpayers Affected by Federally Declared Disasters: Under Code Sec. 7508A(a), the Treasury Secretary can postpone certain tax-related deadlines when there is either a federally declared disaster, a terroristic action, or a military action. In the Consolidated Appropriations Act, 2020, Code Sec. 7508A(d) was added to provide a mandatory minimum extension period of 60 days for taxpayers affected by federally declared disasters, regardless of whether the Treasury Secretary exercised the discretion granted by Code Sec. 7508A(a). Section 80501 of H.R. 3684 clarifies the legislative intent of that provision by stating (1) when the automatic extension ends, (2) what required acts are postponed, (3) the location of a qualifying disaster, and (4) how to proceed when there are declarations relating to multiple disasters. The provision applies to federally declared disasters declared after the date of enactment.

Prior to being amended by H.R. 3684, Code Sec. 7508A(d) provided qualified taxpayers a mandatory 60-day period that is to be disregarded "in the same manner as the period specified under [Code Sec. 7508A(a)]." Last June, the IRS issued final regulations (T.D. 9950) on the new mandatory 60-day postponement under Code Sec. 7508A(d). The IRS concluded that Code Sec. 7508A(d) was ambiguous because it did not specify the time-sensitive acts to be postponed by the mandatory 60-day postponement period and, in Reg. Sec. 301.7508A-1(g), the IRS interpreted Code Sec. 7508A(d) to provide that the time-sensitive acts postponed for the mandatory 60-day postponement period are the acts, if any, that the Treasury Secretary determines in his or her discretion to be postponed under Code Sec. 7508A(a) or (b). Section 80501(a) of H.R. 3684 in effect claws back the IRS's exercise of discretion in the final regulations by amending Code Sec. 7508A(d)(1)(B) to specify that the time-sensitive acts to which the 60-day mandatory postponement applies are the acts described in Code Sec. 7508(a)(1)(A)-(F). These acts are:

(1) filing returns;

(2) paying taxes;

(3) filing a Tax Court petition;

(4) the allowance of a credit or refund;

(5) filing a claim for a credit or refund; and

(6) bringing a lawsuit for a credit or refund.

Postponement of Certain Acts by Reason of Service in Combat Zone or Contingency Operation: Code Sec. 7508(a) allows for the postponement for the performance of certain acts by reason of service in combat zones or contingency operations. Section 80502 of H.R. 3684 amends Code Sec. 7508(a)(1) to clarify that all Tax Court petitions receive the postponement treatment encompassed by Code Sec. 7508(a)(1). Further, the time for the government to file an erroneous refund suit against a taxpayer is also postponed under this provision. This provision applies to any period for performing an act which has not expired before the date of enactment.

Tolling of Time for Filing a Petition with the Tax Court: A taxpayer is provided specific deadlines by which the taxpayer must file a petition in the Tax Court, depending on the type of tax at issue. For example, if contesting a proposed deficiency, a taxpayer has 90 days (or 150 days in certain cases) under Code Sec. 6213 to file a petition, and if contesting an IRS determination to levy or file a notice of federal tax lien under Code Sec. 6330, a taxpayer has 30 days to file a petition. The Tax Court consistently holds these timing rules are themselves part of the Congressional grant of subject matter jurisdiction, and thus cannot be extended. In Guralnik v. Comm'r, 146 T.C. 230 (2016), the Tax Court granted taxpayers limited relief by incorporating Federal Rule of Civil Procedure 6(a)(3) to hold that if the last day for filing a petition falls on a day when the Tax Court is inaccessible, then the last day is extended to the first day the Tax Court reopens. Recently, the Tax Court has been inaccessible and often unable to accept mail for extended periods of time due to weather, lapses in appropriations, and the COVID-19 pandemic. Thus, in order to ensure the timely filing of their petitions, taxpayers have had to monitor the status of the Tax Court and submit a petition virtually the moment the Tax Court reopens.

Section 80503 of H.R. 3684 amends Code Sec. 7451 to provide a tolling period for the time for filing a Tax Court petition when, including by reason of a lapse in appropriations, a "filing location" is inaccessible or otherwise unavailable to the general public on the date a petition is due. Under this provision, taxpayers have an additional 14 days to file a Tax Court petition after the Tax Court reopens from such period of inaccessibility. In addition, Section 80503 adds Code Sec. 7451(b), which provides that for these purposes a "filing location" includes (1) the office of the clerk of the Tax Court, and (2) any online portal made available by the Tax Court for electronic filing of petitions (i.e., the Tax Court's DAWSON e-filing system). This provision applies to petitions required to be timely filed (determined without regard to the amendments made by this provision) after the date of enactment.

New Authority to Postpone Certain Tax Deadlines by Reason of Significant Fires: Section 80504 of H.R. 3684 amends Code Sec. 7508A to change its heading from "Authority to Postpone Certain Deadlines by Reason of Presidentially Declared Disaster or Terroristic or Military Actions" to "Authority to Postpone Certain Deadlines by Reason of Federally Declared Disaster, Significant Fire, or Terroristic or Military Actions." In addition, Code Sec. 7508A is amended by adding "a significant fire" to the list of events that result in the postponement of certain federal deadlines and defines a "significant fire" as any fire with respect to which assistance is provided under Section 420 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act. These amendments apply to fires for which assistance is provided after the date of enactment.

Modification of Tax Treatment of Contributions to the Capital of a Corporation

Section 80601 of H.R. 3684 revises the rules of Code Sec. 118, relating to the tax treatment of contributions to the capital of a corporation, to provide special rules for water and sewerage disposal utilities. Under this new rule, the term "contribution to the capital of the taxpayer" includes any amount of money or other property received from any person (whether or not a shareholder) by a regulated public utility which provides water or sewerage disposal services if: (1) such amount is (i) a contribution in aid of construction, or (ii) a contribution to the capital of such utility by a governmental entity providing for the protection, preservation, or enhancement of drinking water or sewerage disposal services, (2) in the case of a contribution in aid of construction which is property other than water or sewerage disposal facilities, such amount meets certain requirements of an expenditure rule contained in Code Sec. 118(c)(2), and (3) such amount (or any property acquired or constructed with such amount) is not included in the taxpayer's rate base for rate-making purposes.

No deduction or credit is allowed for, or by reason of, any expenditure which constitutes a contribution in aid of construction to which this provision applies. The adjusted basis of any property acquired with contributions in aid of construction to which this provision applies is zero.

This provision applies to contributions made after December 31, 2020.

New Information Reporting Requirements for Cryptocurrency and Other Digital Assets

Under Code Secs. 6045 and 6045A, any person doing business as a broker is required to file annual information returns on Form 1099-B, Proceeds from Broker and Barter Exchange Transactions, to report certain information about their customers to the IRS, such as the customer's identity, the gross proceeds from sales of securities for such customer, and for "covered securities," cost basis information. Brokers are also required to furnish the same information reported to the IRS to their customers by February 15 of the year following the calendar year for which the Form 1099-B is required to be filed.

H.R. 3684 expands the Form 1099-B reporting and furnishing requirements to include cryptocurrency and other digital asset transactions, beginning with returns required to be filed and statements required to be furnished in 2024 for transactions occurring in calendar year 2023.

Observation: Expanding broker reporting to crypto assets was one of the proposals included in the Biden Administration's General Explanations of the Administration's Fiscal Year 2022 Revenue Proposals (also known as the "Greenbook") issued earlier this year. The Greenbook states that tax evasion using crypto assets is a rapidly growing problem, and the global nature of the crypto market allows U.S. taxpayers to conceal assets and taxable income by using offshore crypto exchanges and wallet providers. Beginning with the 2020 Form 1040, page 1 of the form includes the question "At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in virtual currency?"

Definition of Broker Revised: Section 80603 of H.R. 3684 amends the definition of "broker" in Code Sec. 6045(c)(1) to include any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person. Such broker is required to file a return showing the name and address of each customer, with such details regarding gross proceeds and such other information as the IRS may require with respect to such business. A digital asset generally is defined as any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the IRS.

New Return Requirement for Certain Digital Asset Transfers: H.R. 3684 also amends Code Sec. 6045A to provide a return requirement for certain transfers of digital assets not otherwise subject to reporting. In addition, any broker, with respect to any transfer (which is not part of a sale or exchange executed by such broker) of a covered security which is a digital asset from an account maintained by such broker to an account which is not maintained by, or an address not associated with, a person that such broker knows or has reason to know is also a broker, must file a report showing the information otherwise required to be furnished with respect to such digital asset transfers.

New Reporting Penalties for Filing to Furnish Information Relating to Digital Asset Transfers: Additionally, reporting penalties are added under Code Sec. 6724 for failing to furnish the required digital asset transfer information under Code Sec. 6045A.

The above changes relating to cryptocurrency and other digital assets apply to returns required to be filed, and statements required to be furnished, after December 31, 2023.

Changes Relating to Minimum Funding Standards for Single-Employer Defined Benefit Pension Plans

Section 80602 of H.R. 3684 changes the rules relating to minimum funding standards for single-employer defined benefit pension plans by amending (1) the table in Code Sec. 430(h)(2)(C)(iv), relating to segment rates used to determine the shortfall amortization installments with respect to minimum funding standards for single-employer defined benefit pension plans, and (2) the table in Section 303(h)(2)(C)(iv)(II) of the Employee Retirement Income Security Act of 1974.

These amendments apply with respect to plan years beginning after December 31, 2021.

Inclusion of Qualified Broadband Projects and Qualified Carbon Dioxide Capture Facilities in Private Activity Bonds

Sections 80401 and 80402 of H.R. 3684 add qualified broadband projects and qualified carbon dioxide capture facilities to the list of exempt facility bonds in Code Sec. 142.

The amendments relating to qualified broadband projects apply to obligations issued in calendar years beginning after the date of enactment. The amendments relating to qualified carbon dioxide capture facilities apply to obligations issued after December 31, 2021.

Grants for Energy-Efficiency Materials Installed in a Nonprofit Building

Section 40542 of H.R. 3684 authorizes up to $200,000 in grants to individual nonprofit organizations for the purchase of energy-efficiency materials, the installation of which results in a reduction in use of energy or fuel. For this purpose, the term "energy-efficient material" includes:

(1) a roof or lighting system or component of the system;

(2) a window;

(3) a door, including a security door; and

(4) a heating, ventilation, or air conditioning system or component of the system (including insulation and wiring and plumbing improvements needed to serve a more efficient system).

The term ''nonprofit building'' means a building operated and owned by an organization that is described in Code Sec. 501(c)(3) and is exempt from tax under Code Sec. 501(a). In determining whether to award a grant, the following performance-based criteria will be applied:

(1) the energy savings achieved;

(2) the cost effectiveness of the use of energy-efficiency materials;

(3) an effective plan for evaluation, measurement, and verification of energy savings; and

(4) the financial need of the applicant.

Highway Tax-Related Provisions Included in H.R. 3684

(1) Section 80102(a)(1) extends to September 30, 2028, the highway-related taxes in Code Secs. 4041(a)(1)(C), 4041(m)(1)(B), and 4081(d)(1). The taxes under those provisions were originally scheduled to expire after September 30, 2022.

(2) Section 80102(a)(2) extends to October 1, 2028, the tax on the use of certain heavy vehicles in Code Secs. 4041(m)(1)(A), 4051(c), 4071(d), and Code Sec. 4081(d)(3).

(3) Section 80102(b) extends the heavy vehicle use taxes in Code Sec. 4481(f) and 4482(c)(4) and 4482(d), originally scheduled to expire in 2023, to 2029.

(4) Section 80102(c) extends the time for applying for floor stocks refunds under Code Sec. 6412(a)(1).

(5) Section 80102(d) extends the time for engaging in certain exemption transactions in Code Sec. 4221(a) to October 1, 2028, and certain exemption transactions in Code Sec. 4483(i) to October 1, 2029, from October 1, 2022, and October 1, 2023, respectively.

(6) Section 80102(e) amends Code Sec. 9503 to extend the appropriation of certain taxes to the Highway Trust Fund as well as authorize further additional transfers to the trust fund.

(7) Section 80201 amends Code Secs. 4661 to extend and modify certain superfund taxes and rates. This provision also amends and modifies the rules in Code Sec. 4672 for determining taxable substances subject to the superfund excise taxes.

(8) Section 80301 extends the applicable date for the application of customs user fees in the Consolidated Omnibus Budget Reconciliation Act of 1985 as well as the rate for merchandise processing fees in Section 503 of the United States-Korea Free Trade Agreement Implementation Act.

(9) Section 80403 increases the national limitation amount for qualified highway or surface freight transportation facilities from $15 billion to $30 billion.

2021 Year-End Tax Planning for Businesses

The coronavirus pandemic (COVID-19) continued to impact businesses in 2021. In December of 2020 and March of 2021, COVID-19 relief provisions were enacted in the Consolidated Appropriations Act, 2021 (CAA 2021) and the American Rescue Plan Act of 2021 (ARP), respectively. Among other changes, CAA 2021 enacted a provision allowing businesses to fully deduct expenses paid with the proceeds of a forgiven Paycheck Protection Program loan, effectively overriding earlier guidance. The ARP then extended and modified certain refundable payroll tax credits through September 30, 2021. And more recently, Congress approved the Infrastructure Investment and Jobs Act which negatively impacts businesses claiming the employee retention credit.

At press time, practitioners were still waiting to see if Congress will pass the Build Back Better (BBB) Bill, which will likely result in significant tax changes affecting businesses, beginning next year.

The following are some of the considerations to review when deciding what year-end actions may reap the biggest tax benefits for a client's business.

Practice Aid: See ¶320,120 for a comprehensive year-end letter for businesses. For comprehensive year-end letter for individuals, see ¶320,121.

Section 179 Expensing and Bonus Depreciation Deductions

Generally, the two biggest deductions that can reduce a business client's taxable income are the Code Sec. 179 expense deduction and the 100 percent bonus depreciation deduction. It's important to remember that bonus depreciation rules apply unless a taxpayer specifically elects out of those rules. A business may want to elect out of bonus depreciation if the business expects a tax loss for the year and the bonus depreciation would just increase that loss. By not taking bonus depreciation in the current year, a business can push depreciation deductions into future years where it expects to have taxable income that the depreciation can offset. Of course, where the business is operated through a flow-through entity, additional considerations must be given to the tax situation of the owner of the flow-through entity (e.g., the owner's tax bracket this year versus later years) and whether the owner might benefit from the bonus depreciation deductions.

Under the Code Sec. 179 expensing option, a business can immediately expense the cost of up to $1,050,000 of "Section 179" property placed in service in 2021. This amount is reduced dollar for dollar (but not below zero) by the amount by which the cost of the Section 179 property placed in service during the year exceeds $2,620,000.

In order to qualify for the Code Sec. 179 deduction, the property must be acquired by purchase for business use and placed in service before the end of 2021. Qualified real property is also eligible for Code Sec. 179 deduction as are certain improvements to nonresidential real property. However, the deduction is limited to a business's aggregate taxable income for the year derived from the active conduct of a trade or business. Thus, unlike depreciation, the Section 179 expense cannot be used to reduce income below zero.

If a client is looking for business-related property to purchase in order to reap the maximum benefit of the Code Sec. 179 expense deduction and/or the bonus depreciation deduction, a vehicle purchase could result in a substantial tax savings. By purchasing a sport utility vehicle weighing more than 6,000 pounds, a client can obtain a bigger deduction than if a smaller vehicle is purchased. Because vehicles that weigh 6,000 pounds or less are considered listed property, deductions are limited to $18,200 for cars, trucks and vans acquired and placed in service in 2021. However, if the vehicle weighs more than 6,000 pounds, up to $26,200 of the cost of the vehicle can be immediately expensed.

It's also important to remember that, if a client leases a passenger automobile with a value of more than $51,000, the deduction available for that lease expense must be reduced. The lessee is required to include in gross income an amount determined by applying a formula to the amount obtained from a table provided by the IRS in published guidance. Rev. Proc. 2021-31 contains the inclusion amounts for 2021.

Energy Efficient Building Deduction

The Consolidated Appropriations Act of 2021 made the Code Sec. 179D energy efficient building deduction permanent. Thus, if a business owner made certain energy-efficient improvements during the year, such as installing property that is part of (1) an interior lighting system, (2) heating, cooling, ventilation, and hot water systems, or (3) the building envelope, a deduction equal to $1.80 times the square footage of the building may be available.

COVID-Related Employer Tax Credits

Refundable payroll tax credits are available for businesses with under 500 employers that offered paid sick or family leave through September 30, 2021 (i.e., qualified leave wages), to employees who took paid leave due to COVID-19. In addition, an employee retention tax credit (ERTC) is available for the first three quarters of 2021 for businesses which were impacted by COVID-19 but kept employees on the payroll.

Generally, Form 941, Employer's Quarterly Federal Tax Return, is used to claim these payroll tax credits for qualified leave wages paid. Employers report income and social security and Medicare taxes withheld from employee wages, as well as the employer's share of social security and Medicare taxes on the Form 941, although other federal employment tax returns may also be used. In anticipation of claiming the credit, employers can (1) reduce federal employment taxes, including withheld taxes that would otherwise be required to be deposited with the IRS, and (2) when the amount of the credit exceeds the applicable federal employment taxes, request an advance payment of the credit from the IRS for the amount of the credit remaining after reducing federal employment tax deposits, by filing the applicable version of Form 7200, Advance Payment of Employer Credits Due to COVID-19 PDF for the relevant calendar quarter.

In July, the IRS significantly revised Form 941-X to allow for correcting COVID-19 related employment tax credits reported on Form 941. Practitioners should review their client's Forms 941 filed during the year to ensure that all payroll tax credits for which the client is eligible have been claimed.

For the first three quarters of 2021, employers can take tax credits for wages paid for up to 80 hours of paid sick leave in an amount equal to either: (1) the employee's regular wage, capped at $511/day, up to a total of $5,110 if the employee was sick or quarantining, awaiting the results of a COVID test, obtaining or recovering from a vaccine; or (2) two-thirds of the employee's regular wage, capped at $200/day, up to a total of $2,000, if the employee was taking time to care for someone quarantining or to provide care due to COVID-19 school or child care provider closures. In addition, employers may receive tax credits for up to 12 weeks of paid family leave provided to employees who are unable to work for any of the reasons listed above. These credits are equal to two-thirds of an employee's regular wages, capped at $200/day up to a total of $12,000.

The ERTC is available to employers which either (1) had their operations fully or partially suspended under government orders, or (2) experienced a decline in gross receipts for a quarter in 2021 of 20 percent or more compared to the same quarter in 2019 (i.e., a "significant decline in gross receipts). However, if the business did not exist as of the beginning of the same calendar quarter in calendar year 2019, then the same calendar quarter in 2020 is used. The ERTC generally equals 70 percent of the first $10,000 in wages, including certain health plan expenses, per employee in each of the first three quarters of 2021. A special rule applies for a "recovery startup business." For the third and fourth quarters of 2021, such businesses are allowed a credit amount of $50,000 per quarter. A recovery startup business is defined as any employer which (1) began carrying on any trade or business after February 15, 2020, (2) for which the average annual gross receipts for the three tax year period ending with the tax year which precedes such quarter does not exceed $1,000,000, and (3) with respect to such quarter, the operation of the trade or business is not subject to a government-ordered suspension or a significant decline in gross receipts.

Practice Tip: The ERTC was originally available for all four quarters of 2021, but was terminated early as a way to pay for the Infrastructure Investment and Jobs Act. Employers (other than recovery startup businesses) that reduced employment tax deposits and/or received an advance payment of the credit after September 30, 2021, will have to repay those amounts.

Caution: In Notice 2021-49, the IRS points out that, as a result of the interaction of Code Sec. 51(i)(1) and the constructive ownership rules of Code Sec. 267, wages paid to majority owners, their spouses, and children generally are not qualified wages for purposes of the employee retention tax credit. This interpretation appeared to run contrary to the intent of the ERTC legislation, and Congress.

Paycheck Protection Program

Many businesses obtained Small Business Administration loans through the Paycheck Protection Program (PPP) in order to help them through the pandemic. The PPP ended on June 30, 2021. Borrowers may be eligible to have their loans forgiven, and businesses that received a PPP loan of $150,000 or less can file a simplified loan forgiveness application on SBA Form 3508S. A forgiven PPP loan is not includible in income and, pursuant to changes made by CAA 2021, no deduction will be denied, no tax attribute will be reduced, and no basis increase will be denied by reason of the exclusion from gross income of a forgiven PPP loan. In addition, under a safe harbor provided in Rev. Proc. 2021-20, PPP loan recipients that did not deduct certain otherwise deductible expenses paid or incurred in 2020 based on guidance available at that time can elect to deduct these expenses on their 2021 tax return rather than by filing an amended return or administrative adjustment request.

Retirement Plans and Employee Benefits

The employment landscape has changed significantly since the beginning of the COVID pandemic. Many businesses are facing a worker shortage and are reevaluating what it will take to get employees in the door. A business may reap substantial tax benefits, as well as non-tax benefits, by offering a retirement plan and/or other fringe benefits to employees. Businesses that offer such benefits have a better chance of attracting and retaining talented workers which, in turn, reduces the costs of searching for and training new employees. Contributions made to retirement plans on behalf of employees are deductible and the business may be eligible for a tax credit for setting up a qualified plan.

In addition, business owners and spouses can take advantage of the retirement plan themselves. Where a spouse is not currently on the payroll of a business, consideration should be given to adding the spouse as an employee and paying a salary up to the maximum amount that can be deferred into a retirement plan. If the spouse of a business owner is 50 years old or over and receives a salary of $26,000, all of it could go into a 401(k), leaving him or her with a retirement account but no current year taxable income.

To help employees with medical expenses, a business might consider setting up a high deductible health plan paired with a health savings account (HSA). The benefits to the business include savings on health insurance premiums that would otherwise be paid to traditional health insurance companies and having employee wage contributions to the plan not being counted as wages and thus neither the employer nor the employee is subject to FICA taxes on the payroll contributions. As for employees, they can reap a tax deduction for funds contributed to the HSA, and there is no use-it-or-lose-it limit like there is for most flexible spending arrangements (FSAs). Thus, the funds can grow tax free and be used in retirement.

Another employee benefit a business might consider is the establishment of a flexible spending arrangement (FSA). An FSA allows employees to be reimbursed for medical expenses or dependent care expenses and is usually funded through voluntary salary reduction agreements with the employer. The employer has the option of making or not making contributions to the FSA. Contributions made by the business can be excluded from the employee's gross income and thus no employment or federal income taxes apply to the contributions. Reimbursements to the employee are tax free if used for qualified medical or dependent care expenses, and the FSA can be used to pay qualified expenses even if the employer or employee haven't yet placed the funds in the account.

Finally, The Victims of Terrorism Tax Relief Act of 2001 enacted Code Sec. 139, a little-known or used provision that employers may be able to use to compensate employees tax-free for extra expenses incurred due to the COVID-19 pandemic. This could include expenses incurred to set up a home office or to rent a place in which to quarantine or even for medical care. Under Code Sec. 139(a), gross income does not include any amount received by an individual as a qualified disaster relief payment. The term "qualified disaster relief payment" means any amount paid to or for the benefit of an individual:

(1) to reimburse or pay reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a qualified disaster;

(2) to reimburse or pay reasonable and necessary expenses incurred for the repair or rehabilitation of a personal residence or repair or replacement of its contents to the extent that the need for such repair, rehabilitation, or replacement, is attributable to a qualified disaster; or

(3) by a federal, state, or local government, or agency or instrumentality thereof, in connection with a qualified disaster in order to promote the general welfare.

In Rev. Rul. 2003-12, the IRS notes that Code Sec. 139 codifies (but does not supplant) the administrative general welfare exclusion with respect to certain disaster relief payments to individuals. According to the IRS, this exclusion from income applies only to the extent any expense compensated by such payment is not compensated for by insurance or otherwise. Additionally, qualified disaster relief payments do not include qualified wages paid by an employer, even those that are paid when an employee is not providing services.

The term "qualified disaster" includes a disaster determined by the President to warrant assistance by the federal government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act. Since President Trump declared the COVID-19 pandemic a national emergency under the Robert T. Stafford Disaster Relief and Emergency Assistance Act, the provisions of Code Sec. 139 should apply to payments made by employers to employees to compensate them for additional expenses incurred as a result of the pandemic.

Qualified Business Income Deduction

For an individual operating as a sole proprietorship, a partner in a partnership, a member in an LLC taxed as a partnership, or as a shareholder in an S corporation, the qualified business income (QBI) deduction under Code Sec. 199A can significantly help reduce taxable income. The QBI deduction allows eligible taxpayers to deduct up to 20 percent of their QBI, plus 20 percent of qualified real estate investment trust dividends and qualified publicly traded partnership income. A W-2 wage limitation amount may apply to limit the amount of the deduction. The W-2 wage limitation amount must be calculated for taxpayers with a taxable income that exceeds a statutorily-defined amount (i.e., the threshold amount). For any tax year beginning in 2021, the threshold amount is $329,800 for married filing joint returns, $164,925 for married filing separately, and $164,900 for all other returns.

Since the QBI deduction reduces taxable income, and is not used in computing adjusted gross income, it does not affect limitations based on adjusted gross income such as the medical expense deduction or the calculation of social security income that is includible in income. The QBI deduction does not apply to a "specified service trade or business," which is defined as any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, including investing and investment management, trading, or dealing in securities, partnership interests, or commodities, and any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees. Engineering and architecture services are specifically excluded from the definition of a specified service trade or business.

Rental Real Estate

For clients with real estate businesses that generated losses, it's important to determine whether such losses from the activity are deductible. Generally, passive activity losses are only deductible against passive activity income. However, a deduction of up to $25,000 ($12,500 if married filing separately) may be allowed against nonpassive income to the extent an individual actively participates in the rental real estate activities. However, the deduction is subject to a phaseout for individuals with modified adjusted gross income above $100,000 (or $50,000 if married filing separately).

Rental real estate enterprises operated by individuals and owners of passthrough entities may also qualify for the QBI deduction if certain criteria are met. For example, a taxpayer's rental activity must be considerable, regular, and continuous in scope. In determining whether a rental real estate activity meets this criteria, relevant factors include, but are not limited to, the following:

(1) the type of rented property (commercial real property versus residential property);

(2) the number of properties rented;

(3) the taxpayer's or taxpayer's agent's day-to-day involvement;

(4) the types and significance of any ancillary services provided under the lease; and

(5) the terms of the lease (for example, a net lease versus a traditional lease and a short-term lease versus a long-term lease).

A rental real estate activity will be treated as a business eligible for the QBI deduction if certain safe harbor requirements are satisfied, such as:

(1) separate books and records are maintained to reflect the income and expenses for each rental real estate enterprise;

(2) for rental real estate enterprises that have been in existence less than four years, 250 or more hours of rental services are performed per year with respect to the rental real estate enterprise (with slightly less stringent requirements for rental real estate enterprises that have been in existence for at least four years);

(3) contemporaneous records have been maintained, including time reports, logs, or similar documents, regarding the following: (i) hours of all services performed; (ii) description of all services performed; (iii) dates on which such services were performed; and (iv) who performed the services; and

(4) certain compliance requirements are met.

Thus, to qualify for the QBI deduction, it's important to determine if the safe harbor conditions are met and, if not, whether such conditions can be met by year end. Alternatively, even if the safe harbor requirements are not met, certain actions may be taken to ensure that a taxpayer's real estate business falls within the "trade or business" guidelines for taking the deduction.

Meal and Entertainment Expenses

Generally, the business deduction allowable for food or beverage expenses is limited to 50 percent of the amount which would otherwise be allowable as a deduction. However, CAA 2021 enacted a more lenient rule for expenses relating to food and beverages purchased from restaurants in 2021 and 2022. Under this rule, a 100 percent deduction is allowed, providing the expense is properly documented. As part of that documentation, the business purpose of the meal must be provided. The term "restaurant" in this case means a business that prepares and sells food or beverages to retail customers for immediate consumption, regardless of whether the food or beverages are consumed on the business's premises. However, a restaurant does not include a business that primarily sells pre-packaged food or beverages not for immediate consumption, such as a grocery store; specialty food store; beer, wine, or liquor store; drug store; convenience store; newsstand; or a vending machine or kiosk.

Electing the De Minimis Safe Harbor Deduction

If a business has not already done so, it may be advantageous to elect to apply the de minimis safe harbor in Reg. Sec. 1.263(a)-1(f)(1)(ii)(D) to amounts paid to acquire or produce tangible property to the extent such amounts are deducted for financial accounting purposes or in keeping the business's books and records. If the business has an applicable financial statement (AFS), it can use the safe harbor to deduct amounts paid for tangible property up to $5,000 per invoice or item (as substantiated by invoice). If the business doesn't have an AFS, it can use the safe harbor to deduct amounts up to $2,500 per invoice or item (as substantiated by invoice).

Vehicle-Related Deductions and Substantiation Requirements

Deductions relating to vehicles are generally part of any business tax return. Since the IRS tends to focus on vehicle expenses in an audit and disallow them if they are not properly substantiated, it's important to remind business clients that the following should be part of their business's tax records with respect to each vehicle used in the business:

(1) the amount of each separate expense with respect to the vehicle (e.g., the cost of purchase or lease, the cost of repairs and maintenance, etc.);

(2) the amount of mileage for each business or investment use and the total miles for the tax period;

(3) the date of the expenditure; and

(4) the business purpose for the expenditure.

The following are considered adequate for substantiating such expenses:

(1) records such as a notebook, diary, log, statement of expense, or trip sheets; and

(2) documentary evidence such as receipts, canceled checks, bills, or similar evidence.

Records are considered adequate to substantiate the element of a vehicle expense only if they are prepared or maintained in such a manner that each recording of an element of the expense is made at or near the time the expense is incurred.

Increasing Basis in Pass-thru Entities

If a client is a partner in a partnership or a shareholder in an S corporation, and the entity is expecting to pass through a loss for the year, it's important to determine if the partner or shareholder has enough basis to absorb the loss. If not, then actions should be taken before the end of the entity's tax year to increase basis, if possible. Generally, this is done by contributing or loaning money to the entity.

S Corporation Shareholder Salaries

For any business operating as an S corporation, it's important to ensure that shareholders involved in running the business are paid an amount that is commensurate with their workload. The IRS scrutinizes S corporations which distribute profits instead of paying compensation subject to employment taxes. Failing to pay arm's length salaries can lead not only to tax deficiencies, but penalties and interest on those deficiencies as well. The key to establishing reasonable compensation is being able to show that the compensation paid for the type of work an owner-employee does for the S corporation is similar to what other corporations would pay for similar work. Practitioners should document in their workpapers the factors that support the salary being paid to a shareholder.

Also, because there are stringent requirements for who may be an S corporation shareholder, its prudent to check annually as to the residency or citizenship status of S corporation shareholders and S stock beneficiaries (including contingent and residuary beneficiaries).

IRS Releases Retirement-Related COLAs; 401(k) Contribution Limit Increases to $20,500

The IRS released the annual cost-of-living adjustments (COLAs) affecting dollar limitations for pension plans and other retirement-related items for 2022. The 401(k) contribution limit increases to $20,500, up from $19,500 for 2021, while the annual IRA contribution deduction remains unchanged at $6,000. Notice 2021-61.

On November 4, the IRS issued the annual cost-of-living adjustments (COLAs) for pension plans and other retirement-related items for 2022. In general, many of the pension plan limitations will change for 2022 because the increase in the cost-of-living index met the statutory thresholds that trigger their adjustment. However, other limitations will remain unchanged because the increase in the index did not meet the statutory thresholds that trigger their adjustment. The changes include:

(1) The elective deferral (contribution) limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government's Thrift Savings Plan is increased from $19,500 to $20,500.

(2) The salary reduction contribution limit under Code Sec. 408(p)(2)(E) for SIMPLE IRAs is increased from $13,500 to $14,000.

(3) The catch-up contribution limit for employees aged 50 and over who participate in 401(k), 403(b), most 457 plans, and the federal government's Thrift Savings Plan remains unchanged at $6,500. The dollar limitation under Code Sec. 414(v)(2)(B)(ii) for catch-up contributions to a SIMPLE 401(k) plan described in Code Sec. 401(k)(11) or a SIMPLE IRA described in Code Sec. 408(p) for individuals aged 50 or over remains unchanged at $3,000.

(4) The deductible amount under Code Sec. 219(b)(5)(A) for an individual making qualified retirement contributions to a traditional IRA remains unchanged at $6,000.

(5) The deduction for taxpayers making contributions to a traditional IRA is phased out for singles and heads of household who are covered by a workplace retirement plan and have modified adjusted gross incomes (AGI) between $68,000 and $78,000, increased from between $66,000 and $76,000 in 2021. For married couples filing jointly, in which the spouse who makes the IRA contribution is covered by a workplace retirement plan, the income phase-out range is between $109,000 and $129,000, increased from between $105,000 and $125,000 in 2021. For an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered, the deduction is phased out if the couple's income is between $204,000 and $214,000, increased from between $198,000 and $208,000 in 2021. For a married individual filing a separate return who is an active participant, the phase-out range is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.

(6) The AGI phase-out range for taxpayers making contributions to a Roth IRA is $204,000 to $214,000 for married couples filing jointly, up from $198,000 to $208,000 in 2021. For singles and heads of household, the income phaseout range is $129,000 to $144,000, up from $125,000 to $140,000 in 2021. For a married individual filing a separate return, the phase-out range is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.

(7) The limit on the annual benefit under a defined benefit plan under Code Sec. 415(b)(1)(A) is increased from $230,000 to $245,000. For a participant who separated from service before January 1, 2022, the limitation for defined benefit plans under Code Sec. 415(b)(1)(B) is computed by multiplying the participant's compensation limitation, as adjusted through 2021, by 1.0534.

(8) The limit on annual additions for defined contribution plans under Code Sec. 415(c)(1)(A) is increased in 2022 from $58,000 to $61,000.

(9) The annual compensation limit under Code Secs. 401(a)(17), 404(l), 408(k)(3)(C), and 408(k)(6)(D)(ii) is increased from $290,000 to $305,000.

(10) The dollar limitation under Code Sec. 416(i)(1)(A)(i) concerning the definition of key employee in a top-heavy plan is increased from $185,000 to $200,000.

(11) The limitation used in the definition of highly compensated employee under Code Sec. 414(q)(1)(B) is increased from $130,000 to $135,000.

(12) The compensation amount under Reg. Sec. 1.61-21(f)(5)(i) concerning the definition of control employee for fringe benefit valuation purposes is increased from $115,000 to $120,000. The compensation amount under Reg. Sec. 1.61-21(f)(5)(iii) is increased from $235,000 to $245,000.

(13) The dollar amount under Code Sec. 409(o)(1)(C)(ii) for determining the maximum account balance in an employee stock ownership plan subject to a five-year distribution period is increased from $1,165,000 to $1,230,000, while the dollar amount used to determine the lengthening of the five-year distribution period is increased from $230,000 to $245,000.

(14) The annual compensation limitation under Code Sec. 401(a)(17) for eligible participants in certain governmental plans that, under the plan as in effect on July 1, 1993, allowed cost-of-living adjustments to the compensation limitation under the plan under Code Sec. 401(a)(17) to be taken into account, is increased from $430,000 to $450,000.

(15) The compensation amount under Code Sec. 408(k)(2)(C) regarding simplified employee pensions (SEPs) remains unchanged at $650.

(16) The AGI limitation under Code Sec. 25B(b)(1)(A) (i.e., relating to the 50 percent applicable percentage) for determining the retirement savings contribution credit for married taxpayers filing a joint return is increased from $39,500 to $41,000; the limitation under Code Sec. 25B(b)(1)(B) (i.e., relating to the 20 percent applicable percentage) is increased from $43,000 to $44,000; and the limitation under Code Sec. 25B(b)(1)(C) (relating to the 10 percent applicable limitation) and Code Sec. 25B(b)(1)(D) (relating to the zero percent applicable limitation), is increased from $66,000 to $68,000.

(17) The AGI limitation under Code Sec. 25B(b)(1)(A) for determining the retirement savings contribution credit for taxpayers filing as head of household is increased from $29,625 to $30,750; the limitation under Code Sec. 25B(b)(1)(B) is increased from $32,250 to $33,000; and the limitation under Code Secs. 25B(b)(1)(C) and 25B(b)(1)(D) is increased from $49,500 to $51,000.

(18) The adjusted gross income limitation under Code Sec. 25B(b)(1)(A) for determining the retirement savings contribution credit for all other taxpayers is increased from $19,750 to $20,500; the limitation under Code Sec. 25B(b)(1)(B) is increased from $21,500 to $22,000; and the limitation under Code Secs. 25B(b)(1)(C) and 25B(b)(1)(D) is increased from $33,000 to $34,000.

Supervisory Approval Issue Must be Raised during Partnership-Level Proceedings

The Eleventh Circuit affirmed a district court and held that, in partnership tax cases controlled by the Tax Equity and Fiscal Responsibility Act of 1982, the Code Sec. 6751 supervisory approval issue must be exhausted with the IRS before a partner files a refund lawsuit and it must be raised during the partnership-level proceedings. As a result, the taxpayer, a partner in a partnership, was liable for a 40 percent penalty for a gross valuation misstatement made on the partnership's tax return. Ginsburg v. U.S., 2021 PTC 346 (11th Cir. 2021).

Background

In 2001, Alan Ginsburg, Alpha Consultants LLC, Samuel Mahoney, and Helios Trading LLC formed AHG Investments LLC. On its 2001 partnership tax return, AHG Investments reported a $25,618 total loss. But on Ginsburg's 2001 tax return, he reported a $10,069,505 loss from AHG Investments. Ginsburg used the reported $10,069,505 loss from AHG Investments to offset his $22,826,616 in income and decrease his tax liability by $3,583,873.

In 2008, the IRS sent Ginsburg a notice that it was proposing adjustments to the partnership items on AHG Investments' 2001 and 2002 tax returns. The IRS alleged that AHG Investments and its partners had not established that AHG Investments was a partnership as a matter of fact. Instead, the IRS said, it was formed solely for purposes of tax avoidance. According to the IRS, AHG Investments was a sham and lacked economic substance, and its principal purpose was to reduce substantially the present value of its partners' aggregate federal tax liability. Thus, the IRS said, it would disregard the partnership, the "purported" partners of AHG Investments would not be treated as partners, and "any purported losses" would not be allowable as deductions. For Ginsburg, the IRS disallowed the $10,069,505 loss from AHG Investments on his 2001 tax return. And the IRS said it would impose a 40 percent penalty for "gross valuation misstatement." Any of the partners could contest the IRS's adjustments in the Tax Court, the Court of Federal Claims, or the district court in the district of the partnership's principal place of business.

At the partnership-level proceeding, Ginsburg petitioned the Tax Court to contest the part of the IRS's adjustment notice imposing the 40 percent penalty for grossly misstating AHG Investments' value. Ginsburg agreed that he was not entitled to deduct AHG Investments' losses because he was not at risk and the partnership's transactions did not have substantial economic effect. But Ginsburg contested the 40 percent gross valuation misstatement penalty. Based on Ginsburg's concessions, the Tax Court found that AHG Investments was a sham, lacked economic substance, and was formed for tax avoidance purposes. The Tax Court concluded that AHG Investments must be disregarded for federal income tax purposes, and adjusted AHG Investments' 2001 tax return, consistent with the IRS's notice, to show no losses. The Tax Court also rejected Ginsburg's petition and concluded that the 40 percent penalty applied to any underpayment of tax attributable to any gross valuation misstatement, subject to any partner-level defenses.

Based on the Tax Court's decision, the IRS sent Ginsburg a notice of computational adjustment disallowing the $10,069,505 loss from Ginsburg's 2001 tax return, which resulted in a $2,458,964 tax deficiency. The IRS also calculated the 40 percent penalty as $983,586. The notice told Ginsburg that if he wanted to dispute the computational adjustment made to his return, or if he wanted to assert partner-level defenses to any penalty imposed in the notice, he had to pay the adjusted tax in full and then file a claim for refund with the IRS. If the IRS disallowed his refund claim, the notice said that Ginsburg could file a refund suit as provided by law.

Ginsburg paid the $2,458,964 tax deficiency, the $983,586 penalty, and $3,208,674 in interest on the tax deficiency and penalty and filed a claim for refund with the IRS. Ginsburg asked the IRS to refund his $983,586 penalty and $876,198 of interest paid on the penalty. Ginsburg explained that he was entitled to a refund because he reasonably relied in good faith on accounting advice, a tax opinion, legal advice, tax return services, and financial advice from reputable firms and professionals. The IRS denied Ginsburg's refund claim. Ginsburg filed suit in a district court, arguing that he was not liable for the penalty and the interest on the penalty because he acted reasonably and in good faith with respect to the underlying tax issues. The government argued that Ginsburg could not and did not reasonably rely on the advice of his accountants, tax experts, lawyers, and financial advisors to avoid the penalty. Ginsburg contended that he was entitled to summary judgment because the government did not get written approval of the penalty by an immediate supervisor, as required by Code Sec. 6751(b)(1). Without approval, Ginsburg asserted, the penalty is void. The government had the burden to show that the IRS complied with Code Sec. 6751(b)(1), Ginsburg argued, and there was no dispute that it didn't meet that burden here.

The district court granted the government's summary judgment motion and denied Ginsburg's motion. The district court concluded that Ginsburg could not have reasonably relied on the advice of his tax, legal, and financial advisors. And the district court determined that it couldn't consider Ginsburg's Code Sec. 6751(b) supervisory approval argument because he didn't exhaust it in his claim for refund with the IRS. Ginsburg appealed to the Eleventh Circuit.

Analysis

The question in this case, the Eleventh Circuit noted, is when must a partner in a limited liability company or a partnership raise the Code Sec. 6751(b)(1) supervisory approval issue: Before or after the partner files a refund lawsuit or during the partnership-level proceedings or the partner-level proceedings? The Eleventh Circuit held that, in partnership tax cases controlled by the Tax Equity and Fiscal Responsibility Act of 1982, the supervisory approval issue must be exhausted with the IRS before a partner files a refund lawsuit and it must be raised during the partnership-level proceedings. Because Ginsburg did not exhaust the Code Sec. 6751(b)(1) supervisory approval issue before he filed his refund lawsuit, and because he didn't raise the issue during the partnership-level proceedings, the Eleventh Circuit affirmed the summary judgment for the government.

Ginsburg, the court said, had to raise the Code Sec. 6751(b)(1) issue in the partnership-level proceedings before the Tax Court. And he had to exhaust it with the IRS in his claim for refund. Because he did neither, the Eleventh Circuit found that the district court rightly refused to consider Ginsburg's argument and correctly granted summary judgment for the government on Ginsburg's refund lawsuit.

CPA's Advice Did Not Provide Reasonable Cause for Late Returns and Tax Payments

The Tax Court found that a couple was liable for penalties for failing to timely file tax returns, failing to timely pay taxes, and failing to pay estimated taxes. The court rejected the taxpayers' argument that they reasonably relied on the advice of their CPA that filing returns while under audit for earlier years could subject them to perjury charges because, the court said, allowing such a basis for reasonable cause would make timely filing optional for any taxpayer under audit. Morris v. Comm'r, T.C. Memo. 2021-120.

Background

James Morris and Lori Egbers-Morris are husband and wife. James is a successful businessman and owned multiple businesses including Morris Packaging, LLC (Morris Packaging), Morris Converting, LLC (Morris Converting), and Roar Food Group, LLC. During 2015 and 2016, the years at issue, James made most of the day-to-day decisions for these businesses. The Morrises each owned shares in S corporations, James in Heartland Supply Co. and Lori in Commercial Bag Co. In 2013, James expanded his packaging business into the manufacture of converted packaging and formed Morris Converting. He constructed a production facility and invested millions of dollars in machinery and equipment which he financed at least in part through intercompany transactions. Morris Converting expanded rapidly and grew to employ around 175 people.

The Morrises' tax returns for the years at issue were prepared by Dennis Knobloch, a CPA with the firm of Striegel, Knobloch & Co. (SKC). Knobloch prepared the couple's joint returns from 2000 to 2018. James also used SKC as the accountants for his businesses although he employed a receptionist who performed some bookkeeping. SKC had full access to the businesses' bookkeeping records. James relied on SKC to perform monthly reconciliations of his business records, and SKC was able to input and modify bookkeeping entries as necessary without James's approval. A different CPA firm prepared the S corporation returns. James realized after the years at issue that he needed to change his accounting system because of the growth of his businesses and his expansion into manufacturing. He has since expanded the internal accounting staff, hired a chief financial officer, and engaged a new CPA firm to prepare tax returns.

Around 2016, the IRS began an audit for the Morrises' 2013 and 2014 tax years which involved issues relating to capital expenditures incurred by Morris Converting. The Morrises did not timely file a return for 2014 and had not filed a return when the 2016 audit began. SKC represented the Morrises during the audit. James understood that Knobloch was concerned about filing the 2015 return during the audit and duplicating errors on the 2015 return, which had to be signed under penalties of perjury. Knobloch recommended to James that the Morrises settle the years under audit. The IRS received the Morrises' 2014 return in November of 2017. It reported tax of $27,852 and an overpayment of $24,080. The IRS closed the audit in 2018.

The Morrises timely requested extensions for filing their 2015 and 2016 returns, but did not file them by the extended due dates. They did not make a payment of tax with the request for an extension for the 2015 return. Further, the Morrises did not make any estimated tax payments during the years at issue and did not have tax withheld from their paychecks during 2015. James had a minimal amount of tax withheld from his wages during 2016. For 2015 and 2016, the Morrises, respectively, had ordinary income from their S corporations of over $2.2 million and $3 million. During the audit for 2013 and 2014, the revenue agent asked the Morrises to provide their 2015 return to him by May 15, 2017.

The IRS prepared substitute returns for James and Lori for 2015 and 2016 with the filing status married filing separately. In 2018, the IRS received the Morrises' Form 1040 for 2015 showing total tax of $598,926, and for 2016 showing total tax of $1,691,853. The Morrises paid $469,000 with their 2015 return and paid an additional $210,000 toward the tax owed for 2015 by July 1, 2019. They did not make a payment with their 2016 return. In May of 2018, the IRS issued a notice of deficiency for 2015 and 2016 that determined deficiencies on the basis of the substitute returns. The Morrises and the IRS stipulated that the couple had joint deficiencies of $599,469 and $1,691,959 for 2015 and 2016, respectively. Unresolved was their liability for additions to tax for failure to timely file their returns and pay the taxes owed under Code Sec. 6651(a)(1) and (2), and for failure to pay estimated tax under Code Sec. 6654.

The additions tax for failure to timely file returns and pay taxes under Code Sec. 6651(a)(1) and (2) apply unless the taxpayer proves that such failures are due to reasonable cause and not due to willful neglect. There is no reasonable cause exception for failing to pay estimated taxes. Under U.S. v. Boyle, 469 U.S. 241 (S. Ct. 1985), reasonable cause for a failure to file exists where the taxpayers exercised ordinary care and prudence but were nevertheless unable to file the return by the due date. Reasonable cause for failure to pay exists where the taxpayer exercised ordinary business care and prudence in providing for payment but was nevertheless either unable to pay the tax or would have suffered undue hardship if he or she had paid it. Under Boyle, taxpayers may demonstrate reasonable cause through their good-faith, reasonable reliance on the advice of an independent, competent tax professional that no return was required to be filed or that no tax was owed. However, taxpayers have the burden of filing returns and paying taxes owed, and they cannot delegate those duties to an agent or accountant. One does not have to be a tax expert, the Court remarked in Boyle, to know that taxes must be paid when they are due.

The Morrises argued that they had reasonable cause for their failure to timely file their 2015 and 2016 tax returns because Knobloch advised them that filing while under audit for earlier years could subject them to perjury charges, which they argued involved a question of law. They also asserted that they lacked the education and experience to prepare and file their returns themselves because of complicated issues relating to their businesses. Regarding their failure to pay the taxes they owed, the Morrises claimed that they had reasonable cause because they initially believed they would not owe tax for 2015 and 2016 due to the millions of dollars that they spent to start Morris Converting. They contended that they understood from Knobloch that James's businesses would have a tax loss for 2015.

Analysis

The Tax Court held that the Morrises did not have reasonable cause for their untimely filings and tax payments. Regarding their late filings, the court noted that the Morrises were advised to delay filing returns while audits for prior years were completed. In the court's view, allowing such advice to provide a basis for reasonable cause to avoid late filing penalties would make timely filing optional for any taxpayer under audit. The court said that the Morrises were aware that they had a duty to file their return on time and they consciously failed to file. The court further found that, although Knobloch may have informed the Morrises that resolution of the Morris Converting capital expenditures issues might affect reporting for 2015 and 2016, such advice did not excuse their failure to file or their failure to pay tax on their income unrelated to Morris Converting.

The court noted that, during the audit, the revenue agent sought the Morrises' 2015 return and asked them to provide it by May 15, 2017, but the Morrises did not file the 2015 return until nearly a year later. In the court's view, it was not reasonable for the Morrises to continue to rely on Knobloch's alleged advice when the revenue agent was telling them to file the return. The court further found that the Morrises filed their 2016 return more than six months after the audit closed, and only after the IRS issued notices of deficiency to them. The untimely filing of the Morrises' 2014 return in November of 2017, over 2-1/2 years after its prescribed due date, also caused the court to doubt the Morrises' argument that they relied on their CPA to delay filing their 2015 and 2016 returns.

The Tax Court also was not persuaded by that the Morrises reasonably relied on Knobloch's advice that they would not owe tax for 2015 and 2016. The court thought it was significant that the Morrises did not have federal income tax withheld from their wages or pay tax on the substantial amounts of income from their S corporations unrelated to the business expansion of Morris Converting. It was unreasonable, in the court's view, for the Morrises to have believed that they would not owe tax on this income, and Knobloch's alleged advice did not explain why they did not have tax withheld from their wages or pay tax on the S corporation income. Noting that the Morrises had stipulated that their tax for 2015 was over $500,000, and finding that they did not take any steps to ensure timely payment for either year at issue, the court concluded that the Morrises did not exercise ordinary business care and prudence. Nor did they assert or offer any evidence that they were unable to pay the tax owed, or that payment would cause them undue hardship.

With respect to the addition to tax for failing to pay estimated taxes, the court held that the IRS met its burden of showing that the Morrises were required to make payments for both years and failed to make them. Further, the court said, the Morrises did not qualify for any of the exceptions to the penalties listed in Code Sec. 6654(e). Accordingly, the Morrises were liable for the Code Sec. 6654(a) addition to tax for both years.

Tax Court's Jurisdiction Over Whistleblower Appeals Survives Whistleblower's Death

In a case of first impression, the Tax Court held that its jurisdiction over a whistleblower's petition filed under Code Sec. 7623(b)(4) for review of an adverse decision by the IRS Whistleblower Office is not extinguished by the death of the whistleblower. The court found that under federal common law, rights of action under federal statutes survive a plaintiff's death if the statute is remedial rather than penal, and the court determined that Code Sec. 7623(b) has a remedial purpose. Insinga v. Comm'r, 157 T.C. No. 8 (2021).

Joseph Insinga filed a petition under Code Sec. 7626(b)(4) in the Tax Court for review of an adverse determination of the IRS Whistleblower Office (WBO) regarding his claims for an award. Insinga died in March of 2021 while the Tax Court case was still pending. Insinga's estate filed a motion for substitution asserting that as Insinga's successor, the estate should be substituted for Insinga so that the estate could proceed in his place. The IRS did not oppose the motion.

The Tax Court noted that the issue of whether an appeal of a whistleblower's award determination to the Tax Court under Code Sec. 7623(b)(4) survives the death of the whistleblower was a question of first impression. While Tax Court Rule 63(a) allows the Tax Court to substitute a taxpayer's estate as the petitioner if a taxpayer dies while a Tax Court petition is pending, the court first had to determine whether it continues to have jurisdiction over a whistleblower's appeal after the whistleblower who filed it has died.

When a federal statute does not specifically address survival rights, federal common law provides the general rule that rights of action under federal statutes survive a plaintiff's death if the statute is remedial, not penal. Courts apply a three-factor test to ascertain whether a statute is remedial or penal, examining (1) whether the purpose of the statute was to redress individual wrongs or more general wrongs to the public; (2) whether recovery under the statute runs to the harmed individual or to the public; and (3) whether the recovery authorized by the statute is wholly proportional to the harm suffered. In Figueroa v. Sec'y of Health & Human Servs., 715 F.3d 1314 (Fed. Cir. 2013), the Federal Circuit held that, in the absence of a statutory provision to the contrary, common law supplies a presumption in favor of the survival of a remedial right of action arising under a federal statute.

The Tax Court found that, in determining the purpose of Code Sec. 7623(b), opinions addressing the treatment of claims arising under the False Claims Act (FCA), 31 U.S.C. Secs 3729-3733, are illuminating because such qui tam actions involve the roughly analogous circumstance of a "relator" who (like a whistleblower) brings information regarding illegal activity to the attention of the government and, upon successful prosecution of the claim, shares in the recovery. In U.S. v. NEC Corp., 11 F.3d 136 (11th Cir. 1993), the Eleventh Circuit held that a claim under the FCA was remedial and therefore survived the decedent-plaintiff's death. The Eleventh Circuit found that (1) the purpose of a qui tam remedy under the FCA is to redress individual wrongs of the relator, who may suffer substantial harm by bringing the action; (2) qui tam provisions are primarily intended to remedy the harm suffered by the individual relator rather than the public at large; and (3) the relator's recovery depends on, and is proportional to, the extent to which the person substantially contributed to the prosecution of the action.

Applying the three-factor test, the Tax Court concluded that the purpose of Code Sec. 7623(b) is remedial rather than punitive. First, the court found that like the purpose of the FCA's qui tam remedy, the purpose of the award provisions of Code Sec. 7623(b) is to redress individual wrongs of the whistleblower in bringing his or her claim (such as employer retaliation or professional ostracism) by compensating him or her for the harm incurred by doing so. Second, the court found that Code Sec. 7623(b) is intended to provide a remedy to the whistleblower for bringing his or her claim by providing mandatory compensation for claims where the collected proceeds meet certain statutory thresholds. Third, the court found that the recovery due to the whistleblower under Code Sec. 7623(b)(1), which "shall depend upon the extent to which the individual substantially contributed to such action," shows that the whistleblower's recovery is proportional to the harm he or she incurs in bringing his claim. Consequently, the Tax Court held that Code Sec. 7623(b) has a remedial purpose, and therefore a whistleblower's Tax Court petition survives his or her death.

Sixth Circuit: Former Controller Deserved Enhanced Prison Sentence

The Sixth Circuit upheld the enhanced prison sentence given to a former financial controller after concluding that he had caused substantial hardships to the business from which he illegally siphoned $1.7 million. The court found that the recently enacted sentencing enhancement provision to which the controller was subjected was specifically designed to hold individuals like him responsible for the harm inflicted on more financially insecure businesses or people. U.S. v. Piper, 2021 PTC 352 (6th Cir. 2021).

Background

Patrick Piper was the financial controller of Lake Michigan Carferry and Pere Marquette Shipping Company (collectively "Carferry") for many years, including the period of 2007 to May 2018. During that time, Piper also owned and operated Piper Tax & Accounting and Piper Group. Piper Tax & Accounting provides a variety of accounting services to individuals and businesses, including tax preparation services. In his role as financial controller, Piper commonly performed accounting services for Carferry from his Piper Tax & Accounting business by accessing Carferry's accounting software through the internet. Piper's remote access to Carferry's accounting software included the ability to make accounting entries in the software system and to print Carferry checks at his Piper Tax & Accounting business.

Carferry's accounting software included a manual check writing feature which allowed Piper to use the computer system to write and print checks without issuing an invoice to the accounts payable department. Piper used this system to generate manual checks payable to himself and his related companies. After printing those checks, Piper deleted his name or the names of his companies and entered the names of various insurance companies in the check-writing window in order to conceal his fraud. These manual checks were then booked to the insurance expense code in the general ledger before the conclusion of each month either by Piper or others who were unaware of his fraud. From at least 2007 until his employment was terminated in April 2018, Piper used his position to mask his embezzlement of over $1.7 million. On June 1, 2020, pursuant to a plea agreement, Piper pled guilty to one count of bank fraud in violation of 18 U.S.C. Section 1344(a)(1) and (2) and one count of filing a false tax return in violation of Code Sec. 7206(1).

A Presentence Investigation Report prepared by the U.S. Probation and Pretrial Services Office (PSR) calculated Piper's sentencing guidelines range at 63 to 78 months, based on a criminal history category I and an offense level of 26. The offense level included a two-level enhancement for causing a substantial hardship to Piper's victim. The PSR recommended applying the enhancement for four reasons: (1) Piper's failure to make timely payments of payroll taxes resulted in Carferry having to pay substantial penalties and interest; (2) Carferry had to borrow substantial amounts of money from financial institutions to meet operating expenses because of the deficit introduced by Piper's theft; (3) Piper contributed to employee 401(k) plans late, resulting in extra expense because of the need to pay beneficiaries the amount of lost investment income from the late funding; and (4) Carferry lost state-backed unemployment insurance because of Piper's theft, and therefore incurred increased costs associated with having to self-fund unemployment claims.

At sentencing, Piper argued that the enhancement was inapplicable because while Carferry experienced hardship, it was not "substantial" as contemplated by the guidelines. The district court overruled Piper's objection and sentenced him to 63 months imprisonment. The district court emphasized that the harm to Carferry's credit was a motivating factor for its decision. The court noted that, following Piper's embezzlement, Carferry's primary lender - Chemical Bank - insisted that Carferry consolidate a significant portion of its debt to loans backed by a Small Business Administration guaranty as a condition of continuing the lending relationship. This forced Carferry to pay over $100,000 in loans fees and higher interest rates. Additionally, the owners were required to execute a personal guaranty of all of Carferry's existing debt for the first time. Finally, the district court noted that Chemical Bank had indicated that it was not as willing to lend additional funds to the company, and that requests for additional credit would be "met with substantially more analysis and less favorable terms than in the past." The district court concluded that the harm to Car Ferry's credit and banking relationship, along with the adverse impact on its owners, the harms identified in the PSR, and the amount of money stolen from a business that was "treading water" constituted substantial harm under the sentencing guidelines. Piper appealed his sentence to the Sixth Circuit, arguing that the financial harm he caused to Carferry was not substantial and that he should not be held liable for financial harms tangentially related to his crime because Carferry was in a fragile state before his embezzlement.

Piper also moved for a downward departure from the sentencing guidelines due to his health. He argued that because he was obese and had asthma and allergies, he was at higher risk for COVID-19 and these conditions thus warranted home confinement rather than prison. The district court declined to grant a downward departure. The court found that a term of incarceration was necessary, both for specific deterrence and punishment as to Piper, but also "general deterrence for other people who are looking at the cost of this kind of wrongdoing."

Analysis

The Sixth Circuit affirmed the sentence. The court noted that the enhancement provision under which Piper was sentenced is relatively new, having been approved by the U.S. Sentencing Commission in 2015, and Sixth Circuit precedent in its application is scarce. Under the provision, the court observed, a court may increase a defendant's offense level by two if the given offense results in "substantial financial hardship to one or more victims." For this purpose, a "victim" is defined as any person who sustained any part of the actual loss and includes individuals, corporations, and companies. The court observed that, under this enhancement, sentencing courts are advised to consider the extent of the harm rather than merely the total number of victims of the offense (as its predecessor did) in an effort to place greater emphasis on the extent of harm that particular victims suffer as a result of the offense. With respect to the amount of harm that Piper caused to Carferry, the Sixth Circuit concluded that, so long as the district court's inferences about Carferry's financial harm have some support in the record, the district court's determination is entitled to the normal deference that applies to all facts found at sentencing.

With respect to Piper's argument that he should not be held responsible for financial harms tangentially related to his crime because Carferry was in a fragile financial state before his embezzlement, the court replied that the enhancement is specifically designed to hold individuals like Piper responsible for the harm they inflict on more financially insecure businesses or people because it requires a court to take into consideration the individual financial circumstances of the victims. Thus, the court concluded, while Piper might not be directly responsible for the state of Carferry's finances, the financial health of the business in conjunction with the harm caused by Piper bore directly on the applicability of the enhancement.

The Sixth Circuit also agreed that no downward departure in sentencing was warranted in Piper's case. The court noted that the district court explicitly compared Piper's health to the health of the individuals the district court had found eligible for compassionate release due to COVID-19 and concluded that Piper's health conditions did not place him at such a high risk of complications from COVID-19 that he required home confinement. Because the district court found that Piper's health conditions were not extraordinary even in light of the pandemic, the Sixth Circuit held that the district court did not err in rejecting a downward departure.

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Ninth Circuit Rejects Debtors' Attempt to Avoid Liens to Extent of Homestead Exemption

The Ninth Circuit affirmed a Bankruptcy Appellate Panel's decision dismissing a Chapter 7 debtors' adversary complaint relating to tax liens asserted by the IRS. The court rejected the debtors' contention that because the bankruptcy trustee avoided IRS liens securing penalties owed by the debtors, the avoided liens may be preserved for the benefit of the debtors to the extent of their homestead exemption. In re Hutchinson, 2021 PTC 341 (9th Cir. 2021).

Background

The IRS recorded liens for unpaid taxes, interest, and penalties against Leonard and Sonya Hutchinson's residence. After the Hutchinsons filed for bankruptcy, the IRS filed a proof of claim for both the secured and unsecured portions of the IRS's then-existing claim for unpaid taxes, interest, and penalties. The portion of the claim that was secured by liens on the Hutchinsons' residence and attributable only to penalties was over $162,000. The Hutchinsons filed an adversary proceeding against the government and the Chapter 7 trustee, asserting that the IRS's claim for penalties was subject to avoidance by the trustee, and that because the trustee had not attempted to avoid this claim, the Hutchinsons were empowered to do so under 11 U.S.C. Section 522(h). The Hutchinsons sought to avoid the liens and to preserve the liens for their benefit. The trustee cross-claimed against the United States, asserting the right, as trustee, to avoid the liens and alleging that, to the extent the liens were avoided, their value should be recovered for the benefit of the bankruptcy estate. In In re Hutchinson, 2018 PTC 1 (Bankr. E.D. Calif. 2018), a bankruptcy court granted the government's motion to dismiss after holding that 11 U.S.C. Section 551 controls when a bankruptcy trustee avoids a lien and, if the trustee avoids an IRS lien, 11 U.S.C. Section 551 authorizes the trustee to preserve the lien for the benefit of the estate's creditors. The court noted that the Bankruptcy Code precludes debtors from avoiding an IRS tax lien for penalties and, because the debtors could not avoid the lien, they could not preserve it for their own benefit. The debtors appealed to the Ninth Circuit Bankruptcy Appellate Panel (B.A.P.).

Affirming the bankruptcy court, the B.A.P. held that 11 U.S.C. Section 522(h) does not authorize the Hutchinsons to avoid the liens that secured the IRS's penalties claim. The B.A.P. noted that under 11 U.S.C. Section 522(h), a transfer (including a lien) can be avoided by a debtor if (1) the transfer is avoidable by the trustee under 11 U.S.C. Section 724(a); (2) the trustee does not attempt to avoid the transfer; and (3) the debtor could have exempted the property under 11 U.S.C. Section 522(g)(1) if the trustee had avoided the transfer. One of the components of the third requirement, the court stated, is that the debtor could have exempted such property under Section 522(b) if such property had not been transferred. The B.A.P. rejected the Hutchinsons' contention that they met this component because 11 U.S.C. Section 522(b) allowed them to exempt the interest in their principal residence up to the extent of their $100,000 homestead exemption under California law. The B.A.P. held that this contention was foreclosed by DeMarah v. U.S. (In re DeMarah), 1995 PTC 557 (9th Cir. 1995). In that case, the Ninth Circuit held that, because, under 11 U.S.C. Section 522(c)(2)(B), Congress denied debtors the right to remove tax liens from their otherwise exempt property, the Hutchinsons could not avoid a lien for tax penalties under 11 U.S.C. Section 522(h). The B.A.P. also noted that the trustee did attempt to avoid the tax lien to the extent that it secured the penalties claim. The panel rejected the Hutchinsons' contention that, even if the trustee acted to avoid the liens, the property should have been preserved for their benefit, rather than for the benefit of the estate. The B.A.P concluded that the Hutchinsons could not preserve for their own benefit the portions of the tax liens that were avoided by the trustee, and their complaint was therefore properly dismissed in its entirety with prejudice. Under the plain language of 11 U.S.C. Section 551, the B.A.P said, a transfer that is avoided by the trustee under 11 U.S.C. Section 724(a) is preserved for the benefit of the estate. The panel concluded that this aspect of 11 U.S.C. Section 551 is not overridden by 11 U.S.C. Section 522(i)(2), which provides that property may be preserved for the benefit of the debtor to the extent of a homestead exemption, because, under DeMarah, 11 U.S.C. Section 522(i)(2) is subordinate to 11 U.S.C. Section 522(c)(2)(B)'s bright-line rule that debtors lack the right to remove tax liens from their otherwise exempt property. The Hutchinsons appealed to the Ninth Circuit.

Analysis

The Ninth Circuit held that the Hutchinsons' claims all failed as a matter of law and that the B.A.P. correctly affirmed the bankruptcy court's dismissal of the Hutchinsons' complaint. According to the court, because 11 U.S.C. Section 522(c)(2) makes clear that a debtor's exemption power cannot escape a tax lien, regardless of whether that lien was avoided by the trustee, it would be completely contradictory to then construe 11 U.S.C. Section 522(i)(2) (or 11 U.S.C. Section 522(g)) as allowing a debtor, after a trustee has avoided the tax lien, to then preserve the avoided lien "for the benefit of the debtor" by claiming an exemption under 11 U.S.C. Section 522(g). Such a result, the Ninth Circuit said, would create precisely the kind of end-run around 11 U.S.C. Section 522(c)(2)(B) that it had rejected in DeMarah.

Alternatively, the court observed, if the result were that the trustee avoided the lien only to turn over the benefits to the debtor, whose exempt property would then be subject to the lien under 11 U.S.C. Section 522(c)(2)(B), that would effectively nullify the trustee's express lien-avoidance power under 11 U.S.C. Section 724(a). The only way to read these provisions sensibly together, the court said, was to conclude that a debtor may not invoke 11 U.S.C. Section 522(i)(2) in order to override 11 U.S.C. 551's otherwise applicable rule that, after the trustee avoids a lien under 11 U.S.C. Section 724(a), the lien is preserved for the benefit of the estate.

The Ninth Circuit therefore held that the B.A.P. properly concluded that the penalty portions of the tax liens that the bankruptcy trustee successfully avoided were preserved for the benefit of the estate and not for the Hutchinsons.New Paragraph