Federal Tax: Penalties and Estate Tax Deductions

Guidance on Practitioner Penalties and Estate Tax Deductions

by Stuart R. Josephs, CPA

California CPA magazine: June 2007

IRS Notice 2007-39 (IRB 2007-20, May 14, 2007) provides guidance to practitioners, employers and firms that may be subject to monetary penalties under 31 USC Section 330. This Notice also invites comments from the public by Aug. 13, 2007, regarding rules and standards for these penalties.

Generally, Section 330 authorizes the Secretary of the Treasury to regulate CPAs, attorneys, enrolled agents, actuaries and others practicing before the IRS. Regulations under Section 330 are reprinted as Treasury Circular 230.

The 2004 Jobs Act amended Section 330 to provide for monetary penalties for certain prohibited conduct (defined in Circular 230, Section 10.52) after Oct. 22, 2004. As amended, Section 330 authorizes sanctions, including monetary penalties, against a practitioner who is incompetent or disreputable, fails to comply with Section 330’s regulations or, with intent to defraud, willfully and knowingly misleads or threatens a client or potential client.

Monetary penalties also are authorized against an employer or firm if the practitioner was acting on its behalf in connection with the prohibited conduct giving rise to the penalties and the employer or firm knew, or reasonably should have known, of this conduct.

The aggregate penalties cannot exceed the gross income derived, or to be derived, from the prohibited conduct.

Penalties may be imposed for a single act or for a pattern of misconduct. They may be imposed in addition to, or in lieu of, any suspension, disbarment or censure. However, these penalties are not a “bargaining point” that a practitioner may offer to avoid suspension, disbarment or censure if those sanctions are otherwise appropriate.

Notice 2007-39 contains detailed requirements for imposing these penalties, covering the penalty’s amount and determining a separate penalty on an employer or firm.

Example: Attorney X, employed in a national accounting firm’s headquarters, specializes in tax planning. He is involved in the development of off-the-shelf tax planning strategies, including Strategy Z. X has wide discretion over his day-to-day work product and rarely supervises other firm professionals.

He rarely deals directly with clients as this is handled by other firm partners or employees.

X works directly with the firm’s other attorneys, accountants and support staff across the country to market and fine-tune Strategy Z. Clients are examined by the IRS regarding Strategy Z, but X is not identified on any Form 2848 as a representative.

X reports to the firm’s tax practice director, who provides general oversight over X. The director was aware of the strategies X developed, including Strategy Z, although he was not necessarily familiar with each strategy’s technical tax details. The director also knew that Strategy Z generated measurable firm revenue.

The IRS determines that X engaged in prohibited conduct, violating Circular 230, in creating, promoting and marketing Strategy Z. X acted on the firm’s behalf because an agency relationship existed between X and the firm. The misconduct arose in connection with that relationship as X worked on the firm’s behalf promoting Strategy Z.

The firm knew, or had reason to know, of the prohibited conduct in this situation. The director, a member of the firm’s principal management, had general knowledge that X developed the tax-advantaged strategies. Alternatively, absent general knowledge, the director would need to inquire into Strategy Z because it added measurably to the firm’s revenue.

Both X and the firm are subject to a monetary penalty.

Estate Tax Deductions

The IRS proposed regulations April 23 that would amend the existing regulations under IRC Sec. 2053, dealing with estate tax deductions for expenses, indebtedness and taxes. The proposed effective date is estates of decedents dying on or after the date the final

regulations are published in the Federal Register.

The proposals clarify that events occurring after a decedent’s death are to be considered when determining the amount deductible. Thus, Sec. 2053 deductions would be limited to amounts paid by the estate in satisfaction of deductible expenses and claims.

Final court decisions as to the amount and enforceability of the claim or expense would be accepted in determining the amount deductible if the court passes on the facts upon which deductibility depends. Settlements would be accepted if reached in bona fide negotiations between adverse parties with valid claims recognizable under, and consistent with, applicable law.

Protective Refund Claims: A protective refund claim can be filed before the statute of limitations expires to preserve the estate’s right to claim a refund if a liability’s amount will not be ascertainable when this statute expires.

The proposals further preclude deductions for claims that are potential, unmatured or contested when the estate tax return is filed. However, a protective refund claim also can be filed to preserve the estate’s right to claim a refund due to deducting a claim against the estate to the extent it is ultimately paid by the estate.

Estimated Amounts: Certain estimated amounts may be deductible on original returns or through timely or protective refund claims. See Prop. Regs. Sec. 20.2053-1(b)(4) for specific conditions and rules.

Stuart R. Josephs, CPA has a San Diego-based Tax Assistance Practice (TAP) that specializes in assisting practitioners in resolving their clients’ tax questions and problems. Josephs, chair of the Federal Subcommittee of CalCPA’s Committee on Taxation, can be reached at (619) 469-6999 or stuartrjosephs@yahoo.com.