How To Forfeit an IRS Collection Due Process Hearing

I am looking at a Tax Court case.

I presume it was an act of desperation by the taxpayer, otherwise it makes no sense.

Let’s say that you get yourself into a quarter million dollars of tax debt.

You know the Collection bus is coming. You probably should get ahead of it, but it escapes your attention.

You receive IRS notice LT-11.

You are in the Collections sequence.

Let’s talk about the general order of tax collection notices.

   CP-14      Balance Due

   CP-501    Reminder Notice 

   CP-503    Reminder Notice

   CP-504    Notice of Intent to Levy

   LT-11       Notice of Intent to Levy and Notice of Your 

                   Right to a Hearing

Some observations:

First, you are deep into the machinery at this point. There were at least 4 notices sent to you before you received this one.

Second, a levy means that someone is going to take your stuff. This is different from a lien. The IRS can put a lien on your house, as an example. The lien will sit there, damaging your credit along the way, but it will not spring to action until you sell the house. A levy is not so nice. The IRS can drain your bank account with a bank levy, or it can divert (some of) your paycheck with a wage levy.

Third, you have taxpayer rights in response to receiving a LT-11, but there is a time limit. If you respond within 30 days you have full rights; respond after 30 days and you have lesser rights.  Granted, depending on the situation, it may be that both the 30 and 30-plus varieties will have all the rights you need.

You may wonder what the difference is between the CP-504 Notice of Intent to Levy and the LT-11 Notice of Intent to Levy. It is confusing. I wish the IRS used different wording on these notices, but it is what it is.

The difference is the type of Collections rights the taxpayer has. Both the CP-504 and LT-11 give you rights, but the rights under the LT-11 are more expansive.

An appeal under a CP-504 is referred to as Collection Appeal Program (CAP). An appeal under a LT-11 is referred to as Collection Due Process (CDP). There are differences between the two, and a huge difference is that the CAP is non-appealable whereas the CDP is.

If you want the safety net of a possible appeal, you are waiting until the LT-11.

BTW do not assume that all CPAs know this notice sequence and its significance. All CPAs have had some tax education, but not all CPAs practice tax or – more importantly – practice tax procedure to any meaningful extent. Tax procedure is rarely taught in school, and – to a great extent – it is learned through mentoring and practice.  

Our protagonist (Ramey) had several businesses, and he used the same address for all of them. There were other businesses at this address, so I presume we are talking about a shared office space facility. Anyway, the IRS sent the LT-11 notice, return receipt requested. The notice was delivered and someone signed the receipt, but that someone was not Ramey’s employee.

At this point, I am thinking: no big deal.

There is a 30-day time limit if one wants to request a CDP. The 30 days lapsed.

Oh, oh.

Mind you, there is a fallback option if one exceeds 30 days, but the downside is that any decision under the fallback is non-appealable.

Ramey wanted the option to appeal.

He figured he had a card left to play.

The IRS notice has to meet several requirements under Section 6330 before the IRS can actually levy. The notice has to be:

(1)  Given in person;

(2)  Left at the dwelling or usual place of business; or

(3)  Sent by certified or registered mail, return receipt requested, to such person’s last known address.

Ramey argued that he had not signed for the mail, and the person who did sign did not have authority to sign on his behalf.

Seems like weak tea.

The Court agreed:

Mr. Ramey’s chief complaint appears to be that multiple businesses use that address, so mail might be accepted by the wrong person. But, even if that is so, Mr Ramey does not explain how the IRS could have taken this fact into account. Mr Ramey is free to organize his business affairs as he sees appropriate, including by choosing to share a business address with other businesses. But, having made that choice, and having provided the IRS an address shared by multiple businesses, he cannot properly complain when the IRS uses that very address to reach him.”

Ramey blew the 30- day window. He failed to protect his right to appeal to the Tax Court.

The Court correctly pointed out that Ramey still had options. He could, for example, pay the underlying tax, request a refund, and appeal the denial of that refund request in District Court, for example.

So why the fuss about the 30 days?

One does not have to pay the tax before being allowed to file in Tax Court. One however does have to pay the tax in order to file with a District Court or the Court of Federal Claims.

Ramey owed a quarter of a million dollars.

Our case for the home-gamers was Ramey v Commissioner 156 T.C. No. 1.

Can You Tell When You Are Being Audited?

 I am looking at a Tax Court pro se decision.

Pro se means that the taxpayer represents himself or herself.

Technically, that is explanation insufficient. I, for example, could represent someone in Tax Court and it would still be considered to be pro se.

I tend to shudder at pro se cases, because too often it is a case of someone not knowing what they don’t know. And – once you are that far into the tax system – you had better be up-to-speed with tax law as well as tax procedure. Either can trip you up.

There is a cancer surgeon who inherited an IRA in 2013. He took distributions in both 2014 and 2015 – distributions totaling over $508 thousand - but he researched and came to the conclusion that the distributions were not income.

COMMENT:  How did he get there? The first thing that comes to mind is that these were Roth IRAs, but that was not the case. He argued instead that the IRAs included nondeductible contributions, and those nondeductible amounts were not taxable income coming out.

The reference here is to nondeductible IRAs, the cousin to Roth IRAs. These bad boys would be almost extinct except for their use in backdoor Roth conversions. Still, the doctor was wrong: it is EXTREMELY unlikely that a nondeductible IRA would be fully nontaxable. The reason is that only the contributions are nontaxable; any earnings on the contribution would be taxable. I suppose that one could have a completely nontaxable distribution, but that would mean the nondeductible IRA had no - none, nada, zippo - earnings over its existence. That would be among the worst investments ever.

The IRS computerized matching program kicked-in, as the IRA distributions would have triggered issuance of a 1099. The IRS caught 2014. The doctor disagreed he had income. The IRS machinery ground-on and resulted in the issuance of a 90-day letter (also known as a Statutory Notice of Deficiency) for 2014. The purpose of the SNOD is to reduce a proposed tax assessment to an actual assessment, and it is nothing to snicker about. The doctor had the option to appeal to the Tax Court, which he did.

Practice can be described as doing what is not taught in school, so the story took an unusual twist. The doctor was contacted by a revenue agent for a real and actual audit of his 2014 tax return. The agent however was looking at issues other than the IRA, and the doctor did not mention that the IRS Automated Under Reporting unit was looking at 2014. The agent continued blithely on, not knowing about the AUR and eventually expanding his audit to 2015.

QUESTION: Why didn’t the doctor tell the agent about AUR? I would have tried to consolidate the exams myself.

The doctor was dealing with AUR over matching. They wanted money for 2014.

The doctor was also dealing with a living, breathing agent about 2014. The agent wanted money, but that money was from areas other than the IRA.

The doctor took both SNODs to Tax Court.

He argument was straightforward – he invoked the tax equivalent of double jeopardy: Section 7605(b):

         (b) Restrictions on examination of taxpayer

No taxpayer shall be subjected to unnecessary examination or investigations, and only one inspection of a taxpayer’s books of account shall be made for each taxable year unless the taxpayer requests otherwise or unless the Secretary, after investigation, notifies the taxpayer in writing that an additional inspection is necessary.

If there was double jeopardy, the doctor clearly wanted the revenue agent’s proposed assessment, as it did not include the IRA.

Did the doctor have an argument?

This Code section has an interesting history. It goes back to the 1920s, at a time when only the wealthy were subject to income tax and there were no computers, 1099s and what-not. Matching was not even a fevered dream. What did exist, however, was the potential for human abuse and repetitive examinations to beat someone into submission. The progenitor of our Section 7605(b) came into existence as an early version of taxpayer protection and rights.

What the Tax Court focused on was whether there were two “examination(s) or investigations.” If the answer was yes, the Court would have to continue to the next question: was the additional examination “unnecessary?”

The Court did not need to continue to the second question, as technically there were not two examinations. You see, the matching program is driven by 1099s and other reporting forms. The AUR unit is not “auditing” in the traditional sense; it is instead trying to reconcile what a taxpayer reported to what an independent party reported.  

Additionally, the only thing AUR is looking at is income.  AUR is not concerned with deductions. Its review does not rise to the level of an examination as AUR is intentionally ignoring all the deductions on one’s return.

But I get it: it does not feel that way to the person interacting with the AUR unit. And there definitely is no real-world difference when AUR wants additional money from you.

But there is a technical difference.  

The doctor saw two examinations. I suspect most people would agree. However, the doctor technically had one examination. He was not in double jeopardy. Section 7605(b) did not apply.

Our case this time was Richard Essner v Commissioner, TC Memo 2020-23.

IRS Collection Statute Expiration Date (CSED)

 I consider it odd.

I have two files in my office waiting on the collection statute of limitations to expire.

It is not a situation I often see.

Audits, penalty abatements, payment plans, offers and innocent spouse requests are more common.

Let’s talk about the running of the collection statute of limitations.

COMMENT: I do not consider this to be valid tax planning, and I am quite reluctant to represent someone who starts out by intending to do the run. That said, sometimes unfortunate things happen. We will discuss the topic in the spirit of the latter.

Let’s set up the two statutes of limitations:

(1) The first is the statute on assessment. This is the familiar 3-year rule: the IRS has 3 years to audit and the taxpayer has 3 years to amend.

COMMENT: I do not want to include the word “generally” every time, as it will get old. Please consider the modifier “generally” as unspoken but intended.

(2)  The second is the statute on collections. This period is 10 years.

We might conversationally say that the period can therefore go 13 years. That would be technically incorrect, as there would be two periods running concurrently. Let’s consider the following example:

·      You filed your individual tax return on April 15, 2020. You owed $1,000 above and beyond your withholdings and estimates.

·      The IRS audited you on September 20, 2022. You owed another $4,000.

·      You have two periods going:

o  The $1,000 ends on April 15, 2030 (2020 + 10 years).

o  The $4,000 ends on September 20, 2032 (2022 + 10 years).

Alright, so we have 10 years. The expiration of this period is referred to as the “Collection Statute Expiration Date” or “CSED”.

When does it start?

Generally (sorry) when you file the return. Say you extend and file the return on August 15. Does the period start on August 15?

No.

The period starts when the IRS records the return.

Huh?

It is possible that it might be the same date. It is more possible that it will be a few days after you filed. A key point is that the IRS date trumps your date.

How would you find this out?

Request a transcript from the IRS. Look for the following code and date:

                  Code          Explanation

                    150           Tax return filed

Start your 10 years.

BTW if you file your return before April 15, the period starts on April 15, not the date you filed. This is a special rule.

Can the 10 years be interrupted or extended?

Oh yes. Welcome to tax procedure.

The fancy 50-cent word is “toll,” as in “tolling” the statute. The 10-year period is suspended while certain things are going on. What is going on is that you are probably interacting with the IRS.

OBSERVATION: So, if you file your return and never interact with the IRS – I said interact, not ignore – the statute will (generally – remember!) run its 10 years.

How can you toll the statute?

Here are some common ways:

(1)  Ask for an installment payment plan

Do this and the statute is tolled while the IRS is considering your request.

(2)  Get turned down for an installment payment plan

                  Add 30 days to (1) (plus Appeals, if you go there).

(3)  Blow (that is, prematurely end) an installment payment plan

Add another 30 days to (1) (plus Appeals, if you go there).

(4)  Submit an offer in compromise

The statute is tolled while the IRS is considering your request, plus 30 days.

(5)  Military service in a combat zone

The statute is tolled while in the combat zone, plus 180 days.

(6)  File for bankruptcy

The statute is tolled from the date the petition is filed until the date of discharge, plus 6 months.

(7)  Request innocent spouse status

The statute is tolled from the date the petition is filed until the expiration of the 90-day letter to petition the Tax Court. If one does petition the Court, then the toll continues until the final Court decision, plus 60 days.

(8)  Request a Collections Due Process hearing

The statute is tolled from the date the petition is filed until the hearing date.

(9)  Request assistance from the Taxpayer Advocate

The statute is tolled while the case is being worked by the Taxpayer Advocate’s office.

Unfortunately, I have been leaning on CDP hearings quite a bit in recent years, meaning that I am also extending my client’s CSED. I have one in my office as I write this, for example. I have lost hope that standard IRS procedure will resolve the matter, not to mention that IRS systems are operating sub-optimally during COVID. I am waiting for the procedural trigger (the “Final Notice. Notice of Intent to Levy and Notice of Your Rights to a Hearing”) allowing the appeal. I am not concerned about the CSED for this client, so the toll is insignificant.

There are advanced rules, of course. An example would be overlapping tolling periods. We are not going there in this post.

Let’s take an example of a toll.

You file your return on April 15, 2015. You request a payment plan on September 5, 2015. The IRS grants it on October 10, 2015. Somethings goes wobbly and the IRS terminates the plan. You request a Collection Due Process hearing on June 18, 2019. The hearing is resolved on November 25, 2019.

Let’s assume the IRS posting date is April 15, 2015.

Ten years is April 15, 2025.

It took 36 days to approve the payment plan.

The plan termination automatically adds 30 days.

The CDP took 161 days.

What do you have?

April 15, 2025 … plus 36 days is May 21, 2025.

Plus 30 days is June 20, 2025.

Plus 161 days is November 28, 2025.

BTW there are situations where one might extend the CSED separate and apart from the toll. Again, we are not going there in this post.

Advice from a practitioner: do not cut this razor sharp, especially if there are a lot of procedural transactions on the transcript. Some tax practitioners will routinely add 4 or 5 weeks to their calculation, for example. I add 30 days simply for requesting an installment payment plan, even though the toll is not required by the Internal Revenue Manual.  I have seen the IRS swoop-in when there are 6 months or so of CSED remaining, but not when there are 30 days.

Pay Me In Bitcoin

 

He plays right guard for the Carolina Panthers and had a great quote about cryptocurrency:

         "Pay me in Bitcoin.”

We are talking about Russell Okung.

I believe he earned about $13 million for the 2020/2021 season, so he can move a lot of Bitcoin.

And Bitcoin had quite the run in 2020, moving from approximately $7,200 in January to $30,000 by year-end. The payment platform company Square added Bitcoin as an investment, and PayPal started a new service allowing its users to buy, hold and sell Bitcoin through their PayPal account.

Then there is, as always, the near inexplicable behavior of some people. In October, John McAfee (yes, John of McAfee computer security products) was arraigned for tax fraud. He was charged with, among other things, not reporting income for his work promoting cryptocurrencies.

The IRS is paying more attention.

We have existing guidance that the IRS views cryptos – which include Bitcoin and Ethereum – as property and not currency. While this might sound like an arcane topic for a business school seminar, it does have day-day-day consequences. If you buy something for $11 and pay with a $20 bill, there is likely no tax consequence.  A crypto is not currency, however. Pay for that $11 purchase using your Bitcoin and the IRS sees the trading of property.

What does that mean?

Taxwise you sold crypto for $11. You next have to determine your cost (that is, “basis”) in the crypto. If less than $11, you have a capital gain. If more than $11, you have a capital loss. The gain or loss could be long-term if you held the crypto for more than one year; otherwise, it would be a short-term gain or loss.

Assume that you have frequent transactions in crypto. How are you to determine your basis and holding period every time you pay with crypto?

You had better buy software to do this, or use a wallet that tracks it for you. Otherwise you could have a tax mess on your hands at the end of the year.

You can, by the way, also have ordinary taxable income (rather than capital gain) from cryptos. How? Say that you do consulting work for someone and they pay you in crypto.  You have gig income; gig income is ordinary income; that crypto is ordinary income to you.

By the way, mining Bitcoin is also ordinary income.

The IRS had a question about cryptos on a schedule in prior years, but for 2020 it is moving the following question to the top of Form 1040 page 1:

At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”

The IRS moved the question to make it prominent, of course, but there is another reason. Remember that you are signing that tax return “to the best of your knowledge and belief” and “under penalties of perjury.” The IRS is raising the stakes for not reporting.

Expect more computer matching. Expect more notices.   

Even Treasury is upping its game.

There is a form that one files with the Treasury if one owns or has authority over $10,000 or more in a foreign bank or other financial account. We tax veterans remember it as the FBAR (Foreign Bank and Financial Accounts) report, but the name has since been revised to FinCen 114 (Financial Crimes Enforcement Network). Here is Treasury telling us that we will soon be reporting cryptos on their form:

Currently, the Report of Foreign Bank and Financial Accounts (FBAR) regulations do not define a foreign account holding virtual currency as a type of reportable account. (See 31 CFR 1010.350(c)).  For that reason, at this time, a foreign account holding virtual currency is not reportable on the FBAR (unless it is a reportable account under 31 C.F.R. 1010.350 because it holds reportable assets besides virtual currency).    However, FinCEN intends to propose to amend the regulations implementing the Bank Secrecy Act (BSA) regarding reports of foreign financial accounts (FBAR) to include virtual currency as a type of reportable account under 31 CFR 1010.350.

This area is moving in one direction – more reporting. There is currently some inconsistency in how cryptocurrency exchanges report to the IRS (Form 1099-B versus 1099-K versus 1099-MISC). I expect the IRS to lean harder – and soon - on standardizing this reporting. This genie is out of the bottle.

Happy New Year

 

State Taxation of Telecommuting

The year 2020 has brought us a new state tax issue.

To be fair, the issue is not totally new, but it has taken on importance with stay-at-home mandates.

Here is the issue: You work in one state but live in another. Which state gets to tax you when you are working from home?

Let’s start with the general rule: state taxation belongs to the state where the employee performs services, not the state where the employee resides. The concept is referred to as “sourcing,” and it is the same reason a state can tax you if you have rental real estate there.

Let’s follow that with the first exception: states can agree to not follow the general rule. Ohio, for example, has a reciprocal agreement with Kentucky. The agreement provides that an employee will be taxed by his/her state of residence, not by the state where the employee works.   A Kentucky resident working in Ohio, for example, will be taxed by Kentucky and not by Ohio.

Let’s pull away from the Cincinnati tristate area, however. That reciprocal agreement makes too much sense.

We need two other states: let’s use Iowa and Missouri.

One lives in Iowa and commutes to Missouri. Both states have an individual income tax. We have 2020, COVID and stay-at-home. An employee of a Missouri employer works from home, with home being Iowa.

Which state gets to tax?

This one is simple. Iowa.

Why?

Because both states have the same rule: the state of residence gets to tax a telecommuter.

So where is the issue in this area?

With states that are … less reasonable … than Iowa and Missouri.

Let’s go to Captain Obvious: New York.

New York has a “convenience of the employer” addendum to the above discussion. Under this rule, New York asks why the employee is working remotely: is it for the convenience of the employer, or is it for the convenience of the employee? The tax consequence varies depending on the answer.

* If for the convenience of the (New York) employer, then the employee’s state of residence has the first right to tax.

* If for the convenience of the (nonresident) employee, then New York has the first right to tax.

We for example have a Tennessee client with a New York employer who walked into this issue. He lives and works in Memphis, infrequently travelling to New York. We were able to resolve the matter, but New York initially went after him rather aggressively.

How does New York’s rule work with 2020 and COVID?

It doesn’t.

All those employees not commuting to New York were very much observing the convenience of their employer.

Clearly, this was an unacceptable answer to New York.

Let’s change the rule, said New York: the employee’s “assigned or primary” location will now control. If my accounting office was located in New York, for example, that would be my “assigned or primary” office and New York could tax me, no matter where I was.

How could I avoid that result? I would need to have my employer open a bona fide office where I lived. Some people could do that. Most could not.

Yessir.

There is no evolving tax doctrine here. This is ad hoc and reactive taxation, with much caprice, little constancy and the sense that New York will say and do whatever to lift your wallet.

There are few other states that follow this “convenience” rule: Pennsylvania, Delaware and New Jersey come to mind. It is more convenient for them to tax you than not to tax you, to reword the rule.

COVID introduced us to two more states feuding over the taxation of telecommuters: Massachusetts and New Hampshire. Massachusetts decreed that any employee who began working outside the state for “pandemic-related” circumstances would continue to be subject to Massachusetts income tax.

It is the same issue as New York, one might initially think. New Hampshire will allow a tax credit for the tax paid Massachusetts. The accounting fee goes up, but it works out in the end, right?

Nope.

Why?

New Hampshire does not tax W-2 income.

How do states like Massachusetts or New York justify their behavior?

There is an argument: Massachusetts and New York have roads, infrastructure, schools, universities, hospitals and so forth that attracted employers to locate there. Their tax is a fair and appropriate levy for providing and sustaining an environment which allows a person to be employed.

Got it.

Don’t buy it.

I grew up in Florida, which does not have an individual income tax. Somehow the state nonetheless has roads, infrastructure, schools, universities, hospitals and so forth. The only explanation must be divine intervention, it appears.

Additionally, if I lived in New Hampshire – and worked from there – I might prefer that my taxes go to New Hampshire. I after all would be using its roads, infrastructure, schools, universities, hospitals and so on, putting little – or no – demand on Massachusetts. I might in fact be quite pleased to not commute into Massachusetts regularly, if it all. It seems grotesque that Massachusetts will chase me across the fruited plains just because I need a job.

New Hampshire has filed a complaint against Massachusetts with the Supreme Court. The argument is rather simple: Massachusetts is infringing by imposing its tax on New Hampshire residents working in New Hampshire.  Interestingly, Connecticut and New Jersey have filed amicus (“friend of the court”) briefs supporting New Hampshire’s position. Their beef is with New York and not Massachusetts, but they are clearly interested in the issue.

I personally expect the expansion and growing acceptance of telecommuting to be a permanent employment change as we come out of COVID and its attendant restrictions. With that as context, the treatment of telecommuting may well be one of the “next big things” in taxation.

Deducting “Tax Insurance” Premiums

 There is an insurance type that I have never worked with professionally: tax liability insurance.

It is what it sounds like: you are purchasing an insurance policy for unwanted tax liabilities.

It makes sense in the area of Fortune 500 mergers and acquisitions. Those deals are enormous, involving earth-shaking money and a potentially disastrous tax riptide if something goes awry. What if one the parties is undergoing a substantial and potentially expensive tax examination? What if the IRS refuses to provide advance guidance on the transaction? There is a key feature to this type of insurance: one is generally insuring a specific transaction or limited number of transactions. It is less common to insure an entire tax return.  

My practice, on the other hand, has involved entrepreneurial wealth – not institutional money - for almost my entire career. On occasion we have seen an entrepreneur take his/her company public, but that has been the exception. Tax liability insurance is not a common arrow in my quiver. For my clients, representation and warranty insurance can be sufficient for any mergers and acquisitions, especially if combined with an escrow.

Treasury has been concerned about these tax liability policies, and at one time thought of requiring their mandatory disclosure as “reportable” transactions. Treasury was understandably concerned about their use with tax shelter activities. The problem is that many routine and legitimate business transactions are also insured, and requiring mandatory disclosure could have a chilling effect on the pricing of the policies, if not their very existence. For those reasons Treasury never imposed mandatory disclosure.

I am looking at an IRS Chief Counsel Memorandum involving tax liability insurance.

What is a Memorandum?

Think of them as legal position papers for internal IRS use. They explain high-level IRS thinking on selected issues.

The IRS was looking at the deductibility by a partnership of tax insurance premiums. The partnership was insuring a charitable contribution.

I immediately considered this odd. Who insures a charitable contribution?

Except …

We have talked about a type of contribution that has gathered recent IRS attention: the conservation easement.

The conservation easement started-off with good intentions. Think of someone owning land on the outskirts of an ever-expanding city. Perhaps that person would like to see that land preserved – for their grandkids, great-grandkids and so on – and not bulldozed, paved and developed for the next interchangeable strip of gourmet hamburger or burrito restaurants. That person might donate development rights to a charitable organization which will outlive him and never permit such development. That right is referred to as an easement, and the transfer of the easement (if properly structured) generates a charitable tax deduction.

There are folks out there who have taken this idea and stretched it beyond recognition. Someone buys land in Tennessee for $10 million, donates a development and scenic easement and deducts $40 million as a charitable deduction. Promoters then ratcheted this strategy by forming partnerships, having the partners contribute $10 million to purchase land, and then allocating $40 million among them as a charitable deduction. The partners probably never even saw the land. Their sole interest was getting a four-for-one tax deduction.

The IRS considers many of these deals to be tax shelters.

I agree with the IRS.

Back to the Memorandum.

The IRS began its analysis with Section 162, which is the Code section for the vast majority of business deductions on a tax return. Section 162 allows a deduction for ordinary and necessary expenses directly connected with or pertaining to a taxpayer’s trade or business.

Lots of buzz words in there to trip one up.

You my recall that a partnership does not pay federal tax. Instead, its numbers are chopped up and allocated to the partners who pay tax on their personal returns.

To a tax nerd, that beggars the question of whether the Section 162 buzz words apply at the partnership level (as it does not pay federal tax) or the partner level (who do pay federal tax).

There is a tax case on this point (Brannen). The test is at the partnership level.

The IRS reasoned:

·      The tax insurance premiums must be related to the trade or business, tested at the partnership level.

·      The insurance reimburses for federal income tax.

·      Federal income tax itself is not deductible.

·      Deducting a premium for insurance on something which itself is not deductible does not make sense.

There was also an alternate (but related argument) which we will not go into here.

I follow the reasoning, but I am unpersuaded by it.

·      I see a partnership transaction: a contribution.

·      The partnership purchased a policy for possible consequences from that transaction.

·      That – to me - is the tie-in to the partnership’s trade or business.

·      The premium would be deductible under Section 162.

I would continue the reasoning further.

·      What if the partnership collected on the policy? Would the insurance proceeds be taxable or nontaxable?

o  I would say that if the premiums were deductible on the way out then the proceeds would be taxable on the way in.

o  The effect – if one collected – would be income far in excess of the deductible premium. There would be no further offset, as the federal tax paid with the insurance proceeds is not deductible.

o  Considering that premiums normally run 10 to 20 cents-on-the-dollar for this insurance, I anticipate that the net tax effect of actually collecting on a policy would have a discouraging impact on purchasing a policy in the first place.

The IRS however went in a different direction.

Which is why I am thinking that – albeit uncommented on in the Memorandum – the IRS was reviewing a conservation easement that had reached too far. The IRS was hammering because it has lost patience with these transactions.