Allen R. Davison v. Commissioner , 2020 T.C. Memo. 58 ( 2020 )

T.C. Memo. 2020-58UNITED STATES TAX COURT
ALLEN R. DAVISON, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 14765-15L. Filed May 14, 2020.
Allen R. Davison, pro se.
Rachael J. Zepeda, Derek S. Pratt, Alicia E. Elliott, and Trisha S. Farrow,
for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
NEGA, Judge: This case is before the Court on a petition for review of a
Notice of Determination Concerning Collection Action(s) Under Section(s) 6320
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[*2] and/or 6330 (notice of determination).1 After concessions by the parties,2 the
primary issue for decision is whether petitioner is liable for a penalty under section
6700 of $18,000 for each of tax years 2009 and 2010 (years at issue), $36,000 in
total.
FINDINGS OF FACT
Some of the facts are stipulated and are so found. The stipulation of facts
and the attached exhibits are incorporated herein by this reference. Petitioner,
Allen R. Davison, resided in Kansas when the petition was filed. This case was
consolidated for trial with the case of Lemay v. Commissioner, docket No. 19356-
15L. Our opinion in Lemay may be found at T.C. Memo. 2020-59.
I. Background
Petitioner graduated from the University of Nebraska in 1973, where he
earned a bachelor of science degree in business administration. Petitioner
obtained a law degree from the University of Nebraska in 1979 and was admitted
1
Unless otherwise indicated, all section references are to the Internal
Revenue Code in effect for the years at issue. All monetary amounts are rounded
to the nearest dollar.
2
Respondent and petitioner proceeded as if the question of petitioner’s
underlying liability is appropriately before this Court, with the primary issue for
decision being whether petitioner is liable for promoter penalty under sec. 6700.
Since both parties proceeded as though the underlying liability is in dispute, we
will follow their lead.
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[*3] to practice law in Nebraska in 1979. Petitioner became a certified public
accountant (C.P.A.) in 1981 and was licensed in Nebraska, Kansas, and Missouri.3
From 1979 to 1993 petitioner worked for the accounting firm Coopers and
Lybrand. From 1993 to 2001 petitioner worked for the accounting firm Grant
Thornton as a tax partner. In this role petitioner worked on tax matters for clients
under audit. Petitioner first met Bruce Lemay in a professional setting. They
became friends and have maintained that friendship.
While working in the insurance industry Mr. Lemay came to learn of “tool
plans”.4 A former colleague requested Mr. Lemay’s assistance in calculating, or
otherwise determining, how an employer’s participation in a tool plan affected that
employer’s worker’s compensation insurance premiums. Mr. Lemay responded
that he was unfamiliar with tool plans, but he researched this issue and found that
an employer’s participation in a tool plan had no effect on the calculation of the
employer’s worker’s compensation premiums. Mr. Lemay reported these findings
to his former colleague.
3
Petitioner is no longer a licensed C.P.A. in Nebraska, Kansas, or Missouri.
4
“Tool plans” generally attempt to operate to bifurcate an employee’s wages
into a taxable labor portion and a nontaxable portion relating to tool expense
reimbursement.
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[*4] While researching tool plans Mr. Lemay discovered a tool plan company
called ProCheck and began to foster a relationship with its president. Mr. Lemay
and ProCheck’s president discussed tool plans generally, as well the tax aspects
thereof. The president of ProCheck offered Mr. Lemay the opportunity to join
ProCheck. Mr. Lemay sought the advice of petitioner, who held reservations
about ProCheck’s operations and the purported benefits its tool plans offered.
After being apprised of the details of ProCheck, petitioner validated Mr. Lemay’s
concerns, and advised him to decline ProCheck’s offer. Although Mr. Lemay
declined the offer to join ProCheck, Mr. Lemay and the president of ProCheck
agreed to form a new company that would promote tool plans, so long as such
plans were reviewed and approved by petitioner and his employer, Grant
Thornton.
II. Organization of CMS
On September 29, 1999, Mr. Lemay, along with the president of ProCheck
and two other individuals affiliated with ProCheck, organized Cash Management
Systems (CMS), an S corporation, in the State of Virginia.
From 1999 to 2010 petitioner was the key legal and tax planning adviser to
CMS. Immediately after organizing, CMS formally engaged petitioner, and
through him Grant Thornton, to consult and advise CMS regarding the tax benefits
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[*5] of its proposed tool plan products. Petitioner’s first task was to review the
details of the tool plans CMS intended to market. Petitioner managed the CMS
client account for Grant Thornton until he left the firm in 2002. On November 20,
2002, petitioner began serving on CMS’ board of directors. Petitioner was placed
on retainer with CMS for six months during 2008 and all of 2009 and 2010.
During 2009 and 2010 CMS paid petitioner $3,000 per month for his services.
Mr. Lemay organized Xell Enterprises, Inc. (Xell), as an S corporation in
Kansas on April 26, 1999, to operate his own sales-consulting business. After
CMS was organized, however, Xell’s primary purpose became marketing and
selling CMS’ tool plans.
III. Development of the Tool Program
CMS had three different tool plans in its Tool Program: (1) the existing tool
plan, (2) the new tool plan, and (3) the tool use plan. CMS planned to operate the
tool plans in sequence in order to maximize the lifetime tax savings for both the
employees and employers that would choose to enroll with CMS. In addition to
the tool plans and payroll administration, CMS offered legal research and free
audit representation as part of an overall employee benefits package. The tool
plans, administrative support, and audit representation collectively constituted the
Tool Program.
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[*6] CMS designed its tool plans to allow both employers and employees to
claim substantial tax savings by bifurcating an employee’s base pay into a taxable
labor portion and a nontaxable portion for tool reimbursement or use. This
bifurcation was based upon a proprietary formula. CMS promised the avoidance
of Federal income tax withholding, employment taxes, or both, depending on the
tool plan.5 The maximum tool reimbursement or use pay per pay period was 35%
of the participating employees’ wages. CMS made money from fees charged for
administering the tool plans. Upon enrolling both an employer and its employees,
CMS administered the enrolled employer’s payroll and issued associated
statements. Through those associated statements, CMS regularly kept employers
and client-employees abreast of the claimed tax savings from CMS tool plans.
A. The Existing Tool Plan
Under the existing tool plan, an employer recharacterized a portion of each
employee’s base pay as a reimbursement to that employee for the cost of tools
acquired by that employee before enrolling in the plan. The employees were
reimbursed in amounts reflecting the acquisition costs of their tools, rather than
5
We use the term “employment taxes” to refer to taxes under the Federal
Insurance Contributions Act (FICA) and the Federal Unemployment Tax Act. See
Weber v. Commissioner, 138 T.C. 348, 357 (2012); Stevens Techs., Inc. v.
Commissioner, T.C. Memo. 2014-13, at *27-*29; Otto’s E-Z Clean Enters., Inc. v.
Commissioner, T.C. Memo. 2008-54, slip op. at 2 n.2.
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[*7] the replacement costs or the fair market value costs, before enrollment in the
existing tool plan.6 CMS calculated the appropriate tax withholdings for each
employer’s labor pay, but not tool pay, and remitted this information to the
employer. The employer withheld the necessary taxes for the labor pay portion
but did not withhold taxes for the tool portions determined by CMS. CMS
claimed that the existing tool plan was an accountable plan under section 62,
whereby reimbursement paid to employees for the cost of their own tools used on
a job was not considered wages for employment tax purposes.
B. The New Tool Plan
The new tool plan also recharacterized a portion of each employee’s base
pay as a nontaxable reimbursement. The only meaningful difference between the
existing tool plan and the new tool plan was that, under the new tool plan,
employees were reimbursed only for tools purchased after their enrollment.
Otherwise, the bifurcation of an employee’s base pay operated in an identical
manner. The new tool plan also purported to be an accountable plan under
section 62.
6
CMS determined the cost of an employee’s tool inventory by reference to
an estimate of what the employee had originally paid for those tools rather than the
current replacement cost.
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[*8] C. The Tool Use Plan
Once an employee was treated as reimbursed for the cost of his or her tool
inventory under the existing and/or new tool plans, CMS transitioned the client
employee to the tool use plan. CMS offered the tool use plan to allow an
employee to charge his or her employer a fee for the rental of the employee’s tools
during the daily course of the employee’s labor. Similarly to the other plans, the
employee’s base wage was recharacterized into a taxable portion for labor wages
and a tax-exempt portion for rental fees. CMS did not claim the tool use plan was
an accountable plan and accordingly agreed that the rental fees paid pursuant to
the plan were subject to Federal income taxation. CMS did claim, however, that
the rental fees paid pursuant to the tool use plan fell outside the employment tax
definition of wages and thereby reduced the employment tax liability of the
employer and the employee. The tool use plan was available to any employee
enrolled in the CMS tool plans, including those treated as fully reimbursed for the
stated value of their tools under the reimbursement plan, or any employee who was
treated as having fully depreciated the cost of his or her tools before enrollment in
the plan. CMS calculated the tool usage amount for each participating employee
and reported the amount to the employer so that the employee could be paid
accordingly. CMS issued a Form 1099-MISC, Miscellaneous Income, to each
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[*9] client-employee reflecting amounts paid under the use plan. All payments to
those employees came from their employer directly, and they would also receive a
Form W-2, Wage and Tax Statement, from their employer reflecting their labor
pay.
IV. Initial Review of the Tool Plans
Petitioner agreed to review the CMS tool plans and their proposed
administration. Petitioner advised that securing a private letter ruling from the
Internal Revenue Service (IRS) was critical to ensure the viability of the tool
plans. In order to better understand the prospects of securing a favorable private
letter ruling, petitioner and Mr. Lemay sought the advice and counsel of Tom
Ochsenschlager, a partner at Grant Thornton’s national tax office in Washington,
D.C. Mr. Lemay and petitioner provided Mr. Ochsenschlager with relevant
information on CMS and the tool plans it intended to offer.
Through a series of communications occurring in November 1999, Mr.
Ochsenschlager informed petitioner and Mr. Lemay that there was little chance of
securing a favorable private letter ruling from the IRS with respect to the CMS
tool plans. Mr. Ochsenschlager spoke with attorneys from the IRS and advised
petitioner and Mr. Lemay that the IRS believed that the tool plans failed to comply
with the law applicable to accountable plans. Mr. Ochsenschlager stated that the
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[*10] tool plans allowed for reimbursements to employees in amounts exceeding
their out-of-pocket expenses for the year, contravening the statutory requirements
for accountable plans. Further, Mr. Ochsenschlager indicated that the IRS
believed that the tool use plan lacked economic substance, that there was limited
legal authority supporting tool reimbursement plans generally, and that the IRS
had an interest in litigating against taxpayers promoting tool reimbursement plans
such as those proposed by CMS.
Petitioner and Mr. Lemay subsequently met to determine how best to bring
the CMS Tool Program to market in the light of Mr. Ochsenschlager’s concerns.
To that end, on December 2, 1999, petitioner and Mr. Lemay met and developed
the following plan of action: (1) CMS would aggressively proceed in marketing
its three separate tool plans; (2) petitioner would draw up a document on behalf of
Grant Thornton endorsing the Tool Program (Grant Thornton’s justification
paper); (3) petitioner, along with Mr. Lemay, would be included in marketing the
tool plans to targeted clients; (4) petitioner would train Mike East, an employee of
Xell, on the tax aspects of the Tool Program, and Mr. East would then train CMS’
sales agents on the tax aspects of the Tool Program; and (5) training dates for sales
agents, dates for commencing sales calls, and the establishment of sales targets
would be set.
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[*11] During that meeting petitioner and Mr. Lemay agreed that the new tool plan
and the existing tool plan would be promoted as accountable plans but that the tool
use plan was not an accountable plan and payments made thereunder would
instead be properly characterized as incidental rental payments. Petitioner and Mr.
Lemay also agreed that Grant Thornton’s justification paper should serve to
clearly establish that the only risk of enrolling in the new tool plan and the tool use
plan is payment of additional tax and that neither plan carried the risk of penalties
or prosecution. Petitioner was aware that the existing tool plan was aggressive
and bore the risk of penalties, and this awareness led him to omit the existing tool
plan from Grant Thornton’s justification paper. Nevertheless, petitioner and Mr.
Lemay resolved to aggressively market the existing tool plan.
In a letter dated December 6, 1999, Mr. Lemay wrote an associate at Grant
Thornton who assisted petitioner with CMS matters generally. In that letter, for
purposes of memorializing his meeting with petitioner, Mr. Lemay offered specific
instructions about what information he wanted included in Grant Thornton’s
justification paper. Mr. Lemay requested that Grant Thornton’s justification paper
address the tax regulations and cases that demonstrated the validity and
compliance of the new tool plan with accountable plan rules. Additionally, Mr.
Lemay requested that Grant Thornton’s justification paper document the tax cases
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[*12] and regulations supporting the position that payments under the tool use
plan were not subject to employment taxes. Further, Mr. Lemay requested that
Grant Thornton refrain from discussing the existing tool plan in its justification
paper but suggested that its risks should be discussed with prospective clients in
person.
Petitioner wrote and finalized Grant Thornton’s justification paper dated
February 12, 2000, and delivered it to CMS. In accordance with Mr. Lemay’s
instructions, Grant Thornton’s justification paper did not address the existing tool
plan but discussed only the new tool plan and the tool use plan. Grant Thornton’s
justification paper concluded that the new tool plan qualified as an accountable
plan and was therefore exempt from employment taxes and that the potential for a
penalty imposed under section 6672 was limited. The paper also concluded that
payments to employees under the tool use plan would be unlikely to withstand IRS
scrutiny for an accountable plan but that there was a “long line of authority” that
such payments should be treated as exempt from self-employment tax. The paper
further concluded that if the IRS audited returns of an employer enrolled in the
tool use plan and payments made thereunder were recharacterized as wages, the
consequence would be possible examination, collection, and submission of
employment taxes and interest.
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[*13] Petitioner also drafted an executive summary of Grant Thornton’s
justification paper dated February 11, 2000, for distribution to clients and potential
clients of CMS. Petitioner drafted the executive summary because CMS advised
petitioner that its clients likely did not want to read the full opinion but would
prefer an abridged version. The executive summary concluded that the
“reimbursement plan for the cost of the employee’s tools qualifies as an
accountable plan under [section] 62(a)(2)(A).” That summary also concluded that
“there is a long line of authority leading to the conclusion that the usage payments
under CMS’s plan should be treated as other income not subject to the self-
employment tax.”
In both Grant Thornton’s justification paper and petitioner’s executive
summary, petitioner emphasized that the legal positions taken on the Tool
Program were supported by “substantial authority”. Petitioner’s executive
summary did not include a definition of substantial authority or discuss the
likelihood that the plans would fail under IRS scrutiny. Neither Grant Thornton’s
justification paper nor the executive summary emphasized that the legal positions
on the purported tax benefits available under the Tool Program were supported by
“substantial authority” as the term was understood by petitioner and Mr. Lemay--
that the tool plans had a 33.5% chance of withstanding an IRS attack. Further,
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[*14] petitioner’s executive summary did not address or express confidence in the
lawfulness of the existing tool plan, despite the fact that CMS marketed its three
tool plans simultaneously. Grant Thornton’s justification paper and petitioner’s
executive summary were distributed to clients and potential clients of CMS.
Petitioner was aware that Grant Thornton’s justification paper was distributed to
clients and potential clients of CMS.
Following CMS’ receipt of Grant Thornton’s justification paper, Mr. Lemay
determined that the tool plans were ready to market and delivered a presentation to
the CMS board of directors indicating as much. The CMS board of directors
approved the tool plans, sales strategy, and marketing materials developed by
petitioner and Mr. Lemay. CMS began marketing and administering the tool plans
immediately thereafter.
V. Marketing the Tool Plans
A. The Sales Pitch
Because the tool plans aimed to provide tax savings to employers and
employees, CMS needed both parties to enroll in the Tool Program. The first step
in the CMS strategy was to enroll employers whose employees were required to
furnish their own tools. In general this meant marketing to employers in the
heating, ventilation, and air conditioning industry, as well as the automotive and
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[*15] trucking industries. Once CMS successfully enrolled an employer (client-
employer), the next step was to enroll that employer’s employees (client-
employees).
1. Employers
The sales process would typically begin when sales agents, who were
trained and managed by Mr. Lemay, identified a potential client-employer. Once a
potential client-employer was identified, Mr. Lemay or a sales agent would meet
with the client-employer and deliver a presentation on the Tool Program. During
the presentation, Mr. Lemay and the sales agents relied on the marketing strategy
and materials that petitioner developed alongside Mr. Lemay. CMS relied on the
legal positions petitioner expressed in Grant Thornton’s justification paper to
develop its marketing materials. Petitioner reviewed the marketing materials that
CMS gave to its clients.
CMS’ marketing materials included a slide show and informational flyers
that provided an overview of the purported tax savings of CMS’ three plans. As a
general matter, these materials emphasized the Tool Program’s compliance with
relevant laws.7 The materials emphasized petitioner’s conclusion that Grant
7
At a presentation to a potential client in 2008 CMS advertised that CMS’
“unequaled experience has resulted in the successful examination of our program.”
(continued...)
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[*16] Thornton’s support of the program virtually eliminated any tax liability or
risk of penalties, that CMS maintained full compliance with IRS guidelines, and
that CMS’ reimbursement plans met the accountable plan requirements under
section 62. These materials broadly described the tool plans as a “no net cost”
employee benefit that funded an increase in employee take-home pay while also
boosting an employer’s bottom line. The marketing materials failed to clarify to
potential clients how petitioner’s positions on the purported tax benefits available
under the Tool Program were supported by “substantial authority” and what
exactly that term meant.
The materials Mr. Lemay provided to potential clients represented that the
CMS tool plans had been “tested and accepted”, successfully examined, and found
to comply with tax law requirements. Further, these materials emphasized that
Grant Thornton would represent the client in the event of an IRS audit, at no cost.
If prospective or current client-employers had tax questions, petitioner was
available to speak with them. Petitioner did in fact speak with prospective clients
on the tax aspects, and these conversations often resulted in enrollment.
7
(...continued)
At the time this statement was made, the IRS had not completed an audit of any of
CMS’ clients’ returns.
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[*17] Petitioner, individually, was held out in marketing materials as the legal
expert on the Tool Program.
2. Employees
Although an employee’s participation in the tool plan was voluntary, the
employee’s attendance at a CMS or Xell sales presentation was mandatory. Mr.
Lemay pressured client-employers to maximize employee participation in
enrollment on the grounds that it would foster a better employee and employer
relationship and promote greater savings for the employer. When the Tool
Program was met with concern or skepticism by employees, Mr. Lemay often
recommended a one-on-one meeting to explain “why their fear is not accurate.”
During such meetings Mr. Lemay or a sales agent aimed to provide the concerned
employee with a “more accurate insight” into the program and its benefits.
The marketing materials directed toward the prospective client-employees
also emphasized that the tool plans offered an increase in an employee’s take-
home pay. The decision to enroll in the full suite of tool plans was presented as
simple as the decision to pick up a $20 bill on the ground. These marketing
materials, however, did not disclose the level of risk involved with participating in
a CMS plan. Mr. Lemay instructed client-employees who received conflicting
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[*18] advice from an independent tax adviser regarding the Tool Program’s legal
compliance to contact CMS in order to resolve any discrepancies.
B. Postenrollment Procedure
After enrolling, a client-employer executed an agreement to pay CMS fees
for its administration of the Tool Program. CMS would then coordinate with the
client-employer to establish a timeline for enrolling employees and implementing
the Tool Program. Once this timeline was set, CMS would turn its attention to
marketing the Tool Program to the employees.
Although employees could enroll in one or more of the three tool plans,
approximately 90% of all client-employees enrolled in all three. If a client-
employee enrolled in all three tool plans, the first step was his or her completion of
an enrollment form for submission to CMS. At the request of Mr. Lemay
petitioner reviewed the instructions provided on the enrollment form. The
enrollment form included a chart organized by different categories of tools with
corresponding spaces for the client-employee to list the acquisition costs of all the
tools he or she owned at the time of enrollment. Client-employees were
encouraged to include as many tools as possible in determining the total
acquisition costs of their tools, even if some of those tools were not required for
their employment with the client-employer.
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[*19] CMS explicitly instructed client-employees not to state the replacement
costs or the fair market values of their tools on the enrollment forms. If employees
did not have records of the acquisition costs of their tools, they were instructed to
estimate the original costs and write those amounts on the enrollment forms. The
enrollment forms instructed client-employees to enter these estimated costs under
a space for “miscellaneous” tools, without listing each separate tool or its cost.
The enrollment forms also instructed client-employees to answer a yes or no
question as to whether they had depreciated or expensed any of their tools, and, if
so, how much in total. Until 2007 client-employees were not formally required to
provide either receipts supporting the acquisition costs stated on the enrollment
forms or to list the dates they purchased their tools. In 2007 CMS asked
prospective clients and current clients to provide receipts along with their tool
inventories; however, CMS did not enforce this requirement. The marketing
materials emphasized the importance of accurate record substantiation in
accordance with the accountable plan rules. However, no one from CMS or Xell
was responsible for verifying that the stated acquisition costs for employees’ tools
were, in fact, accurate.
The sum total of the client-employee’s acquisition costs for the tool
inventory was tracked as the employee’s base for reimbursement for the duration
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[*20] of his or her enrollment in the existing tool plan. Under the existing tool
plan CMS characterized a fixed percentage of each client-employee’s gross wages
in each pay period as a partial reimbursement for the value of his or her tool
inventory and paid that amount each pay period until the client-employee was
fully reimbursed for the tool inventory. CMS’ practice of encouraging client-
employees to list as many tools as possible had the effect of greatly inflating the
employees’ bases for reimbursement, and therefore increased both the purported
tax savings and the fees received by CMS.
CMS operated the new tool plan in a manner similar to the existing tool
plan. Under the new tool plan, when a client-employee purchased a new tool, he
or she would report the purchase and cost to CMS, and that tool and its value
would be added to the client-employee’s tool inventory and treated as reimbursed
in the same manner as the preexisting tool inventory.
Once a client-employee was reimbursed for the cost of his or her tool
inventory by way of the existing or new tool plans, CMS would transition the
client-employee to the tool use plan. Under that plan CMS categorized a portion
of the client-employee’s base pay as tool rental fees, in a proportion determined by
applying a CMS-developed formula against the total value of the client-
employee’s tool inventory.
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[*21] VI. Professional Advice Regarding the Tool Program and Marketing
Materials
A. Crowe Chizek
After Mr. Ochsenschlager of Grant Thornton’s national tax office concluded
that there was little to no chance of securing a favorable IRS private letter ruling
with respect to the Tool Program, petitioner and Mr. Lemay actively sought a
second opinion. Mr. Lemay contacted the accounting firm Crowe Chizek (Crowe)
to inquire about CMS’ prospects of securing a favorable private letter ruling. Mr.
Lemay provided Crowe with a copy of Grant Thornton’s justification paper for
Crowe’s evaluation.
On October 9, 2000, Robert Zwiers of Crowe wrote a letter (Crowe opinion)
to Mr. Lemay with Crowe’s analysis of Grant Thornton’s justification paper.
Grant Thornton’s justification paper did not include an analysis of the existing tool
plan. Accordingly, the Crowe opinion did not discuss the existing tool plan. The
Crowe opinion stated that Grant Thornton’s justification paper provided
insufficient information for Crowe to determine whether the new tool plan met the
requirements for an accountable plan. The Crowe opinion stated that the IRS had
recently withdrawn a private letter ruling where it had concluded that payments
made under an accountable plan were not subject to Federal employment taxes.
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[*22] The Crowe opinion stated that it was possible the conclusion reached in that
private letter ruling could negatively affect the availability of tax benefits under
the new tool plan. As to the tool use plan the Crowe opinion stated that “there
does not appear to be any authority for * * * [petitioner’s and Mr. Lemay’s]
conclusion” that payments made thereunder were not subject to Federal
employment taxes. Further, the Crowe opinion stated that there was no support for
treating payments to employees, in their capacity as employees, as exempt from
Federal employment taxes unless made under an accountable plan. The Crowe
opinion concluded that there appeared to be little support, if any, for the position
that payments under the tool use plan should be exempt from Federal employment
taxes.
Mr. Lemay did not accept the advice in the Crowe opinion. Rather, he
asked petitioner to draft a response to the Crowe opinion on behalf of Grant
Thornton in which petitioner disputed that advice. In a letter dated November 1,
2000, petitioner responded to the Crowe opinion and sent the response to Mr.
Lemay. Petitioner’s letter concluded that the Crowe opinion incorrectly stated that
there was insufficient information to determine whether the requirements of an
accountable plan were met in the new tool plan. Petitioner also concluded that,
although there was not any caselaw specifically addressing usage payments under
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[*23] a plan similar to the tool use plan, the plan was in compliance with all
relevant law. Petitioner and Mr. Lemay’s support of the Tool Program was
unaffected by the Crowe opinion. CMS made no changes to the Tool Program
after the Crowe opinion.
B. McDermott Will & Emery
Mr. Lemay also contacted the law firm of McDermott, Will & Emery
(McDermott) regarding the Tool Program. In addition to the new tool plan and
tool use plan, Mr. Lemay sought McDermott’s opinion on the existing tool plan,
which was not addressed in Grant Thornton’s justification paper. McDermott sent
Mr. Lemay a memorandum dated June 1, 2001, written by tax attorneys David
Fuller and Janie Cook. Petitioner also received a copy of this memorandum.
McDermott stated therein that tool reimbursement plans were the subject of
increased scrutiny because the IRS had placed employer reimbursement programs
on its Priority Guidance Plan. McDermott’s memorandum warned that the
existing tool plan would likely fail the accountable plan requirements. McDermott
explained that the IRS would not allow CMS to reimburse client-employees for
expenses incurred before the employees’ current employment. McDermott
advised that the new tool plan was “the strongest component of the * * * [Tool
Program] under the accountable plan rules” but also noted that aspects of that plan
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[*24] needed to be modified in order to comply with accountable plan rules.
Specifically, the new tool plan would likely run afoul of the business connection
component of the accountable plan rules if CMS operated a plan in which a client-
employer paid its employees the same weekly amount whether or not the
employees incurred business expenses.
McDermott confirmed petitioner’s conclusion that the tool use plan would
probably fail the accountable plan requirements. McDermott concluded that if the
tool use plan failed the accountable plan rules, there was no support for the
position that payments made under the tool use plan were exempt from Federal
employment taxes. McDermott also warned petitioner that operating the three tool
plans in tandem greatly increased the risk of losing in an IRS audit. This is
because “an independent party bargaining at arm’s length would not agree to both
pay for buying the * * * [employee’s tools and equipment] and then pay for using
the * * * [tools and equipment], unless the latter payment was only intended to
cover maintenance and related continuing costs.”
McDermott offered a number of recommendations for bringing the Tool
Program into legal compliance. McDermott recommendations included, but were
not limited to, the following: (1) that CMS offer only the combined Tool Plans
where expense reimbursements would be for the value of the use of tools and
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[*25] equipment attributable to ongoing maintenance, insurance and inventorying
costs; (2) that CMS enforce a salary reduction if the employee failed to incur or
substantiate tool expenses for any given payroll period; (3) that for the existing
tool plan, CMS ensure all eligible expenses were incurred within a year; (4) that
expenses had not been incurred in the capacity of independent contractor and had
not been previously reimbursed, deducted, or depreciated; and (5) that expenses
have been incurred for tools that would be used to perform services for the
employer.
After Mr. Lemay received McDermott’s memorandum, petitioner and Mr.
Lemay scheduled a meeting with the McDermott attorneys who had drafted it.
Before that meeting Mr. Lemay sent petitioner an email asking how CMS ought to
modify the existing tool plan in the light of the fact that McDermott’s
memorandum cited a private letter ruling in which the IRS had disallowed
reimbursement of the acquisition costs of tools purchased before an employee’s
tenure with his or her current employer. Despite petitioner’s knowledge that
McDermott recommended changes be made to the existing tool plan to bring it
into compliance, petitioner did not modify Grant Thornton’s justification paper.
Further, CMS made no changes to the Tool Program as a result of McDermott’s
memorandum.
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[*26] C. Grant Thornton’s Disavowal of CMS and the Tool Program
On April 15, 2001, petitioner gave Grant Thornton his resignation letter
effective October 15, 2001. Petitioner left Grant Thornton to pursue another full-
time job with the National Association of Independent Truckers, which offered
him a more flexible work schedule. Petitioner continued to work with and on
behalf of CMS after leaving Grant Thornton.
In a letter received by Mr. Lemay dated June 26, 2002, Grant Thornton
demanded that CMS stop using Grant Thornton’s name in marketing the Tool
Program. The letter was written by Robert P. Scales, associate general counsel for
Grant Thornton. In that letter Mr. Scales also advised that CMS did not have
permission to distribute copies of correspondence and memoranda from Grant
Thornton for purposes of marketing the Tool Program. Further, Mr. Scales
insisted that CMS clarify with its existing and potential clients that Grant
Thornton did not endorse the Tool Program.
Mr. Lemay responded to Grant Thornton with a letter dated July 22, 2002.
Mr. Lemay wrote the letter in order to salvage the relationship between Grant
Thornton and CMS. In this letter Mr. Lemay defended CMS’ use of Grant
Thornton’s name in its marketing materials on the ground that the positions CMS
had taken regarding the new tool plan and the tool use plan were made with the
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[*27] knowledge and agreement of petitioner and Mr. Ochsenschlager.8 Petitioner
requested that Grant Thornton provide updated feedback on the tool plans, or
alternatives to bring CMS’ positions current.
Grant Thornton responded to petitioner in a letter dated August 15, 2002,
reiterating that no position or alternative argument could be made to support the
tool use plan. Grant Thornton clarified that a reimbursement plan is either
accountable and thereby exempt from employment taxes or nonaccountable and
subject to both income and employment taxes. Grant Thornton demanded that
CMS no longer market the tool use plan and stop listing its name on marketing
materials. Further, Grant Thornton advised that Rev. Rul. 2002-35, 2002-1 C.B.
1067, effectively rendered moot petitioner’s argument that a tool reimbursement
plan may be nonaccountable and nonetheless avoid employment taxes.9
8
Mr. Ochsenschlager repudiated Mr. Lemay’s assertion that the positions
CMS had taken regarding the tool program were made with his knowledge and
agreement. Mr. Ochsenschlager recalled that his “conclusion was negative” with
respect to the tool plans he reviewed--the new tool plan and the tool use plan. Mr.
Ochsenschlager commented that, on both occasions when he had met with
petitioner and Mr. Lemay to discuss the Tool Program, he expressed no optimism
that the tool use plan would pass muster with the IRS. Mr. Ochsenschlager stated
that the new tool plan could probably be supported if it essentially expensed small
tool purchases, but he regarded the tool use plan as the “bread and butter of CMS.”
9
The facts and ruling in Rev. Rul. 2002-35, 2002-1 C.B. 1067, dealt with
pipeline welders and equipment mechanics. The mechanics were employees who
(continued...)
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[*28] Following receipt of Grant Thornton’s letter dated August 15, 2002, Mr.
Lemay understood that CMS no longer had the support of Grant Thornton.
Despite Mr. Lemay’s knowledge that clients enrolled in the Tool Program under
the assumption that it was supported by Grant Thornton, CMS failed to notify any
of its client-employers or client-employees that Grant Thornton no longer
supported the Tool Program. Although CMS’ relationship with Grant Thornton
terminated in 2002, some clients that enrolled before that time continued to
believe that Grant Thornton was responsible for their audit defense until as late as
2011.
D. Petitioner’s Response to Grant Thornton’s Disavowal
In response to Grant Thornton’s disavowal of its relationship with CMS,
Mr. Lemay requested that petitioner draft a series of memoranda in support of the
Tool Program. First, petitioner drafted a memorandum dated July 24, 2002,
concluding that a number of tax theories supported the conclusion that the existing
tool plan met the business connection requirement of the accountable plan rules.
9
(...continued)
also provided equipment to the employer, and they received a separate payment
for use of the equipment. The ruling held that the payments were subject to both
income and employment taxes. The ruling also stated that “[i]f an arrangement
does not satisfy one or more of * * *[the accountable plan] requirements,” all of
the amounts paid under the arrangement would be paid under a nonaccountable
plan. Id., 2002-1 C.B. at 1068.
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[*29] Petitioner also stated that client-employees ought to be allowed deductions
for the costs of any existing tools used on the job and that such expenses
constituted ordinary and necessary business expenses. Petitioner reasoned that
employees entered into a new business with respect to their existing tool inventory
by enrolling in the CMS Tool Program and that this conversion opened the
doorway to ordinary and necessary business deductions with respect to the cost of
those tools. Petitioner understood that client-employees might have purchased
their tools several years before participating in the existing tool plan. Further,
petitioner understood that client-employees did not hold themselves out as being
in a new or different trade or business by virtue of their enrollment in the CMS
Tool Program.
Petitioner’s memorandum did not address whether tools unnecessary for a
job, or tools used outside of work, were eligible for reimbursement under the
accountable plan rules. Petitioner knew that an employee’s expense incurred for
an unnecessary tool “murkies the water” as to whether it qualifies as an ordinary
and necessary business expense. Mr. Lemay promoted petitioner’s memorandum
dated July 24, 2002, in selling the Tool Program.
Petitioner also drafted a memorandum dated October 10, 2002, which did
not discuss the existing tool plan. This memorandum concluded that “substantial
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[*30] authority” supported the new tool plan’s qualification as an accountable
plan. Petitioner’s opinion expressly defined “substantial authority” as a 33.5%
chance of prevailing if returns were examined by the IRS. This memorandum also
concluded that payments made under the tool use plan were not subject to self-
employment or payroll taxes, but it did not directly conclude that substantial
authority existed for this position. Petitioner reasoned that since the client-
employee was not in the trade or business of renting tools or equipment, rental
payments made under the use plan were not subject to self-employment tax.
Petitioner drafted this memorandum knowing it would be distributed to clients.
Petitioner was aware that Grant Thornton had rescinded its support of the Tool
Program when he drafted his memorandum dated October 10, 2002. That
memorandum did not address potential issues that might arise from using the three
tool plans together.
Petitioner created an executive summary of his memorandum dated October
10, 2002, on November 22, 2002. Petitioner was asked to draft this executive
summary for marketing purposes, and CMS did in fact use it for marketing
purposes.
In the executive summary dated November 22, 2002, the existing tool plan
was mentioned only once. Petitioner wrote: “[A] variation of * * * [the new tool]
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[*31] plan may allow employees to substantiate the cost of their existing tools
when they initially enroll in the plan to take advantage of tax benefits of
reimbursement for existing tools without income tax or employment taxes.”
Further, petitioner asserted that both the new tool plan and the tool use plan were
supported by “substantial authority” and that in the event of an audit, CMS would
provide audit support at no cost. In direct contrast with Grant Thornton’s reading
of Rev. Rul. 2002-35, supra, petitioner did not believe reimbursement plans must
meet the accountable plan requirements in order to avoid employment taxes.10 Mr.
Lemay used this executive summary to help sell the tool plan and to train CMS
and Xell sales agents in marketing the Tool Program.
E. KPMG’s Opinion on the Tool Program
Following Grant Thornton’s disavowal of the Tool Program, Mr. Lemay
sought to bolster the reputation of CMS and the Tool Program by obtaining
support from another independent tax firm. Mr. Lemay also wanted another
opinion on the likelihood of obtaining a favorable IRS private letter ruling. To
10
Petitioner concluded that the technical aspects of the CMS tool use plan
were not addressed by Rev. Rul. 2002-35, supra. Petitioner then concluded that
the IRS tacitly acknowledged that payments for use of property might constitute
rent. He grounded these conclusions on his reading of a 2001 field service advice,
FSA 200127004, which he believed allowed for usage payments that were not
considered wages for the employment tax purposes, regardless of whether such
payments were made under an accountable plan.
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[*32] that end, Mr. Lemay contacted to KPMG’s Wichita office (KPMG) and
requested its review and opinion of petitioner’s memorandum dated October 10,
2002. On April 3, 2003, CMS received KPMG’s opinion on the Tool Program.
There was no discussion of the existing tool plan in KPMG’s opinion.
KPMG advised that the tool use plan failed to meet the accountable plan
rules and advised that Rev. Rul. 2002-35, supra, did not permit alternate
characterizations of payments made to employees. Accordingly, KPMG advised
that payments made to employees be characterized as wages for services rendered,
accountable plan reimbursements, or nonaccountable plan reimbursements.
Further, KPMG stated that nonaccountable plan payments were treated as
additional wages, and employee payments not made under an accountable plan
were subject to income taxation and employment taxation. KPMG noted that there
was no direct or indirect support for bifurcating wages as contemplated under the
tool use plan.
KPMG concluded that the new tool plan appeared to meet the requirements
of an accountable plan but noted that each employer should be encouraged to
adopt formal, written personnel policies providing conditions for reimbursement
consistent with the accountable plan requirements. The record does not reflect
CMS’ having encouraged its clients to do this. Further, no changes were made to
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[*33] the Tool Program in the light of KPMG’s opinion, and CMS did not
distribute it to clients.
F. Further Opinions by Petitioner and a Second Try With McDermott
In 2005 Mr. Lemay requested that petitioner write another opinion for CMS,
as well as an executive summary of that opinion, in the light of the IRS’
then-recent release of Rev. Rul. 2005-52, 2005-2 C.B. 423. That ruling concluded
that tool allowances paid to employees were not paid under an accountable plan
because the substantiation and return of excess requirements were not met.
Further, the ruling concluded that all tool allowance payments under the
arrangement must be included in the employees’ gross income and reported on the
employees’ Forms W-2 and are subject to withholding and payment of Federal
employment taxes. Id., 2005-2 C.B. at 425. Petitioner drafted the requested
opinion dated September 14, 2005, and a related executive summary. This
opinion, like petitioner’s earlier opinions, did not address the existing tool plan or
the valuation formula provided by CMS. Petitioner knew CMS relied on this
opinion and used it to help sell the CMS tool plans. Petitioner knew Mr. Lemay
had requested the executive summary so that CMS and Xell had a shorter, less
complete version of the opinion to distribute to clients.
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[*34] The September 14, 2005, opinion and its executive summary stated that
there was “substantial authority” to conclude that reimbursement for tools
acquired after enrollment, i.e., the new tool plan, would be nontaxable. As with
prior opinions written by petitioner, “substantial authority” meant a 33.5% chance
that the plan would survive IRS scrutiny. With respect to the tool use plan,
petitioner again concluded that payments made to technicians for the use of their
tools were not subject to self-employment or payroll taxes. Petitioner rejected
KPMG’s position that Rev. Rul. 2002-35, supra, precluded nontaxable status for
usage payments made under a plan that fails to comply with the accountable plan
rules, and he instead asserted that Rev. Rul. 2002-35, supra, opened alternative
characterizations such as that promoted under CMS’ use plan.
Petitioner’s opinion and executive summary explained that, under Rev. Rul.
2005-52, supra, “employers using accountable plans to reimburse employees for
the cost of providing tools must substantiate the expenses reimbursed and, to the
extent the plan provides payments before expenses are incurred, the plan must
require that the employee return amounts in excess of the substantiated expenses.”
Petitioner understood this to mean that “the ruling clarifies that an accountable
plan may not use estimates to substantiate the amount of the expenses.” This
negated the viability of CMS’ existing tool plan; however, petitioner’s
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[*35] memorandum and executive summary did not address this concern.
Petitioner’s executive summary did not address the risks of using the three tool
plans together. Further, in the executive summary petitioner reiterated the
conclusions and rationale used in prior opinions, despite new rulings and legal
advice that invalidated these positions.
Mr. Lemay once again sought a favorable independent opinion regarding
the tool plans’ compliance with relevant law, and he again contacted to
McDermott. On December 16, 2005, CMS received another opinion from
McDermott. The McDermott opinion warned:
We believe you should anticipate an audit of a client in which the IRS
will challenge the nontaxable “accountable plan” treatment of the
reimbursements for both current and new inventory, subjecting all
such payments to income and FICA taxes on the basis that the
reimbursements are amounts that would be paid anyway (i.e., as a
usage payment), thus violating the accountable plan regulations. The
IRS is unlikely to respect the reimbursement arrangement nor to
recognize the usage payment as separate from the compensation for
services, subjecting the usage payment to FICA taxes as well.
The McDermott opinion advised that Rev. Rul. 2005-52, supra, “makes it
harder for prospective CMS clients to rely upon the positions being asserted by
CMS.” McDermott went on to explain that the revenue ruling required tool
allowance payments to be included in gross income and reported as wages subject
to withholding and employment taxes if the arrangement does not require
- 36 -
[*36] substantiation and return of excess payments, as required under the
accountable plan rules. McDermott noted that CMS’ reimbursement program
appeared “almost indistinguishable” from the program discussed in Rev. Rul.
2005-52, supra, notwithstanding CMS’ proprietary calculations. CMS did not
distribute this opinion to clients or potential clients. Mr. Lemay and CMS made
no changes to the Tool Program as a result of this opinion.
Petitioner wrote another opinion in support of the Tool Program dated
July1, 2007. Mr. Lemay did not use this opinion primarily for the purpose of
selling the Tool Program, because CMS and Xell were not selling the Tool
Program at that point. Nevertheless, the opinion was distributed to existing
clients, and petitioner wrote it under the assumption that it would be used to
market the Tool Program. Petitioner addressed the existing tool plan in his July 1,
2007, opinion. He concluded that “substantial authority” supported the position
that reimbursements for tools acquired before and after the initiation of CMS’ tool
reimbursement plan were nontaxable under the accountable plan rules.
Around October 2007 CMS made its first substantive change to the tool
program. At that time CMS began to require receipts for purposes of
substantiating payments made under the reimbursement plans. Although this was
a change to the Tool Program that appeared to be required in the light of Rev. Rul.
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[*37] 2005-52, supra, and was advised by McDermott in its 2005 memorandum,
CMS waited over two years to make this change. CMS did not discontinue the
existing tool plan for those already enrolled and made no other substantive
changes to the Tool Program. Therefore, those already enrolled in the existing
tool plan did not have to provide receipts.
Petitioner wrote one more memorandum to CMS dated November 28, 2007,
in response to a Chief Counsel Advice (CCA) in which the IRS announced
increased audit attention would be paid to tool reimbursement plans, such as those
marketed and administered by CMS. Petitioner described the recent CCA as
follows:
This CCA raises some serious concerns regarding [the] CMS existing
tool plan * * * I am concerned that CMS clients need to acknowledge
and understand a “substantial authority” conclusion only avoids tax
penalties; not actual tax and interest. At this point, I am not ready to
recommend a Draconian approach of suspending the existing tool
plan and seeking a legislative remedy, but it should be in the back of
our collective minds.
Petitioner knew that CMS did not attempt to verify client-employees’ statements
regarding the costs, business use, depreciation, and prior reimbursements for their
tools. He recommended that CMS start requiring client-employees to reimburse
their employers for excess reimbursements. Petitioner acknowledged that the
existing tool plan was the “Achilles heel” of the Tool Program and that no matter
- 38 -
[*38] what CMS did to change the existing tool plan, it might not be enough to
bring it into compliance. Despite repeated advice to the contrary, petitioner stated
his confidence that the tool use plan would pass IRS muster and complied with the
relevant rules and regulations. As to the new tool plan, petitioner stated it should
easily pass IRS muster.
On August 22, 2008, Mr. Lemay emailed petitioner and the other CMS
board members indicating that a client of CMS had notified Mr. Lemay that the
IRS issued a coordinated paper dated July 2, 2008, in which it concluded that the
tool and equipment plans it had seen to date failed to meet the accountable plan
requirements. Mr. Lemay subsequently forwarded to petitioner and other CMS
board members an article published in the August 22, 2008, issue of Payroll
Currently entitled “Tool Plan Payments Must Be Included in Employees’ Gross
Income, IRS Says”, which discussed the IRS coordinated paper referenced in the
email dated August 22, 2008. That article ultimately concluded that “the routine
reimbursement of unsubstantiated expenses and the practice of recharacterizing
wages as reimbursements until the employee’s tool inventory value is zeroed out,
only to reinstate the original wage amount at that point, ‘evidence a pattern of
abuse of the accountable plan rules.’”
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[*39] VII. Client Audits, Injunction, and Penalties
A. Client Audits and Injunctions Against CMS, Lemay, and Petitioner
Several CMS clients’ returns were audited by the IRS in connection with
their participation in the CMS Tool Program beginning in 2008. In total 24 CMS
client-employers had returns audited by the IRS. Mr. Lemay received calls from
many of these clients regarding audit representation, and Mr. Lemay provided
these clients with a protest letter drafted by petitioner defending the CMS tool
plans. Each of CMS’ clients whose returns were audited was required to remit
additional employment taxes. The total resulting tax due was $4,591,106.
In February 2008 the United States initiated an action against petitioner to
enjoin him from promoting tax shelters. Mr. Lemay was aware of the suit when it
was initiated. CMS took no action against petitioner on the basis of the injunction
action. Petitioner continued to provide assistance to CMS clients with returns
under audit while his lawsuit was pending.
On May 11, 2010, the U.S. District Court for the Western District of
Missouri found that petitioner had “routinely falsely and fraudulently advised
clients that his tax arrangements were legal.” The District Court concluded that
petitioner’s “record establishes that this cycle will continue unless he is barred
from providing tax advice without significant restraint.” Therefore, the District
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[*40] Court enjoined petitioner from organizing, establishing, promoting, selling,
offering for sale or helping to organize, establish, promote, sell, or offer for sale
any tax plan. As a result of the injunction, petitioner’s C.P.A. licenses were
suspended in 2011.
The District Court required petitioner to provide a copy of its order within
60 days to each client for whom he had provided any type of tax-related advice
within the last five years. Petitioner did not provide a copy of the injunction to
any of CMS’ client-employers or client-employees. Petitioner did notify CMS and
Mr. Lemay of the injunction. Despite the injunction, CMS continued to distribute
protest letters prepared by petitioner to CMS clients with returns under audit. Mr.
Lemay did not notify CMS clients that petitioner was being sued for the promotion
of tax shelters. On December 17, 2010, petitioner was officially suspended
indefinitely from representing anyone in front of the IRS; however, CMS
continued to distribute an unsigned version of petitioner’s protest letter to its
clients.
B. Section 6700 Penalty Examination
In 2008 the IRS opened a section 6700 penalty examination against CMS,
petitioner, and Mr. Lemay regarding the Tool Program. The matter was assigned
to an IRS revenue agent (RA). The RA concluded that CMS and its principals,
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[*41] including petitioner, made a number of false or fraudulent statements
concerning the Tool Program, that petitioner knew or had a reason to know these
statements were false or fraudulent, and that these statements had a substantial
impact on the decision-making process of the clients and caused them to avoid the
payment of employment taxes. Therefore, in accordance with section 6700, the
RA determined that the IRS should assess penalties against CMS, petitioner, and
Mr. Lemay.
To calculate the penalties against petitioner, the RA determined that CMS
paid petitioner a retainer of $3,000 per month from 2008 to 2010. Therefore, the
RA took the gross income petitioner derived from CMS for each tax year at issue,
$36,000, and multiplied that amount by 50%, to arrive at penalties of $18,000 for
tax years 2009 and 2010, $36,000 in total.
The RA prepared and submitted for supervisory approval Forms 8278,
Assessment and Abatement of Miscellaneous Civil Penalties, on January 23, 2014,
for the years at issue. The RA’s immediate supervisor signed and dated the Forms
8278 on March 25, 2014. On June 23, 2014, respondent assessed penalties against
petitioner pursuant to section 6700 for tax years ending December 31, 2009 and
2010, of $18,000 and $18,000, respectively. On that same day, respondent issued
petitioner Notice CP15, Notice of Penalty Charge, for each of the tax years at issue
- 42 -
[*42] formally communicating to petitioner for the first time respondent’s
determination of these penalties. On July 15, 2014, petitioner submitted to
respondent Forms 6118, Claim for Refund of Tax Return Preparer and Promoter
Penalties, for the tax years at issue.11 Petitioner paid $150 toward his penalty
liability for each of the years at issue in conjunction with his submission of the
Forms 6118. Respondent had not acted on petitioner’s Forms 6118 by the time the
notice of determination was issued on May 6, 2015.
Before respondent concluded the section 6700 penalty examination,
petitioner and the U.S. Department of Justice executed a stipulated order for
permanent injunction under sections 7402, 7407, and 7408. This stipulated order
was signed by petitioner on January 9, 2013, and filed on January 14, 2013, with
the District Court in which the injunction action was pending. This stipulated
order enjoined petitioner from further promoting unlawful tool reimbursement,
tool rental, or tool use tax avoidance schemes that could implicate sections 6700
and 6701. The stipulated order also enjoined petitioner from advising customers
that the tool reimbursement and tool reimbursement plans, or any other similar
plan, are consistent with the internal revenue laws. Petitioner, along with Mr.
11
The Notice CP15 stated consistently with sec. 6703(c)(1) that petitioner
could pay not less than 15% of the penalty and file a claim for refund on Form
6118 for the amount paid within 30 days after the date of the Notice CP15.
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[*43] Lemay, executed the same stipulated order on behalf of CMS, which was
signed on January 4, 2013, and filed with the District Court on January 15, 2013.
VIII. CDP Process
On August, 25, 2014, respondent sent petitioner a Final Notice of Intent to
Levy and Notice of Your Right to a Hearing (levy notice) with respect to
petitioner’s unpaid section 6700 penalties for the tax years at issue.12 Petitioner
timely submitted a Form 12153, Request for a Collection Due Process or
Equivalent Hearing (CDP request), dated September 8, 2014, in response to his
receipt of the levy notice. Petitioner’s CDP request disputed his underlying
liability for the section 6700 penalties.
Petitioner’s CDP request was assigned to a settlement officer (SO) with no
prior involvement with the liabilities at issue. On December 4, 2014, petitioner
and the SO held a telephone CDP hearing. During the call, petitioner and the SO
discussed petitioner’s submission of the two Forms 6118 on July 15, 2014. At the
time of the CDP hearing, because respondent had taken no action on petitioner’s
claims for refund, petitioner was eligible to file an action in District Court related
12
The amount owed for each tax year at issue was $17,957, reflecting
respondent’s assessment of additional interest of $107 for each year and
petitioner’s having paid $150 toward each penalty in conjunction with submitting
his Forms 6118.
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[*44] to his claim for refund. The SO stated that he would hold petitioner’s CDP
case open until petitioner timely filed a refund claim in District Court. Petitioner
stated that he would withdraw his CDP request upon filing a refund claim in
District Court. Petitioner and the SO decided to hold a followup conversation on
February 15, 2015, to verify that petitioner timely filed a refund claim in District
Court and withdrew his CDP request.
On February 19, 2015, the SO called petitioner to get an update on the
status of the CDP request withdrawal. The SO informed petitioner that he planned
to sustain the proposed levy, and that a notice of determination would be
forthcoming. Petitioner did not raise any collection alternatives or submit any
financial information. On April 1, 2015, the SO called petitioner again to discuss
petitioner’s CDP case. The SO explained that he planned to sustain the proposed
levy, but he informed petitioner that collection actions could not proceed while the
refund decision was pending. Petitioner and the SO discussed petitioner’s plan to
immediately submit a Form 12257, Summary Notice of Determination, Waiver of
Right to Judicial Review of a Collection Due Process Determination, Waiver of
Suspension of Levy Action, and Waiver of Periods of Limitation in Section
6330(e)(1), for the tax years at issue. The SO sent a letter to petitioner dated
April 1, 2015, enclosing the Form 12257.
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[*45] On April 16, 2015, the SO called petitioner to inquire as to why he had not
received petitioner’s Form 12257. Petitioner indicated he decided not to sign the
waiver, and that he was disputing the underlying liabilities. The SO explained that
he would issue a notice of determination sustaining the penalties shortly. The SO
also reaffirmed that respondent could not move forward with collection until
petitioner’s refund claim was resolved.
On May 6, 2015, the Appeals Office issued a notice of determination
sustaining the proposed levy. The notice of determination indicated that petitioner
did challenge the existence or amount of the tax liabilities on his CDP hearing
request form and that during the CDP process petitioner stated that he disagreed
with the assessment of the section 6700 penalties. The notice of determination
also indicated that respondent could not move forward with collection until
petitioner’s refund claims had been considered or deemed invalid.
On June 8, 2015, petitioner timely filed a petition with this Court.
OPINION
I. Standard of Review
Section 6330 requires the Commissioner to notify a taxpayer if he intends to
levy on that taxpayer’s property. The notice must inform the taxpayer of his or her
right to a CDP hearing regarding the proposed collection action. Sec. 6330(a). In
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[*46] a CDP hearing taxpayers may raise any relevant issue or request the
consideration of a collection alternative. Sec. 6330(c)(2)(A). Taxpayers may not
challenge the existence or amount of the underlying tax liabilities unless they did
not receive a statutory notice of deficiency or otherwise have an opportunity to
dispute the liabilities. Sec. 6330(c)(2)(B). Once the Commissioner issues a notice
of determination at the conclusion of the CDP hearing, the taxpayer may seek
judicial review by timely filing a petition with this Court. Sec. 6330(d).
When the underlying tax liability is properly at issue, we review that
determination de novo. Sego v. Commissioner, 114 T.C. 604, 610 (2000). In the
instant case, the underlying liabilities are attributable to the section 6700 penalties
imposed on petitioner for promoting abusive tax shelters. This Court has
jurisdiction to review the Commissioner’s determination when the underlying tax
liability stems from section 6700 penalties. Gardner v. Commissioner, 145 T.C.
161, 174 (2015), aff’d, 704 F. App’x 720 (9th Cir. 2017). Section 6700 penalties
are not subject to deficiency procedures. Sec. 6703(b). Respondent concedes that
petitioner did not have an opportunity to dispute his liability for the section 6700
penalties with the Appeals Office before his administrative CDP hearing. Further,
the parties proceeded as if petitioner’s underlying liabilities were appropriately
challenged and properly at issue in this case. We follow the lead of the parties and
- 47 -
[*47] review de novo the question of petitioner’s liabilities under section 6700.
We review all remaining issues for abuse of discretion, to ensure those
determinations were not arbitrary, capricious, or without sound basis in fact or
law. See Murphy v. Commissioner, 125 T.C. 301, 320 (2005), aff’d, 469 F.3d 27(1st Cir. 2006); see also Goza v. Commissioner, 114 T.C. 176, 181-182 (2000).
II. Section 6700 Penalties
A. Burden of Proof
Section 6700 penalties are subject to the procedural rules of section 6703.
Section 6703(a) provides that the Secretary bears the burden of proving a
taxpayer’s liability with respect to penalties assessed under section 6700. This
Court has not decided the appropriate standard of proof in determining liability
under section 6700. This Court, in Gardner v. Commissioner, 145 T.C. at 175
n.10, cited a Court of Appeals for the Ninth Circuit decision affirming a District
Court’s application of the preponderance of the evidence standard in a section
6700 case. Additionally, the Court of Appeals for the Tenth Circuit applied the
preponderance of the evidence standard in a case for injunctive relief under
section 7408 based on a violation of section 6700. United States v. Hartshorn, 751
F.3d 1194, 1198 (10th Cir. 2014). We will follow the Court of Appeals for the
Tenth Circuit, the likely appellate venue, and apply a preponderance of the
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[*48] evidence standard. See Golsen v. Commissioner, 54 T.C. 742, 757 (1970),
aff’d, 445 F.2d 985 (10th Cir. 1971).13
B. Elements and Application
To satisfy the burden of proof with respect to section 6700, respondent must
prove by a preponderance of the evidence that petitioner: (1) organized (or
assisted in the organization of) or participated (directly or indirectly) in the sale of
an interest in an investment plan or arrangement, or any other plan or arrangement
and (2) made material statements concerning the “tax benefits”14 to be derived
from that plan or arrangement that petitioner knew or had reason to know were
false. See sec. 6700(a). We address these requirements in turn.
13
This Court has applied a preponderance of the evidence standard with
respect to analogous penalties, such as penalties under sec. 6702(a) for frivolous
tax submissions. See O’Brien v. Commissioner, T.C. Memo. 2012-326.
Additionally, a number of Federal courts have specifically held that preponderance
of the evidence is the appropriate standard of proof under sec. 6700. See United
States v. Estate Pres. Servs., 202 F.3d 1093, 1098 (9th Cir. 2000); Barr v. United
States, 67 F.3d 469, 469 (11th Cir. 1995).
14
For purposes of sec. 6700, “statements concerning the tax benefits” means
the following: a statement with respect to the allowability of any deduction or
credit, the excludability of any income, or the securing of any other tax benefit by
reason of holding an interest in the entity or participating in the plan or
arrangement”. Sec. 6700(a)(2)(A).
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[*49] 1. Petitioner Participated in the Sale of a Plan or Arrangement
Subject to Section 6700 Penalties.
Petitioner does not refer to specific evidence contending that the CMS Tool
Program was not a plan or arrangement under section 6700. Section 6700 does
not define the terms “investment plan or arrangement” or “any other plan or
arrangement”. Further, there are no regulations defining what conduct constitutes
the organization of an entity, plan, or arrangement described in section
6700(a)(1)(A). Nevertheless, Federal caselaw on this issue instructs that a “plan
or arrangement” under section 6700 should be defined broadly, and that the “sale
of a plan or arrangement” component of section 6700 “is satisfied simply by
‘selling an illegal method by which to avoid paying taxes.’” See United States v.
Stover, 650 F.3d 1099, 1107 (8th Cir. 2011) (quoting United States v. Benson, 561
F.3d 718, 722 (7th Cir. 2009)). For purposes of section 6700, “any ‘plan or
arrangement’ having some connection to taxes can serve as a ‘tax shelter’ and will
be an ‘abusive’ tax shelter if the * * * [promoter] makes the requisite false or
fraudulent statements concerning the tax benefits of participation.” United States
v. Raymond, 228 F.3d 804, 811 (7th Cir. 2000). Engaging in a broad range of
marketing activities constitutes participation in the sale of any interest in an entity,
- 50 -
[*50] plan, or arrangement, for purposes of section 6700. See id.; see also United
States v. Kaun, 827 F.2d 1144, 1149-1150 (7th Cir. 1987).
We conclude that respondent has demonstrated that the CMS Tool Program
is a plan or other arrangement under section 6700 and that petitioner assisted and
participated in that plan or arrangement. To those ends, evidence shows, and we
find, that CMS marketed and sold the Tool Program as a multistep benefit plan
through which employers and employees could avoid paying taxes and that
petitioner was a primary and indispensable figurehead in the plan’s marketing and
sale. The Tool Program consisted of three different tool plans: (1) the existing
tool plan; (2) the new tool plan; and (3) the tool use plan. CMS operated the tool
plans in sequence, thereby attempting to maximize the purported lifetime tax
savings for enrolled employees and employers. In addition to the tool plans and
payroll administration, CMS promised to offer legal research and free audit
representation as part of an overall employee benefits package. CMS charged fees
for administering the tool plans. All CMS’ claims that the Tool Program offered a
legal avenue to achieve tax savings were unsupported by law or regulations.
Further, all independent tax professionals with whom petitioner and Mr. Lemay
consulted rejected the position that the Tool Program provided its enrollees a
means to achieve legal tax savings. We find that CMS administered a multistep
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[*51] benefits program, the Tool Program, that had as its primary purpose the
reduction of Federal income and employment taxes. Therefore, the Tool Program
constituted a plan or arrangement under section 6700. See Kaun, 827 F.2d at
1144, 1149-1150; see also United States v. Zanfei, No. 04 C 2703, 2006 WL
2861051, at *8 (N.D. Ill. Sept. 29, 2006).
Petitioner argues that he earned fees from CMS for independent legal
defense work and was not involved in the organization or facilitation of sales of
the CMS Tool Program. We conclude that respondent has shown that petitioner
assisted in the organization of the Tool Program and participated in the sale
thereof. CMS existed solely to market and operate the Tool Program. Petitioner
was not an independent tax adviser to CMS. Petitioner had sat on CMS’ board of
directors since November 20, 2002, and was listed on marketing materials as the
legal authority and tax expert behind the Tool Program. At all relevant times,
petitioner reviewed and provided advice regarding CMS’ marketing materials.
CMS relied on petitioner’s legal opinions in creating its marketing materials.
Petitioner persisted in drafting favorable, outcome-oriented opinions in support of
the legality of the tool plans, despite uniform and repeated advice from
independent tax professionals to the contrary. Petitioner created executive
summaries of his opinions that did not clearly state the risks incident to enrolling
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[*52] in the Tool Program. Petitioner knew that these executive summaries would
be distributed to clients.
CMS offered client-employees the opportunity to speak with petitioner in
order to ameliorate their concerns about the legality of the purported tax benefits
available under the Tool Program. Petitioner did in fact speak with client-
employees about their concerns with the Tool Program. Ultimately, CMS based
its marketing materials entirely on the legal theories and opinions developed by
petitioner regarding the availability of tax benefits under the Tool Program. Thus,
petitioner was instrumental in facilitating the marketing and sales of the CMS
Tool Program.
2. Petitioner Made Material Statements He Knew or Had Reason
To Know Were False.
As relevant here, the section 6700 penalty applies when the organizer (or
assistant thereto) or seller (or assistant thereto) of a subject plan makes or causes
to be made any statement with respect to tax benefits arising from participation in
such a plan that (a) is material and (b) he or she “knows or has reason to know is
false”. See sec. 6700(a). Statements covered by section 6700 include factual
matters that are relevant to the availability of tax benefits and those directly
addressing the availability of tax benefits. See Stover, 650 F.3d at 1108. Advice
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[*53] and recommendations are considered statements for purposes of section
6700. Id. Unqualified statements concerning the tax benefits of a subject plan
have been found to be false or fraudulent statements under section 6700. See
United States v. Gleason, 432 F.3d 678, 683-684 (6th Cir. 2005). The question of
materiality does not require proof that anyone actually relied on the
misrepresentations or lies of the promoter. Gardner v. Commissioner, 145 T.C. at
176. Rather, a statement is material if it would have a substantial impact on the
decision-making process of a reasonably prudent investor or concerns matters
relevant to the availability of a tax benefit. See United States v. Campbell, 897
F.2d 1317, 1320 (5th Cir. 1990).
The question of whether an alleged promoter’s statements were knowingly
false, or whether he or she had reason to know the same, is a question which
requires an evaluation of what a reasonable person in his or her position would
have discovered. See id. at 1321-1322. To determine whether an alleged
promoter knew or had reason to know the statements he or she made were false,
Federal courts have considered: (1) the extent to which he or she relied on
knowledgeable professionals; (2) his or her sophistication and education; and (3)
his or her familiarity with tax matters. United States v. Estate Pres. Servs., 202
F.3d 1093, 1103 (9th Cir. 2000); see Kaun, 827 F.2d at 1149. Further, if petitioner
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[*54] knew his statements contradicted settled law or were contrary to express IRS
guidance, he had reason to know that such statements might be and probably were
false. See Stover, 650 F.3d at 1110. Additionally, omission of material facts
weighs as heavily as making false material statements. See id. at 1109-1111; see
also Hartshorn, 751 F.3d at 1202 (Court of Appeals for the Tenth Circuit applying
section 6700 in the context of an injunction under section 7408 used the
reasonable person test).
Petitioner does not specifically dispute that he made material statements
regarding the tax benefits of the Tool Program. However, he contends broadly
that he did not engage in any illegal conduct and did not make any material
statements that he knew or had reason to know were false regarding the tax
benefits of the Tool Program. Petitioner asserts that the record shows he was
transparent with prospective clients regarding the risks incident to the Tool
Program, specifically that the tool plans would likely be unsuccessful in an IRS
audit. For support, petitioner points out that he never indicated that an enrollee
would have a greater than 33.5% chance of prevailing in an audit.
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[*55] a. Material False Statements About the Existing Tool Plan
Compliance With the Accountable Plan Rules
Respondent argues that petitioner made material false statements concerning
the tax benefits of the Tool Program. Specifically, respondent contends that
petitioner provided false and misleading legal conclusions in his tax opinions and
marketing materials regarding the existing tool plan’s compliance with the
accountable plan rules. Further, respondent contends that such statements would
have a substantial impact on a reasonably prudent investor’s decision-making
process because such statements include matters relevant to the availability of a
tax benefit. See Campbell, 897 F.2d at 1320; see also Stover, 650 F.3d at 1111(“[Stover] promised to reduce his client’s taxable income by hundreds of
thousands of dollars. Any such promise would have had a substantial impact on
the decision making process of a reasonably prudent investor.”). We agree with
respondent and find that petitioner made false and misleading statements
regarding the availability of tax benefits under the Tool Program, particularly as to
the existing tool plan’s compliance with the accountable plan rules.
Under section 62(a)(2)(A), an employee can deduct certain business
expenses incurred in connection with the performance of services for an employer
under a reimbursement or other expense allowance arrangement. If these expenses
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[*56] are reimbursed by the employer pursuant to an “accountable plan”, then the
reimbursed amount is excluded from gross income and is not considered wages or
other compensation. Sec. 1.62-2(c)(4), Income Tax Regs. Thus, expenses
reimbursed pursuant to an accountable plan would be exempt from withholding
and payment of employment taxes. See id. However, if the reimbursement is not
made under an accountable plan, then the amount of the reimbursement is treated
as wages and is included in the employee’s taxable income. Id. subpara. (5).
To qualify as an accountable plan, the plan must: (1) have a business
connection; (2) require substantiation of expenses; and (3) require the return to the
employer of amounts exceeding the employee’s actual expenses. Id. paras. (c),
(d), (e), and (f). A reimbursed employee expense can be “in connection with” the
performance of services as an employee, and excludable from gross income under
the accountable plan rules, only if it is incurred by an employee on behalf of the
employer that provides the reimbursement. Id. para. (d)(1). Reimbursements for
expenses incurred before an employee’s employment with his or her current
employer are not incurred by an employee in the course of his or her current
employment and would thus fail the business connection requirement. See Biehl
v. Commissioner, 118 T.C. 467, 478 (2002), aff’d, 351 F.3d 982 (9th Cir. 2003).
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[*57] At all relevant times, the existing tool plan was marketed as an accountable
plan. Promotional materials reviewed and endorsed by petitioner emphasized the
existing tool plan’s compliance with the laws and regulations on accountable
plans. Although client-employees had the option of enrolling in one or more of
the three Tool Plans, approximately 90% of all client-employees enrolled in the
existing tool plan. Client-employees were instructed to, and did in fact, include on
their enrollment forms the acquisition costs of tools that were unrelated to their
work or purchased in years before their current employment. This practice is
directly inconsistent with the business connection requirement of the accountable
plan rules. See sec. 1.62-2(d)(1), Income Tax Regs.; see also Biehl v.
Commissioner, 351 F.3d at 986-987 (stating that in order to meet the business
connection requirement, reimbursed expenses must be incurred during the course
of employment). Therefore, the existing tool plan did not meet the business
connection requirement of the accountable plan rules.
Petitioner is a tax attorney and was a licensed C.P.A. His opinions
discussed the accountable plan rules at length. He knew that the existing tool plan
was aggressive and not in compliance with the accountable plan rules.
Accordingly, while employed by Grant Thornton, petitioner declined to write an
opinion in support of the availability of tax benefits under the existing tool plan.
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[*58] However, after submitting his resignation from Grant Thornton, he wrote an
opinion endorsing the existing tool plan. He also wrote subsequent opinions in
support of the existing tool plan’s compliance with the accountable plan rules.
Petitioner wrote that the existing tool plan satisfied the business connection
requirement under the accountable plan rules. He stated that the costs for existing
tools should qualify as deductible ordinary and necessary business expenses and
that enrollment in the CMS tool plan would result in an employee’s being in a
newly created trade or business. This plainly conflicts with existing law.
Expenses for which an employee could claim reimbursement from his or her
employer are not necessary business expenses. See Orvis v. Commissioner, 788
F.2d 1406,1408 (9th Cir. 1986) (stating that the prohibition against deductions for
reimbursable expenses is a bright line rule and applies even when an employee is
unaware that the expenses are reimbursable), aff’g T.C. Memo. 1984-533; see also
Carver v. Commissioner, 51 T.C. 932, 936 (1969); Davis v. Commissioner, T.C.
Memo. 1999-250.
Further, petitioner offered no support for his statement that signing up for
the tool reimbursement program converts an employee into a person in a new trade
or business with respect to his or her existing tool inventory. Also, as petitioner
wrote in his analysis of the tool use plan, whether a trade or business exists is
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[*59] determined by the amount of time devoted to the activity, whether it is
performed on a regular or consistent basis, and whether there is a profit motive.
Petitioner considered these factors in concluding that the tool use plan does not
constitute a trade or business with respect to those employees effectively renting
tools to their employer by enrolling in that plan.
Petitioner was aware that several independent tax firms advised CMS that
the Tool Program, particularly the existing tool plan, did not comply with the
accountable plan rules. Nevertheless, he did nothing to discourage CMS from
promoting the existing tool plan. Further, as to the substantiation requirement
under the accountable plan rules, employees must submit information to the
employer sufficient to enable the employer to identify the specific nature of each
expense and conclude that the expense is attributable to the employer’s business
activities. Sec. 1.62-2(e)(3), Income Tax Regs. Each of the elements of an
expenditure or use must be substantiated to the payor. Namyst v. Commissioner,
T.C. Memo. 2004-263, slip op. at 10, aff’d, 435 F.3d 910 (8th Cir. 2006); sec.
1.62-2(e)(3), Income Tax Regs. If an employee is not required to substantiate an
expense to the payor for reimbursement, then the reimbursement arrangement is
not an accountable plan. Sec. 1.62-2(e)(3), Income Tax Regs. Further, if an
employee merely aggregates expenses into broad categories, or reports individual
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[*60] expenses through the use of vague nondescriptive terms (such as
“miscellaneous business expenses”), the substantiation requirement is not
satisfied. Id.In determining the total acquisition costs of a client-employee’s tools, CMS
instructed the client-employee to list as many tools as possible, even unnecessary
or previously acquired tools. If the employee did not have records of the
acquisition costs of his or her tools, the employee was instructed to estimate their
costs. Client-employees were not required to provide either receipts supporting
the acquisition costs stated on the enrollment form or to list the dates they
purchased their tools. Although Mr. Lemay claimed CMS formally changed this
rule in 2007 to require receipts, CMS did not in fact demand receipts from its
current or prospective clients. Per petitioner’s review of CMS’ enrollment form,
petitioner knew that CMS did not require clients or prospective clients to list the
cost of each separate tool but instead directed the client-employee to sort their tool
costs into broad categories, including a “miscellaneous” category. The
instructions that petitioner reviewed and that CMS provided to client-employees
are directly inconsistent with the substantiation requirement of the accountable
plan rules. See id. Ultimately, because the existing tool plan did not meet the
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[*61] business connection requirement or the substantiation requirement, it is not
an accountable plan.
False statements under section 6700 include representations that a plan
qualifies for special tax treatment when the plan does not comply with the law.
See Koresko v. United States, 123 F. Supp. 3d 654, 682-689 (E.D. Pa. 2015). The
opinions and marketing materials petitioner drafted included statements that the
existing tool plan was in compliance with the law on accountable plans. Further,
because statements concerning whether the existing tool plan qualified as an
accountable plan are statements directly relevant to the availability of a tax
benefit, such statements are material. See Campbell, 897 F.2d at 1320.15
Therefore, petitioner made material false statements concerning the availability of
tax benefits under the Tool Program with respect to the existing tool plan’s
qualification as an accountable plan.
b. False Statements About the Tax Benefits of the
Tool Use Plan
Petitioner claimed that the tool use plan allowed client-employees to charge
their employers a nontaxable fee for the rental of the employees’ tools during the
15
The record establishes that petitioner failed the business connection and
substantiation requirements of the accountable plan rules. Consequently, we need
not address whether he failed the excess receipts requirement.
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[*62] daily course of the employees’ labor. Petitioner knew that the tool use plan
failed the accountable plan requirements and did not attempt to claim the tool use
plan was an accountable plan. Instead, petitioner claimed that the rental fees paid
under the tool use plan fell outside the employment tax definition of wages and
payments made thereunder would, from an employer’s point of view, not be
subject to the employment tax liability of the employer. Petitioner claimed that
statutory authority and caselaw supported the tool use plan. Petitioner repeatedly
failed to clearly communicate the risks incident to enrollment in the tool use plan,
i.e., that he believed there was a 66.5% chance it would fail to pass IRS muster.
Petitioner was aware that independent tax professionals completely rejected
his position that payments made under the tool use plan were not subject to
Federal employment taxes. Further, petitioner knew that in Rev. Rul. 2002-35,
supra, the IRS instructed that if a plan or arrangement does not satisfy one or more
of the accountable plan requirements, all amounts paid under that arrangement are
paid under a nonaccountable plan and taxed as wages. Nevertheless, petitioner
persisted in promoting the tool use plan as nontaxable.
Statements are false when assertions are not qualified and customers are not
notified that following the advice could subject them to IRS scrutiny. Stover, 650
F.3d at 1109-1110. Petitioner was repeatedly instructed as to the risks incident to
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[*63] enrollment in the tool use plan, and he failed to clearly and unambiguously
inform CMS’ sales agents, prospective clients, and current clients of that risk.
Therefore, petitioner made false statements as to the tax benefits incident to
participation in the tool use plan, and by extension, the Tool Program. See id.Such claims were material because they concerned the availability of tax benefits
under the Tool Program. See Campbell, 897 F.2d at 1320.
c. Petitioner’s False Statements Concerning the Risks
of Enrolling in the Tool Program
Statements are false when promoters fail to qualify assertions about the
availability of tax benefits and notify clients that following the statements could
subject them to IRS scrutiny. See Stover, 650 F.3d at 1109-1110. Courts have
repeatedly held that a tax promoter’s failure to advise his clients of the
requirements to qualify for a tax benefit qualifies as a false statement. See
Gleason, 432 F.3d at 682, 683; Estate Pres. Servs., 202 F.3d at 1101.
Although petitioner stated in his opinions that there was a mere 33.5%
chance that the new tool plan and the tool use plan would succeed in an IRS audit,
CMS marketed the Tool Program as if there were little to no risk in enrollment.
Instead, the marketing materials emphasized that the tool plans offered a no-cost-
to-you increase in an employee’s take-home pay. Executive summaries petitioner
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[*64] drafted represented that Grant Thornton had determined that the new tool
plan and the tool use plan complied with applicable law and that the tax benefits
purported to flow therefrom were supported by “substantial authority”.
Petitioner’s executive summaries did not disclose that Grant Thornton, KPMG,
McDermott, and Crowe rejected the position that legal authority supported the tool
use plan and the new tool plan as administered by CMS. These executive
summaries also failed to address or express confidence in the lawfulness of the
existing tool plan, despite the fact that CMS marketed all three plans
simultaneously. Petitioner and Mr. Lemay agreed to aggressively market the
existing tool plan, despite their understanding that this plan carried a risk of
penalties and was an aggressive tax planning tactic.
Petitioner’s failure to inform CMS’ clients that the IRS was closely
scrutinizing tool reimbursement plans amounts to a failure to inform those clients
that following his advice could subject them to IRS scrutiny. See Stover, 650 F.3d
at 1109-1110. Further, petitioner did not truthfully disclose the risks incident to
the purported tax benefits under the Tool Program, particularly benefits available
under the existing tool plan. Id. Together, these omissions constitute the
promulgation of additional false statements concerning the tax benefits available
under the Tool Program. Id.; see Gleason, 432 F.3d at 682-683; see also Estate
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[*65] Pres. Servs., 202 F.3d at 1101. Such statements are material precisely
because they concern the availability of tax benefits under the Tool Program. See
Campbell, 897 F.2d at 1320.
d. Petitioner’s Awareness That His Statements About the
Purported Tax Benefits of the Tool Program Were False
Petitioner does not explicitly contend that he did not know or have reason to
know his statements regarding the tool program were false. Petitioner contends
that his opinions appropriately identified and disclosed the risks of the Tool
Program.
Courts have concluded that the “know or reason to know standard” means
what a reasonable person in petitioner’s subjective position would have
discovered. See id. at 1321-1322. We look at (1) the extent to which petitioner
relied on knowledgeable professionals; (2) petitioner’s sophistication and
education; and (3) petitioner’s familiarity with tax matters. See Estate Pres.
Servs., 202 F.3d at 1103. Petitioner had reason to know that statements may be
and probably are false when those statements contradict settled law or are contrary
to express IRS guidance. See Stover, 650 F.3d at 1110.
Petitioner was a practicing tax lawyer and a C.P.A. for over 20 years when
he began writing opinions and creating marketing materials for CMS. Petitioner
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[*66] was a tax partner at Grant Thornton immediately before joining the CMS
board of directors. CMS referred to petitioner in its marketing materials as a tax
expert and legal authority and offered petitioner’s contact information to
prospective client-employers and employees who had questions about the legal
aspects of the Tool Program. Petitioner has a history and pattern of promoting
abusive tax shelters, and he has been enjoined from doing the same in the future.
Put differently, petitioner has a documented history of knowing the falsity of his
statements as to the availability of tax benefits under a plan or arrangement.
Petitioner was aware of guidance issued by the IRS indicating increased
audit attention to tool reimbursement plans such as those marketed and
administered by CMS. Petitioner was repeatedly advised by independent tax
practitioners of the risks that the tool plans would fail to pass muster if returns
were examined by the IRS. Crowe, Grant Thornton, KPMG, and McDermott
informed petitioner that there was no legal authority for the tool use plan.
Petitioner knew that the existing tool plan had little to no chance of success in an
audit. Petitioner also knew that Grant Thornton disavowed the Tool Program on
the grounds there was no legal support in favor of the tool plans.
Ultimately, petitioner was aware of the law and advice contravening the
positions he supported with respect to the Tool Program. Further, his history as a
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[*67] tax partner also cuts strongly in favor of a finding that he was aware that his
statements were false with respect to the tax benefits available under the tool
program. Therefore, petitioner knew or should have known that his statements
were false with respect to the tax benefits available under the Tool Program.
III. Supervisory Approval and Amounts of Penalties
Respondent bears the burden of production with respect to petitioner’s
liability for section 6700 penalties. See sec. 7491(c). As part of that burden,
respondent must show that the written supervisory approval requirement of section
6751(b)(1) was timely complied with. See Graev v. Commissioner, 149 T.C. 485,
493 (2017), supplementing and overruling in part 147 T.C. 460 (2016). On the
record before us we find that respondent has met his burden of production. The
RA’s immediate supervisor personally approved the initial determination of the
section 6700 penalties assessed against petitioner on March 25, 2014, by signing
the Forms 8278 for each of the years at issue. The penalties assessed were first
formally communicated to petitioner by way of a Notice CP15, dated June 23,
2014, for each of the years at issue. Thus, written supervisory approval for the
penalties was given before the first formal communication of the penalties to
petitioner. See Belair Woods v. Commissioner, 154 T.C. __, __ (slip op. at 23)
(Jan. 6, 2020); see also Clay v. Commissioner, 152 T.C. 223, 245-250 (2019).
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[*68] Section 6700(a) provides that for any promoter who makes or causes to be
made any material false statements relating to tax benefits, the amount of the
penalty shall be equal to 50% of the gross income the promoter derived therefrom.
Thus, the penalty is appropriately calculated as 50% of the gross income petitioner
derived from selling, or participating in selling, the Tool Program.16 Respondent
assessed total section 6700 penalties against petitioner of $36,000. In determining
the section 6700 penalty for each of the tax years at issue, the RA identified CMS’
gross receipts derived from the Tool Program, and then multiplied that amount by
50%. For 2009 the RA identified gross receipts of $18,000. For 2010 the RA
identified gross receipts of $18,000. The RA then multiplied the sum of these
amounts, $36,000, by 50% as required by section 6700(a). Respondent
determined penalties against petitioner pursuant to section 6700 for tax years
ending December 31, 2009 and 2010, in the total amount of $36,000. Ultimately,
16
Penalties under sec. 6700 are not assessed for discrete taxable years, but
for conduct and transactions that occur over one or more taxable years, not on an
annual basis. Planned Invs., Inc. v. United States, 881 F.2d 340, 344 (6th Cir.
1989). In Gardner v. Commissioner, 145 T.C. 161, 182 (2015), aff’d, 704 F.
App’x 720 (9th Cir. 2017), this Court expressly agreed with the reasoning in
Planned Investments, concluding that the sec. 6700 penalty is not necessarily tied
to activities or amounts earned in a particular tax year and can be based on
activities and amounts earned in other years.
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[*69] the penalties were appropriately assessed and accurately calculated, and
respondent followed all administrative procedures.
IV. Remaining CDP Issues
When the Court conducts a de novo review of an underlying liability, we
review all determinations not involving the underlying liability for abuse of
discretion. Craig v. Commissioner, 119 T.C. 252, 260 (2002). An action
constitutes an abuse of discretion if it is arbitrary, capricious, or without sound
basis in fact or law. Giamelli v. Commissioner, 129 T.C. 107, 111 (2007). This
review is to ensure that the Appeals Office verified that the Commissioner
complied with the requirements of all applicable law and administrative
procedure, considered all relevant issues raised by the taxpayer, and considered
whether the proposed collection action balances the need for the efficient
collection of tax with the taxpayer’s legitimate concern that the collection action
be no more intrusive than necessary.17 See sec. 6330(c)(3).
The notice of determination sustained the collection action, with the caveat
that collection could not proceed until petitioner’s refund claim was closed. The
17
Petitioner did not request a collection alternative and failed to present
necessary financial information for the SO to consider. See sec.
6330(c)(2)(A)(iii). The record shows the SO verified that the requirements of
applicable law and administrative procedure were followed.
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[*70] only issue that petitioner raised during his CDP hearing was his underlying
liability. The SO addressed this issue. Further, the SO verified that the
assessment of the section 6700 penalty was timely and that petitioner received all
appropriate notices in this respect. Accordingly, petitioner does not allege, and we
do not hold, that the SO abused his discretion in arriving at any of these
determinations.
V. Conclusion
We have considered all the other arguments of the parties, and to the extent
not discussed above, find those arguments to be irrelevant, moot, or without merit.
To reflect the foregoing,
Decision will be entered
for respondent.