FEDERAL TAX UPDATE Taxation Section Program Hot Topics and Updates

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1 FEDERAL TAX UPDATE Taxation Section Program Hot Topics and Updates Robert D. Probasco Thompson & Knight LLP One Arts Plaza 1722 Routh Street, Suite 1500 Dallas, Texas (214) (214) Fax Friday, June 11, :45 a.m. 11:30 a.m.

2 ROBERT D. PROBASCO Partner, Thompson & Knight LLP One Arts Plaza, 1722 Routh Street, Suite 1500, Dallas, TX , Fax PRACTICE Tax Trial Information Management and E-Discovery Solutions PRACTICE DESCRIPTION Robert D. Probasco focuses his practice on IRS audits and appeals and tax litigation. In representing taxpayers in disputes with the IRS, he responds to audit inquiries, drafts protest letters and position papers in response to proposed tax adjustments and penalties, participates in appeals conferences, and prepares and tries tax cases. Mr. Probasco has represented taxpayers in tax disputes covering a broad range of issues. He is a Certified Public Accountant in Texas. REPRESENTATIONS Representing publicly traded financial services company in IRS Appeals proceeding relating to various tax advantaged transactions Representing real estate developer in IRS audit and Appeals proceedings Represented sports franchise and owner in IRS audit and Appeals proceedings involving proposed adjustments of $350 million Representing investors in IRS audits and litigation concerning various alleged tax shelters Representing employee benefit plans and participants in IRS audits and litigation concerning qualification as "10 or more employer plan" Representing oil and gas companies in IRS Appeals proceedings involving enhanced oil recovery (EOR) credits Represented former shareholders in IRS audit and Appeals proceedings concerning transferee liability arising from alleged "midco" transaction Represented a multinational industrial pump and valve manufacturer in IRS audit disputes concerning the tax treatment and valuation of two major acquisitions ($1 billion and $600 million) Litigated tax refund suits for several clients concerning computation of penalties and interest on federal tax deficiencies and refunds Represented a California medical supplies vendor in a sales tax audit by the State of Texas Comptroller's Office Assisting businesses with development or evaluation of document retention policies and practices Represented tax professional in tax shelter promoter investigations by multiple state and federal agencies Represented a leading diversified construction materials company in a Department of Labor compliance audit of the company's 401(k) plan

3 DISTINCTIONS/HONORS Texas Rising Stars by Thomson Reuters (Tax); , PRESS RELEASES/IN THE NEWS "Executive Changes" section, The Dallas Morning News; March 13, 2007 T&K Names New Partners; February 19, 2007 PUBLICATIONS/PRESENTATIONS Client Alert: IRS Plans to Require Disclosure of Uncertain Tax Positions, February 11, 2010 "Living With Transparency," Tax Executives Institute Dallas Chapter Meeting, Dallas, Texas, November 2008 "Retention Requirements for Tax Records," Tax Executives Institute, Dallas Chapter, January 2008 "Ethics and Standards of Tax Practice in the New Age of Transparency: From Self-Assessment to Self-Audit," API (American Petroleum Institute) Federal Tax Forum, Houston, Texas, April 2007 "Surviving IRS Examination and Appeals," Corporate Counsel Review, 2006 "IRS Audits and Appeals," Dallas Bar Association, Tax Section, March 2006 "IRS Audits and Appeals," co-authored with Emily Parker, Tax Executives Institute, Dallas Chapter, March 2006 "Computing Interest on Overpayments and Underpayments: How Difficult Can It Be? Very!," co-authored with Mary A. McNulty, David H. Boucher, and Joseph M. Incorvaia, 102 Journal of Taxation 273, May 2005 "Taxation of Attorney Fees: Recent Developments," March 2005 "Tax Shelter Disclosure and Penalties: New Requirements, New Exposures," co-authored with Mary A. McNulty, Journal of Taxation and Regulation of Financial Institutions 22, January/February 2005 "The Deliberative Process Privilege," Moderator, Court Procedure and Practice Committee, American Bar Association Tax Section, October 2004 "Record Retention Guidelines for Business," 2003 "Indian Tribes, Civil Rights, and Federal Courts," 7 Tex. Wesleyan L. Rev. 119, 2001 "Prosecuting Conduit Campaign Contributions - Hard Time for Soft Money," 42 S. Tex. L. Rev. 841, 2001 ACTIVITIES Professional Member, American Bar Association; Tax Section, Court Procedure & Practice Committee Member, State Bar of Texas; Tax Section, Tax Controversy Committee Member, Dallas Bar Association; Tax Section Member, American Institute of Certified Public Accountants Member, Texas Society of Certified Public Accountants; Dallas Chapter Civic Board of Directors, Greater Dallas Council on Alcohol and Drug Abuse, present Board of Directors, Mental Health America of Greater Dallas, present EDUCATION J.D., 2000, University of Virginia School of Law, Articles Editor, Virginia Law Review; Order of the Coif; Edwin S. Cohen Tax Prize B.S. in Industrial Administration, 1974, with distinction, Iowa State University

4 ADMISSIONS Texas, 2000 Certified Public Accountant, Iowa, 1975 Certified Public Accountant, Texas, 1992 U.S. Ct. of Fed. Claims, 2002 U.S. Tax Ct., 2007 PRIOR EXPERIENCE Law Clerk for the Honorable Sam A. Lindsay, United States District Judge for the Northern District of Texas, Mobil Oil Corporation (various financial positions), Deloitte & Touche (audit and consulting),

5 FEDERAL TAX UPDATE State Bar of Texas Annual Meeting June 11, 2010 Bob Probasco Thompson & Knight LLP 1

6 HOT TOPICS Work-Product Doctrine and Textron Uncertain Tax Positions Economic Substance 2 2

7 WORK PRODUCT DOCTRINE Hickman v. Taylor,,329US U.S. 495( (1947) Fed. R. Civ. P. 26(b)(3) Protects documents prepared in anticipation of litigation Fact work product Opinion work product mental impressions, conclusions, opinions, or legal theories (strongest protection) 3 3

8 WHAT QUALIFIES? Prepared in Anticipation of Litigation Because of test in light of the nature of the document and the factual situation in the particular case, the document can be fairly said to have been prepared or obtained because of the prospect of litigation ; most circuits Primary purpose test the primary motivating purpose behind the creation of the document was to aid in possible future litigation ; United States v. El Paso Co., 682 F.2d 530 (5th Cir. 1982) Neither extends to documents prepared in ordinary course of business, or irrespective of the litigation 4 4

9 TAX ACCRUAL WORKPAPERS Companies Accrue Reserves for Potential Tax Liabilities Roadmap for audit? Disclosure of settlement position? U.S. v. Arthur Young,, 465 U.S. 805 (1984) Tax accrual workpapers are relevant to audit No privilege or work product privilege for accountants IRS Policy of Restraint Exception: listed transactions and financial accounting irregularities 5 5

10 SUMMONS ENFORCEMENT IRS Summons Power United States v. Powell, 379 U.S. 48 (1964) Privileges from Disclosure Attorney-client privilege waived by disclosure to auditor Tax Practitioner privilege waived by disclosure to auditor Work product doctrine the last line of defense 6 6

11 THE BOMBSHELL United States v. Textron, 577 F.3d 21 (1st Cir. 2009) (en banc), petition for cert. filed (Dec. 24, 2009) Tax accrual workpapers are not work product Applied a prepared for use in litigation standard Every lawyer who tries cases knows the touch and feel of materials prepare for a... lawsuit.... No one with experience of law suits would talk about tax accrual workpapers p in these terms. Focused on discussion in Hickman v. Taylor of witness interviews, draft briefs, outlines for cross examination. 7 7

12 STATUS Cert. petition pending Possible wider application legal analysis and risk assessment regarding non-tax issues, if provided to outside auditors to evaluate need for reserve? 8 8

13 HOT TOPICS Work-Product Doctrine and Textron Uncertain Tax Positions Economic Substance 9 9

14 WHY? Tax gap : Estimated difference between tax owed under law and amount paid 2001: gross = $345 B; net (enforcement) = $290 B IRS is asked to collect more with fewer resources Up to 25% of audit time is spent searching for issues rather than discussing and evaluating 10 New disclosure requirement will help prioritize selection of issues and taxpayers to audit 10

15 FINANCIAL STATEMENTS RESERVES Fin 48 Reserve full benefit of issue unless more likely than not correct If more likely than not, reserve amount taxpayer would likely concede in settlement, assuming full knowledge by IRS Present aggregate information in financial statements But the taxpayer analyzes, and documents in tax accrual workpapers, by individual issues Usually not requested by the IRS policy of restraint 11 11

16 NEW DISCLSOURE REQUIREMENT Filed with tax return Required for business taxpayers with assets of $10 million or more Implicit compromise Less information than in tax accrual workpapers But required from all qualifying taxpayers rather than limited by IRS policy of restraint 12 12

17 WHAT WILL BE REPORTED For each uncertain tax position Concise description in sufficient detail for the IRS to determine the nature of the issue Maximum potential tax liability attributable how much additional would the taxpayer pay if it fully conceded the issue Not requesting risk assessment information well, maybe 13 13

18 WHAT IS AN UNCERTAIN TAX POSITION? A position for which h the taxpayer (or a related entity) recorded a reserve in its financial statements A position for which the taxpayer did not record a reserve because It intends to litigate (and win) unless the IRS fully concedes The IRS has a general administrative practice not to challenge such positions 14 14

19 PRACTICAL EFFECT Often the tax position, although uncertain because of ambiguity or lack of guidance, is correct and no additional tax should be due But, armed with knowledge that the taxpayer likely would concede at least part of the benefit, will the IRS auditors write up everything automatically? The IRS says no, but will have to provide training, align incentives, and allocate resources to make this work 15 15

20 QUESTIONS Objective and quantifiable measure of each position Materiality and level of aggregation Privilege and possible broad subject-matter waiver Penalties not identified yet, but the IRS is considering 16 16

21 STATUS IRS requested comments by June 1, 2010 Requirements may change somewhat before they re finalized Intend to require taxpayers to report on their 2010 tax returns filed in

22 HOT TOPICS Work-Product Doctrine and Textron Uncertain Tax Positions Economic Substance 18 18

23 JUDICIAL DOCTRINE A way to deny tax benefit even when transaction complies with literal requirements of Code Test usually involved two prongs Objective transaction was reasonably expected to change taxpayer s economic position (e.g., earn a profit) to a substantial degree Subjective transaction had a significant non-tax business purpose Courts have applied the tests differently Taxpayer must prove both prongs to prevail Taxpayer must prove either prong to prevail Unitary (flexible) approach 19 19

24 HISTORY Popular way to combat tax shelters Early success but a few recent taxpayer victories Supreme Court has not addressed since 1978 Several unsuccessful attempts to codify over the past decade Finally enacted in Health Care and Education Reconciliation Act of

25 CODIFICATION No change to existing judicial framework of whether to apply But defines how taxpayers satisfy the test Meaningful change in economic position and substantial non-tax business purpose If profit potential is basis for either prong Must take into account transaction fees/expenses and (under appropriate circumstances) foreign taxes Present value of reasonably expected pre-tax profit must be substantial in relation to present value of expected net tax benefits 21 21

26 PENALTIES Included in the existing 20% accuracy- related penalty, but No reasonable cause exception If not adequately disclosed, 20% penalty becomes 40% 22 22

27 LEGISLATIVE HISTORY Economic substance doctrine does not apply when tax benefits are consistent with Congressional purpose (e.g. e.g.,, certain targeted credits) Safe harbor for longstanding judicial and administrative practice, where choice between meaningful economic alternatives is based on tax advantages 23 23

28 SAFE HARBORS Capitalizing a business enterprise with debt or equity Operating a foreign business in a domestic or foreign corporation Corporate reorganization or organization Related party transactions, ti as long as they follow arm s length and other applicable concepts 24 24