Case — Statute of Limitations — Federal Excise Tax (ESOP)

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NOTE: On October 1, 2014, the tax court reversed itself and vacated its decision in this case. See 143 T.C. No. 13 (Eggertsen). (The link opens a pdf document on the tax court website.)

TL Case Summ

THE QUESTION

Did the statute of limitations expire for imposing an excise tax on an employee stock ownership plan?

THE DISPUTE

Taxpayer Says: The IRS is barred from assessing the excise tax because the three-year statute of limitations expired.

Internal Revenue Service Says: The statute of limitations expires on the later of three years from the ownership giving rise to the excise tax, or the date on which the Secretary of the Treasury is notified of such ownership.

THE LAW

From Internal Revenue Code Section 4979A(e)(2)(D): The period for the assessment of any tax imposed by section 4979A(a) “shall not expire before the date which is three years from the later of * * * the * * * ownership referred to in such paragraph giving rise to such tax, or * * * the date on which the Secretary [of the Treasury] is notified of such * * * ownership.”

From Federal Tax Regulation 1.1033(a)-2(c)(5): Addresses the meaning of the term “notified” in section 1033(a); indicates that any deficiency attributable to section 1033(a)(2) “may be assessed at any time before the expiration of three years from the date the district director with whom the return for such year has been filed is notified by the taxpayer of the replacement of the converted property or of an intention not to replace, or of a failure to replace, within the required period.” That regulation also provides that if involuntarily converted property is replaced, “notification shall contain all of the details in connection with” such replacement and is to be filed with the District Director before the time or at the time the taxpayer’s annual income tax return is filed.

From Stovall v. Commissioner, 101 T.C. at 151: It is appropriate to use the regulations under section 1033(a) as guidance in determining whether the Secretary was “notified” under section 4979A(e)(2)(D) of the ownership that gives rise to the excise tax under section 4979A(a).

THE CAUSE OF THE DISPUTE

In tax law, the statute of limitations is the time period set by law for the IRS (and taxpayers) to review, analyze, and resolve disputes. In the case of employee stock ownership plans (ESOPs), the IRS has three years to assess a penalty for a prohibited transaction involving the allocation of benefits to disqualified participants. The three-year period expires either three years from the date of the prohibited transaction, or three years from the date the IRS is notified of the prohibited transaction, whichever is later.

The dispute in this case arises from the definition of “notified.”

In 1999, the taxpayer, a subchapter S corporation, established an ESOP (a type of retirement plan where employees own stock in the company they work for). Around April 26, 2006, the taxpayer filed a corporate federal income tax return for taxable year 2005. The corporate return showed that during 2005, the ESOP owned 100% of the corporate stock.

On an unknown date during 2006, the ESOP filed the annual Return/Report of Employee Benefit Plan for taxable year 2005. On the return, the ESOP showed that (1) its effective date was January 1, 1999; (2) it was maintained by the taxpayer during 2005; (3) it had three participants during 2005, two of whom were not identified and were described as “active participants” and one of whom was identified and described as “other retired or separated participants entitled to future benefits”; (4) it held assets at the end of 2005 valued at $401,500; and (5) its assets consisted exclusively of “employer securities.”

On an unknown later date, the ESOP filed an amended return for 2005 that showed that it held assets at the end of 2005 valued at $868,833, which included “employer securities” valued at $401,500.

The ESOP did not file a return of excise taxes for taxable year 2005. The IRS filed a substitute for that return.

On April 14, 2011, the IRS issued a notice of deficiency for 2005. The IRS said one of the ESOP participants was a disqualified person because that participant owned more than 50% of the shares of the S corporation. The IRS assessed an excise tax of $200,750 (50% of $401,500).

The taxpayer said the statute of limitations under the code section imposing the excise tax had expired (section 4979A(e)(2)(D); see “The Law” above).

In reaching a decision, the court had to decide which three year period applied. Since the prohibited ownership existed throughout 2005, the question was whether the IRS was “notified” of the transaction at a later date.

Because the code section does not define “notified”, the court used the definition of that term from federal tax regulation 1.1033(a)-2(c)(5). (See “The Law” above.) The court looked at the information contained in the federal corporate tax return and the employee benefit plan annual return to determine whether those forms provided all of the details necessary for the IRS to conclude the excise tax applied for 2005.

WHAT WOULD YOU DECIDE?

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THE COURT’S DECISION

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HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit TaxingLessons.com and HLCarpenter.com.

This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.

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For the taxpayer.

ORIGINAL DECISION (reversed and vacated by the tax court on October 1, 2014. The taxpayer filed the 2005 corporate income tax return around April 26, 2006. The ESOP filed the 2005 employee benefit plan annual return on a date not established by the record during 2006. Information contained in both of those returns provided all of the details necessary for the IRS to conclude that the excise tax applied for 2005.

Although the record does not establish when in 2006 the ESOP filed the 2005 employee benefit plan annual return, the ownership that gives rise to the excise tax under section 4979A(a) for taxable year 2005 existed on the first day of 2005 and throughout that year.

We find the period of limitations under section 4979A(e)(2)(D) for assessing the excise tax expired on a date in 2009 that is not established by the record. The IRS did not issue the notice to the taxpayer until April 14, 2011, which was after the period of limitations under section 4979A(e)(2)(D) had expired.

Updated opinion (use the link at the beginning of the summary to read the revised decision).

Held: Upon reconsideration of the statute of limitations issue in Eggertsen I, I.R.C. sec. 6501, not I.R.C. sec. 4979A(e)(2)(D), controls resolution of that issue because P did not file Form 5330 or any other document that qualifies as a return for I.R.C. sec. 4979A(a) excise tax purposes within the meaning of I.R.C. sec. 6501(a).

I.R.C. sec. 4979A(e)(2)(D) serves only to extend under the circumstances set forth therein the period of limitations prescribed by I.R.C. sec. 6501.

Held, further, the excise tax that I.R.C. sec. 4979A(a) imposes on P for its taxable year 2005 may be assessed at any time under I.R.C. sec. 6501(c)(3).

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