A corporation sole is a valid legal corporate form that allows religious leaders to incorporate so the ownership of property passes to the successor of the religious organization (instead of the religious leaders’ heirs). Promoters of abusive tax shelters misuse these legitimate corporation sole laws and misrepresent state and federal laws intended for bona-fide churches, religious institutions and church leaders.
Section 6700 of the internal revenue code penalizes promoters, organizers, sellers, and professional advisors of abusive tax shelters who make false statements concerning the tax benefits of schemes such as misuse of the corporation sole.
The IRS can impose this civil penalty even when the purchasing taxpayer does not rely on the false or fraudulent statement or actually underreport tax. In addition, the penalty can be imposed based upon the offering materials of the arrangement without an audit of any purchaser (per Senate Report 97-494).
In 145 T.C. No. 6 (Gardner), the taxpayers, a husband and wife, marketed and promoted a plan involving the use of corporations sole during 2002, 2003, and 2004. The taxpayers sold more than 300 of the plans.
The IRS said the plan was an abusive tax shelter. A US district court agreed and found the taxpayers made fraudulent and false statements about the tax benefits of the plan. The district court said the section 6700 penalty applied because of this behavior.
The IRS began a section 6700 penalty investigation. The agent identified 200 purchasers of the corporation sole plan through examination of bank records. The agent gave the names of the purchasers to a “list keeper” in the IRS’ abusive transactions program.
A list keeper is an IRS employee who takes information received by a revenue agent and determines whether the taxpayer can be traced by way of a tax identification number. Once the individual is identified, the list keeper determines whether that individual has filed tax returns. If returns have been filed, the list keeper acquires copies, which are reviewed by a technical analyst or a revenue agent.
The list keeper found tax returns for more than 100 of the listed individuals. The agent flagged 47 of the returns of purchasers of the corporation sole plan for examination and assessed a $47,000 section 6700 penalty against each of the taxpayers ($1,000 per violation).
The taxpayers said the IRS did not establish that any of the individuals who purchased the corporation sole plan used the plan to avoid federal income tax. The taxpayers argued the purchasers were legitimate ordained bishops, pastors, elders, etc. who had purchased the plan for the governance of their respective churches and/or ministries.
Four of the purchasers testified on the taxpayer’s behalf. Each credibly testified that he did not use his respective corporation sole to avoid taxes, but rather used his corporation sole to administer his ministry in furtherance of good works.
The IRS audited the returns of all four individuals. None had any corporation sole-related adjustments made to his tax return. One witness received a tax refund after his audit.
Here’s the applicable wording of internal revenue code 6700.
(a) Imposition of penalty
Any person who—
(A) organizes (or assists in the organization of)—
(i) a partnership or other entity,
(ii) any investment plan or arrangement, or
(iii) any other plan or arrangement, or
(B) participates (directly or indirectly) in the sale of any interest in an entity or plan or arrangement referred to in subparagraph (A), and
(2) makes or furnishes or causes another person to make or furnish (in connection with such organization or sale)—
(A) 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 which the person knows or has reason to known is false or fraudulent as to any material matter, or
(B) a gross valuation overstatement as to any material matter,
shall pay, with respect to each activity described in paragraph (1), a penalty equal to the $1,000 or, if the person establishes that it is lesser, 100 percent of the gross income derived (or to be derived) by such person from such activity. For purposes of the preceding sentence, activities described in paragraph (1)(A) with respect to each entity or arrangement shall be treated as a separate activity and participation in each sale described in paragraph (1)(B) shall be so treated. Notwithstanding the first sentence, if an activity with respect to which a penalty imposed under this subsection involves a statement described in paragraph (2)(A), the amount of the penalty shall be equal to 50 percent of the gross income derived (or to be derived) from such activity by the person on which the penalty is imposed.
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To impose a $47,000 penalty against each taxpayer, the IRS is obligated to establish that each taxpayer committed 47 acts, which made him/her liable for the section 6700 penalty.
The IRS did just that. The agent explained in detail how he and his colleagues examined bank accounts, customers’ canceled checks, and customers’ tax returns and how he and his colleagues were able to identify 47 corporations sole organized by the taxpayers and correlate payments made by the customers.
The agent classified only 47 income tax returns because they had the most potential for examination adjustments (i.e., most likely to have issues with income, deductions, and/or credits).
The focus of section 6700, however, is not on the recipient; it is on the promoter of the abusive tax shelter. As the legislative history of the statute makes clear, a promoter is liable for the section 6700 penalty even if the IRS does not audit the return of the purchaser. Indeed, even if the purchaser makes no use of the tax shelter and does not underreport his/her tax, the promoter is still liable for the section 6700 penalty. See Senate Report No. 97-494 (Vol. 1), at page 267.