IRS advises abating excess-business-holdings tax

Plain-English summary

A private foundation held too much stock in a for-profit corporation after its tax preparer miscalculated the holdings attributable to the foundation and misread the percentage allowed by § 4943. The preparer documented the analysis, discussed it with the foundation's treasurer, and repeated the same conclusion on the next return. New personnel later found the errors, the foundation filed or amended the required returns, and it sold the relevant stock back to the corporation at a qualified appraised value. The IRS concluded that the foundation had reasonably relied on specific written professional advice that addressed both the facts and the law, even though the advice was wrong. Because the violation was corrected, was not willful neglect, and resulted from reasonable cause, the memorandum advised abating the first-tier § 4943 taxes under § 4962.

Ruling snapshot

• Question: Should first-tier § 4943 tax be abated when a foundation corrected excess business holdings that resulted from reasonable reliance on erroneous written tax advice?
• Outcome: Advice given, abatement recommended
• Key authorities: IRC §§ 4943 and 4962; United States v. Boyle, 469 U.S. 241 (1985)

Full text (IRS public release)

INTERNAL REVENUE SERVICE

NATIONAL OFFICE TECHNICAL ADVICE MEMORANDUM

Number: 201448032
Release Date: 11/28/2014

September 5, 2014

E.O. Exams Programs and Review
Internal Revenue Service

Attn: EO Mandatory Review

MC 4920 DAL

1100 Commerce Street

Dallas, TX 75242

Taxpayer's Name:

Taxpayer's Address:

Taxpayer's Identification Number:
Tax Years Involved:

Date of Conference:

UIL: 9999.98-00

LEGEND:

Foundation =
Corporation =
Founder =
Year =
Year1 =
Date =

ISSUE:

Should the first-tier excise taxes under I.R.C. § 4943 on Foundation’s holding of stocks in a for-
profit business for the years at issue be abated in accordance with § 4962?

FACTS:

Foundation is classified as a private foundation under § 509. Foundation was initially funded
with shares in a for-profit corporation, Corporation, by its founder, Founder. For three years

ending in the most recent tax year in issue, additional Corporation stock was granted to

Foundation by Founder’s brother. By Year, the ownership percentages were as follows:

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The directors of Foundation and Corporation are identical.

In Year, the tax preparer for Foundation analyzed the business holdings of Foundation and its
disqualified persons and outlined them in a memorandum. The memorandum sought to
determine if Foundation held excess business holdings for the prior tax year. The document
concluded that the substantial contributors to Foundation and the family members thereof
owned over seventeen percent of the stock of the corporation, but slightly miscalculated the
total stock attributable to Foundation. The memorandum then misinterpreted the percentage
allowable under § 4943(c)(2) to conclude, incorrectly, that Foundation had no excess business
holdings for the prior tax year. As the analysis concluded, albeit incorrectly, Foundation had no
excess business holdings, the memorandum had no reason to discuss the five-year period to
dispose of gifts, bequests, etc., allowed by § 4943(c)(6). The internal memorandum ends with
the note that the excess business holdings of Foundation should be evaluated annually.

The tax preparer discussed the analysis with Foundation’s Treasurer and provided a copy of the
memorandum for Foundation’s files.

When preparing the return for Foundation’s Year tax year the tax preparer relied upon the
analysis in the prior memorandum in order to determine that Foundation had no excess
business holdings. Foundation did not change its holdings and did not report any excess
business holdings on its Year return. When preparing the returns for Year1, Foundation’s tax
preparer assigned new individuals to the task. The new individuals performed a new analysis of
Foundation’s business holdings, discovered the earlier errors, and found that Foundation had
excess business holdings in Year and Year1. Foundation filed the appropriate returns for Year
and amended its returns for Year.

To correct Foundation’s excess business holdings position, Foundation made an installment
sale of all of the stocks originally granted by Founder back to the corporation for the full value
determined under a qualified valuation of the stock.

Foundation has submitted a Form 4720 for both the Year and Year1 tax years seeking
abatement of the first tier tax under § 4943 for both years.

LAW:

I.R.C. § 507(d)(2) provides that a substantial contributor means any person who contributed or
bequeathed an aggregate amount of more than $5,000 to the private foundation, if such amount
is more than two percent of the total contributions and bequests received by the foundation.

I.R.C. § 4943(a) imposes a ten percent tax on the value of any “excess business holdings” of a
private foundation.

I.R.C. § 4943(c)(1) defines “excess business holdings” as the amount of stock which the
foundation would have to dispose of to a person other than a disqualified person in order for the
remaining holdings of the foundation to be “permitted holdings.”

I.R.C. § 4943(c)(2) defines “permitted holdings” as twenty percent of the voting stock of any
incorporated business enterprise reduced by the percentage of the voting stock owned by all
disqualified persons.

I.R.C. § 4946(a)(1) provides that a “disqualified person,” with respect to a private foundation,
includes a substantial contributor, as defined under § 507(d)(2), a foundation director or officer,
and any spouse, ancestor, child, grandchild, great grandchild, and any spouse of a child,
grandchild, or great grandchild of that contributor, director, or officer.

I.R.C. § 4962(a) provides that if it is established to the satisfaction of the Secretary that:

1. a taxable event was due to reasonable cause and not to willful neglect, and

2. such event was corrected within the correction period for such event, then any
   qualified first tier tax imposed with respect to such event (including interest) shall
   not be assessed and, if assessed, the assessment shall be abated and, if collected,
   shall be credited or refunded as an overpayment.

I.R.C. § 4963(a) provides that, “If any taxable event is corrected during the correction period for
such event, then any second tier tax imposed with respect to such event (including interest,
additions to the tax, and additional amounts) shall not be assessed, and if assessed the
assessment shall be abated, and if collected shall be credited or refunded as an overpayment.”

I.R.C. § 4963(e)(1) defines “correction period” as “the period beginning on the date on which
such event occurs and ending 90 days after the date of mailing under § 6212 of a notice of
deficiency.”

Treas. Reg. § 53.4963-1(e) provides that the correction period with respect to any taxable event
shall begin with the date on which the taxable event occurs and shall end 90 days after the date
of mailing of a notice of deficiency under § 6212 with respect to the second tier tax imposed with
respect to the taxable event. Subparagraph (3) provides that the correction period may be
extended by any period which the Commissioner determines is reasonable and necessary to
bring about correction of the taxable event.

In United States v. Boyle, 469 U.S. 241 n.3 (1985), the Supreme Court described “willful
neglect” “as meaning a conscious, intentional failure or reckless indifference.” To show
reasonable cause, the taxpayer must “demonstrate that he exercised ‘ordinary business care
and prudence.” Boyle, 469 U.S. at 246 (quoting Treas. Reg. § 301.6651-1(c)(1). Additionally,
the court stated, “This case is not one in which a taxpayer has relied on the erroneous advice of
counsel concerning a question of law. Courts have frequently held that “reasonable cause” is
established when a taxpayer shows that he reasonably relied on the advice of an accountant or
attorney that it was unnecessary to file a return, even when such advice turned out to have been
mistaken.” Citing United States v. Kroll, 547 F.2d 393, 395-396 (CA7 1977); Commissioner v.
American Assn. of Engineers Employment, Inc., 204 F.2d 19, 21 (CA7 1953); Burton Swartz
Land Corp. v. Commissioner, 198 F.2d 558, 560 (CA5 1952); Haywood Lumber & Mining Co. v.
Commissioner, 178 F.2d, at 771; Orient Investment & Finance Co. v. Commissioner, 83
U.S.App.D.C., at 75, 166 F.2d, at 603; Hatfried, Inc. v. Commissioner, 162 F.2d, at 633-635;
Girard Investment Co. v. Commissioner, 122 F.2d, at 848; Dayton Bronze Bearing Co. v.
Gilligan, 281 Fed. 709, 712 (CA6 1922). This Court also has implied that, in such a situation,

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reliance on the opinion of a tax adviser may constitute reasonable cause for failure to file a
return. Citing Commissioner v. Lane-Wells Co., 321 U.S. 219, 64 S.Ct. 511, 88 L.Ed. 684
(1944). The court goes on to state, “When an accountant or attorney advises a taxpayer on a
matter of tax law, such as whether a liability exists, it is reasonable for the taxpayer to rely on
that advice. Most taxpayers are not competent to discern error in the substantive advice of an
accountant or attorney. To require the taxpayer to challenge the attorney, to seek a “second
opinion,” or to try to monitor counsel on the provisions of the Code himself would nullify the very
purpose of seeking the advice of a presumed expert in the first place.”

In Woodsum v. Commissioner, 136 T.C. 585 (2011), the court determined that there was no
reasonable cause for the failure to report $3.4 million in income when the taxpayer had provided
its tax preparer with all of the information for it to know that the taxpayer had earned that
income. The court noted that the tax preparers failure to report the income on the return does
not constitute professional advice on which the taxpayer could rely for not reporting the income.

Hans Mannheimer Charitable Trust v. Commissioner, 93 T.C. 35 (1989), involved the imposition
of taxes under § 4945 for failure to exercise the expenditure responsibilities under § 4945(h).
The court stated: “The initial tax is a spur designed to remind the foundation that it has been
remiss. Subsequent compliance with the rules enables the foundation to avoid the real whip of
§ 4945(b)(1), but cannot undo the punishment for its initial infraction.” The court determined
that even if no expenditures were used inappropriately, failure to comply with the regulations
and file the appropriate paperwork warranted imposition of the first-tier tax under § 4945.

In Rembusch v. Commissioner, 38 T.C.M. (CCH) 310 (1979), the court held the taxpayer has

the burden of showing that a failure to file timely returns was due to reasonable cause and not
willful neglect. A mere showing that the delinquency in filing the returns was not due to willful

neglect is not sufficient and that there must also be reasonable cause.

In de Belaieff v. Commissioner, 15 T.C.M. (CCH) 1426 (1956), the court held ignorance of the
law does not constitute reasonable cause. The taxpayer had shown that failure to file returns
was not due to willful neglect, but to ignorance of the law. The taxpayer received advice from
her attorneys regarding the tax treatment of income items, which was correct at the time of the
advice. Subsequently, for the years at issue, there was a change in the law that made them
taxable, but taxpayer continued to treat the items as nontaxable. The court found that even
though taxpayer had legal representation, the failure by the attorneys to provide advice and the
failure by the taxpayer to seek advice, did not constitute reasonable cause.

H.R. Rep. No. 432 (Pt. 2), 98th Cong., 2d Sess. 1472 (1984), and S. Rep. No. 169 (Vol. 1), 98th
Cong., 2d Sess. 591 (1984), provide that where the foundation or foundation manager can
establish that there was reasonable cause for such a violation and that there was no willful
neglect of the rules, the Internal Revenue Service is to have discretionary authority to relieve the
foundation or manager from the first-tier penalty tax, provided that the violation is corrected in
the manner required in order to avoid liability for second-tier taxes. A violation which was
merely due to ignorance of the law cannot qualify for such abatement.

Delegation Order No. 7-11 (11-08-2007) delegates authority to abate substantial first-tier excise
taxes to the Director, Exempt Organizations. “Substantial qualified first-tier tax amount” is
described as a sum exceeding $200,000 for all such tax payments or deficiencies (excluding
interest, other taxes, and penalties) involving all related parties and transactions arising from
chapter 42 taxable events within the statute of limitations as determined by the key district office
involved. See IRM 1.2.46.12(2), (3).

ANALYSIS:

For first tier tax to be abated under § 4962, the tax assessed must be from a taxable event due
to reasonable cause and not to willful neglect, and the taxable event was corrected within the
correction period for such event.

Abatement of taxes under § 4962 requires that the failure to comply with the tax law was due to
(1) reasonable cause, (2) not from willful neglect, and (3) that taxpayer correct its non-
compliance within the applicable correction period. There is no contention that Foundation
acted with willful neglect or that it has not corrected in the appropriate correction period.
However, it is not enough to show that the mistake was merely not due to willful neglect,
Foundation must also show that it was due to reasonable cause. Rembusch, 38 T.C.M. (CCH)

310. Section 4962 does not define “reasonable cause.” Other Code sections and the
     regulations, including § 53.4945-1(a)(2)(v), indicate that the standard should be “ordinary
     business care and prudence.” Under § 301.6651-1(c) and other provisions that impose a
     reasonable cause standard, determining whether reasonable cause was shown requires
     consideration of all the facts and circumstances. The Supreme Court, in Boyle, 469 U.S. at 246,
     states that to show reasonable a taxpayer must demonstrate that it acted with “ordinary
     business care and prudence.” The Court goes on to clarify that “When an accountant or
     attorney advises a taxpayer on a matter of tax law, such as whether a liability exists, it is
     reasonable for the taxpayer to rely on that advice.” Boyle, 469 U.S. at 251.

Foundation claims that its error was due to reasonable cause based on the tax advice of its tax
preparer. In the year before Year Foundation’s tax preparer drafted a memorandum stating that
Foundation did not have excess business holdings. The prepared advice was not based on the
five-year period for disposal provided for gifts under § 4943(c)(6), which was still in effect. The
written analysis by the tax preparer concluded that the amount of the holdings did not constitute
excess business holdings and were thus permissible. This analysis gave no indication that
Foundation’s excess business holdings position would change without any change to the actual
share holdings. Thus, Foundation had professional advice, before to the date it would need to
reduce its excess business holdings, that it did not have excess business holdings due to not
reaching, what it believed to be the applicable holdings. Based on the written advice of the tax
preparer Foundation believed it had no need to reduce its business holdings. This tax advice
was provided with full knowledge of the facts as demonstrated by email exchanges between
Foundation and the preparer.

In the first year in question, Foundation’s tax preparer again relied on the analysis of the prior
year’s memorandum. Relying on this memorandum the tax preparer examined the nearly
identical tax holdings of Foundation and came to the same erroneous conclusion, which the tax
preparer provided to Foundation. When preparing Foundation’s Year1 tax filings Foundation’s
tax preparer performed a new analysis with new individuals. It was at this time that the tax
preparer informed Foundation it had excess business holdings for both Year and Year1.
Foundation states that it reasonably relied upon the advice of its tax preparer to mistakenly
carry excess business holdings.

It is necessary to examine other parts of Chapter 42 to define “reasonable cause” since it is not
defined within § 4962 or its regulations. Section 53.4955-1(b)(7) provides language to interpret
reasonable written advice when evaluating the reasonable cause of a foundation manager for
agreeing to a political expenditure. This section provides that such agreement is done with
reasonable cause if the opinion addresses itself to the facts and applicable law. A written
opinion is not considered reasoned if it does nothing more than recite the facts and express a

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conclusion. The written advice of counsel in this case addresses the facts and the applicable
law for this case. The written advice incorrectly concludes that Foundation should be below the
35 percent limit rather than the 20 percent limit. It should not be incumbent upon Foundation to
validate the analysis of the professional tax preparer who has full information when it has
received specific advice relating to the conclusions used in the preparation of its taxes.
Foundation had specific communications with its tax preparer on this topic and knew that the
preparer provided a specific analysis which cites both the law and the facts in the relevant case.
There was no information in the written advice that put Foundation on notice as to the erroneous
conclusion. Therefore, Foundation should be considered to have reasonable cause to continue
with its status quo level of business holdings until it had been advised otherwise.

Foundation’s excess business holdings were not performed with willful neglect and they have
been corrected. Foundation also had reasonable cause to maintain its business holding level
since it received written advice from a professional tax preparer that addressed both the facts
and the law relating to this issue for Foundation. H.R. Rep. No. 432 discussing the enactment
of § 4962 states that the reasoning behind the abatement rule is that all strict impositions of
Chapter 42 taxes were not necessary in order to enforce compliance with the letter and spirit of
the rules. Abating the first-tier taxes in this case is consistent with that reasoning.

Based on the foregoing:

The § 4943 taxes on excess business holdings should be abated under § 4962 since
Foundation sought the advice of a well-respected tax preparer, had specific conversations with
that preparer regarding its stock holdings, and received specific advice from that preparer noting
that there were no excess business holdings.

A copy of this memorandum is to be given to Foundation. Section 6110(k)(3) of the Internal
Revenue Code provides that it may not be used or cited as precedent.

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