In Case Of 'First Impression,' Tax Court Decides Seven-Year-Long IRS Tax Dispute In Favor of Valensi Rose PLC Client

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Valensi Rose, PLC partner and lead attorney Michael R. Morris prevailed in a prolonged Tax Court proceeding on behalf of the Estate of Leonard Rosen against the Internal Revenue Service. The nearly seven-year-long dispute was narrowed down to the legal consequences of the IRS misapplying an erroneous refund of the Estate's Federal income tax to the estate tax liability after the estate voluntarily returned the erroneous refund to the IRS.

Valensi Rose, PLC partner and lead attorney Michael R. Morris prevailed in a prolonged Tax Court proceeding on behalf of the Estate of Leonard Rosen against the Internal Revenue Service. The nearly seven-year-long dispute was narrowed down to the legal consequences of the IRS misapplying an erroneous refund of the Estate's Federal income tax to the estate tax liability after the estate voluntarily returned the erroneous refund to the IRS. (United States Tax Court, Washington, DC - Docket No. 18844-04)

The dispute began with the filing of the estate's 2000 income tax return. The court documents showed it reported income from two off-shore bank accounts of a Panamanian corporation, owned by the decedent, with balances of approximately $6.5 million.

Records also showed on June 4, 2001, the estate filed the decedent's 2000 income tax return, reporting and paying $1,073.654 of income tax. On July 7, 2001, the estate sent the IRS a check in the amount of $2,068,548 for the estate tax, which included a deduction of $1, 067,990 for the estate's income tax already paid to the IRS.

According to court documents, on August 13, 2001 the IRS mistakenly assessed only part of the liability reported on the income tax return and erroneously refunded $499,757 to the estate, plus interest. On the advice of counsel, Valensi Rose PLC, the erroneous refund was promptly returned to the IRS with an explanatory letter detailing the IRS error along with a copy of the decedent's income tax return. The IRS sent a letter that it would reply to the return of the refund within 60 days, which it never did.

Beginning in 2001, the IRS recharacterized the returned $499,757 on multiple occasions, bouncing the payment between the estate and income tax accounts. In June 2002 the IRS credited this $499,757 against the estate's unpaid estate tax liability. In November 2005, after the 3-year period of limitations had expired on the decedent's income tax return, and while the estate and the IRS were embroiled in Tax Court litigation, the IRS recharacterized the $499,757 as an income tax payment, decreasing the estate tax payments by a similar amount.

Mr. Morris felt that during the estate tax audit, the IRS took an aggressive position toward Valensi Rose's client, as well himself, with accusations that the estate had intended to defraud the IRS because the estate tax return was not timely filed. Although most of the delay was attributable to the time lag in obtaining records from offshore banks, the IRS issued its notice of deficiency, which included a fraud penalty of nearly $1.5 million dollars. Thereafter, the IRS took the depositions of Mr. Morris and the estate's accountant in an attempt to prove fraud. This penalty was ultimately conceded by the IRS during the Tax Court proceedings. Mr. Morris said he was not aware of any Tax Court decision upholding a fraud penalty in similar circumstances.

In response to the IRS' notice of deficiency, Valensi Rose petitioned the United States Tax Court. Although most of the issues were settled, the taxpayer and the IRS remained at odds over the proper crediting of the $499,757. The IRS contended it had authority in November 2005 to reapply the erroneous refund back to the income tax liability, claiming the Tax Court had no jurisdiction over this controversy. Mr. Morris vigorously contested those assertions, arguing that the Tax Court's jurisdiction included the authority to determine that the $499,757, erroneously applied by the IRS to the federal estate tax, had to stay put.

In a case of "first impression," on October 20, 2008, Judge David Laro rejected all of the IRS' arguments. Given that the three-year statute of limitations for assessment on the 2000 Federal income tax had expired, Judge Laro held in favor of the estate, ruling that the $499,757 erroneously refunded as income tax had to now be legally credited against the estate tax. Estate of Leonard Rosen, 131 T.C. No. 8.

Mr. Morris is a former IRS trial lawyer and Certified Tax Specialist. He was assisted in the case by Valensi Rose Partner Wayne R. Johnson, who is currently chair of the California State Bar's Taxation Section Executive Committee.

About Valensi Rose, PLC:
Established in 1952, Valensi Rose, PLC is a full-service business law firm providing its clients with the broad range of legal services needed in a complex business environment. The firm is AV® rated by Martindale Hubbell (its highest rating). The firm's practice areas include: federal, state and international tax planning and litigation; estate planning and probate; civil litigation, family law, real estate; business and corporate law; non-profit law; labor and employment law; and music, entertainment and intellectual property law. For more information please visit http://www.vrmlaw.com.

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Jim Goyjer
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