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I had a call from a
prospective client who wanted me to contest the IRS's determination that
his income was taxable. When I asked what his authority was for
taking that position, he cited Code Section 861. I advised
him that I would not take his case, that his position that this Code
Section applied to him was groundless.
Be very suspicious if any
promoter, preparer or anyone ever tries to tell you that there is an easy
way out of paying taxes. While with the IRS, I used to tell
taxpayers that if a particular scheme or proposal sounds too good to be
true, it probably is.
I am including a recently
released Revenue Ruling that addresses the Section 861-865 scam that is
circulating around the country. Do NOT fall for it as it
will most likely end up costing you considerably more in taxes,
penalties and interest than the taxes you hope to save.
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Rev. Rul. 2004-30, 2004-12 IRB, 03/01/2004, IRC Sec(s).
Headnote:
Reference(s):
Full Text:
Purpose
The Service is aware that some taxpayers are attempting to reduce their
federal tax liability by taking the position that United States citizens
and residents of the United States are not subject to tax on their wages
and other income earned or derived within the United States (“the Section
861 position”). These taxpayers rely on sections 861 through 865 of the
Code and the regulations (in particular, Treasury Regulation ' 1.861-8) to
argue that taxes are only imposed on income derived from certain
foreign-based activities. The Service also is aware that promoters,
including return preparers, are advising or recommending that taxpayers
take frivolous positions based on this argument. Some promoters may be
marketing a package, kit, or other materials that claim to show taxpayers
how they can avoid paying income taxes based on this and other meritless
arguments.
This revenue ruling emphasizes to taxpayers, and to promoters and return
preparers who assist taxpayers with this scheme, that there is no
authority in sections 861 through 865 that permits an individual to take
the position that either the individual or the individual's U.S.-based
income is not subject to federal income tax. This argument has no merit
and is frivolous. The rules of sections 861 through 865 have significance
solely in determining whether income is considered from sources within the
United States or without the United States, which is relevant, for
example, in determining whether a U.S. citizen or resident may claim a
credit for foreign taxes paid.
The Service is committed to identifying taxpayers who attempt to avoid
their tax obligations by taking frivolous positions, such as the Section
861 position. The Service will take vigorous enforcement action against
these taxpayers and against promoters and return preparers who assist
taxpayers in taking these frivolous positions. Frivolous returns and other
similar documents submitted to the Service are processed through its
Frivolous Return Program. As part of this program, the Service confirms
whether taxpayers who take frivolous positions have filed all of their
required tax returns, computes the correct amount of tax and interest due,
and determines whether civil and criminal penalties should apply. The
Service also determines whether civil or criminal penalties should apply
to return preparers, promoters, and others who assist taxpayers in taking
frivolous positions, and recommends whether a court injunction should be
sought to halt such activities. Other information about frivolous tax
positions is available on the Service website at www.irs.gov.
Issue
Whether an individual may avoid income tax by claiming that under sections
861 through 865, United States citizens and residents are not subject to
tax on wages and other income earned or derived in the United States.
Facts
A taxpayer who is either a citizen or resident of the United States files
a return excluding income received from U.S. sources, claiming that the
income is not subject to tax because sections 861 through 865 purportedly
provide that only certain foreign source income is subject to tax.
Law And Analysis
Sections 861 through 865 do not limit gross income subject to United
States taxation to foreign-source income. In Notice 2001-40, 2001-1 C.B.
1355, the Service advised taxpayers that it considers the Section 861
position to be a frivolous position. Courts repeatedly have rejected this
and similar arguments as frivolous, and have penalized taxpayers who make
these types of arguments. See, e.g., Takaba v. Commissioner, 119 T.C. 285
(2002) (concluding that “[t]he 861 argument is frivolous” and sanctioning
both the taxpayer and his attorney for making such frivolous arguments);
Madge v. Commissioner, T.C. Memo. 2000-370 (concluding that the argument
that only foreign income is taxable is frivolous). For more information,
please see Notice 2001-40. Notice 2001-40 and other information on
frivolous tax positions are available on the Service website at
www.irs.gov.
Civil And Criminal Penalties
In determining the correct amount of tax due, the Service will include
income that taxpayers attempt to exclude based on the Section 861
position. In addition to liability for tax due plus statutory interest,
individuals who claim tax benefits on their returns based on this and
other frivolous arguments face substantial civil and criminal penalties.
Potentially applicable civil penalties include: (1) the section 6662
accuracy-related penalty, which is equal to 20 percent of the amount of
taxes the taxpayer should have paid; (2) the section 6663 penalty for
civil fraud, which is equal to 75 percent of the amount of taxes the
taxpayer should have paid; (3) a $500 penalty under section 6702 for
filing a frivolous return; and (4) a penalty of up to $25,000 under
section 6673 if the taxpayer makes frivolous arguments in the United
States Tax Court.
Taxpayers relying on this scheme also may face criminal prosecution for:
(1) attempting to evade or defeat tax under section 7201 for which the
penalty is a fine of up to $100,000 and imprisonment for up to 5 years; or
(2) making false statements on a return under section 7206 for which the
penalty is a fine of up to $100,000 and imprisonment for up to 3 years.
Persons who promote this scheme and those who assist taxpayers in claiming
tax benefits based on this scheme also may face penalties. Potential
penalties include: (1) a $250 penalty for each return prepared by an
income tax return preparer who knew or should have known that the
taxpayer's argument was frivolous (or $1,000 for each return where the
return preparer's actions were willful, intentional or reckless); (2) a
$1,000 penalty under section 6701 for aiding and abetting the
understatement of tax; and (3) criminal prosecution under section 7206 for
which the penalty is a fine of up to $100,000 and imprisonment for up to 3
years for assisting or advising about the preparation of a false return or
other document under the internal revenue laws. Promoters and others who
assist taxpayers in engaging in these schemes also may be enjoined from
doing so under section 7408.
Holding
Any position that, under sections 861 through 865, United States citizens
and residents are not subject to tax on wages and other income earned or
derived in the United States is frivolous. Taxpayers attempting to reduce
their federal tax liability by taking frivolous positions based on this
argument will be liable for the actual tax due plus statutory interest. In
addition, the Service will determine civil penalties against taxpayers
where appropriate, and those taxpayers also may face criminal prosecution.
The Service also will determine appropriate civil penalties against
persons who prepare frivolous returns or promote frivolous positions, and
those persons also may face criminal prosecution. Promoters and others who
assist taxpayers in engaging in these schemes also may be enjoined from
doing so under section 7408.
DRAFTING INFORMATION
This revenue ruling was authored by the Office of Associate Chief Counsel
(Procedure and Administration), Administrative Provisions and Judicial
Practice Division. For further information regarding this revenue ruling,
contact that office on (202) 622-4910 (not a toll-free call).
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