Davison v. Commissioner of Internal Revenue, 051420 FEDTAX, 14765-15L

Docket Nº:14765-15L
Opinion Judge:NEGA, JUDGE
Attorney:Allen R. Davison, pro se. Rachael J. Zepeda, Derek S. Pratt, Alicia E. Elliott, and Trisha S. Farrow, for respondent.
Case Date:May 14, 2020
Court:United States Tax Court

T.C. Memo. 2020-58

ALLEN R. DAVISON, Petitioner



No. 14765-15L

United States Tax Court

May 14, 2020

Allen R. Davison, pro se.

Rachael J. Zepeda, Derek S. Pratt, Alicia E. Elliott, and Trisha S. Farrow, for respondent.



This case is before the Court on a petition for review of a Notice of Determination Concerning Collection Action(s) Under Section(s) 6320 and/or 6330 (notice of determination).1 After concessions by the parties, 2 the primary issue for decision is whether petitioner is liable for a penalty under section 6700 of $18, 000 for each of tax years 2009 and 2010 (years at issue), $36, 000 in total.


Some of the facts are stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference. Petitioner, Allen R. Davison, resided in Kansas when the petition was filed. This case was consolidated for trial with the case of Lemay v. Commissioner, docket No. 19356-15L. Our opinion in Lemay may be found at T.C. Memo. 2020-59.

I. Background

Petitioner graduated from the University of Nebraska in 1973, where he earned a bachelor of science degree in business administration. Petitioner obtained a law degree from the University of Nebraska in 1979 and was admitted to practice law in Nebraska in 1979. Petitioner became a certified public accountant (C.P.A.) in 1981 and was licensed in Nebraska, Kansas, and Missouri.3From 1979 to 1993 petitioner worked for the accounting firm Coopers and Lybrand. From 1993 to 2001 petitioner worked for the accounting firm Grant Thornton as a tax partner. In this role petitioner worked on tax matters for clients under audit. Petitioner first met Bruce Lemay in a professional setting. They became friends and have maintained that friendship.

While working in the insurance industry Mr. Lemay came to learn of "tool plans".4 A former colleague requested Mr. Lemay's assistance in calculating, or otherwise determining, how an employer's participation in a tool plan affected that employer's worker's compensation insurance premiums. Mr. Lemay responded that he was unfamiliar with tool plans, but he researched this issue and found that an employer's participation in a tool plan had no effect on the calculation of the employer's worker's compensation premiums. Mr. Lemay reported these findings to his former colleague.

While researching tool plans Mr. Lemay discovered a tool plan company called ProCheck and began to foster a relationship with its president. Mr. Lemay and ProCheck's president discussed tool plans generally, as well the tax aspects thereof. The president of ProCheck offered Mr. Lemay the opportunity to join ProCheck. Mr. Lemay sought the advice of petitioner, who held reservations about ProCheck's operations and the purported benefits its tool plans offered. After being apprised of the details of ProCheck, petitioner validated Mr. Lemay's concerns, and advised him to decline ProCheck's offer. Although Mr. Lemay declined the offer to join ProCheck, Mr. Lemay and the president of ProCheck agreed to form a new company that would promote tool plans, so long as such plans were reviewed and approved by petitioner and his employer, Grant Thornton.

II. Organization of CMS

On September 29, 1999, Mr. Lemay, along with the president of ProCheck and two other individuals affiliated with ProCheck, organized Cash Management Systems (CMS), an S corporation, in the State of Virginia.

From 1999 to 2010 petitioner was the key legal and tax planning adviser to CMS. Immediately after organizing, CMS formally engaged petitioner, and through him Grant Thornton, to consult and advise CMS regarding the tax benefits of its proposed tool plan products. Petitioner's first task was to review the details of the tool plans CMS intended to market. Petitioner managed the CMS client account for Grant Thornton until he left the firm in 2002. On November 20, 2002, petitioner began serving on CMS' board of directors. Petitioner was placed on retainer with CMS for six months during 2008 and all of 2009 and 2010. During 2009 and 2010 CMS paid petitioner $3, 000 per month for his services.

Mr. Lemay organized Xell Enterprises, Inc. (Xell), as an S corporation in Kansas on April 26, 1999, to operate his own sales-consulting business. After CMS was organized, however, Xell's primary purpose became marketing and selling CMS' tool plans.

III. Development of the Tool Program

CMS had three different tool plans in its Tool Program: (1) the existing tool plan, (2) the new tool plan, and (3) the tool use plan. CMS planned to operate the tool plans in sequence in order to maximize the lifetime tax savings for both the employees and employers that would choose to enroll with CMS. In addition to the tool plans and payroll administration, CMS offered legal research and free audit representation as part of an overall employee benefits package. The tool plans, administrative support, and audit representation collectively constituted the Tool Program.

CMS designed its tool plans to allow both employers and employees to claim substantial tax savings by bifurcating an employee's base pay into a taxable labor portion and a nontaxable portion for tool reimbursement or use. This bifurcation was based upon a proprietary formula. CMS promised the avoidance of Federal income tax withholding, employment taxes, or both, depending on the tool plan.5 The maximum tool reimbursement or use pay per pay period was 35% of the participating employees' wages. CMS made money from fees charged for administering the tool plans. Upon enrolling both an employer and its employees, CMS administered the enrolled employer's payroll and issued associated statements. Through those associated statements, CMS regularly kept employers and client-employees abreast of the claimed tax savings from CMS tool plans.

A. The Existing Tool Plan

Under the existing tool plan, an employer recharacterized a portion of each employee's base pay as a reimbursement to that employee for the cost of tools acquired by that employee before enrolling in the plan. The employees were reimbursed in amounts reflecting the acquisition costs of their tools, rather than the replacement costs or the fair market value costs, before enrollment in the existing tool plan.6 CMS calculated the appropriate tax withholdings for each employer's labor pay, but not tool pay, and remitted this information to the employer. The employer withheld the necessary taxes for the labor pay portion but did not withhold taxes for the tool portions determined by CMS. CMS claimed that the existing tool plan was an accountable plan under section 62, whereby reimbursement paid to employees for the cost of their own tools used on a job was not considered wages for employment tax purposes.

B. The New Tool Plan

The new tool plan also recharacterized a portion of each employee's base pay as a nontaxable reimbursement. The only meaningful difference between the existing tool plan and the new tool plan was that, under the new tool plan, employees were reimbursed only for tools purchased after their enrollment. Otherwise, the bifurcation of an employee's base pay operated in an identical manner. The new tool plan also purported to be an accountable plan under section 62.

C. The Tool Use Plan

Once an employee was treated as reimbursed for the cost of his or her tool inventory under the existing and/or new tool plans, CMS transitioned the client employee to the tool use plan. CMS offered the tool use plan to allow an employee to charge his or her employer a fee for the rental of the employee's tools during the daily course of the employee's labor. Similarly to the other plans, the employee's base wage was recharacterized into a taxable portion for labor wages and a tax-exempt portion for rental fees. CMS did not claim the tool use plan was an accountable plan and accordingly agreed that the rental fees paid pursuant to the plan were subject to Federal income taxation. CMS did claim, however, that the rental fees paid pursuant to the tool use plan fell outside the employment tax definition of wages and thereby reduced the employment tax liability of the employer and the employee. The tool use plan was available to any employee enrolled in the CMS tool plans, including those treated as fully reimbursed for the stated value of their tools under the reimbursement plan, or any employee who was treated as having fully depreciated the cost of his or her tools before enrollment in the plan. CMS calculated the tool usage amount for each participating employee and reported the amount to the employer so that the employee could be paid accordingly. CMS issued a Form 1099-MISC, Miscellaneous Income, to each client-employee reflecting amounts paid under the use plan. All payments to those employees came from their employer directly, and they would also receive a Form W-2, Wage and Tax Statement, from their employer reflecting their labor pay.

IV. Initial Review of the Tool Plans

Petitioner agreed to review the CMS tool plans and their proposed administration. Petitioner advised that securing a private letter ruling from the Internal Revenue Service (IRS) was critical to ensure the viability of the tool plans. In order to better understand the prospects of securing a favorable private letter ruling, petitioner and Mr. Lemay sought the advice and counsel of Tom Ochsenschlager, a partner at Grant Thornton's national tax office in Washington, D.C. Mr. Lemay and petitioner provided Mr. Ochsenschlager with relevant information on CMS and the tool plans it intended to offer.

Through a series of communications occurring in November 1999,...

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