Lemay v. Commissioner of Internal Revenue, 051420 FEDTAX, 19356-15L

Docket Nº:19356-15L
Opinion Judge:NEGA, JUDGE
Attorney:Bruce W. Lemay, 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. 2020-59

BRUCE W. LEMAY, Petitioner



No. 19356-15L

United States Tax Court

May 14, 2020

Bruce W. Lemay, 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 penalties totaling $46, 984, $74, 694, and $59, 398 under section 6700 for tax years 2008, 2009, and 2010, respectively (years at issue).


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, Bruce W. Lemay, resided in Kansas when the petition was filed. This case was consolidated for trial along with the case of Davison v. Commissioner, docket No. 14765-15L. Our opinion in Davison may be found at T.C. Memo. 2020-58.

I. Background

Petitioner graduated from Boston College in 1973, where he earned a bachelor's degree in English. From 1981 to 1996 petitioner was a corporate executive in the insurance industry, primarily working in the fields of property and liability insurance. Petitioner first made the acquaintance of Allen Davison in a professional setting. They became friends, and have maintained that friendship since the early nineties.

It was while working in the insurance industry that petitioner first came to learn of "tool plans".[3] A former colleague had requested petitioner'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. Petitioner 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 an employer's worker's compensation premiums. Petitioner reported these findings to his former colleague.

While researching tool plans petitioner discovered a tool plan company called ProCheck and began to foster a relationship with its president. Petitioner and ProCheck's president discussed tool plans generally, as well as their tax aspects. The president of ProCheck offered petitioner the opportunity to join ProCheck. Petitioner sought the advice of Mr. Davison, as petitioner held reservations about ProCheck's operations and the purported benefits its tool plans offered. After being apprised of the details of ProCheck, Mr. Davison validated petitioner's concerns, and advised him to decline ProCheck's offer. Although petitioner declined the offer to join ProCheck, petitioner 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 Mr. Davison and his employer, Grant Thornton.

II. Organization of CMS

On September 29, 1999, petitioner, 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. Petitioner at all relevant times sat on that company's board of directors. From 1999 through the summer of 2002 petitioner served as the president of CMS. After 2002 petitioner served as executive vice president of CMS.

Shortly after organization, CMS formally engaged Mr. Davison, and through him Grant Thornton, to consult with and advise CMS with respect to the tax benefits of its proposed tool plans. Mr. Davison managed the CMS client account for Grant Thornton. Mr. Davison's first task was to review the proposed tool plans' compliance with law.

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 enrolled in its plans. In addition to the tool plans and payroll administration, CMS would offer 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.4 The CMS Tool Program purported to offer tax savings by limiting 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 to participating employees. Through those associated statements, CMS 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 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 no taxes would be withheld 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 by way of the existing and/or new tool plan, CMS transitioned the client-employee to the tool use plan. CMS offered the tool use plan as a method to allow an employee to charge his or her employer a fee for the rental of his or her tools used during the daily course of his or her labor. Similarly to the other plans, the employee's base wages were recharacterized into a taxable portion for labor and a tax-exempt portion for rental fees. CMS did not claim the tool use plan was an accountable plan, thus rental fees paid under 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 Program, including those treated as fully reimbursed for the stated value of their tools under the existing or new tool 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 his or her employer so that the employee could be paid accordingly. CMS issued a Form 1099-MISC, Miscellaneous Income, to each client-employee for tool pay received 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

Mr. Davison agreed to review the tool plans and their proposed administration. Mr. Davison 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. Davison sought the advice and counsel of Tom Ochsenschlager, a partner at Grant Thornton's national tax office in Washington, D.C. Petitioner and Mr. Davison 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, Mr. Ochsenschlager informed petitioner and Mr. Davison that there was little chance of securing a favorable private letter ruling from the IRS with respect to the CMS tool plans. Mr. Ochsenschlager spoke with attorneys from the IRS and advised petitioner and Mr. Davison that the IRS believed that the tool plans failed to comply with the law applicable to accountable plans. Mr. Ochsenschlager stated that the tool plans allowed for reimbursements to employees in amounts exceeding their out-of-pocket expenses, contravening the statutory requirements for accountable plans. Further, Mr. Ochsenschlager...

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