Part I. Rulings — Internal Revenue Bulletin 2005-30

Section 61.—Gross Income Defined

26 CFR 1.61–1(a): Gross income. (Also: §§ 102, 118, 139, 165, 1033; 1.102–1, 1.118–1, 1.165–1, 1.1033(a)–1.)

Disaster relief grants for businesses. This ruling holds that a grant received by a business under a state program to reimburse businesses for losses incurred for damage or destruction of real and personal property on account of a disaster is not excludable from gross income under the general welfare exclusion, as a gift under section 102 of the Code, as a qualified disaster relief payment under section 139, or as a contribution to the capital of a corporation under section 118. The business may elect under section 1033 to defer including in income gain realized from receipt of the grant to the extent the grant proceeds are used to timely purchase property similar or related in service or use to the destroyed or damaged property.

Rev. Rul. 2005–46

ISSUES:

(1) Is a grant that a qualifying business receives under a state’s program to reimburse losses that any qualifying business incurred for damage or destruction of real and personal property on account of a disaster excludable from gross income —

(a) under the general welfare exclusion; (b) as a gift under § 102 of the Internal Revenue Code;

(d) as a contribution to the capital of a corporation under § 118?

(2) May a qualifying business defer, under § 1033, recognition of gain realized on receipt of a grant payment made under the state program?

FACTS

An area within state ST was affected by a disaster. To aid in the recovery of the area of ST affected by the disaster, ST enacted emergency legislation appropriating funds for grants to reimburse uncom

pensated losses that any qualifying business incurred due to damage to, or destruction of, real property and other tangible assets, including buildings, structures, fixtures, equipment, and inventory (collectively, the “eligible losses”) on account of the disaster.

The grants are available only if the qualifying business agrees to continue its operations for a minimum of 5 years in or near the area in ST affected by the disaster. Reimbursement of eligible losses is limited to the fair market value of the property just before the time of the loss and is reduced by any other reimbursement that the qualifying business received to compensate for the property losses. A qualifying business must submit an application to ST describing the nature, extent, and amount of the uncompensated eligible losses that the qualifying business incurred.

As a result of the disaster, X, a corporation, incurred $90,000 of uncompensated eligible losses for destruction of equipment used by X in its trade or business. The adjusted basis of the equipment was $10,000. X did not deduct the $10,000 loss for the destruction of the equipment on any federal income tax return. X submitted an application to ST for a grant to reimburse X for the uncompensated eligible losses. During X ’s subsequent taxable year, ST officials approved a $90,000 grant based on the destruction of X ’s property and paid the $90,000 to X .

Within the 2-year period prescribed by § 1033(a), X purchased for $150,000 (by using the entire grant proceeds of $90,000 plus $60,000 of other funds) equipment to replace the destroyed equipment. The replacement equipment was similar or related in service or in use to the destroyed equipment. X has used the replacement equipment in its trade or business since the time of the purchase. X elected under § 1033(a)(2)(A) to defer gain realized on the involuntary conversion of its equipment into money.

LAW AND ANALYSIS

Section 61(a) provides that, except as otherwise provided by law, gross income means all income from whatever source

derived. Under § 61, Congress intends to tax all gains or undeniable accessions to wealth, clearly realized, over which taxpayers have complete dominion. Commis- sioner v. Glenshaw Glass Co ., 348 U.S. 426 (1955), 1955–1 C.B. 207. The Internal Revenue Service has consistently concluded that payments to individuals by governmental units under legislatively provided social benefit programs for the promotion of the general welfare are not included in a recipient’s gross income (“general welfare exclusion”). See, e.g., Rev. Rul. 74–205, 1974–1 C.B. 20; Rev. Rul. 98–19, 1998–1 C.B. 840. To qualify under the general welfare exclusion, payments must (i) be made from a governmental fund, (ii) be for the promotion of the general welfare ( i.e., generally based on individual or family needs), and (iii) not represent compensation for services. Rev. Rul. 75–246, 1975–1 C.B. 24; Rev. Rul. 82–106, 1982–1 C.B. 16. Payments to businesses generally do not qualify under the general welfare exclusion because the payments are not based on individual or family needs. See Bailey v. Commissioner, 88 T.C. 1293, 1300–1301 (1987), acq ., 1989–2 C.B. 1; Rev. Rul. 76–131, 1976–1 C.B. 16; Notice 2003–18, 2003–1 C.B. 699. Section 102(a) provides that the value of property acquired by gift is excluded from gross income. Under § 102(a), a gift must proceed “from a ‘detached and disinterested generosity,’ ... ‘out of affection, respect, admiration, charity or like impulses.’” Commissioner v. Duberstein, 363 U.S. 278, 285 (1960), 1960–2 C.B. 428. On the other hand, payments that proceed “primarily from the ‘constraining force of any moral or legal duty’ or from ‘the incentive of anticipated benefit’ of an economic nature” are not gifts. Duberstein at 285. Governmental grants in response to a disaster (whether to a business or an individual) generally do not qualify as gifts because the government’s intent in making the payments proceeds from a government’s duty to relieve the hardship caused by the disaster. In addition, a government can expect an economic benefit from programs that relieve business or individual hardships. See Kroon v. United States,

2005–30 I.R.B. 120 July 25, 2005

It may not be compensation, such as a direct payment for a specific, quantifiable service provided for the transferor by the transferee;
It must be bargained for;
The asset transferred must foreseeably result in a benefit to the transferee in an amount commensurate with its value; and
The asset ordinarily, if not always, will be employed in or contribute to the production of additional income and its value will be assured in that respect.

Under § 362(c)(2), if money is received by a corporation as a contribution to capital, and is not contributed by a shareholder as such, then the basis of any property acquired with such money during the 12-month period beginning on the day the contribution is received shall be reduced by the amount of such contribution. The excess (if any) of the amount of such contribution over the amount of the reduction shall be applied to the reduction of the basis of any other property held by the taxpayer.

Section 165(a) allows a deduction for any loss sustained during the taxable year and not compensated for by insurance or otherwise. Section 165(b) limits the amount of the deduction for the loss to the adjusted basis of the property, as determined under § 1011. Section 1.165–1(d)(2)(iii) provides that if a taxpayer has deducted a loss and in a subsequent taxable year receives reimbursement for such loss, the amount of the reimbursement must be included in gross income for the taxable year in which received, subject to the provisions of § 111, relating to recovery of amounts previously deducted.

Section 1033(a) provides that if property, as a result of its destruction in whole or in part, is involuntarily converted into money, the gain, if any, is recognized except to the extent that the electing taxpayer, within 2 years after the close of the first taxable year in which any gain was realized (or at the close of such later date as may be designated pursuant to an application of the taxpayer under § 1033(a)(2)(B)(ii)), purchases other property similar or related in service or use to the property so converted (“qualified replacement property”). Under § 1033(a)(2), qualified replacement property is treated as purchased only if, but for the provisions of § 1033(b), its unadjusted basis would be

Civil No. A–90–71 (D. Alaska 1974), and Rev. Rul. 2003–12, 2003–1 C.B. 283.

Section 139(a) excludes from gross income any amount received by an individual as a qualified disaster relief payment. Section 139(b) provides, in part, that the term “qualified disaster relief payment” means any amount paid to or for the benefit of an individual —

(1) to reimburse or pay reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a qualified disaster (§ 139(b)(1));

(2) to reimburse or pay reasonable and necessary expenses incurred for the repair or rehabilitation of a personal residence, or repair or replacement of its contents, to the extent that the need for such repair, rehabilitation, or replacement is attributable to a qualified disaster (§ 139(b)(2)); or

(3) if such amount is paid by a federal, state, or local government, or agency or instrumentality thereof, in connection with a qualified disaster in order to promote the general welfare (§ 139(b)(4)). Thus, § 139(b)(4) codifies (but does not supplant) the administrative general welfare exclusion with respect to certain disaster relief payments to individuals.

Section 118(a) provides that, in the case of a corporation, gross income does not include any contribution to the capital of the taxpayer. Section 1.118–1 of the Income Tax Regulations provides that § 118 also applies to contributions to capital made by persons other than shareholders. For example, the exclusion applies to the value of land or other property contributed to a corporation by a governmental unit or by a civic group for the purpose of inducing the corporation to locate its business in a particular community, or for the purpose of enabling the corporation to expand its operating facilities. However, the exclusion does not apply to any money or property transferred to the corporation in consideration for goods or services rendered, or to subsidies paid for the purpose of inducing the taxpayer to limit production.

The Supreme Court of the United States has considered the contribution to capital concept. In Detroit Edison Co. v. Com- missioner, 319 U.S. 98 (1943), 1943 C.B. 1019, the Court held that payments by prospective customers to an electric utility company to cover the cost of extending the utility’s facilities to their homes were part of the price of service rather than con

tributions to capital. The case concerned customers’ payments to a utility company for the estimated cost of constructing service facilities that the utility company otherwise was not obligated to provide.

Later, the Court held that payments to a corporation by community groups to induce the location of a factory in their community represented a contribution to capital. Brown Shoe Co. v. Commissioner, 339 U.S. 583 (1950), 1950–1 C.B. 38. The Court concluded that the contributions made by the citizens were made without anticipation of any direct service or recompense, but rather with the expectation that the contributions would prove advantageous to the community at large. Brown Shoe Co . at 591. The contract entered into by the community groups and the corporation provided that in exchange for a contribution of land and cash, the corporation agreed to construct a factory, operate it for at least 10 years, and meet a minimum payroll. Brown Shoe Co. at 586.

Finally, in United States v. Chicago, B. & Q. R. Co ., 412 U.S. 401 (1973), 1973–2 C.B. 428, the Court, in determining whether a taxpayer was entitled to depreciate the cost of certain facilities that had been funded by the federal government, held that the governmental subsidies were not contributions to the taxpayer’s capital. The Court recognized that the holding in Detroit Edison Co . had been qualified by its decision in Brown Shoe Co . The Court in Chicago, B. & Q. R. Co . found that the distinguishing characteristic between those two cases was the differing purposes motivating the respective transfers. In Brown Shoe Co ., the only expectation of the contributors was that such contributions might prove advantageous to the community at large. Thus, in Brown Shoe Co ., because the transfers were made with the purpose, not of receiving direct service or recompense, but only of obtaining advantage for the general community, the result was a contribution to capital.

The Court in Chicago, B. & Q. R. Co . also stated that there were other characteristics of a nonshareholder contribution to capital implicit in Detroit Edison Co . and Brown Shoe Co . From these two cases, the Court distilled some of the characteristics of a nonshareholder contribution to capital under both the 1939 and 1954 Codes —

It must become a permanent part of the transferee’s working capital structure;

July 25, 2005 121 2005–30 I.R.B.

basis in the replacement equipment would equal $70,000 (excess of $150,000 cost of replacement property over $80,000 gain not recognized).

HOLDINGS

Under the facts of this ruling: (1) A grant that a qualifying business receives under a state’s program to reimburse losses that any qualifying business incurred for damage or destruction of real and personal property on account of a disaster is not excludable from gross income

(a) under the general welfare exclusion; (b) as a gift under § 102; (c) as a qualified disaster relief payment under § 139; or

(d) as a contribution to the capital of a corporation under § 118.

(2) A qualifying business that receives a grant payment under the state’s program to reimburse losses that the qualifying business incurred for damage or destruction of real and personal property may elect to defer including in income gain realized from receipt of the grant under § 1033 to the extent the grant proceeds (or other funds in lieu of the grant proceeds) are used to timely purchase property similar or related in service or use to the destroyed or damaged property.

DRAFTING INFORMATION

The principal author of this revenue ruling is Sheldon A. Iskow of the Office of Associate Chief Counsel (Income Tax and Accounting). For further information regarding this revenue ruling, contact Mr. Iskow at (202) 622–4920 (not a toll-free call).

Section 102.—Gifts and Inheritances

26 CFR 1.102–1: Gifts and inheritances.

A grant received by a business under a state program to reimburse businesses for losses incurred for damage or destruction of real and personal property on account of a disaster is not excludable from gross income as a gift under section 102 of the Code. See Rev. Rul. 2005-46, page 120.

determined under § 1012. In accordance with § 1033(a), the gain is recognized only to the extent that the amount realized upon such conversion exceeds the cost of the qualified replacement property.

Under § 61, X must include in gross income ST ’s $90,000 grant payment unless another provision of the Code excludes it from income or defers recognition of the income.

X may not exclude ST ’s $90,000 grant payment from gross income under the general welfare exclusion, because that exclusion is limited to individuals who receive governmental payments to help with their individual needs ( e.g., housing, education, and basic sustenance expenses).

X may not exclude the grant payment from gross income under § 102 because ST ’s intent in making the grant payments proceeds, not from charity or detached or disinterested generosity, but from the government’s duty to relieve the hardship resulting from the disaster and the economic benefits it anticipates from a revitalized economy in the area of ST affected by the disaster. See Kroon . ST did not enact the legislation authorizing the grant program for any donative purpose.

X may not exclude the grant payment from gross income under § 139 because that exclusion applies only to individuals. Even if X ’s business were a sole proprietorship or the disaster were a qualified disaster under § 139, the grant payments would not qualify for exclusion from gross income under § 139 because the grant payments are not made for any of the specific purposes described in § 139(b)(1), (2), and (4).

X may not exclude the $90,000 grant payment from gross income under § 118. The ST grant program compensates qualifying businesses for uncompensated eligible losses they incurred as a result of the disaster. Accordingly, these payments are more akin to insurance payments received for losses than contributions to capital of a corporation within the definition of § 118 and the case law. Because the $90,000 grant payment is not excludable from gross income under § 118, the basis of the replacement equipment purchased by X is not determined under § 362(c)(2).

Under § 61, X realizes gain of $80,000 ($90,000 grant proceeds received less $10,000 adjusted basis in the destroyed equipment). X must recognize the $80,000 gain unless X elects to defer recognition of the gain under § 1033.

X may defer including in income the entire $80,000 gain because X meets all of the requirements to defer the gain under § 1033. First, the grant payments are compensation for the involuntarily converted property. Second, X made the required election under § 1033 and, within 2 years after the close of the taxable year in which X received the ST grant payment, replaced the destroyed equipment with qualified replacement property, the basis of which would be determined under § 1012 if § 1033(b) did not apply. Third, the cost of the qualified replacement property ($150,000) exceeds the gain realized on the conversion of the destroyed equipment into money ($80,000). Amounts paid by X to repair damaged or destroyed property, including amounts paid for debris removal and other clean-up costs, are generally treated as amounts paid to purchase qualified replacement property.

X ’s basis in the replacement equipment is $70,000 ($150,000 cost of qualified replacement property less $80,000 unrecognized gain on the conversion of the destroyed equipment into money). See § 1033(b)(2).

The ST grant program reimburses uncompensated eligible losses incurred by any qualifying business. Therefore, the grant payments are treated as compensation received for such losses under § 165. If X had properly deducted the $10,000 adjusted basis of the equipment as a loss on a prior year federal income tax return, and the loss reduced the amount of X ’s tax in that year, then X would be required by § 111 and the tax benefit rule to include $10,000 of the $90,000 gain realized from the receipt of the ST grant in gross income, as ordinary income, on its federal income tax return for the year it received the grant. See § 1.165–1(d)(2)(iii). Under § 1033, X could defer including in income the remaining $80,000 of gain ($90,000 grant less $0 adjusted basis in the converted property less $10,000 recovery of the prior year deduction). In addition, X ’s

2005–30 I.R.B. 122 July 25, 2005

Section 118.—Contribu- tions to the Capital of a Corporation

26 CFR 1.118–1: Contributions to the capital of a corporation.

A grant received by a business under a state program to reimburse businesses for losses incurred for damage or destruction of real and personal property on account of a disaster is not excludable from gross income as a contribution to the capital of a corporation under section 118 of the Code. See Rev. Rul. 2005-46, page 120.

Section 139.—Disaster Relief Payments

A grant received by a business under a state program to reimburse businesses for losses incurred for damage or destruction of real and personal property on account of a disaster is not excludable from gross income as a qualified disaster relief payment under section 139 of the Code. See Rev. Rul. 2005-46, page 120.

Section 165.—Losses

26 CFR 1.165–1: Losses.

A taxpayer that deducted a loss under section 165 of the Code for damage or destruction of real and personal property on account of a disaster and that receives a grant under a state program to reimburse businesses for such losses may be required to include an amount in gross income. See Rev. Rul. 2005-46, page 120.

Section 472.—Last-in, First-out Inventories

26 CFR 1.472–1: Last-in, first-out inventories.

LIFO; price indexes; department stores. The May 2005 Bureau of Labor Statistics price indexes are accepted for use by department stores employing the retail inventory and last-in, first-out inventory methods for valuing inventories for tax years ended on, or with reference to, May 31, 2005.

Rev. Rul. 2005–45

The following Department Store Inventory Price Indexes for May 2005 were issued by the Bureau of Labor Statistics. The indexes are accepted by the Internal Revenue Service, under § 1.472–1(k) of the Income Tax Regulations and Rev. Proc. 86–46, 1986–2 C.B. 739, for appropriate application to inventories of department stores employing the retail inventory and last-in, first-out inventory methods for tax years ended on, or with reference to, May 31, 2005.

The Department Store Inventory Price Indexes are prepared on a national basis and include (a) 23 major groups of departments, (b) three special combinations of the major groups - soft goods, durable goods, and miscellaneous goods, and (c) a store total, which covers all departments, including some not listed separately, except for the following: candy, food, liquor, tobacco, and contract departments.

BUREAU OF LABOR STATISTICS, DEPARTMENT STORE INVENTORY PRICE INDEXES BY DEPARTMENT GROUPS

(January 1941 = 100, unless otherwise noted)

Groups May 2004 May 2005

Percent Change from May 2004

to May 2005 ¹

Piece Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 483.5 487.9 0.9
Domestics and Draperies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 542.2 533.8 -1.5
Women’s and Children’s Shoes . . . . . . . . . . . . . . . . . . . . . . . . . . . . 645.0 666.7 3.4
Men’s Shoes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 868.4 878.3 1.1
Infants’ Wear . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 575.6 572.5 -0.5
Women’s Underwear. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 512.2 544.1 6.2
Women’s Hosiery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 338.2 343.1 1.4
Women’s and Girls’ Accessories . . . . . . . . . . . . . . . . . . . . . . . . . . . 567.5 594.1 4.7
Women’s Outerwear and Girls’ Wear . . . . . . . . . . . . . . . . . . . . . . . 377.2 366.8 -2.8
Men’s Clothing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 548.4 563.9 2.8
Men’s Furnishings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 594.3 585.5 -1.5
Boys’ Clothing and Furnishings . . . . . . . . . . . . . . . . . . . . . . . . . . . . 445.2 431.0 -3.2
Jewelry. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 905.2 892.1 -1.4
Notions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 797.5 811.0 1.7
Toilet Articles and Drugs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1001.4 999.7 -0.2
Furniture and Bedding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 613.8 606.8 -1.1
Floor Coverings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 587.9 599.4 2.0
Housewares. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 714.8 716.6 0.3
Major Appliances. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 201.6 204.5 1.4
Radio and Television. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42.4 39.5 -6.8
Recreation and Education ² . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80.8 78.5 -2.8
Home Improvements ² . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129.1 136.5 5.7
Automotive Accessories ² . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112.1 114.6 2.2

Groups 1–15: Soft Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 570.1 568.3 -0.3 Groups 16–20: Durable Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 384.2 382.3 -0.5 Groups 21–23: Misc. Goods ² . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93.4 93.2 -0.2

July 25, 2005 123 2005–30 I.R.B.

BUREAU OF LABOR STATISTICS, DEPARTMENT STORE INVENTORY PRICE INDEXES BY DEPARTMENT GROUPS

(January 1941 = 100, unless otherwise noted)

Groups May 2004 May 2005

Percent Change from May 2004

to May 2005 ¹

Store Total ³ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 503.2 501.5 -0.3

1Absence of a minus sign before the percentage change in this column signifies a price increase. 2Indexes on a January 1986 = 100 base. 3The store total index covers all departments, including some not listed separately, except for the following: candy, food, liquor, tobacco and contract departments.

DRAFTING INFORMATION

The principal author of this revenue ruling is Michael Burkom of the Office of Associate Chief Counsel (Income Tax and Accounting). For further information regarding this revenue ruling, contact Mr. Burkom at (202) 622–7924 (not a toll-free call).

Section 1033.—Involuntary Conversions

26 CFR 1.1033(a)–1: Involuntary conversion; non- recognition of gain.

Under section 1033 of the Code, a taxpayer may elect to defer including in income gain realized from the receipt of a grant under a state program to reimburse businesses for losses incurred for damage or destruction of real and personal property on account of a disaster to the extent the grant proceeds are used to timely purchase property similar or related in service or use to the destroyed or damaged property. See Rev. Rul. 2005-46, page 120.

Section 6325.—Release of Lien or Discharge of Property

Discharge of property; refund action. This ruling clarifies that, in light of amendments to sections 6325 and 7426 of the Code made by the IRS Restructuring and Reform Act of 1998, a person not liable for the underlying tax may not file a refund action under the holding of United States v. Williams, 514 U.S. 527 (1995).

Rev. Rul. 2005–50

ISSUES

Whether a third party can maintain a refund action under section 1346(a)(1) of Title 28 in light of the 1998 amendments to sections 6325 and 7426 of the Internal Revenue Code (the Code)?
Whether a judicial remedy is available to a third party who seeks discharge of a federal tax lien under section 6325(b)(2) of the Code?

FACTS

Situation 1 : The Service filed a notice of federal tax lien in County A listing an amount due of $100,000 for taxes assessed against Taxpayer. Taxpayer and Taxpayer’s spouse, Person A, who is not liable for the tax assessed against Taxpayer, jointly own real property in County A. The real property is valued at $150,000. After the notice of lien was filed, Taxpayer deeded her interest in the property to Person A pursuant to a divorce decree. Person A sought a discharge of the tax lien from the property and was informed by the Service that the value of the interest of the United States was $100,000. Person A deposited $100,000 with the Service, and the Service issued a certificate of discharge under section 6325(b)(4). Person A then requested the return of $25,000 of the deposit, arguing that the tax lien attached only to Taxpayer’s 50% interest in the property. The Service disagreed and declined to return any portion of the deposit. Person A did not file suit under section 7426(a)(4) within 120 days after the

certificate of discharge was issued. Within 60 days after the 120-day period expired, the Service applied the $100,000 deposit to Taxpayer’s outstanding tax liability. Two hundred days after the certificate of discharge was issued, Person A filed an administrative claim for refund. The Service did not act on the claim and, six months later, Person A filed an action in district court pursuant to 28 U.S.C. § 1346(a)(1), seeking a refund of $25,000 of the deposited funds.

Situation 2 : Same as above, except instead of depositing funds under section 6325(b)(4), Person A waived his right to make a deposit under section 6325(b)(4) under applicable Service procedures. The Service determined that the value of the lien interest of the United States was $75,000 and Person A made a partial payment in that amount under section 6325(b)(2). The Service issued a certificate of discharge pursuant to section 6325(b)(2). Person A filed an administrative claim for refund 200 days after issuance of the certificate of discharge, challenging the Service’s determination of the value of the lien interest of the United States. The Service did not act on the administrative claim and, six months later, Person A filed an action in district court seeking a refund of the $75,000 payment.

LAW AND ANALYSIS

Section 6321 provides that if any person liable to pay any tax neglects or refuses to pay after notice and demand for payment, the amount due shall be a lien in favor of the United States on all property and rights to property, whether real or personal, belonging to that person. Sec

2005–30 I.R.B. 124 July 25, 2005

section 6325(b)(4). Wilson v. United States, 2004 WL 790220, at *2, 93 AFTR 2d 2004–1390 (E.D. Tenn. Feb. 24, 2004) (“On its face, 26 U.S.C. § 7426(a)(4) limits itself to permitting claims pursuant to 6325(b)(4).”). Courts lack subject matter jurisdiction over cases brought challenging the Service’s valuation determination if the certificate of discharge was sought under section 6325(b)(2), rather than section 6325(b)(4). Wilson, 2004 WL 790220, at *2.

HOLDINGS

Situation 1 . Person A cannot maintain a refund action under 28 U.S.C. § 1346(a). If a discharge is obtained under section 6325(b)(4), the owner of the property has 120 days after the date the certificate of discharge was issued to bring a judicial action under section 7426(a)(4). Person A did not file a timely suit under section 7426(a)(4), and no other action may be brought.

Situation 2 . Person A cannot maintain a refund action under 28 U.S.C. § 1346(a) or an action for substitution of value under section 7426(a)(4). A substitution of value action is available only to a third party who seeks a discharge and makes a deposit or furnishes a bond pursuant to section 6325(b)(4).

DRAFTING INFORMATION

The principal author of this revenue ruling is Deborah Grogan of the Office of Associate Chief Counsel (Procedure and Administration). For further information regarding this revenue ruling, contact Ms. Grogan at (202) 622–3610 (not a toll-free call).

Section 7426.—Civil Actions by Persons Other Than Taxpayers

A revenue ruling clarifies that, in light of amendments to sections 6325 and 7426 of the Code made by the IRS Restructuring and Reform Act of 1998, a person not liable for the underlying tax may not file a refund action. See Rev. Rul. 2005-50, page 124.

26 CFR 301.7426–1(a)(1): Wrongful levy.

Judicial remedy for wrongful levies. This ruling clarifies that a wrongful levy action under section 7426 of the Code is

tion 6322 provides that once the federal tax lien has arisen, it continues until the tax liability giving rise to the lien is paid or becomes unenforceable by reason of lapse of time. See I.R.C. § 6502 (collection after assessment). In order for the lien imposed by section 6321 to be valid against certain persons, notice must be filed by the Service in accordance with section 6323.

Section 6325(b) provides several procedures for discharging property subject to a lien imposed by section 6321. Under section 6325(b)(2)(A), the Service may issue a certificate of discharge pursuant to which the government is paid the value of its lien interest in the property to be discharged. Persons who request a certificate of discharge under section 6325(b)(2)(A) may not seek judicial review of the Service’s valuation determination through a refund action under 28 U.S.C. § 1346(a)(1). See City of Richmond v. United States, 348 F. Supp. 2d 807, 813–14 (E.D. Ky. 2004). Persons who request a certificate of discharge under section 6325(b)(2)(A) also may not seek judicial review of the Service’s valuation determination through an action for substitution of value under section 7426(a)(4).

A second discharge procedure is set forth in section 6325(b)(4), under which the owner of property subject to a federal tax lien (other than the person liable for the tax) has the right to obtain a discharge upon either depositing cash or furnishing a bond acceptable to the Service in the amount the Service has determined to be the value of the lien interest of the United States. I.R.C. § 6325(b)(4)(A). The Service must refund the amount deposited or release the bond, to the extent that it determines that the taxpayer’s unsatisfied liability giving rise to the lien can be satisfied from a source other than property owned (or owned in part) by the third party, or to the extent that it determines that the value of the interest of the United States in the property is less than the Service’s prior determination of value. I.R.C. § 6325(b)(4)(B). Any amount not used to satisfy the liability shall be refunded to the owner of the property. I.R.C. § 6325(b)(4)(C).

The owner of the property has 120 days after the date the certificate of discharge under section 6325(b)(4) is issued to file a substitution of value action in district court challenging the Service’s determina

tion of the value of the lien interest of the United States. I.R.C. § 7426(a)(4). If the owner of the property does not challenge the Service’s determination within the 120-day period, the Service shall, within 60 days after the expiration of the 120-day period, apply the amount deposited or collect on the bond to the extent necessary to satisfy the liability secured by the lien. If the owner successfully challenges the Service’s determination of the value of the lien interest of the United States, the court shall enter judgment ordering a refund of the amount deposited or a release of the bond to the extent that the amount of the deposit or bond exceeds the value of the lien interest determined by the court. I.R.C. § 7426(b)(5).

Sections 6325(b)(4) and 7426(a)(4) were enacted as part of the Internal Revenue Service Restructuring and Reform Act of 1998, Pub. L. No. 105–206, 112 Stat. 685, in response to the inadequate remedy problem identified by the Supreme Court in United States v. Williams, 514 U.S. 527 (1995). See S. Rep. No. 105–174, at 54–55 (1998), reprinted in 1998–3 C.B. 537, 590–91. In Williams, the Court held that a third party who paid another person’s tax liability under protest had standing to bring a refund action under 28 U.S.C. § 1346(a)(1). The Court noted that the third party “had no realistic alternative to payment of a tax she did not owe, and we do not believe that Congress intended to leave parties in respondent’s position without a remedy.” 514 U.S. at 529 (footnote omitted). Sections 6325(b)(4) and 7426(a)(4) provide the remedy that was unavailable to the third party in Williams . Section 7426(a)(4) specifically states that “[n]o other action may be brought by such person for such a determination.” Additionally, section 7426(a)(4) imposes a strict 120-day time limit for filing a substitution of value action in district court challenging the Service’s determination of value. Permitting a third party to bring another action, such as a refund suit, would conflict with the 120-day limit Congress imposed on actions brought under section 7426(a)(4). See City of Richmond, 348 F. Supp. 2d at 813–14.

The cause of action Congress provided in section 7426(a)(4) is limited to cases in which a third party has received a certificate of discharge from the Service under

July 25, 2005 125 2005–30 I.R.B.

Circuit, in Dahn, disagreed with WWSM and distinguished Williams as addressing only the unavailability of a wrongful levy or any other remedy to the third person whose property was encumbered by a federal tax lien. Dahn, 127 F.3d at 1253.

The Service agrees with and will follow the holding in Dahn that Williams should be limited to the unique facts of that case and did not overturn the established principle that section 7426 is the exclusive remedy in the case of a wrongful levy. The rationale in Williams is inapplicable to wrongful levy suits because Congress created an exclusive remedy under section 7426 for third persons claiming an interest in property levied upon by the Service. Moreover, because Congress has now provided a judicial remedy for third persons seeking to challenge the value of a federal tax lien encumbering their property, Williams would appear to have limited applicability. See City of Richmond v. United States, 348 F. Supp. 2d 807, 813–18 (E.D. Ky. 2004) (citing section 6325(b)(4) (third person may request a certificate of discharge in exchange for a deposit or bond) and section 7426(a)(4) (cause of action for third persons requesting certificate of discharge under section 6325(b)(4))); see also IRS Restructuring and Reform Act of 1998, Pub. L. No. 105–206, § 3106, 112 Stat. 685 (1998) (enacting section 6325(b)(4) and 7426(a)(4)).

HOLDING

Y’s only judicial remedy is to file a wrongful levy suit under section 7426(a). Because Y failed to file a wrongful levy suit within nine months from the date of the levy, the court lacks jurisdiction over Y’s suit.

DRAFTING INFORMATION

The principal author of this revenue ruling is Glenn Thomas of the Office of Associate Chief Counsel, Procedure and Administration (Collection, Bankruptcy & Summonses Division). For further information regarding this revenue ruling, contact Branch 1 of the Collection, Bankruptcy and Summonses Division at (202) 622–3610 (not a toll-free call).

the only remedy available to a third person whose property was levied to satisfy the tax debt of another.

Rev. Rul. 2005–49

ISSUE

Whether a wrongful levy suit is the only judicial remedy for a person asserting that its property was wrongfully levied upon by the Internal Revenue Service (the Service) to satisfy the tax debt of another?

FACTS

On June 1, 2002, the Service assessed taxes against X. The Service sent notice and demand for payment to X, who refused to pay. The Service discovers and identifies a bank account that it believes belongs to X, but that is held in the name of Y. Y is not liable for the taxes assessed against X. After providing notification of collection due process rights to X, on January 2, 2003, the Service served a levy on the bank requesting that it turn over all property belonging to X, including the account held in the name of Y. In response to the levy, the bank turned over to the Service cash from the account that was held in the name of Y. On October 15, 2003, Y filed an action in district court seeking a return of its property. In its complaint, Y asserted a wrongful levy claim under section 7426(a)(1) and, in the alternative, asserted a claim under 28 U.S.C. § 1346(a)(1) for refund of taxes erroneously or illegally collected.

LAW AND ANALYSIS

If a person liable to pay any tax fails to pay the tax after notice and demand for payment and notification of collection due process rights under section 6330, pursuant to section 6331, the Service may collect such tax by levy upon all property or rights to property belonging to such person. A person other than the person against whom the tax is assessed (a third person) claiming an interest in levied property may bring a wrongful levy suit under section 7426(a)(1). A third person also may file an administrative request under section 6343(b) and section 301.6343–2(b) of the

Regulations on Procedure and Administration for the return of property wrongfully levied upon. An administrative request under section 6343 is not a prerequisite to filing suit for wrongful levy under section 7426. Unless a timely administrative request for the return of wrongfully levied property is filed with the Service, “no suit or proceeding under section 7426 shall be begun after the expiration of 9 months from the date of the levy. . ..” I.R.C. § 6532(c)(1).

A taxpayer may file a civil action under 28 U.S.C. § 1346(a)(1) for the refund of taxes erroneously or illegally collected. Under section 7422(a), no suit for the recovery of taxes shall be made before an administrative claim for refund is filed with the Secretary in accordance with section 6511 and the regulations thereunder. No suit may be filed for six months after an administrative claim is filed, unless the Secretary acts earlier to deny the claim. In all events, no suit may be filed later than two years from the date the Secretary’s notice of disallowance of the claim is mailed. I.R.C. § 6532(a).

Courts have held that the exclusive judicial remedy for a third person claiming an interest in property levied upon by the Service is a wrongful levy suit under section 7426. See, e.g., Dahn v. United States, 127 F.3d 1249 (10th Cir. 1997); EC Term of Years Trust v. United States, 93 A.F.T.R.2d 2004–2005, 2004 WL 911307 (W.D. Tex. Apr. 23, 2004). The Ninth Circuit held to the contrary in WWSM In- vestors v. United States, 64 F.3d 456 (9th Cir. 1995). WWSM was, however, incorrectly decided. In WWSM, the Ninth Circuit held that a third person claiming an interest in property levied upon by the Service may file a refund suit after the nine-month limitations period for filing a wrongful levy suit has run. The court relied on United States v. Williams, 514 U.S. 527 (1995), which held that 28 U.S.C. § 1346(a)(1) permits a refund suit when a third person pays a tax under protest to discharge a tax lien from its property. The Supreme Court’s opinion in Williams was premised on a finding that in the absence of a refund suit, the third person would have no meaningful judicial remedy. The Tenth

2005–30 I.R.B. 126 July 25, 2005