Paresky– A Mirror Image of Pfizer

Today we welcome back Bob Probasco. Bob directs the Low-Income Taxpayer Clinic at Texas A&M University School of Law in Fort Worth. In this post Bob discusses the Paresky case in the Court of Federal Claims and follows up on issues he discussed in his post last month on the Pfizer case and the difficult issues arising from suits for overpayment interest. For good measure this terrific post sweeps in Bernie Madoff, equitable tolling and the possibility of some refund suits with no statutes of limitation.  Les

 I wrote a blog post recently on a jurisdictional issue in the Pfizer case, concerning claims for overpayment interest.  The district court for the Southern District of New York denied the government’s first motion to dismiss (based on lack of jurisdiction) but granted its second motion to dismiss (based on expiration of the statute of limitations).  Pfizer appealed and we’re still waiting to hear from the Second Circuit.

In the meantime, the Court of Federal Claims issued its decision on August 15th in the case Paresky v. United States, docket no. 17-1725, another suit for overpayment interest that involved essentially a mirror image of the jurisdiction issue in Pfizer. It also had some other interesting procedural twists and turns.

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Background

Here’s a recap of what the CFC called “[t]wo different, divergent, and conflicting jurisdictional paths . . . proffered by the parties.”  The first jurisdictional path is that set forth in 28 U.S.C. § 1346(a)(1)– district courts and the CFC have concurrent jurisdiction over

Any civil action against the United States for the recovery of any internal-revenue tax alleged to have been erroneously or illegally assessed or collected, or any penalty claimed to have been collected without authority or any sum alleged to have been excessive or in any manner wrongfully collected under the internal-revenue laws.

Let’s call this “tax refund jurisdiction,” because that is its primary use – although Pfizer argued about whether that is the only use.

The second jurisdictional path is “Tucker Act jurisdiction” – 28 U.S.C. § 1346(a)(2)for district courts and 28 U.S.C. § 1491(a)(1) for the CFC – which authorizes suits for

any claim against the United States . . . founded either upon the Constitution, or any Act of Congress or any regulation of an executive department, or upon any express or implied contract with the United States, or for liquidated or unliquidated damages in cases not sounding in tort.

What about statutes of limitation?  There is a general six-year statute of limitations for actions in federal courts – 28 U.S.C. § 2401 or 2501, for district courts and the CFC respectively. The Code also sets forth a statute of limitations.  Specifically, Section 7422 of the Code requires a refund claim be filed first for any suit

for the recovery of any internal revenue tax alleged to have been erroneously or illegally assessed or collected, or of any penalty claimed to have been collected without authority, or of any sum alleged to have been excessive or in any manner wrongfully collected.

And Section 6532 precludes a suit under Section 7422 begun more than 2 years after the IRS mails a notice of disallowance of the claim.

One might infer a link between the jurisdictional grant itself, for “tax refunds” or under the Tucker Act, and the corresponding statute of limitations.  That is, suits brought under the “tax refund” jurisdictional grant would be subject, based on similar language, to Code sections 7422 and 6532. Suits brought under the Tucker Act, however, would be subject to the general six-year statute of limitations for the district courts and the CFC.  However, the plaintiffs in both of these cases argued for a disconnect – either “tax refund” jurisdiction + the general six-year statute of limitations, or Tucker Act jurisdiction + the Code’s refund suit statute of limitations.  And there is actually a footnote in E.W. Scripps Co. v. United States, 420 F.3d 589 (6th Cir. 2005) stating that the similarity of the language in Section 7422 and 28 U.S.C. § 1346(a)(1) doesn’t necessarily mean they are interpreted the same way.

 (Some cases have applied both statutes of limitations to tax refund suits, so the statute of limitations doesn’t remain open indefinitely when the IRS doesn’t issue a notice of disallowance of the claim.  See, e.g., Wagenet v. United States, 104 A.F.T.R.2d (RIA) 2009-7804 (C.D. Cal.). The Court of Claims, on the other hand, held that the six-year statute of limitations doesn’t apply to tax refund suits and allowed a refund suit filed 2 years after the notice of disallowance, which wasn’t issued until 28 years after the original refund claim.  Detroit Trust v. United States, 131 Ct. Cl. 223 (1955).  The IRS agrees with the latter position.  Chief Counsel Notice 2012-012.  But we’re wandering far afield from the issues in Pfizer and Paresky.)

Pfizer– recap

Pfizer brought its suit in district court under tax refund jurisdiction.  Its issue revolved around whether a taxpayer is entitled to overpayment interest when: (a) the IRS issued a refund within 45 days of the claim (when overpayment interest is not required under the exception in Section 6611(e)), (b) the check was not received, and (c) a replacement check was issued more than 45 days after the refund claim.  Pfizer wanted to rely on a favorable Second Circuit precedent on this issue, so it wanted to file in the SDNY rather than the CFC, but Tucker Act jurisdiction for district courts is limited to claims for $10,000 or less.  Thus, Pfizer filed its suit asserting tax refund jurisdiction.

Because Pfizer filed its suit late under the Section 6532 statute of limitations, it argued that its “tax refund suit” was subject instead to the general six-year statute of limitations.  The SDNY agreed that suits for overpayment interest qualified for tax refund jurisdiction, following Scripps.  So the taxpayer won on the government’s first motion to dismiss. But the court concluded tax refund jurisdiction carries with it the Section 6532 statute of limitations.  So the taxpayer lost on the government’s second motion to dismiss.  On appeal, Pfizer continues to argue for tax refund jurisdiction + Tucker Act statute of limitations.

Enter the Pareskys

The Pareskys had a different problem.  They filed their suit in the CFC as a Tucker Act claim.  But in their case, the two-year statute of limitations in Section 6532 was still open although the six-year statute of limitations for Tucker Act claims was not.  Two years is less than six years, but the two different limitation periods began running at different times.  So the Pareskys argued that a Tucker Act claim was nevertheless subject to the statute of limitations for tax refund suits.  Again, they argued for one jurisdictional grant coupled with a statute of limitations apparently applicable to a different jurisdictional grant. As with Pfizer, but in reverse.

The Pareskys’ problems traced back to investments with Bernie Madoff.  They reported substantial income for 2005 through 2007 that turned out to be fictitious.  On their tax return for 2008, they claimed a net operating loss from the Ponzi scheme. Revenue Procedure 2009-20 provides an optional safe harbor method of treating losses from investments in fraudulent schemes. That method precludes double-dipping: taxpayers claim the entire loss in the year the fraud was discovered but cannot file amended returns to exclude the fictitious income (never received) that was reported in taxable years before the discovery year.

The Pareskys did not follow the optional Revenue Procedure method.  Instead, in October 2009, they filed amended returns on Forms 1040X for years 2005 – 2007, to exclude the fictitious income reported in those years. The claimed a loss on their 2008 tax return, when they discovered the fraud.  In December 2009, they filed Form 1045s, claiming tentative carryback refunds under Section 6411for years 2003 – 2007, by carrying back the net operating loss from 2008. But the net operating loss was reduced by the amount of the fictitious income for 2005 – 2007, so there was still no double-dipping.  The overpayment interest claim involves solely the tentative carryback refunds, not the refunds associated with the amended returns on Forms 1040X.

The refunds claimed on Forms 1045 for tentative carrybacks, totaling almost $10 million, were issued in April and May of 2010, just a few months after the Pareskys filed the Forms 1045 in December 2009.  The government paid no interest on those refunds, even though it issued the refunds more than 45 days after it received the Forms 1045, because it argued the applications were not in processible form when originally submitted.  The Pareskys, of course, disagreed.

The IRS examination of the Pareskys’ tax liabilities for 2003 through 2008, trigged by the amended returns, also included the refunds sought on the Forms 1045 as well as the Pareskys’ claim for overpayment interest on the Form 1045 refunds.  The examination continued until October 2011, during which time the parties agreed to an extension of the limitations period. In October 2011, the IRS began preparing a report to the Joint Committee on Taxation (JCT), required under Section 6405 for large refunds.  (Section 6405(a) prohibits the IRS from issuing such large refunds until 30 days after the IRS submits the report to JCT, but that restriction does not apply to refunds made under Section 6411.  Section 6411 provides for only a “limited examination” of the tentative carryback applications before issuing the refund.)  The IRS submitted the report to JCT on January 25, 2013, stating that the refunds sought on the Forms 1045 had been approved.

The Pareskys filed a protest with the IRS on June 6, 2014, concerning the resolution of the examination. Appeals determined, on September 4, 2014, that no overpayment interest was due on the Form 1045 refunds because the refunds were issued within 45 days after the applications were submitted in processible form.  That determination letter instructed the Pareskys to file a formal claim on Form 843 by September 12, 2014, which they did.  The claim was denied on September 24, 2015, and the Pareskys filed their complaint in the CFC on September 15, 2017.

Was it timely? 

The government argued that, under the Tucker Act, the claim accrued in May 2010 and the plaintiffs did not file suit within the six-year statute of limitations.  The plaintiffs asserted three alternative arguments.  First, they argued that the tax refund statute of limitations, rather than the six-year period applicable to Tucker Act claims, applied and began running when their claim was denied on September 24, 2015. Second, they argued that if the six-year limitations period applied, their claim didn’t accrue until the report to JCT on January 25, 2013.  Finally, they argued that under the “accrual suspension rule” the claim doesn’t accrue until the plaintiff is aware of the claim.  The court rejected all three arguments.

The Sixth Circuit in Scripps and the SDNY in the Pfizercase agreed that taxpayers could bring a suit for overpayment interest under the “tax refund jurisdiction” provision.  But the CFC didn’t buy that argument.  There were too many precedents in that court, the Federal Circuit, or the Court of Claims to the contrary.  The Federal Circuit might decide to overrule those, but the CFC would not.

The court also rejected the argument that the suit was filed within the six-year limitations period. The claim accrued when the underlying tax refunds were “scheduled.”  There was an evidentiary dispute regarding when the refunds had been scheduled; the Pareskys therefore argued that the date of the report to JCT was the earliest moment when it was certainthat the refunds had been allowed.  But the government pointed out that the report to JCT has nothing to do with the date a tentative carryback refund is allowed, and the court found the government’s evidence sufficient to establish that the refunds were scheduled in early 2010.

The accrual suspension rule didn’t save the Pareskys either.  The IRS may not have explicitly disclosed to the taxpayers the date that the refunds were scheduled, but they received the refunds and knew they did not include overpayment interest.  Those were the relevant facts that established their claim and the IRS did not conceal those.

Equitable tolling or estoppel?

In both Pfizer and Paresky, the IRS sent the taxpayers a letter stating a different statute of limitations than the court determined applied to their respective situations.  Appeals sent Pfizer a letter stating that the six-year statute of limitations applied, presumably because the claim involved overpayment interest, without addressing the impact of which jurisdictional grant Pfizer would rely on.  The Pareskys received the determination by Appeals concerning their protest and also a denial of their subsequent refund claim, both of which stated the Section 6532 statute of limitations, without addressing potential different treatment for claims involving overpayment interest.

That misinformation certainly seems to provide a potential factual predicate for equitable tolling or estoppel of filing deadlines, but many courts have been resistant to that.  Carl Smith and Keith Fogg are continuing their quest to overcome that resistance including by filing an amicus brief in Pfizer, which I am shamelessly paraphrasing for the following summary.

In brief, statutory deadlines that are “jurisdictional” cannot be waived or extended for equitable reasons.  Unfortunately, as the Supreme Court observed in 2004, courts have been careless in applying that label.  “Clarity would be facilitated if courts and litigants used the label ‘jurisdictional’ not for claim-processing rules, but only for prescriptions delineating the classes of cases (subject-matter jurisdiction) and the persons (personal jurisdiction) falling within a court’s adjudicatory authority.”  Kontrick v. Ryan, 540 U.S. 443, 455 (2004).  The Supreme Court has also held that time periods in which to act are almost never jurisdictional, unless Congress makes a “clear statement” to that effect.  In particular, if the filing deadline and the jurisdictional grant are not part of the same provision, that likely indicates that the time bar is non-jurisdictional. United States v. Wong, 135 S. Ct. 1625 (2015).

Carl and Keith are arguing in Pfizer that Section 6532’s statute of limitations is not jurisdictional and is subject to estoppel under the standard set forth in recent Supreme Court decisions.  The Supreme Court has never ruled on whether the Section 6532(a) deadline is jurisdictional or subject to estoppel or equitable tolling.  However, before the recent Supreme Court decisions, the Second Circuit applied estoppel to prevent the government from arguing that the filing deadline barred the court from hearing the case.  Miller v. United States, 500 F.2d 1007 (2nd Cir. 1974).  Although some other circuits had disagreed, the Second Circuit could rely on that precedent to estop the government in the Pfizer case.

Theoretically, the same result should apply to the six-year filing deadline in 28 U.S.C. § 2501. Alas, this argument would not work for the taxpayers in the Pareskycase.  The Supreme Court has not ruled on Section 6532’s deadline but it has ruled on 28 U.S.C. § 2501, and concluded that it was jurisdictional and therefore not subject to equitable tolling or estoppel. John R. Sand & Gravel Co. v. United States, 552 U.S. 130 (2008). However, that was more a matter of stare decisisbecause the Court had called the deadline jurisdictional in a number of opinions over decades.  In the Wongcase, the Court held that the FTCA filing deadline in 28 U.S.C. 2401(b) was non-jurisdictional and subject to equitable tolling, while observing that the John R. Sand & Gravel Co.did not follow the Court’s current thinking because of those precedents.

So – hopefully Carl and Keith will persuade the Second Circuit in Pfizer, as well as other courts in other cases.  The National Taxpayer Advocate also proposed, in her most recent annual report to Congress, a legislative fix by amending the Code to provide that judicial filing deadlines are non-jurisdictional.  We wish them well!

Where do we go from here?

The Court of Federal Claims agreed to transfer the case, at the plaintiffs’ request and over the government’s objections, so the Pareskys are headed to the Southern District of Florida. They hope to persuade the SDF that a suit for overpayment interest fits within “tax refund jurisdiction” and the suit therefore would be timely under the tax refund statute of limitations in Section 6532.  There is a split between the Federal Circuit and the Sixth Circuit – add the Second Circuit if it affirms the District Court in the Pfizer case.  Neither party cited precedents from the Eleventh Circuit, so it’s at least possible that the SDF will follow Scrippsand find it has jurisdiction.

Meanwhile, Pfizer is still waiting for a ruling by the Second Circuit.  Paresky offers arguments for both sides in PfizerParesky held that the six-year statute of limitations applies (good for Pfizer) but that tax refund jurisdiction is not available (bad for Pfizer).  Pfizer has requested, if the Second Circuit affirms the SDNY, that it also transfer the case to the CFC.  It seems that court would clearly have jurisdiction under the Tucker Act, and Pfizer met the six-year statute of limitations, so the CFC apparently would hear the merits of the case.  The favorable Doolin precedent in the Second Circuit wouldn’t carry as much weight in the CFC but Pfizer might still prevail on the merits.

The government stated in its brief that it may or may not oppose transfer, depending on whythe Second Circuit (hypothetically) rules against Pfizer.  If the Second Circuit rules that “tax refund jurisdiction” does not apply to suits for overpayment interest, the government would not oppose transfer.  But if the Second Circuit agrees that “tax refund jurisdiction” applies to the case and rules against Pfizer only on the basis that Pfizer did not file its suit within two years of the notice of disallowance, the government asked that transfer be denied.

Designated Orders: 7/23 to 7/27 Part Two

Patrick Thomas of Notre Dame Law School returns with Part Two of this week’s designated orders, focusing on the Coffey case, which as Patrick mentions was discussed in two recent guest blog posts by Kandyce Korotky and Joe DiRuzzo. Christine

Intent to “File” vs. Intent to File a “Return”: A Follow-up to the Court’s Divided Coffey Decision

Docket No. 4949-10, James Coffey v. C.I.R. (Order Here)

This latest (though likely not final) installment of the Coffey case comes on Respondent’s motion for reconsideration. Kandyce Korotky and Joe DiRuzzo have previously covered interesting aspects of the Court’s fractured decision in Coffey here and here.

Briefly, the January 2018 decision in this case holds that Petitioners filed returns with the Service when the United States Virgin Islands Bureau of Internal Revenue (VIBIR) electronically forwarded copies of the Petitioners’ 2003 and 2004 Forms 1040 to the IRS Philadelphia Service Center. Therefore, when the Service determined that the Coffeys were not bona fide residents of the U.S. Virgin Islands, the statute of limitations on assessment had already begun to run. When the Notice of Deficiency was issued to the Coffeys, the statute had expired.

As noted in Kandyce’s and Joe’s posts, the decision was highly fractured. Judge Holmes was assigned the case and issued the decision, which four other judges joined. Judge Thornton wrote an opinion concurring in the result only, which seven judges joined. Finally, Chief Judge Marvel wrote a dissent, which three judges joined. Under sections 7460(a), 7444(c), and 7459(a) & (b), Judge Holmes’ opinion was the opinion of the Court, because he was assigned the case. Yet, the majority of the Tax Court didn’t agree with the rationale of that opinion. Kandyce and Joe raise interesting questions regarding the precedential value of this opinion—and of Tax Court opinions in general.

Now, Respondent filed a motion for reconsideration of Judge Holmes’ opinion, which was—naturally—assigned to Judge Holmes for disposition. Rule 161 governs motions for reconsideration in the Tax Court, but provides nothing more than timing requirements. The Tax Court therefore adjudicates such motions pursuant to Federal Rule of Civil Procedure 60(b), which governs motions for reconsideration in federal court. Under FRCP 60(b), a court may “relieve a party . . . from a final judgment, order, or proceeding” primarily for issues affecting the propriety of the decision, such as newly discovered evidence or fraud. Courts have also granted motions to reconsider if the court “committed clear error or the initial decision was manifestly unjust.” See, e.g.School Dist. No. 1J v. ACands, Inc., 5. F3d 1255, 1263 (9th Cir. 1993).

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Respondent argues that Judge Holmes should reconsider the Court’s decision because the Court committed two “substantial errors.” First, the Court found Respondent conceded that a third party filing a taxpayer’s return—without more—wouldn’t affect whether a return was “filed” under section 6501. Second, the Court stated that it was undisputed that the Service actually processed the returns from VIBIR in Philadelphia. (This second issue involves whether VIBIR or the IRS stamped Petitioner’s return, but from Judge Holmes’ explanation, it doesn’t seem fairly in question that the IRS did so). From the context, I presume Respondent asked only for the Court to clarify its statements as to these two points—not to vacate or reverse the decision entirely.

Judge Holmes clarifies the statements, but not to the Service’s (or the dissent’s) favor. He finds that the Service did indeed concede the first point, based on Respondent’s statements during hearings, trial, and on the briefs. The subjective intent of a third party, Respondent said in a memorandum supporting a prior motion, informs not whether the return has been filed, but whether the document filed is a return (under the Beard test). Judge Holmes characterizes Respondent as trying to back away from this statement now, as the crux of the case turned on whether a return that VIBIR sent to the Service (but which the Coffeys didn’t intend to send to the Service) counts as “filed.” He notes that counsel conceded the point directly in an oral argument hypothetical on an (earlier) motion for reconsideration, but never corrected this concession.

Even if Respondent did concede the point, Judge Holmes still addresses whether the concession misstated the law. After all, the concession was central to the case, and the Court could have gotten the law wrong.

Interestingly, Judge Holmes responds here to Chief Judge Marvel’s finding in her dissent that a taxpayer must subjectively intend to file a return for the statute of limitations to run under section 6501. Under section 6501, she argues, a return only starts the statute if it is the “return required to be filed by the taxpayer.” Not by VIBIR or any other third party that isn’t duly authorized to act for the taxpayer.

Judge Holmes separates this into two concerns: one regarding a third-party filing, and another regarding a taxpayer’s subjective intent to file a return. He finds, in contrast, that sending a return to the IRS via a third party does not affect whether the return is “filed” for purposes of section 6501. Further, he finds that a taxpayer’s subjective intent is not required for a return to be filed under section 6501 (whether sent via a third party or otherwise). Judge Holmes views section 6501 more broadly, arguing that “6501(a) answers the question of whose return’s filing starts the statute of limitations running”, rather than who must intend to file the return. Specifically, he finds that section 6501(a)’s exclusion of information returns from the definition of “return” provides the context to support this conclusion.

On the third party issue, Judge Holmes cites Allnutt v. Commissioner, T.C. Memo. 2002-311 and Winnett v. Commissioner, 96 T.C. 802, 808 (1991). Judge Holmes argues that both cases show that a third party may file a return with the correct office of the IRS, even if this third party wasn’t the taxpayer’s agent and the returns were sent without the taxpayer’s knowledge. In Allnutt, the taxpayer sent the returns to the district counsel, rather than the district director; in Winnett, the returns were sent to the wrong service center.

I’m not sure I’m convinced that this distinction matters, as the taxpayer in these cases clearly intended the returns to be filed with the Service. But distinction or not, it does strain credulity to argue that a third-party cannot “file” a return for a taxpayer. The Good Samaritan hypothetical to which Judge Holmes refers is persuasive. One could think of other hypotheticals (e.g., the Not-So-Good Samaritan, who alters a lost tax return’s direct deposit information) that would, from a policy angle, cause concern with the Service processing a third party return. But such a return would clearly not be the taxpayer’s return—i.e., not the return the taxpayer intended to file.

Judge Holmes next directly addresses intent issue, which formed the core of Chief Judge Marvel’s dissent. He relies again on Allnutt and Winnett for the proposition that intent to file the returns is not necessary. I think he conflates again here the notion for subjective intent to file in a particular place within the IRS, and the intent to file a return with the IRS at all. Again, I don’t find this distinction necessary to his conclusion regarding a subjective intent to file.

Judge Holmes then suggests that the dissent and Respondent are themselves conflating the Beard test—and its requirement that the taxpayer intend a document to be his or her return—with this purported subjective intent to file requirement. Indeed, these are separate questions. Judge Holmes runs through a litany of cases, which Chief Judge Marvel citeed approvingly in her dissent. He characterizes these cases as similarly conflating the “filed” and “return” requirements of section 6501 as both requiring a subjective intent requirement. These cases include Berenbeim v. Commissioner, T.C. Memo. 1992-272, Alnutt, Friedmann v. Commissioner, T.C. Memo. 2001-207, Espinoza v. Commissioner, 78 T.C. 412 (1982), and Dingman v. Commissioner, T.C. Memo. 2011-116. In each of these cases, the Court referenced some notion of a taxpayer’s intent to file a return, which Chief Judge Marvel uses in her dissent to support her argument that some intent to file requirement must exist. Judge Holmes dismisses all as either conflating the intent for a document to be a “return” under Beard, as dicta, or otherwise as not supporting an “intent to file” requirement.

Because Judge Holmes finds that the Court committed no substantial errors, he denies the motion for reconsideration.

Putting aside the very interesting merits of the intent to file requirement, this case nicely crystalizes the many problems with the designated order process, the Court’s aversion to formal opinions, and the precedential value of Tax Court’s opinions. I’ll be writing about this issue in future work.

Briefly stated, while I tend to agree with Judge Holmes on the merits, I find it problematic that Judge Holmes alone controlled the disposition of this motion, given the fractured nature of the underlying opinion. Because a single judge may independently “designate” an order, Judge Holmes could ensure that practitioners see this analysis (and did). However, designated orders can potentially serve to dispose of cases without the collaboration of other judges. Against the precedential background of division opinions, this would seem to relegate some difficult issues to non-precedential orders alone, without the benefit of the full court’s analysis.

I am further troubled that Judge Marvel could not consider Judge Holmes’ responses to her arguments in constructing her dissent. It is common practice in the Supreme Court to review competing drafts, such that the justices may respond to opposing concerns. Sometimes, this process can change the opinions of those on the other side. Presumably, Judge Marvel will not be able to respond formally to Judge Holmes’ contradiction of her arguments. This practice seems incongruous with a reflective judiciary.

None of this is to say that Judge Holmes deserves blame for this result. Indeed, the case is assigned to him, and under applicable Tax Court rules, he is charged with responding to any motions. Further, given the number of cases and importance of the Tax Court to tax compliance, reasons of judicial economy may favor case disposition by individual judges. But the Tax Court must balance judicial economy with the transparency and collaborative decision-making that the opinion process better enables.

Designated Orders: 7/23 to 7/27 Part One

Patrick Thomas from Notre Dame Law School brings us this week’s designated orders in three parts. After a few lean Designated Order weeks we have an abundance of issues to discuss. Part One begins with a sad case where a disabled taxpayer’s conservator failed to file tax returns for her ward and also apparently failed to adequately assist the taxpayer’s counsel in the CDP hearing. We then take a sharp, brief detour into TEFRA issues. Christine

The Tax Court (primarily Judges Holmes and Gustafson) issued 17 separate designated orders this week, which must at least approach a record number for the period we’ve been reviewing these orders.

Not discussed here are a routine bench opinion from Judge Buch and a couple “Chai ghouls” from Judge Holmes. In one such case, Brown v. Commissioner, the IRS continues to press the argument Caleb noted last week, that penalty approval forms are non-hearsay as statements introduced not for their truth, but for their independent legal significance. Another case from Judge Gustafson involved the six-year statute of limitations for gross omissions of income.

Finally, William Schmidt will be blogging separately about Judge Jacobs’ “order” (in my view, this should read “opinion”) in Taylor v. Commissioner, which grants a default judgment in a deficiency case. Significantly, it upholds a civil fraud penalty and the 10 year EITC ban under IRC § 32(k) without much discussion of the substance for either, or the thorny jurisdictional issues of the latter.

Unconcerned Conservator Provides No Disability Defense in CDP

Docket No. 23949-13L, Iannello v. C.I.R. (Order Here)

This petitioner is permanently and totally disabled, but had a conservator, his mother, appointed under state law. In such situations, the conservator steps into the shoes of the individual for all legal purposes—including the filing and payment of the individual’s federal income taxes.

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The conservator’s failure to file petitioner’s 2008 tax return resulted in a substitute-for-return assessment, which eventually resulted in a notice of intent to levy and a CDP appeal, requesting a collection alternative. At the time, petitioner also had liabilities for 2003 and 2004, and hadn’t filed a tax return from 2003 through 2011. In March 2013, the settlement officer (SO) faxed petitioner’s counsel transcripts to complete the unfiled returns, and later rescheduled the May 2013 CDP hearing when counsel requested additional time. At the June hearing, the Form 433-A and delinquent returns were unprepared. The SO gave counsel yet more time, eventually resulting in unsigned, draft returns in August. After still not receiving the requested information, the SO issued a Notice of Determination (NOD) in September, upholding the levy. A few weeks thereafter, counsel finally sent the signed returns to the SO; the 2008 liability was thereby partially abated.

Counsel filed a petition challenging the NOD, primarily arguing that the NOD didn’t note that petitioner was disabled; further, it was difficult to work with the conservator, who traveled during the summer. The petition also noted that the 2008 return should have reduced the SFR assessment. For a time, it seemed that the parties would settle, but eventually Respondent filed a motion for summary judgment.

Judge Holmes finds first that the underlying liability is not at issue, and that therefore, the proper standard of review is abuse of discretion. While the petition focuses on 2008, the Service has now accepted the 2008 return and reduced the liability accordingly. So, there’s no dispute regarding this year.

Moreover, Judge Holmes notes that this issue wasn’t raised in the CDP hearing itself—only afterwards. He cites 26 C.F.R. § 301.6330-1(f)(2), Q&A-F3, which notes that “an issue is not properly raised . . . if consideration is requested but the taxpayer fails to present Appeals with any evidence with respect to that issue after being given a reasonable opportunity to present such evidence.” (emphasis added). While counsel submitted unsigned draft returns for 2008, “those were simply not enough” for Judge Holmes, who cites Beard v. Commissioner for this proposition. I’m not sure I’d agree with the notion that submitting unsigned draft returns is insufficient to raise a liability challenge in a CDP hearing. Does Judge Holmes mean to say that such returns constitute “[no] evidence”? It seems to me there’s a wide distance between the application of the failure to file penalties in Beard and whether an issue is properly raised in an administrative proceeding.

It doesn’t appear that this issue was sufficiently briefed. Petitioner may also have had a “prior opportunity” problem in raising the underlying liability (did he or his conservator receive the 2008 Notice of Deficiency?). And in any case, the Service did adjust 2008 as requested. So Judge Holmes is ultimately correct on the standard of review here (though I am puzzled why the decision does not stick to what seems to me the clearest rationale for upholding Appeals’ determination).

Judge Holmes determined that Appeals didn’t abuse its discretion, even though petitioner’s disability status wasn’t noted in the Notice of Determination. Clearly, the SO considered the disability status and presence of a conservator, as she noted these circumstances in the case file. She also gave counsel a great deal of additional time in preparing the requested returns and financials. After six months from the originally scheduled hearing, she upheld the levy when these documents weren’t forthcoming. Judge Holmes therefore upholds Appeals’ decision and allows the Service to proceed with collection.

An Overview of Partner Assessment & Collection Procedure under TEFRA

Docket No. 23411-14, Freedman v. C.I.R. (Order Here)

In Freedman, Judge Halpern nicely sets forth the assessment and collection procedures against individual partners stemming from partnership-level adjustments under TEFRA.

Freedman was the sole member of an LLC, and the grantor and sole beneficiary of a trust, which held all of the interests in the partnership Pinnacle Trading Opportunities. The Service previously adjusted Pinnacle’s tax return for 1999, which resulted in a Tax Court decision under docket number 19291-05. In that case, the Court decided to disregard Pinnacle as a partnership; it also found under section 183 that Mr. Freedman did not have a profit motive for Pinnacle’s transactions. The Court also reduced Mr. Freedman’s capital contributions to $0, disallowed foreign currency trading losses, and disallowed other deductions. Finally, the Court applied a 40% gross valuation misstatement penalty under section 6662.

Following that case, which concluded in 2013, the Service issued a Notice of Deficiency to Mr. Freedman individually. This Notice mirrored the adjustments for the partnership, given that Mr. Freedman was the only person involved in the partnership.  Critically, the Notice also applied the 40% gross valuation misstatement penalty. Mr. Freedman petitioned the Tax Court.

Respondent filed a motion to dismiss for lack of jurisdiction, essentially arguing that all the adjustments in this Notice were adjudicated in the prior proceeding. Under TEFRA, tax items related to a partnerships are adjusted in a partnership-level proceeding; under section 6225(a), no collection is permitted against the partners until that proceeding is concluded.

After that proceeding is concluded, however, the Service may immediately assess and collect tax against individual partners in some circumstances. Under section 6230(a)(1), the Service need not resort to individual deficiency procedures if no partner-level determinations are necessary to calculate the resulting tax due; that is, if a tax adjustment results from mere “computational adjustments” under section 6231(a)(6). For example, if a partnership-item adjustment increases an individual taxpayer’s adjusted gross income, this may result in a reduced medical expense deduction because of the 10% AGI floor. If further determinations are necessary to calculate the partner’s liability resulting from “affected items” from the partnership-level determination—for example, a partner’s basis in a partnership—the Service must follow deficiency procedures.

Penalties are also generally calculated at the partnership level under TEFRA under section 6221, and may be assessed and collected against the partner without further deficiency procedures under section 6230(a)(2)(A)(I). This makes challenging penalties difficult if any partner-level defenses exist; partners are relegated to refund suits in these cases.

In Freedman, petitioner generally insists that the Court must determine Mr. Freedman’s outside basis in the partnership, and as such, the Service had to resort to deficiency procedures to assess tax against him individually. Among the multiple substantive adjustments, the Court finds that an outside basis calculation—while an “affected item” from any partnership proceeding—simply isn’t relevant to the calculation of Mr. Freedman’s individual tax liability. For example, the Court determined that Pinnacle’s allowable foreign currency trading losses and interest expenses were $0; it also determined that Pinnacle had no profit motive. As such, the Court agrees with Respondent that it has no jurisdiction to entertain these items, and partially grants Respondent’s motion as to these adjustments.

Regarding the penalty, Mr. Freedman sticks with his insistence on outside basis, arguing that any penalty resulting from an outside basis adjustment can be properly adjudicated in this forum. He concedes that any penalties resulting from partnership-level adjustments aren’t properly contestable here.

Again, Judge Halpern finds that outside basis simply doesn’t enter into it. The penalty here was entirely based on partnership-level items—specifically, the contributions to the partnership. So the Court lacks jurisdiction as to that portion of the penalty.

But Judge Halpern also finds that the prior case’s penalties weren’t based on the adjustments to interest expenses or foreign currency trading losses. To the extent the Service calculated a penalty on these items, Mr. Freedman can raise partner-level defenses in this deficiency proceeding.

American Institute of Certified Public Accountants v. Internal Revenue Service  —  A Contrary Perspective

Last week we discussed the IRS victory in AICPA v IRS. Today we welcome back guest blogger Stu Bassin who offers a different take on the case and critiques the underlying merits of IRS oversight over unenrolled preparers.  Les

The D.C. Circuit’s recent decision in AICPA v. Internal Revenue Service  allowed the Service to continue its voluntary Annual Filing Season Program—a program which grants unlicensed tax return preparers with limited rights to represent taxpayers during audits if they satisfy continuing professional education requirements and pass a competency examination.  In a recent post, Professor Book heralded the decision as a “major victory” for the Service and urged Congress to enact legislation providing the Service with greater authority to regulate unregistered return preparers.  I offer a different perspective.

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First, some background. About ten years ago, the Service responded to concerns that incompetent and unscrupulous tax return preparers were taking advantage of taxpayers and producing a disproportionate number of “problem” tax returns.  It  promulgated rules which required all return preparers who are compensated for preparing returns (e.g., attorneys, accountants, and unlicensed preparers) to qualify for and obtain Preparer Tax Identification Numbers (PTINs).  The regulations required preparers to pass a competency examination and complete required continuing professional education as a condition to obtaining a PTIN, although other provisions of the regulations largely exempted attorneys and CPAs from these requirements.

Unlicensed preparers, concerned that the new requirements would increase their cost of operating and possibly put them out of business, filed suit challenging the Service’s authority to regulate preparers who did nothing more than prepare returns [Personal aside. My father was a part-time unlicensed preparer who provided excellent service to taxpayers and used the fees he earned to pay for his children’s college education.  He gave up his practice when he learned of the additional costs and burdens that the new requirements would impose].  In Loving v. Internal Revenue Service, the D.C. Circuit ruled that the Service did not have statutory authority to regulate preparers whose activities were limited to preparing returns for other taxpayers.  In subsequent years, the Service has sought legislation providing it with authority to regulate these unlicensed preparers, although Congress has not granted the Service the requested regulatory authority.

The Service developed its Annual Filing Season Program in response to Loving, offering unlicensed preparers the opportunity to obtain a certificate of completion and limited rights to represent taxpayers during audits if they completed the continuing education requirements and passed the competency examination.  The program is voluntary—unlicensed preparers can continue to prepare returns without participating in the program–although the Service has made substantial efforts to sell the program to unlicensed preparers.   The most recent data suggests that relatively few of the unlicensed return preparers have elected to participate in the program.

Almost from the outset, the AICPA challenged the legality of the program.  After extensive wrangling over standing issues and two trips to the court of appeals, the D.C. Circuit upheld the validity of the program.  The key to the court’s ruling was its characterization of the program as voluntary and, therefore, not subject to the legal analysis developed in Loving.   This post does not address the legal merits of the ruling, but instead focuses upon the contentions of Professor Book and others that the result should be applauded from a policy perspective and that the experience with the Annual Filing Season Program demonstrates that Congress should grant the Service authority to regulate unlicensed preparers.

My analysis begins by accepting the proposition that policies which protect the public from unethical and incompetent preparers by putting them out of business should be applauded. But, has the voluntary Annual Filing Season Program contributed to that effort?  Less than 15% of the unlicensed preparers volunteered to fulfill the education requirements and take the competency examination required by the program. Presumably, these were primarily the most competent, ethical, and professional unlicensed preparers in the marketplace.  Conversely, the Service’s voluntary program did nothing to prevent the unethical and incompetent (along with the “ghost” preparers who prepare returns but do not sign the return as a paid preparer) from continuing to practice as they have in the past.  Ultimately, the question arises is whether the chronically understaffed Service has obtained a significant improvement in the quality and honesty of the preparer community from the resources it has invested in the voluntary program.

A recent report of the Treasury Inspector General for Tax Administration (TIGTA) provides disturbing evidence that the Service has misdirected its resources. The report began by summarizing the surprisingly wide array of penalties and other tools currently available to the Service to police preparer misconduct.  Notwithstanding these tools, TIGTA found—

  •  More than 1.3 million PTINs have been issued, most without any investigation of whether the applicant had a criminal background, a history of defrauding taxpayers, or any record of identity theft.  Once a PTIN is issued, it is only revoked if the holder is incarcerated or legally enjoined from return preparation.
  • More than 26,000 applicants for PTINs stated on their PTIN applications that they were not in compliance with their tax obligations.  The Service has taken no action to closely monitor the conduct of those preparers.
  • During Processing Year 2016, 72,590 preparers with inactive PTINs filed 2.7 million returns, yet the Service assessed penalties against 215 of these preparers.
  • The Service identified 4200 leads during one quarter relating to “ghost preparers” who prepared returns for compensation, but did not sign the returns.  In prior years, the Return Preparer Office referred an average of less than 65 cases for examination.
  • During calendar years 2012-2015, the Service collected only 15 percent of the penalties assessed against individual return preparers.
  • The Service did not identify a single instance where a return preparer audit was instigated based upon an issue which arose through the Annual Filing Season Program.

Interestingly, most of TIGTA’s recommendations concerned basic steps that the Service should have taken years ago to enforce of existing laws to police dishonest preparers, but had failed to take.

The basic question arising from this data is whether the Service’s Annual Filing Season Program has represented a wise investment of the Service’s scarce resources.  We know that the vast majority of the return preparers in the marketplace are honest and competent, yet the Service’s Annual Filing Season Program focuses on them, burdens them with added paperwork filing requirements, and expends a substantial amount of the Service’s resources in administering a program directed at honest and competent preparers.  The program, however, does not require dishonest and incompetent preparers to participate, take the continuing education courses, or pass the competency examination.  Indeed, it appears that the Service does little to enforce existing laws which could be employed to put dishonest preparers out of business.  More startling, as TIGTA reported, even when the data currently collected by the Service identified preparers filing returns using inactive PTINs or as ghosts, the Service rarely proceeded with investigations or other action against these miscreants.  And, the Service cannot excuse this inaction based upon the lack of resources—the Return Preparer Office alone employs nearly 200 employees. Rather, those resources are being directed toward administering an Annual Filing Season Program focused upon collecting forms from honest preparers.

All of this brings us back to the basic question of whether the Service should be granted more regulatory authority over unregistered preparers.  While Professor Book says it should, I believe that new legislation and expanded regulatory authority is the wrong idea.  All agree that the principal problem is dishonest and incompetent return preparers. The record developed by TIGTA shows that the Service focuses its efforts on collecting forms and data from honest preparers who choose to participate in the Annual Filing Season Program.  It does little, however, to enforce the rules already on the books to police miscreants by investigating preparers it already knows are using inactive PTINs or have their own unpaid tax liabilities. Increasing the Service’s authority to impose additional requirements upon return preparers will not alter the conduct of these wrongdoers.  Unfortunately, it seems that they will continue to flout any new rules (and the existing rules) with little risk that the Service will act against them.

In sum, I believe that giving the Service additional statutory authority to regulate several hundred thousand more unregistered preparers is a bad idea.  Additional regulatory authority will impose substantial compliance burdens and costs upon reputable preparers while devoting more of the Service’s resources to managing even more forms and data relating to honest preparers.  Yet, the Service does not employ the data and legal authority it currently has to identify and weed out wrongdoers.  Expanding its regulatory authority over unregistered preparers will channel more of the Service’s resources into managing regulation of the honest, not using existing law to address misconduct by the disreputable, inept, and unethical. That is hardly good public policy.  Rather, the orientation of the Service and the Congress should be to devoting the Service’s resources to aggressive enforcement of the existing rules against the unethical and incompetent.  That is the better route to removing the bad apples from the system.

Designated Orders 7/16 – 7/20

Caleb Smith from the University of Minnesota brings us this week’s designated orders. The parade of orders involving Graev continues and Professor Smith explains the evidentiary issues present when the IRS seeks to enter the necessary approval form after reopening the Tax Court record. Professor Smith also provides advice, based on another order entered this week, on how to frame your CDP case. A non-procedural matter that might be of interest to some readers is ABA Resolution 102A passed this week, urging Congress to repeal the repeal of the alimony deduction. For those interested in this issue, the resolution contains much background on the deduction.  Keith

Submitting Evidence of Supervisory Approval Post-Graev III

Last week, William Schmidt covered three designated orders that dealt with motions to reopen the record to submit evidence of supervisory approval under IRC 6751. I keep waiting for this particular strain of post-Graev III clean-up to cease, but to no avail: the week of July 16 two more designated orders on issues of reopening the record were issued. Luckily, there are important lessons that can be gleaned from some of these orders on issues that have nothing to do with reopening the record (something that post-Graev III cases shouldn’t have to worry about). Rather, these cases are helpful on the evidentiary issues of getting supervisory approval forms into the record in the first place.

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Choosing the Right Hearsay “Exception” Fakiris v. C.I.R., dkt. # 18292-12 (here)

In Fakiris, the IRS was once again confronted with the issues of (1) reopening the record to get supervisory approval forms into it, and (2) objections to those forms on hearsay grounds. At the outset (for those paying attention to docket numbers), one may be forgiven for wondering how it is even possible that this case was not decided well before Graev III. The briefing in Fakiris was completed in August, 2014 with no apparent court action until June, 2017. Judge Gale walks us through the procedural milestones in a footnote: although a decision was entered for the IRS about a year ago in T.C. Memo. 2017-126, the IRS filed a motion to vacate or revise (surprisingly, since they appear to have won on all fronts). The decision that the IRS sought to vacate includes a footnote (FN 20) providing that because petitioner did not raise a 6751 issue, it is deemed conceded. At the time, there was some uncertainty about whether the taxpayer had to affirmatively raise the issue, or whether it was a part of the IRS’s burden of production under Higbee. See earlier post from Carl Smith.

In any event, and no matter how old the case may be, it is still before the Court and the record must still be reopened for the IRS to succeed on the IRC 6751 issue. After the usual explanation of why it is proper for the Court to exercise its discretion to reopen the record, we arrive at the evidentiary issue: isn’t a supervisory approval form hearsay? At least so objects petitioner.

Where petitioners object to IRS supervisory approval forms as “hearsay” it appears to be the standard operating procedure of IRS counsel to argue the “business records” exception (see FRE 803(b)). Generally, the IRS prevails on this theory, but this theory creates potentially needless pitfalls. Fakiris demonstrates those pitfalls, noting that under the business record exception the IRS has certain foundational requirements it must meet “either by certification, see 902(11), Fed. R. Evid. [here], or through the testimony of the custodian or another qualified witness, see Rule 803(6)(D), Fed. R. Evid.” Without that foundation, the business records exception cannot hold -and indeed, in Fakiris the IRS lacks this foundation and is left spending more time and resources to go back and build it as their proffered evidence is excluded from the record.

So how does one avoid the time-consuming, perilous path of the “business exception?” Judge Gale drops a rather large hint in footnote 9: “We note that Exhibits A and B [the actual penalty approval forms] might also constitute “verbal acts”, i.e., a category of statements excluded from hearsay because ‘the statement itself affects the legal rights of the parties or is a circumstance bearing on conduct affecting their rights.’” If it is a “verbal act” it is categorically not hearsay (and not an “exception” to the hearsay rule). I have made exactly this argument before, although I referred to verbal act as “independent legal significance.” I am surprised that the IRS does not uniformly advanced this argument. In the instances that the IRS used it, the IRS has prevailed (as covered in the designated orders of the previous week). Judge Gale also refers to the advisory committee’s note to bolster the argument that the supervisory approval form is not hearsay: “If the significance of an offered statement lies solely in the fact that it was made, no issue is raised as to the truth of anything asserted, and the statement is not hearsay.” Advisory Committee Note on FRE 801(c) [here]. To me, that is what appears to be happening here. The IRS is simply trying to prove that a statement was made (i.e. a supervisor said “I approve of this penalty.”) The penalty approval form is that statement. It is absurd to think that the form is being offered for any other purpose (e.g. as evidence that the taxpayer actually was negligent, etc.).

If you don’t believe me (or Judge Gale), perhaps Judge Holmes will change your mind? In a designated order covered last week in Baca v. C.I.R., the IRS prevails on a theory that the supervisory approval form is a verbal act, without relying on the business exception. In reaching that determination, Judge Holmes references not only the FRE advisory committee note on point, but also Gen. Tire of Miami Beach, Inc. v. NLRB, 332 F.2d 58 (5th Cir. 1964) providing that a statement is a nonhearsay verbal act if “inquiry is not the truth of the words said, merely whether they were said.”

If you just aren’t sold on the “verbal acts” argument, Judge Gale’s Footnote 9 has yet more to offer. As a second possible avenue for getting the penalty approval form into evidence, Judge Gale suggests the public records exception of FRE 803(8). This exception to hearsay requires proper certification, but apparently has been successfully used by the IRS in the past with Form 4340 (See U.S. v. Dickert, 635 F. App’x 844 (11th Cir. 2016)).

All of this is to say, I think the IRS has ample grounds for getting the supervisory approval form properly into evidence. For petitioners, though it is likely a losing argument, if there are actual evidentiary concerns you must be sure to properly raise those objections -even if in the stipulation of facts. A second designated order issued the same week as Fakiris (found here) does not even get to the question of whether the forms are hearsay after reopening the record -presumably because the objections were never raised (the docket does not show a response by petitioner to the IRS’s motion to reopen the record).

Setting Yourself Up for Favorable Judicial Review on CDP Cases: Jackson v. C.I.R., dkt. # 16854-17SL (here)

Taxpayers that are unable to reach an agreement with the IRS on collection alternatives at a Collection Due Process (CDP) hearing generally have an uphill battle to get where they want to go. Yes, they can get Tax Court review of the IRS determination, but that review is under a fairly vague “abuse of discretion” standard. Still, there are things that petitioners can do to better situate themselves for that review.

At an ABA Tax Section meeting years ago, a practitioner recommended memorializing almost everything that is discussed in letters to IRS Appeals. Since the jurisdiction I practice in is subject to the Robinette “admin record rule,” it is especially important to get as much as possible into the record. Conversely, one may argue that the record is so undeveloped that it should be remanded because there is nothing for the Court to even review: see e.g. Wadleigh v. C.I.R., 134 T.C. 280 (2010). The order in Jackson provides another lesson: how to frame the issue before the Court.

In Jackson, the taxpayers owed roughly $45,000 for 2012 – 2015 taxes due to underwithholding. After receiving a Notice of Intent to Levy, the Jacksons timely requested a CDP hearing, checking the boxes for “Offer in Compromise,” “I Cannot Pay Balance,” and “Installment Agreement” on their submitted Form 12153. Over the course of the hearing, however, the only real issue that was discussed was an installment agreement -albeit, a “partial pay” installment agreement (PPIA). A PPIA is essentially an installment agreement with terms that will not fully pay the liability before the collection statute expiration date (CSED) occurs.

Obviously, the IRS is less inclined to accept a PPIA than a normal installment agreement, because a PPIA basically agrees to forgive a part of the liability by operation of the CSED. Sensibly, IRS Appeals required a Form 433-A from the Jacksons to determine if a PPIA made sense.

The Form 433-A submitted by the Jacksons appears to have pushed the envelope a bit. Most notably, the Jacksons claimed $740 for monthly phone and TV expenses (the ultra-deluxe HBO package?) and $629 per month in (voluntary) retirement contributions as necessary expenses. The settlement officer downwardly adjusted both of these figures (and possibly others) pursuant to the applicable IRM, and determined that the Jacksons could afford to pay much more than the $300/month they were offering. Going slightly above and beyond, the settlement officer proposed an “expanded” installment agreement (i.e. one that goes beyond the typical 72 months) of $1,100 per month. The Jackson’s rejected this, but appear to have proposed nothing in its stead. Accordingly, the settlement officer determined that the proposed levy should be sustained.

Judge Armen notes that with installment agreements (as with most collection alternatives under an abuse of discretion standard of review), “the Court does not substitute its judgment for that of the Appeals Office[.]” Sulphur Manor, Inc. v. C.I.R., T.C. Memo. 2017-95. If the IRS “followed all statutory and administrative guidelines and provided a reasoned, balanced decision, the Court will not reweigh the equities.” Thompson v. C.I.R., 140 T.C. 173, 179 (2013).

The Thompson and Sulphur Manor, Inc. cases provide, in the negative, what a petitioner must argue for any chance on review. Starting with Sulphur Manor, Inc., the petitioner must strive to present the question as something other than a battle of who has the “better” idea. In other words, don’t frame it as a battle of bad judgment (IRS Appeals) vs. good judgment (petitioner). If it must be a question of judgment, then Thompson gives the next hint on how to frame the issue: not that the IRS exercised “bad” judgment, but that they didn’t provide any reasoning for their decision in the first place (i.e. that they did not “provide a reasoned, balanced decision”). A lack of reasoning is akin to an “arbitrary” decision, which is by definition an abuse of discretion.

Better than framing the determination as lacking any reasoning, however, is where the petitioner can point to “statutory and administrative guidelines” that the IRS did not follow. Of course, this is difficult in collection issues because there are generally fairly few statutory guidelines the IRS must follow in the first place. But administrative guidelines do exist in abundance, at least in the IRM. Of course, this cuts both ways: the IRM can also provide cover for the IRS when it is followed, but appears to get to an unjust outcome.

Returning to the facts of Jackson, the petitioner faced an extremely uphill (ultimately losing) battle. It is basically brought before the Court as a request for relief on the grounds that the taxpayer just doesn’t like what the IRS proposes. As Judge Armen more charitably characterizes the case, by failing to engage in further negotiations with Appeals on a proper amount of monthly installment payments, “petitioners framed the issue for decision by the Court as whether the settlement officer, in declining to accept their offer of a partial payment installment agreement in the monthly amount of $300, abused her discretion by acting without a reasonable basis in fact or law.” This is asking for a pretty heavy lift of the Court, since there is no statute that provides the IRS must accept partial pay agreements, and the facts show the IRM was followed by the IRS. Not surprisingly, the Court declines to find an abuse of discretion.

Odds and Ends: Remaining Designated Orders

End of an Era? Chapman v. C.I.R., Dkt. # 3007-18 (here)

The Chapmans appear to be Tax Court “hobbyists” -individuals that enjoy making arguments in court more than most tax attorneys, and generally with frivolous arguments. The tax years at issue (going back to 1999) have numerous docket numbers assigned to them both in Tax Court and the 11th Circuit, all with the same general take-away: you have no legitimate argument, you owe the tax. But could this most recent action be the secret, silver bullet? Could this newfound argument, that they are not “taxpayers” subject to the Federal income tax when the liability is due to a substitute for return, be their saving grace?

Nope. All that argument does is get them slapped with a $3,000 penalty under IRC 6673(a). One hopes this is the end of the saga.

The Vagaries of Partnership Procedure: Freedman v. C.I.R., dkt. # 23410-14 (here)

Freedman involves an IRS motion to dismiss for lack of jurisdiction the portion of an individual’s case that concerns penalties the IRS argues were already dealt with in a prior partnership-level case. For a fun, late-summer read on the procedures under TEFRA for assessment and collection against a partner, after a partnership-level adjustment, this order is recommended.

 

Review of Stephanie Hunter McMahon’s “The Perfect Process is the Enemy of the Good: Tax’s Exceptional Regulatory Process”

We welcome guest blogger Sonya Watson who teaches at UNLV law school where she is an assistant professor in residence and the director of the Rosenblum Family Foundation Tax Clinic. In the last few weeks, with decisions in Altera and Good Fortune, we have seen major circuit courts of appeal opinions considering whether Treasury’s regulations withstand challenge. Professor Watson returns to provide us with another review of a tax procedure article that directly considers the relationship of Tax regulations and broader administrative law concepts. Keith

Earlier this year I reviewed Professor Kristin Hickman’s article, “Restoring the Lost Anti-Injunction Act,” in which she argued that that a narrow interpretation of the Anti-Injunction Act (“AIA”) is warranted to protect taxpayers’ presumptive right to pre-enforcement judicial review of agency rules and regulations under the Administrative Procedure Act (“APA”).  While the AIA prevents pre-enforcement review of tax laws, the APA allows pre-enforcement review. Hickman argues that it is especially important that taxpayers are able to invoke the APA and hold the IRS to the APA’s standards because of Treasury’s and IRS’ belief than in many instances, the APA does not apply to them. Today I review Professor Stephanie McMahon’s “The Perfect Process is the Enemy of the Good: Tax’s Exceptional Regulatory Process” in which McMahon plays devil’s advocate. McMahon argues that tax is exceptional and as such, Treasury and IRS shouldn’t be bound to the letter of the APA. Rather, Treasury and IRS should follow the spirit of the APA. She argues that this is especially true considering that the APA is not without flaws and that other agencies may not properly adhere to the APA either.

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Because the procedures set out in the APA don’t always accomplish the APA’s goals, rather than focusing on whether agencies strictly adhere to the procedures set out in the APA, we should focus on whether the procedures that the agency does employ are in line with the goals underlying the procedures provided in the APA. The goals underlying the APA’s procedures include: the promotion of public deliberation; reasoned agency decision-making with few errors; and agency accountability to the public and Congress. McMahon argues strict adherence to the APA can thwart accomplishment of these goals. In particular, she takes issue with the APA’s notice and comment process.

The notice and comment process, along with the hard look doctrine, which requires agencies to “consider all comments and to explain why it was not persuaded by all but frivolous comments,” may cause agencies to delay or defer issuing guidance because doing so is too burdensome in terms of resources. Producing guidance costs money:

When not excepted from notice and comment procedures, agencies face significant costs associated with compliance. Although it is impossible to calculate all of the costs of rulemaking because data is unavailable or immeasurable, Professor David Franklin notes, “Congress, the President, and the courts have all taken steps that have made the notice-and-comment rulemaking process increasingly cumbersome and unwieldy. Even critics of tax exceptionalism note that the “procedures are quite burdensome.” Many federal agencies have responded by foregoing notice and comment and issuing interpretative tools, policy statements, and informal guidance. “[B]usy staffs, tight budgets, and a variety of competing priorities” may affect how agencies weight the choice of rulemaking tools.

Further, there is always the risk that that courts may invalidate a rule to which Treasury and IRS have devoted its scare resources.

Aside from being a drain on resources, the notice and comment process creates the potential for agency capture. Agency capture occurs when an interested party influences an agency by dominating it “in ways that are detrimental to the public purpose for which it was created.” There are several ways to capture an agency, one of which is with information. In the context of the IRS, the notice and comment process may lead to information capture if an interested taxpayer inundates the IRS with large amounts of information—evidence and arguments pertaining to a rule—which then may have the effect of drowning out other voices or overcomplicating the issues, making it more difficult for less sophisticated taxpayers to participate. Because the APA’s notice and comment process does not provide a way to effectively filter information so that agencies aren’t overwhelmed by the information received, the process may not achieve its goal of increased public participation in rulemaking. Further, the notice and comment process may be unnecessary considering that “[i]nformal meetings, roundtables, speeches and leaks, advisory committees, and negotiated rulemaking are ways to really get information from the public.”

To the extent that Treasury can promote the goals underlying the APA without following the APA, McMahon believes it makes sense for Treasury to do so. To this end she states that Treasury is justified in availing itself of the good cause exemption to the APA. The good cause exemption allows agencies to issue binding guidance without notice and comment by explaining why notice and comment would be “impracticable, unnecessary, or contrary to the public interest.” Regarding Treasury’s use of the good cause exemption, McMahon writes:

Good arguments can be made for the good cause exemption to apply widely in the tax context. Currently tax provisions are tied to the federal government’s budget and there are restrictions on both deficit spending and the national debt. As a part of the federal fiscal planning, tax provisions are almost always estimated to have immediate effect, and that estimation is necessary in order to accomplish other goals of federal budgeting. In other words, if tax provisions were given delayed effective dates to permit time for notice and comment, this delay would alter the cost calculation of the federal budget.

The foregoing is in addition to the consideration that taxpayers and tax practitioners need Treasury to create guidance quickly in order to be able to better ensure compliance with the ever evolving tax laws.

Courts’ deference to agency rules is another important consideration in the debate over whether Treasury should be required to adhere to the APA. The more likely it is that courts will defer to an agency, the more important it is to make sure that the agency follows proper procedure in creating a rule. Final, legislative regulations enjoy significant deference but interpretative, proposed and, temporary regulations, as well as other types of guidance (revenue rulings, etc.) may enjoy less deference. This is because although agencies theoretically have broad discretion under Chevron, courts often apply tax-specific standards when deciding the extent to which they should defer to tax guidance, making deference harder to secure in the tax arena. Therefore, the idea that courts’ deference to agency rules make it vitally important that agencies follow proper procedure should be tempered with the knowledge that courts often don’t defer to agencies and that this is especially true in the case of Treasury and IRS.

Finally, adherence to the APA might inhibit the use of heuristics. The notice and comment process is meant to provide a means for an agency to receive information it should consider when creating guidance. However, it is unlikely that an agency will receive information regarding all the considerations it should make in creating guidance. So rather than relying on the notice and comment process to receive the information it needs to create good guidance, Treasury should create and rely on heuristics whenever possible. Heuristics are rules of thumb that aid decision making. Using heuristics in the administration of the Internal Revenue Code would allow non-experts to participate by giving them rules that are easier to apply. It also allows Treasury to keep up with changes in the law—because the Code continuously evolves, it is impossible to create guidance that will cover all possible scenarios. Heuristics don’t provide the specificity that regulations do, so using heuristics helps ensure compliance by those who might otherwise plan around the rules. Anyway, taxpayers and practitioners already use heuristics to understand and apply the code:

Developed through common law and now incorporated into practice by the IRS, tax lawyers know that gross income is interpreted broadly while deductions are construed narrowly as a matter of legislative grace, income is to be taxed to earners, substance prevails over form, and (although possibly threatened by codification) transactions need economic substance. These ideas, among others, guide the practice of law and the choices taxpayers make when they report the tax consequences of their activities. Without such guideposts, every new tax provision must be fully and singularly explicated, and any ambiguity litigated from scratch.

McMahon does acknowledge, however, that more detailed guidance may be necessary when heuristics are insufficient.

 

 

Some Tax Court Geography

We welcome back as a guest poster frequent commenter Bob Kamman.  Those of you who are regular readers of the blog know that Bob has a sharp eye and an inquisitive mind. He saw in a designated order post the statement by the National Taxpayer Advocate that her office is looking to add a tax clinic to Hawaii. Drawn to the beautiful islands, Bob began to do his research about the tax issues he might face should he seek to establish a low income taxpayer clinic (LITC) in that state. I think he is sharing the information in case there are other readers who might also be interested. As you can see from our prior post, Hawaii is not the only state looking for an LITC. Keith

The seas are infested with sharks. The land is scorched by flowing lava. It is no place for a young person. But volunteers are needed. So in the twilight of my tax years, I could accept the risks. The National Taxpayer Advocate has asked for help with establishing a low-income taxpayer clinic in Hawaii, and I am ready. I understand grant money is available.

First, of course, I checked out whether there is really a need for tax help in the middle of the South Pacific. Does federal enforcement of tax laws really extend that far?

One measure of need (and there are probably better ones) is the number of Tax Court petitions filed from a place. The Tax Court website provides an easy, although somewhat inaccurate count. A “Docket Inquiry” yields the number of petitioners from each state. Of course, in many cases there are two names for each petition because of joint returns, or multiple petitions for the same issue, if partnerships and their members are counted.

Yet you can imagine yourself at the Tax Court door, watching about 100 people file their petitions each business day (mostly, by mail or delivery service), and asking, “Where do they all come from?”
And it is of some interest, at least to me, if there are geographical differences in the origins of these tax disputes.

So here are the results of my research. I started with the 2017 rank by population of each state, along with the District of Columbia and Puerto Rico. And then I found how many petitioners came from each location, so far this year.

This method works for most states, but not the ten largest by petitioner count, because the Tax Court docket inquiry function lists only the first 500. So those were ranked according to earliest date of the first 500 petitions.

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What stands out from this table is that nothing much stands out. With few exceptions, the results are about what you would expect.

Some states rank five or six places lower in petitioner count than in population rank. It is not unreasonable to assume that compliance levels are higher in them: Kentucky, Alabama, North Carolina, West Virginia, Indiana, Nebraska, Wisconsin and Maine. Or, you could assume that a higher percentage of rural residents discourages trips to Tax Court trial sites.

Delaware ranks five places higher, and Maryland eight places higher, in petitioners compared to population. Delaware is home to many corporations, but most file from some other state. The IRS Baltimore District used to administer Washington, D.C., also. Maybe the IRS staffing in Maryland is still weighted more heavily than needed.

And then there are the four contiguous Western states where petitioner rank significantly exceeds population rank: Utah, Nevada, Colorado and Arizona. What do they have in common? A low percentage of rural residents. Someone with more access to data than I have, should research what percentage of Tax Court cases are filed by taxpayers who live within a two-hour drive of the courthouse.

Of course, for most of Hawaii trial attendance requires a flight to Oahu. But there are still more petitioners in Hawaii, than in twelve other states; Washington, D.C.; and our Atlantic islands of Puerto Rico. Help is definitely needed. I am just waiting for a call.

Designated Orders: 7/9/18 to 7/13/18

William Schmidt from the Kansas Legal Aid Society brings us this weeks designated orders. Three orders in cases involving the Graev issue keep that issue, no doubt the most important procedural issue in 2018, front and center. As with last week, there is an order in the whistleblower area with a lot of meat for those following cases interpreting that statute. Keith

For the week of July 9 through July 13, there were 9 designated orders from the Tax Court. Three rulings on IRS motions for summary judgment include 2 denials because there is a dispute as to a material fact (1st order based on employment taxes here) (2nd order involves petitioners denying both having a tax liability and receiving notice of deficiency for 2012 here) and a granted motion because petitioner was not responsive (order here). What follows are three orders where Judge Holmes takes on Chai ghouls, an exploration of a whistleblower case, and two quick summaries of cases. Overall, the Chai ghoul cases and whistleblower case made for a good week to read judicial analysis.

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Chai Ghouls

All three of these are orders from Judge Holmes that deal with Chai and Graev issues. The first two discussed were later in the week and had more analysis. As you are likely aware, the Chai and Graev judicial history in the Tax Court has led to several current cases that need analysis regarding whether there was supervisory approval regarding accuracy-related penalties, as required by Internal Revenue Code section 6751. In each of these cases, the IRS has filed a motion to reopen the case to admit evidence regarding their compliance with 6751(b)(1).

  • Docket Nos. 11459-15, Hector Baca & Magdalena Baca, v. C.I.R. (Order here).

The Commissioner filed the motion to reopen the record to admit the form. The Bacas couldn’t tell the Commissioner whether or not they objected to the motion. When given a chance to respond, they did not object. The Bacas did not raise Code section 6751 at any stage of the case (petition, amended petition, trial, or brief). The Commissioner conceded 6662(c) (negligence or disregard) penalties because the only penalty-approval form found is the one for 6662(d) (substantial understatement) penalties.

The Court’s analysis sets out the standard for reopening the record. The evidence to be added cannot be merely cumulative or impeaching, must be material to the issues involved, and would probably change the outcome of the case. Additionally, the Court should consider the importance and probative value of the evidence, the reason for the moving party’s failure to introduce the evidence earlier, and the possibility of the prejudice to the non-moving party.

The Court then analyzes those elements set out above. For example, the Court finds the penalty-approval form to be properly authenticated nonhearsay and thus admissible. Ultimately, the Commissioner had less reason to anticipate the importance of section 6751 because it was following Chai and Graev that it was clarified the Commissioner had the burden of production to show compliance with 6751 when wanting to prove a penalty.

In this case, the Court states because the Bacas did not object to the accuracy-related penalties, that is some excuse for the Commissioner’s lack of diligence. Additionally, the Court concludes that it can’t decide the Bacas would be prejudiced because they never said they would be.

Takeaway – Respond when the court requests your opinion or you may suffer consequences that could have been avoided if you had raised your hand and notified the court of your concerns.

  • Docket Nos. 19150-10, 6541-12, Scott A. Householder & Debra A. Householder, et al., v. C.I.R. (Order here).

This set of consolidated cases differ from the Bacas’ case because of an objection submitted by the petitioners. Arguments by the petitioners begin that the record should not be reopened because the Commissioner’s failure to introduce evidence of compliance with 6751(b)(1) shows a lack of diligence, and the Commissioner doesn’t offer a good reason for failing to introduce the form despite possessing it when trying the cases. They argue they would be prejudiced by reopening the record because they have not had a chance to cross-examine the examining IRS Revenue Agent on their case. They argue the form is unauthenticated and that both the declaration and the form are inadmissible hearsay.

Again, the form is found to be admissible nonhearsay. Regarding the authentication argument, the IRS recordkeeping meets the government’s prima facie showing of authenticity. The Court brings up that the Revenue Agent in question was a witness at trial that the petitioners did cross-examine, it’s just that they did not have section 6751 in mind at the time. In fact, the Court reviews a set of questions the petitioners listed and finds that those answers likely would not have helped them so comes to the conclusion that they would not be prejudiced by admitting the form.

Overall, both parties should have been more diligent to bring up section 6751. Since they did not, the lack of diligence on the Commissioner’s part is counterbalanced by the probative value of the evidence and the lack of prejudice to the petitioners if the record were reopened to admit the form.

Takeaway – The IRS is not the only party on notice of the Chai and Graev issue. Petitioners bear responsibility to raise the issue of supervisory approval just as the IRS has a responsibility to show proper authorization of the penalty. The court seems to be shifting a bit from prior determinations.

  • Docket Nos. 17753-16, 17754-16, 17755-16, Plentywood Drug, Inc., et al., v. C.I.R. (Order here).

These consolidated cases also deal with the 6751 accuracy-related penalties and the IRS motion to reopen the record to admit penalty-approval forms. While the petitioners originally disputed the penalties, they conceded penalties on some issues but did not want to concede penalties on others. As a result, they did not object to the Commissioner’s motion. The Court did not grant the motion regarding penalties determined against the corporate petitioner as it would not change the outcome of the case. In Dynamo Holdings v. Commissioner, 150 T.C. No. 10 (May 7, 2018), the Court held that section 7491(c)’s burden of production on penalties does not apply to corporate petitioners, so that, in a corporate case, where the taxpayer never asked for proof of managerial approval and so did not get into the record either a form or an admission that no form was signed, the taxpayer had the burden of production on this section 6751(b) issue and had failed. For the penalties determined against the individual petitioners, the Court granted the motion since they did not raise any objections.

In all three cases, the Court orders to grant the IRS motion to reopen the record to admit the penalty-approval form attached to the motion (with the exception of the denial of the application to Plentywood Drug, Inc.).

Comments: I must admit when Judge Holmes mentions Chai ghouls in his orders it makes me think of Ghostbusters (Chai ghoul bustin’ makes him feel good?). In looking over these three cases, it seems to me they have the same result no matter what the petitioners did. It is understandable when the petitioners never objected to the penalties or the approval form. However, the Householders objected and still got the same result. Perhaps I am more sympathetic to the petitioners, but the reasoning also does not follow for me that petitioners would not be prejudiced by admitting a form that allows them to have additional penalties added on to their tax liabilities. 

Whistleblowers and Discovery

Docket No. 972-17W, Whistleblower 972-17W v. C.I.R. (Order here).

By order dated April 27, 2018, the Court directed respondent to file the administrative record as compiled by the Whistleblower Office. Petitioner filed a motion for leave to conduct discovery, the IRS followed with an opposing response and the petitioner filed a reply to respondent’s response. On June 25, the Court conducted a hearing on petitioner’s motion in Washington, D.C., where both parties appeared and were heard.

Internal Revenue Code section 7623 provides for whistleblower awards (awards to individuals who provide information to the IRS regarding third parties failing to comply with internal revenue laws). Section 7623(b) allows for awards that are at least 15 percent but not more than 30 percent of the proceeds collected as a result of whistleblower action (including any related actions) or from any settlement in response to that action. The whistleblower’s entitlement depends on whether there was a collection of proceeds and whether that collection was attributable (at least in part) to information provided by the whistleblower to the IRS.

On June 27, 2008, the petitioner executed a Form 211, Application for Award for Original Information, and submitted that to the IRS Whistleblower Office with a letter that identified seven individuals who were involved in federal tax evasion schemes. The first time the petitioner met with IRS Special Agents was in 2008 and several meetings followed. The IRS focused on and investigated three of the individuals listed on petitioner’s Form 211 following those initial meetings.

The first taxpayer (and I use that term loosely for these three individuals) was the president of a specific corporation. In 2013, that individual was convicted of tax-related crimes including failing to file personal and corporate tax returns due in 2006, 2007, and 2008. This person received millions of dollars in unreported dividends (from a second corporation, also controlled by this individual). This individual was ordered to pay restitution of $37.8 million.

The second individual was the chief financial officer of the corporation. This person received approximately $13,000 per month from the corporation in tax year 2006 but failed to report that as taxable income, and did not file a tax return in 2007. After amending the 2006 tax return and filing the 2007 tax return, the criminal investigation ended. The Revenue Officer assessed trust fund recovery penalties for the final quarter of tax year 2006 and all four quarters of tax year 2007. This taxpayer filed amended tax returns for 2005 and 2006 in March 2009 and filed delinquent returns for 2007 and 2008 in July 2010. The IRS filed liens to collect trust fund recovery penalties of approximately $657,000 and income tax liabilities of $75,000 for tax years 2005 and 2006.

The third individual was an associate of the first two but had an indirect connection with the corporation. This taxpayer had delinquent returns for 2003-2011 and there was a limited scope audit for tax years 2009 and 2010. The IRS filed tax liens for unpaid income taxes totaling approximately $2.4 million for tax years 2003 to 2011.

For each of the individuals, the IRS executed a Form 11369, Confidential Evaluation Report, on petitioner’s involvement in the investigations. For taxpayer 1, the IRS Special Agent stated that all information was developed by the IRS independent of any information provided by petitioner. For taxpayer 2, the form includes statements the Revenue Officer discovered the unreported income and petitioner’s information was not useful in an exam of the 2009 and 2010 tax returns. For taxpayer 3, the form states the taxpayer was never the subject of a criminal investigation (which is inconsistent with the record) and that petitioner’s information was not helpful to the IRS.

The petitioner seeks discovery in order to supplement the administrative record, contending the record is incomplete and precludes effective judicial review of the disallowance of the claim for a whistleblower award. Respondent asserts the administrative record is the only information taken into account for a whistleblower award so the scope of review is limited to the administrative record and petitioner has failed to establish an exception.

The Court notes the administrative record is expected to include all information provided by the whistleblower (whether the original submission or through subsequent contact with the IRS). The Court’s review of the record in question is that it contains little information, other than the original Form 211, identifying or describing the information petitioner provided to the IRS. While the record indicates that there were multiple meetings concerning the three taxpayers, there are few records of the dates and virtually no documents of the information provided. The Court agreed with the petitioner that the administrative record was materially incomplete and that the circumstances justified a limited departure from the strict application of the rule limiting review to the administrative record.

The Court states the petitioner met the minimal showing of relevant subject matter for discovery since the administrative record was materially incomplete and precluded judicial review. The information petitioner seeks is relevant to the petitioner’s assertion that the information provided led the IRS to civil examinations and criminal investigations for the three taxpayers and led to the assessment and collection of taxes that would justify an award under section 7623(b). The IRS did not deny petitioner’s factual allegations and did not argue the information sought would be irrelevant so failed to carry the burden that the information sought should not be produced.

The Court limited petitioner’s discovery to three interrogatories concerning conversations with a Revenue Officer and two Special Agents, two requests for production of documents concerning notes and records of meetings with those three individuals.

Petitioner sought nonconsensual depositions if the IRS did not comply with the interrogatories and requests for production of documents. Since the Court directed the IRS to respond to the granted discovery requests, it is premature to consider the requests for nonconsensual depositions at this time. The footnote cites Rule 74(c)(1)(B), which calls that “an extraordinary method of discovery” only available where the witness can give testimony not obtained through other forms of discovery.

Respondent is ordered to respond to those specific interrogatories and requests for production of documents by August 17, 2018.

Comment: On the surface, this step forward looks to be a win for the petitioner as there seems to be a cause and effect that justifies a substantial whistleblower award. I discussed the case with an attorney with a whistleblower case in his background who commented that to get a whistleblower award the whistleblower had to be the first one to make the reporting and the information had to be outside public knowledge (though that was outside the tax world). From his experience, the government made it difficult to win a whistleblower award and I would say that looks to be the case here.

Miscellaneous Short Items

  • The Petitioner Wants to Dismiss? – Docket No. 11487-17, Gary R. Lohse, Petitioner, v. C.I.R. (Order here). Petitioner files a motion to dismiss for lack of jurisdiction, stating the notice of deficiency is not valid. The judge denies his motion because there is a presumption of regularity that attaches to actions by government officials and nothing submitted by the petitioner overcomes that presumption.
  • Petitioner Wants a Voluntary Audit – Docket No. 24808-16 L, Tom J. Kuechenmeister v. C.I.R. (Order here). Petitioner filed a motion for order of voluntary audit, also claiming that the IRS was negligent in allowing the third party reporter to issue the forms 1099-MISC for truck driving. As Tax Court is a court of limited jurisdiction, the Court cannot order the IRS to conduct a voluntary audit. While the petitioner was previously warned about possible penalties up to $25,000, this motion was filed prior to the warning so no penalty assessed for this motion. Petitioner’s motion is denied.

Takeaway: Each time here, the petitioner does not understand the purpose of the Tax Court. The petitioners may have come to a better result by treating Tax Court motions as surgical tools rather than as blunt weapons.