New Rock Baptist Church Continues Development of Collection Due Process Law

Located not too far from the Tax Court’s building in D.C., New Rock Baptist Church and its nursery school provided the setting for an interesting full TC opinion looking at who can bring a Collection Due Process (CDP) case as well as when does the case become moot.  The Court finds that only the real taxpayer can bring a CDP case even if the IRS lists the wrong taxpayer in its notice of federal tax lien and that fixing the lien problem by withdrawing the notice does not end the CDP case for the taxpayer seeking to adjudicate their collection issue.

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It’s not unusual for a church to host a nursery school.  It’s not unusual for the church and the nursery school to exist as two separate entities despite the close relationship they have in sharing a building and often other matters as well.  In this case, the church and the school did have separate identities and separate EINs and even separate addresses.  The nursery school ran into trouble with its payroll taxes.  The IRS eventually assessed a decent sized liability of over $400,000 against the nursery school and decided that it needed to file a notice of federal tax lien in order to protect its interest.

Unfortunately, when the IRS filed the notice of federal tax lien, it did not file it in the name of the New Rock Baptist Church Child Development Center but rather filed it in the name of New Rock Baptist Church.  Although the NFTL correctly identified the address and EIN of the nursery school, the church did not appreciate having a NFTL filed in its name rather than the name of the nursery school and took the opportunity to join in filing a CDP request.  The person receiving the CDP notice at the nursery school seems to have shared the notice with the church, and one might even imagine some discussions occurring regarding the nature and the existence of the NFTL, because the nursery school also filed a CDP request.

The CDP requests of the church and the school were consolidated in the hands of one settlement officer.  I base my comments on the opinion and not the underlying documents.  Based on the opinion, it appears that the CDP requests filed by both entities focused on obtaining an installment agreement for the nursery school instead of focusing on the separate issue of the correctness of the NFTL.  The SO, perhaps unaware of the incorrectness of the NFTL, rejected the proposed installment agreement stating “no collection alternative can be approved.”  The Court notes that the SO did not make the basis for rejection clear.  I would speculate that the basis was a failure of the nursery school to keep current with its filing requirements or payment requirements.  Surprisingly, although perhaps attributable to neither party raising the issue, the SO further determined that “the NFTL was correctly and properly filed.”  Even if neither the church nor the nursery school mentioned the incorrect name on the NFTL, the existence of CDP requests from both entities should have served as at least a mild clue that something was amiss.

On June 20, 2014, the IRS issued a notice of determination.  The Court’s choice of words makes me think that only one notice of determination was issued.  It was sent, like the NFTL to the correct address, with the correct EIN and the wrong taxpayer name.  The nursery school and the church jointly petitioned the Tax Court from the notice of determination requesting that the IRS should withdraw the NFTL.  Chief Counsel’s office requested a remand of the case to Appeals for it to: 1) give further consideration into withdrawing the NFTL, and 2) provide greater explanation regarding why it rejected the IA.  The Court granted the motion of the IRS for a remand.

On remand the IRS assigned a new SO.  The new SO, perhaps alerted to the issue by the Chief Counsel attorney, determined that the NFTL was ambiguous (this is the Court’s word; it is possible to conclude that the NFTL was simply wrong or that it violated disclosure laws by wrongfully naming a taxpayer with no liability and telling the world that it had a whopping liability) and that the NFTL should be withdrawn.  The new SO determined that the nursery school did not qualify for an IA because it was not in compliance with all return filing requirements.  Despite having identified the problem with the lien, the new SO sent the supplemental notice of determination to the correct address for the nursery school, with the correct EIN and with the name of the church rather than the nursery school.  Some things die hard.  Once the IRS has used the wrong name, getting it to switch and use the right name can require an act of God, or at least a Tax Court judge, and here again the IRS misidentifies the taxpayer even after recognizing the problem of misidentification.

Before finishing the discussion of the case, I want to pause here to make sure everyone understands that the withdrawal of the NFTL does not impact the federal tax lien itself which continues to exist and continues to attach to all property and rights to property owned by the nursery school.  Withdrawal of a NFTL simply removes the notice of the lien but not the lien itself.  Withdrawing the notice has an impact on the security of the lien and its priority vis a vis other creditors, but not the validity of the underlying lien or the liability secured by the lien.  Do not get sucked into thinking that withdrawal of the NFTL fixes the nursery school’s tax problems.  Withdrawal does, however, remove from the public record the erroneous statement that the church has a tax liability.  The church may still need more statements from the IRS to the effect that it never owed any federal taxes giving rise to the NFTL because creditors will, or may, know that the withdrawal does not signal the church no longer owes.

So, back in the Tax Court the IRS moves to dismiss the case as moot since the new SO fixed the problem by withdrawing the NFTL.  The nursery school, however, says not so fast because it still wants to have a hearing on the liabilities it owes.  The Tax Court determines that it has jurisdiction over the CDP case involving the nursery school basically finding that even though the NFTL did not mention the nursery school by its precise name it was close enough to trigger CDP rights; however, with respect to the church the Court finds that it was not a proper party.  It says no valid notice of determination was issued to the church despite the fact that the notice of determination listed the name of the church and not the nursery school.  Maybe this works in an opinion written when the NFTL has already been withdrawn; however, I am troubled that an entity clearly listed on the NFTL and on the notice of determination is denied the opportunity to seek relief from the impact of the NFTL.

Perhaps the Court thinks that the 7432 provisions regarding liens provide sufficient protection but it does not spell out why it thinks an individual or entity listed on an NFTL and listed in the notice of determination as the taxpayer against whom the IRS is taking collection action giving right to a CDP hearing has no right to seek redress through such a hearing.  It says that no valid federal tax lien existed with respect to the church.  True, but CDP protection does not depend on a valid federal tax lien it depends on the filing of an NFTL.  Determining the validity of the NFTL is an integral part of the CDP process.  A taxpayer listed in an NFTL should be able to use the CDP process to contest the validity of the NFTL and the underlying lien.  The Court does not explain why the lack of an underlying federal tax lien has an impact on the jurisdiction of the Court in a CDP case.  Does this mean that if the Court should reach the conclusion in another case that no lien exists, say because the assessment is invalid, it must dismiss the case rather than grant relief.  I cannot follow the logic here.

The Court also says no valid notice of determination was issued.  I have a similar problem.  A notice of determination was issued in the name of the church.  Yes, the IRS made a mistake in sending the notice of determination (as well as the notice of supplemental determination) in the name of the church but that should not prevent the church from receiving relief.  Maybe it would be useful for a taxpayer who wrongfully gets listed on an NFTL and who receives a notice of determination to have a court opinion that says it was wrong so it can show its creditors that it was wrong.

The Court may reach its conclusion because the notice of determination uses the separate address of the nursery school to say that the church did not receive this notice.  It does not make that explicit and the link between the organizations still creates a problem for the church that CDP might resolve.

In the end, after determining that it has jurisdiction to consider the CDP relief requested by the nursery school, the Court finds that the withdrawal of the NFTL did not moot the case.  Even though it has jurisdiction and even though issues regarding liability still exist, the nursery school has problems that prevent it from getting any relief through CDP.  It raised some issues it wanted the Court to address after making its CDP request, and the Court says those issues are not properly before it.  Because the nursery school was not in compliance with its filing requirements at the time of the Appeals determination, the Court sustains the Appeals determination that it is not eligible for an IA.  The nursery school alleges that it is now in filing compliance, and the Court responds correctly that losing a CDP case does not prevent it from entering into an IA at the conclusion of the case.  That’s the nice thing about CDP.  It’s just a skirmish on the road to collection and not the ending point.

 

 

Can the Wrong Return Start the Statute of Limitations on Assessment

In In re Quezada, the bankruptcy court in Austin, Texas faced the issue of whether a Form 1040 could start the statute of limitations for filing Form 945.  The court declined to grant summary judgment to the IRS finding that the issue was one of substantial compliance and it did not have enough information to make the determination.  Because the issue of one return triggering the start of the statute of limitations for another is not an issue we have previously discussed, the case deserves some attention.

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Mr. Quezada is a brick layer and one whom the IRS says owes $1,269,561.89.  It will take him quite a while to lay enough bricks to pay off a liability of that magnitude.  Mr. Quezada not only lays bricks but he hires others to assist him.  The hiring of others leads to his problems.  Many people worked for him over the years.  He treated these other workers as independent contractors; however, he did not file or send the IRS the necessary forms (e.g. Form 1099) in connection with the payments to these individuals.  His substantial liabilities stem from this failure over a period of several years.

Assuming that the individuals who worked with him were independent contractors, Mr. Quezada still had reporting obligations to the IRS.  The IRS, in this proceeding, did not contest that the individuals working with Mr. Quezada were independent contractors.  He needed to provide the Taxpayer Identification Numbers (TINs) to the IRS of all of these individuals or withhold 28% of certain taxable payments and to report on Form 945 this “backup withholding.”  If an employer fails to withhold the taxes and to file the Form 945, the employer can still avoid liability by showing that the independent contractors reported and paid taxes on the payments received from the employer.  To meet this exception, the employer must obtain a Form 4669 (Statement of Payments Received) from each of the persons treated as an independent contractor.  This form involves the independent contractor declaring under penalty of perjury that a tax return was filed reporting all of the payments received from the employer.  If you have a large number of independent contractors and if some time has passed before the IRS comes looking for compliance with the payment rules, it could prove quite difficult to locate and persuade all of the individuals receiving these payments to sign such a document.

In this case, Mr. Quezada failed to do any of the three things that could have kept him from having a huge liability for the backup withholding.  He did file his own return for the years at issue reporting the income and expenses of the business.  Of course, this provides no assistance to the IRS in identifying the individuals he paid and how much he paid.  Because several years had passed before the IRS came to him to question his employment tax situation, he argues that the time for the IRS to do this has passed.  The IRS counters that his failure to file Form 945, the correct return for reporting the backup withholding, keeps the statute of limitations on assessment open for an unlimited period.

The IRS argued that filing Form 1040, while nice and important for other reasons, has nothing to do with the liability at issue in this case.  The bankruptcy court finds that no court has ruled on the issue of whether a Form 1040 can trigger the three-year limitations period for Form 945; however, it notes that several cases have addressed the issue of one return triggering the statute of limitations where taxpayer has failed to file another return.  The leading case on this issue is Commissioner v. Lane-Wells Co., 321 U.S. 219 (1944).  In Lane-Wells, the issue concerned whether filing a corporate tax return could cause the statute of limitations to run on the taxpayer’s obligation to file a personal holding company return.  The Supreme Court rejected the taxpayer argument that a corporate return would trigger the time limitation for file a personal holding company return.

Finding that the liabilities were separate, the Court found the need to file each of the returns.  The test articulated by the Court was that the statute of limitations is not triggered by the different return if the information in that return is insufficient to “show the facts on which liability could be predicated.”

In a case with facts closer to those presented by Quezada, the Ninth Circuit in Springfield v. United States, 88 F.3d 750 (9th Cir. 1996) held that filing Form 1099 did not start the time period where the taxpayer was required to file Forms 940 and 941.  In that case, the taxpayer treated salesmen as independent contractors rather than employees and then argued that it put the IRS on notice of the issue when it submitted the Forms 1099 for these individuals.  The Ninth Circuit opinion created a narrower test finding that the issue of whether one return could trigger the statute of limitations for another turned on “whether the return filed sets forth the facts establishing liability.”  It found that Form 1099 did not provide the IRS with the necessary information.

The bankruptcy court in Quezada concluded that the rationale in these cases turned on substantial compliance.  It looked at the elements of a return as articulated in Beard v. Commissioner, a case we have discussed often in the context of what triggers a discharge when a return is filed late.  The bankruptcy court determined that the decision of substantial compliance turns on the specific facts of each case and since it did not have the Form 1040 filed by the Quezadas, it could not make a decision at this point.

I have sympathy for the Quezadas because many, if not most, of the individuals paid during the years at issue probably did file tax returns and pay taxes on the wages paid to them.  Probably, the Quezadas will be paying the tax twice in effect.  I will be surprised if the bankruptcy court finds a way to hold that the Form 1040 takes the place of Form 945.  To make matters worse for the Quezadas, if the bankruptcy court finds that their Form 1040 cannot take the place of Form 945, that decision also means that the liability cannot be discharged because of the unfiled return.  I suspect an offer in compromise may be in their future.

Determining the Amount in Dispute for Purposes of a Whistleblower Award

In Smith v. Commissioner, 148 T.C. No. 21 (June 7, 2017), the Tax Court looked for the first time at the issue of the amount in dispute for purposes of determining whether the individual providing information to the IRS should receive an award based on a mandatory or discretionary basis.  The information provided directly led to recovery of an amount that did not reach the minimum amount to trigger a mandatory award percentage; however, the information caused the IRS to audit a taxpayer and recover through that audit an amount significantly in excess of the amount needed to trigger the mandatory award percentage.  The question before the Court was the meaning of amount in dispute as it related to the triggering of the mandatory award percentage.  The Tax Court decided that the amount in dispute was the larger amount which will mean a bigger payday for the informant.  The Court did not determine the final amount of the award but sent it back to the IRS to make an award determination consistent with its decision.

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When I worked for Chief Counsel, I had a number of cases generated by whistleblowers.  Their information provided vital pointers to underreporting, non-reporting, or false reporting which, at the time, the IRS rewarded with total discretion.  My observation was that the IRS tended not to be too generous in its determination of the award amount but, nonetheless, individuals still came forward with valuable, and not so valuable, information based on motives not always driven by the potential of a financial reward.

Congress decided that it wanted to incentivize individuals to come forward with information about underreporting of taxes in larger cases because it felt greater incentives and more clarity in the amount of the potential reward would ultimately benefit the government by encouraging more people to come forward.  I am unsure if we have enough data yet to know how successful the law has been but enough high profile cases exist to convince me, as a casual observer and as someone who saw the results during their much less public stage prior to the enactment of the whistleblower provisions, that the incentives do make a difference.

Perhaps Congress felt that for smaller cases, other incentives provided the necessary basis for coming forward and the IRS could continue to have discretion on how much to pay the informant which Congress preserved in IRC 7623(a); however, for “big” cases, Congress stepped up with the concept of mandatory awards in 7623(b).

The Smith case works through the statute to find meaning regarding the definition of a big case.  Congress defined it using the term “amount in dispute” in IRC 7623(b)(5)(B) ; however, the meaning of that term still needed interpretation prior to the Smith case.  The Tax Court noted that it had made some determinations regarding 7623(b)(5)(B) starting with the determination in Lippolis v. Commissioner, 143 T.C. 393, 396 (2014) in which it considered whether the $2 million threshold of 7623(b)(5)(B) was jurisdictional or should be asserted as an affirmative defense.  The Smith opinion works its way through other opinions concerning the provision.

The information provided by Mr. Smith proved very valuable to the IRS for reasons that went beyond the direct information he provided.  The IRS ended up collecting almost $20 million; however, it calculated that the portion of this amount directly related to the information he provided only amounted to $1.7 million.  Since the amount directly related to his information fell below the $2 million threshold for a mandatory award, the IRS determined the amount of his award using its discretion.  The minimum mandatory award would net Mr. Smith 15% of the amount related to his information while the IRS using its discretion awarded him 10% – almost $90,000 less.

“Respondent argues that certain common words or phrases in section 7236(b)(1) require him to follow the same quantitative measure in determining the $2 million threshold of section 7623(b)(5)(B).  In particular, respondent focuses on the words “any” and “action” in the context of section 7623(b)(1)….  Respondent goes on to contend that section 7623(b)(1) therefore defines the scope of the words “any action” for purposes of section 7623(b), and accordingly governs the use of the phrase “any action” in section 7623(b)(5).”

The Tax Court finds the interpretation of the IRS to be misplaced.  It looks at IRC 7623 as a whole as its history and determines that “’action’ for purposes of subsection (b) is the detecting of underpayments of tax or violations of tax law without any qualifier as to quantity or amount.”  Based on this interpretation of the statute, the Court finds that “action” does not establish another technical definition for 7623(b).

Therefore, the Tax Court declines to accept the interpretation by the IRS that action means that only the directly attributable dollars count in determining “amounts in dispute” for purposes of determining if the information meets the $2 million threshold for making a mandatory award.  Petitioner’s information caused the IRS to begin an examination that resulted in the collection of over $20 million.  The phrase in the statute “’amounts in dispute’ is not specifically limited to only those amounts directly or indirectly attributable to the whistleblower information.  Once the monetary thresholds are met and the government recovers ‘collected proceeds’ resulting from the action, the mandatory provisions of subsection (b)(1) or (2) apply.”

Looking at the applicable regulation as well as the statute, the Tax Court determines that the “regulation does not support respondent’s narrow view that the ‘amount in dispute’ is limited to the portion to which award percentages are applied….  The regulation provides instead that the amounts in dispute are the amounts that resulted from the actions with which IRS proceeded based on the whistleblower information.  Accordingly, it does not follow that the limiting standards of section 7623(b)(1) and (2) providing for a percentage to be applied to the portion of ‘collected proceeds’ to which the whistleblower’s information ‘substantially contributed’ would also apply in determining whether the initial $2 million threshold has been met.”

The Tax Court’s interpretation will allow whistleblowers to benefit from collateral items discovered by the IRS in an audit in the application of the percentage applied to their award.  In many, if not most, cases, the IRS would not audit the party targeted by the whistleblower.  Because the IRS would not audit the taxpayer without the intervention of the whistleblower, it makes sense to allow the whistleblower to enjoy the mandatory percentage with respect to that portion of the award clearly attributable to the information provided.  The issue should only arise in cases in which the IRS has benefited in material and fairly substantial ways from the information provided by the whistleblower.  Even though it must pay a higher percentage than it would have paid if it had total discretion, the amount paid remains much less than the amount recovered.

Duty of Consistency in Tax Cases

Last fall I wrote a post about the case of United States v. Holmes.  The post focused on the timeliness of a suit brought by the IRS to foreclose its lien and reduce its assessment to judgment.  Taxpayers argued that the IRS brought the suit too late.  The IRS argued that it timely filed the suit based on an extension of the statute of limitations on collection created by the filing of a request for a Collection Due Process hearing in the final year of the statute of limitations on collection.  The prior post focused on the need to consider the fact that a CDP request extends the statute of limitations on collection before making a request for a regular CDP hearing and that in many cases requesting a CDP equivalent hearing best serves a taxpayer’s interest because the equivalent hearing does not extend the statute of limitations.

Taxpayers lost the case in the district court because it determined that the CDP request held open the statute of limitations.  They appealed that loss and in early June they lost again in a 3-0 decision by the 5th Circuit.  In the prior post, I touched on the issue of the duty of consistency.  The 5th Circuit spends almost all of its time on this issue and I will focus on it here without going back over all of the facts discussed in the earlier post.

The taxpayers owed a fair amount of money but the IRS did not focus on their case until late in the statutory period for reasons not made known in the case.  When it finally focused on their case, it filed notices of federal tax lien and it sent a notice of intent to levy.  While I questioned in the earlier post whether requesting a CDP hearing in the final year of the statute of limitations on collection was a good idea, the taxpayers appear to have income and assets that could have been taken had they done nothing.  They sent by certified mail two requests for a CDP hearing.  The IRS seemed to have lost the requests and did not offer a hearing.  Taxpayer husband wrote back seven months later insisting that the IRS received his CDP request and enclosing the certified mail receipt showing that the IRS timely received the request.  The Appeals Office of the IRS then held a CDP hearing and sustained the proposed levy action.

In requesting dismissal of the suit as untimely, taxpayers argue that the IRS should not suspend the statute of limitations for the period from October to May during which it had misplaced the CDP requests.  The district court held that the taxpayers could not bludgeon the IRS for not recognizing their CDP requests and then argue that these requests should not suspend the statute of limitations on collection.  The Circuit Court agreed and went back through each of the three elements of the equitable principle of duty of consistency.

The first element requires a representation by the taxpayer.  Here, the taxpayers adamantly represented to the IRS that they mailed the CDP request.  The Circuit Court finds that these protestations and presentation of proof more than satisfied this element.

The second element requires that the IRS rely on the representation.  Here, it accepted the representation that the CDP requests were mailed in October and offered the CDP hearing requested by the taxpayers.

The third element requires that the taxpayer attempts to change or characterize the representation after the statute of limitations has run.  That is exactly what happened here.

Taxpayers argue that as a legal matter the doctrine of duty of consistency does not apply to situations such as this involving the collection of taxes but applies when a taxpayer takes an inconsistent position from one year to the next with an item like depreciation.  The Fifth Circuit rejected this argument pointing out that the principle involves a basic equitable question and citing to several cases that did not involve the type of narrow application sought by the taxpayers.  On the whole, the Holmes case provides good precedent for the IRS on the duty of consistency issue as well as a reminder to other taxpayers to carefully consider whether to request a CDP hearing late in the life of the statute.

Chai not Gaining Traction with Tax Court or IRS

Back in March, Steve blogged about the 2nd Circuit’s decision in Chai v. Commissioner reversing the Tax Court and finding that the IRS had a duty to prove that the immediate supervisor of the employee imposing a penalty met the requirements of the previously long forgotten IRC 6751.  The Chai decision came shortly after a fully reviewed Tax Court opinion in which the Court, in Graev v. Commissioner, held that the IRS did not have a duty to prove that the immediate supervisor had signed.  See my blog post here.  The 2nd Circuit essentially adopted the views of the dissent in Graev.  Because appellate venue for Graev lies in the 2nd Circuit, the decision in that case will unlikely stand; however, the opinion can still provide precedent for Tax Court cases appealable to other circuits as the Tax Court applies its Golsen rule.  This post will focus on what is happening post-Chai and how that might impact your clients who are unable to move to New York City or other fine locations in the 2nd Circuit.

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The first matter to discuss is Graev.  The IRS has chosen not to roll over and accept Chai as applying in a way that resolves the Graev case.  The IRS filed a motion with the Tax Court asking it to reconsider its opinion in Graev in light of the Chai decision.  The critical paragraph of the motion states:

“Respondent requests that the Court vacate its decision in this case and order additional briefing on what steps the Court should take in this case in light of the Chai opinion. Respondent has views which it believes will benefit the Court to consider in the changed circumstances of this case.”

The Tax Court granted this motion and issued an order vacating the decision and requiring the parties to file simultaneous briefs by June 1, 2017.  The petitioner and respondent timely filed these briefs.  The Court ordered the parties to file responsive briefs by June 20; however, petitioner filed a motion requesting until June 30 to file responsive briefs and permission to file a response to the responsive briefs by July 31.  The Court granted petitioner’s request so it will be at least a month before this case becomes fully at issue again.

The vacation of the decision raises an interesting question with respect to the Golsen rule.  Does the Graev opinion control future decisions of the Tax Court if the decision in the case is vacated at the request of the government?  The answer to that question appears to be yes as discussed further below.

While you might have expected that the IRS requested the vacation of the decision in Graev so that it could concede the IRC 6751 issue, the IRS has taken the fight to a new level, and in fact, in the first post-Chai brief filed in the Graev case, the IRS did not even cite to Golsen.  The brief filed by Frank Agostino’s firm cited Golsen four times and devoted the first of six sections of the brief to this issue.  In the statement of the case, petitioner’s brief states:

The issue is whether the rule in Golsen v. Commissioner, 54 T.C. 742 (1970), aff’d, 445 F.2d 985 (10th Cir. 1971), and the United States Court of Appeals for the Second Circuit’s opinion in Chai v. Commissioner, 851 F.3d 190 (2d Cir. 2017), aff’a in part and rev’a in part, T.C. Memo. 2015-42, 109 T.C.M. (CCH) 1206 (2015), require this Court to vacate its decision determining the Graevs liable for 20% accuracy-related penalties under section 6662(a) and instead enter a decision for the Graevs adjudging them not liable for the penalties because the Commissioner failed to comply with the written-approval requirements of section 6751(b)(1).

So, the next opinion by the Tax Court in this case will have the opportunity to decide a number of issues concerning the application of the 2nd Circuit’s decision on the these types of cases.  Petitioner frames the issues in this manner:

The Second Circuit’s opinion in Chai requires this Court to vacate the March 7th Decision for five reasons. First, Chai is controlling in this case pursuant to the rule in Golsen v. Commissioner, 54 T.C. 742, 757 (1970), aff’d, 445 F.2d 985 (10th Cir. 1971), because this case is appealable to the Second Circuit, because the holdings in Chai are squarely on point and the facts are indistinguishable, and because the failure to follow Chai would result in inevitable reversal upon appeal.

Next, in rejecting the majority’s holding and reasoning in Graev II that the 6751(b)(1) issue was not ripe in a deficiency proceeding (i.e., it was premature), the Second Circuit in Chai held that the issue of the Commissioner’s compliance with the requirements of section 6751(b)(1) is ripe for review in a deficiency proceeding.

Third, by rejecting the concurrence’s holding and reasoning in Graev II that the Commissioner’s failure to comply with the written-approval requirements of section 6751(b)(1) is excusable as harmless error, the Chai Court held that the written-approval requirement in section 6751(b)(1) is a “mandatory, statutory element of a penalty claim” that is not subject to harmless error analysis.

Fourth, the facts of this case, as found in Graev I and Graev II, require a holding that the Commissioner did not comply with the requirements of section 6751(b)(1) in determining the 20% accuracy-related penalties at issue.

Fifth, the Chai Court rejected the Commissioner’s contention that an amended answer filed by his attorneys can cure his failure to comply with the written-approval requirement of section 6751(b)(1) because compliance at the time of the initial determination is a “mandatory, statutory element.” Thus, the Court must vacate the March 7th Decision and its determination that the 20% accuracy related penalties may be assessed.

In contrast, the IRS frames the issues as follows:

Because this case is appealable to the Second Circuit, this Court’s holding in Graev v. Commissioner, 147 T.C. No. 16 (2016), regarding the timing of the supervisory approval of the initial determination of a penalty assessment cannot stand on appeal. Therefore, this Court must face additional issues regarding whether there was adequate supervisory approval of the initial determination of a penalty assessment in this case.

Those issues are: (1) whether the timely supervisory approval of a 40 percent accuracy-related penalty was, in effect, approval of the alternative position of the 20 percent penalty; (2) whether an attorney’s recommendation to include the 20 percent penalty in the statutory notice of deficiency, which recommendation was approved and adopted, can constitute the initial determination of the penalty assessment in this case; and (3) if a penalty assessment arises from an assertion raised in the amendment to answer in this case, whether the initial determination of that penalty assessment was made by the attorney who asserted the penalty in the amendment to answer. To avoid the potential for piecemeal litigation of these issues, respondent requests a ruling on each one even if the Court decides more than one issue in respondent’s favor.

So, the next phase of Graev could focus on the ability of the Chief Counsel attorney and the supervisor of that attorney to initiate and provide the appropriate supervisory approval.  If the IRS wins this argument, it will win the case and it will avoid the problem that occurs in cases in which Chief Counsel attorneys in the answer or subsequent pleadings change the penalty from the penalty imposed by the Commissioner in the notice of deficiency.  We will closely watch the case and keep you informed.

Meanwhile, there are many other cases in which petitioners have suddenly decided to raise the failure of the IRS to obtain the proper supervisory approval for a penalty.  We blogged about such a case decided almost immediately after Chai.  A more recent case shows another side.  On June 12, 2017, Judge Lauber issued an order in the case of Zolghadr v. Commissioner in which he rejected their Chai argument for two reasons.  First, petitioners did not raise the argument in time in a deficiency case.  Remember that both Chai and Graev were also deficiency cases where  the timing of raising the argument was also a concern.  Second, and more important for this discussion, he addressed the merits and the current viability of Graev stating:

“Alternatively, even if petitioners’ argument were timely, their reliance on Chai is misplaced because this case is appealable to the U.S. Court of Appeals for the fourth Circuit, not to the U.S. Court of Appeals for the second circuit, which decided the chai case.  For cases in which the appellate venue is a court of appeals other than the second Circuit, the applicable Tax Court rule is that enunciated in Graev v. Commissioner, 147 T.C. (slip. Op. at 42 n.25).  Under that case respondent has no burden of production to demonstrate compliance with section 6751(b).”

While we are waiting for the “final answer” in Graev, you should not wait to raise the IRC 6751 argument in your case.  In addition, you now know that at least one judge on the Tax Court views Graev as controlling which means you may have to move your case into the applicable circuit court if your client lives outside the Second Circuit.  I think Judge Lauber’s view of the current applicability of the Golsen rule as it applies to Graev is a view shared by other judges on the Tax Court.  Do not expect to roll into Tax Court citing Chai and automatically winning.

Sentencing Fight in Former Judge Kroupa’s Criminal Case

We have reported before on the rather shocking criminal tax case of a former Tax Court judge.  We reported on her indictment in April of last year, her guilty plea in the fall of last year and of the fallout in some of her cases stemming from the criminal matter.  The case has moved into the phase in which the judge must sentence former Judge Kroupa for the crime to which she plead guilty.  The sentencing phase has moved slower in this case than I would have anticipated; however, it has been many years since I worked regularly on criminal tax cases and my expectation of the tempo may be outdated.

The sentencing phase usually involves a review of the situation and then a write-up of facts and recommendations by a probation officer followed by an opportunity for the defendant and the government to offer comments on a proposed sentence.  At the time of the plea, the parties knew that the sentencing guidelines would produce a recommended prison sentence in the range of 30-37 months.  Although the guidelines do not bind the judge, the parties know that the guidelines have a significant influence in most cases and certainly serve as a starting point for the judge’s decision.  Based on the crime to which she pled guilty and some upward and downward adjustments for knowledge, position and cooperation, the parties knew when they reached the plea agreement where the starting point for sentencing would place this case.

In recent filings with the district court, the defendant and the government have set out their positions.  The defendant takes the position that 20 months would be an appropriate sentence under the circumstances.  The government argues for the guideline amount of time in prison.  Both documents bear reading if you want to gain a better understanding of the process in general.  The document filed by former Judge Kroupa lays open her life in a way that you would not want to do unless compelled to do so by the circumstances existing here.

In recent posts, we have talked about privacy of information in a court proceeding.  In last Friday’s post concerning designated orders, Samantha Galvin described for us a recent order concerning the privacy of information.  In a post earlier this week, I described the efforts of a taxpayer in a refund suit to keep his name out of the public record.  In this criminal case where the defendant fights for her freedom with a difference of potentially 17 months (or more because the sentencing judge is not bound by the guidelines or the recommendation of the government) of incarceration hanging in the balance, she does not raise privacy as a concern.  The case demonstrates how naked one becomes in a criminal case and how rights of privacy that can cause such concern in a civil case do not apply.  Because our blog focuses on civil and not criminal tax matters, we will not delve further into the arguments by the parties.  Even for those of us who practice in the civil arena, knowing what happens in the worst case, a criminal indictment, benefits us and our clients as we work to keep them from committing a tax crime.

Remaining Anonymous While Suing the IRS

In the recent case of John Doe v. United States, No. 1:16-cv-07256 (SDNY), the plaintiff requested that the court allow him to pursue the case without having his name made public.  The court said no.  It would not allow him to proceed anonymously for reasons discussed below.  At the last Tax Court regular trial session in Boston, I watched as someone, for reasons similar to Mr. Doe’s, asked that the court seal the record and the court said no.  We have blogged before on the rules for sealing the record in Tax Court.    John Doe’s case points out some of the policy considerations present in trying to hide your name or your personal medical information while pursuing a judicial remedy.  In general, courts seem to take a very different view of the protection of personal medical information than we do as a society after the passage of the HIPPA laws.  Where is the right balance in opening up personal medical information or keeping things discreet?

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John Doe filed a claim for refund which the IRS denied because he filed it after the applicable time period.  He sought to hold open the time period arguing that the delay resulted from his financial disability as described in IRC 6511(h).  We have blogged before, here, here, here and here, about 6511(h) and the difficulties most taxpayers have in meeting the criteria for relief the IRS has imposed in Rev. Proc. 99-21.

To meet the criteria for financial disability, the taxpayer must provide the IRS with detailed medical information.  This medical information supports taxpayer’s failure to follow through with routine responsibilities that could have a direct correlation to work activities.  Putting such information in the public domain could easily have the effect of limiting an individual’s future job prospects. While a taxpayer might feel uncomfortable turning over lots of sensitive personal medical information to the IRS in order to provide that the criteria for financial disability exists, at least taxpayers should feel comfortable knowing that providing their personal medical information to the IRS cloaks it with the protections of IRC 6103 and makes it as private as President Trump’s returns.

If a taxpayer seeking to use the financial disability provisions to hold open the statute fails to convince the IRS and must move forward to court to seek relief from the agency decision, the protections regarding that personal medical information can become subordinate to the public’s right to know.  In Sealed Plaintiff v. Sealed Defendant, 537 F.3d 185,188-189 (2nd Cir. 2008), the Court stated “[T]he interests of both the public and the opposing party should be considered when determining whether to grant an application to proceed under a pseudonym.”

In John Doe’s case, the Court notes that the 2nd Circuit has created a non-exhaustive list of factors to consider when deciding whether to allow a party to proceed anonymously.  This list includes:

  • “Whether the litigation involves matters that are highly sensitive and of a personal nature”;
  • “Whether identification poses a risk of retaliatory physical or mental harm to the party seeking to proceed anonymously or even more critically, to innocent non-parties”;
  • “Whether identification presents other harms and the likely severity of those harms”;
  • Whether the plaintiff is particularly vulnerable to the possible harms of disclosure, particularly in light of the plaintiff’s age”;
  • “Whether the suit is challenging the actions of the government or that of private parties”;
  • “Whether the defendant is prejudiced by allowing the plaintiff to press his claims anonymously, whether the nature of that prejudice differs at an particular stage of the litigation”;
  • “Whether the plaintiff’s identity has thus far been kept confidential”;
  • “Whether the public’s interest in the litigation is furthered by requiring the plaintiff to disclose his identity”;
  • “Whether, due to the purely legal nature of the issues presented or otherwise, there is an atypically weak public interest in knowing the litigants’ identities”; and
  • “Whether there are any alternative mechanisms for protecting the confidentiality of the plaintiff.”

Think about these factors in the context of a whistleblower case where the effective default is anonymity.  In John Doe’s case the court found that “alternative mechanisms for protecting the confidentiality of the plaintiff weighs against allowing anonymity.”

Plaintiff argued that disclosing his identity would impact his future career prospects because of the personal and sensitive medical information that he would have to show in order to prove his case.  The court noted that redacting and sealing submissions regarding sensitive medical information happens routinely.  In the Tax Court case I watched a couple of months ago, a pro se litigant’s request to seal medical records was summarily denied with little discussion.  The decision may have been the right decision but forcing someone to lay bare their medical history in order to succeed in a case puts the individual to hard choices about the importance of the current case versus the long term consequences of making the medical information public.

Tax Court Rule 27 protects the disclosure of the identity of minors and a host of other information.  Prior to filing a petition or submitting information to the Tax Court take a careful look at the list of information protected and the means of protecting the information.  The Tax Court protects the social security number of petitioners and has a special form to use to disclose the number to the court but not the public.  The Tax Court is concerned about inadvertent disclosure of the social security number and other sensitive information, and directs petitioners (and respondent) to redact such information before filing documents with the court.  The Tax Court practice concerning access to documents filed in its cases seeks to protect the information of litigants at the expense of full public access in its balancing of the competing interests regarding the information.  How does sensitive medical information fit into this scheme of protection about which the Court has given much thought?

The comments in the John Doe case by the district court in the Southern District of New York point to the different standards between requesting anonymity as a party and requesting redaction or sealing of records that come into a case.  In addressing each of the concerns raised by Mr. Doe, the court points to the ability to redact or seal information as an adequate remedy that will protect the sensitive information without creating the serious issues courts have with permitting a plaintiff to proceed anonymously.

Conclusion

The case, and the cases cited in the opinion, point to the very high bar that a plaintiff faces in seeking to proceed anonymously.  At the same time everyone has rights regarding their medical information.  Like corporations that seek to seal a court record regarding proprietary information, individuals have rights to protect medical information that could have an adverse commercial or personal impact.  By raising the concerns at the outset of the case, the individual plaintiff sets the stage for success on motions to seal or redact the medical information.  Even though John Doe loses his motion to protect his identity, he has certainly heightened the awareness of the court to the need to protect his medical information.

If you know that you have sensitive information you want to keep out of the public record, having a conversation with the court and the opposing party early in the proceeding will allow the court to reflect on how best to protect the information and not place the judge in the position of having to rule on such a motion during trial or as a trial begins.  Pro se litigants will struggle to understand the importance of this timing but representatives should not.

 

Seventh Circuit Sustains Tax Court Decision Enforcing Stipulation

In Shamrock v. Commissioner, No. 16-3811 (7th Cir. Mar. 14, 2017), the Seventh Circuit affirmed the decision of the Tax Court in T.C. Memo. 2016-193. The case has an interesting history because of the representative chosen by petitioners.  Petitioners filed their Tax Court petition pro se but were assisted in their case by Grant Niehus.  Mr. Niehus is a lawyer, and was at all relevant time, but is not licensed to practice in Illinois.  I note that it is likely that although this is a case set for trial in Chicago, it would not surprise me to learn that the lawyer representing the IRS in the Chicago office of Chief Counsel is also not licensed to practice in Illinois.  Because federal tax practice is a federal practice, lawyers can represent taxpayers nationwide on federal tax issues in the U.S. Tax Court and are not limited to practicing in states in which they are licensed.  Working for Chief Counsel, attorneys must be licensed in one state, a member in good standing, and an active member of the bar but Chief Counsel attorneys need not be a member of the bar of the state in which they are practicing.  So, I do not find that statement that Mr. Niehus is not licensed to practice in Illinois to be especially important.  He did, however, have another problem and that caused the Tax Court to do a lot more work in this case.

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It is important that a lawyer properly hold himself out to his clients.  There were concerns that Mr. Niehus did not properly explain his status to his clients.  The Circuit Court opinion states that Mr. Niehus, in addition to not having a license to practice in Illinois, was not admitted before the Tax Court.  It is his inability to practice before the Tax Court that greatly concerned the 7th Circuit when it looked at the first appeal. It should be noted that getting admitted to practice before the Tax Court generally takes little effort if you are admitted and in good standing before the highest bar of one state.

He advised the taxpayers to stipulate that only half of the relief they sought in the Tax Court was appropriate.  They did that and the Tax Court accepted their stipulation.  After entering into that stipulation, the taxpayers discovered that Mr. Niehus was not licensed to practice in Illinois and requested that the Tax Court set aside their stipulation.  The Tax Court refused to set aside the stipulation – a decision consistent with its general treatment of such requests – and the taxpayers appealed.  On appeal, the 7th Circuit reversed and remanded the case.  The 7th Circuit criticized the Tax Court for enforcing the stipulation without considering the possible deceit of Mr. Niehus.

On remand the taxpayers chose another somewhat non-traditional representative.  They chose a CPA authorized to practice before the Tax Court.  I have written before about the ability of non-attorneys to practice before the Tax Court and if you go back to 1924 when the Board of Tax Appeals was created, CPAs were authorized to represent clients before Board.  Their ability to do so based on the professional designation continued into the 1940s when it was removed and a successful passage of a test was required for non-attorneys to represent clients before the Tax court.  The taxpayers’ new representative, Sheldon Drobny, was one of the small percentage of individuals who passed this test.

After a hearing, the Tax Court issued a brief 99 page opinion explaining that the advice the taxpayers received from their original representative was good advice.  The taxpayers did not agree with the Tax Court and went for a second round before the 7th Circuit.  Now in possession of a detailed explanation of tax issues and how the advice of Mr. Niehus lined up with the correct tax result, the 7th Circuit agreed with the Tax Court.  The 7th Circuit notes that the taxpayers did not accuse Mr. Niehus of malpractice, that the Tax Court found he provided “competent, valuable, diligent and effective” assistance.  It holds the “dispositive principle is ‘no harm no foul.’”

The case deserves some attention because of the tension between stipulations and effective representation.  The Tax Court relies heavily on the stipulation process.  Tax Court Rule 91 requires the parties to stipulate to the fullest extent possible.  When the parties submit a stipulation, the Court does not easily allow one party to back out of it after submission.  See, e.g., Muldavin v. Commissioner, T.C. Memo 1997-531  It does not want to look behind each stipulation to determine if the facts are correct or what motivated the stipulation of the facts.

However, when a taxpayer’s representative has not accurately represented himself to the taxpayer in terms of his capacity competing concerns arise which cause the Court to need to look into the statements by the representative as they impact the integrity of the system.  The system relies on appropriate representation and if a taxpayer is duped or inappropriately represented the Court must step in to rectify the situation.  The recent case of Liu v. Commissioner  presented this issue to the 5th Circuit which refused to set aside a stipulated decision based on the alleged bias of petitioners’ former attorney because it found the attorney did not cause the stipulation.  This is also why the removal of a representation from the ability to practice before the Court is important as discussed in an earlier post which case was affirmed on appeal by the D.C. Circuit.

The 7th Circuit’s concerns were legitimate and caused the Tax Court to go behind the stipulation in great depth.  In the end, the Tax Court’s lengthy opinion essentially proves that Mr. Niehus gave proper advice and gets the parties back to where they were at the time of the original stipulation but now without concerns that the integrity of the system was impugned.  This case shows how much additional work can result when accusations of attorney or judicial misconduct arise.