Priority Status of Individual Mandate Tax Obligation

In In re Chesteen, No. 17-11472 (Bankr. E.D. La. 2-9-2017), the bankruptcy court determined that the liability imposed by the individual mandate is not a tax but a penalty. The consequence of that determination is that the IRS has a general unsecured claim in the debtor’s bankruptcy case and not a priority claim. With the elimination of the individual mandate last year, this decision may not have a significant impact; however, it is another in a series of cases pairing back items in the IRC that are classified as tax for purposes of the bankruptcy code. Guest blogger Bryan Camp teed up this issue and correctly predicted the outcome in a post in 2016.

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The debtor failed to sign up for health insurance. That failure resulted in a liability to the IRS. He filed for chapter 13 bankruptcy on June 8, 2017. Both the debtor and the IRS filed multiple schedules or claims listing varying amounts of priority tax liability; however, in the final claim filed by the IRS it listed, inter alia, the amount of $695.00 due for 2016 as an excise tax entitled to priority status. The debtor objected to the claim, arguing that it was not a tax but a penalty.

Excise taxes that arise within three years of the filing of a bankruptcy petition receive priority status pursuant to BC 507(a)(8)(E)(i). The individual mandate liability is imposed under IRC 5000A and is labeled as an excise tax. The label placed on a liability by the Internal Revenue Code does not control the character of a debt for bankruptcy purposes. As we have discussed previously here, and here, the Supreme Court has determined that a liability labeled as a penalty under IRC 6672 is, for bankruptcy purposes, a tax in Sotelo v. United States, 436 U.S. 268, 275 (1978) and that an excise tax under IRC 4971(b) is, for bankruptcy purposes, a penalty in CF&I Fabricators, 518 U.S. 213, 224 (1996).

The court in Chesteen cites to Sotelo and CF&I Fabricators and numerous other cases that have decided this issue. To decide whether the individual mandate is a tax or a penalty, the court must determine whether the primary purpose of the individual mandate serves to support the government or punish and discourage certain conduct. The court cited CF&I Fabricators for the proposition that the proper analysis turns on whether the liability acts more like a penalty or more like a tax. The IRS argued that the individual mandate excise tax had many characteristics similar to the trust fund recovery penalty imposed by IRC 6672. The court rightly rejected that argument. The individual mandate bears little resemblance to the TFRP in form or substance; however, that does not necessarily mean that it is a penalty.

The court found that it is “designed to deter citizens from living without health insurance.” While true, that also does not necessarily control the determination. Many taxes seek to encourage or deter certain behaviors. If ever tax that influenced behavior or, sticking to the negative side, tried to keep people from doing certain things the number of liabilities imposed in the IRC which achieved the label of tax for bankruptcy purposes could be quite small. Here, the court looked also at the limitation imposed on the collection of the individual mandate. The severe limitation on the IRS collection function with respect to this tax influenced the court in its thinking of the special nature of this liability.

The court also looked at the label Congress placed on the individual mandate. In the statute imposing this liability, Congress referred to the liability 18 times as a penalty and none as a tax. While not controlling, this labeling certainly played an influential role in the thinking of the court.

Conclusion

To my knowledge, this decision represents the first bankruptcy court to render an opinion on the character of the individual mandate. The court follows traditional analysis in reaching the conclusion that the liability falls more on the penalty side of the equation than the tax side. Much about provisions placed into the Internal Revenue Code such as the Affordable Care Act will fail traditional tests of tax. As Congress loads more and more non-traditional liabilities into the IRC, practitioners should push back hard on the label of tax which results in priority status, which results in non-dischargeability. These types of issues will continue to provide a battleground for the IRS.

 

Taxpayer Call to IRS Automated Call Site Broadcast Over Radio on Howard Stern Show: Judge Hits Taxpayer With the Hein

Perhaps I am the last person on the planet to know about this case, but in an opinion issued on March 9, 2018, Judge Burroughs of the District of Massachusetts found that the broadcasting of a conversation between a taxpayer and an IRS collector working at its Automated Call Site (ACS) did not give rise to a claim against Howard Stern nor could that taxpayer seek a claim against the IRS under the Federal Tort Claim Act; however, the case can move forward as a violation of the disclosure laws under IRC 6103. For anyone with a curious nature and the love of an amazing story, find the opinion in Barrigas v. United States here.

When I read the opening lines of the case I wondered how in the world would someone calling ACS have their conversation broadcast on a radio show. Not long into the opinion I found out. Truth is stranger than fiction and no one could have made up a case like this. An ACS employee decided that it would be a good idea while he was working to give a call to the Howard Stern radio show. His call was placed on hold by the show (some poetic justice there) and he remained on hold for some unspecified time. While on hold with the Howard Stern show, he received a call from a taxpayer concerning her account. The taxpayer had a payment plan, and while paying on the plan the IRS offset her current year tax return.

So, the ACS employee and the taxpayer begin a 53 minute conversation about her issue and at some point in that conversation the ACS employee comes off of hold with the Howard Stern show and goes live. Now the conversation, at least the ACS’ employee’s side of the conversation, gets broadcast to the listeners of the Howard Stern show. Mr. Stern is puzzled by the conversation taking place. He and another gentleman make comments about it and apparently tried without success to get the attention of the ACS employee. At the end of the three minute portion of the conversation which was broadcast (the transcript of which is spelled out in the opinion), the ACS employee provides the telephone number of the taxpayer. The providing of that telephone number apparently allowed alert listeners of the show to light up the phone of the taxpayer.

The taxpayer was not happy or amused that her conversation with ACS was partly broadcast over the radio, and available for some time thereafter on its web site, so she brought suit against the IRS and Howard Stern. We do not learn from the case the fate of the ACS employee. One suspects that the manager of the ACS employee will be writing memos for the remainder of their career. The career of the ACS employee may be cut short by this episode. Look for a new provision in the IRM directing ACS employees not to call talk radio shows while on duty.

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Reading this post will not bring you much tax knowledge, but how could we not write about such a case. It’s probably best to read the opinion rather than the post but I will provide you with a distilled version of the legal issues and the approach the court took to those issues. For me, the most important thing about the case is that it could exist at all.

Tort Claim Against IRS

The first issue addressed is the taxpayer’s claim against the IRS using the Federal Tort Claims Act. This Act provides a limited waiver of sovereign immunity. Although the Act waives sovereign immunity, it includes a specific exception to the waiver for tax matters for “”[a]ny claim arising in respect of the assessment or collection of any tax or customs duty. . . .” 28 U.S.C. § 2680(c). In the end, the court finds that the exception applies to this situation. This determination keeps the IRS from having liability for damages to the taxpayer arising out of the on air conversation. The taxpayer argued that the phone call by the ACS employee was clearly outside of his duties as an IRS employee and that created an exception to the rule limiting the waiver of sovereign immunity. The court found that basically every time the IRS would get into a bad situation, the agent would be acting outside the scope of their duties since the IRS was not going to give them duties that would harm people in a tortious manner. In this section of the court’s discussion, it did cite to another case in which an IRS employee checking out a casualty loss on a taxpayer’s property took a picture that captured someone standing in a house adjacent to the property in question in less clothes than the individual wanted to be caught on camera. That case provides just another example of the many ways one could not predict that trouble could arise.

Claim against Howard Stern

After dismissing the claim against the IRS for tort damages, the court next looked at the claim against Howard Stern. It determined that Mr. Stern had done nothing wrong by picking up the call from the IRS employee and acknowledged that the call was confusing to Mr. Stern when first received. Her first claim is one of invasion of privacy under Massachusetts’s law. The court found that the actions of Mr. Stern could not be viewed as an intentional act to invade her privacy. The court further found that even if Mr. Stern’s actions were viewed as intentional, “[p]laintiff has not plausibly alleged an unreasonable, substantial, or serious intrusion into highly personal information. To state a claim for invasion of privacy, Plaintiff must prove that there was ‘[1] a gathering and dissemination of facts of a private nature that [2] resulted in an unreasonable, substantial or serious interference with [her] privacy.’”

She alleged that Mr. Stern was negligent in broadcasting the information. Here, the court found ‘[p]laintiff has failed to state a claim under the Massachusetts Privacy Act because, among other things, the disclosed information was not sufficiently personal or intimate in nature.” Most of the conversation disclosed no information about her because the radio show only picked up what the IRS employee was saying and not what the taxpayer was saying. This was not a conference call situation. The data available from the one-sided conversation provided little information about the taxpayer and if the IRS employee had not mentioned her phone number would have provided no information about her.

Her last claim was for intentional infliction of emotional distress. Here again, the court could not find the intent on the part of Mr. Stern necessary for her to succeed. So, it dismissed this count as well and dismissed Mr. Stern and his company from the case.

Disclosure

What remains after this opinion is the cause of action seeking damages for the IRS disclosing tax return information. The court did not discuss the disclosure violation aspect of the lawsuit other than to say that it was not dismissing that part of the case. I will be surprised if we ever see an opinion on that part of the case because I expect that the IRS will work hard to settle that aspect of the case. If it does not, however, we will get the chance for another interesting blog post.

 

Summonsing Records for the French Taxing Authority

A couple years ago, I wrote a post about the efforts of the IRS to assist the Danish tax agency to collect from a taxpayer in the United States. That case involved a levy on the taxpayer’s assets. Recently, another one of the five countries that have collection treaties with the IRS had an opinion issued based on the efforts of the IRS to assist it in collecting taxes due to France. In the case of Hanse v. United States, No. 1:17-cv-04573 (N.D. Ill. March 5, 2018), the court analyzes the treaty provisions in the context of a summons enforcement case. The application of the summons laws in this case results in an order that the information sought be provided to the IRS/France.

I wrote a post almost four years ago on the failure of tax administration to negotiate collection provisions into every tax treaty and not just have it in five treaties that happen to have been written at a time when someone thought this was a good idea. In a global economy, it still seems like a good idea. We have passed laws seeking to ensure that we know about the income of U.S. citizens around the world and leaned on other countries to cooperate in helping the IRS know of the income. To complement that effort, the IRS needs to have the treaty tools to collect when assets exist overseas and it cannot obtain personal jurisdiction over the taxpayer. The absence of collection language in our tax treaties makes it difficult, and at times impossible, for the IRS to collect from taxpayers who park their assets in the vast majority of countries since the IRS lacks a mechanism for reaching those assets.

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France is investigating the potential wealth tax and income tax liabilities of Mr. Hanse for the years 2013-15. The French tax authorities sent to the IRS an exchange of information request seeking information in connection with its investigation. France particularly wanted information about two transfers by Mr. Hanse totaling over 500,000 €. The request stated that Mr. Hanse was a French citizen and that the French tax authorities had exhausted the remedies domestically available for gathering the information. The IRS did not have the information requested. The U.S. competent authority determined that the request was proper under the treaty provisions. So, the IRS served a summons on the party to whom the funds were transferred, a third party in the US, and sent notice to the taxpayer at the address provided by the French authorities.

The taxpayer timely filed a petition to quash the summons raising three objections: 1) the IRS failed to comply with the administrative steps necessary for a valid summons under the IRC because it contacted third parties without providing advanced notice under IRC 7602(c)(1); 2) France could not obtain the information through its own laws so it should not use the treaty to accomplish what it could not do if this were an entirely domestic situation; and 3) the summonsed party is a law firm and some of the materials requested by the summons required protection from disclosure by the attorney client privilege.

The IRS moved to dismiss and attached to its motion affidavits from the competent authority and the revenue agent serving the summons. The court decided to treat this as a motion for summary judgment which is normal in most contexts, though not as normal in a summary proceeding such as a summons enforcement.

Before addressing the first argument, the court notes that the IRS must meet the four elements of the Powell test. We have discussed those elements before. A similar notice argument was addressed in a recent post written by Les. The court notes that the burden on the IRS with respect to the summons remains the same whether the summons involves a “normal” U.S. taxpayer or is done at the request of a treaty partner. Here, the court finds that the affidavits allow the IRS to meet its burden under the Powell test, which it acknowledges is not a heavy burden.

Good Faith of French Investigation

The taxpayer argues that French law would not allow the French authorities to obtain the information sought through the summons and, therefore, those authorities should not circumvent French law and obtain the information just because the U.S. laws do permit the gathering of the information. The court takes this as a challenge to the “legitimate purpose” element of the Powell test. This is where a treaty summons gets a little interesting. Looking at prior case law involving other treaty summonses issued on behalf of France, the court finds that to satisfy the Powell test it need not look at the good faith of the treaty partner but only at whether the IRS acted in good faith in issuing the summons. Since the taxpayer did not challenge whether the IRS issued the summons in good faith and the court saw no indication of bad faith, it finds that this challenge fails.

Compliance with IRC

Petitioner challenges the issuance of a summons to a third party where the IRS has not provided the taxpayer with a notice pursuant to IRC 7602(c)(1). We have written very little about IRC 7602(c), which is a provision that came into the code in the 1998 Restructuring and Reform Act. Les addressed it in an earlier post and notes at least one case that has held the taxpayer should receive specific notice of contact of third parties. Most issues involving this code section, which requires the IRS to notify taxpayers before it contacts thirds parties about them looking for information, concern the IRS position that Pub 1 generically informs them of the possibility that the IRS might do this (thus satisfying the statutory requirement) versus the need, in the view of some taxpayers, for the IRS to specifically tell them who it intends to contact.

Here, the IRS neither generically nor specifically informed the taxpayer of its intent to contact a third party by serving the summons. The taxpayer argues that this failure makes the summons unenforceable. The IRS argues that the protection of IRC 7602(c) does not extend to the taxpayer because it “does not include the liability for any tax imposed by any other jurisdiction.” 26 C.F.R. 301.7602-2(c)(3)(C). The court agrees with the IRS. This creates an interesting exception for taxpayers whose summons cases arise under treaty language

Attorney Client Privilege

I recently wrote on another summons case in which the taxpayer sought to keep the IRS from information based on the attorney-client privilege. The court here notes that a blanket assertion of attorney-client privilege does not work and that the taxpayer needs to assert the privilege on a document by document basis. Because the taxpayer did not support the privilege claim with “any facts from which the Court could find a privilege attaches to the documents that are requested in the summons” the court rejects his privilege argument.

Conclusion

Some aspects of the treaty summons differ from a “normal” summons in their application because of the interplay of the code with non-US taxpayers. Here, the summons gets enforced and presumably France gets the information it needs in order to move forward with its tax investigation. Only a handful of these cases have been reported, suggesting either that countries do not need to resort to the treaty very often in order to complete their investigations or that investigators do not use this tool as effectively as they might. As the global economy continues to push through borders, we should expect more of these cases and there could be many more if we negotiated different treaty language regarding collection.

 

 

 

Dischargeability of the First Time Homebuyer Recapture Liability

In Betancourt v. United States, the bankruptcy court for the Western District of Missouri addresses an issue of the character of a debt owed to the IRS as it determines the dischargeability of that debt.

The taxpayer seeks a determination that this type of debt gets discharged in bankruptcy because it does not fall within any of the enumerated exceptions to discharge that apply to taxes. The court finds for the taxpayer. Although the issue here is narrow and has scarcely be litigated, it points to the problem the IRS can have when a debt does not conform to norms for tax debt and the IRS seeks to prevent a discharge.

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Ms. Betancourt purchased a home in Liberty, Missouri in 2008. She claimed the first-time homebuyer credit and received a $7,500 credit on her 2008 return. To obtain the credit, she needed to purchase a home for the “first time”, between April 9, 2008 and May 1, 2010. However, Congress was not just concerned with the initial purchase and added in the law a requirement for repayment of the credit over a 15-year period in certain circumstances. For those unfamiliar with this credit, some links to the IRS descriptions of the credit, here, here, here and here, may help in understanding the issue. Ms. Betancourt argues that the debt for repayment of the credit relates either to 2008 when she received the credit or 2010 when her repayment period began. Based on when she incurred the debt she argues that it is not entitled to priority status and neither is it excepted from discharge.

The IRS argues that the recapture obligation arises each year and that for the years starting with 2017, when she filed bankruptcy, the debt is a future debt contingent upon events that have not yet occurred and, therefore, it did not need to file a claim for this future debt and the future debt was not discharged by the bankruptcy case. It filed a claim for $39.00 as a priority amount because that was the amount of unpaid repayment due at the time of the filing of the bankruptcy petition. The IRS relied on the decision in In re Bryan, 2014 WL 789089 (Bankr. N.D. Cal. 2014), in which the court characterized the obligation to repay the new homebuyer’s credit as a non-dischargeable tax rather than a dischargeable general obligation. Bryan held that the obligation to repay was a tax obligation and that characterization triggers the application of the discharge provisions for taxes rather than for general claims.

At issue here is both the character of the debt as tax and the character of the debt as a fixed future obligation or an obligation so contingent as to fail to meet the broad definition of the word claim. Rather than viewing the repayment obligation as a tax obligation, the court in Betancourt views the transaction as a loan when viewing all of the parts of the transaction. If the credit and its repayment obligation has the character of a loan rather than a tax, then the bankruptcy outcome is completely different. The court cited an IRS Information Release, IR-2008-106, which states “the credit operates much like an interest free loan because it must be repaid over a 15 year period.” Form 5405 is subtitled “Repayment for the First Time Homebuyer Credit” and the instructions for the Form repeat the term “repayment.” There are other bankruptcy cases in which the courts have looked at the substance of the transaction in characterizing the nature of a liability in order to determine its status as a claim in the bankruptcy case. Two of the most famous examples of this are Sotelo v. United States, 436 U.S. 268 (1978), in which the Supreme Court characterized the trust fund recovery penalty of IRC 6672 as a tax rather than a penalty because it is a provision designed to allow the IRS to collect the underlying tax and not one imposing a penalty on the person assessed. In 1996, the Supreme Court in United States v. Reorganized CF&I Fabricators of Utah, Inc., 518 U.S. 213 (1996) determined that the excise tax imposed by IRC 4971 for late payment of funds into a pension plan was not a tax but rather was a penalty, calling into question the character, for purposes of filing a bankruptcy claim, of a whole host of excise taxes imposed for wrongful behavior or to discourage “sin,” such as the excise taxes on cigarettes and alcohol.

In addition to the tax versus loan issue, the court also raises the issue of what constitutes a debt. This is a much litigated issue in bankruptcy because it goes to the core of when a claim must be filed and when the discharge provisions come into play. The court cites to the precedent on this issue in support of its conclusion that the IRS possesses a right to payment which triggers an obligation to file a claim against the estate and not to rely on future repayment as a basis for arguing the debt is not a claim.

The court finds that the right to payment arose before the filing of the bankruptcy petition, which fits within the definition of claim in B.C. 101(5)(A). It determines that this prepetition debt is not a priority tax obligation but a non-tax one. Stripped of its tax veneer, the debt loses its exception to discharge and the court determines that the repayment obligation is dischargeable.

Conclusion

I do not know if the IRS will appeal this decision. The decision could impact a decent number of individuals who benefitted from the first time homebuyer credit and whose obligation to repay has not yet run. Any dischargeability determination like this has consequences for anyone who has gone through bankruptcy with this type of debt since they could still bring a discharge action even if the bankruptcy ended some time ago. If correct, the decision would mean that the IRS probably has a number of discharged debts on its books that it continues to attempt to collect in violation of the discharge injunction. The decision could also implicate other situations in which Congress chooses to use the tax code to front money to taxpayers as it did here in an attempt to spend our way out of the great recession. If Congress is concerned about the loss of priority status here, it may need to structure similar provisions differently in the future to make sure that they do not lose their character as tax debt and to make sure, if they want these types of debt to retain priority claim status throughout the repayment period, that the debt arises anew each year (or something to keep it new enough for priority status). The court seems clearly right on the issue of whether this debt meets the requirements of being a claim. The tax versus non-tax character of the debt is closer since the taxpayer is repaying a tax benefit, but I cannot say that the court was wrong on that aspect of its decision either.

 

Using an Affidavit to Avoid Summary Judgment

We have been requested to notify you that the USD School of Law-RJS Law Tax Controversy Institute will take place this summer on July 20, 2018 at the University of San Diego School of Law Campus. Some PT guest bloggers will be speaking as will Chief Judge Paige Marvel of the Tax Court. For more information about the conference go here.  It is nice to have a conference that focuses on the issues discussed in this blog.

In United States v. Stein, the 11th Circuit reverses longstanding precedent in that circuit and allows a taxpayer to get past a summary judgment motion filed by the IRS and reach the jury. The decision may not result in a victory for Mrs. Stein in the long run but it allows her, and other similarly situated taxpayers (as well as litigants in non-tax cases), to put on their case.

As I will discuss further below, the concurring opinion of Judge Pryor in this en banc opinion provides a history lesson supporting the reasoning of the Court’s opinion and gives interesting insight into the relationship between the dreaded Stamp Act and Mrs. Stein’s ability to move past summary judgment.

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The IRS brings relatively few affirmative suits to collect. It does so when the amounts justify the expenditure of effort, the potential to actually collect exists, and, usually, the taxpayer’s cooperation with administrative collection efforts has been less than robust. In this case, the IRS sues Mrs. Stein seeking to reduce its assessment of approximately $220,000 to judgment. It alleged that she had unpaid taxes for 1996 and 1999-2002.

As is normal in these cases, the IRS submitted account transcripts showing her outstanding liabilities and an affidavit from an IRS officer supporting and explaining the transcripts. It moved early in the case for summary judgment based on this information. Mrs. Stein, in response, filed an affidavit in which she stated that to the best of her recollection she paid the taxes at issue. Her affidavit addressed each year in turn with such a statement; however, it did not contain any corroborating evidence of payment.

The district court granted the IRS summary judgment concluding that the evidence presented by the IRS created a presumption that the assessments were correct and that Mrs. Stein “did not produce any evidence documenting said payments.” Her lack of documentation did not allow her to overcome the presumption of correctness. So, the district court determined there was no genuine dispute as to any material fact making the IRS entitled to summary judgment as a matter of law.

She appealed the district court’s decision to the 11th Circuit but lost her appeal. She requested en banc review of the decision. The en banc review resulted in a reversal of the prior decisions in her case and a reversal of Mays v. United States, 763 F.2d 1295 (11th Cir. 1985). In reversing, the panel examined FRCP 56 which governs summary judgment and determined that “nothing in Rule 56 prohibits an otherwise admissible affidavit from being self-serving. And, if there is a corroboration requirement for an affidavit, it must come from a source other than Rule 56.”

The panel states that it makes no difference that this is a tax case. The same summary judgment standard applies in tax cases as in other areas of the law. Doubling back to its earlier statement on corroborating, the panel says Rule 56 simply has no such requirement and that “a non-conclusory affidavit that complies with Rule 56 can create a genuine dispute concerning an issue of material fact, even if it is self-serving and/or uncorroborated.” Of course, this does not mean Mrs. Stein will win her case – far from it. Unless she obtains some proof of her payment of the liabilities or finds a basis for attacking the assessments beyond the statements in her affidavit, I expect she will lose in the end.

Getting past summary judgment is still a big deal. It allows her to gather evidence in support of her payments she may not have done before and it allows her to tell her story to a jury which is where Judge Pryor’s concurrence comes into play.

Judge Pryor states that he writes “to highlight the irony of our earlier precedent when viewed in the light of the history of the Seventh Amendment.” He explains that in the decades before the American Revolution, parliament grew tired of American juries which held for American interests in tax case. So, it expanded the jurisdiction of the Admiralty Courts, which sat without juries, to include trade cases even though those cases would have resulted in jury trials in England. It later expanded the jurisdiction of Admiralty Courts in America to cover matters involving the Sugar Act and the Stamp Act, seeking to avoid “friendly” juries in America.

The colonies strenuously objected to these measures and the right to a jury trial became one of the chief complaints leading up to the revolution. It became an issue in the Constitutional Convention as well and Alexander Hamilton wrote about it in the Federalist Papers. He equated the granting of summary judgment in these circumstances to the type of behavior that our forefathers sought to avoid in overthrowing the yoke of British rule. Judge Pryor’s concurring opinion is a good read for history buffs and perhaps for any lawyer wanting to know more about the origins of American law and how to craft an argument.

By seeking en banc review, Mrs. Stein not only overturned three decades of 11th Circuit precedent but got us a history lesson as well. I wish her the best in finding proof that she did pay the taxes so that her story has a happy ending.  Perhaps, if victorious, she will celebrate by drinking some tea and reflecting fondly on our forefathers.  I would like to expand Judge Pryor’s logic to beat back the government’s current view of the Flora rule where taxpayers such as Mr. Larson are denied an opportunity to even step into court to dispute their tax liability without shelling over millions and millions of dollars.

 

Clash Between Claim of Attorney Client Privilege and Summons Power

In an unpublished opinion in United States v. Servin (No. 2-16-cv-05615), the Third Circuit upheld the enforcement of a summons against a Pennsylvania attorney. This case does not break new ground but serves as a reminder of the power of the IRS summons and the limitations of the attorney-client privilege. Mr. Servin did receive some relief from the summons so his efforts in contesting it were not entirely without success.

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Mr. Servin must owe a decent amount of taxes since his case is in the hands of a revenue officer. Today, taxpayers often must owe in excess of $100,000 to have their case handled by a revenue officer, although that amount can vary based on location and other factors. I have commented before that having a revenue officer assigned to your case is like getting concierge service because you have a knowledgeable individual to work with to resolve the issues rather than having to deal with the Automated Collection Site (ACS); however, my comment was somewhat tongue in cheek because having a revenue officer assigned to your case, particularly if you are not working to resolve the matter, can cause a taxpayer many problems as the knowledgeable revenue officer uses the powerful collection tools at the disposal of the IRS. Here, the taxpayer feels the effect of having his account assigned to a revenue officer rather than to ACS.

This case involves a collection summons which seeks to obtain from him information that would allow the IRS to collect the outstanding liability. Specifically, the revenue officer wants from him information about which clients owe him so that the revenue officer can send a levy to these individuals and businesses in order to collect the outstanding taxes Mr. Servin has not voluntarily paid. The summons requests Mr. Servin’s current client list, including names and addresses of all of the clients and a list of his cases that will be settling or have settled within a specified time period, including names and addresses of the parties to the case (who would also be persons the revenue officer would levy.) Undoubtedly, having levies served on all of your clients and opposing parties would not enhance Mr. Servin’s business. Preventing that from happening would protect his business and professional interest, in addition to client confidentiality which is why we have this summons case on which to report.

Mr. Servin does not contest that the IRS meets the general Powell standards for issuing the summons. The meet the Powell requirements, the government must show that the summons: (1) is issued for a legitimate purpose; (2) seeks information that may be relevant to that purpose; (3) seeks information that is not already within the IRS’s possession; and (4) satisfies all administrative steps required by the Internal Revenue Code. United States v. Powell, 379 U.S. 48, 57-58 (1964). He argues narrowly based upon the defense of attorney-client privilege. Unfortunately for Mr. Servin, the Third Circuit has pre-existing precedent on the issue of using the attorney-client privilege to protect client identities from summons enforcement in the case of United States v. Liebman, 742 F.2d 807 (3d Cir. 1984). The precedent does not favor the outcome he seeks. The Third Circuit precedent is similar to precedent that exists in other circuits.

The general rule does not permit an attorney to protect client names and addresses from summons enforcement based on attorney client privilege. The Third Circuit finds that Mr. Servin fails to identify any circumstances that would cause his case to fall out of the general rule and allow him to shield his client information. The Pennsylvania Rules of Professional Conduct do not prevent this disclosure despite his desire to use those rules and his citation to them.

He does win a partial victory because the court modifies the summons to eliminate the name of individuals that have not yet settled but will settle in the future. This victory reflects the concerns that the IRS limit its intrusion into client information of an attorney. The IRS does not often or lightly summons attorneys for client information. The revenue officer who wants to summons an attorney must persist in order to obtain permission to do so. Summonsing an attorney results in reviews by both Chief Counsel and Tax Division lawyers before the summons is allowed. IRM 5.17.6.14 & 15 discusses some of the special issues related to summonses issued to attorneys. The reason that the IRM requires much higher level of review of summonses issued to attorneys stems from the very matter at issue in this case. The IRS recognizes the sensitivity of client information and does not want to let revenue officers run loose in seeking this information. So, it wants a review before it seeks enforcement. The IRS also does not like to issue summonses that it does not enforce since doing so undermines the authority of its summonses. This causes it to require review of summonses in sensitive areas.

Here, the revenue officer seeks information that the attorney cannot protect. The summons victory may cause Mr. Servin to full pay the liability in order to avoid having levies issued to many of his clients. If so, the summons itself may serve as a very valuable collection tool. If it does not cause Mr. Servin to full pay the liability, his clients and many individuals in his community may be about to learn about their attorney’s tax compliance or tax dispute. It is possible that he could still contest the liability and prove that he does not owe. It’s hard, however, to unring the bell and explain to a host of people that he did not owe when they receive a levy seeking payment of the liability which is why this is a very sensitive matter even if the names are not protected by attorney-client privilege.

The discussion of the relationship between Pennsylvania’s Rules of Professional Conduct serves as an important reminder that those rules too have limits, especially when they run into a valid investigation of an attorney’s conduct. PA Rule of Professional Conduct 1.6 is broader than the attorney client privilege; it provides that “A lawyer shall not reveal information relating to representation of a client unless the client gives informed consent, except for disclosures that are impliedly authorized in order to carry out the representation.”

Servin claimed “in the absence of the client’s informed consent the lawyer must not reveal information relating to the representation – moreover a presumption exists against such disclosure.”

The opinion notes however that the Rules of Professional Conduct are not relevant in the court’s consideration of whether to enforce a summons; rather those rules relate to a state’s possible disciplinary proceedings against a lawyer. Comments to PA Rule 1.6 specifically provide that the scope of the rule is limited by substantive law, and numerous PA cases provide that the Professional Conduct Rules do not govern or affect the application of the attorney-client privilege.

 

 

The Freedom of Information Act and the Office of Professional Responsibility

Working for over three decades for Chief Counsel’s office, one of my goals was to avoid disclosure issues both on a personal and professional level. On a personal level, I wanted to know enough to keep out of trouble and on a professional level I wanted to avoid getting labeled as someone who knew disclosure law because that could lead to more assignments regarding disclosure issues which I did not want. At Chief Counsel’s office, FOIA was lumped in with IRC 6103 and the Privacy Act. Practicing at a clinic, I only want to know enough about the Office of Professional Responsibility (OPR) to avoid having contact with it. Just as I did not want to know more about section 6103 than I needed in order to avoid trouble while working at Chief Counsel’s office, I do not want to learn more about OPR. I want to know the ethical rules but not what happens when you break them, because I hope that is knowledge I will never need.

Today’s case takes me into the confluence of two things I try to avoid and yet the case has important lessons worth discussion. In Waterman v. IRS, 121 AFTR2d 2018-__(D.D.C. 1-24-2018), the issue before the court is a request for records from OPR regarding an investigation of an attorney. The attorney, Brad Waterman, practices in D.C. and has for several decades. He graduated from my law school the year before me and we have met on several occasions. He has an excellent practice and the last time we met he was splitting his time between D.C. and Florida, depending on the season. The fact that he is seeking records from OPR concerning an investigation does not mean he engaged in inappropriate behavior. I know nothing about the investigation other than it was quickly closed which, it turns out, is his problem in this case. His case caused OPR to change its procedures despite, or maybe because of, his FOIA difficulties to make it easier for someone in his situation to obtain records from OPR.

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In representing a client in a matter involving a tax exempt bond, Mr. Waterman caused the revenue agent in the IRS Tax Exempt Bond office to feel that Mr. Waterman engaged in misconduct. The revenue agent, through his manager, made a referral to OPR. After investigation, OPR determined that “the allegation against Waterman did not warrant further inquiries or action.” I recently attended the ABA Tax Section meeting, at which I attended the Standards of Practice committee meeting in an effort to keep up on ethical issues. At that meeting, the director of OPR, Steve Whitlock, spoke and he talked about this case. I began writing this post on the plane to San Diego to attend the meeting. So, when the director started talking about this case, I woke up from my normal meeting stupor and started listening carefully. I hope I heard and understood him correctly.

Apparently, OPR decided not to pursue this case without sending out a letter to Mr. Waterman asking him for information. OPR regularly determines that many of the referrals it receives do not warrant further investigation and do not require making the referred individual submit material. When it makes this decision at the internal investigation stage, the case is closed with a letter to the individual informing the individual of the closure of the case without need for input from the individual. This was the normal procedure at the time OPR closed Mr. Waterman’s case. It was also, and still is I believe, the normal procedure for the OPR letter informing the individual of its conclusion to also inform the individual that OPR would retain the file on the matter for 25 years and that it reserved the right to reference the file in any future OPR investigations. Ouch. I suspect that receiving such a letter with the language about retention drove Mr. Waterman to want to know as much about the referral and investigation as possible in the event that it might have future ramifications.

The problem Mr. Waterman faced in trying to obtain information about the referral is that because OPR closed its investigation at the time of the sending of the letter, he could not use the section 6103 procedures, see here and here, that OPR suggests individuals use to obtain information about the referral. Had his case not been closed with an early letter, he would have instead received a far more ominous letter informing him of the investigation and asking him to respond to the allegations. In that situation, OPR would not have a closed investigation but a very open one. During an open investigation, OPR suggests that individuals use the section 6103 process to obtain information about the investigation. Because his investigation was closed by the time Mr. Waterman knew he wanted information, he could not use the section 6103 procedure and instead had to revert to FOIA in order to try to obtain the information.

The OPR director stated at the ABA meeting that because of this case, OPR was changing its procedures. Now, instead of issuing the one letter and closing the case immediately, it is going to issue a preliminary letter giving the target individual 60 days to make a statement to OPR and to obtain information about the investigation through section 6103. See the following paragraph for a link to this letter. Now, a recipient of this “good” OPR letter, if there is such a thing, can use the section 6103 procedures for obtaining information before OPR closes its case 60 days later. If someone receiving this good letter fails to ask for information about the investigation under section 6103 during that 60 day period, then they will face the same FOIA obstacles which Mr. Waterman encountered and which I will discuss below. I hope that neither I nor any reader will need the benefit of this knowledge, but just in case I provide it for any who have the misfortune of a referral.

Attached to the outline created by the director of OPR for his presentation at the ABA meeting were samples of the three letters sent by OPR. The first letter is called the pre-allegation letter. This is the letter alerting the recipient of an OPR investigation that is not being dropped after the initial internal review by OPR. The second letter is called the “soft conduct letter – initial” This is the letter giving the recipient the chance to request information from OPR using IRC 6103 and avoiding the problems faced by Mr. Waterman. This letter would be sent to someone that OPR determines not to investigate further after reviewing the incoming allegations. The third letter is called the “soft conduct letter” which should be sent about 60 days after the initial soft conduct letter and which would inform the recipient that OPR was closing its investigation.

The FOIA case does not discuss the merits of the investigation. From the opinion, it is clear that Mr. Waterman made informal requests for information about the investigation and did not receive everything that he wanted. So, he made a formal FOIA request. In responding to the FOIA request, the IRS withheld certain information asserting primarily FOIA exemption 5, which “allows agencies to withhold information that would not be available by law to a party … in litigation with the agency.”

In the FOIA case, Mr. Waterman agreed that the IRS search for the requested records was adequate. I want to take a brief detour here to mention another recent FOIA case, Ayyad v. IRS, No. 8-16-cv-03032 (D. Md. 2-2-2018). In the Ayyad case, the requester did not agree that the search for the records was adequate and for good reason. An examination of the taxpayer was pending for about a decade when they filed the FOIA request seeking records, which included the administrative file developed by the revenue agent including all written correspondence relating to the examination. With relatively amazing speed for a FOIA case, the IRS identified 2,885 pages of responsive records but did not produce a Vaughn index detailing the redacted and withheld records. After the taxpayers filed their FOIA suit, the IRS informed the Court it found an additional 872 pages. Later, after the taxpayer stated records were still missing, the IRS found another 6,568 pages. Needless to say, the IRS did not cover itself in glory in this case and did not prevail. Its inadequate searches and its failures to submit proper Vaughan indices resulted in an unfavorable FOIA decision. So, it is not unimportant that Mr. Waterman agreed with the IRS search. His case was much less involved and he undoubtedly knew what records were out there, but the Ayyad case provides a note of caution in relying on the first submission of records from the IRS.

In Mr. Waterman’s case, the court found that the Vaughn index properly described the withheld documents and the basis for the exemption (also a major issue in the Ayyad case). The documents at issue were pre-deliberative and involved material created by the revenue agent who made the referral, his manager, preliminary findings of the OPR investigator, and an email between OPR and counsel. The court finds all of the documents meet the test under FOIA exemption 5. If I understood Mr. Whitlock correctly, Mr. Waterman would have received the referring documents under a section 6103 request made during an open OPR investigation. I do not believe he would receive the other two documents under section 6103.

I am very sympathetic with Mr. Waterman’s right to know the basis for the investigation. Because OPR is retaining the records for 25 years, he has genuine concerns. I applaud OPR for changing its procedures to allow other similarly situated individuals to obtain records under the more friendly section 6103 procedures. I hope the information in this post is information you and I will never need to know.

 

The Newly Nominated Commissioner

The press reports that President Trump would nominate Chuck Rettig as the new IRS Commissioner were followed with a formal announcement. Assuming he is confirmed, Mr. Rettig will serve as the first tax lawyer in this position in the new millennium. I applaud the return to having someone run the IRS who has a deep understanding of tax law but perhaps this shows my age rather than my management acumen. In addition to applauding the return to the position of commissioner someone who has a career in tax law, I also applaud the selection of Mr. Rettig who will perform ably in this position based on his experience and demeanor.

For those interested in tax procedure and tax controversy, it is especially notable that the President has nominated Mr. Rettig. Even in the bygone era of tax lawyers as commissioners, it was not necessarily the norm to appoint a tax lawyer who specialized in controversy rather than tax planning. This is an important opportunity for the shaping of tax administration by someone very familiar with tax procedure and the issues created when taxpayers have a problem with the IRS. One earlier commissioner with a litigation background (having taken Flora v. United States to the Supreme Court twice) who served with distinction and stood up to President Nixon when he sought to use the IRS to torment his “enemies” was Randolph Thrower. It is a proud tradition to uphold.

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Since the appointment of Charles Rossotti in 1999, Presidents have appointed a series of individuals with management experience but not tax experience. Mark Everson became commissioner in 2003 with a fair amount of government management experience, Douglas Shulman in 2008 with public and private management experience, and John Koskinen in 2013 with significant public and private management experience. Each of the “management” commissioners over the past two decades had the type of experience necessary to run a large organization, but a steep learning curve on the culture of the IRS and the tax laws it administers. With the exception of Commissioner Everson, I met each of the others briefly and formed favorable impressions. Commissioner Koskinen seemed terrific but could not shake the real or apparent hatred of several vocal members of Congress.

From the time I started working at the IRS and for several decades before, the traditional appointee to the position of Commissioner was a tax lawyer. Usually someone from a big firm and someone with decades of tax experience. Even a lawyer at a big firm, however, has no experience managing a large organization like the IRS with many components. As the information technology component of the administration of the IRS became more and more important, the desire for a tax lawyer became less and less. So, for the past two decades we have had a commissioner who was a management specialist rather than a tax specialist who might surround themselves with others with strong management experience. It’s past time to try a tax lawyer again.

So, who are getting? I had the pleasure to serve with Mr. Rettig on the ABA Tax Section governing council first as co-fellows at large and then with Mr. Rettig elevated to the executive leadership of the section in charge of the finances. He took on the leadership position at a time of challenging finances for the section and he immediately took on the hard task of finding places to cut the budget and seeking new sources of revenue. He has done an excellent job in this position. He has management experience as the managing partner of his firm. He has quite a resume of service to the profession and to the government on advisory boards. He has also been one of the creative forces and leaders behind a very successful ABA conference on offshore issues.

Much of Mr. Rettig’s practice in the past several years has centered on representing individuals with assets offshore who needed to reach an agreement with the IRS. In this type of practice he must learn criminal tax law, civil tax procedure, tax litigation, and a lot of client management. My friend John McDougal who spearheaded the IRS efforts in offshore identification and compliance prior to his retirement has nothing but good things to say about Mr. Rettig as a practitioner having worked with him closely on a number of matters. Praise from John is not easy to come by. I have heard praise for Mr. Rettig from those who work closely with him on many occasions.

Mr. Rettig has a great personality and the kind of personality that will allow him to build the kind of rapport with Congress that the IRS desperately needs in order to get back to proper funding levels. I do not mean to suggest that I think he can charm his way to greater budgets, but I think he will figure out how to work with the appropriate people to make it possible to make a winning pitch for the type of support and the amount of funding that the IRS needs to properly do its job.

The non-tax background commissioners of the past two decades have been smart people with lots of relevant experience in running an organization but it will be refreshing to have a leader of the IRS who knows the tax system from the trenches. He is someone who can quickly size up the proposals being made to him from the compliance and taxpayer assistance functions. Having worked with many clients seeking to hide their money offshore and seeking to fix a problem of having an offshore account created by someone else, he will be able to size up the types of strategies that will allow the IRS to put resources into the proper place to promote compliance based not just on reports from various IRS functions but from decades of working with taxpayers seeking to comply (or not) with the tax laws.

The President has made a great choice. I hope Congress will quickly confirm the choice so that the IRS does not go too long without leadership.