Leslie Book

About Leslie Book

Professor Book is a Professor of Law at the Villanova University Charles Widger School of Law.

Tax Court Judicial Conference Application Deadline Extended to This Friday

Readers may have heard that the Tax Court is holding a judicial conference from Monday evening March 26 to mid-day on Wednesday, March 28, 2018 at Northwestern University Law School. The Tax Court has issued a release about the conference, including information about how to apply to attend.

The Tax Court has extended the deadline to apply, from Wednesday until Friday, November 17.

The Tax Court release discusses the court’s interest in attracting a diverse conference community. The conference will be an opportunity to hear panels on issues of interest to tax litigation as well as give the court a chance to get feedback on ways to improve the tax litigation process. The panels consist of judges, academics, and practitioners from government and the private sector.

Getting together with people who share an interest in the tax litigation process sounds like a great way to spend a few days.

Court Orders Release of IRS Documents Despite Deliberative Process Privilege

Government agencies enjoy the cloak of the deliberative process privilege to protect from discovery in court or in FOIA proceedings internal deliberations that are part of their decision making process. Anadarko Petroleum v United States, a recent district court magistrate’s order, illustrates that the protection is not absolute, resulting in possible disclosure of a range of IRS documents that perhaps will shed light on how the agency apparently changed its view on a technical loss deferral regulation under Section 267.

I will summarize the issue and case below.

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Anadarko brought a $25 million refund suit; the substantive issue involved its taking a loss that arose from a liquidation of one of its subsidiaries. The precise question concerned whether a deferral of the loss ended in 2007, when Anadarko liquidated its subsidiary in a taxable liquidation. The government argued that the deferral should have continued, consistent with a regulation Treasury promulgated under Section 267 in 2012 and which Treasury claimed at the time was clarifying existing rules.

In the suit, Anadarko served interrogatories and sought a variety of documents that it felt showed that the 267 regulations did not clarify existing rules because IRS had previously taken differing views on the issue. It asked for documents relating to private letter ruling, a Chief Counsel advisory opinion and even an ABA Tax Section presentation at or around the time of finalizing the regs.

The government argued that the deliberative process privilege insulated the documents from discovery. That privilege essentially keeps from FOIA requests or court discovery agency predecisional documents, including the types that Anadarko sought.

While the privilege is a powerful cloak, it is not absolute. Courts are supposed to weigh the government’s strong interest in protecting full access to how it comes to a decision with the need of the party seeking the requested documents.

In concluding that Anadarko’s need trumped the agency’s interest the magistrate focuses on how agency changes on an issue may be relevant in a court’s legal interpretation. It did not matter, in the magistrate’s view, that the request considered documents that did not in and of themselves directly relate to precedential agency determinations.

In concluding that the government had to comply with the discovery, the court also felt that the request was proportional and reasonable, in light of the amount at issue and the costs to the government in complying. Backstopping its proportionality conclusion was its view that the nonprecedential documents had a bearing on the court’s ultimate task of sorting out the merits of the taxpayer and government’s views of  Section 267 and the regs.

Conclusion

Anadarko is an important taxpayer victory. I am not well versed with the substantive issue in this case. I suspect, however, that the court’s willingness to allow discovery has a lot to do with what the magistrate believes is at a minimum a less than complete explanation accompanying the regs. If IRS takes differing views on a technical issue, and yet when promulgating a final regulation Treasury claims that it is merely clarifying what the law had been all along, a court (and taxpayers) are justifiably curious as to how that explanation jives with what came before the final reg.

ABA Tax Section Seeking Nominations For Janet Spragens Pro Bono Award

The ABA Tax Section is accepting nominations for its annual award given to an individual or law firm for sustained and outstanding achievements in pro bono activities in the tax law. Nominations will be accepted until December 8th. Information about the straightforward submission process and a listing of the criteria for both firms and individuals can be found here.

The award is named after the late Professor Janet Spragens, who was a pioneer in the tax clinic movement and a mentor to me when I started teaching and directing a tax clinic over 20 years ago.

For those of you who did not have the pleasure of knowing Janet, a wonderful tribute to her from Nancy Abramowitz, her longtime colleague at American University, can be found here. One of my professional highlights was accepting the award on Janet’s behalf when I was able to share with the Tax Section my thoughts on Janet.

I know Janet would be pleased with the work that so many are doing to make the tax system fairer and more accessible.

 

AIA Bars Suit Attempting to Invalidate Insurance Transaction Disclosure Requirements

Earlier this month in CIC Services v IRS a federal district court in Tennessee dismissed a suit that a manager of captive insurance companies and its tax advisor had brought that sought to invalidate IRS disclosure obligations on advisors and participants in certain micro captive insurance arrangements. The case illustrates the still-long reach of the Anti-Injunction Act, which, despite some recent cracks, serves as a formidable barrier to challenging IRS rules outside traditional deficiency or refund procedures.

I will briefly summarize the case and highlight the court’s rationale in dismissing the suit.

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A 2016 Notice indicated that IRS felt that micro captive insurance transactions had the potential for tax avoidance and classified them as transactions of interest. (For background on micro captive insurance companies and the IRS Notice, see a Tax Adviser article here). Failure to comply with the disclosure obligations could lead to hefty civil penalties under Sections 6707(a), 6707A and 6708(a).

CIC, a manager of captives, and an individual who also managed captives and provides tax advice to them, sued in federal district court, claiming in part that the Notice imposed substantial costs and that the IRS in the Notice effectively promulgated legislative rules in APA parlance without complying with mandatory notice and comment requirements. The plaintiffs sought an injunction prohibiting the IRS from enforcing the Notice and a declaratory judgment claiming that the notice was invalid.

The district court held that the Anti-Injunction Act prohibited the suit. The outcome is a fairly straightforward application of the law, though the AIA landscape is somewhat in flux as a result of the Supreme Court’s discussion of the related Tax Injunction Act in the Direct Marketing case from a few years ago. As you may recall, Direct Marketing involved a Colorado law that required out-of-state retailers to provide the state with information reports on their sales to residents of the state. In Direct Marketing, the Supreme Court held that the requirements were not sufficiently connected with the collection or assessment of tax for the challenge to be barred by the Tax Injunction Act, legislation that is similar to though slightly different from the AIA in that it imposes restrictions on cases involving taxes imposed by the states rather than the federal government

The CIC Services case essentially follows the same logic as the majority Florida Bankers case, where the DC Circuit held that the AIA prevented bankers from challenging heightened reporting requirements when the failure to comply would lead to civil tax penalties under Subchapter 68B of the Code (for a criticism of Florida Bankers, see Part 2 of a PT guest post by Pat Smith here).

In this case, Plaintiffs’ claims and their requested injunction necessarily operate as a challenge to both the reporting requirement and the penalty or tax imposed for failure to comply with the reporting requirement. Because the Notice contemplates assessing penalties for non- compliance pursuant to 26 U.S.C. §§ 6707(a), 6707A, and 6708(a), all found within Subchapter 68B of the Internal Revenue Code, Plaintiffs seek, at least in part, to restrain the IRS’s assessment or collection of a tax. Accordingly, the Court lacks subject-matter jurisdiction over Plaintiffs’ claims because they are barred by the AIA and the tax exception to the DJA.

CIC argued in the alternative that they be given the chance to amend the complaint “[i]n the event this Court concludes that the complaint should be dismissed based upon one or more curable pleading defects.” In particular, plaintiffs in their briefing told the court that they had in fact complied with the Notice requirements and would not be subjected to any penalties. The Court held that this did not alter the fact that by seeking an injunction, the suit sought to restrain assessment or collection, even if not directly from plaintiffs.

Conclusion

Challenges to IRS rules such as in the Notice reveal the obstacles that taxpayers and advisors have in challenging rules outside mainstream tax litigation paths. The issue is somewhat more nuanced than perhaps the brief CIC opinion suggests, as there is considerable uncertainty as to whether Direct Marketing should be read as support for narrowing the reach of the terms assessment and collection when considering challenges to IRS rules that may result in penalties, especially in the reporting context. As the Chamber of Commerce district court opinion that allowed the challenge to the anti-inversion regs typified and discussed a few times in PT, including in excellent guest posts by Bryan Camp and Daniel Hemel, there is just enough of an opening to allow creative judges the opportunity to let challenges seemingly within the reach of the AIA as traditionally understood to get through the cracks.

In the months ahead we will see more cases discussing the AIA and how far if at all Direct Marketing should be read to allow earlier challenges to IRS rules that can have far-reaching impact on taxpayers and advisors.

 

 

House Republicans Introduce Major Tax Reform Legislation

House House Ways and Means Committee Chairman Kevin Brady (R-TX) introduced the Tax Cuts and Jobs Act, self-described as “bold legislation to overhaul America’s tax code for the first time in 31 years.”

Text of the bill is here; the press release is here.

There is not much in the legislation with a procedural or tax administration focus (with the exception of expanding IRS math error power when there is no SS# accompanying a CTC claim), though the scope of the changes for both individual and business taxpayers portends a major impact on tax administration.

For a summary in table form, see the Tax Foundation twitter post here 

Some of the highlights on the individual side: eliminating the deduction for tax prep advice, alimony and personal casualty losses, and medical expenses. In addition it cuts back the mortgage interest deduction cap (tying it only to principal residence and halving the cap on the deduction), Section 121 exclusion on gain from principal residences (requiring a 5 out of 8 yr use/ownership rather than current 2 out of 5 years) and allows state and local property tax deductions but only up to $10,000.  In addition it boosts the standard deduction and eliminates the dependency exemption deduction (though the definition is still retained for credit purposes).

The Child Tax Credit is increased to $1,600; most of the increase is nonrefundable and the income phase out is also increased so it has little impact on moderate and low income workers, though the $1,000 refundable portion of the CTC is indexed to inflation.

On the pass through income side, an issue we previously discussed, the bill limits the top rate on pass through income to 25%; it has what appears to be a complex anti-abuse provision that is summarized by the Tax Foundation in its review  as follows:

Begins with assumption that 70 percent of income derived from a business is compensation subject to ordinary rates and 30 percent is business income subject to the maximum 25 percent rate for active owners. Businesses can “prove out” of the 70/30 split based on demonstrated return on business capital at the short-term applicable federal rate (AFR) plus 7 percent. Certain specified service industries, like health, law, financial services, professional services, and the performing arts are excluded from the 70/30 split and can only claim the benefit of the lower pass-through rate to the extent that they can “prove out” their business income.

Professor Batchelder on Twitter flags this “prove out” as “the heart of the pass-through loophole for the wealthy” and “great for gaming” and a provision that tax lawyers will “love.”

 

 

Sometimes Participation Is Bad: To Participate Meaningfully and Barring the Right to Claim Spousal Relief

Keith, Stephen and I are in the thrice-annual process of sifting through hundreds of developments and choosing the cream of the crop for inclusion and analysis in the Saltz/Book treatise. A case that slipped through when it came out earlier this year is Rogers v Commissioner, which discusses the modified version of res judicata that applies to requests for spousal relief. We discuss the issue extensively in Chapter 7C, which is a standalone chapter addressing relief from joint and several liability.

Rogers provides another piece in the puzzle as to when a taxpayer will be prevented from claiming innocent spouse relief by virtue of failing to raise the claim in an earlier proceeding.

I will briefly discuss the issue and the case below.

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The doctrine of res judicata, or claim preclusion, provides that a previously litigated matter may not be pursued further by the same parties once there has been a final decision on the merits. Section 6015(g)(2) modifies the common law doctrine of res judicata with regard to claims for relief from joint and several liability. It provides that judicata does not bar a taxpayer from requesting relief under section 6015(b), (c), or (f) if: (1) relief from joint and several liability under section 6015 was not an issue in the prior proceeding; and (2) the taxpayer did not participate meaningfully in the prior proceeding.

The statute does not discuss what it means to participate meaningfully in the prior proceeding. Over the years, there have been a handful of cases that have set out what it means to meaningfully participate in a prior proceeding.

Back quickly to the facts of Rogers. Mrs. Rogers and her spouse were no stranger to taxes or tax problems. Mr. Rogers was a tax lawyer who gained some attention principally by putting together debt distressed investments in Brazilian consumer receivables that purportedly generated worthless debt deductions.

The opinion discusses how IRS examined the Rogers’ joint 2004 return, which eventually led to a notice of deficiency proposing an approximate $466,000 tax adjustment mostly stemming from unreported income and excess deductions from Mr. Rogers. The Rogers’ petitioned and tried the matter in Tax Court; Mr. Rogers was counsel for both himself and his wife (as he was for Mrs. Rogers in this matter).

In a 2014 Tax Court opinion, the Tax Court mostly agreed with the IRS and found that they failed to 1) include  income from the husband’s activity and 2) substantiate some business  deductions.  On appeal the 7th Circuit affirmed the Tax Court.

In the original Tax Court deficiency case, Mrs. Rogers did not claim relief under Section 6015. After the Tax Court decision became final, Mrs. Rogers filed a Form 8857, claiming spousal relief for a number of years, including 2004, the year that was the subject of the deficiency proceeding.

IRS denied the claim, and Mrs. Rogers filed a standalone petition to Tax Court seeking court review of the IRS’s denial. IRS moved to dismiss the case as per Section 6015(g)(2) on the grounds that she had her chance in the deficiency case to raise a claim for spousal relief and she was not now entitled to a second apple bite.

This teed up the issue: did Mrs. Rogers materially participate in the deficiency case? If she did, Section 6015(g)(2) would prevent her from having the opportunity to get relief from joint and several liability.

Prior cases discuss meaningful participation as essentially a facts and circumstances analysis, with the opinions identifying specific acts such as signing documents and participating in settlement discussions with IRS as indicative of someone meaningfully participating. The cases also look to the sophistication and experience of the person who later seeks relief.

With that context, the opinion describes the wife’s background: she was independently wealthy, had a long career as a teacher and school administrator, went to law school after her education career ended (and before the tax problems that generated the claim for relief from joint liability) and started a practice that focused on appealing local property tax assessments.

Despite her experience, Mrs. Rogers claimed that she relied fully on her husband in the Tax Court deficiency case and did not sign documents or otherwise engage in the specific acts leading up to the trial and in the trial itself that suggested involvement. As a result, she claimed that she was generally unaware of the defenses and arguments in the prior case.

The Tax Court disagreed, with her education, experience and resources all working against her:

Petitioner’s testimony about the extent of her ignorance is not credible. She was an educator and administrator and the holder of several advanced degrees, and her husband of 45 years was an extremely well-practiced tax attorney. Before the 2012 trial she had successfully completed at least four courses in tax and accounting. She maintained substantial real property, bank accounts, and other assets in her own name. During 2004 and in later years petitioner managed and participated in significant business dealings involving her own properties. Her tax returns show she was an active real estate agent.

The opinion concluded with a statement that Section 6015(g)(2) was not meant to “provide a second chance at relief for a litigant who had the wherewithal and the opportunity to raise a claim in a prior proceeding.”

Conclusion

This opinion shows the risks of not raising a request for relief from joint and several liability when the opportunity is there in a deficiency case. Sophisticated and well-resourced litigants who do not raise the claim will have a hard time, even if as in here the underlying deficiency case involved the other spouse’s business and the other spouse was an experienced tax lawyer who tried the case.

TIGTA Releases Report on Return Preparers and Refundable Credits

Earlier this month TIGTA released a report discussing its review of compliance issues associated with refundable credit returns prepared by tax return preparers. The report is heavily redacted, but it has some interesting statistics and also provides further evidence as to how resource constraints limit IRS ability to do its job. The report also notes that IRS has not sufficiently referred egregious preparers to other functions, like Criminal Investigations or the Return Preparer Office.

Here are some of the report highlights:

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In processing year 2015 (I assume for 2014 tax returns) IRS identified 27.5 million returns with an EITC, and it approximates that 47%, or 13 million, were prepared by a return preparer. I note that EITC returns prepared by a return preparer have been decreasing, in part likely due to the growth of DIY software and also possibly due to a growth in ghost returns, where preparers fail to sign the return to avoid possible scrutiny and penalty.

Using its secret sauce scoring formula, the IRS was able to identify return preparer EITC returns that have potentially erroneous claims. TIGTA notes that IRS flagged 150,000 return preparers with characteristics that suggest they were preparing returns with errors relating to qualifying children or income misreporting, or both.

IRS has a robust tiered approach to return preparer compliance treatments; that includes phone calls, a variety of letters, “knock and talk” visits, due diligence audits, and even more severe treatment like injunctions or criminal referrals. (For a more detailed summary of IRS approach, see its EITC preparer toolkit summary.)

TIGTA notes that IRS selected 49,563 preparers for potential compliance treatments; due to resource constraints, IRS identification of a preparer needing treatment did necessarily not lead to that preparer getting treated.

In fact in FY 2016, the IRS completed various compliance treatments to address just over 24,000 return preparers identified as filing high rates of tax returns with characteristics of an erroneous EITC claim. The report breaks down the treatment and noted that IRS evaluates the success of its treatments. In part it does so by scoring the preparers’ future years’ returns and compares those to both a control group and the preparers’ past returns.

The TIGTA report not surprisingly found that a visit from an armed CID agent had a positive effect on future compliance (less so when an armed CID agent was not there); so did due diligence audits, and the audits that selected fewer returns had a similar effect as more expansive audits.

TIGTA knocked IRS for insufficiently documenting why certain preparers did not get treated; it also noted that about 39% of preparers who received a knock and talk visit or due diligence visit did not improve their compliance in the next year. TIGTA felt IRS needed a better job of putting in place written procedures discussing referrals to other functions, especially in light of the high number of preparers who apparently did not alter their behavior after the treatment; IRS pushed back a bit and said it did not think more procedures were needed but that there should be greater instances where a different function takes action.

The report also discusses the impact of letters and general contacts before the fact that were meant in a sense to nudge preparers to do the right thing. That is a topic I am keenly interested in; a paper that I and co-authors Dave Williams and Krista Holub (both of Intuit) wrote discusses possible ways that IRS can influence taxpayers and to a lesser extent preparers with behavioral economics techniques. For those with an interest, a draft is here; a final version will come out next year in the Virginia Tax Review.

I suspect that there is more work that IRS can do to examine the impact of letters and communication in general on return preparers. I am intrigued that IRS seems to have a different strategy for new preparers; it seems like reaching out and educating preparers before they develop entrenched bad practices is a good policy.

As Congress has recently expanded due diligence penalties to include CTC and AOTC, interest in preparers and compliance will likely increase. The TIGTA report is a useful reminder that IRS, while not able to regulate preparers in the way it sought before Loving, does have a variety of ways to influence and punish bad preparers. It seems IRS has a pretty good handle on finding preparers who are likely serving up erroneous returns; whether it has the resources or appetite to go after them fully is another issue.

 

Tax Court Extends Camara and Allows Switch in Filing Status

This week in Knez v Commissioner, the Tax Court held that when a taxpayer files a return erroneously claiming head of household status that return did not constitute a “separate return” under section 6013(b). A few weeks ago guest poster Tom Thomas discussed Camara v Commissioner, where the Tax Court reversed itself and held that an erroneous election as single was not a separate return within the meaning of Section 6013(b)(2).

Knez thus extends Camara to an analogous situation and closes the circle on the 8th Circuit Ibrahim case from a few years ago.

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As a refresher, Section 6013(b)(2) bars a joint return for a married taxpayer who initially filed a separate return if either spouse received a notice of deficiency and files a petition with the Tax Court. The issue often has great significance for lower income taxpayers, as many benefits (such as EITC) are not available to a married taxpayer who fails to file a joint return. If the married taxpayer discovers the mistake after filing a petition, the IRS view of Section 6013(b)(2) bars the claiming of a credit that the taxpayer would have been entitled to had they filed correctly in the first instance.

While Camara involved an initial erroneous single return and Knez a HOH return, the Tax Court concluded “that this distinction makes no legal difference: Because the filing status initially selected by each married taxpayer was legally impermissible, the logic of our Opinion in Camara has equal force here.”

In so doing, it reviewed the rationale of Camara, which itself is aligned with Ibrahim (which involved a switch from HOH to single). Noting that an election suggests a choice, “[w]e reasoned in Camara that “there is no valid ‘choice’ embodied in a return on which the taxpayer has erroneously indicated a filing status that is not legally available to him or her.” Thus, Congress’ “use of the word ‘election’ strongly supports the conclusion that an erroneous single return is not a ‘separate return.’”

It also walked through the legislative history of 6013(b)(2):

[The legislative history] shows that Congress intended this provision to alleviate problems arising from married taxpayers’ inability to change a permissible election they had made concerning their filing status, an election the courts had deemed binding and irrevocable. As we concluded in Camara, this legislative history strongly suggests that the term “separate return” as used in section 6013(b) means a return filed as “married filing separately,” because that is the only filing status (other than joint filing) that is permitted for married taxpayers.”

Wrapping it up, the court concluded:

Our reasoning in Camara applies with equal force here. Petitioner did not make an “election” to file as a head of household, because that filing status was not legally available to her. See sec. 2(b)(1) (“[A]n individual shall be considered a head of household if, and only if, such individual is not married at the close of his taxable year.”). And because that filing status was legally impermissible, the statute’s legislative history indicates that petitioner’s erroneously filed original return did not constitute a “separate return.”

Conclusion

Knez makes no mention of the initial decision by the taxpayer’s filing status error to be the result of a good faith mistake as opposed to intentionally misstating filing status. (It also does not discuss why HOH was not available for Knez under the “abandoned spouse” rules of Section 7703(b), which might have meant that the status was correct in the first instance;) [Ed. UPDATE: footnote 6 does in fact mention this and notes that neither party argued that the provision applied]. As our hardworking blogging colleague Lew Taishoff notes here in his discussion of Knez, there is no reason to suspect from the opinion that the taxpayer was playing games. He warns, however, that Knez presents an opportunity for gamesmanship (for example, if a married couple’s earned income allows for a greater EITC when filing separately a compared to filing a joint return).

Mr. Taishoff suggests that perhaps Congress should fix the problem. To be sure, while taxpayers no doubt can improperly claim to be unmarried to goose a benefit, IRS has plenty of other tools in its arsenal to attack that, including imposing two and ten year bans on taxpayers who recklessly or fraudulently claim an EITC.

As Tom noted in his guest post discussing Camara, it still remains to be seen whether the Service will recommend an appeal on this issue.

Stay tuned.