Leslie Book

About Leslie Book

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

A PT Anniversary and Court Finds IRS Summons on Coinbase Suggests an Abuse of Process

Today marks the 4th anniversary of Procedurally Taxing. Our first post, Welcome to Procedurally Taxing, discusses our goals for the blog. As I discussed in that initial post, we hoped to become a source for developments and to act as a filter to allow readers to hone in on some key issues relating to tax administration and tax procedure. When we started we had no idea how much work was involved in writing and editing. We also did not anticipate how much we would benefit from our readers, many of whom contact us, offer comments and become guest posters. So thanks to our readers for inspiring us to remain engaged.

Enough of the mush and on to some tax procedure.

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We have previously discussed the IRS issuance of a John Doe summons on Coinbase. The case has been proceeding and last week an order from a magistrate judge out of the Northern District in California held that an anonymous customer could intervene in the summons enforcement proceedings. This brief posts highlights some of those developments.

Coinbase is an exchange that deals in convertible virtual currency. It operates a bitcoin wallet. It is a big player in the virtual currency market. IRS has been concerned that parties using bitcoin are not complying with their tax obligations. Recall that in 2014 IRS issued Notice 2014-21, where IRS opined that virtual currencies are property for tax purposes, potentially triggering a gain or loss on sale or exchange of a virtual currency.

Flash forward a few years and IRS serves up its John Doe summons on Coinbase. The requested information was voluminous, including:

Account/wallet/vault registration records for each account/wallet/vault owned or controlled by the user during the period stated above including, but not limited to, complete user profile, history of changes to user profile from account inception, complete user preferences, complete user security settings and history (including confirmed devices and account activity), complete user payment methods, and any other information related to the funding sources for the account/wallet/vault, regardless of date.

At the recent ABA Tax Section meeting there was lots of talk about how the IRS summons was overbroad, potentially sweeping up small transactions and people whose information would likely be of no interest to the IRS.

Following service of the summons a number of parties, including Coinbase, sought to intervene to quash the summons. Coinbase also sought to narrow the scope of the summons.

This summer there was oral argument on the motions and IRS informed the court that it has narrowed the scope of the summons. The CA district court order on the motions describes that narrowing:

In particular, [IRS] now seeks information for users with at least the equivalent of $20,000 in any one transaction type (buy, sell, send or receive) in any one year during the 2013-2015 period. Further, the IRS does not seek records for users for which Coinbase filed Forms 1099-K during this period or for users whose identity is known to the IRS.

The order does a nice job laying out the procedures for IRS to get enforcement of a John Doe summons, highlighting that it (as with a generic third party or taxpayer summons) is not self-enforcing and also reviewing the special protections Congress set out in Section 7609(f) before the government can get records when it does not know the identity to whom the records belong.

As with any summons enforcement proceeding, the government has to show that it is issuing its summons in good faith and in pursuit of a Congressionally authorized purpose.

The interesting part of the recent order is the District Court considering whether one of the Coinbase customers has the right to intervene under the Federal Rules of Civil Procedure. There is a bit more to the issue than I describe but whether a party has a right to intervene in the absence of a privilege claim mostly turns on whether the IRS procedures amounted to an abuse of process.

In finding that there was an abuse, the court emphasized that the original summons was far too broad in relation to the government’s legitimate interest in seeking information that may pertain to potential evaders. It is worth honing in on the government’s position and the court’s rebuke:

As of 2014, Coinbase had one million users; thus, the IRS seeks broad data on likely hundreds of thousands of users. These records include complete user profiles including user payment methods, records of Coinbase’s due diligence on their customers, powers of attorney, complete user security settings and history (including confirmed devices and account activity), among other documents. The IRS offers no explanation as to how the IRS can legitimately use most of these millions of records on hundreds of thousands of users; instead, it claims that as long as it has submitted a declaration from an IRS agent that the IRS “is conducting an investigation to determine the identity and correct federal income tax liabilities of United States persons who conducted transactions in a virtual currency during 2013-2015” the Court must find that the Summons does not involve an abuse of process. It contends that “there seems to be a substantial gap between the number of people transacting in virtual currency (for which tax consequences might attach) and those that are reporting such transactions.”

(emphasis added)

The order pushes back on the government’s perspective, claiming that it “proves too much”:

Under that reasoning the IRS could request bank records for every United States customer from every bank branch in the United States because it is well known that tax liabilities in general are under reported and such records might turn up tax liabilities. It is thus no surprise that the IRS cannot cite a single case that supports such broad discretion to obtain the records of every bank-account holding American. While the narrowed Summons may seek many fewer records, the parties agreed to have the Court decide the motion on the original record, and so it has.

The order is also interesting for its rebuke of the government’s position that a customer (unlike Coinbase itself) did not have a protected interest that would allow it to intervene. There is little law in this area, bit the court order distinguishes between enforcement and issuance proceedings. The court holds that a customer who learns of the John Doe summons through some other means can intervene in an enforcement proceeding but not on the issuance of the summons itself:

There is nothing in the John Doe summons procedure adopted by Congress to provide protections to those to whom the IRS could not give notice that suggests that when the John Doe nonetheless learns of a summons from other means the John Doe has no interest in challenging the enforcement of that summons. The government’s assertion that to do so would place an undue burden on the IRS’s legitimate use of John Doe summons makes no sense. All that is being addressed here is the proposed intervenor’s right to intervene in a proceeding that is already taking place. Moreover, as the IRS concedes, if it knew of the applicant’s identity, it would have to give the applicant notice and the applicant would have the opportunity to challenge enforcement. It is thus unsurprising that the one case to have discussed the issue, at least that the parties have cited, assumed that a subject of a John Doe summons could challenge its enforcement.

That the direct interests of the other parties are now involved in this proceeding is as the court implies a good development. Allowing information from customers to be directly introduced provides an opportunity for the court to be better informed. While the government has a clear view as to what it believes Coinbase customers are up to, the strong reaction to the IRS efforts and the IRS’s narrowing of the summons itself suggest that the IRS worldview may be a bit narrow.

Stay tuned, as the court will now likely address the merits of challenges to the summons itself.

Important DC Circuit Opinion on Anti-Injunction Act and Offshore Disclosure Regime

We have previously briefly discussed the challenge that a group of noncompliant taxpayers brought against the IRS decision to disallow participation in the so-called Streamlined Procedures of the offshore disclosure program. Last year, a district court held that the Anti Injunction Act (AIA) barred the taxpayers from challenging the IRS decision. Last week the DC Circuit Court of Appeals in Maze v IRS upheld the district court.

Maze is the latest in a series of important Anti Injunction Act decisions and reflects the statute’s ability to insulate IRS decisions from judicial review until a taxpayer fits squarely within deficiency, refund or CDP procedures.

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The main issue that the Maze opinion considers whether the AIA is a bar to preventing the court from considering the taxpayer’s argument that the IRS should have used streamlined disclosure procedures rather than transition streamlined procedures. Streamlined procedures allow for no payment of accuracy related penalties; transition rules required payment of up to eight years of those penalties. (Readers looking to learn more on the offshore disclosure program can look to our colleague Jack Townsend over at Federal Crimes Blog; Jack is also the primary author in the criminal tax penalty chapter in the Saltzman Book treatise, and we discuss the IRS offshore disclosure policies in detail in the treatise).

The importance of Maze for our purposes is its consideration of the AIA and in particular Maze’s efforts to get court review of the IRS decision to shoehorn her into the Transition Streamlined procedures rather than the regular Streamlined disclosure procedures.

This takes us into the AIA itself, which is codified at Section 7121. The AIA provides that “no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person . . . .”  The key in the case is whether the lawsuit would have the effect of restraining the assessment or collection of any tax. There is a current ambiguity as to whether restrain for these purposes is defined broadly or narrowly. Not surprisingly the government argued for a broad application, urging that the term includes “litigation that completely stops the assessment or collection of a tax but also encompasses a lawsuit that inhibits the same.” Maze urged a more narrow reading, arguing restrain refers “solely to an action that seeks to completely stop the IRS from assessing or collecting a tax.”

The scope of the term “restrain” is a hotly contested issue in AIA litigation; proponents of the narrow reading have pointed to the analogous Supreme Court discussion of the term in the Direct Marketing opinion from a couple of years ago. Earlier this year, the Tenth Court of Appeals in Green Solutions carefully distinguished Direct Marketing and held that the broader reading of restrain is the more appropriate reading in the context of federal AIA litigation.

The DC Circuit in Maze sidestepped this definitional issue; in resolving the opinion in favor of the government the court assumed that the more narrow reading that the taxpayers urged was correct. Using that narrow reading, the DC Circuit still found that the taxpayers came up short.

To get there it first concluded that for these purposes accuracy related penalties are taxes for purposes of the AIA (as the Court discussed not all penalties are taxes for these purposes). After reaching that decision, it was fairly easy to get to the government’s view:

As participants in the 2012 [Offshore Voluntary Disclosure Program], the plaintiffs are required to pay eight years’ worth of accuracy-based penalties. These penalties are treated as taxes under the AIA and any lawsuit that seeks to restrain their assessment or collection is therefore barred…. This lawsuit, in which the plaintiffs seek to qualify to enroll in the Streamlined Procedures, does just that; to repeat, the Streamlined Procedures do not require a participant to pay any accuracy-based penalties for the three years covered by the program. Thus, their lawsuit would have the effect of restraining—fully stopping—the IRS from collecting accuracy-based penalties for which they are currently liable. We believe this fact alone manifests that the AIA bars their suit. See 26 U.S.C. § 7421(a).

To shift the focus away from the lawsuit’s impact on a possible assessment or collection, Maze emphasized that its efforts concerned a desire to apply to Streamlined procedures, which in and of itself alone was not a determination that there were no penalties due. The DC Circuit rejected that view:

They note that their eligibility to enroll alone, viewed in vacuo, has no immediate tax consequence. But we have never applied the AIA without considering the practical impact of our decision. Rather, we have recognized our need to engage in “a careful inquiry into the remedy sought . . . and any implication the remedy may have on assessment and collection.” Cohen, 650 F.3d at 724 (emphasis added). And here, the plaintiffs concede that they will enroll in the Streamlined Procedures if they are deemed eligible, see Oral. Arg. Rec. 3:10-3:15, thereby stopping the IRS from collecting the 2012 OVDP accuracy-based penalties.

The taxpayer noted that the Streamlined procedures would not have resulted in a more favorable treatment if the IRS determined that there was willful noncompliance or a foot fault with the Streamlined procedures. That too was not enough:

But the fact that their attempt to take advantage of the Streamlined Procedures’ more lenient tax treatment might be thwarted by the possibility of an adverse IRS determination does not make their lawsuit one that is not brought “for the purpose of restraining the assessment or collection of any tax.” 26 U.S.C. § 7421(a).

Conclusion

There are still important definitional questions that the courts are wrestling with as the IRS and Treasury get dragged kicking and screaming into the 21st Century post Mayo world. Using its centuries old shield of tax exceptionalism that is the AIA, the IRS still enjoys powerful procedural protections that essentially shoehorn procedural challenges to IRS rulemaking decisions to traditional tax litigation. The DC Circuit in Maze was careful to note (and the DOJ attorney conceded at oral argument) that Maze could have challenged the IRS position in a refund suit. This concession is important because there is an exception to the AIA if there is no other remedy for the alleged wrong. Of course, a traditional tax refund suit generally requires full payment, and that is a considerable bar and practical limit on taxpayers who do not like the rules of the game. Cases like Maze suggest that while the IRS is less special than it used to be the IRS still enjoys a limit on court inquiry into its decisions.

 

TIGTA Report Shows IRS Has a Long Way to Go On Employment Related Identity Theft

The other day I wrote about the Electronic Tax Administration Advisory Committee and its annual report showcasing many successes and improvements IRS made when it came to identity theft. Part of the success ETAAC discussed included a major drop in identity theft receipts, which the report suggests is the product of better detection at the front end of the return filing process. TIGTA, in a report from last month, highlights a different story when it comes to employment related identity theft. Essentially TIGTA found that IRS materially understates the number of employment-related identity theft cases and has had major systemic flaws in informing victims.

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What is employment related identity theft? As most readers know, to gain employment one must have valid Social Security number. Individuals who are not authorized to work in the US sometimes use other peoples’ Social Security numbers to secure employment. They then file a individual income tax return using an Individual Taxpayer Identification Number (ITIN). Individuals whose SS numbers are used by someone else can be in for a surprise after they file a tax return (or do not file due to not having an obligation to file) when IRS may send an Automatic Underreporting (AUR) notice reflecting the income that was earned by someone else who illegitimately used their SS number.

IRS procedures are supposed to catch returns that are submitted by an ITIN user that reflect someone else’s SS # associated with wages. In IRS speak, that is known as an ITIN/SSN mismatch. When all works well, IRS places an identity theft marker on the victim’s account, and prevents victims from getting an AUR notice.

TIGTA found that all does not work well, with a number of systemic issues associated with placing markers on accounts. It examined over a million e-filed returns that had an SS/ITIN mismatch and found that in about 51.8% of the time IRS put the appropriate identity theft marker on the account. The IRS did not place markers on the remaining 48%; that was because many in that 48% group did not have a tax account (Note IRS defines tax account as an active account as one “for which the taxpayer’s Master File account, which contains the taxpayer’s name, current addresses, and filing requirements, etc., exists on the IRS computer system capable of retrieving or updating stored information.”).

Of the e-filed returns, there were another 60,000 or so victims who did have a tax account but still did not have an id theft marker placed; IRS noted various reasons, including its placing only one marker per return even if the return filed has multiple incorrect SS# associated W-2s and that some of the victims were minors and IRS did not have procedures in place to inform minors.

TIGTA sensibly recommended that IRS take steps to improve its process of placing id theft markers on all e-filed returns. IRS generally agreed with the recommendations and said it would monitor progress “and determine, by July 2018, the requisite programming changes needed to ensure that identity theft markers are properly applied when the potential misuse of an individual’s SSN becomes evident.”

In addition to e-filing issues, TIGTA noted major problems that the IRS has had in placing identity theft markers when a return reflecting an ITIN/SS mismatch is not e-filed:

Specifically, guidelines state that a Form W-2 is not required for Line 7 (Wages, Salaries, Tips, etc.) of Form 1040. As such, the IRS has no way to identify ITIN/SSN mismatches associated with paper tax returns. In addition, if the ITIN filer voluntarily attaches a Form W-2 with an SSN, IRS internal guidelines do not require employees processing these returns to place an employment identity theft marker on the SSN owner’s tax account.

TIGTA recommended that IRS require ITIN filers to attach W-2s with their 1040’s; IRS rejected that recommendation because it noted that “wages constitute taxable income under Internal Revenue Code Section 61 and are reportable even when a Form W-2 is not provided or is otherwise unavailable at the time of return filing.” IRS did, however, agree to put better procedures in place when a paper filed ITIN return does in fact include W-2s that reflect a mismatch.

Conclusion

The TIGTA report shows that IRS has a lot of room for improvement. People need to be vigilant, as IRS in many cases does not take action even if it has information that reflects a high likelihood that someone is improperly using a Social Security number. As TIGTA notes, if IRS fails to place an identity theft marker on an account, “victims can be subjected to additional burden when the IRS processes their tax returns.” It may trigger confusing and stressful notices and limit the ability for IRS and others to help victims unwind the effects of the identity thief. IRS needs to do a better job here, as the costs for victims in time, stress and potentially dollars are likely very significant.

Electronic Tax Administration Advisory Committee Report to Congress: Updates on E-Filing, Refund Fraud and Identity Theft

Last month the Electronic Tax Administration Advisory Committee issued its annual report to Congress. ETAAC was born in the 98 Restructuring Act; it is an advisory committee that is made up of a number of volunteers from the private sector, consumer advocacy groups and state tax administrators. As I discuss below, the report considers e-filing and refund fraud and identity theft issues.

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When formed in 98, ETAAC’s mission was principally directed at IRS reaching an 80% rate of electronic return filing; this year’s report details the substantial progress in meeting that target, though there is a range in e-filing that is based on type of return. For example individual income tax returns are e-filed at around 88%; exempt org returns are in the mid-60% range. ETAAC projects this year that the overall electronic filing for all returns will exceed 80%.

A Shifting Focus to Refund Fraud and Identity Theft

With ETAAC essentially fulfilling its primary mission, last year its charter was amended to include the problem of Identity Theft Tax Refund Fraud (ITTRF), which, as the report states, threatens to undermine the integrity of our tax system:

America’s voluntary compliance tax system and electronic tax filing systems exist, and succeed, because of the trust and confidence of the American taxpayers (and policy makers). Any corrosion of trust in filing tax returns electronically would result in reverting back to the less-efficient and very costly “paper model.” That option is neither feasible any longer nor desirable.

The report discusses the IRS’s convening of a Security Summit and last year’s special $290 million appropriation to “improve service to taxpayers, strengthen cybersecurity and expand their ability to address identity theft.” The main goals relating to ITTRF include educating and protecting taxpayers, strengthening cyber defenses and detecting and preventing fraud early in the process.

The report discusses a number of ITTRF successes in the past year:

  • From January through April 2016, the IRS stopped $1.1 billion in fraudulent refunds claimed by identity thieves on 171,000 tax returns; compared to $754 million in fraudulent refunds claimed on 141,000 returns for the same period in 2015. Better data from returns and information about schemes meant better filters to identify identity theft tax returns.
  • Thanks to leads reported from industry partners, the IRS suspended 36,000 suspicious returns for further review from January through May 8, 2016, and $148 million in claimed refunds; twice the amount of the same period in 2015 of 15,000 returns claiming $98 million. Industry’s proactive efforts helped protect taxpayers and revenue.
  • The number of anticipated taxpayer victims fell between/during 2015 to 2016. Since January, the IRS Identity Theft Victim Assistance function experienced a marked drop of 48 percent in receipts, which includes Identity Theft Affidavits (Form 14039) filed by victims and other identity theft related correspondence.
  • The number of refunds that banks and financial institutions return to the IRS because they appear suspicious dropped by 66 percent. This is another indication that improved data led to better filters which reduced the number of bad refunds being issued.
  • Security Summit partners issued warnings to the public, especially payroll industry, human resources, and tax preparers, of emerging scams in which criminals either posed as company executives to steal employee Form W-2 information or criminals using technology to gain remote control of preparers’ office computers.

E-file Signature Verification

While ETAAC shifts its focus to include security and fraud detection, it still examines how IRS is doing in the e-file arena. One area in the report that I think warrants further reflection is ETAAC’s recommendation that IRS improve its ability to allow taxpayers to verify an e-filed return. The report discusses the history of signing and verifying an e-filed return, which now requires that the taxpayer have access to the prior year’s AGI or a special PIN.  While most software will allow for those numbers to carry over from last year’s returns, at times taxpayers may not know last year’s AGI or the PIN (e.g., when there is a switch in software) and ETAAC tells us that this has triggered many taxpayers abandoning e-filing and reverting to paper filing.

The report discusses how the IRS Get Transcript online tool ostensibly could facilitate taxpayers getting access to their last year’s AGI but that access has a clunky authentication process that has led to a very high fail rate for users (the Report also discusses the compromising of a prior iteration of the Get Transcript online tool and other data breaches).

As IRS works out the kinks with its “Future State” platform, authentication and ease of taxpayer access will be crucial. Of course, given the backdrop of dedicated and as the report notes nimble and dedicated criminals who continue to probe for weaknesses this will continue to be a challenge for IRS and its partners.

IRS Expresses Disapproval of Tax Court Case Allowing EITC for Separated But Married Taxpayer

There are many complexities in the Internal Revenue Code. There are also many nuances in tax procedure. Put the two together and there are ingredients for the need for guidance. Earlier this week the IRS issued a nonacquiesence in a 2016 Tax Court case that had slipped through and I had not noticed.

The case at issue is Tsehay v. Commissioner, T.C. Memo. 2016–200. In Tsehay, the taxpayer, a custodian whose first language was not English, had an on again off again relationship with his spouse. During 2013, the taxpayer testified (credibly, according to the opinion) that he his wife and their children lived with him though by 2014 they had separated. He, using a paid return preparer, filed a 2013 return as head of household and claimed his kids as qualifying children for the EITC and dependency exemptions. HOH status was crucial for purposes of the EITC, as married taxpayers who are not divorced or separated (or who do not live apart from their spouse for the last 6 months of the year and who otherwise generally pay ½ of the household and childcare expenses) cannot claim the EITC unless they file a joint return. There is no similar anti-MFS rule in place for claiming children as dependents.

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The opinion concluded that his credible testimony regarding his living with his kids was enough to justify his receiving dependency exemptions and the EITC.

It appears that the judge and IRS counsel may have missed the special rule that prevents MFS taxpayers from claiming the EITC.

This takes us to earlier this month when the IRS announced that it did not acquiesce in the case. We have not discussed this form of guidance in the blog. The Internal Revenue Bulletin nicely describes the IRS policy on commenting on case law, which comes in the form of acquiescence, acquiescence in result only, or nonacquiescence:

It is the policy of the Internal Revenue Service to announce at an early date whether it will follow the holdings in certain cases. An Action on Decision is the document making such an announcement. An Action on Decision will be issued at the discretion of the Service only on unappealed issues decided adverse to the government. Generally, an Action on Decision is issued where its guidance would be helpful to Service personnel working with the same or similar issues. Unlike a Treasury Regulation or a Revenue Ruling, an Action on Decision is not an affirmative statement of Service position. It is not intended to serve as public guidance and may not be cited as precedent.

Actions on Decisions shall be relied upon within the Service only as conclusions applying the law to the facts in the particular case at the time the Action on Decision was issued. Caution should be exercised in extending the recommendation of the Action on Decision to similar cases where the facts are different. Moreover, the recommendation in the Action on Decision may be superseded by new legislation, regulations, rulings, cases, or Actions on Decisions. Prior to 1991, the Service published acquiescence or nonacquiescence only in certain regular Tax Court opinions. The Service has expanded its acquiescence program to include other civil tax cases where guidance is determined to be helpful. Accordingly, the Service now may acquiesce or nonacquiesce in the holdings of memorandum Tax Court opinions, as well as those of the United States District Courts, Claims Court, and Circuit Courts of Appeal. Regardless of the court deciding the case, the recommendation of any Action on Decision will be published in the Internal Revenue Bulletin.

The recommendation in every Action on Decision will be summarized as acquiescence, acquiescence in result only, or nonacquiescence. Both “acquiescence” and “acquiescence in result only” mean that the Service accepts the holding of the court in a case and that the Service will follow it in disposing of cases with the same controlling facts. However, “acquiescence” indicates neither approval nor disapproval of the reasons assigned by the court for its conclusions; whereas, “acquiescence in result only” indicates disagreement or concern with some or all of those reasons. “Nonacquiescence” signifies that, although no further review was sought, the Service does not agree with the holding of the court and, generally, will not follow the decision in disposing of cases involving other taxpayers. In reference to an opinion of a circuit court of appeals, a “nonacquiescence” indicates that the Service will not follow the holding on a nationwide basis. However, the Service will recognize the precedential impact of the opinion on cases arising within the venue of the deciding circuit.

At times, the AOD that the Service issues has an extensive discussion of the reasoning. Other times, as in AOD 2017-05 on Tsehay, it just states the conclusion that the Service does not acquiesce in the decision. That nonaqciescence makes sense, as it appears that Tsehay is just the result of a counsel and judicial foot fault on the law. It is intended to remind counsel attorneys (and taxpayers) that it is inappropriate to rely on Tsehay for the position that married taxpayers who file an MFS return  or who are required to file an MFS return are entitled to the EITC. As a guest post from Andy Grewal discusses a couple of years ago, while Tax Court memo opinions are not supposed to be precedential (and are intended to be used only in clear cut or heavy factual cases), as a practical matter advocates and the court itself often look to and effectively rely on these cases so Counsel wanted to clear the air.

Because AODs give direct insight into Chief Counsel’s litigating position and because understanding that position allows a representative to provide valuable advice about the likelihood a case will go to trial rather than settle, the more AODs the IRS issues the better. Back in the 1970s the IRS issued AODs routinely. Today, issuing an AOD seems to be the exception rather than the rule. Still, the AODs that are issued provide a benefit when trying to understand what will happen with a case and they should not be overlooked.

District Court Pokes Facebook FOIA Request

Like many social media and tech companies, Facebook has drawn IRS scrutiny over its licensing of technology to low tax offshore affiliates. That dispute is in Tax Court. Seeking to obtain information about the IRS audit, Facebook filed a FOIA request seeking documents related to the dispute. The FOIA request has now generated its own separate litigation.

Not surprisingly, the files IRS has on the Facebook exam are voluminous and it asked Facebook to extend the time to respond to the request. While the IRS served up thousands of pages of records, it did not provide all Facebook wanted. Facebook sought to compel the IRS to issue responsive documents in electronic format. Last month’s district court opinion held that Facebook was not entitled to the records in that format.

While we do not discuss FOIA frequently in PT, we have recently revised our FOIA discussion in the Saltzman and Book treatise. FOIA is an important tool for practitioners seeking information relating to tax disputes. There are some interesting procedural aspects of the Facebook FOIA case.

Facebook emphasizes that if a requester wants documents in electronic format, the request itself must clearly say so. The original Facebook request did not indeed indicate the format that the company wanted the documents. As the opinion notes, [i]t asked for all records ‘whether maintained in electronic or hardcopy format,’ but did not specify the format for production.”

While the Facebook opinion stated that “metadata is an important part of electronic records in today’s world…” the opinion emphasized that without a specific request for a document in a particular form the courts have no basis to order production because there was no valid FOIA request in the first instance:

With respect to its request for electronic-format documents, then, Facebook did not submit a valid FOIA request in compliance with the IRS’s regulations. The request did not trigger the IRS’s FOIA obligations, the IRS did not have an opportunity to exercise its discretion in analyzing the request, and so Facebook has not exhausted its administrative remedies.

A separate and somewhat academic discussion in the opinion considered whether the exhaustion requirement was jurisdictional. There is a split on that issue; some courts have concluded that the exhaustion requirement is a prudential consideration rather than a jurisdictional prerequisite. Facebook argued that even in fact it was a jurisdictional requirement the court could find that ordering Facebook to submit a revised FOIA request was futile (thus allowing the court to compel production in electronic format).

The court declined to resolve the jurisdictional versus prudential dispute, emphasizing that even if the request were not jurisdictional courts waive the exhaustion requirement only if the waiver was consistent with the purpose of the exhaustion requirement:

Whether analyzed prudentially or jurisdictionally (with a futility exception), the ultimate question is the same: does the failure to exhaust undermine the purposes and policies of FOIA exhaustion — i.e. to give the IRS a chance to exercise its discretion and to review its decisionmaking process before judicial intervention? Put another way: would dismissal promote that purpose?

The answer here is yes. Judicial intervention now would deprive the IRS the opportunity to exercise its discretion and analyze Facebook’s (now clarified) request for electronic documents and metadata, and dismissal would give the IRS the chance to do so. The court is not convinced that Facebook’s refiling of a revised FOIA request to specify the format (and content) of the records it seeks would be futile.

Conclusion

The opinion is a careful reminder that what often takes the form of boilerplate requests for information in fact can have practical significance if a FOIA dispute winds up in court. As some disputes can relate to administrative files with millions of documents, and as the world increasingly becomes digital, litigants seeking information from the IRS must be careful and precise when seeking information.

Court Sentences Kroupa; NTA On Appeals’ Changes; Tax Reform Still Percolating

Kroupa Sentenced

Earlier this week Keith discussed the differing views that former Tax Court Judge Kroupa and the government had on sentencing. Yesterday the court, agreeing with the government, sentenced former Judge Kroupa to 34 months. Her ex-husband received 20 months. The Minnesota Lawyer recounts the tale; for those interested our prior posts link to the underlying documents in the case.

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NTA Blogs on Appeals’ Changes

I am a keen reader of what the National Taxpayer Advocate writes; her take on tax administration often offers both an insider and outsider perspective. Her recent blog post on Appeals’ changes in bringing in Compliance and Counsel to Appeals conferences does just that; she appreciates what motivated Appeals to make the changes, and then discusses and reflects on why practitioners, such as the ABA Tax Section, have raised concerns. I recommend a full read of this post but this snapshot shows some of the issues she has with the new procedures:

The new approaches being put into place by Appeals make it appear as though Appeals no longer trusts its own Hearing Officers and that these Hearing Officers require the guidance and oversight of Counsel and Compliance to reach the correct determinations. As a former practitioner, I would think long and hard before bringing a case to Appeals under these new rules.

Tax Reform on the Horizon (and Some Thoughts on Tax Administration)

There is lots of talk this week on the Senate’s proposed health care legislation. On a separate legislative track is deeper tax reform for business and individual taxpayers. On Procedurally Taxing we steer clear from most of the big macro policy issues underlying the tax reform policy choices. We have, however, noted that many reform proposals do implicate key issues of tax administration. For example, last year Keith discussed the House Blueprint for tax reform and its proposal to add a new small claims court to hear tax cases.

The other day Speaker Ryan offered his tax reform pitch and assurance that reform will happen in 2017 as part of a talk he gave to the National Association of Manufacturers. Now, I have scratched my head thinking about border adjustability and contemplated the possible ways that service providers may try to shift income into pass through entities in light of some of the specific proposals that many are kicking around. But my ears perked up when I heard the Speaker justify, at least in part, individual tax reform on the difficulties Americans face when they file their tax returns:

Look at what happens during tax season. I could describe the complexity of the code all day, but what really defines our tax code is that sense of dread that you feel. You know that feeling?

You have to navigate long, complicated forms to file your returns. You need to wade through a seemingly endless amount of deductions and credits, each with its own rules and eligibility requirements.

And then, after you tally up those deductions, you are placed in up to seven different federal tax brackets based on your income level.

And at the end you hope—I mean really hope—that you do not owe a bunch this year. You hope, because you do not really know ahead of time. How could you? This whole system is too confusing, and just too darn expensive.

The solution, according to Ryan is to “start over.”

First, we will eliminate harmful, burdensome taxes including the death tax and Alternative Minimum Tax.

Next, we will clear out special interest carve outs and excessive deductions, and focus on keeping those that make the most sense: home ownership, charitable giving, and retirement savings.

We will consolidate the existing seven brackets into three, double the standard deduction, and simplify things to the point that you can do your taxes on a form the size of a postcard. Wouldn’t that be nice?

And finally—and most importantly—we will use the savings from eliminating these loopholes to lower tax rates.

Let me say that again: We are going to cut taxes

I am intrigued by the Speaker’s reference to the way that Americans meet their annual tax return obligations. A brief article  from Bloomberg earlier this year estimates that only 5 million out of the 165 million or so individual returns are done manually.The overwhelming majority of Americans today do not wade through IRS forms. Instead, they answer user friendly prompts generated by increasingly freely provided software; those that do not use a DIY product either pay a preparer or use free preparers at VITA or TCE sites.

The Speaker is thinking about taxpayer burden using a 20th century model; fewer and fewer taxpayers actually work with an actual IRS form. The bigger point the Speaker makes though I think is that despite the decreasing mental burden on Americans in actually filing their tax returns, many Americans are clueless going into filing season when it comes to understanding their individual and family tax situation. Many Americans, especially lower and moderate income Americans, do not grasp the hodgepodge of credits and deductions that Congress has put in the Code for one reason or another.

If thinking about tax administration when it comes time to pass reform, Congress should simplify our tax system so the average American can understand what their return reflects and how their actions may in fact align with tax law. When thinking about tax reform, Congress should strongly consider paring back the myriad credits and deductions that leave most Americans befuddled. In addition, while Congress may choose (and have good reason) to use the IRS to administer social policy provisions, including some credits, actually aligning the substantive provisions with the reality of Americans’ lives would contribute to a tax system that the IRS could administer and the public could understand.

9th Circuit Finds No Conflicts of Interest or Duress in Taxpayer Challenges to Extensions of the Statute of Limitations

A recent published Ninth Circuit opinion, Twenty-Two Strategic Investment Funds v US, illustrates the difficulties taxpayers face when they argue that the courts should disregard a consent to extend the statute of limitations (SOL) on assessment due to an advisor’s conflict of interest or a taxpayer’s alleged duress.

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Twenty-Two Strategic Investments involved an investment in the ill-fated KPMG BLIPs loss generating foreign currency investment tax shelter.

For those wanting a brief summary of the shelter, the opinion serves that up nicely:

In order to participate in the BLIPS program, a client would establish a single-member limited liability company (“LLC”), which would take out a specific loan with a participating lender and contribute all of the loan funds to a strategic investment fund, an LLC managed by Presidio, which would then purchase foreign currency assets. After a brief period, usually about sixty days, the client would exit the BLIPS program, the assets would be sold, and the loan would be repaid with interest and pre-payment penalties. The result of this series of transactions was a tax loss for the client approximately equal to the amount of the offset he or she was seeking.

Presto. Tax losses. The only problem was that IRS and DOJ got wind of the scheme, and civil liability and even criminal sanctions followed. This post, however, is not so much about BLIPs but the after effects for one of the unlucky investors who the IRS eventually came after in light of the BLIPs going bust.

The procedural issues in the case turned on the taxpayer arguing that extensions of the SOL on assessment were invalid. There were two reasons that the taxpayer argued the extensions were invalid: 1) the taxpayer’s accountant and return preparer Smith had a conflict of interest which the IRS knew about and 2) the individual taxpayer Gonzales left holding the bag on the consequences of the disallowed losses signed the extension under duress. If the extensions were invalid, the assessments were out of time.

This is a published Ninth Circuit opinion, and that is in part why it drew my interest (there are not so many published circuit court tax procedure opinions). Yet the taxpayer’s arguments were pretty thin.

On the conflict issue, the taxpayer had pointed out that his accountant Smith “instrumental in selling the [tax] shelter to Gonzales,” received a commission for involving Gonzales in BLIPS, and signed the 2000 tax return that the IRS was auditing.”

There are some cases in the TEFRA context (this is a TEFRA case but TEFRA discussions on the blog draw as much interest as last week’s PBS documentary on steel manufacturing in Warsaw Pact countries following the reforms of Soviet Premier Kosygin so I will skip those) where criminal investigations of the tax matters partner resulted in an impermissible conflict that the courts concluded prevented the TMP from binding the partnership.

Here, however, the issue related to the individual taxpayer binding himself, not from a TMP who the courts noted had incentives to extend the SOL that ran directly counter to the individual investors ultimately potentially liable for civil taxes and penalties.

Not enough for a conflict that would bring into question the extension’s validity:

Other than this vague implication of wrongdoing, Gonzales offers no evidence that Smith’s involvement in promoting BLIPS and his involvement in preparing Gonzales’s 2000 tax return combined to create a conflict of interest three years later when the IRS approached Gonzales himself about extending the limitations period. There is no evidence in the record that the IRS contacted Smith during the time he was advising Gonzales to request that Gonzales agree to extend his limitations period. Nor is there evidence that Smith ever provided any advice to Gonzales regarding extending his limitations period. Furthermore, as the district court observed, “[a]lthough Steve Smith represented Gonzales during the audit that flowed from his 2000 tax return, Gonzales had designated different representation before signing the consents.

The remaining issue concerned Gonzales’ argument that he signed the extensions under duress. Duress generally requires evidence of wrongful pressure to coerce someone into signing a contract or other agreement that they would ordinarily not sign. Duress in the tax context is an “action[] by one party which deprive[s] another of his freedom of will to do or not to do a specific act.” Price v. Comm’r, 43 T.C.M. 18 (T.C. 1981), aff’d, 742 F.2d 1460 (7th Cir. 1984).

Gonzales’ duress argument centered on two main events: IRS met with him without his legal representative and an IRS agent served a summons on him at his residence before asking him to extend the SOL. As with the conflict argument, the court had little problem disposing of it as a challenge to the extension.

Gonzales can recall no details of the meeting other than its location. He cannot remember any questions agent Doerr asked him or any particular things agent Doerr said that were intimidating or coercive. His testimony was that he was worried that he might be in legal trouble and that the IRS could ruin his life. His conclusion was founded on inference. However, the fact that the agent declined to assure Gonzales that the IRS would not be pursuing lawful action against him does not justify an inference that Gonzales was deprived of his freedom of will to such a degree that he signed the consents to the extensions under duress.

Similarly, the court noted that there was nothing out of the ordinary with the agent serving a summons at his residence; in fact, Section 7602 provides that it may be “delivered in hand to the person to whom it is directed, or left at his last and usual place of abode.” Simply put, that the summons caused Gonzales stress was not enough; stress or taxpayer fear following IRS agents taking legally authorized actions do not amount to duress.

Parting Thoughts

Taxpayers sign extensions of the SOL for many reasons. After the fact, it is difficult to unwind those extensions, just as it is difficult to unwind a stipulation, as Keith discussed last week here.

The duress issue in this case to me is the more interesting of the two. There are a handful of cases where the courts have found that IRS agents have impermissibly threatened taxpayers to sign documents. For example, in the 1973 TC memo opinion Robertson v Commissioner an agent’s specific threat to seize a taxpayer’s house if he did not sign a form constituted duress.

Duress also comes up in the context of determining whether a spouse agreed to file a joint tax return or other document (including an extension of the SOL) in light of pressure or abuse coming from the other spouse. There are a handful of cases as well looking into whether a spouse’s actions reach the level of duress. That is an issue we discuss in the Saltzman Book treatise; the upshot is that on occasion coercive forces both outside and inside the marriage have reached the level for a court to conclude that the document would not have been signed except for the constraint applied to the taxpayer’s will.