Second Circuit Tosses Penalties Because of IRS Failure To Obtain Supervisor Approval

–Or, Tax Court Burnt by Second Circuit’s Hot Chai

Yesterday the Second Circuit decided a very important decision in favor of the taxpayer pertaining to the Section 6571 requirement that a direct supervisor approve a penalty before it is assessed.  In Chai v. Commissioner, the Second Circuit reversed the Tax Court, holding the Service’s failure to show penalties were approved by the immediate supervisor prior to issuing a notice of deficiency caused the penalty to fail.  In doing so, the Second Circuit explicitly rejected the recent Tax Court holdings on this matter, including Graev v. Commissioner, determining the matter was ripe for decision and that the Service’s failure prevented the imposition of the penalty.  Chai also has interesting issues involving TEFRA and penalty imposition that will not be covered (at least not today), and is important for the Second Circuit’s rejection of the IRS position that the taxpayer was required to raise the Section 6571 issue.   It is lengthy, but worth a read for practitioners focusing on tax controversy work.

PT regulars know that we have covered this topic on the blog in the past, including the recent taxpayer loss in the very divided Tax Court decision in Graev v. Commissioner.  Keith’s post on Graev from December can be found here.  For readers interested in a full review of that case and the history of this matter, Keith’s blog is a great starting point, and has links to prior posts written by him, Carlton Smith, and Frank Agostino (whose firm handled Graev and also the Chai case). Graev was actually only recently entered, and is appealable to the Second Circuit, so I wouldn’t be surprised if the taxpayer in that case files a motion to vacate based on the Second Circuit’s rejection of the Tax Court’s approach in Greav.

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Before discussing the  Second Circuit holding, I will crib some content from Keith, to indicate the status of the law before yesterday.  Here is Keith’s summary of the holding in Graev:

The Court split pretty sharply in its opinion with nine judges in the majority deciding that the IRC 6751(b) argument premature since the IRS had not yet assessed the liability, three judges concurring because the failure to obtain managerial approval did not prejudice the taxpayers and five judges dissenting because the failure to obtain managerial approval prior to the issuance of the notice of deficiency prevented the IRS from asserting this penalty (or the Court from determining that the taxpayer owed the penalty.)

That paragraph from Keith’s post regarding the holding doesn’t cover the lengthy and nuanced discussion, but his full post does for those who are interested.  The Second Circuit essentially rejected every position taken by the majority and concurrence in Graev, and almost completely agreed with the dissenting Tax Court judges (with a  few minor differences in rationale).

For its Section 6751(b) review, the Second Circuit began by reviewing the language of the statute.  It highlighted the fact that the Tax Court did the same, and found the language of the statute unambiguous, a conclusion with which the Second Circuit disagreed.

Section 6751(b)(1) states, in pertinent part:

No penalty under this title shall be assessed unless the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination…[emph. added]

The Tax Court found the lack of specification as to when the approval of the immediate supervisor was required allowed the immediate supervisor to approve the determination at any point, even after the statutory notice of deficiency was issued or the Tax Court reviewed the matter.

The Second Circuit, however, found the language ambiguous, and the lack of specification as to when the approval was required problematic.  The Second Circuit stated “[u]understanding § 6751 and appreciating its ambiguity requires proficiency with the deficiency process,” and then went through a primer on the issue.  To paraphrase the Second Circuit, the assessment occurs when the liability is recorded by the Secretary, which is “essentially a bookkeeping notation.”  It is the last step before the IRS can collect a deficiency.  The Second Circuit stated the deficiency is announced to the taxpayer in a SNOD, along with its intention to assess.  The taxpayer then has 90 days to petition the Tax Court for review.  If there is a petition to the Court, it then becomes the Court’s job to determine the amount outstanding.  As it is the Court’s job to determine the amount of the assessment, the immediate supervisor no longer has the ability to approve or not approve the penalty.  The Second Circuit agreed with the Graev dissent that “[i]n light of the historical meaning of ‘assessment,’” the phrase “initial determination of such assessment” did not make sense.  A deficiency can be determined, as can the decision to make an assessment, but you cannot determine an assessment.

The Second Circuit then looked to the legislative history, and found the requirement was meant to force the supervisor to approve the penalty before it was issued to the taxpayer, not simply before the bookkeeping function was finalized.  The Court further stated, as I noted above, if the supervisor is to give approval, it must be done at a time when the supervisor actually has authority.  As the Court noted, [t]hat discretion is lost once the Tax Court decision becomes final: at that point, § 6215(a) provides that ‘the entire amount redetermined as the deficiency…shall be assessed.”  The supervisor (and the IRS generally) can no longer approve or deny the imposition of the penalty.  The Court further noted, the authority to approve really vanishes upon a taxpayer filing with the Tax Court, as the statute provides approval of “the initial determination of such assessment,” and once the Court is involved it would no longer be the initial determination.  Continuing this line of thought, the Second Circuit stated that the taxpayer can file with the Tax Court immediately after the issuance of the notice of deficiency, so it is really the issuance of the notice of deficiency that is the last time where an initial determination could be approved.

This aspect of the holding is important for two reasons.  First, the Second Circuit is requiring the approval at the time of the NOD, and not allowing it to be done at some later point.  Second, this takes care of the ripeness issue.  If the time is set for approval, and it has passed, then the Court must consider the issue.

Of potentially equal importance in the holding is the fact that the Second Circuit stated unequivocally that the Service had the burden of production on this matter under Section 7491(c) and was responsible for showing the approval. It is fairly clear law that the Service has the burden of production and proof on penalties once a taxpayer challenges the penalties, with taxpayers bearing the burden on affirmative defenses.   The case law on whether the burden of production exists when a taxpayer doesn’t directly contest the penalties is a little more murky (thanks to Carlton Smith for my education on this matter).  The Second Circuit made clear its holding that the burden of production was solely on the Service, and the taxpayer had no obligation to raise the matter nor the burden of proof to show the approval was not given.  The Service had argued the taxpayer waived this issue by not bringing it up earlier in the proceeding, which the Second Circuit found non-persuasive.

As to the substance of the matter, the Second Circuit held the government never once indicated there was any evidence of compliance with Section 6751.  Since the Commissioner failed to meet is burden of production and proof, the penalty could not be assessed and the taxpayer was not responsible for paying it.  A very good holding for taxpayers, and we would expect a handful of other case to come through soon.  Given the division within the Tax Court, and the various rationales, it would not be surprising to see other Circuits hold differently.

Tax Court Holds That a Notice of Deficiency Stating Taxpayer Owes $.00 Meets Standard

In a fully reviewed case, the Tax Court holds, in a very fractured vote, that an IRS Notice of Deficiency stating the taxpayer owes $.00 is a valid notice of deficiency conferring jurisdiction on the Court. The decision in Dees v. Commissioner, 148 T.C. 1 (2017) finds the judges engaged in a debate about just how bad a Notice of Deficiency can be and still meet the standard of a Notice of Deficiency. In upholding the notice as valid, the split vote came out seven judges in favor of the notice in an opinion by Judge Buch, two judges in favor of the notice in a concurring opinion by Chief Judge Marvel, one judge in favor of the notice in a lengthy concurring opinion by Judge Ashford (for a total of 10) versus seven judges in a dissent by Judge Foley and six of those same judges signing onto a separate dissent written by Judge Gustafson. The result almost reminds you of a presidential election and makes me feel better that the Harvard tax clinic was able to unify the Court in a jurisdictional case last year, Guralnik discussed here, in which it voted 16 to 0 against a position espoused by the clinic.

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One of the interesting aspects of the opinion is the opportunity it gave the Court to recount the many ways in which it has held over the years that bad Notices of Deficiency still conferred jurisdiction. Judge Buch cites to a host of cases in which the IRS screwed up the Notice of Deficiency in one way or the other and yet the Court still found a valid notice existed. Those cases included notices which determined taxes on a calendar year basis even though the taxpayer used a fiscal year (Miles Prod. Co. v. Commissioner, 96 T.C. 595 (1991)); even though the IRS attached pages concerning another taxpayer (Campbell v. Commissioner, 90 T.C. 110 (1988)); and even though the notice attached pages related to a different year from the notice (Erickson v. Commissioner, TCM 1991-97)(citing older Tax Court opinions with the same issue.)

When the IRS makes a mistake in the Notice of Deficiency and the Tax Court nonetheless holds that the notice meets the minimum standard to satisfy the statutory definition of a Notice of Deficiency, the IRS still faces some hurdles in most cases because the burden of proof often shifts to it to prove the basis for the poorly described adjustment. In the Dees case, the various opinions supporting the notice discussed the burden shifting aspect of the Court’s jurisprudence with respect to poorly drafted notices. The judges in the dissent noted the many ways a bad notice can still constitute a valid notice but reached a tipping point with a notice that on its face said that the taxpayer had a $.00 deficiency. I cannot do a great job of distilling all of the arguments presented in the five separate opinions in a blog post but I will try to briefly describe the points made by each opinion.

“Majority” Opinion

Judge Buch’s opinion follows a long line of Tax Court opinions holding that various problems with the Notice of Deficiency do not invalidate the notice. In this regard, the opinion here represents just another small step in a 90-year march to save notices whenever possible while imposing other consequences on the IRS for the failures in its notice. In order to save this notice, Judge Buch looks at the notice as a whole and does not stop on the first page of the notice where the notice states quite clearly that it finds no deficiency. Judge Buch, as the Court has done in many prior opinions, goes into the back pages of the notice to figure out that the IRS really did find something wrong with the taxpayer’s return and that what it found wrong really did result in a deficiency in the taxes reported on the return. This opinion finds that in making the determination to validate a notice a Court looks at both objective and subjective facts. The objective facts include the “package” of the notice as a whole. When read together what does the IRS really say? Here, it found, as is common in the opinions reviewing the validity of notices, that when considered as a whole, the notice made sufficiently clear that the IRS did find the taxpayer had claimed a refundable credit he should not have claimed, the IRS intended to disallow that claim, and that in disallowing that claim the tax result created a liability that meets the definition of deficiency. Judge Buch’s opinion goes on to look at the subjective effect of the notice in order to determine its validity. Here, he found that not only did the notice as a whole evince a deficiency determination but the taxpayer realized what the IRS intended to say even though the IRS drafted an inartful notice. Because this notice met both prongs of the test for a valid notice, Judge Buch and six other judges determined that this notice conferred jurisdiction on the Tax Court.

Concurring Opinions

Chief Judge Marvel agrees with Judge Buch’s opinion to the extent that it discusses the objective test to determine the validity of the notice including the use of material outside the notice itself, but she balks at the second prong. She finds the subjective intent of the taxpayer regarding the notice inappropriate. Those references draw on dicta in earlier opinions and the Court should not elevate “those references into a test that has no place in resolving the real jurisdictional issue – whether the Commissioner in the notice of deficiency made a determination with respect to the taxpayer that confers jurisdiction on this Court.”

Judge Ashford writes alone but also writes the longest of the opinions. At the risk of distilling her argument too far, she seems to say that the title of the document is what really matters. If the IRS sends a letter entitled Notice of Deficiency, the IRS has sent a Notice of Deficiency and the rest of the discussion concerns other issues. She looks hard at the relevant statutes more than prior law. She too disagrees with Judge Buch’s opinion concerning the importance of the taxpayer’s subjective intent. On this point she writes that “we will never find that we lack jurisdiction under it, because we will never be faced with a case in which a taxpayer has not filed a petition.” While it is true that the Tax Court will never be faced with a case in which the taxpayer has not filed a petition, it may be faced with a case in which the taxpayer files a petition long after the 90 days passes and after the statute of limitations on assessment passes in which the taxpayers argues that a timely petition was not filed because the taxpayer did not believe that the document entitled Notice of Deficiency that said the taxpayer owed $.00 was really a Notice of Deficiency. In such a case, the Tax Court would face the intent issue under the view of the Buch opinion.

Dissents

Judge Foley and the other six judges joining in the dissent choke on the notion that a Notice of Deficiency can exist where the notice says $.00 on its face because the notice “does not fairly advise the taxpayer that the Commissioner has, in fact, determined a deficiency and … specify the year and amount.” His opinion points out that the existence of a deficiency represents the most fundamental requirement of a Notice of Deficiency. His opinion finds that “only taxpayers with counsel at the ready and pro se taxpayers with extrasensory perception will be able to divine the meaning of these misleading missives.” Because the Notice of Deficiency is designed to satisfy certain fundamental rights and because a notice that on its face says that the taxpayer owes nothing seems not to satisfy those rights, it is hard to argue with the concerns expressed by the dissent. The dissent is short and does not spend much time with prior precedent because it seems to view that the line crossed here is not one that can be patched up by flipping through the back pages of the notice or relying on the taxpayer understanding the true meaning of what the IRS intended. I interpret the bottom line of this opinion as saying that even though the Tax Court has a long history of precedent looking at the back pages of the Notice of Deficiency to ascertain what it really means or looking at other documents, as Chief Judge Marvel points out, that precedent does not support crossing the line to uphold a notice which on its face says the taxpayer owes $.00. Once the notice says that, it does not warrant further inquiry but simply fails to satisfy a necessary condition.

Judge Gustafson writes a separate dissent in which all of the judges joining in Judge Foley’s dissent also join except for Judge Gale. Judge Gustafson further articulates the importance of putting the $.00 amount on the face of the Notice of Deficiency. He points out that the notice twice states that the deficiency is $.00. “A notice that reports such a zero is not a notice of a deficiency; it is a notice of no deficiency.” (emphasis in original) He looks to the requirement that the IRS mail a Notice of Deficiency. Here it mailed a notice of disallowance and of no deficiency. This meant that the notice lacked a statutory predicate and the Court should dismiss the case.

Conclusion

The Tax Court bends over backwards to determine it has jurisdiction when a taxpayer files something within the time frame set out by the relevant statute – usually 90 days. It treats many types of documents filed by petitioners as petitions, or imperfect petitions, allowing taxpayers to perfect their filing as long as the original document arrives at the Court on time. As pointed out by all of the prior opinions cited in Judge Buch’s opinion, the Court has similarly bent over backwards as it determines jurisdiction when a taxpayer timely files a petition in response to a Notice of Deficiency containing defects by allowing the IRS to repair the damage caused by the inadequacy of its notice.

The Dees case presents a factual situation the Court had not previously faced – a notice that literally says no deficiency exists but which when you dig deeper shows that the IRS really did mean to say a deficiency did exist. The majority views the poorly drafted notice as just one more example of a notice that requires peeking behind the first page and they have plenty of case support for that view. The dissent says there must be some line over which the IRS cannot cross and still have a valid notice and that this notice crosses that line. Because I do not have to vote, I will stop there except to say that to the extent the majority is correct, I think the concurring opinion of Chief Judge Marvel places a reasonable limit on the inquiry to which the Court should go in making its determination. It seems tough enough to determine what the IRS means with the written notice without having to try to figure out what the taxpayer thought the IRS meant and how that matters for purposes of granting the Court jurisdiction.

Tax Court Again Holds APA Does Not Impact Validity of Statutory Notice of Deficiency

One of the main issues in tax procedure over the next few years will be the  relationship of IRS actions with the Administrative Procedure Act. Last week in Taking a Hard Look at Court Review of Treasury Regulations I discussed an article that considered rulemaking in light of 5 USC § 706(2)(A), which empowers a court to invalidate a rule that is “arbitrary” and “capricious.” That issue is front and center in the Altera case involving the validity of regulations under Section 482. That case is currently on appeal in the Ninth Circuit.

A close cousin of the Altera issue is teed up in the context of IRS adjudications in QinetiQ v Commissioner, a case on appeal in the Fourth Circuit. In QinetiQ, well-represented taxpayers are arguing that the IRS’s poorly explained notice of deficiency  should be set aside for its arbitrariness. (for previous PT posts on QinetiQ see here and here).

In QinetiQ the taxpayer is arguing that by violating the APA the notice should lose its validity and IRS would have to issue a properly detailed notice to generate a possible deficiency. A side issue would be whether the SOL on assessment would be tolled while the parties fought over the validity of the original notice, an issue I am certain that IRS and taxpayers would disagree over.

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In Ax v Commissioner, the Tax Court has not embraced the position that the APA imposes additional obligations on the IRS’s issuance of stat notices, as we explained in Tax Court Rules that APA and Administrative Law Principles Do Not Bar IRS From Amending Answer and Asserting New Grounds for Deficiency. Professors Stephanie Hoffer and Chris Walker followed up and gave additional context on this issue in A Few More Words on Ax and the Future of Tax Exceptionalism.

Circuit courts will soon be weighing in on this issue. Oral argument in the Fourth Circuit in QinetiQ occurred in late October; for an audio of that interesting argument see here. The argument is rich, with taxpayer counsel framing the issue as one of basic fairness in terms of dealing with the government and DOJ counsel describing the impact of a taxpayer win as potentially “catastrophic.”

Other cases are in the pipeline where taxpayers are making similar arguments. In Soechting v Commissioner taxpayers argued in a summary judgment motion that a shoddy notice of deficiency invalidated the notice under the APA. In an October order, the Tax Court disagreed, relying on Ax. The taxpayers then requested that the Tax Court certify the issue for immediate appeal to a circuit court (presumably the Fifth Circuit, as taxpayers reside in Texas). Under IRC § 7482(a)(2)(A), the Tax Court has the authority to certify an issue in a case for immediate appeal if there “is a substantial ground for a difference of opinion…”

In an order from earlier this week the Tax Court denied that request:

Petitioners’ submissions make it abundantly clear that they disagree with the Court’s position that the issuance of a notice of deficiency is not subject to the Administrative Procedures Act (APA). But this Court has repeatedly adhered to that position in the past, and most recently in Ax v.Commissioner, 146 T.C.__ (April 11, 2016). Petitioners have presented no authority to the contrary. Their reliance upon Altera Corp. v. Commissioner, 145 T.C. 91 (2015) is misplaced as that case addresses the applicability of the APA to the Commissioner’s regulation promulgation authority.

As I have explained previously, taxpayers are swimming upstream on this issue though there is an atmospheric problem with IRS issuing notices that may be wrong on their face or at best failing to explain much about why IRS is proposing a deficiency. Yet taxpayers generally have the right to de novo review of a stat notice. There are other remedies and specific provisions addressing inadequate stat notices, and taxpayers enjoy the right to meaningful prepayment review of IRS actions. While the courts are pushing IRS toward the mainstream of administrative law in some areas I suspect that this is one issue where tax procedure may stay somewhat outside APA norms.

The Burden of Gifts

I am a firm believer that it is better to give than to receive, but I find buying presents to be overwhelming.  I can never find the right mix of thoughtfulness and pizzazz, so I usually put it off far too long and then end up doing most my shopping at RiteAid.  My wife does all of our holiday shopping, which means I only have to shop for her.   Clearly a lucky woman getting all of those fine convenient store items (if you all wanted to comment and provide suggestions as to what I should buy my wife, it probably wouldn’t be a bad thing.  What I know after 15 years about her gift preferences are that she would rather they not come from RiteAid, and she doesn’t think tax related gifts are awesome—takes all kinds).

The taxpayers in Cavallaro v. Commissioner did not have similar problems.  Their gift was much more complex, but everyone  loves huge amounts of wealth.  The burden in this case  was not what to get or how much to spend.  Here, it was the burden of proof (more specifically, which party had the burden and what that burden of proof actually was).  The Tax Court and First Circuit both held the taxpayers were unable to shift the burden to the Service, but, interestingly, the First Circuit determined the Tax Court had misapplied the taxpayers’ burden as having to prove their proper tax liability instead of simply proving the Service’s assessed tax was incorrect, which some are suggesting is a significant taxpayer friendly holding.

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The Facts –Merging Companies, Giving Gifts.

So, what did the Cavallaros get their sons?  A merger, resulting in a gift worth about $29,670,000 (that is on my list, but probably not going to be under my tree).  The Cavallaros had a successful company  (“Knight”) that made custom tool and machine parts.  Husband owned 49%, and wife had 51%.  At some point, they tried to expand into a liquid dispensing system manufacturer, but it initially failed.  One of the sons asked if he could continue to try to develop the system under a new entity (“Camelot”), and the parents agreed.  That son and two other sons owned Camelot.  Ten or so years later, the Cavallaros brought in lawyers and accountants to review their estate plan.  The accountants felt the now successful other line of business (“newtech”) was part of, or owned by, Knight.  This was how it was treated by Knight and how it was kept on the books.  The lawyers, however, felt it should be treated as having already passed to Camelot, which was marketing and selling the technology, and which would have already transferred the value to the three sons.

The lawyer, in trying to convince the accountant of this, stated, “[h]istory does not formulate itself, the historian has to give it form without being discouraged by having to squeeze a few embarrassing facts into the suitcase by force.”  Facts can be the worst.  The lawyer eventually convinced the accountant and family, and then had affidavits, memos, and a confirmatory bill of sale evidencing newtech in Camelot.

The family had a valuation of the two companies post merger, which the valuation expert valued  at $70MM to $75MM, with the Knight portion worth about $13MM to $15MM (less than 20% of the total company). Camelot, with the ownership of newtech, was valued at over 80%.    After the merger, Mr. C got 18 shares of the merged company, Mrs. C got 20 shares, and each son got 54 shares.  Shortly thereafter, the company was sold, with the Cavallaros getting $10.8MM total, and each son receiving $15.4MM.

Later, the IRS examined the two companies, and disagreed about the ownership of newtech, leading it to investigate the transaction for potential gifts from the merger.  The Service eventually issued a notice of deficiency for the gifts from the Cavallaros to their sons.  The IRS’ initial position, without an appraisal, was that Camelot had no value, resulting in a roughly $46MM gift from the merger, with $12.6MM in tax due.  The service also imposed penalties for the failure to file the return and for fraud under Sections 6651(a)(1) and 6663(a).

The Cavallaros took the matter to the Tax Court, and during discovery found that the Service had a valuation done after the deficiency was issued, which had been done by an accountant named Bello, and the appraisal indicated Knight had a value of $22.6MM prior to the merger (not $0).  The Cavallaros used the valuation to make two arguments against the Service, both of which could have shifted the burden of proof to the Service.  First, the Cavallaros argued that the original deficiency was arbitrary and excessive.  Second, the Cavallaros argued the Service had initially taken the position that Camelot was a shell corporation used for a sham transaction, which was used solely for making a disguised gift.  The Cavallaros argued that the Service’s new position that the Cavallaros had grossly understated the value of Camelot was a “new matter” under Tax Court Rule 142.  Based on this, the taxpayers sought to shift the burden of proof to the Service.

The First Circuit summarized the tax court holding as follows:

The Tax Court denied the Cavallaros’ renewed motion to shift the burden of proof to the Commissioner. While noting that it was “evidently true that the Commissioner did not obtain an appraisal before issuing the notices” of deficiency, the Tax Court found that there was a sufficient basis for issuing the notices and, thus, that they were not arbitrary. Further, the court found unpersuasive the Cavallaros’ argument that the Commissioner’s litigating position was a “new matter” and stated that the Commissioner’s “partial concessions as to Camelot’s non-zero value” did not require a new theory or change the issues for trial.

And, summarized the Cavallaros’ appeal on this issue, and the question of what the burden was, as follows:

On appeal, the Cavallaros renew their claim that the Tax Court erred by failing to shift the burden of proof to the Commissioner for two independent reasons: because (1) the original notices of deficiency were arbitrary and excessive, and (2) the Commissioner relied on a new theory of liability. They make two additional arguments. First, they claim that the Tax Court improperly concluded that Knight owned all of the [newtech] related technology. Second, they contend that the Tax Court erred by misstating their burden of proof and subsequently failing to consider alleged flaws in Bello’s valuation of the two companies.

In general, there is a presumption of correctness of an IRS notice of deficiency, and the taxpayer must prove by a preponderance of the evidence that the Service erroneously assessed tax (which isn’t necessarily the same as showing the taxpayer’s correct tax liability).  It is worth noting that this examination began prior to the enactment of RRA98, which amended Section 7491 dealing with burdens of proof.  Those changes made it easier, in certain circumstances, for taxpayers to shift the burden to the Service, but those provisions were not available to the Cavallaros (although I’m not sure that would have mattered in this case).

Excessive and Arbitrary

As indicated above, the first argument the Cavallaros made was that the deficiency notice was excessive and arbitrary.  Not much text was devoted to this argument, and the First Circuit noted this was a limited doctrine.  Essentially, a taxpayer must argue that the assessment has “no factual relationship to the taxpayer’s liability…” Zuhone v. Comm’r, 883 F2d 1317 (7th Cir 1989).  The Court said its question was “whether the [taxpayers] have carried their burden of producing evidence from which it can [conclude] that their deficiency assessments utterly lacked rational foundation.”  Although the Service initially used no formula, and had no valuation, the Court found that did not result in a conclusion that the initial assessment lacked a rational foundation.  As the Service had seen statements about “squeezing a few embarrassing facts into a suitcase,” and other information about aggressive planning, the Court found sufficient evidence to conclude the Camelot substantially less, and perhaps no, value.

The policy behind this makes sense.  The taxpayer has all the information, and may not have  been cooperating, but the Court was fairly dismissive of this argument, when there were some negative facts for the Service (obtaining a valuation shortly after assessment, which showed substantial value – hard to imagine it had none of that information when assessing).

New Matter

The Cavallaros second argument was that the Service was raising a new matter, which based on the facts from the First Circuit, seems like an aggressive characterization.  Under the Tax Court rules, a party raising a “new matter” has the burden of proof on that matter.  If the Service seeks to impose tax based on a rationale not in the notice, it is treated as having raised a “new matter”.  See Shea v. Comm’r, 112 TC 183 (1999).  Whether a new theory is a new matter is not always clear.  The Court noted, a new theory is “treated as a new matter when it either alters the original deficiency or requires presentation of different evidence.” Wayne Bolt & Nut Co. v. Comm’r, 93 TC 500 (1989).  That is not the case if the theory “clarifies or develops the original determination.”

Here, the Cavallaros believed that the original argument was that Camelot was a worthless sham, but at trial the government argued that Camelot was overvalued by the Cavallaros.  The notice, however, never indicated Camelot was a sham.  The notice stated:

[Under Section 2511,] donor’s merger of Knight Tool Co. into Camelot Systems, Inc. in return for 19% of the stock of Camelot Systems, Inc. resulted in a gift of $23,085,000.00 to the other shareholders of Camelot Systems, Inc. Accordingly, taxable gifts are increased $23,085,000.00.

The Court stated that the “clear implication was that, because Knight was undervalued, the…merger allowed for a disguised gift…”  The Court found that when the IRS subsequently changed its position on the value from $0 to around $22.7MM, it was “simply a refinement”, which it held was in line with its position that, “if a deficiency notice is broadly worded and the Commissioner later advances a theory not inconsistent with the language, the theory does not constitute a new matter…”  The Court also found that the notice clearly informed the Cavallaros that the Service was questioning their valuation.   This holding, again, makes sense, but I have conflicted feelings about incentivizing the Service to issue notices that are overly broad and vague.

What Was the Burden?

The most interesting aspect of the holding came from the application of the burden of proof in relation to challenging the IRS’s valuation of the entities.  The Cavallaros, before the Tax Court, had attempted to challenge the valuation report by Bello that was relied upon by the Service and the Court, believing it to have substantial flaws.  The Tax Court disallowed this challenge, believing it to be unnecessary.  The Tax Court stated that the Cavallaros had “the burden of proof to show the proper amount of their tax liability.”  The Tax Court had found that the Cavallaros’ valuations were incorrect, because they assumed full ownership of newtech in Camelot and the Tax Court had held the technology was owned by Knight.  The Tax Court further held that without valuations, the Cavallaros could not prove their correct tax liability, and therefore lost the case, so challenging the Bello valuation wasn’t necessary.  The Cavallaros, however, argued that their burden was not to show the proper amount of tax, but to prove that the alleged deficiencies by the Service were erroneous.  One avenue of doing this was to address the flaws in the Bello valuation.

In this instance, the First Circuit agreed with the Cavallaros, stating:

 [a]lthough the Tax Court did not misallocate the burden of proof at trial, we agree with the [taxpayers] that the Tax Court misstated the content of that burden.  The Commissioner’s deficiency notices enjoyed a presumption of correctness, and the [taxpayers] had the burden of proving by a preponderance of the evidence that they were erroneous.

The First Circuit held this was a clear error, and the Cavallaros should have had the opportunity to show the valuation was arbitrary and excessive, which could have then indicated the Service assessment was incorrect.   The First Circuit remanded the case to the Tax Court to determine the evidentiary value of the Bello valuation, stating that if it was not valid the Tax Court would be responsible for determining the correct valuation and amount of tax due.

This procedural misstep by the Tax Court was a bit of a gift for the taxpayers, allowing them another shot at reducing their tax burden.  I would note, the Tax Court did state the burden correctly in the text of the holding, which it stated in multiple places as the petitioner having to show the deficiency notice was incorrect, and indicating “where the Commissioner has made a partial concession of the determination in the notice of deficiency, the petitioner has the burden to prove the remaining determination wrong” (quoting Silverman v. Comm’r, 538 F2d 927 (2d Cir. 1976)).  However, in the discussion of the review of the valuations, it did state, “[i]t is the Cavallaros who have the burden of proof to show the proper amount of their tax liability, and neither of the expert valuations they provided comports with our fundamental finding that Knight owned [newtech]…”  This did lead to the Tax Court not reviewing the valuations.

This was a good catch by the litigating attorneys, and goes to show that you need to pay close attention to every aspect of a holding, because even though a Court may correctly state the rules, it still can drift from those rules in coming to its holding.  At least one other commentator, Dominick Schirripa at Bloomberg BNA, believes this could be a substantial holding for taxpayers.  He indicates it is fairly common  for the Court to require the taxpayer to show the correct liability in order to prove the Service’s assessment is incorrect.  Mr. Schirripa may be correct, but I think my expectation from the case is a little more tempered (which Mr. Schirripa also notes in his post).   It would seem for many income tax cases, and gift and estate, showing the correct tax is really the only way to show that the Service assessment was incorrect.  In this case, where a valuation is at question, there are various ways to attack the Service’s valuations without presenting evidence of the correct tax due.  Since it may be limited circumstances where this is the case, this holding may not broadly impact how cases are handled before the Tax Court, but it is worth keeping in mind when reviewing a potential case.

 

 

 

After the Tax Court Finds It Lacks CDP Jurisdiction, Seventh Circuit Says It Should Keep Quiet About Other Collection Issues

We welcome back frequent guest blogger, Carl Smith, who discusses a recent 7th Circuit case that rejects a line of cases decided by the Tax Court concerning the scope of its authority when dismissing a Collection Due Process case.  Keith

In a precedential opinion issued on November 18 in Adolphson v. Commissioner, the Seventh Circuit affirmed the Tax Court’s dismissal of a Collection Due Process (CDP) petition under section 6330(d)(1) for lack of jurisdiction. The Tax Court dismissed the petition because the IRS had never issued a notice of determination after a CDP hearing – a ticket to the Tax Court.  But, the Seventh Circuit was unhappy that the Tax Court also went on to consider (though, ultimately reject) the taxpayer’s argument that there had been no CDP hearing and no notice of determination (NOD) only because the IRS failed to send a notice of intention to levy (NOIL) to the taxpayer at the taxpayer’s last known address.  In effect, the Seventh Circuit said that where the Tax Court lacks jurisdiction because of the lack of an NOD, the Tax Court should keep quiet about other potential collection issues – such as, in this case, whether the IRS had issued an NOIL to the taxpayer’s last known address before it had started levying.  The Seventh Circuit particularly rejected a line of Tax Court opinions beginning with Buffano v. Commissioner, T.C. Memo. 2007-32 – which, according to the Seventh Circuit, the Tax Court has only intermittently followed – in which the Tax Court has considered as part of its jurisdictional dismissals, issues going to the validity of NOILs.

This post will discuss Buffano, the unpublished order issued by Judge Carluzzo in Adolphson, and the Seventh Circuit opinion in Adolphson.

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Readers are no doubt aware that before the IRS issues a CDP NOD (a ticket to the Tax Court), the IRS Office of Appeals must hold a CDP hearing.  CDP hearings can only be requested after the IRS validly issues an NOIL or NFTL.  One way for the IRS to validly issue an NOIL or NFTL is to send it by certified or registered mail to a taxpayer’s last known address.  Sections 6320(a)(2)(C) and 6330(a)(2)(C).  If certified or registered mail is used for an NOIL, levy is prohibited for the 30-day period in which a taxpayer can request a CDP hearing.  Section 6331(d)(1) and (2).  If a CDP hearing is requested, no levy is allowed and the collection statute of limitations is suspended until the CDP hearing (and any judicial appeals) are over.  Section 6330(e)(1).

Buffano

In Buffano, the first the taxpayer knew about collection was when the IRS sent a levy to his employer.  The taxpayer was upset that he had not, before then, received an NOIL.  The taxpayer sent a Form 12153 requesting a CDP hearing with respect to the taxes being levied, and the IRS decided that, since it had sent an NOIL to what it had thought was the taxpayer’s last known address (even though the NOIL was returned by the USPS undelivered), the IRS had done all it needed to do to commence levy.  Since the request for a CDP hearing was made more than 30 days after the IRS mailed the NOIL, the IRS instead gave the taxpayer an equivalent hearing.  At the end of the equivalent hearing, the taxpayer was unsatisfied with the equivalent letter, and, within 30 days, filed a petition in the Tax Court under section 6330(d)(1).

The IRS moved to dismiss the case for lack of jurisdiction on the ground that no NOD following a CDP hearing had been issued.  Thus, the taxpayer had not received a ticket to the Tax Court.  The taxpayer cross-moved to dismiss for lack of jurisdiction on a different ground:  No NOIL had validly been sent to his last known address.  The court decided that it had to determine the reason for the jurisdictional dismissal that was inevitable in the case.  The Tax Court held that the NOIL had not been sent to the taxpayer’s last known address.  Thus, it was invalid, and the dismissal was predicated on the NOIL’s invalidity.  Presumably, the Tax Court expected that this holding would mean that the IRS had to send a new NOIL to the taxpayer for the same taxes before the IRS could commence any levy.

In subsequent cases presenting the same fact pattern as Buffano, the Tax Court has sometimes (but not always) followed Buffano and issued a ruling on whether or not the NOIL was mailed to the last known address.  If the NOIL was mailed to the last known address, then the Tax Court has dismissed for lack of jurisdiction on the basis of a lack of an NOD.  If the NOIL was not mailed to the last known address, the Tax Court has dismissed for lack of jurisdiction on the basis of a lack of a validly-mailed NOIL.  See, e.g., Anson v. Commissioner, T.C. Memo. 2010-119; Space v. Commissioner, T.C. Memo. 2009-230; Kennedy v. Commissioner, T.C. Memo. 2008-33.

Adolphson Tax Court Order 

Mr. Adolphson’s fact pattern was quite similar to Buffano – i.e., he first learned of collection from an actual levies on third parties who held his funds, but he had never before received an NOIL. Unlike Buffano, he did not thereafter ask for and get an equivalent hearing, but went straight to the Tax Court.  In the Tax Court, Mr. Adolphson first moved to restrain further levies and for the Tax Court to order the IRS to refund what had already been levied – arguing that the IRS had not sent an NOIL to his last-known address and citing Buffano.  Then, the IRS cross-moved to dismiss for lack of jurisdiction because of the absence of an NOD.  The IRS, however, attempted to show it had mailed an NOIL to his last known address.  Since Mr. Adolphson had not filed returns for many years, there was a serious issue as to which address was his last known address.

In an unpublished order at Docket No. 21816-14L, issued on February 3, 2015, Special Trial Judge Carluzzo granted the government’s motion, first stating:

Petitioner agrees that the Court is without jurisdiction in this matter. That being so, his motion to restrain must be denied as our authority to grant the relief he seeks arises only in cases where our jurisdiction under section 6330(d) has properly been invoked. See sec. 6330(e). Petitioner, however, disagrees with respondent’s ground for the dismissal.

Then, the judge distinguished Buffano as follows (footnote omitted):

Petitioner’s reliance upon Buffano is misplaced. The record in Buffano contained information showing the address shown on the taxpayer’s relevant Federal income tax return, the starting point for purposes of establishing a taxpayer’s last known address. See sec. 301.6212-2(a) Proced. & Admin. Regs.; Kennedy v. Commissioner, 116 T.C. 255 (2001); Abeles v. Commissioner, 91 T.C. 1019 (1988). Petitioner has not established what, if any, address was shown on his Federal income tax return(s) most recently filed before the relevant notices of intent to levy were issued.  Furthermore, under the circumstances before us and contrary to petitioner’s suggestion, the address shown on respondent’s November 5, 2012, letter to him is hardly determinative as to his “last known address” for purposes of section 6330.

Because of the paucity of information as to petitioner’s last known address, we decline to make any finding on the point in resolving the jurisdictional motion before us. To the extent that there are any irregularities in the assessment process giving rise to the above-mentioned liabilities, or to the collection of those liabilities, petitioner’s remedies, if any, lie in a different Federal court.

Adolphson Seventh Circuit Opinion 

The Seventh Circuit affirmed the Tax Court, but using a lot of words criticizing both the Tax Court’s rulings and the DOJ lawyers’ briefs and oral argument.  In a 16-page opinion, the panel took apart Judge Carluzzo’s barely 3-page order.

Initially, the panel stated that, if it were going to apply the Buffano line of cases, it disagreed that the IRS had shown that it mailed an NOIL to the taxpayer’s last known address.  In particular, the panel noted that some of the IRS evidence of mailing consisted of improperly-authenticated transcripts that only indicated the issuance of one or more NOILs, but there was no evidence in the record of any mailing or evidence of even the address used.  The panel accused Judge Carluzzo of improperly shifting the burden of proof on mailing to the taxpayer and wrote:  “In other words, had the tax court followed Buffano and required the Commissioner to prove proper mailing, the ‘paucity of information’ should have led to a win for Adolphson.” Slip op. at 10-11.

The panel was also critical of the DOJ lawyers for, among other things, (1) not taking a position on whether the Buffano line of cases was correct, (2) not taking a position on whether Judge Carluzzo correctly distinguished Buffano, (3) making no attempt to justify the IRS collection behavior in the case, and (4) unhelpfully arguing that “Adolphson, proceeding pro se, erred by asking the tax court to enjoin further collection efforts and refund money already collected, rather than asking the court to invalidate the levies.”  Id. at 11.  “Instead, the Commissioner insists that Adolphson is relegated either to an administrative claim before the IRS or a refund suit in district court, while maintaining that ‘whether the IRS mailed a Notice of Intent to Levy to taxpayer’s last known address is not relevant in this case.’” Id.

Turning to the law, the panel wrote:

Notwithstanding this unwillingness to confront the salient issue, the Commissioner is correct that, absent a notice of determination, the tax court lacks jurisdiction under 26 U.S.C. § 6330(d).  A decision invalidating administrative action for not following statutory procedures is a quintessential merits analysis, not a jurisdictional ruling. The Buffano line of cases therefore represents an improper extension of the tax court’s statutorily defined jurisdiction.

Id. at 12 (citations omitted).

The panel blamed the Tax Court’s error in Buffano on its uncritically importing into CDP, from its deficiency jurisdiction case law, the practice of allowing a taxpayer who files a late deficiency petition to ask that the court determine that the notice of deficiency was not sent to the last known address, and, so, the Tax Court lacked deficiency jurisdiction because of an invalid notice.  Calling the deficiency jurisdiction practice “less problematic”, the panel distinguished it from determining whether an NOIL was properly sent to a last known address, since the challenged notice in a deficiency case is the ticket to the Tax Court (the “jurisdictional hook”), whereas an NOIL is not.  In a passage I find confusing, the panel wrote:

Although calling this ground for dismissal [of an improperly-mailed notice of deficiency] “jurisdictional” is a misnomer, the logical underpinning is the same: The tax court is determining whether the IRS has met statutory requirements to proceed with collection, but there isn’t a question of whether or not the jurisdictional hook exists (were there no deficiency, there would be nothing to collect).

Id. at 14.  Earlier in the opinion, the panel had written:

This [Buffano] practice of invalidating collection activity [in a CDP case] where the tax court lacks statutory authority to proceed also violates the Tax Anti‐Injunction Act, 26 U.S.C. § 7421(a), which (with exceptions inapplicable here) 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.” This statute deprives courts of jurisdiction to enter pre‐collection injunctions and “protects the Government’s ability to collect a consistent stream of revenue” by ensuring that “taxes can ordinarily be challenged only after they are paid, by suing for a refund” under 28 U.S.C. § 1346(a)(1). By invalidating levies despite the absence of a notice of determination under § 6330—a taxpayer’s jurisdictional hook to enter tax court—decisions such as Buffano stand in direct opposition to the Act.

Id. at 12-13 (citations omitted).

Ultimately, the panel concluded that a taxpayer in Mr. Adolphson’s position is left only the remedy of a refund suit.  I would call that remedy completely useless, since one can only get a court to order a refund in such a suit if one has overpaid one’s taxes.  Lewis v. Reynolds, 284 U.S. 281 (1932).  It is of no relevance in a refund suit whether the IRS improperly forced all or part of the tax payments by a procedurally-improper levy.

The panel regretted that it saw no statutory remedy for Mr. Adolphson’s plight:

The framework used in Buffano to scrutinize the IRS’s compliance with its statutory obligations does have equitable appeal; a taxpayer to whom the IRS fails to mail a Final Notice of Intent to Levy and, through no fault of her own, misses the 30-day window to request a CDP hearing might otherwise be left without an opportunity to petition the tax court prior to seizure of her assets. This is the system devised by Congress, however . . . .  Troubling though this [refund suit] “remedy” may be, given the expense and potential delays inherent in such a suit, there is no lawful basis for expanding the tax court’s jurisdiction to resolve the perceived problem. Absent a notice of determination, the tax court simply has no lawful authority to hear a taxpayer’s claim under § 6330(d).

Adolphson, at 15-16.

Observations

Because Mr. Adolphson was pro se and the DOJ’s briefing was so unhelpful, the panel may have misunderstood certain things about tax procedure when it wrote the opinion.  The opinion conspicuously fails to mention three possible avenues for relief for him.

First, section 6330(e)(1) suspends the collection statute of limitations if a person requests a CDP hearing.  In this case, no CDP hearing was requested because no NOIL was issued to the last known address (probably).  Section 6330(e)(1) goes on to provide:

Notwithstanding the provisions of section 7421(a), the beginning of a levy or a proceeding during the time the suspension under this paragraph is in force may be enjoined by a proceeding in the proper court, including the Tax Court.  The Tax Court shall have no jurisdiction under this paragraph to enjoin any action or proceeding unless a timely appeal has been filed under subsection (d)(1) and then only in respect of the unpaid tax or proposed levy to which the determination being appealed relates.

Since there was no NOD here to which an appeal under subsection (d)(1) could be timely, the Tax Court lacked that injunctive power under subsection (e)(1).  I don’t see the district court having injunctive power under (e)(1), either, since the injunctive power is provided during the period of the suspension.  Since no CDP hearing was requested (probably, since no NOIL was issued to the last known address), no suspension period is in effect.

Second, the Supreme Court acknowledged a judicial, equitable exception to the anti-injunction act in Enochs v. Williams Packing & Navigation Co., 370 U.S. 1 (1962).   To succeed under that exception, a taxpayer must show (1) that under no circumstance could the government prevail, and (2) that there is equity jurisdiction – i.e., that the taxpayer would suffer irreparable harm if the government’s actions were not enjoined.  While I think that an IRS levy made without previously sending a proper NOIL might meet the first requirement, merely being forced to pay money would doubtless not be considered irreparable injury.  However, there might be irreparable injury if, say, the levies would end up forcing the taxpayer’s business into bankruptcy.

Short of injunctive relief, though, Congress has provided in section 7433 a suit for money damages on account of negligent wrongful collection actions.  But, under this section, a taxpayer is limited to actual damages – and I am not sure merely paying taxes prematurely constitutes actual damages.  However, collateral damage – such as the levies ending up causing the taxpayer to lose clients or to go into bankruptcy – would seem to be compensable damages.

I also don’t think the Adolphson court appreciated how the dismissal of a deficiency petition for lack of jurisdiction because of an invalid notice doesn’t amount to an injunction against the IRS.  The Tax Court has jurisdiction to find facts necessary to its jurisdiction. When the Tax Court determines that a notice of deficiency wasn’t valid, that is a jurisdictional fact found by the court that could be used by a taxpayer in later litigation to collaterally estop the IRS from, say, judicially foreclosing on the tax lien that arose from the deficiency.  By contrast, if the Tax Court holds an NOIL was invalid, the court would be deciding an issue not necessary to its CDP jurisdiction, so the discussion would be dicta.  A taxpayer could not use this dicta to collaterally estop the IRS in later litigation from arguing that the NOIL was valid. The result of a ruling in a Buffano-type case that the NOIL wasn’t properly mailed is simply an advisory opinion to the IRS not to pursue collection under that NOIL. The IRS usually follows that advice. But, since the Tax Court shouldn’t be issuing advisory opinions, perhaps that is part of why I agree with the Seventh Circuit that Buffano is incorrect.

Finally, Adolphson may also call into question Craig v. Commissioner, 119 T.C. 252 (2002), where the Tax Court held that it has jurisdiction under section 6330(d)(1) to hear a case where the IRS mistakenly issued an equivalent hearing letter, rather than an NOD.  In Craig, the Tax Court said it would treat the equivalent hearing letter as an NOD.  Adolphson seems to suggest that when no NOD was actually issued, the Tax Court should just keep quiet about any other merits issue, as it lacks jurisdiction under section 6330(d)(1).

 

Seventh Circuit May Hold 90-day Period to File Deficiency Petition Not Jurisdictional

We welcome back frequent guest blogger, Carl Smith, who discusses a surprising development in the issue of whether a time period to file a Tax Court petition in a deficiency case is jurisdictional. Jurisdictional in this context is a code word for set in stone. Depending on the outcome of this case, jurisdiction in Tax Court cases could get very interesting. Keith

As you may recall from a recent post of mine, Keith and I are in the midst of litigation in the Circuit courts about whether the time periods in which to file Tax Court petitions in Collection Due Process (CDP) (§ 6330(d)(1)) and stand-alone innocent spouse (§ 6015(e)(1)(A)) cases are jurisdictional or subject to equitable tolling under recent non-tax Supreme Court case law that has made time periods to file almost never jurisdictional.  Even though the Supreme Court has been issuing many opinions on its new jurisdictional thinking since 2004, our arguments are, shockingly, ones of first impression in the Circuit courts. In June, the Tax Court, en banc, rejected our arguments in a CDP case named Guralnik v. Commissioner, 146 T.C. No. 15 (June 2, 2016), basically saying that the Supreme Court case law we cited is distinguishable because it does not involve tax law or the Tax Court and because the Tax Court would prefer to stick, by analogy and stare decisis, to its old case law holding the § 6213(a) period to file jurisdictional. See Byran Camp’s post on Guralnik here.

I have done a couple of posts on the case of Tilden v. Commissioner, T.C. Memo. 2015-188, see my posts here and here. It is a deficiency case that was taken up on appeal. On October 6, 2016, the parties did oral argument before the Seventh Circuit in the case, and it appears that at least two judges on the panel, Judge Easterbrook and Chief Judge Wood, (and maybe all three) are inclined to hold that the current non-tax Supreme Court case law on jurisdiction makes the § 6213(a) time period to file a deficiency case non-jurisdictional. If they do this in the deficiency area, it will certainly constitute a revolution in the tax controversy world and a slap at the unanimous Tax Court holding in Guralnik. Yikes!

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By way of background on the Tilden case, I quote from one of my earlier posts:

Tilden is a case where a deficiency petition arrived at the Tax Court after the 90th day.  It arrived by certified mail (United States Postal Service (USPS)), but bore no real postmark, just a shipping label from stamps.com and a certified mail receipt, both dated the 90th day, and the latter only dated in the handwriting of an employee of the taxpayer’s attorney.  Applying regulations under section 7502 and prior Tax Court case law, Judge Armen held that since internal USPS tracking data showed that the USPS first got possession of the envelope after the 90th day, section 7502 did not apply, the petition was untimely, and the Tax Court therefore lacked jurisdiction.

In the appeal, both the taxpayer and the DOJ are arguing that Judge Armen was wrong and that the Seventh Circuit shouldn’t rely on the provision of the § 7502 regulations that he relied on. Both sides now agree that this case should be treated as if the envelope bore a non-USPS postmark, where the regulations would treat the filing as timely if the petition arrived at the Tax Court within a normal period that would apply to regular mail sent by USPS on the last date to file. The parties agree here that the petition arrived 8 days after the last date to file. Given the extra screening done to Tax Court mail since the 2001 anthrax scare, the DOJ and IRS now concedes that 8 days is within the outer edge of the normal period for USPS mail to reach the Tax Court from Utah.

The parties filed briefs in the Seventh Circuit arguing about which was the correct regulation under § 7502, but not discussing, one way or the other, recent non-tax Supreme Court case law on whether time periods to file are jurisdictional. Indeed, the parties at oral argument admitted ignorance of the non-tax Supreme Court case law that appellate judges are applying almost every week to overturn prior holdings.

The parties just assumed that the time period to file a deficiency petition was jurisdictional, as most Circuit courts and the Tax Court had held long ago. But, no one has ever asked the Tax Court or a Court of Appeals to reconsider whether the § 6213(a) period is really still jurisdictional under the Supreme Court’s new case law severely limiting the use of the word “jurisdictional”. Under that new case law, time limits to file in courts are not jurisdictional, unless either (1) Congress has made a “clear statement” in the statute that it wants the time period to be jurisdictional, or (2) the Supreme Court has for over 100 years in its own opinions held the time period jurisdictional (even though the time period wouldn’t be considered jurisdictional under the new Supreme Court rules).

At the oral argument in Tilden on October 6 (which can be heard on the Seventh Circuit’s website and linked above), at least two and maybe all of the judges on the panel spent a large part of each side’s time asking: “Why isn’t the § 6213(a) filing period not jurisdictional under current non-tax Supreme Court case law?”  It is clear that at least two of the judges think that the time period is obviously not still jurisdictional under that case law.  No judge on the panel suggested it was.

The judges were rather shocked that neither party’s lawyer was prepared to discuss the jurisdictional issue under current Supreme Court case law, but Robert Metzler of the DOJ noted to the court that this same issue was being raised in two other cases, Duggan v. Commissioner (a Ninth Circuit CDP case, where Keith and I are amicus) and Matuszak v. Commissioner (a Second Circuit innocent spouse case under § 6015(e), where Keith and I are taxpayer’s counsel and which Meltzer erroneously said was going on in the Third Circuit). Metzler was confused. Keith and I are litigating, as counsel for the taxpayer, a § 6015(e) case named Rubel v. Commissioner in the Third Circuit. Metzler forgot to mention Rubel.  Metzler also failed to mention that none of our cases involve the deficiency time period in § 6213(a), so the issue is not exactly the same, but only similar.

Metzler is counsel for the DOJ in the Duggan case, and only on October 4 (i.e.,2 days before the Seventh Circuit oral argument in Tilden), the Ninth Circuit had accepted Keith and my amicus brief in the Duggan CDP case. At the same time, the Ninth Circuit ordered Metzler to file a response to our amicus brief no later than October 25. (Metzler is not the DOJ counsel in either Matuszak or Rubel.)  Metzler told the Seventh Circuit that he was just beginning to familiarize himself with the issues we raised, but that he was not prepared to make any argument on the jurisdictional point to the Seventh Circuit. He offered, instead, to provide supplemental briefing, but the judges were not interested in more briefing on Supreme Court case law on jurisdiction that they said they already knew quite well.

Metzler also warned that this panel might have to go en banc to overrule Seventh Circuit existing precedent, Petrulis v. Commissioner, 938 F.2d 78, 79 (7th Cir. 1991); Sanders v. Commissioner, 813 F.2d 859, 861 (7th Cir. 1987); and McPartlin v. Commissioner, 653 F.2d 1185, 1188 (7th Cir.1981); that described the filing period as jurisdictional. But, Judge Easterbrook seemed already to have looked at those opinions: The statement in Sanders that timely filing is a jurisdictional defect for a deficiency case was dicta, not the least necessary to the holding. Thus, Sanders is not current Seventh Circuit precedent. While the other two opinions clearly state that the filing period is jurisdictional, the Supreme Court would call those two opinions “drive-by jurisdictional rulings,” deserving of no precedential weight, since it would not have mattered in either case whether the time period was called an element of the claim to be proved, instead of a jurisdictional defect. See Arbaugh v. Y & H Corp., 546 U.S. 500, 511 (2006).

Although it is always dangerous to predict, at the end of the argument, it seemed that the judges were going to hold that the § 6213(a) time period is not jurisdictional and remand the case to the Tax Court.  The judges pointed out that since non-jurisdictional statutes of limitations are subject to waiver, and the IRS was not arguing that the petition was untimely, the Tax Court could just proceed to the merits after a remand if the Seventh Circuit held the time period not jurisdictional.

The day after the oral argument, a fairly desperate Meltzer submitted an FRAP 28(j) letter in which he argued that, just as the Supreme Court in John R. Sand & Gravel Co. v. United States, 552 U.S. 130 (2008), refused to use its new thinking on jurisdiction to overturn its prior holdings for over 100 years that the 6-year time period in which to file a suit in the Court of Federal Claims under 28 U.S.C. § 2501 is jurisdictional, similar stare decisis grounds should caution the Seventh Circuit from overruling its precedent under § 6213(a). Unfortunately for the government, the Supreme Court has not said there is a stare decisis exception from its current rules on jurisdiction to consistent prior holdings of lower courts. So, I doubt this comment will go anywhere with the Seventh Circuit, though the Tax Court accepted this argument in Guralnik.

Oddly, Meltzer, in his letter, makes no attempt to show that the Congress made a “clear statement” in § 6213(a) that the time period to file is jurisdictional.

Finally, in his letter, Meltzer referred the Seventh Circuit to the Tax Court’s opinion in Guralnik, which, he said, “contains a well-reasoned discussion of whether the jurisdictional status of time limits for Tax Court petitions has been changed by recent Supreme Court cases.”

Observations

Even though a good argument could be made that the deficiency jurisdiction time period is not jurisdictional, Keith and I have been careful not to make that argument and to point out to the courts why we aren’t making that argument. While such a holding might benefit individuals who are seeking equitable tolling for a late-filed deficiency petition, we fear the argument’s consequences on people who had no good reason for late filing. Most people have no good reason for late filing.

It has long been held that a person who files a deficiency petition late can, after the case is dismissed for lack of jurisdiction, simply pay the tax and sue for refund in district court. Budlong v. Commissioner, 58 T.C. 850, 854 n.2 (1972); McCormick v. Commissioner, 55 T.C. 138, 142 n.5 (1970). That is because § 7459(d) provides, in relevant part:

If a petition for a redetermination of a deficiency has been filed by the taxpayer, a decision of the Tax Court dismissing the proceeding shall be considered as its decision that the deficiency is the amount determined by the Secretary. An order specifying such amount shall be entered in the records of the Tax Court . . . unless the dismissal is for lack of jurisdiction.

If the § 6213(a) filing period is not jurisdictional, then, if a person files a late Tax Court deficiency petition, § 7459(d) would turn the decision in the case into a decision on the merits upholding the deficiency.  I am not sure that the person could then pay and sue for a refund.  Wouldn’t the Tax Court merits decision be res judicata in the district court for the same tax year?

Further, the point of the Supreme Court making a stare decisis exception to its new rules because of a long history of its case law holding a time period jurisdictional is that Congress, having read that case law, might have legislated on the assumption that the time period was jurisdictional. Even though there is no Supreme Court case law interpreting § 6213(a) or its predecessors, it is clear that Congress has legislated on the assumption that § 6213(a) is jurisdictional. The Committee reports accompanying the 1998 legislation adding a sentence to the end of that subsection allowing taxpayers to rely on the last date to file shown in notices of deficiency state that Congress is making the change because the time period is jurisdictional. See H. Rept. 105-364 (Part 1) at 71, 1998-3 C.B. 373, 443; S. Rept. 105-174 at 90, 1998-3 C.B. 537, 626. Accord H.R. (Conf.) Rept. 105-599 at 289, 1998-3 C.B. 747, 1043-1044.

It would have been helpful if Meltzer had also told the Seventh Circuit about the potential § 7459(d) problem we foresee and the Committee report language noted in the prior paragraph.

Well, if the Seventh Circuit rules § 6213(a)’s time period is not jurisdictional, I suppose the problem we foresee could easily be fixed by a statutory amendment to § 7459(d).

 

Private Carriers, APA Impact on Notices and New Blog

Les and I each wrote short, essentially follow up posts which we are combing into one.  We anticipate we will be writing more on mailing deadlines and on the APA impact on notices.  Keith

Using Private Carriers to Meet a Filing Deadline

In Notice 2016-30, IRS published a new list of designated private delivery services  (“designated PDSs”) for purposes of the timely mailing treated as timely filing/paying rule of section 7502. The Notice provides rules for determining the postmark date for these services. The Notice updates Notice 2015-38, which had updated Notice 2004-83. This marks the second time IRS has updated the rules in under a year after an eleven or so year run for the original notice.

The main change is that the notice, effective April 11, 2016, adds to the acceptable list a number of DHL-provided services. IRS dropped DHL in last year’s following DHL’s cutback in services.

The Notice reminds people that not all services offered by the anointed carriers qualify as PDS’s. We have discussed numerous times issues taxpayers and practitioners have had meeting petition deadlines. Failing to track which services qualify can have major consequences. Keith has discussed the sad case of Guralnik v Commissioner when the taxpayer used FedEx First Overnight to mail his petition, a service not found within the 2004 notice but one IRS added in 2015. In addition, a summary opinion from a couple of years ago, Sanders v Commissioner, involved a pro se taxpayer who sent in his petition on day 89 using UPS Ground. UPS Ground was then and is still not one of the many UPS services that the IRS treats as a PDS.

In Sanders, the petition arrived at Tax Court after the 90-day period elapsed. IRS moved to dismiss, and the Tax Court held that the petition was untimely “because UPS Ground has not been designated by the Commissioner as a private delivery service.”

Addressing the consequences the Tax Court added:

In so holding we acknowledge that the result may appear harsh, notwithstanding the fact that petitioner had nearly 90 days to file his petition but waited until the last moment to do so However, the Court cannot rely on general equitable principles to expand the statutorily prescribed time for filing a petition.

The Tax Court concluded that Sanders was not without recourse; he could pay the tax and file a refund claim and suit. Given that he deficiency was for two years and totaled over $40,000, with the Flora rule requiring full payment, that option may not have given Sanders much comfort.

Follow up on Statutory Notice and the Administrative Procedure Act Post

One commenter on the post suggested additional links.  After the post was written, QuinetiQ filed its reply to the Government’s brief.  So, this brief post will provide a quick update of documents available for those interested in this case.

In the post I provided a link to the Tax Court opinion; however, the commenter pointed out that the most pertinent document from the Tax Court case was an order, linked here, setting out the Court’s views on the motion to dismiss based on lack of jurisdiction due to the (allegedly) improper notice of deficiency.  The order provides details about the Tax Court’s reasoning in denying the motion that I did not include in the original post.

In the 4th Circuit, QuinetiQ filed the opening brief as the appellant.  For some reason we could not access that brief and did not include it as a link in the post.  It is linked here.  Now that QuinetiQ has filed a reply brief, it is also available and is linked here.  The briefs filed by QuinetiQ make clear that it thinks the notice of deficiency in this case really provided no meaningful notice.  Not having seen that notice I can only imagine from other notices I have seen that the possibility certainly exists that the notice itself was bad.  Then the question is so what?  Must the taxpayer move forward on the substance of the matter gleaning what it can from the notice, from what it knew of the audit and from the information that comes out during the Tax Court case or can it get a court to strike the notice of deficiency as inadequate under provision s of the Administrative Procedure Act.  Do those provisions apply to an informal agency action such as a notice and, if they do, in applying them to this notice, should it be stricken?  Is this just another example of tax exceptionalism that needs to fall or is the notice of deficiency something totally covered by the IRC, outside of the APA, and subject to very relaxed standards for what provides adequate notice.

 

New Tax Blog

A group of tax professors, some of whom publish great material on tax procedure, have just started a new blog for those who might be interested.  Check it out at https://surlysubgroup.com/

 

 

Statutory Notice Language and the Administrative Procedure Act

Yesterday, Les posted about the Tax Court decision in Ax v. Commissioner holding that the APA did not prevent the IRS from amending its answer to add additional bases for supporting its deficiency determination.  Last year, we failed to write about the case of QinetiQ U.S. Holdings v. Commissioner, T.C. Memo 2015-123 which seeks to significantly change statutory notices issued by the IRS.  Guest blogger Sean Akins, one of petitioner’s counsel at the Tax Court level, made brief mention of the case in his post on sealing the records in the Tax Court but did not address the major procedural issue in the case.  Although the case may significantly change the way the IRS must issue statute notices of deficiency, it only has importance if the petitioner wins the novel argument.  Because the government won in the Tax Court, the case remains obscure.  Due to its potential significance, it bears watching, with other APA cases seeking to change Tax Court practice, as it moves forward.  Petitioner appealed the case to the 4th Circuit where the parties have recently filed their briefs.

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Petitioner timely filed a petition in Tax Court and then moved to dismiss the case for lack of jurisdiction arguing that the notice of deficiency was invalid.  The invalidity of the notice, according to petitioner, resulted from the failure of the notice to provide an adequate description of the issues causing the IRS to send the notice.  While other cases (see here, here and here) over the years have attacked the validity of the notice of deficiency on the grounds of insufficiency and the Tax Court has upheld some notices that must have caused it to hold its nose, no petitioner prior to QinetiQ argued that the notice of deficiency lacked validity because it failed to follow the Administrative Procedure Act (APA).

We have published several posts (see here, here and here) on the APA and its impact on tax regulations.    We have not, however, written about the impact of the APA on more day to day notices issued by the IRS and how, if at all, the APA impacts what the IRS must put in those notices.  That is the issue QuinetiQ takes on.  The IRS argument is essentially that the APA does not apply to things such as a notice of deficiency and the Tax Court agreed.  The taxpayer will make its arguments again before the 4th Circuit.  While the taxpayer may have a low chance of success, big changes in the notice process will occur if it does succeed.

The IRS position is that the IRC does not required detailed reasoning in a notice of deficiency and that the specific language of the IRC regarding the notice of deficiency trumps the provisions of the APA.  The IRS points to IRC 7522 which requires only that the notice briefly inform the taxpayer concerning the proposed deficiency for a specific year and amount.  Section 7522(a) also contains a statement that an inadequate description does not invalidate the notice.  This creates a tough hurdle for the taxpayer to overcome in attacking the validity of a notice of deficiency.

With respect to the “reasoned explanation” requirement petitioner argues that the APA imposes on notices of deficiency, the IRS argues that this misinterprets the APA requirement.  Such an explanation must support agency action in the context of formal rulemaking but not in the context of a notice of deficiency which acts more like an informal rulemaking determination.  The Supreme Court has held that the notice of deficiency does not require a detailed explanation although not necessarily in response to an argument such as petitioners make in this case.

Whether the 4th Circuit reverses the Tax Court or simply lets stand a decision that continues with the same rules for the notice of deficiency to which we have become accustomed, the case bears watching if you have interest in what a notice of deficiency should say.  When I started working on tax cases in the 1970s every case on which the IRS sought to issue a notice of deficiency went through the review staff of the examination division.  The revenue agents had a strong dislike for the review staff because it regularly caught their mistakes and required them to redo their work.  The review staff carefully crafted notices of deficiency.  The effort that the IRS put into the notices at that time seems amazing today as I look back on the procedure then and now.  Revenue agent reports were transformed from sometimes loose language about a proposed change to much more descriptive language that had a better chance of standing up to a challenge.  We have come a long way from the days when a review staff crafted the notice of deficiency and from what may have been expected when the statutory provisions and early case law were written.

Today, the vast majority of notices get issued using the 30 day letter attached to the formal notice letter.  Little, if any, review of the notice occurs and most notices concern small cases handled by the correspondence unit.  Even in larger cases the amount of review is quite small given the amount of money at stake.  Because the change over to the notices of deficiency without review and careful language has now existed for over two decades, we are accustomed to notices that do not provide a great deal of notice in many cases.  Whether or not Quinetiq wins the case for APA level descriptions in notices of deficiency, it might be appropriate to think about how we arrived at the current state of “notice” in these notices and whether a better level of notice should exist.  We have posted now on several occasions about correspondence from the IRS that does not adequately advise the taxpayer of what is happening or what will happen.  Poorly written notices of deficiency raise many of the same issues and place on taxpayers the burden of proof in Tax Court cases concerning matters that sometimes contain inadequate or incorrect descriptions.  Of course, if we want the IRS to spend the time to provide better notice, we must also make the commitment to provide adequate staffing.