Court Orders Release of IRS Documents Despite Deliberative Process Privilege

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

I will summarize the issue and case below.

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

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

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

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

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

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

Conclusion

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

Update on Schaeffler Privilege and Work Product Dispute With IRS

Last December we discussed the Schaeffler Group’s multi-million dollar dispute with the IRS and in particular the Second Circuit’s opinion concerning attorney-client privilege and work product protection. See PT guest poster Ben Bolas’s Schaeffler v. United States: Second Circuit Rejects District Court’s Limitations on Attorney-Client Privilege and Work Product Doctrine in the Context of Tax Advice.

As Ben discussed, the Second Circuit reversed the district court and pushed back on opinions that had limited privilege in the face of parties having a common interest beyond a legal interest. The Second Circuit held that Schaeffler did not waive the attorney-client privilege and work product protections when Schaeffler shared opinions and communications with financial institutions pursuant to a common interest agreement even though the parties had a shared commercial interest. In resolving the summons dispute with respect to some of the documents at issue, the Second Circuit remanded the case to determine whether other documents were protected by the attorney client privilege or work product doctrine.

Law 360 a couple of weeks ago reported that the parties had settled the underlying tax dispute. See Schaeffler, IRS End $25M Dispute Over Stake Sale Loss, (not a free link) where it stated that the parties had “come to an accord ‘with respect to all issues’ in the U.S. Tax Court case.

With that resolution I was somewhat surprised when I came across last week the district court issuing an opinion and order that resolved an ongoing dispute regarding the IRS summons despite the merits settlement. In this brief post, I will discuss the nature of the dispute and offer a reason why the parties were still fighting about the summons even though the underlying case settled.

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Here is how the District Court framed the dispute:

On appeal, the United States Court of Appeals for the Second Circuit vacated this Court’s judgment and remanded the case for “further proceedings.” The IRS recently withdrew the summons and now moves to dismiss the petition for lack for subject matter jurisdiction on the ground that it is moot. Schaeffler has cross-moved for entry of a judgment quashing the summons.

The District Court opinion detailed further the parties’ actions following the Second Circuit opinion:

Schaeffler appealed the Court’s decision to the Second Circuit.See Notice of Appeal, filed June 6, 2014 (Docket # 55). The Circuit vacated this Court’s judgment and “remand[ed] for such further proceedings as may be necessary to determine, in a manner consistent with this opinion, whether any remaining documents are protected by the attorney-client privilege or work-product doctrine.” Schaeffler v. United States, 806 F.3d 34, 45 [116 AFTR 2d 2015-6708] (2d Cir. 2015). The Second Circuit’s mandate issued on January 28, 2016. Mandate, filed Jan. 28, 2016 (Docket # 64).

This Court then ordered “[t]he parties … to consult to determine whether there should be any further proceedings in this matter.” Order, filed Jan. 29, 2016 (Docket # 65). On February 5, 2016, the parties submitted a joint letter “agree[ing] that there is no need for further proceedings ….” Letter from Todd Welty and Rebecca S. Tinio, filed Feb. 5, 2016 (Docket # 66). The parties represented that they were “working to draft stipulated dismissal documents.” Id.

One week later, however, on February 12, 2016, the IRS withdrew the summons that was the subject of the petition to quash. Ramirez Decl. ¶ 5. In a letter, the IRS informed Ernst & Young that “[n]o further attempt will be made by the Internal Revenue Service to seek production of records from Ernst & Young under this summons.” Letter from Hugo Ramirez to Melissa Galetto, dated Feb. 12, 2016, appended as Exhibit 1 to Ramirez Decl. The instant motions to dismiss and for entry of judgment followed.

The rest of the opinion essentially discusses the mootness doctrine, which stems from Article III of the constitution. That doctrine requires that courts have an actual controversy before it. Last week’s district court opinion notes that there are many cases that have held that the withdrawal of an IRS summons moots a petition to quash that summons. In finding that no exception to the mootness doctrine applied, the opinion granted the IRS’s motion to dismiss and denied Schaeffler’s motion for entry of judgment quashing the summons.

What was going on with the dispute? It was not entirely clear to me but I discussed the opinion with Jack Townsend, who authors the Federal Tax Crimes blog and who is the successor author with me on the Saltzman and Book criminal tax penalties chapter in IRS Practice and Procedure. Jack suggests that in opposing the government’s motion to withdraw and in cross-moving for an entry of a judgment quashing the summons Schaeffler “might want the issue to be final between Schaeffler and the Government via some type of preclusion (res judicata or collateral estoppel) if the issue arises in the future as may be likely in subsequent audit proceedings or litigation.” While this is merely an inference it makes sense to me.

While for Schaeffler the resolution of the summons dispute means that there is no court order quashing the summons on privilege grounds (and some opening for future disputes between the parties), the Second Circuit opinion remains a powerful weapon for parties seeking the attorney client privilege and work product as well as the ability to raise the common legal interest doctrine generally.

 

 

 

 

Tax Court Order Sets Out Quick Peek Process in Discovery Dispute

A couple of weeks ago the Tax Court issued an order in the ongoing dispute between IRS and Guidant relating to over billions in adjustments for the years 2001-07 involving transfer pricing and the transfer of intangibles to foreign corporations (as well an accuracy-related penalty). We have on occasion in the blog discussed the high stakes and intense battles surrounding privilege disputes (see for example DOJ and Davis Polk Take off the Gloves in Recent Discovery Dispute Involving GE’s $660 Million Tax Refund Suit).

There have been a series of discovery disputes in the Guidant case, which is not surprising for a case of this size. In the latest dispute, Guidant has been seeking documents from IRS, and IRS has claimed deliberative process privilege for over 4,000 documents. Guidant filed a motion to compel. IRS had sent across privilege logs and Guidant thought the logs were “inadequate and fail to provide the necessary information to support the privilege or at the minimum are deficient in a number of formatting and practical issues or have missing essential information.” The taxpayers argued that “hundreds of entries on respondent’s logs fail to identify the deliberative process involved and fail to identify the decision to which they relate.” The taxpayers suggested that the Court “issue a Protective Order for the benefit of respondent if respondent would release the documents to petitioners during discovery.” IRS felt that the Protective Order “would not adequately protect respondent and suggested “that a sampling of the thousands of documents claimed to be subject to the privilege be examined in camera by the Court.” The taxpayers objected to the sampling because they felt that it “would be inherently biased because respondent would know what the documents contained because they had possession of them but petitioners would not know.”

With that impasse, the order notes that the parties agreed to use a “quick peek” procedure to resolve the dispute, with the requirement that the parties file a status report. I was not familiar with that process, and briefly describe it below.

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A 2015 New York Law Journal article from attorneys Christopher Boehning and Daniel Toal at Paul Weiss discusses their use and defines them as follows:

Under “quick peek” agreements, parties to a litigation may produce documents after little to no privilege review, subject to the understanding that any privileged documents disclosed will be returned to the party who produced them free from the recipient’s assertion of waiver.

Quick peek agreements grew out of 2008 changes to the Federal Rules of Evidence (FRE) that sought to mitigate the risks of inadvertent waivers of privilege. FRE 502(b) provides that if a party takes reasonable steps to prevent disclosure a mistaken production of privileged material does not waive the privilege. The FRE 502(b) change resolved conflicts in common law and were significant. In addition to FRE 502(b), as the 2015 NY Law Journal article states “FRE 502(d) is even more sweeping. Under that provision, parties may ask a court to enter an order specifying that the parties’ production of privileged material does not constitute waiver, even if the parties fail to take reasonable steps to prevent its disclosure.”

From FRE 502(d) (and Advisory Committee Notes accompanying Federal Rule of Civil Procedure 26(b)(2)) is how we get to quick peek. The Paul Weiss authors state that FRE 502(d) has encouraged the use of quick peek agreements, which has the potential to speed discovery because it reduces the amount of privilege review before production.

Observations on the Procedure

As my recent Tax Court experience is in tax clinic cases where discovery was rare, I sought thoughts on the process from Sean Akins, Special Counsel at Covington, co-author of Thomson Reuters’ Litigation of Federal Tax Controversies and former Procedurally Taxing guest poster. While Sean likewise has no direct experience with the process, he does have significant insight, noting that quick peek “is consistent with the Tax Court’s practice of seeking to have the parties communicate and cooperate to the greatest extent possible” and that he “suspects that the Court hopes that the parties will be able to agree that certain documents are truly protected by the deliberative process privilege, some are not, and as to the others there remains a fair dispute.” As Sean observes, even if the parties still may dispute whether privilege attaches, it could lessen the need for further court intervention “because Petitioners will have the opportunity to review the substance of the documents, and it may be that they elect not to challenge the privilege claim if they determine some of the documents lack relevance/materiality.”

Sean also however expressed “a little surprise” at its use in the context of the government claiming deliberative process privilege:

[T]the quick peek method was utilized concerning documents purportedly subject to the deliberative process privilege.  The theory behind that privilege, as I understand it, is that assuring government employees of confidentiality with respect to their decision-making process should permit those individuals to provide more candid advice.  Allowing a quick peek, even if the privilege attaches and remains unwaived, cuts against this, as the decision-making process is revealed.  Somewhat ironically, the IRS resisted the notion that a protective order would adequately protect the IRS should the documents be produced to Petitioners.  But, nothing in the Order that the Court issued would preclude Petitioners or their counsel from disclosing to others the substance of what they learned during the quick peek process.  In the absence of protections against such disclosure, I would have opted for a protective order.

Sean adds that “he would be interested to keep an eye on this and see how it is ultimately resolved, and whether the parties are again before the Court with a more narrow set of documents requiring an in camera review.” We will keep an eye on the Guidant case and also for other orders where the Tax Court uses this approach.

For those interested I include the language from the order setting out the procedure:

  1. Respondent does not waive any privilege it has asserted with respect to deliberative due process or any other privilege it has previously asserted in this case. The privilege is not waived in this litigation and any disclosure is also not a waiver in any other Federal or State proceeding.
  2. Counsel for respondent shall disclose each document for which he claims privilege and counsel for petitioners shall review such document but is not permitted to retain or copy such document unless both counsel agree otherwise or except as provided.
  3. All documents which both counsel agree are properly claimed as privileged shall remain so and respondent shall not be required to produce that document further. All documents which both counsel believe are not properly claimed as privileged shall be immediately produced and given to petitioners.
  4. The parties shall file a status report after they have concluded their quick peek procedure.

Summary Opinions for the second half of May

Here is part two of the items from May we didn’t otherwise cover.  We’ll have the June items shortly, and then July.  Hopefully, I’ll get back on track for weekly summaries in the near future.

  • The Sixth Circuit in Ednacot v. Mesa Medical Group, PLLC affirmed the lower court tossing a physician assistant’s claim that an employer wrongfully withheld employment taxes.  The Court determined this was tantamount to a refund suit, which required the taxpayer to first file an administrative claim for refund with the IRS prior to bringing suit.  There seems to be a lengthy past between the parties in this case.  The petitioner brought up a valid seeming point that she did not know if the withholdings were paid to the IRS, and therefore wasn’t sure if the refund was appropriate, but the Court held that Section 7422 was designed to funnel these issues through the administrative process.
  • Couple interesting privilege cases recently, including the Pacific Management Group decision blogged by Joni Larson for us.  In a case that may have a somewhat chilling effect on making reasonable cause claims, the Tax Court has held that claiming reasonable cause to the substantial valuation misstatement penalty waived attorney client privilege and the work product doctrine for certain communications between the taxpayer and its lawyer and accountant.  See Eaton Corp. and Sub. v. Comm’r.  This holding was the affirming of a motion for reconsideration.  The Court found that although there was an objective determination under Section 6662(e)(3), whether relying on the advice on Section 482 was based on the facts and circumstances, including the advice of the lawyer.  By claiming reasonable cause, the privileges were waived for that issue.
  • Taxpayer was successful arguing against the substantial understatement penalty in Johnston v. Comm’r, but it was because the taxpayer didn’t actually owe the tax.  The IRS had argued that a debt between the taxpayer (an executive of a telcom company) and his company was discharged by his employer when he moved to a related entity.  There was credible evidence that it was not discharged and payment continued.  There was the pesky issue that the loan wasn’t paid until the IRS audited the individual, but the Court found that the audit prompted the company to do something with the loan and it hadn’t been tax avoidance…must have been persuasive testimony.
  • LAFA issued guidance on the effect on the limitations period on assessment for payroll tax when the wrong form is filed. (LAFA 20152101F).  Employers are generally required to file quarterly returns on Form 941 for employment taxes when they are paid in that period.  A different form, Form 944 is used for certain employers with little  employment tax liability, and that is required annually.  The statute generally runs from the date of the deemed filing of employment tax returns, which is April 15 the following year.  See Section 6501(a)&(b).  The LAFA reviews the following three situations:
  1. Employer is required to file Form 944, but instead timely files four quarterly Forms 941.

  2. Employer is required to file Form 944, but timely files Form 941 for the first and second quarters of the year instead, and files nothing for the third or fourth quarters of the year.

  3. Employer is required to file quarterly Forms 941, but timely files annual Form 944 instead.

 

The quick conclusions were:

  1.  Assuming the Forms 941 purport to be returns, are an honest and reasonable attempt to satisfy the filing requirements, are signed under penalty of perjury, and can be used to determine Employer’s annual FICA and income tax withholding tax liability, the Forms 941 meet the Beard formulation and should be treated as valid returns for purposes of starting the period of limitations on assessment.

  2.  An argument can be made that the Forms 941 for the first and second quarters of the tax year constitute valid returns under the Beard formulation since they purport to be returns and are signed under penalty of perjury. However, given that Employer’s FICA and income tax withholding tax liability for the third and fourth quarters will not necessarily be equal to that reported for the first two quarters, the Forms 941 arguably are not sufficient for purposes of the determining Employer’s annual FICA and income tax withholding tax liability and may not be honest and reasonable attempts to satisfy the tax law.

  3.  Assuming the Form 944 purports to be a return, is an honest and reasonable attempt to satisfy the filing requirements, can be used to determine Employer’s annual FICA and income tax withholding tax liability, and is signed under penalty of perjury, Employer’s Form 944 meets the Beard formulation and should be treated as a valid return for purposes of the period of limitations on assessment.

  • A taxpayer in a chapter 11 case, Francisco Rodriquez (not the current Brewers closer who pitched for the Mets before choking out his relative in the clubhouse) was successful in avoiding a lien under 11 USC 506 on property held by the taxpayer that was already underwater with three prior liens.  In re Rodriguez, 115 AFTR2d 2015-1750 (Bktcy D MD 2015).  Section 506 allows liens to be stripped if the property lacks equity, which was what the taxpayer was attempting.  SCOTUS in Dewsnup v. Timm held that  a chapter 7 debtor cannot “strip down” an allowed secured claim (clearly, I was not the debtor, otherwise SCOTUS would have tossed on some Its Raining Men, and granted my right to strip down—I only did it to pay for college, I swear—and yet, still so many student loans).  Various other cases have held that Dewnsup does not extend to other chapters in bankruptcy, and the District Court held that lien stripping was appropriate in chapter 11 under the taxpayer’s circumstances.
  • The Tenth Circuit continues its clear prejudice and hatred towards Canadians (I completely made that up and that link is NSFW) in Mabbett v. Comm’r, where it found the Tax Court properly tossed a petition as being untimely that was filed by a resident of the US, who was a Canadian citizen.  The Court found the Service had properly sent the stat notice to the taxpayer at her last known address (and even if that was not the case, her representative had forwarded her a copy well before the due date of the petition).  The taxpayer also claimed that she was entitled to the 150 day period to file her petition to the court under Section 6213(a) because she was a Canadian citizen.  The Court stated, however, that the statute was clear that the 150 day rule only applies when “the notice is addressed to a person outside the United States.”  The taxpayer had been traveling, and was Canadian, but failed to show she was outside of the United States at the time the notice was sent.
  • In case you haven’t seen, the Service has started a cybercrimes unit to combat stolen ID tax fraud.  In my mind, this is sort of like the IRS and Tron having a lovechild, which I would assume to look like this.  Jack Townsend has real coverage on his Federal Tax Crimes Blog.
  • Jack also has coverage of the new IRS FBAR penalty guidance, which can be found here

 

Summary Opinions for May, part 1

May got away from me, and so has much of June.  I’ll post the Summary Opinions for May in two parts, and handle June in the same manner.  Below are some of the tax procedure items in May that we didn’t otherwise cover:

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  • The Middle District of Louisiana, after the Fifth Circuit vacated and remanded the case, reversed its prior decision and, under Woods, held that the Section 6662(e) valuation misstatement penalty could be imposed when the underlying transaction had been determined to lack economic substance. Chemtech Royalty Associates, LP v. US.   This case was the result of some crazy tax planning by Dow Chemicals to goose its basis in a chemical plant.  Here is Jack Townsend’s prior coverage of the case.
  • Sticking with substantial valuation misstatement penalty, the Tax Court in Hughes v. Comm’r upheld the penalty against a KPMG partner who claimed a step up in basis in stock when he transferred the shares to his non-resident spouse.  This was based on some informal tax research, and conversations with some co-workers that were also informal.  The Court essentially felt Mr. Hughes should have known better, and tagged him with a big penalty (probably didn’t help he was transferring the shares to try and ensure his ex-wife couldn’t make a claim for the increase in value).
  • IRS has released Chief Counsel Advice regarding abatement of paid tax liabilities.  In taxpayer friendly advice, CCA 201520010 states the language of Section 6404(a) is “permissive” and does not require the liability to be outstanding.  That Section states the “IRS is authorized to abate the unpaid portions of the assessment of any tax or any liability in respect thereor…”  The reference to “unpaid”, according to the CCA, is not binding on the Service.
  • The Service has released CCA 201519029, which provides advice on when preparer penalties can apply in situations where the prepared didn’t sign the return or didn’t file the return, and when a refund claim was made after the statute had expired.  For the third situation, the Service stated that “understatement of liability” does not include claims barred by the statute.  The full conclusions in the CCA are:

Issue 1: Yes. If the return is not filed, a penalty under I.R.C. § 6694(b) may be assessed if the return preparer signed the return and the return preparer’s conduct was willful or reckless.

Issue 2: Yes. Under the language of I.R.C. § 6694(b)(1), the return preparer penalty may be assessed if the tax return preparer prepares any return or claim for refund with respect to which any part of an understatement of liability is due to willful or reckless conduct. There is no requirement that the Service allow the amounts claimed on an amended return before the I.R.C. § 6695(b) penalty may be assessed.

Issue 3. The penalties under I.R.C. §§ 6694(a), 6694(b) or 6701 should not be assessed merely because the return preparer made and filed a claim for refund after the period of limitations for refunds had expired, because an “understatement of liability” does not include claims that are barred by the period of limitations. In addition, there may be extenuating circumstances that weigh against asserting the penalty. The amended return, for example, may be perfecting an earlier timely informal claim for refund.

  • The Service has announced it will be refunding the registered tax return preparer test fees.  There will be a second refund procedure where you can request your time back…but it will be ignored.
  • Professor Andy Grewal in early May had an excellent blog post on Yale’s administrative law blog, Notice and Comment, which highlights more potential penalties on employers attempting to follow the ACA requirements.
  • Another CCA (CCA 201520005) , where the IRS has held that the deficiency procedures apply to the assessment of the penalty under Section 6676 to erroneous refund claims based on Section 25A(i) American Opportunity Credit, since the penalty can only apply to a refund claim based on the credit if that claimed credit is part of a deficiency.  Carlton Smith previously had a blog post touching on this issue, found here, where he persuasively criticized  this position.  You should check out the entire post, but I’ve recreated a portion below:

A third issue discussed by the PMTA is how the section 6676 penalty is to be assessed.  Frankly, I read the Code as providing that the assessment is done like a section 6672 responsible person trust fund penalty — straight to assessment, without the deficiency procedures applying.  That seems to be what section 6671 provides.  But, the PMTA takes the position that only for underlying issues on which the section 6676 penalty applies where there is no jurisdiction in the Tax Court under the deficiency procedures, such as for excessive refund claims regarding employment taxes or the section 6707A reportable transaction penalty, the section 6676 penalty is done by straight assessment, without prior notice to taxpayers.  However, for section 6676 penalties on what would constitute a “deficiency” — and excessive refundable credit claims are clearly part of a deficiency under section 6211(b)(4)‘s special rules — the PMTA concludes that the section 6676 penalty should be asserted in a notice of deficiency.  The PMTA reasons that Tax Court cases have in the past held that a penalty which is computed as a function of a deficiency (which I would point out includes extra late-filing and late-payment penalties on the tax deficiency) are also treated under the deficiency procedures.  This reasoning is all mixed up.  The Tax Court applies the deficiency procedures to penalties like the late-filing and late-payment penalties of section 6651(a) that are imposed on the tax deficiency only because of special language in section 6665(b) that directs the Tax Court to do so.  There is no similar language in section 6671 directing deficiency procedures to apply to any penalties imposed in the following sections.

  • And another CCA (201517005), this one dealing with the statute of limitations for refunds based on foreign taxes deducted.  Specifically, whether a refund claim more than ten years (yr 13) after the tax year in question (yr 2) was timely when it resulted from an NOL (yr 4) where the taxpayer elected to deduct foreign taxes paid instead of taking foreign tax credit.  The IRS concluded that no, Section 6511(d)(2) applied to the NOL and required the claim to be made three years after the NOL year.  Section 6511(d)(3), which allows for a ten year statute for refunds pertaining to foreign tax credits, was not applicable.
  • Apparently, some states are starting to scale back the amount of tax credits available for movie productions.  Two years ago, The Suspect was filed in my building, staring Mekhi Phifer and no one else you have ever heard of.  I think it was “catered” by a fast food joint, and they may have been using our coffee pots to make coffee.  I can’t imagine Pennsylvania dropped the big bucks to land that film.
  • Emancipation day is throwing off filings again next year.  I always assumed that had something to do with the date of the Emancipation Proclamation, but I was wrong. The Emancipation Proclamation went into effect January 1st, 1863.  On April 16th, 1862, President Lincoln signed the Compensated Emancipation Act, freeing the enslaved living in the District of Columbia.  The linked Rev. Ruling explains what those in Massachusetts who are celebrating Boston Marathon Day (Patriots Day-celebrating the shot heard round the world) should do also.
  • Initially when writing this, I was watching the US women’s national team take it to Colombia, and recalling what a jackass Sepp Blatter has been.  Hoping this article is in reference to the shoe dropping on him next.  Even if he didn’t evade taxes, he should have to pay someone money for suggesting he would boost viewership of the women’s game with hot pants.  Or for not knowing who Alex Morgan is…or for making the women play on turf.

Summary Opinions for 11/07/14 & 11/14/14

Trying to get somewhat back on schedule with the SumOp’s, so we are covering two weeks of material in this post.

First, I want to note that Keith has a really interesting post up on Forbes regarding Microsoft filing a FOIA suit yesterday against the IRS to determine the extent to which the IRS is using an independent contract (here the law firm Quinn Emanuel) in its examination.  This is going to be a very hot  topic moving forward.  That post will find its way to PT later today, but probably not until late in the afternoon.

Before getting to the items we missed over the last few weeks, we had a very strong guest post by Christopher Rizek on the Sexton v. Hawkins case, which was very well received two weeks ago. You should check it out if you didn’t read it when we originally posted.  In October, we had a somewhat related post from Michael Desmond on the future role of Circular 230 in tax compliance, which can be found here.  The comments to that post, which are found here, have recently expanded significantly, as various Villanova LLM students were asked to respond as part of their professional responsibility class.  The students provide some quality feedback, astute observations, and ask some good follow up questions.

To the other procedure.

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  • Veolia Environment is still fighting with the IRS over document discovery.  We touched on this last year around this time.  The case again discusses privilege regarding various draft reports by experts, and other lawyer communications.  For one draft valuation, which was then shared with the company’s accountants at PWC, the Court found privilege had not been waived, stating, “PWC is not an adversary nor a conduit to an adversary.”  That seems like a favorable view on what is required to blow privilege.  The case goes through many other specifics as to the types of documents that remained privileged.
  • Jumping to a case from early October that we (I) missed in Comparini v. Comm’r, where the Tax Court determined it had jurisdiction to review an IRS determination to deny the taxpayers’ whistleblower claim.  The letter was not formatted as a determination, and prior letters had been sent to taxpayers; however, letter was the first one to use term “determination”, stated the matter was closed, and did not indicate any further administrative procedures were available.  The Court found that prior letter could have been a determination, but this later letter was also a determination (there is an interesting back and forth in the concurring and majority opinion about the basis for jurisdiction).  The concurring opinion, and Judge Holmes in comments to the CA Bar Association, both noted that the Court is having to spend a lot of time on procedural matters and jurisdictional questions due to the Whistleblower Offices’ habit of issuing various statements that seem to be determinations, and not having set forms for indicating when a determination had been made.  Tax Litigation Survey has coverage here.
  • Another older item that I didn’t catch.  The Service issued an Action on Decision  with regard to the Dixon case from last September, which we wrote about here.  The case had to do with an employer’s ability to designate employment tax payments that were not withheld at the source.  The Service believes the Tax Court was wrong in Dixon in deciding such payments can be designated against a taxpayer’s specific liability.
  • From Jack Townsend’s Federal Tax Crimes Blog, a discussion of the jury instructions in the Weil case as regard the good faith defense.  Not a long post, but interesting summary of this attack on the government’s case, and how the instructions could have influenced the jury.
  • Earlier this year, Google killed off one of its coupon saving sites, Zavers (reminds me of Zima’s “zomething different” slogan—don’t use Z’s where they are not needed—your company will fail), but the remains of the aggressive tax planning of Zavers’ chief technology officer have been resurrected by the Tax Court in Brinkley v. Comm’r.  As a side note, it is nice to be Google, who bought Zavers for close to $100MM in 2011, probably spent a bundle more on it, and are now walking away, as it was not growing fast enough (so says the article linked above).  The underlying matter has to do with Mr. Brinkley’s characterization of his income as capital gains, whereas the Service and Tax Court thought a portion should be ordinary income.  He had apparently been very clear that his ownership should never dip below 3% of the stock, which Zavers agreed to; however, at the time of the Google purchase, he owned around 1%.  In the end, he was paid as though he still held 3%.  The two tax procedure items involved the shifting of the burden, and reliance on a practitioner as reasonable cause.  Neither treads new ground.

On the shifting of the burden, the taxpayer argued that he offered reasonable evidence that an item of income reported on an information return was incorrect, shifting the burden under Section 6201.  The Court, however, was relying on other evidence submitted by the IRS, and not the information return, so the burden did not shift.  Mr. Brinkley also argued that he complied with Section 7491, and produced “credible evidence to support his position as to a factual issue, complie[d] with substantiation requirements, and cooperate[d] with the Secretary with regard to all reasonable requests for information,” but the Court found that Mr. Brinkley failed to offer any credible evidence of his position.

As to the reliance, the Court found that Mr. Brinkley failed to disclose his percentage of the stock to his advisers, how much that was valued at, and  did not provide them with all the documents from the deal.  It is clear law that where the adviser is not informed of all pertinent information, the taxpayer cannot rely on the adviser’s advice or work to get out of a penalty.

  • Susquehanna Bank, which was purchased last week by a North Carolina bank, recently won a lien priority case in the Fourth Circuit.  The Court held the district court incorrectly determined a trust deed, which the bank received prior to the IRS lien, but failed to record, was entitled to priority under Section 6323(h) based on Maryland law relating the recording of the trust deed back to the execution date.  However, the holding was affirmed because the bank was protected by Maryland’s equitable conversion law, which directs that when a taxpayer executes a deed in exchange for a loan prior to a lien filing, the deed took priority.
  • Kurko v. Comm’r is packed with tax procedure.  Lew Taishoff’s blog has some coverage here.   The cases discusses credit elect overpayment jurisdiction before the tax court, tolling for financial disability under Section 6511(h), how those interact, and the Court’s “next friend” rules under Tax Court Rule 60(d).  The Court encouraged Ms. Kurko, who suffered from substantial mental health issues, to have someone file a Motion to Be Recognized as Next Friend.  The Court said such motion should recite that:

o   The person filing would like to be recognized as Ms. Kurko’s next friend and would represent her best interests;

o   That Ms. Kurko cannot prosecute the case without help;

o   The person has a significant relationship with Ms. Kurko; and

o   There is no other person better suited to serve as next friend.

  • The Tax Court had occasion to review the 2006 changes to Section 6664, and the removal of the reasonable cause defense to the gross valuation misstatement penalty in Reisner v. Comm’r.  Prior to 2006, old Section 6664(c)(2) allowed the reasonable cause defense to the penalty when value was provided by a qualified appraiser and the taxpayer made a good faith attempt to determine the value.  That was tossed in the 2006 amendment for gross valuation misstatements (those with only substantial valuation misstatements can still show reasonable cause).  In Reisner, the taxpayer received a charitable deduction for a façade easement.  A portion carried forward to 2005 and 2006.  The Service determined the donation was valueless, and no deductions were allowed.  The gross valuation misstatement penalty was not imposed in 2004 or 2005 because the taxpayer was able to show reasonable cause.  For 2006, the return was filed after the changes to the statute, and the Service imposed the penalty on the carryover charitable deduction.  The Court held the penalty was correctly imposed, stating:

Because their 2006 return was filed after the effective date of 2006 amendments to I.R.C. sec. 6664(c)(3), Ps are precluded under that section from raising a reasonable cause defense to imposition of the gross valuation misstatement penalty for the underpayment on their 2006 return attributable to the carryover of their charitable contribution deduction.

An interesting result, where the action was protected in the initial year, but the statutory change resulted on penalties in future years based on the same transaction.

  • The Ninth Circuit reversed the Tax Court in JT USA, LP v. Comm’r, holding Section 6223(e)(3)(B) was clear and unambiguous and did not allow a partner in a partnership to elect out of the TEFRA proceedings unless the partner elects to have all his or her partnership items treated as non-partnership items.  For the majority, that was all partnership items, regardless if those were owned through other entities.  From the case:

 

26 U.S.C. § 6223(e)(3)(B), entitled “Notice to Partners of Proceedings,” reads in pertinent part, “In any case to which this subsection applies, if paragraph (2) does not apply, the partner shall be a party to the proceedings unless such partner elects – . . . (B) to have the partnership items of the partner for the partnership taxable year to which the proceeding relates treated as nonpartnership items.

In the prior proceeding, the tax Court held that that “§ 6223(e)(3)(B) permits taxpayers to opt out of the partnership proceeding with respect to their indirect interests but to leave in that proceeding their alleged remaining direct partnership interests.”  The Ninth Circuit disagreed, and said that the plain language states it is all or nothing when it comes to opt out.  The opinion was split, and the dissent stated the taxpayer should have the ability to completely elect out with regard to their direct interests in the partnership, but not do so with the indirect interest in the partners (and/or the other way).  I found this surprising, and my initial (somewhat uninformed) thought is that the tax court had this right.

 

Summary Opinions for 4/18/2014

VillanovaWildcatsIt is absolutely gorgeous out today.  A great day to run the Boston Marathon, which my mother-in-law is doing this morning.  Go Jean!  I can’t imagine how the environment feels, with such emotion following last year.  My house will be cheering all the runners and the City of Boston today.

Last week had two great guest posts, for which we are grateful.  Professors Stephanie Hoffer and Christopher Walker of Ohio State posted the first part of their two part article on the Death of Tax Exceptionalism and the Tax Court.  These are teaser posts for a full article to be published soon. Professors Hoffer and Walker argue forcefully that the Tax Court and some circuit courts have failed to situate  court review of IRS determinations as within the mainstream of administrative law. We believe the article is important and practical procedural scholarship and recommend a read.  And, our (guest) blogger, Carlton Smith posted on timely filing from prison and the recent Sharma case.  Mr. Smith’s most recent post highlights this interesting specific issue, but, of course, also provides great insight into a range of other procedure areas like equitable tolling, appellate venue, and the Golsen rule.

To the other procedure items from last week:

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  • Sticking with Carlton Smith. He sent us an email earlier this week updating us on the cases currently considering Rand and penalties.  Carl has written on this before for us, most recently in his very well received post, “Seven Tax Court Judges Depart From the Court’s Penalty Precedents.”  This week, the Tax Court published its decision in Faecher v. Comm’r, following Rand and indicating the Court has some duty to remove penalties even when not plead by the taxpayer, stating: 

The Commissioner generally bears the burden of production with respect to the liability of any individual for any penalty or addition to tax. Sec. 7491(c).  However, we have held that where the taxpayer fails to state a claim with respect to a penalty or addition to tax, the Commissioner incurs no obligation to produce evidence in support of the individual’s liability pursuant to section 7491(c), see Funk v. Commissioner, 123 T.C. 213, 216-218 (2004); Swain v. Commissioner, 118 T.C. 358, 364-365 (2002), at least where nothing in the record suggests the addition or penalty has been incorrectly computed. Where, as here, the record demonstrates that the penalty sought by respondent is erroneously calculated, we conclude that it should not be sustained, without regard to whether petitioner has stated a claim in the petition concerning the penalty. 

    Later in the week, other orders were issued in similar cases, with similar results.  Appeals in these cases can go to various courts, including the DC Circuit,      Second Circuit and Seventh Circuit.  I am sure Mr. Smith will continue to monitor on this matter, and provide us with additional insight.

  • I am happy to engage in some self-promotion for Villanova here (although somewhat envious, because Villanova wasn’t throwing this cash around when I was going through).  The Grad Tax Program has announced its Villanova Graduate Tax Program Assistantships for 2014-2015.  The program provides tuition scholarship  for up to two (2) full-time LL.M. students.  The recipients receive a complete waiver of tuition and academic fees for the Villanova Graduate Tax Program courses that will fulfill the requirements of the degree program (24 credits).  In exchange for the free tuition, you are enslaved to Keith Fogg for  20 hours of service per week in the Villanova Federal Tax Clinic for case-related and research work.  I jest, but the Villanova Federal Tax Clinic provides some of the best preparation for the actual practice of law, and prospective students would be hard pressed to find a better clinic director than Keith Fogg (apart from Les who directed when I was there).  Interested students must apply to the Villanova Graduate Tax Program  and indicate an interest in this assistantship on the program application in order to be considered.  The application deadline for Fall is July 31st.  Please email graduatetaxprogram@law.villanova.edu with any questions. 
  • Reuben Miller posted the final order to a LinkedIn group in Jackson v. Comm’r, the case where the Court questioned whether Notice 3219 was a valid SNOD.  We previously covered this case here, and here.  The Court held that the taxpayers were not mislead by the notice, it had jurisdiction to review the matter, and appears to have taken into consideration the fact that the Service will no longer be using the language in the form that it found questionable in coming to those determinations.   A nod should be given to the Tax Court for prodding the Service to fix a faulty form, and the Service should be commended for its prompt response to the problem (assuming reports are correct that the form has been retired and/or reworked).  Interesting, the Hoffer/Walker article I discussed above makes the point that the Tax Court could be doing more of this institutional prodding if the APA were held to apply to Tax Court proceedings.
  • The Tax Court last week in Ad Investment 2000 Fund, LLC v. Comm’r agreed with the IRS that taxpayers waived attorney-client privilege with respect to opinion letters from a law firm when the taxpayers attempted to invoke the affirmative defenses of good faith and state of mind even though the taxpayers were not raising a reliance of counsel defense.  This case will garner some attention, and we hope to have some follow up content in the near future. 
  • Slovakia has found a way to turn tax procedure into a successful game show, which the country seems to love and has assisted the taxing authority in increasing compliance.  I have not fact checked any of this, and it is all taken from a NYT blog found here.  The government had been losing revenue from its VAT because taxpayers were failing to comply with the reporting requirements.  Auditing and prosecuting was an expensive way to handle the issue, so Slovakia created a lottery where the government selected winners based on VAT receipts submitted to the government.  Each citizen (not the merchant) submits the receipts, which are then checked against the merchant’s filings.  Any purchase over one Euro can be submitted.  Every month, a receipt is selected, and the taxpayer either receives a car, or a chance to be on the Slovakian version of the Price is Right (I’m picturing Borat meets Bob Barker, which is probably totally wrong, and offensive to the Slovakians).  Although the article provides no direct proof, VAT collections are way up since the start, and many taxpayers have complained about merchants providing fake receipts or no receipts, making it easier to focus on cheats.  I’m not sure which is more effective, but Slovakia’s plan is certainly more interesting than the IRS YouTube videos. 
  • The Tax Court has found that an estate was not eligible to pay its estate tax installments under Section 6166, as it failed to make the election on a timely filed Form 706.  In Estate of W. R. Woodbury v. Comm’r, the estate did include a letter indicating its intent to make a Section 6166 election when it made its extension request.  Two and half years after the extension period passed, the estate filed its return and elected Section 6166.  The Court did consider whether the letter was an effective election under Section 6166, but it failed to include the requirements found under the statute and under Treas. Reg. § 20.6166-1.  Specifically, the applicable assets and their values were not included in the transmittals. 
  • Additional IRS notice regarding the various phone scams targeting taxpayers. The Service reiterated that it always sends written notices regarding amounts outstanding, and never asks for credit card information over the phone.  The notice also notes that the scammers are threatening deportation, arrest, shutting off utilities, and revoking driver’s licenses.