Designated Orders: 6/25 – 6/29/2018

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Patrick Thomas from Notre Dame Law School brings us this week’s designated order posts. The first one he discusses serves as a reminder that litigation can be very tedious when the parties do not get along. Keith 

This week’s orders provided a sequel in the continuing saga of the Murphy Family’s tax disputes, another exposé on the lack of basic tax literacy, and a reminder to Appeals and Counsel on the importance of clarity in notices of determination. Judge Leyden also issued a routine order in a CDP case, in addition to two orders from Judge Jacobs. 

Docket Nos. 8039-16, 14536-16, 14541-16, Murfam Enterprises, LLC v. C.I.R. (Order Here) 

Our first order is one in a flurry of recent orders in this consolidated case, which is set for a special trial session on August 6, 2018 in Winston-Salem, North Carolina before Judge Gustafson. Caleb Smith covered one of these orders last time, which disposes of a motion to compel responses to interrogatories, and to address a jurisdictional issue with the timing of the petition.

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This particular order resolves Respondent’s motion for an order to show cause under Rule 91(f); this asks the court to issue an order to Petitioner to show cause why Respondent’s proposed stipulations shouldn’t be admitted. Essentially, the parties had a dispute over the breadth and content of their stipulations of fact. As Judge Gustafson frames the issue, it seems rather silly.

On May 31, Respondent’s counsel proposed to Petitioner’s counsel a non-comprehensive stipulation about the parties, tax returns, notice of deficiency, and appraisals. Instead of working on that version of the stipulation, Petitioner’s counsel proposed his own stipulation that was comprehensive and would not agree to sign Respondent’s truncated stipulation.

Indeed, Rule 91(a)(1) requires a comprehensive stipulation—or at least, as comprehensive as possible:

The parties are required to stipulate, to the fullest extent to which complete or qualified agreement can or fairly should be reached, all matters not privileged which are relevant to the pending case, regardless of whether such matters involve fact or opinion or the application of law to fact. Included in matters required to be stipulated are all facts, all documents and papers or contents or aspects thereof, and all evidence which fairly should not be in dispute.

But Judge Gustafson notes that those stipulations need not be filed in a single document. While it’s common to file stipulations one after the other, there could be circumstances where a single comprehensive stipulation makes sense. Judge Gustafson identifies those scenarios as:

  • Simple cases
  • Cases where parties engage in “horse-trading” of stipulated facts.
  • Cases where unfairness would arise if parties attempted to stipulate helpful facts for themselves, while leaving unhelpful facts for a later date.

This being a complicated case, Judge Gustafson suggests a basic stipulation on truly non-contested issues (like parties, tax returns, notices, etc.). The parties could sort through the rest later.

Judge Gustafson also seems miffed at the “maddening” counter-drafts that were exchanged in crafting this (then unfiled) stipulation. To this practitioner, this seems like a failure of communication combined with latter gamesmanship. It’s clear, from the prior order Caleb covered, that counsel are simply not communicating effectively with each other. They hadn’t clarified which attorney would first draft the stipulation, so both did; then both parties wanted to use their own version.

Judge Gustafson grants the Order to Show Cause, requiring petitioner to file a response under Rule 91(f)(2) by July 2, 2018. Under the rule, the responding party must state whether a dispute (in whole or part) exists as to the moving party’s proposed stipulations, along with an explanation for any disputed item. Judge Gustafson warned that if the response was evasive or incomplete, then any of Respondent’s affected stipulations of fact would be deemed admitted. Alternatively, the parties could file a joint stipulation of facts by July 2—which Judge Gustafson clearly preferred. 

As these Designated Order posts are somewhat delayed, we helpfully know what happened—and while all’s well that ends well, it was not going well for Petitioner’s counsel for some time. Judge Gustafson issued this order on June 25; Petitioner filed a response on the evening of June 26, with a lengthy explanation about the timing of drafts and his objections on some of Respondent’s proposed stipulations.

Judge Gustafson responded the next day with a further order, excoriating Petitioner’s counsel for wasting precious time explaining the logistics of the stipulation process, rather than actually working toward a stipulation. He orders the parties to continue to work towards the basic stipulation, and notes that the Order to Show Cause remains active. Finally, he orders that Petitioner may file an additional response no later than July 2—but, to stave off a further tit-for-tat, no earlier than July 1!

Of course, should the parties file a joint stipulation, all would be forgiven. And indeed, that’s just what occurred on June 29.

Docket No. 714-16, Haynes v. C.I.R. (Order Here)

This case presents a very straightforward legal issue. I highlight it because I’ve heard the following belief frequently from Clinic clients: if taxes are withheld from the client’s pension, 401(k) distribution, IRA distribution, gambling winnings, etc… they’ve done all they need to do vis-à-vis the government. The taxes are paid. End of story.

Except, it’s not. Our federal income tax system—because of its progressive rates, deductions and credits that depend upon future events, and “pay-as-you-go” requirements—rests on two fundamental premises: (1) we estimate our yearly tax obligation and pay tax through withholding or estimated tax payments as we receive income, and then (2) we calculate what we should have paid, after the year has occurred, based on our knowledge of the income we earned and other situations bearing on our ultimate federal income tax liability. As such, we file a tax return to report these facts and reconcile any discrepancy between our estimate and our actuality.

Thus, there’s no guarantee that the amount of taxes withheld will match the taxes that person owes for the tax year. In fact, it’s a near certainty that they will not.

Yet I’ve encountered numerous taxpayers who do not understand these fundamental premises. Many see the tax season as a means to obtain the tax benefits allowed under Code, but do not understand the underlying purpose of the income tax return. Others are new to the United States, coming from countries that have very different taxation schemes.

It seems the Petitioner here suffered the same misunderstanding. She received $11,923 from a qualified retirement plan in 2013, and was under age 59 ½ when the distribution occurred. The retirement plan administrator withheld about $2,384 from the payment, and issued a Form 1099-R reflecting this distribution, the withholding, and that no known exception to the 10% penalty under section 72(t) applied.

Petitioner went to a paid preparer, who timely filed Petitioner’s 2013 tax return. The return reported Petitioner’s wages, business loss, and unemployment compensation; the return didn’t report the retirement distribution as income. Additionally, the return didn’t report the 10% penalty under section 72(t); it did, however, contain a Form 5329, which noted that the early distribution was included in income and claimed an exception to the 72(t) penalty due to permanent and total disability. The preparer also included the withholding from the 1099-R on the return, which resulted in a $4,333 refund paid to Petitioner.

Because the 1099-R reported the income, Petitioner was subject to an Automated Underreporter. In addition to the additional tax and penalty from the 1099-R, it alleged she had also omitted interest and dividend income (which was not contested).

Petitioner responded to the AUR directly, stating that she was “forced to take money from … [her] 401k just to survive”, and noting that she reported the distribution on Form 5329. Later, she responded that “she had already been taxed on the $11,923 distribution because . . . $2,384 had been withheld….”

The AUR unit responded via letter as follows:

When you have federal withholding taken out of a distribution it does not mean the income does not have to be reported on line 15b/16b [in the section for “Income”] of Form 1040; federal withholding helps to cover any taxes on that distribution. In order to determine taxes due, the taxable portion listed on the Form 1099-R box 2a [i.e., the section for “Taxable amount”] needs to be reported on line 15b/16b.

I’m glad to see the Service attempting to educate taxpayers, but the response doesn’t quite get at the core problem. This letter presumes understanding of the yearly estimation and reconciliation underlying the federal income tax system. But, as noted above, many of my clients (and this Petitioner) do not understand. It may seem like second nature to the Service, but I’d suggest that this correspondence approach this problem at an even more basic level.

Eventually the Service issued a notice of deficiency, Petitioner timely filed a petition with the Tax Court, and Respondent answered the petition, alleging affirmatively that Petitioner was not disabled under 72(t)(a)(iii) and was under age 59 ½. The disability exception requires a taxpayer to be “unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration.” IRC § 72(m)(7). Essentially, qualifying as disabled under the Social Security Act will be sufficient under section 72.

Petitioner spoke with Appeals and agreed she was not disabled (she had a full-time job shortly after the tax year in question), but wanted to review other exceptions to the penalty. In a subsequent call, she agreed no other exception applied, but she wanted to go to trial. Afterward, Respondent moved that its allegations in the answer be deemed admitted, because Petitioner didn’t file a reply; the court granted this motion.

This caused Respondent to file a motion for summary judgment—a relative rarity in deficiency cases—because all undisputed material facts meant that the tax should have been included in income and subject to the section 72(t) penalty. Petitioner responded, blaming her tax return preparer for the error, and asking to be “exonerated” from the tax debt.

Indeed, from a practical standpoint, that’s where I find the majority of fault in this matter. The return preparer should have been able to advise their client on this very straightforward issue. Had the return been filed correctly, Petitioner would have received a reduced refund—approximately $2,899 instead of the $4,333 she actually received. Instead, she owes this deficiency, plus interest.

Nevertheless, from a legal standpoint, Petitioner clearly owes the tax and 72(t) penalty. Because no material evidence remained undisputed, Judge Ashford grants summary judgment for Respondent.

Docket No. 22140-15L, Houk v. C.I.R. (Order Here) 

This order highlights something of a tautology: a Tax Court order needs to adequately explain what it’s ordering. Respondent had moved for entry of decision “sustaining the supplemental [N]otice [of Determination]” in this CDP levy case. But from the face of the supplemental notice, the decision documents, and the motion for entry of decision, Judge Gustafson can’t discern the final result in the case. As a bonus, he also goes out of his way to chastise Appeals for using boilerplate language in its notices of determination.

This case stemmed from an unpaid, self-assessed joint income tax debt for 2013. The Service sent a Notice of Intent to Levy and petitioners requested a CDP hearing. Appeals issued a first Notice of Determination, upholding the levy for failure to provide financial information. So far, so typical.

The Houks petitioned the Tax Court, but eventually conceded (after Respondent filed a motion for summary judgment) that they were not entitled to remand on the collections issue—or, apparently, to innocent spouse relief.

They did receive a remand to Appeals for their challenge to the underlying liability. While at first blush a bit counterintuitive, taxpayers may challenge self-assessed tax debts in a CDP hearing, so long as there’s been no prior opportunity to dispute the debt. Montgomery v. C.I.R., 122 T.C. 1, 8-9 (2004). Mr. Houk filed an amended return in the supplemental hearing, and Appeals issued a supplemental Notice of Determination stating the following:

[Appeals] made the determination to adjust your account to the amended return filed to correct the amount of taxes you now owe. The Appeals Officer submitted the Form 3870, Request for Adjustment for an abatement of prior tax assessment in the amount of $7,369.00.

Does this mean that the Houks originally reported $7,369 as tax owed on the original return, the Service agreed to abate everything? Does it instead mean $7,369 would be abated, and some liability would remain? The difference very much matters, as the supplemental notice does only just that—by its explicit words, it supplements the original Notice of Determination, which upheld the levy action. But the supplemental notice also states that if any balance due remains (making the second option more likely), Appeals would need to discuss a “collection resolution” with petitioners.

Neither the Notice of Determination nor the rest of the record clarifies this issue for Judge Gustafson. Likewise, the decision documents repeat the request in Respondent’s motion that the supplemental notice be “sustained in full” and that the proposed levy is likewise sustained.

Judge Gustafson is uncomfortable—justifiably in my view—with sustaining the supplemental notice in its present state. Citing section 7459(c), he notes that in deficiency cases “the Court’s decision ‘must specify[] the amount of the deficiency.’“ (Section 7459(c) is not as commanding as advertised, but in conjunction with section 7459(d), the Court has plausibly read the section as implying this requirement in deficiency cases. See Estate of Ming v. C.I.R., 62 T.C. 519 (1974).) So too in CDP cases challenging the underlying liability; the Court should “specify the amount of the adjusted liability.” He cites Judge Pugh’s order in Dykstra v. Commissioner as an example. To that end, he orders Respondent to supplement the motion and proposed decision documents to clearly specify the adjustments in this case. If collection activities will continue, he requires Respondent to attach “account transcripts or other appropriate records, showing the remaining liability . . . .”

Finally, Judge Gustafson—for reasons that don’t quite appear to connect to this case—bemoans the use of boilerplate in Appeals’ notices of determination. Specifically, he notes the fact that all notices of determination contain the following title:

NOTICE OF DETERMINATION CONCERNING COLLECTION ACTIONS UNDER SECTION 6320 and/or 6330.

This lets Appeals avoid altering language in determining whether a hearing is based on a proposed levy or a filed Notice of Federal Tax Lien. Similarly, the notices contain language regarding the verification requirements:

There was a balance due when the Notice of intent to Levy was issued or when the NFTL filing was requested.

He suggests that this sentence, in particular, causes a further lack of clarity as to whether the Appeals officer did verify there was a balance due. “One assumes that someone at Appeals actually did address [this] question . . . but one dislikes assuming.” Judge Gustafson concludes that “we cannot endorse the ‘and/or’ approach reflected in IRS Appeals’ notices.” Here’s hoping that someone at Chief Counsel pays attention to this order.

That “we” is also an interesting way to conclude this Order. Is this more than Judge Gustafson’s opinion? I presumed that orders were the opinion of one judge alone, rather than the full court. I’d be very interested to know if that presumption is in any way incorrect.

Finally, I’ll note that one of my very first (and very slightly) embarrassing moments as a young tax attorney involved the boilerplate Judge Gustafson criticizes. I’d filed my first petition from a CDP levy hearing for a client in Tax Court, and—wanting to be exacting in my pleading—I titled the petition as “Petition for Levy Action Under Code Section 6330(d)”. Sure enough, upon filing, the clerk struck out my title and replaced it with “Petition for Lien or Levy Action Under Code Section 6320(c) or 6330(d)”. I agree entirely with Judge Gustafson, but what’s good for the goose is good for the gander…

 

 

Comments

  1. Norman Diamond says:

    ‘So too in CDP cases challenging the underlying liability; the Court should “specify the amount of the adjusted liability.” He cites Judge Pugh’s order in Dykstra v. Commissioner as an example. To that end, he orders Respondent to supplement the motion and proposed decision documents to clearly specify the adjustments in this case.’

    The described order is insufficient. The amount of the adjusted liability depends on amount of payments already paid, amount of tax which should have been paid, and amount of addition to tax. When the adjustment is only the amount of addition to tax, it does not reveal the amount of adjusted liability.

    When the adjustment is positive due to addition to tax but the adjusted liability is negative due to overpayments, Greene-Thapedi’s trap applies. Every kind of court refuses to accept jurisdiction.

    ‘”There was a balance due when the Notice of intent to Levy was issued or when the NFTL filing was requested.”

    He suggests that this sentence, in particular, causes a further lack of clarity as to whether the Appeals officer did verify there was a balance due.’

    That’s not really the problem. In some other section of the Notice of Determination, the Settlement Officer does state that she verified that there was a balance due. As far as I can tell, the Settlement Officer performed this verification by looking at some set of administrative records, without knowing that the administrative records had been heavily altered by employee(s) who might or might not have been arrested as reported by TIGTA. There needs to be some way to make the Court determine the actual amount of adjusted liability instead of relying on altered records and accepting a simple adjustment.

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