Designated Orders: 7/9/18 to 7/13/18

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William Schmidt from the Kansas Legal Aid Society brings us this weeks designated orders. Three orders in cases involving the Graev issue keep that issue, no doubt the most important procedural issue in 2018, front and center. As with last week, there is an order in the whistleblower area with a lot of meat for those following cases interpreting that statute. Keith

For the week of July 9 through July 13, there were 9 designated orders from the Tax Court. Three rulings on IRS motions for summary judgment include 2 denials because there is a dispute as to a material fact (1st order based on employment taxes here) (2nd order involves petitioners denying both having a tax liability and receiving notice of deficiency for 2012 here) and a granted motion because petitioner was not responsive (order here). What follows are three orders where Judge Holmes takes on Chai ghouls, an exploration of a whistleblower case, and two quick summaries of cases. Overall, the Chai ghoul cases and whistleblower case made for a good week to read judicial analysis.

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Chai Ghouls

All three of these are orders from Judge Holmes that deal with Chai and Graev issues. The first two discussed were later in the week and had more analysis. As you are likely aware, the Chai and Graev judicial history in the Tax Court has led to several current cases that need analysis regarding whether there was supervisory approval regarding accuracy-related penalties, as required by Internal Revenue Code section 6751. In each of these cases, the IRS has filed a motion to reopen the case to admit evidence regarding their compliance with 6751(b)(1).

  • Docket Nos. 11459-15, Hector Baca & Magdalena Baca, v. C.I.R. (Order here).

The Commissioner filed the motion to reopen the record to admit the form. The Bacas couldn’t tell the Commissioner whether or not they objected to the motion. When given a chance to respond, they did not object. The Bacas did not raise Code section 6751 at any stage of the case (petition, amended petition, trial, or brief). The Commissioner conceded 6662(c) (negligence or disregard) penalties because the only penalty-approval form found is the one for 6662(d) (substantial understatement) penalties.

The Court’s analysis sets out the standard for reopening the record. The evidence to be added cannot be merely cumulative or impeaching, must be material to the issues involved, and would probably change the outcome of the case. Additionally, the Court should consider the importance and probative value of the evidence, the reason for the moving party’s failure to introduce the evidence earlier, and the possibility of the prejudice to the non-moving party.

The Court then analyzes those elements set out above. For example, the Court finds the penalty-approval form to be properly authenticated nonhearsay and thus admissible. Ultimately, the Commissioner had less reason to anticipate the importance of section 6751 because it was following Chai and Graev that it was clarified the Commissioner had the burden of production to show compliance with 6751 when wanting to prove a penalty.

In this case, the Court states because the Bacas did not object to the accuracy-related penalties, that is some excuse for the Commissioner’s lack of diligence. Additionally, the Court concludes that it can’t decide the Bacas would be prejudiced because they never said they would be.

Takeaway – Respond when the court requests your opinion or you may suffer consequences that could have been avoided if you had raised your hand and notified the court of your concerns.

  • Docket Nos. 19150-10, 6541-12, Scott A. Householder & Debra A. Householder, et al., v. C.I.R. (Order here).

This set of consolidated cases differ from the Bacas’ case because of an objection submitted by the petitioners. Arguments by the petitioners begin that the record should not be reopened because the Commissioner’s failure to introduce evidence of compliance with 6751(b)(1) shows a lack of diligence, and the Commissioner doesn’t offer a good reason for failing to introduce the form despite possessing it when trying the cases. They argue they would be prejudiced by reopening the record because they have not had a chance to cross-examine the examining IRS Revenue Agent on their case. They argue the form is unauthenticated and that both the declaration and the form are inadmissible hearsay.

Again, the form is found to be admissible nonhearsay. Regarding the authentication argument, the IRS recordkeeping meets the government’s prima facie showing of authenticity. The Court brings up that the Revenue Agent in question was a witness at trial that the petitioners did cross-examine, it’s just that they did not have section 6751 in mind at the time. In fact, the Court reviews a set of questions the petitioners listed and finds that those answers likely would not have helped them so comes to the conclusion that they would not be prejudiced by admitting the form.

Overall, both parties should have been more diligent to bring up section 6751. Since they did not, the lack of diligence on the Commissioner’s part is counterbalanced by the probative value of the evidence and the lack of prejudice to the petitioners if the record were reopened to admit the form.

Takeaway – The IRS is not the only party on notice of the Chai and Graev issue. Petitioners bear responsibility to raise the issue of supervisory approval just as the IRS has a responsibility to show proper authorization of the penalty. The court seems to be shifting a bit from prior determinations.

  • Docket Nos. 17753-16, 17754-16, 17755-16, Plentywood Drug, Inc., et al., v. C.I.R. (Order here).

These consolidated cases also deal with the 6751 accuracy-related penalties and the IRS motion to reopen the record to admit penalty-approval forms. While the petitioners originally disputed the penalties, they conceded penalties on some issues but did not want to concede penalties on others. As a result, they did not object to the Commissioner’s motion. The Court did not grant the motion regarding penalties determined against the corporate petitioner as it would not change the outcome of the case. In Dynamo Holdings v. Commissioner, 150 T.C. No. 10 (May 7, 2018), the Court held that section 7491(c)’s burden of production on penalties does not apply to corporate petitioners, so that, in a corporate case, where the taxpayer never asked for proof of managerial approval and so did not get into the record either a form or an admission that no form was signed, the taxpayer had the burden of production on this section 6751(b) issue and had failed. For the penalties determined against the individual petitioners, the Court granted the motion since they did not raise any objections.

In all three cases, the Court orders to grant the IRS motion to reopen the record to admit the penalty-approval form attached to the motion (with the exception of the denial of the application to Plentywood Drug, Inc.).

Comments: I must admit when Judge Holmes mentions Chai ghouls in his orders it makes me think of Ghostbusters (Chai ghoul bustin’ makes him feel good?). In looking over these three cases, it seems to me they have the same result no matter what the petitioners did. It is understandable when the petitioners never objected to the penalties or the approval form. However, the Householders objected and still got the same result. Perhaps I am more sympathetic to the petitioners, but the reasoning also does not follow for me that petitioners would not be prejudiced by admitting a form that allows them to have additional penalties added on to their tax liabilities. 

Whistleblowers and Discovery

Docket No. 972-17W, Whistleblower 972-17W v. C.I.R. (Order here).

By order dated April 27, 2018, the Court directed respondent to file the administrative record as compiled by the Whistleblower Office. Petitioner filed a motion for leave to conduct discovery, the IRS followed with an opposing response and the petitioner filed a reply to respondent’s response. On June 25, the Court conducted a hearing on petitioner’s motion in Washington, D.C., where both parties appeared and were heard.

Internal Revenue Code section 7623 provides for whistleblower awards (awards to individuals who provide information to the IRS regarding third parties failing to comply with internal revenue laws). Section 7623(b) allows for awards that are at least 15 percent but not more than 30 percent of the proceeds collected as a result of whistleblower action (including any related actions) or from any settlement in response to that action. The whistleblower’s entitlement depends on whether there was a collection of proceeds and whether that collection was attributable (at least in part) to information provided by the whistleblower to the IRS.

On June 27, 2008, the petitioner executed a Form 211, Application for Award for Original Information, and submitted that to the IRS Whistleblower Office with a letter that identified seven individuals who were involved in federal tax evasion schemes. The first time the petitioner met with IRS Special Agents was in 2008 and several meetings followed. The IRS focused on and investigated three of the individuals listed on petitioner’s Form 211 following those initial meetings.

The first taxpayer (and I use that term loosely for these three individuals) was the president of a specific corporation. In 2013, that individual was convicted of tax-related crimes including failing to file personal and corporate tax returns due in 2006, 2007, and 2008. This person received millions of dollars in unreported dividends (from a second corporation, also controlled by this individual). This individual was ordered to pay restitution of $37.8 million.

The second individual was the chief financial officer of the corporation. This person received approximately $13,000 per month from the corporation in tax year 2006 but failed to report that as taxable income, and did not file a tax return in 2007. After amending the 2006 tax return and filing the 2007 tax return, the criminal investigation ended. The Revenue Officer assessed trust fund recovery penalties for the final quarter of tax year 2006 and all four quarters of tax year 2007. This taxpayer filed amended tax returns for 2005 and 2006 in March 2009 and filed delinquent returns for 2007 and 2008 in July 2010. The IRS filed liens to collect trust fund recovery penalties of approximately $657,000 and income tax liabilities of $75,000 for tax years 2005 and 2006.

The third individual was an associate of the first two but had an indirect connection with the corporation. This taxpayer had delinquent returns for 2003-2011 and there was a limited scope audit for tax years 2009 and 2010. The IRS filed tax liens for unpaid income taxes totaling approximately $2.4 million for tax years 2003 to 2011.

For each of the individuals, the IRS executed a Form 11369, Confidential Evaluation Report, on petitioner’s involvement in the investigations. For taxpayer 1, the IRS Special Agent stated that all information was developed by the IRS independent of any information provided by petitioner. For taxpayer 2, the form includes statements the Revenue Officer discovered the unreported income and petitioner’s information was not useful in an exam of the 2009 and 2010 tax returns. For taxpayer 3, the form states the taxpayer was never the subject of a criminal investigation (which is inconsistent with the record) and that petitioner’s information was not helpful to the IRS.

The petitioner seeks discovery in order to supplement the administrative record, contending the record is incomplete and precludes effective judicial review of the disallowance of the claim for a whistleblower award. Respondent asserts the administrative record is the only information taken into account for a whistleblower award so the scope of review is limited to the administrative record and petitioner has failed to establish an exception.

The Court notes the administrative record is expected to include all information provided by the whistleblower (whether the original submission or through subsequent contact with the IRS). The Court’s review of the record in question is that it contains little information, other than the original Form 211, identifying or describing the information petitioner provided to the IRS. While the record indicates that there were multiple meetings concerning the three taxpayers, there are few records of the dates and virtually no documents of the information provided. The Court agreed with the petitioner that the administrative record was materially incomplete and that the circumstances justified a limited departure from the strict application of the rule limiting review to the administrative record.

The Court states the petitioner met the minimal showing of relevant subject matter for discovery since the administrative record was materially incomplete and precluded judicial review. The information petitioner seeks is relevant to the petitioner’s assertion that the information provided led the IRS to civil examinations and criminal investigations for the three taxpayers and led to the assessment and collection of taxes that would justify an award under section 7623(b). The IRS did not deny petitioner’s factual allegations and did not argue the information sought would be irrelevant so failed to carry the burden that the information sought should not be produced.

The Court limited petitioner’s discovery to three interrogatories concerning conversations with a Revenue Officer and two Special Agents, two requests for production of documents concerning notes and records of meetings with those three individuals.

Petitioner sought nonconsensual depositions if the IRS did not comply with the interrogatories and requests for production of documents. Since the Court directed the IRS to respond to the granted discovery requests, it is premature to consider the requests for nonconsensual depositions at this time. The footnote cites Rule 74(c)(1)(B), which calls that “an extraordinary method of discovery” only available where the witness can give testimony not obtained through other forms of discovery.

Respondent is ordered to respond to those specific interrogatories and requests for production of documents by August 17, 2018.

Comment: On the surface, this step forward looks to be a win for the petitioner as there seems to be a cause and effect that justifies a substantial whistleblower award. I discussed the case with an attorney with a whistleblower case in his background who commented that to get a whistleblower award the whistleblower had to be the first one to make the reporting and the information had to be outside public knowledge (though that was outside the tax world). From his experience, the government made it difficult to win a whistleblower award and I would say that looks to be the case here.

Miscellaneous Short Items

  • The Petitioner Wants to Dismiss? – Docket No. 11487-17, Gary R. Lohse, Petitioner, v. C.I.R. (Order here). Petitioner files a motion to dismiss for lack of jurisdiction, stating the notice of deficiency is not valid. The judge denies his motion because there is a presumption of regularity that attaches to actions by government officials and nothing submitted by the petitioner overcomes that presumption.
  • Petitioner Wants a Voluntary Audit – Docket No. 24808-16 L, Tom J. Kuechenmeister v. C.I.R. (Order here). Petitioner filed a motion for order of voluntary audit, also claiming that the IRS was negligent in allowing the third party reporter to issue the forms 1099-MISC for truck driving. As Tax Court is a court of limited jurisdiction, the Court cannot order the IRS to conduct a voluntary audit. While the petitioner was previously warned about possible penalties up to $25,000, this motion was filed prior to the warning so no penalty assessed for this motion. Petitioner’s motion is denied.

Takeaway: Each time here, the petitioner does not understand the purpose of the Tax Court. The petitioners may have come to a better result by treating Tax Court motions as surgical tools rather than as blunt weapons.

 

Comments

  1. Bob Kamman says:

    Another order by Judge Holmes involving Chai ghouls was posted today (August 2). The ghouls may be causing glitches in his spell-checker, because he refers to an “IRS group mananger.” This order will probably be a designated order; it’s too early in the day for those to appear on the Tax Court website. The order has 11 pages but it ends on page 8; the page numbers don’t start until the fifth page. I’m not sure how that happens, but I’m sure there is probable cause.

    https://www.ustaxcourt.gov/InternetOrders/DocumentViewer.aspx?IndexSearchableOrdersID=267705

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