Levies on Retirement Accounts – Part 2 of 3 Social Security

In Part 1 of this series of posts on levies, I wrote about the ability of and the restrictions on levies on retirement plans by the IRS. In this post, I will discuss the ability of the IRS to levy upon a taxpayer’s social security payments, the choice the IRS has in how to do that, and the restrictions the IRS places upon itself as it decides to impose these levies. The big difference between levying on retirement accounts and on social security derives from the source of the funds. Retirement accounts rest with private parties while it is the government itself that makes the social security payments while at the same time being the party owed the unpaid taxes. In many ways, taking all or a part of a taxpayer’s social security payments is a form of offset; however, the Code does not treat it as an offset the same way it treats the offset of a refund in one year and a liability for a prior period.

IRC § 6331(h)(2)(A), as prescribed by the Taxpayer Relief Act of 1997, Pub. L. No. 105-34, § 1024, authorizes the IRS to issue continuous levies on certain federal payments. The Bureau of the Fiscal Service (BFS) (formed from the consolidation of the Financial Management Service and the Bureau of the Public Debt) is the Department of Treasury agency that processes payments for various federal agencies. Payments subject to FPLP include any federal payments other than those for which eligibility is based on the income or assets of the recipients. With a regular offset, the IRS simply programs its computers to check for any liabilities before it sends the refund to BFS for payment to the taxpayer. With social security, the IRS sends notice of the liability to BFS and the taking of the funds occurs at that level outside of the IRS since the funds, although coming from the federal government, come from another agency.

IRC Section 6334(a)(11) exempts from levy certain needs based payments such as Supplemental Security Income payments to the aged, blind, and disabled as well as State or local government public assistance or public welfare programs for which eligibility is determined by a needs or income test. The exemptions in section 6334 do not apply to regular social security payments since they are based on contributions and not based on need. Some taxpayers receiving social security do not need their social security payments to meet basic needs but many do. The IRS knows that many social security recipients will face hardship if all or a part of their social security payments are taken to satisfy tax liabilities. The debate concerns how to take the money of the taxpayers who do not need it while identifying the taxpayers who need it in order to avoid hardship.

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As with the discussion on retirement accounts, this discussion is built upon a report issued by the Treasury Inspector General for Tax Administration (TIGTA). On June 30, 2016, TIGTA issued “Revenue Officer Levies of Social Security Benefits Indicate That Further Modification to Procedures Is Warranted” in which it discusses in detail the rules governing the IRS levy upon social security benefits and reviews how the IRS has done in following those rules. The discussion starts with a reminder of the federal payment levy program (FPLP). For the publication on FPLP created by the Taxpayer Advocate’s office look here.

Federal Payment Levy Program and Social Security

The TIGTA report describes the FPLP as follows:

“The FPLP is an automated program that includes taxpayers in both the Automated Collection System and the Collection Field function along with inventory that is currently not being worked by either Automated Collection System or the Collection Field function….

Through the FPLP, the IRS can issue a continuous levy of 15 percent on Social Security benefits. During Fiscal Year 2014, the majority of revenue collected by the FPLP program was from Social Security benefits. Between Calendar Years 2002 and 2006, the IRS had a low-income filter for Social Security benefits levied through the FPLP, but that particular filter was found to be inaccurate by the Government Accountability Office. The Government Accountability Office’s recommendation advised the IRS to eliminate the exclusion until a more accurate criterion could be developed. “

The IRS reinstated the filter in 2011, and it causes taxpayers whose income presents itself to the IRS as under 250% of poverty to bypass the FPLP in order that they can receive their full payment.

IRM 5.11.7.2 contains the description of all of the automatic offset programs operated between the IRS and Treasury. While the offset of funds from social security payments is the largest of these programs, it is only one of several including many designed to capture past due taxes from federal employees. According to IRM 5.11.7.2.3.4.2, the IRS sends the name of social security recipients with past due taxes over to the IRS after sending out a notice of intent to levy letter:

“For Social Security payments matched, a FPLP levy will be transmitted to BFS at least eight (8) weeks but no more than twenty-six (26) weeks from when the CP 91 or 298, Intent to seize up to 15% of your Social Security benefits, was issued (indicated by the unreversed TC 971 AC 169 posting cycle). A FPLP levy TC 971 AC 662 will post on the module with the literal “SSA” displayed in the Miscellaneous Field and TIN in the XREF TIN field.”

The NTA has written extensively on social security levies and particularly on the issue of the filters imposed to allow certain accounts to bypass the social security levy. For background, an interested reader might want to check out her report found here from the 2014 annual report to Congress. The discussion in the report focuses heavily on the decision of the IRS to exclude from its filters those taxpayers with unfiled returns. This discussion which also gets some play in the TIGTA report focuses on the reason for these levies and whether levies on retirement accounts and social security payments where taxpayers are known to be especially vulnerable should be used for general enforcement. The IRS has long used the levy as a means of promoting compliance because it wakes up the taxpayer by moving the IRS from its status as “pen pal” by sending many letters requesting payment, to the status of law enforcement when the taxpayer feels the pain of lost funds.

Collection by Revenue Officers

The TIGTA report focuses on the collection by revenue officers of social security payments. As discussed previously, the cases in the hands of revenue officers, the IRS field collection agents, will primarily be accounts in which a large amount of tax is due. TIGTA points out that revenue officers have no special instructions regarding pursuit of collection from social security payments. It made the following diverse findings from its interviews of 26 collection employees at various levels:

When making Social Security levy determinations, revenue officers are not required to consider whether the taxpayers’ income level is below 250 percent of the Federal poverty level . Field Collection procedures require that they determine if the FPLP process will be part of their strategy to resolve the case. Some other observations made in our audit interviews include:

  • Some Field Collection group managers require that all other taxpayer resources be levied before attempting to levy Social Security benefits, while others do not.
  • Some group managers believed that, in upwards of 90 percent of their cases in which paper levies are made on taxpayers, the taxpayer possesses no other source of income.
  • Some group managers stated that the case had to be “egregious” before Social Security Benefits would be levied above the 15 percent FPLP levy.
  • Some group managers indicated that Social Security levies were used to get a taxpayer’s attention, while others believed such use of a levy is not appropriate.
  • Some revenue officers use Form 668-W, Notice of Levy on Wages, Salary, and Other Income, which ensures that levied taxpayers receive the exemptions to which they are entitled, while others use Form 668-A, Notice of Levy, to maximize the levy.
  • Most interviewees indicated that most cases involving Social Security benefits already have an FPLP levy on the case when the case is assigned.
  • In one territory, the territory manager indicated that the groups in that territory never levy 100 percent of Social Security benefits. A revenue officer within that same territory indicated that he had issued as many as five Social Security levies in the past year and used Form 668-A to levy the maximum amount.
  • All interviewees indicated that a financial analysis should be performed on a Collection Information Statement to assess the taxpayer’s ability to pay the tax, and all stated that the“250 percent above Federal poverty level” criterion is not factored into their analysis.

In most of the cases in which the revenue officers were assigned, the IRS had already begun collecting 15% through the FPLP process and the question for the revenue officer was whether to take the entire social security payment. The median amount owed of the accounts sampled by TIGTA was over $80,000. TIGTA found that in 85% of the cases in which the revenue officer decided to levy, the decision fell within the guidance; however, in 15% of the cases the levy exacerbated or caused hardship. TIGTA noted that in the cases in which it determined the levy caused hardship the notes of the revenue officer usually supported the conclusion reached by TIGTA. TIGTA recommended better guidance for revenue officers on when to pursue a taxpayer’s social security and the IRS management agreed.

Conclusion

The ability to determine between a “can’t pay” and a “won’t pay” taxpayer is a difficult decision that requires both training and judgment. Both TIGTA and the NTA have written about the failure of the IRS to train and the failure of revenue officers and their managers to use appropriate judgment. If a revenue officer levies on a client’s social security payments because the client did not cooperate or did not file past due returns, use the decision in Vinatieri v. Commissioner, 133 T.C. 392 (2009) as well as the relevant manual provisions to convince the revenue officer to remove the levy. TIGTA’s report shows that the IRS gets the decision right most of the time but if the 15% error rate is correct, that still leaves a large number of taxpayers, many of whom are unrepresented, losing necessary funds to make ends meet. Providing revenue officers with better training and better oversight requires funds which is a problem we have discussed many times before.

 

 

 

Levies on Retirement Accounts – Part 1 of 3 Pension Plans and IRAs

Thanks to two Treasury Inspector General for Tax Administration (TIGTA) reports and one bankruptcy case, In re F. Lee Bailey, I am inspired to do a three-part series on how the IRS levies on retirement accounts. I note also that the National Taxpayer Advocate has blogged recently on this general topic. The first post will focus on the power of the IRS to levy and the decisions it makes in issuing a levy to obtain either a stream of payments from a retirement account or the retirement account itself. The second post will focus on the levy on social security payments, and the third post will look at the application of those policies in a specific case involving a well-known attorney who has fallen from the heights of the profession and has recently filed his second bankruptcy petition. I issued two posts, here and here, focusing on the levy of military retirement benefits in the past couple of months that also speak to this topic from both a policy and individual perspective.

The levy serves as the calling card for the IRS to taxpayers who have not responded to correspondence requesting payment. As I have discussed before, the IRS often hopes that the levy will cause the taxpayer to begin working with it. When the levy hits the taxpayer’s salary, retirement benefits, or similar stream of payments, it leaves the taxpayer in a position in which the taxpayer must deal with the IRS in some fashion because the loss of the stream of payments does not permit the taxpayer to make the payments necessary for life’s necessities. While it is common for the IRS to levy on wages and put the taxpayer into hardship, the discussion in the manual and the TIGTA reports makes clear that the employee generating the levy on retirement payments should consider this before making the levy rather than just using the levy as an enforcement tool. This is just one way in which the levy on retirement benefits differs from ordinary levies.

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Levy Basics

To set the scene for this discussion of levies, looking at the basics of levy may help in understanding what the IRS can do with this enforcement tool. The levy allows the IRS to step into the taxpayer’s shoes and receive payments to which the taxpayer is entitled or to take control of property that the taxpayer could control. Levy is a provisional remedy and does not give the IRS greater rights to the property than the taxpayer has. Levy can set the scene for a fight over property rights through the wrongful levy process.

In United States v. National Bank of Commerce, 472 U.S. 713 (1985), the Supreme Court said that Congress could not have devised a broader lien than the federal tax lien. The comment about the federal tax lien has relevance to a post about levies because the IRS needs to have a lien on the property it intends to levy. National Bank of Commerce was a levy case in which the taxpayer, Mr. Reeves, had a joint bank account with his wife and mother. Only Mr. Reeves owed the IRS. The IRS levied on the bank account and demanded that the bank turn over all of the money in the account since Mr. Reeves could have walked up to the teller window and made a similar demand. The bank refused, arguing that before it turned over the money it needed the consent of co-owners of the account. In a 5-4 decision, the Court reversed the lower courts and ordered that the bank must turn over the money but made clear that levy is a provisional remedy and that turning over the money to the IRS did not deprive the taxpayer’s wife or mother from recovering the money upon a showing that it belonged to them and not to Mr. Reeves.

After issuing the notices required in IRC 6330 and 6331, the IRS can take a taxpayer’s property without court approval. For the small number of taxpayer’s who seek Collection Due Process relief after receipt of the notice, the Tax Court must bless the use of the levy. For the vast majority of taxpayers, the IRS makes decisions on what and when to levy without interference from any judicial body. In most cases, the levy comes as a surprise to taxpayers who fail to appreciate the meaning of the correspondence warning them of the IRS’s intent to levy and who only appreciate the power the IRS possesses once it takes the levy action.

Basics of TIGTA Report

On September 26, 2017, TIGTA issued a report entitled “Procedures for Retirement Account and Thrift Savings Plan Levies Not Always Followed by Revenue Officers.” The report not only looks at specific levy actions taken by the IRS but does an excellent job of explaining the rules governing collection employees when levying on a retirement account. My discussion here will highlight the rules. If you have a case with this issue or questions not answered by this post, you should carefully read the report and the related Internal Manual Provisions (referred to in this post sometimes as “Manual” and sometimes as “IRM”).

The report breaks up its discussion of retirement account levies essentially into three parts: 1) levies on the income stream from a retirement account; 2) levies on the retirement account itself; and 3) levies on thrift saving accounts. Thrift savings accounts belong only to federal employees, and I am not going to discuss that part of the report because of its limited coverage; however, if you represent a current or retired federal employee with money in a thrift saving account, this discussion is valuable.

If the taxpayer has already retired and receives payment from some type of defined benefit or defined contribution plan or an IRA, the IRS can levy on the stream of payments. It gives broader authority to its employees to levy on a stream of payments than on the retirement account itself. Internal Revenue Manual 5.11.6.1 provides that both revenue officers and employees of the Automated Collection System (ACS) can levy on the stream of payments. If the IRS levies on a stream of retirement payments before the statute of limitations expires, the levy reaches the future stream of payments that comes after the expiration of the statute because the levy has taken over the taxpayer’s defined rights to future payment prior to the expiration of the statute.

Levying on a Stream of Payments from a Retirement Account

The manual gives relatively detailed instructions on when and how collection employees can levy on the stream of payments. Before levying on this stream of retirement payments, ACS employees should check to see that the IRS has properly sent the notice of intent to levy and if the file indicates taxpayer is in a hardship situation. These are basically the same procedures required for regular levies. The difference in process for the stream of levy payments is the requirement that the ACS employee obtain managerial approval. Since the manager has little information to review when making this decision, the report leaves the impression that such approval is fairly routine. The TIGTA review determined that ACS employees followed the required procedures in the cases reviewed.

TIGTA also found that ACS employees were not required to consider the financial situation of the taxpayer before issuing the levy. TIGTA looked closely at the 30 cases it identified and found that in about 25% of those cases the levy on the stream of payments placed the taxpayers in a hardship situation. It recommended that the IRS change it procedures to place more emphasis on determining if the levy would cause hardship. The IRS agreed to emphasize that ACS and managers should pay attention to available data; however, it is not sending the employees out to gather additional data. I do not see a distinction between levying on a stream of payments and levying on someone’s wages but the TIGTA report sends the message that more protection is needed for these payments than wages.

The rules for cases in the hands of revenue officers are slightly different than those for ACS employees. The IRS expects that revenue officers assigned to individual accounts will know more about the taxpayers assigned to them than an ACS employee who does not have individual taxpayers assigned. The manual requires that revenue officers follow all normal levy procedures and to “use discretion” when determining whether to levy on a stream of payments from a retirement account. In addition to normal pre-levy procedures, revenue officers were required to consider the taxpayer’s:

– responsiveness to attempts at contact and collection

– filing and paying compliance history

– effort to pay the tax

– whether current taxes are being paid; and

– financial condition, including information related to economic hardship determinations.

TIGTA’s review of 28 cases found that about 15% of the taxpayers were in a hardship situation. While TIGTA felt the IRS should not have levied if it knew the taxpayer faced hardship, IRS management disagreed and responded that a revenue officer can levy if the taxpayer fails to respond or misses deadlines. TIGTA, sounding like the National Taxpayer Advocate (NTA), recommended changes to the manual to place more emphasis on hardship pointing out that if the IRS simply uses the levy as a wake-up call to the taxpayer without giving thought to hardship it not only places an undue burden on the taxpayer but also causes more work for the IRS as it unwinds the levy.

NTA comments on this levy issue can be found here, here and here. This recommendation also mirrors a recommendation TIGTA made with respect to levies on social security payments which I will discuss in the next post in this series. The IRS agreed to make changes to IRM 5.11.1.3.1 to reflect this dialogue. Notice that in the new IRM provision a reference to Taxpayer Bill of Rights is baked right into the directions on what the revenue officer should do. In this report, TIGTA recommended that the IRS change this newly drafted IRM provision to make it even clearer that the financial condition of the taxpayer is a primary consideration in making the levy and the IRS agreed to make that revision.

Levying on the Retirement Account Itself

Only revenue officers can levy on a retirement account. Because revenue officers are primarily assigned to cases in which the taxpayer owes a fair amount of money, in some geographic locations this means more than $100,000, many taxpayers whose accounts remain in ACS will not face the prospect of having their retirement account levied even though the ACS employee might levy any stream of payment that exists. The manual creates four discrete rules that govern levy upon the retirement account itself and create barriers to the use of such a levy as a tool:

  • Revenue officers must consider “all alternatives” before issuing a levy on a retirement or IRA account.
  • Revenue officers must determine if the taxpayer’s conduct has been flagrant. Look here for a detailed explanation of flagrant behavior. It includes such things as making voluntary contributions to retirement accounts while asserting an inability to pay past due taxes; demonstrating a pattern of uncooperative or unresponsive behavior; being convicted of tax evasion; being assess the fraud penalty; assisting others in evading taxes and incurring a tax liability based on illegal income. This requirement means that otherwise cooperative taxpayers may get a pass on having their retirement funds levied.
  • Revenue officers must determine whether the taxpayer depends on the money in the retirement account or will depend on it in the near future for necessary living expenses; and
  • Revenue officers must prepare a memorandum summarizing the taxpayer’s compliance history and reason for the levy and obtain approval from the Area Director. This type of requirement creates a bureaucratic barrier that will stop many cases because the revenue officers do not have the time or the inclination to do this type of work and expose themselves to criticism from their group manager or the area director. Whenever you find this higher level approval provisions in the manual, they serve as a signal to the employee that except in extreme cases this is something to be avoided.

Conclusion

Retirement accounts receive special consideration. Giving too much deference to money in retirement accounts generally favors higher income taxpayers over lower income taxpayers because of who is most likely to have money built up in retirement plans. The IRS must carefully balance its enforcement in this area to pursue these accounts when the taxpayer has the ability to pay while holding back from enforced collection against these accounts where a levy would create economic consequences for the taxpayer that would engender hardship. This balance is often made harder for the IRS because taxpayers do not always respond quickly or completely concerning their financial situation. TIGTA rightly seeks to have the IRS not blindly use the levy as it might ordinarily do to spur taxpayer cooperation but to look within its database for information regarding the hardship that might occur if the levy takes place. This is a good dialogue. TIGTA does a nice job in this report laying out the issues and the rules.

 

Republican Tax Bill Passes Senate

The Senate passed sweeping tax legislation last night. There is lots to digest in the bill, and there still is a reconciliation process to clear up differences between the House and Senate versions. As with the House legislation, there is not much procedure in the bill, though some of the substantive changes have major administrative implications.

While not the main focus, the Senate bill has some procedural provisions, which I highlight below:

  • Changes the due diligence rules to include due diligence requirements associated with Head of Household filing status as well as CTC, EITC and AOTC;
  • Extends time to return property subject to levy under Section 6343 from nine months to two years;
  • Extends time to bring a wrongful levy suit under Section 6532 from nine months to two years;
  • Caps user fees for installment agreements and explicitly waive fees for taxpayers at or under 250% of federal poverty guidelines;
  • Defines proceeds under the whistleblower provisions to include interest and penalties under internal revenue laws and proceeds from laws IRS investigates, administers or enforces including criminal fines, civil forfeitures and violations of reporting requirements; and
  • Modifies rules relating to property exempt from levy due to the elimination of the dependency exemption deduction and the increase in the standard deduction; the Senate bill provides that the amount that escapes levy is the sum of the standard deduction and $4,150 times the number of dependents in the taxpayer’s household. Given the increase in the standard deduction this amounts I believe to an additional amount of income that will be free of IRS levy; however absent submission of a verified statement the IRS is to treat a taxpayer as a MFS taxpayer with no dependents.

This is a moving target, and what comes out of the sausage factory is still up for grabs.

 

 

An Internship Announcement for Students and a Request for Support from a Fellow Blogger

We try not to abuse your inbox but occasionally we receive requests that might be of interest to the community working in the tax procedure area. Today, we bring forward two separate matters.

Access to Tax Court Records

First, Peter Reilly, who blogs at Forbes where we occasionally blog, is interested in hearing from individuals interested in a discussion concerning public access to Tax Court documents and requested that we notify readers of PT. He is writing a “piece about the Tax Court’s lack of electronic transparency.” For those of you who have sought Tax Court records, you know that the Tax Court electronic docket does not have the same links that you would find on Pacer. The Tax Court has reasons for the way their electronic docket works which are rooted in privacy concerns for the parties who file petitions. Practitioners, and others wanting access to Tax Court records, have concerns about the ability to access the public records at the Court. Peter asked for our assistance it pointing people to him who have an interest in engaging in this debate. He can be reached at peterreillycpa@gmail.com

Tax Division of the Department of Justice

If you want to get a great start on learning tax procedure, it is hard to imagine a better place than the Tax Division. You would work with great lawyers while learning the ins and outs of tax litigation. Copied below is a message sent out by Dara Oliphant, Counsel, Office of Management and Administration at the Tax Division soliciting interested individuals to apply for an internship with them:

I am writing to encourage your students to consider applying for a volunteer legal internship with the DOJ Tax Division. The Tax Division represents the United States in courts across the country in a wide spectrum of interesting and cutting-edge cases involving issues arising under federal tax law. Our Division is ranked as “one of the best places to work” in government by the Partnership for Public Service. We seek to create a work environment and organizational culture that reflect the diversity of American society and that foster the success of every employee by appreciating and building upon the skills, experiences, and uniqueness that each employee brings to the workplace. We also place a high value on diversity of experience and cultural perspective and encourage applications from all interested eligible candidates. More information about the Tax Division is available at: https://www.justice.gov/tax

Currently, the Tax Division is accepting applications from law students who wish to volunteer during the Summer, and the deadline is January 1, 2018.  As set forth in the job announcement link – https://www.justice.gov/legal-careers/job/law-student-volunteer-summer-141 – we have approximately four summer volunteer positions available in Washington, DC and one in Dallas, TX.

(We are also accepting applications for students looking for internship positions for Fall 2018, and that deadline is May 1, 2018.  I will send a follow-up with that announcement when it is posted.  We generally hire between 13-16 volunteer interns during each academic semester.)

 

 

 

Priority Status of Transferee Liability in Bankruptcy

Two types of claims exist in bankruptcy – secured and unsecured. Every creditor wants to be a secured creditor. In theory, secured creditors pass through bankruptcy unaffected. That theory has many notable exceptions but, nonetheless, it is best to be a secured creditor.

If you cannot be a secured creditor, the next best thing is to be a priority creditor. Congress has looked at the type of debts that exist in the United States and decided that certain of those debts, about ten, deserve recognition above all the rest. It lists these special “priority” debts in section 507 of the bankruptcy code. If your debt makes it onto this list, your debt gets paid before general unsecured claims receive payment. The higher you are on the list, the better you are. Think of the list of priority debts as a cruise ship with the best cabins at the top and the worst at the bottom. Then think of general unsecured claims as steerage existing in the hold of the ship below all of the priority claims. Depending on when the money in the estate runs out, only certain creditors get paid. All of the creditors in the first priority must be paid before any payments go to the next level down, and so on through each level. Wherever the money runs out, the creditors in the group where it runs out get paid pro rata and any creditors below that level go home empty handed.

It is in this context that the fight in In re Kardash, No. 8:16-bk-05715 (September 21, 2017) takes place. The IRS convinced the Tax Court to hold in T.C. Memo 2015-51 and T.C. Memo 2015-197 that he owed about $4.3 million as a result of fraudulent transfers, and the 11th Circuit affirmed the Tax Court’s decisions at 866 F.3d 1249 (11th Cir. 2017). For more background on the Tax Court aspect of this case see Steve’s prior post here and a subsequent post about the case by Peter Reilly here. The IRS seeks to have the transferee liability of Mr. Kardash treated as a priority claim in his bankruptcy case (although he is married Mr. Kardash filed a chapter 11 bankruptcy individually and his wife did not file). Mr. Kardash objected to treating the transferee liability as a priority claim. Usually, it is the trustee who cares more than the debtor, but there is a second importance to priority status for tax claims because any tax claim entitled to priority status is excepted from discharge if it does not get paid in the bankruptcy case. Tax debts not entitled to priority status can also be excepted from discharge but the rules for those debts are more restrictive. So, the classification of the claim makes a big difference both to the other creditors of the estate and, potentially, to Mr. Kardash.

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Mr. Kardash was an employee and minority shareholder with an 8.65 share of a company that was defunct by the time of the bankruptcy case. He managed the operations of the company but was not a responsible person under IRC 6672. (If he did owe any money as a responsible person, such a debt would always be entitled to priority status under bankruptcy code 507(a)(8)(C)). During the relevant period, the company had revenue in excess of $450 million but paid no income taxes. The IRS subsequently audited the company and determined that it owed over $120 million for these years. The two controlling shareholders siphoned substantially all of the cash out of the company. Mr. Kardash received about $3.5 million during the years 2005-2007, and he reported the distributions as dividends and paid tax on it.

The IRS sent him a notice of transferee liability regarding these dividends as well as bonuses he received in 2003 and 2004. He petitioned the Tax Court, which ruled that the dividends paid to him in 2005-2007 were fraudulent transfers under applicable Florida law because they were not made in compensation for his services and the company was either insolvent at the time it paid him or became insolvent as a result of the payments.

The IRS can file a priority claim under bankruptcy code 507(a)(8)(A) for unsecured claims for “a tax on or measured by income or gross receipts for a taxable year ending on or before the date of the filing of the petition….” The bankruptcy court states that the transferee liability under IRC 6901(a) (the basis for Mr. Kardash’s liability) does not by its terms impose a tax. While this is a true statement, the transferee liability provisions seek to provide the IRS with a basis for collecting tax that has otherwise gone unpaid. The bankruptcy court quotes from the Tax Court’s description of the case:

“Section 6901(a) is a procedural statute authorizing the assessment of a transferee liability in the same manner and subject to the same provisions and limitations as in the case of the taxes with respect to which the transferee liability was incurred. Section 6901(a) does not create or define a substantive liability but merely provides the Commissioner a remedy for enforcing and collecting from the transferee of the property the transferor’s existing liability.”

The bankruptcy court points to an 11th Circuit decision in Baptiste v. Commissioner, 29 F.3d 1533 (11th Cir. 1994), holding that “any liability to which section 6901(a) applies is not a tax liability, but rather an independent liability.” The 11th Circuit found that IRC 6901(a) is purely a procedural statute. The Baptiste case was not a bankruptcy case; however, in In re Pert, 201 B.R. 316, 320 (Bankr. M.D. Fla. 1996), a bankruptcy court in the same jurisdiction as the court deciding Mr. Kardash’s case relied upon Baptiste in determining that a transferee liability was not entitled to priority status. The bankruptcy court states that the Baptiste and Pert decisions control the decision here. I do not necessarily agree with that statement as the Circuit Court decision addresses a different aspect of a transferee liability and a bankruptcy court is not bound by decisions of bankruptcy judges at the same level. Nonetheless, these cases provide support for the decision that the transferee liability is not entitled to priority status.

The Court disagrees with the decision of the 10th Circuit in McKowen v. Internal Revenue Service, 370 F.3d 1023 (10th Cir. 2004). The McKowen case involved the issue of discharge and not directly the issue of priority status, though the two can be linked. The McKowen case adopted a functional approach to the classification of the transferee liability claim which is the approach sought by the IRS. A middle ground here would be to treat the debt as non-priority but excepted from discharge similar to debts where a fraudulent return has been filed. Such treatment would allow other creditors of the estate to take before the payment of the derivative liability created by 6901(a), but would also allow the IRS to have the opportunity to collect on a debt that the actions of the company owing the debt has prevented the IRS from collecting. Neither the priority provision of bankruptcy code section 507 nor the discharge provisions of bankruptcy code section 523 neatly address the circumstances of a transferee liability. It is surprising that almost 40 years after the passage of the bankruptcy code, an issue of this type remains unresolved.

In arguing that the court should apply a functional analysis in determining whether the transferee liability receives priority status the IRS cited to United States v. Reorganized CF&I Fabricators of Utah, Inc., 518 U.S. 213 (1996) in support of its position that a bankruptcy court must look to the basis for a liability in determining the liabilities status. In CF&I the Supreme Court determined that a liability labeled a tax was really a penalty just as in Sotelo v. United States, 436 U.S. 268 (1978)(in a case involving the trust fund recovery penalty) the Supreme Court found a liability labeled a penalty was really a tax. See a post by Bryan Camp discussing this issue for further details. As you can see from the fact that cases have twice gone to the Supreme Court to classify tax claims, this is a serious issue. The parties’ briefs are excellent and set out the issue in great detail if you are seeking more understanding of the issue. See Debtor’s Response and Opposition to the IRS’S Motion for Summary Judgment and the Reply to Debtor’s Response and Opposition to the United States’ Motion for Summary Judgment.

Conclusion

I look for the IRS to appeal this decision unless it determines that the 11th Circuit precedent controls the issue. The decision here does not directly address discharge but only the priority of the IRS claim. Depending on the amount of money in the estate, the priority status of the claim may not matter as much as the discharge issue. From the pleadings it appears that the efforts of the IRS to collect from Mr. Kardash partially involves its ability to reach property held as tenancy by the entireties based on the decision in United States v. Craft, 535 U.S. 274 (2002) and a subsequent 11th Circuit case, United States v. Offiler, 336 F. App’x 907, 909 (11th Cir. 2009) interpreting Craft. I wrote about the Craft case here.

A part of the fight in the bankruptcy case involves use of the proceeds of a house that the taxpayer and his wife jointly owned. The IRS objected to certain uses of those proceeds because the debtor’s proposed use would reduce its recovery. The debtor is 75 and now on social security. The prospects for recovery here will come from existing property and not future income but the IRS may determine that its ability to collect from Mr. Kardash is less important than establishing the principle regarding the classification of transferee liabilities in bankruptcy cases. If it does, Mr. Kardash will not only have selected bad business partners but also a bad issue to litigate since the IRS may push the litigation without his concern for the cost vs. benefit.

 

 

 

 

Delinquency Penalties: Boyle in the Age of E-Filing

The issue of when a taxpayer can be insulated from the imposition of civil penalties when the taxpayer depends and relies on the advice of a tax professional is an issue that we have discussed many times on PT and which fills many pages in the Saltzman Book treatise IRS Practice and Procedure. This month the American College of Tax Counsel (ACTC) filed an amicus brief in the Fifth Circuit case Haynes v US, which looks at the issue with a modern twist: can a taxpayer who uses an authorized e-filer expecting that the return be timely filed avoid a delinquency penalty if in fact there was an error in the processing of the e-filed return but the IRS or the preparer did not notify the taxpayer of the error until a couple of years passed and penalties accrued?

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As many PT readers know, Boyle creates a bright line that prevents taxpayers from arguing reasonable cause based on good faith reliance on an advisor when it comes to meeting tax-filing deadlines. Boyle is a Reagan era case, well before today’s e-file world. The brief, which is exceptionally well done, explains that many e-file reject returns would clearly be accepted as returns under the Beard test if they were sent in via snail mail. The current e-file regime essentially makes it easy for rejects, as IRS has required taxpayers to identify prior year’s AGI or a special PIN to verify the return (a task not all are up for).

As I have discussed previously when IRS rejects an e-filed individual income tax return that cannot be rectified taxpayers “must file the paper return by the later of the due date of the return or ten calendar days after the date the IRS gives notification that it rejected the electronic portion of the return or that the return cannot be accepted for processing.” (as per the Handbook for Authorized E-file Providers of Individual Income Tax Returns). If there is no timely notification and little way for the taxpayer to independently check whether the return was rejected, it seems unfair to apply Boyle in these circumstances.

The ACTC brief (note: Keith and I are ACTC fellows though we did not participate in the drafting of the brief; Peter Connors of Orrick and Professor Jon Forman at Univ of Oklahoma Law School led the charge for ACTC ) makes the case much more forcefully. As the brief discusses, the act of e-filing is not nearly as simple as placing a paper return in the mail. Requiring a taxpayer to independently check to ensure that the return has been accepted, absent major developments in the so-called Future State of tax account information, seems to me unfair. By requiring a taxpayer to double check with the preparer or IRS to ensure that the e-filed return has been accepted places additional burdens on taxpayers using a preparer. If anyone should have that responsibility, it is the preparer, and a preparer who fails to ensure that the IRS has accepted the return should face the penalty music, not the taxpayer.

We will watch this case with interest and keep readers posted.

Designated Orders: 11/13 to 11/17/2017

We welcome back Patrick Thomas who directs the tax clinic at Notre Dame. Patrick had a busy week for orders as the Court cleared out cases in preparation for Thanksgiving week. All of the material is good but Patrick covers what happens from a collection perspective when you lose a Tax Court case and take an appeal. This is not a topic we have addressed previously. Keith

I’ve begun the last few posts noting that it was a “light week” for designated orders; I seem to have tempted the Designated Order gods, because this past week there were nine total orders, with three bench opinions by Judge Gustafson and other very meaty orders. They included Judge Gustafson’s request that parties file supplemental briefs regarding the whether a new matter existed under Rule 142(a) sufficient to shift the burden of proof to the IRS; Judge Panuthos’s dismissal of a CDP matter for mootness due to full payment of the liability; and Judge Holmes’s denial of a motion to for reconsideration. Finally, two of the bench opinions raise interesting substantive tax law issues: one opinion looks at the increase in a home’s basis due where the taxpayer engaged in both bank and bankruptcy fraud during the home’s sale. Another explores the blurry line between physical and emotional damages in section 104(a)(2), and is deserving of fuller discussion.

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Dkt. # 22795-16L, Gardner v. C.I.R. (Order Here)

When an order begins with a teaser that the Court is assessing a section 6673 penalty for the maximum $25,000 amount, my interest is piqued. Upon researching the Gardner’s substantial history in the Tax Court, with the IRS, and even in the U.S. District Court, I can understand why. They appear to be incorrigible tax protestors, deserving perhaps of a far greater penalty than the $25,000 statutory maximum under section 6673. That is, the Service may want to start looking at sections 7201 et seq.

According to Judge Vasquez in a prior opinion, the Gardners have not filed a federal income tax return since 1993. At that time, the Gardners founded “Bethel Aram Ministries”, which served as vessel through which to promote their abusive tax shelter. The shelter’s design required income to be “donated” to corporations (called a “corporation sole”) that the taxpayer owned. The taxpayer would then deduct the “donation” as a charitable contribution. Further, any business income was to be routed through a trust which owned a majority interest in an LLC that operated the business. The trust would also donate its income to the corporation sole, which would pass tax-free to the taxpayer. The Gardners were enjoined from promoting this shelter and were subjected to a penalty under section 6700 of $47,000 for so doing.

The Gardners apparently made substantial income from promoting this shelter (approximately $250,000 in 2004; one wonders about the effectiveness of a $47,000 penalty), but didn’t report the income or pay any tax on it. The IRS assessed tax and additions to tax under section 6020(b) for 2002, 2003, and 2004, which were upheld by the Tax Court and the Ninth Circuit. The total owed across these three years was approximately $263,000.

The Gardners eventually challenged a CDP levy notice for 2004, which made its way to the Tax Court last year. Judge Lauber upheld the Notice of Determination, and also assessed a $10,000 section 6673 penalty because of the Gardners’ largely frivolous arguments (e.g., accusing the IRS of lying, defamation, and conspiring to deny their First Amendment rights to freedom of speech and religion), warning the petitioner “that she risks a much larger penalty if she engages in similar tactics in the future.”

The Gardners now challenge a CDP lien notice for 2002 and 2003, apparently using the same arguments in their challenge to 2004 (e.g., that they do not owe the tax assessed). The tax was determined in a deficiency proceeding in which the Gardners participated, so they certainly had no right to challenge the liability in either CDP hearing. Yet try again as they do (recycling the same frivolous arguments as before), Judge Halpern executes Judge Lauber’s warning, and assesses a $25,000 penalty under section 6673. Are nearly $400,000 in tax and penalties enough to stop the Gardner’s intransigence? Color me skeptical.

Judge Halpern spent some time going through the Gardners’ substantive arguments. Some of the arguments addressed strike me as those that the Tax Court routinely skips (e.g., that the failure to sign Form 1040 nullifies any assessment, or that the signatures on the Form 4340 summary records of assessment constitute perjury). One wonders where individual judges and the Tax Court as an institution do and should draw lines regarding such arguments.

One procedural item worth mentioning (as I don’t see that we’ve covered it before), is the propriety of an assessment while an appeal from the Tax Court is pending. Under section 7485, sections 6213(a) and 7481 bar assessment and collection during an appeal only if the taxpayer files a notice of appeal, along with a bond of up to twice the deficiency. Otherwise, the tax may be assessed once the Court enters its opinion.

Here, the Gardners argued that because the assessment occurred while their Ninth Circuit appeal was pending, section 6213 barred the assessment. However, the Gardners failed to either post a bond or ask the Tax Court for a bond in a lower amount. They complained that the Tax Court should have fixed a bond for them, and that the bond should have been waived given their lack of income. Judge Halpern dispenses with both arguments, as the Gardners did not comply with section 7485. There’s also nothing in the statute to suggest that the Tax Court must or may fix a bond amount sua sponte.

Judge Halpern’s opinion shows that litigants can either (1) pay the full statutory maximum of twice the deficiency, or (2) file a motion to fix a bond in a lesser amount. He further notes that the court does not have any statutory discretion to waive section 7485, even for cases of financial hardship. I wonder if any Clinics lucky enough to litigate an issue up to the Courts of Appeal have contended with section 7485. While Judge Halpern notes the statutory restriction that a bond of some kind must be set, could it perhaps be set at $1 in cases of financial hardship, accompanied by a substantial legal question?

Dkt. # 20104-14L, Bongam v. C.I.R. (Order Here)

One of Judge Gustafson’s three bench opinions explores a number of a procedural issues. Mr. Bongam (the litigant in the important case of Bongam v. Commissioner, 146 T.C. 52 (2016), which held that the 30 day period for petitioning the Tax Court begins when the notice of determination is mailed—not the date of the notice of determination) was involved with two companies—Dynamic Visions and One Stop Medical Supplies—that ultimately failed to properly withhold and pay over their employee’s taxes to the IRS. Accordingly, given Mr. Bongam’s involvement in both companies, the IRS assessed a Trust Fund Recovery Penalty against him. The IRS filed a Notice of Federal Tax Lien regarding the assessments, the IRS upheld the lien at a CDP hearing that Mr. Bongam timely requested, and Mr. Bongam petitioned the Tax Court.

In the CDP hearing and at trial, Mr. Bongam asserted that while he both possessed co-signature authority and was a shareholder and officer at One Stop, he had no operational authority in the business; that was reserved to the lone employee in the organization, a Mr. Forkwar. As such, he had no idea that the payroll taxes were going unpaid.

One can only challenge the underlying liability in a CDP case if the taxpayer didn’t have a prior opportunity to dispute that liability. For most TFRP cases, this opportunity generally presents itself in the right to request an administrative review from IRS Appeals, after the TFRP is proposed. While opportunity for judicial review exists as a matter of course for TFRPs, under current law, a chance to appeal administratively will constitute a prior opportunity.

But if the taxpayer doesn’t receive notice of that opportunity, it’s not really an opportunity at all. Here, Mr. Bongam didn’t receive the Letter 1153 assessing the TFRP for One Stop—though IRS Appeals initially believed he had. They relied on the Letter 1153 that assessed Dynamic’s TFRP, not One Stop’s. Further, a second Letter 1153 that assessed TFRPs for One Stop didn’t have a certified mail response card; so, the Court held, its delivery couldn’t be confirmed. As such, Judge Gustafson allows Mr. Bongam to challenge his TFRP for One Stop, and finds on the merits that Mr. Bongam was not a responsible person.

For Dynamic, there were no problems with delivery of the Letter 1153 according to the Court. While Mr. Bongam stated at trial that he didn’t receive the letter and that the signature on the certified mail receipt was not his, Judge Gustafson didn’t find that credible. The Court even compared that signature to those on Mr. Bongam’s pleadings, and found them to be similar. I’m not sure that’s a proper role for the Court, but the other evidence at hand safely shows that Mr. Bongam received the Letter 1153. And, in any case, Judge Gustafson notes the Mr. Bongam was a responsible person who willfully failed to withhold and pay over Dynamic’s payroll taxes.

While Mr. Bongam cannot challenge the liability, he may challenge whether that liability has been paid. Indeed, he raised such a claim, submitting various checks that were made payable to the IRS. Judge Gustafson views this challenge not as one to liability, but as one regarding either whether the tax is “unpaid” for purposes of section 6330(c), or an IRS verification failure under section 6330(c)(1).

Either way, for many of the checks, Mr. Bongam wasn’t able to show that they were made to satisfy the trust fund portion of the liabilities. This raises an incredibly important issue for anyone dealing with a TFRP case. From a potential responsible person’s perspective (at least, one who can control payment of payroll taxes by the employer), any voluntary payments from the employer towards the payroll tax liability ought to be designated to the trust fund portion of the liability; that is, the portion constituting income tax and the employee’s portion of FICA taxes. Otherwise, the payments will may be applied to the employer’s portion of FICA taxes—for which a responsible person is not liable under section 6672.

Dkt. # 18773-16W, Depadro v. C.I.R. (Order Here)

Finally, this is your periodic reminder that to claim a whistleblower award under section 7623, the IRS must both act upon the information provided through instituting an administrative or judicial action AND collect tax from the target of that action. The petitioners here alleged that the IRS was negligent in failing to do so, and on that basis, the petitioners should receive a monetary award. Judge Guy quickly dispenses with that argument (facially persuasive though it might sound to a wannabe whistleblower) and grants the Service’s motion to dismiss.

 

The Jarndyce Case, Judge Mark Holmes, and the Taxation Literary Tradition

We welcome back guest blogger Bob Kamman. Although Bob has practiced tax law in the Phoenix area for many years, he began his studies and his career as a journalist. Today, he draws from the Tax Court judge most likely to make literary references to provide us with a literary background on one of Judge Holmes’ opinions as well as some additional literary happenings at the Court. Because the supporting references needed for this post differ from those in most of our post, Bob has used footnotes which can be found, appropriately, at the end of the post. Keith

Lawyers and law students can be categorized as those who already recognize the name Jarndyce, and those who eventually will. Tax Court Judge Mark Holmes falls into the first category, as shown by his reference in his “undesignated” order of October 23, 2017, in an estate-tax case filed in 2005.

“This complex case,” Judge Holmes wrote, “was on the Court’s December 10, 2007 trial calendar for Miami, Florida, and stems from the death of Mr. Boulis back in 2001. Related cases sprawled over two continents and several different courts, but the last pieces were several peripheral issues in the probate proceeding that remained on appeal in the state-court system until last year. The final state-court issues are about fees appropriately charged to the estate during this Jarndyce v. Jarndyce – like litigation. The parties report mediation ongoing. If this mediation succeeds in producing a settlement, it remains likely that the liquidation of administrative expenses will be the last remaining chores in this long-running case.”

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The reader will not find Jarndyce in any published case reports, nor with a Lexis search. Rather, its story is one of the related plots in the classic novel by Charles Dickens, “Bleak House.” To understand the English legal system of the 19th Century, much of which provided the framework for American procedure, one must read Dickens. He was not a lawyer, but as a young man he worked as a court reporter, as in both meanings: Shorthand transcription of court proceedings, and newspaper coverage of trials. The fictional Jarndyce case may be an exaggeration of how prolonged litigation can deplete an estate, but it was a familiar story to readers on both sides of the Atlantic in 1853.

I searched other Tax Court orders and decisions available at the Court’s website. Surprisingly, this is the only reference to Jarndyce. I searched for Dickens. There were petitioners named Dickens, and petitioners with an address on Dickens Street. But the only other Dickens reference came from an opinion by the same Judge Holmes.

That Summary Opinion was written in 2004, and gained some media attention at the time. The case involved a playwright who had not yet shown a profit. Judge Holmes wrote his 28-page opinion in two acts. Act 1 was “Background” and Act 2 was “Discussion.” Next time you research Section 183, this case would be a good starting point. But for everyone, Judge Holmes’ “Prologue” is like Dickens’ “Christmas Carol.” It can be read and enjoyed, one taxable year after another. Before the start of another busy filing season may be the best time to renew our appreciation:

* * *

“Taxation! Wherein? And what taxation?”

       Henry VIII act I, sc. 2 [Footnote *1]

Prologue

It is a truth little remarked on by scholars that tax law has been a fount of literature for 5,000 years. The oldest literary work still extant–the Epic of Gilgamesh–is a long narrative of a friendship begun during a protest against government exactions.[*2] In more recent times, some of our language’s most notable authors have used fiction to delve into tax policy: consider Shakespeare’s criticism of the supply-side effects of a 16-percent tax rate; [*3] Swift’s precocious suggestion of a system of voluntary self-assessment; [*4] and Dickens’ trenchant observation on the problems of multijurisdictional taxing coordination:

[The town’s] people were poor, and many of them were sitting at their doors, shredding spare onions and the like for supper, while many were at the fountain, washing leaves, and grasses, and any such small yieldings of the earth that could be eaten. Expressive signs of what made them poor, were not wanting; the tax for the state, the tax for the church, the tax for the lord, tax local and tax general, were to be paid here and to be paid there, according to solemn inscription in the little village, until the wonder was, that there was any village left unswallowed. [*5]

Taxation has also sparked creativity in newer literary genres. See It’s a Privilege on Urinetown: The Musical (RCA Victor) (musical re excise tax); J. Kornbluth, Love and Taxes (staged monologue re income tax) (unpublished manuscript, 2003). Tax collecting jobs have helped finance the careers of such notable revenue agents as Chaucer,[*6] Paine,[*7] and Hawthorne.[*8] And tax records are a famously important source of information for scholars of both ancient civilizations [*9] and modern authors.[*10]

This case follows in that long, but little-noted, tradition. Petitioner, N. Joseph Calarco, is a respected professor of theater at Wayne State University in Detroit. He also writes plays. On his 1997 tax return, he deducted his playwriting expenses as a Schedule C business loss. Respondent disallowed both the loss and several itemized deductions that petitioner took on his Schedule A. These disallowances created a deficiency of $3,869 to which respondent added an accuracy related penalty of $774. Petitioner, following the lead of Henry VIII’s first Queen Katherine, [*11] filed a timely petition in this Court. . . .

* * *

Judge Holmes added an Epilogue to his opinion in the Boulis case. I had read it several times before I realized that “survive” rhymes with “155.”

Epilogue

Dramatists used to finish with some rhymes,

Mostly iambs with a pinch of dactyly,

But in these more prosaic times

Works usually end more matter-of-factily.

In our Court, though, the oldest ways seem somehow to survive–

A decision will be entered

under Rule 155.

FOOTNOTES:

1 This case was heard pursuant to the provisions of Internal Revenue Code section 7463. Section citations are all to that Code. This decision is not reviewable by any other court, nor should the opinion or its literary references be cited as precedent in future proceedings.

2 David Ferry, “Gilgamesh, A New Rendering In English Verse”, 14-15 (Farrar, Straus, and Giroux 1992).

 

3 Shakespeare, “Henry VIII”, act I, sc. ii. (“A sixt part of each? / A trembling contribution! Why, we take / From every tree, lap, bark and part o’ th’ timber; / And, though we leave it with a root, thus hack’d, / the air will drink the sap.”)

4 Jonathan Swift, Gulliver’s Travels, A Voyage to Laputa, Etc. 162 (W. W. Norton & Co., Inc., New York, 1964) (1726). (“The highest tax was upon men who are the greatest favourites of the other sex, and the assessment according to the number and natures of the favours they have received; for which they are allowed to be their own vouchers. . . . The women were proposed to be taxed according to their beauty, and skill in dressing; wherein they had the same privilege with the men, to be determined by their own judgment.”) See generally Levmore, “Self-Assessed Valuation Systems For Tort and Other Law”, 68 Va.L.Rev. 771, 779 (1982).

5 Charles Dickens, “A Tale of Two Cities” 119 (Everyman’s Library, Knopf, 2002) (1859).

6 While Controller of the Customs, “[t]here was great variety in what [Chaucer] had to do, and he came in contact with a variety of people. He must have seen infinite venality, witnessed colorful subterfuges, heard improbable and ridiculous dodges and lies and excuses.” Donald Howard, “Chaucer” 212 (1987).

7 “I act myself in the humble station of an officer of excise, though somewhat differently circumstanced to what many of them are, and have been a principal promoter of a plan for applying to Parliament this session for an increase in salary.” Letter of Thomas Paine to Oliver Goldsmith, December 21, 1772, Reprinted in George Hindmarch, “Thomas Paine: The Case of the King of England And His Officers of Excise”, Published by the Author in 1998, Surrey, England.

8 Indeed, it is reported that Hawthorne once contemplated writing sketches entitled “Romance of the Revenue Service” and “an ethical work in two volumes on the subject of Duties”, though sadly neither project was ever undertaken. Randall Stewart, “Nathaniel Hawthorne, A Biography” 53 (Archon Books, 1970).

9 See, e.g., Tonia Sharlach, “Provincial Taxation and the Ur III State” (2004).

10 See A. L. Rowse, “William Shakespeare, A Biography” 280-281 (1963) (use of obscure records to trace author’s movements); Vitale v. Commissioner, T.C. Memo. 1999-131 (use of obscene records to trace author’s movements).

11 “These exactions, whereof my sovereign would have note, they are most pestilent to the bearing; and, to bear’ em the back is sacrifice to the load.” “Henry VIII”, I. ii. 11. 47-50.