Designated Orders: 5/21/18 to 5/25/18 by Caleb Smith

In this installment of designated orders covering the week of May 21, guest blogger Caleb Smith of the University of Minnesota covers several deficiency cases in which the taxpayer failed to carry their burden of proof. Professor Smith also updates us on a few Graev issues including a Chief Counsel Notice from June 6 which will be the subject of additional discussion on this blog and elsewhere. Christine

Knowing When To Hold ‘Em and When To Fold ‘Em

Chief Special Trial Judge Carluzzo cleaned house with designated orders through three bench opinions on S-Cases. These cases didn’t have much in common except that the taxpayer probably never should have gone to trial. Two of the cases deal mostly with evidence and credibility issues (and the same IRS trial attorney for both), and one deals with too-good-to-be true legal arguments. We’ll start with the evidence/credibility issues.

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It is not uncommon that I come across IRS examiners (or law students) that harbor the belief that there is one particular document (and one particular document only) that a taxpayer needs in order to “prove” something. For law students, I suspect this is an offshoot of reading mostly appellate decisions where the facts are already set in stone. For IRS examiners, I suspect this is an offshoot of reading mostly the IRM and mistaking it for the law.

In any event, most of the time there are some documents that are better than others and some sources of evidence that are more reliable (and likely to be considered credible) than others, but usually your job is simply to show something convincing to the finder of fact. Where documentary evidence should exist (for example, a lease or bank records) you can be sure that the IRS is going to bring that issue up. Part of being a lawyer is gauging the likelihood of success on the evidence you do have, and if there is a compelling and credible narrative for why certain documents don’t exist, advising and planning accordingly. Fuller v. C.I.R. (dkt. # 14627-17S) is one instance where candid advice on review of the evidence would be “you have no chance in court.” Hadrami v. C.I.R. (dkt. # 11377-17S) is another.

In Fuller, the taxpayer claimed some rather large itemized deductions – the size of which (relative to income) likely tripped up the IRS smell-test known as Discriminant Inventory Function (DIF) selection. Here, we are not given the taxpayer’s reported income, but we do have some fairly eye-popping deductions: $41,628 for medical, $24,237 for charitable contributions, and $12,567 for unreimbursed employee expenses. Oh, and $850 in tax preparation fees for purchasing tax preparation software (the Turbo-Tax super-elite premium package?). Failing the smell-test, what evidence does the taxpayer have to convince the fact-finder of the propriety of her deductions?

Not a scrap of paper. And testimony that basically works against her as a matter of law. These are not auspicious circumstances.

To begin with, the charitable deductions already present an uphill battle since they require strict substantiation. Ms. Fuller has nothing for them, but does have the (apparent) excuse that her records have been destroyed by household floods. The loss of records in a flood or disaster area is an actual, recognized exception, but it isn’t going to do the trick here – at least in part because the taxpayer can’t explain why other third party records (presumably not subject to floods) don’t exist. Why no bank records of these massive contributions? The same question applies with equal force to the medical expenses and tax preparation fees.

The unreimbursed employee expenses of $12,567 present a different issue. Apparently these expenses stem from a home office. Two immediate legal issues come up: (1) as an employee, is this home office maintained for the convenience of the employer (see Hamacher v. C.I.R., 94 T.C. 348, (1990)), and (2) the usual killer, is the home office exclusively used on a regular basis as the principal place of business (see IRC 280A(c)(1))? Since the taxpayer’s own testimony is that the “home office” is her dining room table where she worked a couple days a week, winning advice would be that she is “unlikely” to succeed. And sure enough, she does not.

Hadrami is a twist on Fuller: documents exist and are introduced by the taxpayer, but they only serve to undermine his testimony. Hadrami was (or claimed to be) a limousine driver, providing his lucky riders a taste of the good life in a 2003 Lincoln Town Car… that had at least 291,380 miles on it in 2012. When Hadrami claims to have purchased the car from the limousine operating company, “Rim Limo,” in 2013 the odometer (allegedly) read 320,673 miles. Interestingly enough, when the DMV has record of the taxpayer purchasing the car in 2014, the odometer continued to read 320,673 miles. Judge Carluzzo notes that something is amiss.

Judge Carluzzo determines that it is doubtful that the taxpayer actually owned the vehicle for the tax year in question (2013). This is especially so as the Rim Limo job required him to park the limo and “return home” in his own car. The mileage log offered by the taxpayer “raises more questions than it answers.” One interesting substantive legal note in this case deserves mention on that point, which is that these expenses were NOT subject to the strict substantiation requirements we usually see trip up taxpayers, and accordingly the Cohan rule would apply. Judge Carluzzo notes that the definition of passenger automobiles (i.e. the listed property usually prompting strict substantiation) does NOT include vehicles used by the taxpayer directly in the trade or business of transporting persons for compensation or hire. See IRC 280F(d)(5)(B). As someone who routinely comes across Uber drivers subject to audit with partial, but not sterling, records of expenses, I find this to be a noteworthy point.

The taxpayer also offers his Wells Fargo bank records to substantiate other expenses (for example, over $1000 in meals and entertainment)… but apparently does not actually delineate where in his records those expenses are to be found. Handing a stack of papers to someone and saying “please find deductions for me” is what you do with your tax preparer, not a Tax Court Judge or IRS attorney. Speaking of tax preparers…

The return that prompted this whole ordeal apparently was prepared with the help of a tax “professional.” As usual, the “professional” saw nothing wrong with claiming (and the taxpayer nothing wrong with incurring) a $22,253 net loss from driving a limo. I suppose one goes into the limo business more for the love of carting around prom-goers than for the money. That, or some people just can’t say no to tax outcomes that seem too good to be true…

Which brings us to the last in Judge Carluzzo’s trilogy of bench opinions: Rykert v. C.I.R., Dkt. # 10427-17. Rather than a “tax professional” preparing questionable returns, Judge Carluzzo worries that Mr. Rykert may have been taken in by “advice he was receiving from an organization whose status to practice law is questionable.” In other words, the “only suckers pay tax” crowd that appear to have found technicalities with every aspect of our tax administration. This particular strain appears to be challenging who actually has the authority to sign a Notice of Deficiency at the IRS and what makes for a valid Notice of Deficiency (the taxpayer does not appear to disagree with any of the substantive items therein).

With what appears to be very genuine concern for a misguided petitioner, Judge Carluzzo does not throw out the case but instead grants an oral motion for continuance in the hope that Petitioner secures counsel and the matter resolves itself without trial. Presumably, that counsel will know whether to hold or fold. As to whether petitioner heeds that advice, one can only hope. A similar designated order (this time from Judge Cohen) suggests that some taxpayers probably just won’t take advice when it isn’t the outcome they want. In Loetscher v. C.I.R., dkt. # 10197-17L, the petitioner raises numerous tax protestor or otherwise frivolous arguments, and is warned of the possibility of penalties up to $25,000. Judge Cohen tries valiantly to bring the light of reason to the petitioner, but notes that the petitioner “failed to consult with the volunteer lawyers present and available” and “when the Court made a last attempt to persuade her to abandon the erroneous approach she [the petitioner] responded ‘I’m sticking to what I said about that.’” Not surprisingly, petitioner soon lost her case.

Graev Updates

The most substantive Graev order (found here and dealing with jeopardy assessments) has already been dealt with earlier in a stand-alone post here. I commend readers that haven’t had a chance to read it, and particularly the insightful comments posted thereunder.

A second Graev designated order was issued by Judge Holmes in Humiston v. C.I.R., dkt. # 25787-16L. This order provides still more insight on this rapidly developing area of law. It does so on two areas: (1) under what circumstances a taxpayer must specifically raise the issue of IRC 6571(b) compliance, and (2) with much less detail, what penalties are exempt IRC 6751(b)(2)(B) as “automatically calculated by electronic means.”

On the issue of whether a taxpayer must specifically raise the issue of IRC 6751 compliance, Judge Holmes raises a few questions. First, Judge Holmes notes that the taxpayer did not put IRC 6751 compliance at issue, and that generally that means it must be conceded. Since it is a summary judgement motion by the IRS, the taxpayer is pro se, and the issue is “cutting edge,” Judge Holmes ultimately lets the taxpayer off the hook for that potential problem. But what is interesting to me is how Judge Holmes phrases what the “error” is. This is a collection due process case, and the problem isn’t that the taxpayer specifically fails to put the penalty at issue. It is that the taxpayer doesn’t raise the issue of the settlement officer (SO) failing to verify all applicable law was followed per IRC 6330(c)(1). This potentially bolsters the reading that in a CDP case, verifying IRC 6751(b) compliance is part and parcel of the SO’s responsibilities under IRC 6330(c)(1) -which would be especially important for taxpayers who failed to challenge a penalty on a Notice of Deficiency that they previously (actually) received. The recently decided precedential opinion in Blackburn v. C.I.R., 150 T.C. No. 9 (2018) somewhat addresses this issue, but that case mostly stands for the proposition that there is no requirement to “look behind” the supervisory approval, if it exists. Although the boilerplate “I verified that all applicable law was followed” will not suffice on its own, some written record of supervisory approval is likely enough. A very recent Chief Counsel memorandum (CC-2018-006) describes the section 6751(b) verification requirement in a CDP case as as part of the section 6330(c) requirement even where the liability is not at issue, but notes that the IRS does not have the burden of production in such a case. In other words, the taxpayer may need to do a little more to put it at issue before the court.

Although it was only a footnote in a non-precedential designated order, one other aspect of the Humiston decision bears mention. It isn’t immediately clear whether the IRS argued that the penalty at issue (in this case, a Trust Fund Recovery Penalty (TFRP)) did not need section 6751 compliance, and it appears as if the SO simply failed to consider it at all. Nonetheless, Judge Holmes puts a stamp of disapproval on the notion that TFRPs would not need to meet IRC 6751(b) requirements,  both because they are penalties “under the code” and because it is doubtful to Judge Holmes’ mind that they could be automatically calculated through electronic means (the IRC 6751(b)(2)(B)) exception). This is important because in Blackburn the IRS explicitly made the argument in the alternative that IRC 6751 didn’t apply to TFRPs. The Court didn’t rule on that issue because it found compliance by the IRS anyway. My reading of the not-so-subtle tea leaves in Judge Holmes’ designated order is that the Court would almost certainly find section 6751 to apply to TFRPs if that issue was squarely before it.

Final Clean Up

There were two other designated orders for the week of May 21 that will not be discussed in this post. One was from Judge Jacobs granting a motion for continuance and remand (found here), and one was from Judge Thornton denying a motion to vacate or revise the Court’s opinion (found here).

When to Waive CDP Rights

Professor Caleb Smith discusses Toney Jr. v. C.I.R., Dkt. # 25496-16SL, a designated order from a few weeks ago. Rather than embed the discussion in Caleb’s DO Post, we have split this off to discuss issues surrounding waiving CDP rights, with Caleb looking for input from readers who may have considered what is the best practice when reaching an agreement with a Settlement Officer in a CDP case . Les

The order in Toney v Commissioner actually deals with the oft questioned “prior chance to argue the underlying tax” blogged about hereand here among others. The case is a pretty clear loser on that point, since Mr. Toney had previously had Appeals conferences and argued the tax.  But it got me thinking about a different issue that I have had with the IRS: specifically, how to approach Form 12257 “Waiver of CDP Rights and Summary Notice of Determination” from both legal and tactical perspectives.

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In Toney, the taxpayer and the IRS settlement officer came to an agreement to full-pay the liability within 60 days. The settlement officer prepared the 60-day extension form and a Form 12257 “Summary Notice of Determination” and sent it to Mr. Toney. A Notice of Determination (and the judicial review it affords) seemed unwarranted, since both parties agreed on the proper outcome.

But for reasons unknown Mr. Toney did not full pay and did not sign the Form 12257. The IRS settlement officer got tired of waiting and sent a Notice of Determination sustaining the lien instead.

From the outset it is important to note that Form 12257 is likely NOT a determination for IRC 6330(d)(1)purposes, despite having the phrase “Summary Notice of Determination” as its header. It is really more of a contract, and in any case too contingent to be a “determination.” For one, the taxpayer has to sign it to give it force, and for two even if the taxpayer signs it, it still requires secondary approval by an IRS Appeals manager.  See Fine v. C.I.R., T.C. Memo. 2016-217. In any event, the IRS does not treat it as a Notice of Determination (and no Tax Court decision has either): if the taxpayer does not sign and return Form 12257, the IRS sends an actual Notice of Determination to the taxpayer later.

Because it is not a Notice of Determination, it neither starts the clock running on petitioning Tax Court nor gives the Tax Court jurisdiction on such a petition. In other words, nothing much happens until you sign and have the Form 12257 approved or the IRS gets tired of waiting and sends an actual Notice of Determination.

And that is where the question of tactics arises. After a CDP hearing in which there appears to be a meeting of the minds on the correct outcome, a friendly IRS Appeals/Settlement officer will often suggest signing a Form 12257 to “speed up the process.” For example, if both parties agree that the taxpayer should be eligible for a payment plan of $100/month, why even retain judicial review? Why not just enter into the plan and waive the right to review?

One might be concerned that after waiving the right to judicial review the IRS will take some action that seems inconsistent with (or just completely reneges on) the agreement the parties came to. Not to worry, the IRS Appeals/Settlement Officer may retort: the very terms of Form 12257 provide “I [the taxpayer] do not waive my right under Appeals’ retained jurisdiction to receive another hearing with Appeals if I disagree with the IRS over how it followed Appeals’ determination.”  In other words, Appeals still has your back if the IRS doesn’t follow through on its apparent promises.

Yet believe it or not, having Appeals retain jurisdiction but without Court review is likely cold comfort for many practitioners. Generally, I give fairly high marks to IRS Appeals… when it is localIRS Appeals. When the IRS Appeals/Settlement officer is at a “campus” (Fresno comes to mind) my experiences have been, shall we say, less encouraging. It is in precisely those situations that I am reluctant to sign away the right to judicial review.

Perhaps because of this the best practice is to insist on an ACTUAL Notice of Determination. On the downside, this slows things down and creates more work for the IRS which in turn might not make for the most collegial relationship with the Appeals/Settlement officer. On the plus side, you’re here to look out for your client’s interests not the workload of the IRS, and frankly because part of the problem stems from impersonal IRS campus officers, developing relationships with them might be close to impossible. I can think of exactly one campus AO that I’ve had twice, and I’m not positive she remembered me. Of course, some consideration hinges on just how valuable Tax Court review of a collection action is under the fairly permissive “abuse of discretion” standard of review.

But assuming (as I do) that having access to Tax Court review is better than not, a problem remains. In the hypothetical I’ve proposed, you have reached a meeting of the minds with the IRS after a CDP hearing. Say both parties agree to an Installment Agreement and that the IRS will release a lien after three monthly payments are made. You nonetheless insist on a Notice of Determination, since you’d rather have the option of court review than not: you trust the Appeals/Settlement Officer but want to be sure the IRS follows through.

What good is the Notice of Determination in that instance? If three months later the IRS does not withdraw the lien what judicial review do you have? Your ticket has expired by the time you have cause to use it. I suppose one could argue on some sort of contract theory ground that failure of the IRS to properly follow through with the Form 12257 terms should be litigable. But I’d rather not mess around with that, and I’m not sure that in any case the Tax Court (which, lest we forget, is of eminently limited jurisdiction) would be amenable to the argument.

And so I end with a humble question to the readers of PT on this conundrum: what are the best practices you’ve found for working with Form 12257? Has it been an issue? Have you had post-CDP actions taken by the IRS that have caught you off-guard (either from Form 12257 or a Notice of Determination)?

Evidence, S-Cases, and Collection Due Process Review. Designated Orders 4/23/2018 – 4/27/2018

Professor Caleb Smith from the University of Minnesota Law School presents this week’s edition of Designated Orders; in addition to thinking about the challenges of substantiating expenses (and how the world shifts starting in 2018 for unreimbursed employee expenses), the post considers a healthy dose of Graev/Chai issues, a topic that Caleb discussed in a well-attended panel at the recent ABA Tax Section meeting. Les

It was a prolific week for designated orders from April 23 through April 27, with 10 issued. Here are the highlights:

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The Benefits of an S-Case: Morgan v. C.I.R., Dkt. # 7695-17S (here)

We begin with an order addressing a very common issue: substantiating business expenses, particularly of the dreaded IRC 274 variety.  This designated order and bench opinion from Judge Carluzzo is a good example of the power (and limitations) of an S-Case when you have a fairly sympathetic taxpayer situation.

When a taxpayer clearly has expenses but kept poor records (worse, no records) it strikes many as extremely unfair that they should be fully disallowed any deduction of those expenses. Sometimes taxpayers can rely on Cohan in those circumstances. But, as has been discussed by Professor Bryan Camp elsewherethe Cohan doctrine only goes so far: especially with “listed” expenses. A Tax Court Judge may well believe that you had (otherwise) deductible expenses, but disallow any deduction because you didn’t meet substantiation requirements. That is the law, after all, and the law is what a Judge must apply, even in S-Cases.

So what good are the relaxed rules of an S-case for substantiation (rather than strictly evidence) issues?

I think Morgan gives a good taste of why an S-case still has value in such instances. It has less to do with evidence, and more to do with S-cases being non-precedential. Here, the taxpayer arguably meets the strict substantiation requirements of IRC 274… but just barely, if not without some charity from Judge Carluzzo. I am not so sure such treatment would be afforded in a regular (potentially precedential) case.

The taxpayer in Morgan worked in asbestos remediation. His job is exactly the sort that requires frequent travel and has no regular place of employment: on any given day, Mr. Morgan would receive his marching orders (“go remove the flooring from 123 Main Street”) and head on his way. Over the course of the year he went to about 25 different locations, some which were fairly far from his residence (up to 58 miles away). Mr. Morgan kept track of the dates and locations of travel, occasionally accompanied by the name of the customer, on loose-leaf paper. He then calculated the mileage by plugging the information into MapQuest.

Is that good enough under IRC 274? There are at least a couple reasons to think not.

First the IRS calls into question just how “contemporaneous” these records really are, apparently having elicited some questionable testimony to that point during cross-exam. Judge Carluzzo notes this as a “serious concern,” but ultimately decides that the records are still “reliable enough.”

Then, and most importantly, there is the legal question of whether the records actually show deductible mileage in the first place. Because Mr. Morgan had no regular place of employment, his travel from home to a temporary site would be deductible (rather than commuting) mileage ONLY if the temporary site was “outside of the metropolitan area” that Mr. Morgan lived in. The records as submitted show mileage and location, but apparently not whether that location was “outside of the metropolitan area where the taxpayer normally lives and works.”

Judge Carluzzo could, at this point, say the records aren’t enough: the taxpayer has the burden of proof to show that they are entitled to the deduction, showing that they traveled outside the metro area they normally live and work in is an element of the deduction, and they failed to show demonstrate that. I think in a non-S Case that may well have been the outcome. Instead, Judge Carluzzo finds that it would “be unfair to deny the entire deduction because we lack that specific information.” His creative (and I’d say fair) solution is to infer that mileage logs showing a distance greater than 40 miles are likely outside of the metro area, and therefore allowed. Not a perfect solution, but an equitable one. He leaves it to the IRS and the petitioner to recalculate the deductible expenses based on that understanding (I question how much, if any, will actually be deductible thereafter, since Mr. Morgan was an employee that will have to deduct the mileage as a miscellaneous itemized expense subject to the 2% AGI floor. Note also that beginning this year, regardless of how wonderful Mr. Morgan’s records are (or if all locations are outside the metro) he will not be allowed any deduction since the “Tax Cuts and Jobs Act” completely eliminated it.)

In any event, Morganshows the ability of S-cases to allow for equitable solutions where taxpayers are caught between fairly esoteric law and the general notion that such law, if strictly applied, would appear to result being taxed on more net income than you really had. The S-case designation won’t save you from IRC 274, but it just may give you more wiggle room thereafter.

As an aside, the rule that the temporary work location must be “outside” the metro area has never sat particularly well with me. The metro area requirement is written nowhere in statute but was put forth by the IRS in Rev. Rul. 99-7as a way for determining personal vs business mileage. The need to promulgate somesort of distinction between non-deductible personal (commuting) expense and “away from home” deductible mileage is understandable given the vagaries of the Code on that issue. I’m just not so sure using “metropolitan area” as the touchstone strikes a desired balance between administrative workability and fairness.

On the “administratively workable” side, it seems odd to use the somewhat mushy “metro area” (nowhere further defined) rather than, say, just a set number of miles from the taxpayer’s actual residence. Similarly, on the “fairness” side it seems to penalize those that live in large metro areas (for example, Los Angeles). Is it really less of “commuting” if the new job location is across a river/state line 10 miles away in a rural area versus across town but 60 miles away? What if you live at the edge of the “metro area?”

Apparently, these are the thoughts that keep me awake at night…

Filling Out the Contours of GraevWeaver v. C.I.R., Dkt. # 262-15S (here) and Collins v. C.I.R., Dkt. # 9650-14 (here)

For those needing their weekly fix of Chai (more accurately Graev, but that doesn’t work as a pun) Judge Ashford and Judge Halpern provide the fix.

By way of extremely brief background, after Graev III the burden of proof is on the IRS to show supervisory approval of penalties under IRC 6751. These two orders don’t break any new ground on that issue, but do provide useful primers on a hot issue that practitioners need to be aware of.

With Collins, we see the usual (and likely to be dwindling) arguments on whether the Tax Court should reopen the record for cases with one foot in the Graev (that is those that took place before Graevwas decided but remained open after Graev III). These cases are, of course, finite and largely coming to an end, so in a sense have mostly historical value. However, they may also provide some insights to petitioners in future sure-to-be frequent fights over evidentiary proof of supervisory approval under IRC 6751.

Collins provides the usual script, with Judge Ashford punctuating a few keys points. First, the usual: IRS moves to reopen the record because they didn’t originally introduce evidence of supervisory approval of a penalty on the very-reasonable ground that at the time the Court had hitherto said they didn’t need to. Second, the petitioner tries very hard to come up with a reason why the IRS shouldn’t now be allowed to reopen the record. Third, the Tax Court says, “we have discretion to open the record, and petitioner’s reasons not to just aren’t good enough.”

In future IRC 6751 litigation, the IRS shouldn’t need to reopen the record to introduce evidence of supervisory approval: Graev IIImakes clear they should do that upfront. Nonetheless, where the IRS seeks to submit into evidence a Civil Penalty Approval Form that purports to show proper supervisory approval under IRC 6751, the petitioner will need to think critically about what arguments they may still be able to make to show a failure of IRC 6751 compliance. Collinsprovides a little insight on what those arguments may be and their likelihood of success.

First, it is clear that objecting to the introduction of a Civil Penalty Approval Form on hearsay grounds won’t work. The exception offered by the IRS and readily accepted by Judge Ashford is FRE 803(6) often referred to as the “business records rule.” That is enough for the IRS to carry the day on hearsay objections, though frankly I think it is more than the IRS actually needs.

Judge Ashford takes as a given that the Civil Penalty Approval Form is “inadmissible hearsay” absent an exception applying. I’m not so sure that is correct: how is it that the IRS could have a legal requirement under IRC § 6751 to show “written approval” and yet the written approval itself be inadmissible hearsay absent exception? I think most law students taking evidence would similarly find that result puzzling, though begrudgingly accept it because hearsay doctrine is mostly incomprehensible. However, for the student sticking with that initial reaction (“it seems wrong that this would generally be hearsay”), I think they may be on to something.

Without going into too great depth, I will say that I think the Civil Penalty Approval Form may not be hearsay at all because it has “independent legal significance.” The IRS is offering the form essentially because the IRS has to, as an element of its case, much in the same way that contract and defamation cases necessarily have to introduce out-of-court statements. If those statements were treated as hearsay (thus requiring an exception for admissibility) many would likely fail because they weren’t business records, etc. To me, the crux of the issue is simply “does written approval exist?” and the IRS Civil Penalty Approval Form is submitted for that purpose. That is arguably a “non-hearsay use” of the Civil Penalty Approval Form and should therefore not be evaluated as hearsay needing an exception for admission.

And this gets to the second point: what are you really trying to argue when the IRS offers a Civil Penalty Approval Form? In Collins, the objection was really about the authenticityof the document -not whether it purports to show supervisory approval. The IRS included a statement from the supervisor that signed the document attesting to its authenticity. Because Judge Ashford approached the Civil Penalty Approval Form as hearsay admissible only under FRE 803(6), this statement (or something similar) is required as certification under FRE 902(11)and thus admissible (and sufficient, in this case to show that the form was authentic).

The authentication argument (as well as the hearsay argument) in Collinsis a loser, and I believe will almost always be a loser in future cases absent extremely bad actors in the IRS. So what can we take from Collins? To me, it is the primacy of the written document in IRC 6751 cases. As a taxpayer, saying “I don’t trust it,” probably won’t work. But, there are other rules of evidence (and tactical approaches) that may.

IRS records can be pretty bad at times. My assumption is that, moving forward, where the IRS cannot provide ANY written approval of the penalty they will concede the issue or argue no approval is needed under IRC 6751(b)(2). But the more interesting cases may be where the IRS has some written record that, taken as a whole, seems to show supervisory approval -but not a clear, single “Civil Penalty Approval Form.” In those cases I think the rules of evidence give practitioners new potential methods for attack. The question of “why isn’tthere a single approval form?” comes to mind. If that is the “regularly conducted activity” of the IRS (under FRE 803(6)), absence of those regular entries seems all the more important (and testimony from the IRS about the absence would appear to be admissible under FRE 803(7). I have seen the IRS provide any number of different forms of “written approval” (including what seem to just be case notes) for the penalty. If it is the practice to have an actual, standard approval form, one might hold the IRS’s feet to the fire when they fail to do so and instead try to provide other corroborating (written) evidence. I daresay in these circumstances, litigants may need to reacquaint themselves not only with hearsay but also the best evidence doctrines.

I’m sure such issues will play out to the delight of the Tax Court in the not so distant future.

The second designated order involving Graev again brings up problems that will soon be relics of history. Although the order doesn’t break much new ground, Judge Halpern does provide a helpful timeline of the Graev/Chai saga, as well as a reference to a far-less-frequently cited case that touches on IRC § 6751 pre-Chai: Legg v. C.I.R., 145 T.C. 344. I assume the reason Legg did not result in the firestorm Graev has is because Legg found that the requirements of IRC § 6751 were met by the IRS, and didn’t touch whether they were applicable in the first place: everything in Legg hinged on whether the approval was part of the “initial determination.”

The Weaver situation blissfully will soon be a thing of the past. Weaver had its trial after Chai, but before Graev I. The briefing was completed after the second Circuit reversed Chai, but before the Graev III about-face. The question posed by Judge Halpern, as it so often has been, is “How does Graev III affect this case?” Since the case was not yet decided when Graev III was decided, I assume the answer will be that the IRS needs to comply with IRC 6751 (with a motion to reopen the record) or the penalty falls under the automated exception of IRC 6751(b)(2).

Insisting a Little Too Much on Your Day in Court: Ryskamp v. C.I.R., Dkt. # 20628-17 (here)

When you frequently comb through the US Tax Court orders archive some names begin to seem familiar. Ryskamp is one such name, and the accompanying order illustrates why. The order itself is fairly routine: taxpayer wants to get into Tax Court on a CDP case without having the proper “ticket”:  that is, a Notice of Determination (or letter that should be a notice of determination). Rather, Mr. Ryskamp has only Notice LT16, which he attempts to pass off as a Notice of Determination. This is akin to trying to get into a Hamilton by presenting an expired bus ticket. And the Court is not having it. And for good reason.

This does not appear to be a taxpayer that is (justifiably) confused about the limits of Tax Court jurisdiction -what IRS letters serve as tickets and what IRS letters don’t. Rather, Mr. Ryskamp ALREADY had petitioned (and had his day in court) for nearly all of the years at issue after a previous CDP hearing and judicial review. But that happened in 2014… perhaps Mr. Ryskamp forgot, or believed he had a new opportunity?

Doubtful: he appealed his original CDP case to the D.C. Circuit in 2015. Then, losing on appeal, Mr. Ryskamp petitioned the Supreme Court in 2016 (cert denied, as one might expect).

So why does Mr. Ryskamp believe the Tax Court should now, at long last, once more hear his arguments about why he shouldn’t pay his 2003, 2005, 2006 and 2009 taxes? Because, Mr. Ryskamp asserts, “when a petition raises substantive due process arguments, the Tax Court must address them.” Interesting premise, although he could not have picked a less amenable (or appropriate) forum to make them in.

One feels for both the IRS, Judge Guy, and frankly honest taxpayers everywhere in cases like these: resources are wasted addressing inane and time-consuming arguments by serial tax-delinquents. It is easy enough for Judge Guy to resolve this issue (the boilerplate “Tax Court is a court of limited jurisdiction” does the trick), but simply finding in favor of the IRS/dismissing the case does not seem a full remedy. Depending on one’s constitution, readers may feel a twinge of retributive justice was later served Mr. Ryskamp,in the form of a $1000 penalty for challenging a collection action for the “2018 tax year” (somehow). A tip of the hat for my Designated Orders colleague William Schmidt for directing me to that outcome.

Odds and Ends: Remaining Designated Orders

How to Compel Discovery

Judge Jacobs issued two orders: onedenying a pro se petitioner’s motion to compel discovery from the IRS (presumably because they did not try to use informal means of discovery first), and onegranting the IRS’s motion to compel discovery from the taxpayer (after fairly extensive attempts to utilize informal means of discover). They don’t provide too much insight on the issues, but are a reminder of the Tax Court imperative to use informal methods of discovery as much as possible.

How Not to Move for Summary Judgment:Lamprecht v. C.I.R., Dkt. # 14410-15 (here)

Knowing when is appropriate to move for summary judgment can be difficult even for trained attorneys. Through denying a pro se petitioner’s motion in Lamprecht, Judge Gustafson lays out a few more helpful tips. In Lamprecht, one of the petitioner’s wanted SJ against the IRS, and explicitly “assumed” that the Tax Court (or IRS) was already aware of the relevant facts thus far developed. If your SJ motion really just says “Judge, you’ve heard us talk enough by now, you know what is relevant and what isn’t, please make your decision,” it is not likely to pass muster. Perhaps you are right, and all the relevant issues/facts have been established… but it is your responsibility to show what those are and (equally importantly) why they mean you should win. As Judge Gustafson writes, “the task of extracting from prior filings “the facts in this action that are relevant to [a summary judgment] motion” and then the task of searching the record to see whether those alleged facts can be supported by materials in the record” are the responsibility of the moving party.

Miscellany

Two designated orders from Judge Carluzzo (a bench opinion finding against a taxpayer that never showed up for trial here, and an order amending a caption here) are not discussed. There is an additional order addressing waiver of CDP rights; that will serve as a standalone post at a later time.

Designated Orders: 3/26/2018 – 3/30/2018

Guest blogger Caleb Smith of the University of Minnesota bring us the designated orders from the last week of March. These orders do not offer unique insights but Caleb does a nice job of categorizing them and providing useful insights. With a minor exception, this week is surprisingly light on cases with the Graev issue. Keith

There were six designated orders during the final week of March, none of which were particularly consequential. There is, however, a common thread that runs through them all: the extra work that the Tax Court puts in with pro se parties. The orders (all of which involve pro se taxpayers) can be categorized as follows:

  • Where the Petitioner “Files and Forgets”

Anderson v. C.I.R., Dkt. No. 30766-15L

Hoffer v. C.I.R., Dkt. No. 17545-15L

In two of the designated orders, the petitioner appears to have filed in court and then washed their hands of having to deal with what comes thereafter. As Judge Gustafson notes in Anderson v. C.I.R., it is the petitioner’s duty to prosecute the case after filing the petition, and failure to do so can result in dismissal. But the Court does not dismiss such cases without giving quite a few opportunities to the petitioner, and generally requires the IRS to give a fairly detailed account of their attempts to reach the individual.

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Judge Gustafson stops short of dismissing the case because of their own concern that the taxpayer may have changed addresses (without notifying the Court, as they are required to do under Rule 24(b)). Judge Gustafson even goes the extra mile in providing numerous addresses the taxpayer may be found, and ordering the Tax Court Clerk to send standing pretrial orders to each of them. Kudos to Judge Gustafson.

Similarly, Judge Leyden gives more than a fair shake to the petitioners in Hoffer v. C.I.R. Though the petitioners appear to occasionally send (some) information to the IRS during the CDP process, they never quite give what is asked, and they never really participate in the CDP hearings. When it is docketed in court, the IRS files a motion for summary judgment which Judge Leyden sets for hearing in Indiana. The petitioner does not show up (usually, a bad sign for your prospects, but in this case perhaps excusably because of medical problems). Judge Leyden still does not grant summary judgment because there was, nonetheless, a dispute on material facts (apparently, the IRS acknowledged that it had made some computational errors, but insisted that they were non-material). The case is remanded to Appeals to work out the issues at a supplemental CDP hearing. The IRS tries multiple times to set a supplemental hearing and to receive supplemental information… but the petitioners seem to place it on the back-burner.

It is something of an open question as to whether Judge Leyden goes the extra mile, or simply as far as the law requires, in her final decision. Clearly, Judge Leyden gives the petitioners more than enough of their opportunity to be heard in court. But Judge Leyden also affirmatively required that the IRS show proof that it complied with IRC § 6751(b) for the accuracy penalty without it appearing as if the petitioners raised the issue (the CDP hearing was solely on collection grounds). As noted before here, it is unclear if every judge would go this far with 6751. Nonetheless, for Judge Leyden when the IRS failed to show this the taxpayer was due a limited win: relief from the IRC 6662 penalty that had been applied against them.

  • Where the Petitioner Files… But Really Shouldn’t Have

Graham v. C.I.R., Dkt. No. 9815-17SL

Wendt et al v. C.I.R., Dkt No. 11366-17S

Then there are the cases where the petitioners are engaged, but really should have left things alone. Sometimes, the IRS can make quick work of the case through summary judgment. In Graham v. C.I.R., the taxpayer seems unwilling to do much of anything (file back year tax returns, submit financial statements) except combat the IRS, in this case by filing a “Motion to Deny Summary Judgment.” Judge Armen has little trouble finding for the IRS in this case, but just to be sure that the petitioner gets the picture (that this is over and done with) adds a provision at the end of the order advising the petitioner not to show up in court on April 30 (the original calendar call). Kudos to Judge Armen in making that clear to the taxpayer.

Wendt et al v. C.I.R. is another instance where the petitioner really should have left things alone, but decided to keep fighting. This order also comes to us on a summary judgment motion, but this time through a bench opinion rendered after a hearing on that motion.

The facts (and law) are simple enough. Taxpayers claimed two education benefits (American Opportunity Credit as well as tuition and fees deduction) for the same student and the same expenses. For those keeping track, this is a “no-no” sometimes given the vaguely disgusting label of “double-dipping.” Also for those keeping track, arguing that you didn’t elect to take a credit when your tax return shows that you did is unlikely to carry the day. Convoluted legal arguments that you didn’t elect the credit “under the Internal Revenue Code” (even if you admit you took the credit on the tax return) are also unlikely to meet welcoming arms of the Court.

Judge Carluzzo notes that the petitioner’s testimony (and legal argument) could result in a worse outcome for the taxpayer: a higher deficiency, because the American Opportunity Credit is more valuable than the tuition and fees deduction. In essence, a hardnosed IRS attorney (or possibly the Court) could have held the petitioners’ feet to the fire on their own testimony. Kudos to Judge Carluzzo (and the IRS) for not pushing for that result, tempting though it may have been.

  • Where the Petitioner Files… And it is Unclear if They Should Have

Bell v. C.I.R., Dkt. No. 1973-10L

Saustegui v. C.I.R., Dkt. No. 20674-17

Finally, the last two designated orders involve taxpayers that clearly could use assistance from counsel in getting to the correct outcome, whatever that may be. In Bell v. C.I.R. Judge Gustafson explicitly puts out the bat-signal for LITCs in North Carolina to assist with one petitioner in a case that has apparently been dragging for eight years. In Saustegui v. C.I.R. Judge Guy does not advise the pro se party to request LITC assistance, but from the looks of it such counsel may be helpful (though one is never sure the party will be receptive). Instead, in denying the petitioner’s motion for summary judgment where evidentiary issues clearly persist, Judge Armen strongly encourages the petitioner to meet with IRS counsel and try to work things out. Perhaps an enterprising LITC or pro bono practitioner in the Miami area may nonetheless be willing to lend a hand.

 

Designated Orders Post: Week of 2/26 – 3/2 Estate of Michael Jackson, A New Graev Issue and More

Caleb Smith who teaches and directs the clinic at University of Minnesota bring us this weeks designated order post. He starts with the now obligatory designated order concerning yet another aspect of Graev and ends with orders from two frequently recurring judges in the designated order post, Judges Holmes and Gustafson. Judge Holmes puts up another other in the ever popular Estate of Michael Jackson case. It is a “Thriller.” Keith

There were quite a few designated orders last week, but most warrant only a passing mention. Those that will not be discussed include involve motions for summary judgment, granted in full here and here and in part here and here. Of course, we start our substantive discussion with an order continuing the clean-up of Graev III.

Giving the IRS a Chance: Hendrickson v. C.I.R., Dkt. No. 6863-14 (order here)

It seems fairly clear at this point when the IRS does and does not need supervisory approval for a penalty. I believe there may be a future, litigable question as to when the IRS can bypass the supervisory approval issue by relying on computers instead of humans for the determination, but when fraud is alleged (as it was in this case) it is pretty clear that approval will be needed.

Here, trial took place a week after Chai reversed Graev (but ONLY for the 2nd circuit, which this case would not be appealable to). Later, after the Tax Court reversed itself (Graev III) the court ordered the parties to address what effect that reversal had on their present case. The IRS, quite sensibly, took it to mean “Graev III means we need to introduce evidence of supervisory approval in a deficiency proceeding. So… we need to make a motion reopen the record and introduce that evidence.” The IRS then, quite sensibly, made that motion.

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Which brings us the present order…

To some (including a few of my students), insisting on compliance with IRC 6751(b) sometimes looks like a technicality that “bad-actor” taxpayers are trying to take advantage of. In some instances, that may well be so.

Here, with a civil fraud penalty at play, one gets a sense of the “technicality” argument in full force. Judge Buch has little trouble finding that it is within his discretion to open the record in this case (Judge Holmes dealt with a slightly less clear case weeks ago, here). The IRS was playing by the rules that bound the Tax Court at the time of the Hendrickson trial: that is to say, the rules of Graev I and II. Those rules did not require producing evidence of supervisory approval prior to assessment in any case other than those appealable to the 2nd Circuit. When it appears, as is suggested here, that the IRS actually had supervisory approval but failed to introduce it into evidence (in accordance with the Tax Court interpretation of the law, at the time), there isn’t much beyond a technical argument to be made as to why they shouldn’t be allowed to introduce that into evidence now. Kudos to the taxpayers (pro se) in their zealous self-representation… but I surmise they are just accumulating interest on their tax bill at this point.

Volume 36: Estate of Michael Jackson v. C.I.R., Dkt. No. 17152-13 (order here)

We return to another Designated Order favorite: the never-ending saga of Michael Jackson’s estate. Here, after years of motion practice, a trial that produced 36 volumes of transcript, and no less than three separate stipulations of fact, we arrive at the initial stages of post-trial briefing. When you have this voluminous of a record, with evidence so frequently objected to, it is obviously difficult to know what you can (and can’t) rely on as in the record for the brief you are working on. Judge Holmes kindly takes on the task of sorting out one evidentiary issue confronting the parties: resolving the hearsay objections reserved throughout the stipulations.

For practitioners that want an in-depth analysis of numerous hearsay exceptions, I strongly recommend a close reading of Judge Holmes’ order. For tax practitioners generally, I think another aspect is worth highlighting.

And that aspect is the nature of stipulations. This order highlights the proper method of objecting to stipulations on most evidentiary grounds: you note (thereby reserving) your objection, you don’t fail to stipulate. We have seen instances where the two parties fail to get along, and then fail to stipulate, with the Court generally taking a dim view of that approach. Tax Court Rule 91(a) specifically states that an objection may be noted (to relevance or materiality), but that such objection is not, in itself, is not a reason to fail to stipulate.

Stipulations of fact are extremely important in Tax Court cases, and should not be taken lightly in preparing for trial. You should obviously be sure that you’ve stipulated absolutely everything that you need to (if you are submitting fully stipulated), but you also should consider objections and, even then, what your objections have the effect of doing. In this order, with very sophisticated parties (including the newly nominated Commissioner’s firm) it is informative how the taxpayer phrased some of the objections: not that the exhibits were admissible, but only that they could not be cited to as evidence of “truth of the matter asserted.” That is a nuance that often goes missed (but was stressed by the federal district judge that taught my evidence class): the reason you introduce the evidence is critical to whether (and to what extent) it is admissible.

Going Through the Motions: Langdon & Fuller v. C.I.R. (Dkt. No. 22414-15) and York v. C.I.R. (Dkt. No. 2122-17)

Another set of nearly identical orders provide a quick lesson for tax practitioner. As a change to the usual guidance the Tax Court provides to pro se taxpayers, the orders actually give a lesson to IRS counsel. And that lesson is that when you want the court to “do something,” you generally ask through a motion.

Here, a joint status report was given to the court that likely reflected both parties’ near imminent settlement. All that is left is to draft and file a decision document, so the IRS asks for more time to do so in the joint status report. Pretty uncontroversial… but denied, because the request for additional time was not made in a motion.

I tell my students that there aren’t usually “magic words” you need to know when asking the Tax Court to do something: students pull templates off of the internet with archaic “Here comes taxpayer John Smith by his representative Caleb Smith” and worry that if they omit that line the court won’t have any clue what to do with their document. At the same time, though there aren’t magic words, I tell my students to look to the US Tax Court rules to see what, if anything, the Court would want covered in the motion. As an unfortunate example we’ve had to deal with, there are specific things the Court wants in a motion to withdraw (see Rule 24(c)). A quick search of orders citing to that rule shows order after order denying the motion for failure to address something mentioned in the rule. Where there is a specific rule on point, use it as your lodestar.

These orders, denying a request for more time because it was not made in the form of a motion, may seem formulaic (and thus give rise to a “magic word” worry), but Judge Gustafson does a good job of explaining why it isn’t just insistence on form. For one, it makes the job of the judge easier to ask via motion. By using a motion, you also indicate to the court whether the opposing side has an objection (or is aware of the request at all). But perhaps most importantly, by asking the court to do something via motion you ensure that your request is actually seen and heard… With roughly 22,000 cases pending at the end of October, 2017, one can only imagine the amount of paper that accumulates on any given judge’s desk. As Judge Gustafson seems to hint, judges are people too, and if you want to make sure a request isn’t overlooked, you have to give it the bold heading of a request: in other words, a motion.

 

 

ABA Tax Section Submits Comments on Rev. Proc. 99-21

We welcome guest blogger Caleb Smith who runs the tax clinic at University of Minnesota and who regularly blogs with us on designated orders. Recently, Caleb headed up a comment project for the ABA Tax Section on Rev. Proc. 99-21. In the almost 20 years after the passage of section 6511(h), the IRS has not issued regulations concerning that subparagraph and to my knowledge had not previously called for comments. The opportunity to comment on this provision is a very positive development and the group headed by the Caleb did an excellent job in their comments on this provision and how the IRS could change some of the rules it applies in administering the provision to follow more closely the purpose of the statute and to make it easier for taxpayers to comply without making it more difficult for the IRS to administer. The IRS is rightfully concerned that it does not want to open a floodgate of requests for relief that it would have to manage and concerned that it would not receive appropriate information to allow it to make the proper decision concerning relief to allow someone to claim a refund after, and sometimes long after, the statute of limitations had expired.  

Because I was aware that the ABA Tax Section was making these comments and because I wanted to highlight the specific issue of who can appropriately provide information to the IRS regarding someone’s disability, I also sent in comments on this issue on the narrow issue of who the IRS should listen to in making this decision. I am hopeful that a fresh look at this issue after 20 years of administration and litigation will allow the IRS the opportunity to improve upon the original procedures making it easier for it and taxpayers to appropriately determine and obtain relief. Keith

With all the focus on Graev, it can sometimes be easy to lose sight of the other, important issues that Procedurally Taxing has consistently blogged about. One such issue that, absent PT’s coverage, may not have been at the forefront of practitioner’s consciousness are the problems with Rev. Proc. 99-21 in determining “financial disability.” Much like supervisory approval in Graev, financial disability is a product of the 1998 IRS Restructuring and Reform Act that may not have been given quite its due in the decades after its enactment. Since the ABA Tax Section recently submitted comments to the IRS about concerns it has with the Rev. Proc. now seems a good time to get reacquainted with the issue.

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The Crux of Rev. Proc. 99-21: Showing “Financial Disability”

The phrase “Financial Disability” probably doesn’t mean a lot to most tax practitioners (or doctors, or anyone else, for that matter). But for tax purposes, the concept is somewhat simple: under IRC 6511(h), financial disability of a taxpayer tolls the statute of limitations for claiming a refund. Thus, financial disability allows for refunds that would otherwise be time-barred. There aren’t a lot of exceptions to the mechanical (and mind-boggling) statutory provisions governing refund claims, so this provision may come as both a surprise and relief to many. The problem is largely in proving that one is financially disabled. And this, in turn, is problematic at least in part because of the IRS procedures for showing financial disability in Rev. Proc. 99-21.

Along with Christina Thompson of Michigan State and Eliezer Mishory of the IRS, I presented on this topic at the most recent Low-Income Taxpayer Clinic conference in Washington, D.C. On giving the presentation, I encountered two general reactions: (1) many practitioners expressed that they previously had no idea what “financial disability” was (some expected our presentation to be about collection issues, probably “financial hardship”) and (2) practitioners that did know what financial disability was shared very similar frustrations with how to prove it. Those frustrations almost all dealt with Rev. Proc. 99-21.

Procedurally Taxing has covered this issue numerous times. Early posts note the near-futility of taxpayers challenging the IRS in court on financial disability grounds. The trend, however, has shifted in taxpayer’s favor (posts here and here). Courts progressed from questioning Rev. Proc. 99-21 in Kurko v. Commissioner to outright holding for the taxpayer when the IRS failed to provide rationale for rules within Rev. Proc. 99-21 in Stauffer v. IRS.

IRS Request for Comments and the ABA Tax Section Submission

My hope is that, in the aftermath of Kurko and Stauffer, the IRS will be more receptive to changes to Rev. Proc. 99-21 because there is little reason to stick with a sinking ship. The general criticisms in the ABA comments could be summarized as:

(1) Rev. Proc. 99-21 is not faithful to the intent of the enabling statute, stemming largely from the Congressional override of the Supreme Court in Brockamp;

(2) Changes are needed to ensure that vulnerable taxpayers are protected and any such change should, at the minimum, make it likely that the taxpayer in Brockamp would be found “financially disabled”; and

(3) Rev. Proc. 99-21’s disallowance of psychologists as a professional that can attest to a mental impairment is poorly reasoned, poorly drafted, and vulnerable to challenge in Court.

The suggestions provided to remedy these issues were sensitive to IRS worries that changes to Rev. Proc. 99-21 may open floodgates for late refund claims that cannot be quickly resolved, or that may allow the simply negligent to cash-in. The four recommendations are meant to balance legitimate IRS concerns while also protecting taxpayer rights and getting to the correct outcome. Some of the recommendations work towards administrative ease (publishing a list of prima facie section 6511(h) applicable medical conditions), while others focus on the realities that “financially disabled” (often low-income) taxpayers face (like poor medical records and greater involvement with psychologists and social workers than medical doctors).

I encourage readers to take a look at the submitted comments and to keep financial disability on their radar in the future. It can mean quite a lot to the more vulnerable individuals in society.

 

 

Designated Orders, January 29 – February 2: Holmes Continues Plumbing the Depths of Graev

Regular contributor Professor Caleb Smith continues on our theme of discussing the long reach of Graev and related issues.  Les

There were five designated orders last week, but only one worth going into much detail on. Of course, it involved Judge Holmes once more considering some implications of Graev. The other orders involved a taxpayer erroneously claiming the EITC with income earned as an inmate (here); and three orders by Judge Gustafson working with pro se taxpayers: two of which are in the nature of assisting the taxpayer (how file a motion to be recognized as next friend here, and clarifying how to enter evidence here) and one granting summary judgment to the IRS (here). Note parenthetically that in the latter order Judge Gustafson goes out of his way to mention that the IRS approved a 6662(a) penalty in compliance with IRC 6751 [erroneously cited as 7651]. IRC 6751, of course, is the issue du jour, and the focus of today’s post.

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Rajagopalan & Kumar, et al. v. C.I.R., Dkt. # 21394-11, 21575-11 [here]

Supervisory Approval: Is it Needed for Every “Reason” Behind the Penalty?

For those that need to catch up, the Procedurally Taxing team has provided a wealth of analysis and insight on the Graev/Chai case developments. For “Graev III” fallout readers are encouraged to visit this, this and this post (to name a few). Judge Holmes in particular has been at the forefront of raising (if not quite resolving) unanswered questions that lurk in the aftermath of Graev III. In Judge Holmes’s most recent order, we see two questions bubble to the surface. One of those issues should only provide a temporary headache to the IRS: the procedural hurdle for the IRS to introduce into evidence that they complied with IRC 6751 if the record has been closed. The other issue, however, could well create a lasting migraine for the IRS: whether the IRS form showing supervisor approval also sufficiently shows approval for the rationale of the penalty. That problem isn’t directly answered in the order, but I think it is the most interesting (and most likely to remain a lasting problem) so we will begin our analysis with it.

Imagine the IRS asserts that a taxpayer understated their tax due by $5500 (with that amount being more than 10% of the total tax due). The IRS issues a Notice of Deficiency that throws the book at the taxpayer with an IRC 6662(a) penalty because of this substantial understatement of income tax and because the taxpayer was negligent. In so doing, the IRS is relying on two separate subsections of IRC 6662 as their legal basis for the penalty’s application: subsections (b)(1) and (b)(2).

Imagine further that the IRS did the right thing and had a supervisor sign-off on the penalty prior to issuing the Notice of Deficiency. Does the supervisor need to approve of both rationales (i.e. (b)(1) and (b)(2))? Or is the fact that the penalty, to some degree, got supervisory approval enough on its own? What if the Tax Court finds that this same taxpayer only understated $4500 in tax on their return? Now only negligence could get the IRS to a 6662(a) penalty: do we need to have proof that the supervisor approved of that ground for raising the penalty?

These are questions that Judge Holmes has raised before, in his concurrence of Graev III. Judge Holmes lays out a parade of horribles beginning on page 45 of the opinion, one of which deals with approval of one, but not two, grounds for an IRC 6662(a) penalty (on page 46, point 4). This made me wonder exactly what the supervisory approval form looks like, and if it sets these points apart. With the sincerely appreciated assistance of frequent PT blogger Carl Smith and lead Graev III attorney (also PT contributor) Frank Agostino, I was able to gaze upon this fabled supervisory approval form, which can be found here. And, sure enough, the form does break down 6662 penalties (to a degree). It breaks down IRC 6662 into four categories: (1) Negligence, (2) Substantial Understatement, (3) all other 6662(b) infractions, and (4) 6662(h). The neatly delineated checkboxes certainly make it seem like a supervisor is only “approving” whichever specific penalty rationale they check yes next to.

Looking to the statute at issue provides little guidance on what “amount” of supervisory approval is needed, only that the “initial determination” is personally approved before making the determination. Taking the above accuracy penalty as an example, one could argue that the penalty needing approval is only IRC 6662(a), so that is all that need be approved broadly. The supervisor has agreed that the penalty should apply and the worry of it being used as a bargaining chip is lessoned. The statute isn’t intended to provide a through legal review of all penalty theories, but only to be sure that they aren’t being applied recklessly as “bargaining chips.”

However, one could just as reasonably argue that the nature of the penalty’s application requires some degree of specificity: the penalty is only applied to the amount of the underpayment attributable to that rationale. If our hypothetical taxpayer understated by $5500, but only $1,000 of it is due to negligence, then you would have two potential penalty values: $1,110 (20% of substantial understatement) or $200 (20% for the portion attributable to negligence). Yes, the penalties arise under the same code section (broadly: 6662(a)), but their calculation depend on the rationale (narrowly: 6662(b)(1) or (2)). Since that leads to two different potential penalty amounts, it would seem (in a sense) to be two different penalties. Certainly, one would think two separate approvals were needed if the penalties were IRC 6662(a) or IRC 6662(h), as they apply two different penalty percentages. Why should it be different if they potentially apply against two different amounts of understatement?

Questions I’m sure Judge Holmes looks forward to in future briefs. Though the intent of IRC 6751 is laudable, the language certainly leaves much to be desired.

In the interest of taxpayer rights, however, I think it is important to note that the IRS has created at least some of these problems on their own. From my perhaps biased perspective, accuracy penalties under IRC 6662(a) are most troublesome when applied “automatically” or with little thought against low-income taxpayers that may simply have had difficulty navigating complicated qualifying child rules. In my practice I deal less with the “bargaining chip” and more with the “punitive” aspect of penalties. We have already seen how reflexively the IRS will slap EITC bans without proper approval or documentation here. There may be reason to believe the IRS is just as reflexive with these IRC 6662(a) penalties. Consideration of the relevant IRM is illustrative:

IRM section 20.1.5.1.4 details “Managerial Approval of Penalties.” It lays out the general requirement of IRC 6751 that supervisory approval is required for assessment of a penalty, and then details two important exceptions (one of which I’ll focus on): there is no need for supervisory approval on penalties that are “automatically calculated through electronic means.”

This, by the IRS interpretation, includes IRC 6662(a) penalties for both negligence and substantial understatement if so determined by AUR… so long as no human employee is actually involved in that AUR determination. In other words, we are to trust that no safeguard is needed when the (badly outdated) computers of the IRS determine that there was negligence on the part of the taxpayer. I would note that it appears that this also applies for campus correspondence exams though that is not immediately clear. IRM 20.1.5.1.4(2)(b) implies as much by referring to IRM 20.1.5.1.4(4) (the exception to human approval provision), but that latter provision only mentions the AUR function.

But wait, there’s more. Per that same IRM, if the taxpayer responds to the letter (or notice of deficiency) proposing the penalty then the IRS needs supervisory approval because now it is out of the realm of machines and into the realm of humans. This would seem to imply that taxpayers only have the protection of IRC 6751 if they are noisy. If they aren’t noisy, the IRS hasn’t violated a right of the taxpayer they failed to assert: the right never existed by virtue of failing to assert it. (Apologies for getting metaphysical on that one.)

Bringing it back to the realm of legal/statutory analysis, this still doesn’t seem quite right. Wasn’t the “initial” determination of the penalty already done prior to the taxpayer responding? Or is that irrelevant because at the computer stage it was not an “initial determination of such assessment” (whatever that means)? Judge Holmes, again, has signaled what he believes to be a coming storm on the “initial determination” question. I have no doubt that, given the sloppiness of the statute and the rather poor procedures in place for the IRS, that question is likely to be litigated.

Other Temporary Problems Addressed in Rajagopalan

Though I have devoted the bulk of this post to the issue of “types” of supervisory approval, most of the designated order actually dealt with a different issue. Luckily it is an issue that should be less of a problem moving forward: the IRS scrambling to get evidence of supervisory approval into the court record when the record’s already closed.

As the docket numbers indicate, these consolidated trials have been going on for quite some time: a child born when the Rajagopalan petition was filed would probably be learning their multiplication tables right now. The supervisory approval requirement of IRC 6751 was in effect well before the Rajagopalan trial and record was closed… so how could the IRS possibly have an excuse to reopen the record at this later date?

Obviously, because of the brave new post-Graev III world we now live in. Judge Holmes notes that the IRS had some reason to anticipate the IRC 6751 issue, but doesn’t seem to fault the IRS too much for that failure. Instead, Judge Holmes lays out the requirements to reopen the record: the late evidence must be (1) not merely cumulative or impeaching, (2) material to the issues involved, and (3) likely to change the outcome of the case. In other words, it must be very important towards proving what is at stake (not simply disproving other evidence). But even if it is all of these things, if the diligence of the party trying to reopen the record has to be weighed against the prejudice reopening the record will do to the other party. This final weighing test demonstrates the high importance we place on parties being able to question and examine evidence in a usual proceeding.

So, the IRS has the “golden ticket” (i.e. a document that shows actual supervisory approval) but the record is closed. Is that golden ticket enough to reopen or is the petitioner so prejudiced by this inability to confront the evidence that it should remain closed?

Clearly the supervisory approval form is very important to the case, meeting tests (1), (2) and (3) above. Further, the supervisory approval form is admissible as a hearsay exception through the business records rule (FRE 803(6)). However, the IRS supervisor declaration authenticating the supervisory approval form does, potentially, run afoul of the rules of evidence since it is offered after trial without reasonable written notice to the adverse party. See FRE 902(11).

In the end, the petitioners concern with being unable to challenge the supervisory approval forms is given little weight. Cross-exam would likely have done nothing. The issue is supervisory approval, which is shown by a particular form that the IRS is now offering: either the forms “answer those questions or they don’t.”

This seems like a practical way to frame an increasingly thorny issue.

 

 

 

Designated Orders: Week of 1/1/2018 – 1/5/2018 aka New Year, New Graev III(?)

This week’s designated orders come courtesy of Caleb Smith at University of Minnesota. It is not surprising that Graev III and other issues related to penalties continue to dominate the order pages at the Tax Court. As one might expect in reading Graev III and previous designated orders, Judge Holmes has problems with the way things are working. In two cases Caleb discusses, we find out about the problems and how to attack them. Keith

Estate of Michael Jackson v. C.I.R., dkt. # 17152-13 [here];

Oakbrook Land Holdings, LLC v. C.I.R., dkt. # 5444-13 [here]

2018 begins with Judge Holmes continuing the inquiry into the aftermath of Graev III, and raising some new issues. As Carl posted earlier [here], even if we now know that the IRC 6751(b)(1) argument can be raised in a deficiency case, there certainly remain questions to be answered about the contours of its applicability and interplay with IRC 7491(c) (the IRS burden of production on penalties).

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The main issue in Judge Holmes’s two orders is the interplay of these statutes with taxpayers that are not “individuals” as defined in the code. That is, how does the burden of production issue in 7491(c), which by its language applies to penalties against individuals come to effect partnerships and estates?

Consider the varying breadth of the primary statutes at play:

  • IRC 6751(b)(1): “No penalty under this title shall be assessed […]”

Thus, subject to the exceptions listed in IRC 6751(b)(2), the supervisory approval requirement appears quite broad. By its language, it appears to apply to all penalties found in the Internal Revenue Code.

OK, so we know that supervisory approval is broad. But when exactly does the IRS have the burden of production to show that it has complied? That seems a slightly narrower… As relevant here:

  • IRC 7491(c): the IRS “shall have the burden of production in any court proceeding with respect to any individual for any penalty […]”

So if the penalty is against an individual, the IRS bears the burden of production. That, of course, prompts the question: what is an “individual” for tax purposes? For guidance there, we look to the definitions section of the code. As relevant here:

  • IRC 7701(a)(1): “The term “person” shall be construed to mean and include an individual, a trust, estate, partnership, association, company or corporation.”

This definition clearly contemplates that not every entity is an “individual.” In fact, an individual is basically limited to a natural human. Putting these three statutes together, you seem to get (1) supervisory approval required for all penalties, but (2) burden of production for the IRS to show approval only when the penalty is against a natural human.

The question seems more complicated in the case of partnerships than estates (go figure). For one, in TEFRA cases the petitioner is the partner that files the petition: which may be an individual, but it may also be another partnership, association, etc. Another wrinkle: in the TEFRA/partnership context, the court is looking at the applicability of the penalty, not the liability. Does that change the analysis? 7491(c) explicitly deals with a court proceeding “with respect to the liability […] for any penalty[.]” Is determining applicability the same (or close enough) to being “with respect to” the liability of the penalty for IRC 7491(c) to apply in TEFRA? I would think yes, but I (blessedly) do not frequently work with partnership issues.

As far as I can tell the question of whether the IRS should have the burden of production on penalties (generally) against estates, partnerships, etc. is not much changed under Graev III. The only real difference now is that the IRS (may) have to wrap in supervisory approval as part of their burden of production. In reading Judge Holmes’s orders, I couldn’t help but get the sense that his questions have less to do with the outcome of Graev III and more to do with general problems in the law concerning penalties. In fact, it seemed to me that Graev III simply provided the Court an opportunity to review some issues that may have been lurking for some time.

In both orders, Judge Holmes lists multiple memorandum decisions that apply the burden of production against the IRS for penalties against estates and in the partnership context, respectively. However, Judge Holmes also notes that the cases either don’t really address the question (for applicability against estates), or are fairly unclear in their rationale (for applicability in the partnership context… again, go figure).

The court decision that explicitly does apply the burden of proof on the IRS in a partnership context appears particularly weak. That case is Seismic Support Services, LLC v. C.I.R., T.C. Memo. 2014-78. The issue is addressed in a footnote (11), where the Court actually notes that the language of IRC 7491(c) applies “on its face” to individuals and that numerous Tax Court decisions have refused to apply IRC 7491(c) against the IRS when the taxpayer isn’t an individual. In fact, a precedential decision explicitly says that 7491(c) doesn’t apply when the taxpayer is not an individual: see NT, Inc. v. C.I.R., 126 T.C. 191.

Case closed… right?

Well, no, because other memorandum decisions have applied IRC 7491(c) against the IRS when the taxpayer was a corporation. Why it is that Judge Kroupa in Seismic Support Services, LLC decides that she should follow the lead of the memorandum decisions is beyond me. Those decisions provide essentially no analysis as to whether IRC 7491(c) should apply against non-individuals, whereas NT, Inc. specifically states why it shouldn’t. I would not be surprised if the Court began a trend towards consistency in this matter, abandoning Judge Kroupa’s approach and opting for what appears to be the correct statutory reading: if it isn’t an “individual,” the burden of production for penalties does not apply to the IRS. Partnership issues may complicate that matter, but generally speaking (and especially for estates), it does not appear that IRC 7491(c) should apply.

Throughout all of this, one thing that surprised me was that the IRS has not raised the issue before. In fact, the case that explicitly holds that IRC 7491(c) does not apply in the case of corporate taxpayers (NT, Inc. v. C.I.R.), the IRS (by motion) stated that it did apply… and the Court had to say of its own volition “no, in fact it does not.” Little issue, I suppose, because the IRS won either way.

And that may be the ultimate lesson: if and when the burden of production will actually change the outcome. In essentially all of the cases cited by Judge Holmes (i.e. the cases I reviewed) it is likely the IRS didn’t much care about the burden of proof. They were arguing a “mechanical” applicability of a penalty (like substantial undervaluation) such that it really didn’t matter who had the burden of production, since the burden would be met (or not met) depending on how the Court valued the underlying property (in the estate cases).

But where the penalty requires something more (say, negligence) the IRC 7491(c) issue would definitely be important. Alternatively, if it becomes a requirement that the IRS affirmatively show compliance with IRC 6751 without the taxpayer raising that issue, it may also change the calculous. Like so many other penalty issues, we don’t yet have clarity on how that will turn out.

Remaining Orders:

There were three other designated orders that were issued last week. An order from Special Trial Judge Carluzzo granting summary judgment against an unresponsive pro se taxpayer can be found here, but will not be discussed. The two remaining orders don’t break new ground or merit nearly as much discussion, but provide some interesting tidbits:

A Judge Buch order in Collins v. C.I.R., (found here) may be of some use to attorneys that have some familiarity with federal court, but no familiarity with Tax Court. In Collins, the pro se taxpayer (apparently an attorney, but without admission to the Tax Court) attempts to compel discovery, and cites to the Federal Rules of Civil Procedure (FRCP) Rule 37 to do so. Among many other errors (ranging from spelling, to failing to redact private information), this maneuver fails. For one, it fails because Mr. Collins appears to seek information “looking behind” the Notice of Deficiency (i.e. to how or why the IRS conducted the examination) which older Tax Court decisions frown upon. (I would say that the outcome of Qinetiq (discussed here) generally reaffirms this approach.)

But the more imminent reason why Mr. Collins approach fails is that he doesn’t comply with the Tax Court Rules before looking to the FRCP as a stand-in. And those rules (at R. 70) plainly require attempting informal discovery before using more formal discovery procedures. All of which is to say, attorneys that are accustomed to litigating in other fora should understand that Tax Court is a different animal than they may be expecting.

Finally, An order from Judge Gustafson (found here) shows still more potential problems for the IRS on penalty issues, this time IRC 6707A concerning failure to disclose reportable transactions. The Court surmises (and orders clarification through a phone call) that the IRS may have lumped multiple years of penalties (some for time-barred periods) into one aggregate penalty for a non-time barred year. This is almost certainly a no-no, and if it turns out the IRS calculated the later (open) penalty in that way one would expect the phone call to involve some large dollar concessions from the IRS.