Getting to Yes, Sooner

We welcome back guest blogger Scott A. Schumacher who writes on new initiatives to resolve pro se Tax Court cases at an earlier stage. Scott directs the low income taxpayer clinic at the University of Washington and its graduate tax program. He is a former Tax Court clerk and Department of Justice attorney with a deep knowledge of the system. Keith 

Among the things that make litigating in the United States Tax Court unique are the stipulation process and the Court’s informal discovery rules. Rule 91 requires the parties to stipulate “all matters not privileged which are relevant to the pending case, regardless of whether such matters involve fact or opinion or the application of law to fact.” Rule 70 provides that “the Court expects the parties to attempt to attain the objectives of discovery through informal consultation or communication before utilizing the discovery procedures” allowed under the Court’s rules. Both of these rules are designed to encourage the parties to resolve as much of their case as possible prior to trial, and to make the trials as short and expeditious as possible, without unnecessary participation by the Tax Court.

The rules governing the pre-trial process are also designed to facilitate settlement of cases. Tax Court Judges based in Washington, D.C., attending trial session for a week or two in a given city, simply cannot try all of the cases set for the particular trial session. These rules do indeed work, and the vast majority of cases settle prior to trial. Of course, this is not unique to the Tax Court. Indeed, at least 95 percent of civil cases in the federal courts settle, which is similar to Tax Court statistics. What is different is the percentage of pro se litigants in the Tax Court, which can impact the timing of settlements. Approximately 70 percent of the cases in Tax Court are filed pro se, nearly three times the percentage of civil cases filed by pro se litigants in other federal courts.

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For various reasons, stemming from a lack of understanding of tax law or tax procedure, fear, sloth, lack of resources, illness or all of the above, pro se litigants often do not settle cases that could – and should – be settled easily and early in the process. They have no ability to evaluate the strength of their case and whether or on what terms they should settle. They also do not know which facts and documents should be stipulated to and, indeed, which facts are relevant to their case. The cooperative winnowing process of Rules 70 and 91 often does not work as anticipated with unrepresented litigants. As a result, the courtroom at a Tax Court calendar call is pullulating with perplexed pro se petitioners who have no idea why they are there and what their case is about. Many of them meet with an IRS attorney for the first time at the calendar call. The reality of their impending appearance before a federal judge spurs them into action. Accordingly, many cases settle on the day of the calendar call.

Low-Income Taxpayer Clinics and pro bono attorneys have long been integral to this calendar call settlement process. The ABA Tax Section and the Tax Court have worked with clinics and volunteer attorneys to marshal resources at calendar to assist taxpayers at that point. These attorneys provide expert knowledge of the tax law, tax procedure, and the Court’s rules, and advise on the likelihood of success on a case. Equally important, this advice is coming from a neutral party that petitioners believe they can trust. Nonetheless, this process is far from perfect. At calendar call the attorneys working with the petitioner often have only a few minutes to evaluate, negotiate, and resolve cases, and the petitioner’s case may require further development that cannot be accomplished during the trial calendar. In addition, waiting until the calendar call to resolve these cases requires the IRS to prepare and submit pretrial memoranda, copy exhibits, call witnesses and do all of the things necessary to succeed at trial. It also requires the Court to do preparation work for each case still at issue at the time of calendar call. The current process can interject needless uncertainty and extra work into the week’s trial calendar.

In an effort deal with these shortcomings, IRS counsel, LITCs, and other pro bono attorneys have employed various methods to deal with this crush of time. In some cities, the lawyers arrive at the courthouse an hour before the calendar call and meet with potential petitioners before their case is called. While this adds some time to the process, it does not address all of the issues. In Baltimore, IRS counsel and the LITCs developed a program where the LITCs host settlement conferences attended by pro se petitioners and IRS counsel, with the LITCs and pro bono attorneys acting as intermediaries. These sessions are held approximately six weeks prior to the calendar call and are designed to replicate the process that occurs at the calendar call, but without the pressure of time. In addition, if the case cannot be resolved during that session, the parties have additional time to exchange documents and continue negotiations. The cast of characters has been expanded to include employees from IRS Appeals, Exam, Collections and the Taxpayer Advocate Service, providing a more thorough and holistic resolution of the taxpayer’s case.

These “pro bono days” or “tax clinic days” have been quite successful in resolving cases, and they have been replicated in several cities around the country. My clinic at the University of Washington in Seattle has participated in several of these, and we find the process much better than the one that occurs at calendar calls.

The biggest issue with these pro bono days is getting petitioners to actually participate in the process. While all pro se petitioners are invited, few respond. IRS Counsel and the LITC and pro bono programs in the Los Angeles area recently adopted a process where the settlement conferences or pro bono days are conducted as part of the Branerton conference. As readers of this blog know, Tax Court rules require the parties to meet and informally exchange information and documents prior to engaging in formal discovery, the so-called Branerton conference. Since pro se petitioners are required, at least in theory, to meet with IRS counsel at the Branerton conference, the idea is that more of these petitioners will participate in a settlement conference. So far, the participation rate has been appreciably higher, and the feedback has been very positive.

More can be done. In this regard, IRS Chief Counsel William Wilkins has suggested that the Tax Court require pro se litigants to participate in “Status Calendars.” These would require pro se petitioners to appear by telephone before a Tax Court Judge so that the Court can ascertain the status of the case. LITCs and IRS counsel would also participate in these calls. During the call, the judge would inquire about the status and make it clear that the parties must meet prior to the calendar call to discuss the case. Under Wilkins’ proposal, a case would not be calendared for trial until a pro se petitioner had participated in a Status Calendar call or a motion to calendar for trial had been filed.

Regardless of the method chosen, active participation by the Tax Court in the early settlement process can only increase participation in these programs. This, as Martha Stewart would say, is a good thing. As a result of the innovations to-date, not only have more cases been settled and settled earlier in the process, I am convinced the settlements reached are more just for petitioners. Settlements at the calendar call are, by definition, hastily reached, and the petitioner may well have left issues on the table. The additional time, case development, and more extensive participation by attorneys at the pro bono days allows for a better presentation of the taxpayer’s case. Whatever the Court can do to encourage pro se petitioners to participate in a settlement conference as early as possible will benefit all parties involved.

Winning the He-Said-She-Said Case

Today we welcome guest blogger, Scott Schumacher.  Scott directs the tax clinic and the graduate tax program at the University of Washington.  His clinic won an interesting case late last year which had both procedural and substantive issues present.  Scott accepted our invitation to blog on the case but wisely waited for the appeal period to run before submitting the post.  The primary issue discussed here involves the age old question of conflicting testimony.  Reading the opinion and Scott’s description below, it is easy to see the importance of properly developing and presenting the facts.  Legal arguments do not mean much until the necessary facts lay the foundation.  Keith

I like to tell my students that tax touches everything.  From marriage to divorce, birth to death, nearly every life or financial event has tax consequences.  It is not surprising, therefore, that the outcome of many tax cases turns on differing recollections of facts between parties, including between former spouses.  Is a payment to a former spouse alimony or child support?  Did one spouse in an innocent spouse case know or have reason to know of an understatement?  The United States Tax Court routinely wrestles with these thorny questions, and lawyers representing one of the parties must determine how to prove that their client is telling the truth.  A recent case decided by the Tax Court, Roberts v. Commissioner, dealt with just such a situation.  Issued as a T.C. opinion because it resolved a novel legal issue on who should be taxed on an IRA distribution, Roberts also involved several procedural issues that I hope will be of interest to the readers of Procedurallytaxing.com.

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The facts and the issue in the Roberts case were pretty straightforward.  Roberts owned several IRA accounts, and during the year at issue, someone withdrew substantial amounts from those accounts.  Roberts said his now ex-wife forged his signature and took the money, while the ex-wife said that she had nothing to do with it.  The IRS took the position that even if she took the money, Roberts as the owner of the retirement accounts, was still taxable on the withdrawals.  There was some case law that seemed to suggest that, but the cases were far from definitive. See Bunney v. Commissioner (generally the payee or distributee of an IRA is the participant or beneficiary who is eligible to receive funds from the IRA.)

We therefore had to prove that Roberts did not request or receive the IRA withdrawals, and even if we proved he didn’t, that he was nevertheless not the “distributee,” despite the fact that he was the person who was the participant in the IRA and was eligible to receive distributions.

Proving who signed a document can be challenging, particularly without expert testimony.  However, we noticed some obvious discrepancies between Roberts’ normal signature and the signatures on the IRA withdrawal requests.  While Roberts is known by friends and family as “Andy Roberts,” he signs every document with his full formal name, “Andrew W. Roberts.”  In addition, as a former member of the military, he dates every document he signs with the date first, then the month, and finally the year.  We had numerous documents showing how he signs and dates documents.  A notable exception were the IRA withdrawal requests.  Those were signed “Andy Roberts,” and they were dated with the month first and then the date.

Based on these discrepancies, along with significant other evidence, including the fact that the IRA withdrawal requests were faxed from Roberts’ wife place of employment, Judge Marvel found that Roberts’ wife had in fact withdrawn the funds from his IRA accounts.  The Court went on to hold that because Roberts did not request, receive, or benefit from the IRA distributions, he was not a payee or distributee within the meaning of section 408(d)(1). While this legal question is obviously the most important aspect of the Court’s decision, this holding would not have been possible had we not been able to prove Roberts did not request or receive the IRA distributions.

The final legal and procedural wrinkle in the case involved the penalties.  The IRS had asserted the substantial understatement penalty against Roberts.  However, the Service did not assert, until its reply brief, the negligence penalties, and the Tax Court will not consider arguments raised for the first time in a reply brief. (As an aside, I am continually surprised that the IRS does not, as a matter of course, assert both the negligence and substantial understatement penalties in a Notice of Deficiency).  A defense to both penalties is that the taxpayer acted with reasonable cause and in good faith.  The substantial understatement penalty has the additional defense of “substantial authority.”  Significantly, while there is no threshold for the application of the negligence penalty, the substantial understatement penalty requires that the understatement of tax exceed the greater of 10 percent of the tax required to be shown on the return or $5,000.

We did not have a great reasonable cause defense.  Roberts relied on his wife to file his return, even though they were separated at the time the return was filed.  He did not ask to see the return before it was filed, nor did he file an amended return after he learned that the original return was incorrect.  There was also no benefit in having the Court focus on what the taxpayer should have done, but did not.  Finally, we knew that if we won the primary issue, the understatement of tax would not be large enough for the substantial understatement to apply.  Thus, we did not put on any evidence regarding the penalties.  Fortunately, we prevailed on the underlying tax issue, and the substantial understatement penalty was therefore not applicable.

As result, not only did Robert not get hit with a penalty, he received a refund.  While lengthy trials are not the norm in Tax Court, and many cases turn solely on legal issues, winning the factual battle can help you win the war.

Does Equity Have a Role in Offers in Compromise?

Today’s guest blogger is Professor Scott A. Schumacher from the University of Washington School of Law.  In addition to teaching there and directing its graduate tax program, he also directs the federal tax clinic.  Last week the Tax Court issued an opinion in a Collection Due Process (CDP) case on an Effective Tax Administration offer in compromise.  Very few opinions exist on those types of offers and we are excited for Scott to bring us some insight on the case.  The case was presented to the Tax Court on cross motions for summary judgment.  That is also a rarity.  The case itself is worth reading.  If you have a CDP case in Tax Court you have a high chance that the IRS will file a summary judgment seeking to have the Court rule on the basis of the administrative file in the case.  The recent litigation that we have discussed previously in the blog concerning the appellate venue for CDP cases and the absence of a record rule case in the DC Circuit might have some applicability in these types of cases.  The tactic of filing a cross motion for summary judgment is an interesting tactic and perhaps more practitioners will follow Scott’s lead.  Keith 

            Anyone with even a passing familiarity with the Offer in Compromise (OIC) program knows that in submitting an OIC, taxpayers must offer at least the net equity in their assets plus their net future income over a period of months.  So, in answer to the question posed in the title, yes, equity obviously has a role in an OIC.  However, a recent case litigated by the Federal Tax Clinic at the University of Washington School of Law addressed a different type of equity. 

            On March 18, 2014, the United States Tax Court issued its opinion in Bogart v. Commissioner.  Bogart was a Collection Due Process case in which the taxpayers were seeking Court review of the denial of their OIC.  When they filed their OIC, the Bogarts alleged that it would be unfair and inequitable to hold them liable for the tax liability that stemmed from income embezzled by their bookkeeper.  Ruling on cross motions for summary judgment, the Tax Court remanded the case to IRS Appeals because it failed to adequately consider the OIC on public policy and equity grounds. 

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             This case is significant because it highlights the all-too common situation of the IRS asking for abuse of discretion review where it has failed to exercise the discretion in the first place.  It is also significant in that it addresses the growing number of cases where taxpayers have been the victim of embezzlement or fraud.  

The Bogarts’ tax liability was the result of unreported income that was embezzled by the bookkeeper of their S Corporation.  The Bogarts did not learn of the embezzlement until an IRS audit two years after the tax year, and the criminal case against their bookkeeper was not resolved for another two years after that.  In the case of embezzlement, the embezzled funds are taxable to the intended recipient (in this case, the S Corporation), even though the corporation never actually received the money.  

The remedy the tax laws provide is a theft loss deduction.  However, in order to claim a theft loss, the investigation, prosecution, and any restitution order must be completed and taken into account before a theft loss may be ascertained and claimed.  For the Bogarts, the case against their former bookkeeper was not resolved until four years after the year of the embezzlement.  Because of the limitations inherent in theft loss and the three-year net operating loss rule, any relief from the harshness of including in income the embezzled funds was not available to them.  

            Their only option was to submit an OIC.  The problem with an OIC, Doubt as to Collectability, is that they had saved too much money in their retirement accounts and could fully pay the liability.  (So much for planning ahead for your retirement!)  They also could not submit an OIC, Doubt as to Liability, because the law is clear that they were taxable on the embezzled funds and were not entitled to a theft loss deduction.  That left an OIC based on “Effective Tax Administration” (ETA).  

Congress expanded the OIC rules in 1998 to allow the IRS to consider ETA Offers.  In implementing the ETA Offer rules, Congress specifically instructed the Service to consider hardship, public policy, and equity.  The IRS rules on public policy and equity are set out in IRM 5.8.11.2.2 and provide that the taxpayers must show, among other things, that the circumstances of the case are such that other taxpayers would view the compromise as a fair and equitable result.  Representing themselves pro se in their CDP case, the Bogarts filed an ETA Offer that included statements that they were victims of embezzlement by their bookkeeper and that “full payment would cause economic hardship and would be unfair and inequitable.”  Appeals rejected their ETA Offer without addressing the equity argument. 

In the Tax Court, we argued that as victims of embezzlement and fraud, the acceptance of the Bogarts’ offer would not give the appearance of placing them in an unfairly beneficial position. In fact, we submitted that other taxpayers would be shocked to learn that someone could be taxed on income that was stolen before it was ever deposited into their bank account.  In addition, Congress provided a remedy to ameliorate this unfairness – a theft loss.  However, because the investigation and prosecution of embezzler took so long, the Bogarts could not claim a theft loss to reduce their liability.  This is precisely the type of case where equitable relief should be granted – the strict application of the tax laws create a result that Congress and the public would find unfair. 

The Tax Court agreed that the case should be remanded.  Even though the rejection of an OIC is reviewed for abuse of discretion, the Court has repeatedly held that the IRS abuses its discretion when it fails to adequately consider a proposed collection alternative.  Here, the appeals officer never explicitly addressed the equity argument, and remand was therefore required. 

The failure of the IRS to specifically address issues raised by the taxpayer is not unique to the Bogarts’ case, nor is this problem confined to collection cases.  Indeed, perhaps the most common area where this occurred is in innocent spouse cases.  While it appears to be getting better, the IRS would almost routinely deny a claim for innocent spouse relief without providing any reasoning.  

The Bogarts’ case is also not an isolated incident of the IRS refusing to apply equitable grounds in ETA Offers.  Indeed, Nina Olson, in her 2012 Annual Report to Congress, listed as a Most Serious Problem the Service’s refusal to approve ETA Offers in cases involving embezzlement or theft of tax payments by payroll service providers (PSP).  The NTA decried the ambiguous policies and procedures that limit the use of ETA OICs as a viable collec­tion alternative for victims by third parties in failing to remit payroll taxes to the IRS: “Victims of PSP failures are employers who tried to (and to their mind, did) comply with the tax laws. The IRS’s failure to acknowledge this reality demonstrates a lack of concern for the victim’s economic harm and increases the risk of future noncompliance and business failure.”   

The Tax Court’s decision in Bogart will hopefully encourage the IRS to expand its use of ETA Offers to relieve victims of fraud from unfair and burdensome tax liabilities.