Designated Orders: A Mixed Bag – Easements and Common Issues (11/26/18 to 11/30/18)

William Schmidt of Legal Services of Kansas brings us this weeks designated orders. The orders this week contain a lot of meat. Two of the orders deal with expert witnesses and problems with those witnesses. In one case the IRS seeks to exclude a petitioner’s expert because the expert is a promoter of tax schemes rather than a true expert and in another case petitioner seeks to exclude respondent’s expert because the expert destroyed the material he thought was not relevant to his expert opinion. Many other matters, particularly regarding conservation easements, deserve attention in these orders as well. Keith

The week of November 26 to 30, 2018 had seven designated orders. The week was a mixed bag. Some orders focused on less common issues like charitable contributions of easements, while other orders looked at routine deficiency or Collection Due Process issues.

Easement Issues, Part One

Docket No. 29176-14, George A. Valanos & Frederica A. Valanos v. C.I.R., available here.

To begin with, this designated order is 30 pages. Most designated orders do not reach a page count in the double digits so it is a rarity to find one this long. As a result, there are multiple items to discuss that I will be summarizing.

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The petitioners asked the Court to determine whether the IRS improperly denied their non-cash charitable contribution deduction for a conservation easement in tax years 2005 to 2007. The IRS filed a motion for partial summary judgment that the Court denies. The sole issue stated for decision is whether the petitioners’ conservation easement deed of gift satisfied the perpetuity requirements of IRC section 170(h)(5) and 26 C.F.R. sections 1.170A-14(g)(2) and (6). Because of the genuine dispute as to material facts, Rule 121(b), and a lack of clarity and specificity in the parties’ contentions of law, the Court denied the IRS motion for partial summary judgment.

For background, the order discusses the subject property, the mortgages affecting the subject property and the conservation easement, the subordination agreements, the conservation easement, the petitioners’ tax returns and charitable deduction disallowance, and the Tax Court proceedings.

Of note is that the recalculations of petitioners’ tax liabilities resulted in deficiencies of $192,486 for 2005, $153,742 for 2006, and $104,662 for 2007. The IRS also determined that the petitioners were liable for gross valuation misstatement penalties under section 6662(h) or, in the alternative, section 6662(a). On September 3, 2014, the IRS issued a notice of deficiency, and the petitioners timely mailed their petition to Tax Court.

The Commissioner moved for partial summary judgment on the grounds that the Greater Atlantic Bank subordination was defective and therefore the conservation easement did not meet the requirements for the charitable contribution deduction. The IRS appeared to initially concede any issue with the Wells Fargo deed of trust.

After the parties fully responded to the motion for partial summary judgment, the Court issued its opinion in Palmolive Bldg. Investors, LLC v. Commissioner, 149 T.C. ___ (Oct. 10, 2017), (discussed below). The Court issued an order that invited the parties to file supplemental memoranda addressing the implications for this case.

In its supplemental filings, the IRS arguments are that similar to the Palmolive subordinations, the Greater Atlantic Bank and Wells Fargo subordinations failed to adequately meet the requirements of subordination of the lenders’ interests in insurance proceedings. The IRS reiterated the Greater Atlantic Bank argument but added the argument that the Wells Fargo subordination did not meet requirements because it did not use the term “subordinate.”

The petitioners responded with arguments that the conservation easement and subordination agreements are valid, all section 170 requirements are satisfied, and they are entitled to all the deductions taken on their original returns.

In the discussion, the order begins with general principles and reviews the principles of summary judgment, conservation easements under section 170(h), the perpetuity requirement of 26 C.F.R. section 1.170A-14(g) (broken down into mortgage subordination and extinguishment proceedings), the relation of federal taxation and state law property rights, real property ownership and mortgage theory (looking at sections on real property ownership, legal interests and equitable interests, and mortgage theory), and District of Columbia’s real property law (with this section looking at mortgages in the District of Columbia, deeds in the District of Columbia, and conveyances of personal property in the District of Columbia).

Next in the discussion is the parties’ contentions, broken down between the Greater Atlantic Bank deeds of trust and their subordination agreement, and the Wells Fargo deed of trust and its subordination agreement.

Third in the discussion is the analysis portion. The first part of the analysis begins by stating that factual disputes are not resolved under Rule 121.

Next is that Section 1.170A-14(g)(2) requires subordination of mortgages. This second part includes sections on the need for attention to local law, Greater Atlantic Bank’s subordination agreement and the Wells Fargo subordination. The Greater Atlantic Bank subordination agreement section looks at the sufficiency of one general subordination agreement for two deeds of trust, the undated subordination agreement, and compliance with District of Columbia law’s recording and other requirements (broken down further into application of state-equivalent real estate law and recording requirements – validity as to third parties). The Wells Fargo subordination looks at the failure to use the verb “subordinate” and subordination or conveyance of an executory interest.

The third part of the analysis looks at the Section 1.170A-14(g)(b) requirement that the donee receive a proportionate share of extinguishment proceeds. This is broken down further to look at Greater Atlantic Bank’s subordination as to proceeds and Wells Fargo’s subordination as to proceeds.

The fourth part of the analysis turns to mortgage theory in light of conservation easements.

The order then turns to unanswered questions. The Court provides a list of nineteen unanswered questions, stating that thorough answers to these questions would allow the Court to analyze the parties’ respective arguments and reach a conclusion of the issues discussed within the order.

In the conclusion, the Court states disputes of fact exist and that the statements from both parties need further explanation and citations to legal authority.

Judge Gustafson orders that the IRS motion for partial summary judgment is denied. The facts assumed in the order are not findings for trial, and each party must be prepared to prove the relevant facts. No later than December 21, 2018, the parties must file a joint status report (or separate reports if that is not expedient) with their recommendations as to further proceedings in this case.

Takeaway: If you want to experience the complexity of the discussion, issues and questions in this case, I recommend you click the link above. This order dives deeply into an examination of the interaction between various areas of law, such as property (subordination agreements, mortgages, and conservation easements) and tax (charitable contribution deductions) while balancing the intersection of federal law and District of Columbia law.

Easement Issues, Part Two: The Palmolive Orders

Docket No. 23444-14, Palmolive Building Investors, LLC, DK Palmolive Building Investors Participants, LLC, Tax Matters Partner v. C.I.R.

The Tax Court issued an opinion in this case, 149 T.C. No. 18 (Oct. 10, 2017), holding that Palmolive is not entitled to a charitable contribution deduction for the contribution of a façade easement because of their failure to comply with certain requirements of IRC section 170. It is still at issue regarding Palmolive’s liability for IRS penalties asserted, which is set for trial commencing January 22, 2019, in Chicago, Illinois.

  • Order 1 available here. The IRS filed a motion for leave to file a second amendment to their answer, where they would supplement the answer with an allegation that Palmolive’s appraiser was a “promoter” and therefore not a qualified appraiser. The Court grants the motion for leave to amend, but the IRS needs to transmit a detailed written statement of the facts on which it will rely at trial to support its contention he was a “promoter.” Palmolive’s assertions in their opposition are deemed to be requests for admission for the IRS to respond to under Rule 90.
  • Order 2 available here. Palmolive filed a motion for summary judgment and the IRS filed their own motion for partial summary judgment in response. In a conference call with the parties, Judge Gustafson explained his expectations as to how he is likely to rule on the issues raised in the motions. He suggested that Palmolive “might wish to forego further filings on the motions and instead use its time to prepare for trial.” Palmolive’s counsel stated there would be no further filing on the issues 2 to 4, but would file a reply as to issue 1. The judge stated he expects to grant the IRS motion on issue 4, regarding the IRS written supervisory approval of the initial determination of penalties in compliance with IRC section 6751(b), but that the order or opinion might not be issued until soon before trial. The parties are to prepare for trial on the assumption that issue 4 will not be a subject of trial. Note: there was a subsequent designated order on issue 1 that will potentially be addressed in another blog post that is available here. Spoiler alert: Palmolive loses on issue 1.

Takeaway: This is a case with multiple filings and has complexity. One takeaway from these orders is that when the judge tells you not to do something it is in your best interest to comply.

Motion to Strike

Docket No. 14214-18, Pierre L. Broquedis v. C.I.R. (Order here).

It is not often that we see a Motion to Strike in a Tax Court case. Here, Petitioner states paragraphs and exhibits in Respondent’s answer are false or not concise statements of the facts upon which Respondent relies.

The Court cites Tax Court Rule 52, where the Court may order stricken from any pleading any redundant, immaterial, impertinent, frivolous, or scandalous matter. The Court states that motions to strike are not favored by federal courts. Matters will not be stricken from a pleading unless it is clear that it can have no possible bearing on the subject matter of the litigation. Additionally, a motion to strike will not be granted unless there is a showing of prejudice to the moving party.

The Court concludes the allegations and exhibits bear a relationship to the issues in the case. Also, petitioner failed to show that he would be materially prejudiced by a denial of his motion to strike. The Court then ordered to deny the motion to strike.

Takeaway: Since the Court states that motions to strike are not favored by federal courts, they should be avoided. While Rule 52 spells out the Court’s ability to order material stricken, this case illustrates that there are rare circumstances when the Court will grant such an order.

The Numbers Don’t Match

Docket No. 7737-18, Kelle C. Hickam & Nancy Hickam v. C.I.R. (Order here). Petitioners filed their petition with 6 numbered statements in their paragraph 5. Respondent filed an answer, admitting to certain paragraphs in the petition. Petitioners, thinking that the IRS partially conceded the case, submitted a motion for partial summary judgment. The Court states: “Petitioners, however, appear to believe that respondent’s numbered paragraphs in his answer refer to their numbered responses in the petition’s paragraph 5. They do not. Respondent’s paragraphs in his answer refer to the numbered paragraphs on the petition.” Since there are genuine disputes of material fact, the Court denied the motion.

Takeaway: While I understand that court documents are not always easy to understand, it would have been wise for these unrepresented petitioners to talk about the pleadings with someone who is familiar with court procedure. It should be a simple step to match the paragraphs between the Petitioner’s petition and the Respondent’s answer. The IRS is not going to concede material issues when they file an Answer. You’re not going to get that lucky.

Miscellaneous Short Items

  • Supervisor Conspiracy – Docket No. 15255-16SL, Robert L. Robinson v. C.I.R. (Order and Decision here). The petitioner mentions that his supervisor obstructed/impeded his payments and that there was a conspiracy. Otherwise, this looks to be a routine Collection Due Process case, granting the IRS motion for summary judgment because they followed routine procedures.
  • Materials Destroyed – Docket No. 20942-16, Donald L. Bren v. C.I.R. (Order here). Petitioner filed a motion in limine to exclude from evidence the report of respondent’s expert, Robert Shea Purdue, because he deliberately discarded documents and deleted electronic records investigated but disregarded in reaching the conclusions set forth in his report. The Court granted that motion.

 

 

Designated Orders: The Nonresponsive Petitioner (10/29/18 to 11/2/18)

This week’s post on designated orders is written by William Schmidt of the Kansas Legal Aid Society. Similar to the statistical post on designated order provided by Patrick Thomas a few weeks ago, William uses a slow week in designated orders to provide us with a reflective post on one of the root causes of trouble in Tax Court and with the tax system generally. Keith

The week of October 29 to November 2, 2018 had a total of three designated orders. To begin, the first order, here, is a short order regarding a joint filing of a stipulation of settled issues.

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Short Take: Docket No. 21940-15 L, James L. McCarthy v. C.I.R.

The second order, here, discusses ownership of real estate by a trust that IRS Appeals determined has been acting as the petitioner’s nominee. The petitioner has submitted both an offer in compromise and a partial payment installment agreement. Since Appeals determined the petitioner is connected with the trust, it becomes a factual issue regarding the real estate in question being an asset of the trust (affecting petitioner’s assets to determine his collection alternatives listed above). The IRS stance is that the property in question could be used to satisfy petitioner’s liability. The parties are to submit their memoranda regarding their arguments concerning the ownership of the property and petitioner’s ability to enjoy its benefits or treat it as his own during the ownership period by November 14.

The Nonresponsive Petitioner and Related Issues

Docket No. 18347-17 L, Kazuhiro Kono v. C.I.R., available here.

This case does not offer much for analysis. The petitioner did not submit requested documents to the IRS, did not respond to a second request, did not file a response to the IRS motion for summary judgment, and did not appear at the Tax Court docket. As a result, the Tax Court granted the IRS motion for summary judgment based on petitioner’s overall lack of responsiveness.

Since there is not much to focus on this week, I am going to take a detour and focus the rest of the blog post on an examination of the responsiveness of taxpayers during the Tax Court process. I am working on a presentation with some of the others who post here on designated orders so I have been doing some big picture thinking about Tax Court and designated orders.

  1. Types of Clients

In practice, I get to meet several types of clients. There are four categories I can think of who inherently have issues in dealing with IRS bureaucracy:

  • Low Income Taxpayers – The inability to afford higher education may be the beginning of barriers to understanding tax issues for some low income taxpayers. Another is the inability to take time to communicate with the IRS. Taxpayers often cannot take off work in order to have time to wait on the phone in order to deal with tax issues, especially if they are on a tight budget. The lack of funding for the IRS has increased wait times in order to talk with a customer service person on the phone, which leads to dissatisfaction and quitting attempts to deal with the IRS.
  • Disabled – There can be many categories here, whether physical or mental disabilities. If a taxpayer does not have the energy, ability or capacity to deal with tax issues, that person might be confused by the tax system or give up because it takes too much to handle.
  • Elderly – Again, this group may be declining in health or mental ability and lack the energy, ability or capacity to deal with tax issues.
  • English as a Second Language – I am using this category to cover all those who have difficulty with English, whether they are immigrants to the United States or not. Those who do not speak the language or understand American culture have that additional barrier to add to issues with understanding tax terminology or dealing with the IRS.

One client of mine has a case regarding financial disability (see past Procedurally Taxing postings here and here). She had paranoia and a nervous breakdown that prevented her from signing her 2012 tax refund before the 3-year deadline expired. I have had to be extra patient to work with her to fill out paperwork and get medical support regarding her disability. I am trying to prove that her medical issue should allow her an exception to the 3-year deadline.

Another client is a Spanish speaker who was audited for claiming her grandchildren as dependents and including other child-related benefits. After providing rounds of documents to the IRS, she was tired and got to the point where she did not want to gather more documents for me to provide to the IRS. I am glad to say that we have been successful in convincing the IRS to allow her to claim those dependents, but they wanted me to speak with my client about substantiating her future claims correctly.

  1. Nonresponsiveness

In surveying several of the past designated order postings, I looked for patterns of nonresponsive petitioners. Some of the broadest patterns are the lack of providing documents and ignorance of procedures.

Often, the IRS requests that a client fill out a Form 433-A or submit unfiled tax returns. For disorganized clients, that is an uphill battle, discussed more in the next section. Additionally, filing tax returns (especially in the off-season) may be a cost that taxpayers are unable to overcome.

For the unrepresented taxpayers, it does seem like they have a do-it-yourself mentality. Unfortunately, that means their courage leads them into areas for which they are not prepared. These taxpayers venture into areas of court or tax procedure they are ignorant of and it often leads to their detriment when the Tax Court finally grants the IRS motion for summary judgment.

To begin, there are some basics of court procedure that non-attorneys should realize they need to follow. They should show up in court for all hearings on their cases. If their case is scheduled for a calendar call, trial or any other special hearing, pro se petitioners should realize they need to show up. Participation in any legal hearing does not guarantee success, but it generally improves the judge’s opinion in the favor of those who appear unless the person is obnoxious.

Something else that should be obvious to unrepresented taxpayers is that they need to respond to court filings, especially the judge’s orders telling them to do so. By not responding to a judge’s orders, unrepresented taxpayers especially hurt their own cases.   It should be obvious to a taxpayer in Tax Court that doing something is often better than doing nothing.

One key piece a taxpayer should also realize is just what arguments are at issue. Collection Due Process (CDP) cases in Tax Court are one of the areas where taxpayers have problems. A CDP case in Tax Court concerns how the IRS treated the taxpayer. Were proper procedures followed? Did the taxpayer get his or her due process in treatment of the tax issue? A CDP hearing is not the place for the taxpayer to argue the merits of the tax at issue. Most likely, that ship has already boarded, sailed away, and docked at its port destination. Even though that is the case, there are still Tax Court petitioners trying to argue the merits of the tax at issue when they should be making arguments concerning due process.

This scratches the surface regarding complicated areas of court procedure. When it comes to hearsay or other trial arguments, taxpayers should be thinking about finding representation instead of making arguments without assistance.

The other area where taxpayers need to respond is regarding tax procedure. Ignorance of taxes will not serve people well in Tax Court. In looking at claims from child-related tax benefits to rental expenses, the common denominator is that the IRS requires substantiation for those claims.

I find it becomes necessary to be the middleman between my clients and IRS departments such as IRS Appeals or counsel. While my clients may have documentation regarding claims on their tax returns, I have found I need to translate communications from the IRS to the client and vice versa. It has also been necessary to organize documents so the IRS can review what the client has set aside. The IRS certainly does not like it when a taxpayer dumps unorganized documents in their lap as proof against the IRS audit. I went through the Tax Court process assisting a client who had boxes of documents. A current client has a suitcase of tax paperwork that needs to be organized for the IRS.

I think it is bizarre that taxpayers try to tackle areas of court and tax procedure when they are ignorant in those areas. I can understand that they want to save money, but they often ignore IRS notices about the LITC program. Several of them qualify for free assistance, but they choose to take on the IRS without any assistance at all. Why they do this makes no sense to me – they should at least call up the nearest LITC office to see what they have to say.

  1. Potential Solutions

A colleague (SueZanne Bishop) and I presented on “Gaining Independence Through Organized Financial Records” at the 2017 Kansas Conference on Poverty. While we did not have statistical data, we did have experiential learning to provide regarding the difficulties in working with clients to gather their financial data in areas of tax, family law, bankruptcy, estate planning and other areas of law. We spoke about the issues with handing an extensive form to clients to fill out regarding their assets, income, expenses or other financial data (such as IRS Form 433-A or forms used to expedite court filing). I also brought up how there may be additional steps involved in filling out a form, such as how the insolvency worksheet in IRS Publication 4681 needs financial information based on the date of a debt’s cancellation and not current financial information.

Some solutions we provided were giving clients more manageable chunks to a client (perhaps one page at a time) or regular meetings for each part of the form. I often talk through Form 433-F with clients rather than have them fill it out alone when I need that information in order to help them qualify based on their financial hardships for Currently Not Collectible status.

The theory behind our presentation was that helping clients to get organized now may give them assistance with greater problems in the future. Knowledge and the ability to budget would add to their skill sets. Organized data would reduce attentional strain (not dividing their focus between their finances and their children, for example). Adding this accomplishment might empower them to deal with the next problem and the next.

Often I think of how clients at legal aid organizations, LITCs, and other assistance programs would have difficulty dealing with their issues without the help we provide.

I do not know if the petitioner above, Mr. Kono, had any of the issues I mentioned. I wanted to provide alternative theories (not excuses) for why petitioners axre not as responsive as the IRS or the Tax Court would prefer. I know the IRS and the Tax Court try to educate taxpayers about the existence of the LITC program and I am dismayed why more do not ask for help. I also salute all pro bono volunteers who assist before and during Tax Court calendar calls.

Takeaway: I do not mean for this to be a blatant plug for the LITC and pro bono programs, but there is something to be said for those of us who act as the intermediaries between taxpayers and the IRS. The lack of IRS funding that in turn prevents quality customer service is but one of the barriers that taxpayers deal with so I wanted to provide another side of the story for the nonresponsive petitioners in these Tax Court cases. Potentially there is more to a petitioner’s story than laziness on why they did not do more in these cases.

 

 

Designated Orders: Penalties Imposed and Analysis of an Investment Firm (10/1/18 to 10/5/18)

Designated Order blogger William Schmidt from the Legal Aid Society of Kansas brings us this week’s orders. Keith

This week provides 4 designated orders. The batch includes two related orders regarding penalties for the same petitioner, analysis of an investment firm and an order concerning specific memos required before trial (Order Here). That order is a good example of what is needed in a pretrial memo in a case under regular tax case procedures: issues of fact and law, each party’s position and theories, expert witness testimony anticipated, and status of stipulations of facts.

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Tax Court Penalties Imposed

Docket # 16108-14 L, Rodney P. Walker v. C.I.R. (Order and Decision Here).

Docket # 9435-15 L, Rodney P. Walker v. C.I.R. (Order and Decision Here).

While there have been previous designated orders for Mr. Walker, his cases were not discussed here before. Each of the two cases are collection due process cases. One case concerns collection by levy for Mr. Walker’s unpaid 2007 and 2009 income taxes (16108-14) while the other case concerns collection by lien of his unpaid 2001 through 2007 income taxes. Otherwise, the orders are virtually identical yet ordered on two separate days.

Originally, Mr. Walker’s cases were remanded to IRS Appeals for a supplemental hearing on the issues listed above. The settlement officer provided him an explanation of how his 2007 and 2009 taxes were calculated and afforded him the opportunity to file returns claiming lesser taxes but he did not file those returns. Mr. Walker instead used the hearing to raise an issue previously ruled on by the Court.

The Court believed Mr. Walker used the period of remand primarily for delay and issued an order on August 27 to show cause that it was not a frivolous argument and why no penalty should be imposed. In fact, the penalty in question is from Internal Revenue Code (IRC) section 6673(a)(1). The section authorizes a penalty of up to $25,000 if the taxpayer has instituted or maintained proceedings before the Tax Court primarily for delay or if the taxpayer’s position is frivolous or groundless.

Mr. Walker did not respond to the August 27 order to show cause. The Court then imposes a section 6673(a)(1) penalty of $5,000 (it is my understanding that even though these are separate orders there would only be one penalty imposed). The Court orders that the IRS may proceed with the collection actions for the years in question.

Takeaway: The Tax Court is showing its teeth with regard to frivolous or groundless filings. While it is doubtful a petitioner that would file such a case is a reader of this blog site, it is worthwhile to note that the Tax Court is not afraid to impose penalties on petitioners trying to use the Tax Court just as a means of delaying IRS taking collection actions. While other cases have brought up the penalty without imposing it (giving little more than a slap on the wrist), this is a time where the Court made use of this power and imposed a decent penalty.

Was it a “Trade or Business”?

Docket # 8486-17, 8489-17, 8494-17, 8497-17, Richard M. Hellmann & Dianna G. Hellmann, et al., v. C.I.R. (Order Here).

GF Family Management, LLC (GFM) is an investment management firm owned and operated by members of the same family (the petitioners) and it is a family office as defined by federal securities law. The petitioners each hold a 25% profits interest in GFM and the assets managed by GFM were held by six investment partnerships. GFM held a 1% interest in each partnership, and trusts where the petitioners are the beneficiaries held (individually or collectively) the remaining 99% of each partnership.

GFM claimed expense deductions as a “trade or business” under IRC section 162. That would allow for GFM to claim ordinary business expense deductions for operating costs such as salaries, rent or investment expenses. The IRS contends GFM was actually engaged in activity “for the production or collection of income” or “for the management, conservation, or maintenance of property held for the production of income” under IRC section 212. That treatment would mean GFM’s expenses would be treated as miscellaneous itemized deductions subject to the 2% floor imposed by IRC section 67(a). The treatment will also be limited by application of the alternative minimum tax. Carryover of net operating losses are only permitted for a trade or business so that would also be limited for GFM.

Within this order, there is comparison to the fact situation in Lender Management, LLC v. C.I.R. Within that case, the Court emphasized the need to examine each case individually. In that case, the Court determined that it was in fact a trade or business.

Overall, the question is whether the owners of the family office are “actively engaged in providing services to others” (citing Lender Management) or are simply providing services to themselves. The Court provides factors for its analysis and proceeds to list factual issues it would like answered.

The parties are ordered to provide a joint status report by November 5. Within the report they are to express whether the facts will need to be developed at trial or to supplement the factual record through a stipulation of facts. Also, the parties will need to state whether the stipulation of facts could be submitted for decision without trial under Rule 122.

Takeaway: The IRS examination of this investment firm seems logical as the structure provides benefits to its family members. Is the firm actually a “trade or business” or is functioning in more of a self-serving capacity? The Court’s stance also sounds logical as the facts do not necessarily parallel the Lender Management facts so it is necessary to do further factual investigation to determine what kind of role the firm functions under. It is worth noting the major tax implications such a decision will result in for GFM, as listed above.

 

 

Designated Orders 9/3/18 to 9/7/18: A Plea Agreement, a Follow-up, and More Graev

We welcome designated order guest blogger William Schmidt from the Legal Aid Society of Kansas who writes on this week’s designated orders. In the first case petitioners make an argument that has been made before and failed. It fails again because their agreement in the criminal case about the scope of prosecution does not prohibit the IRS from pursuing them to determine their correct civil tax liability. Keith

For the week of September 3 to 7, there were 6 designated orders from the Tax Court. The first two are regarding two separate petitioners requesting to consolidate their cases and filing motions for summary judgment based on a plea agreement from prior litigation. The next 2 are a pair of orders that follow up from a previous posting (March). There is another Graev follow-up case. The final order, here, deals with a Collection Due Process hearing where petitioners question why they were audited for a home office expense when they were not audited in prior years.

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The Plea Agreement Does Not Cover Tax Court

Docket No. 22616-17, Krystina L. Szabo v. C.I.R., available here.

Docket No. 22560-17, Michael P. Martin v. C.I.R., available here.

This pair of Tax Court designated orders for a married couple are very similar, but distinct. In fact, the cases have so much in common, the couple filed motions to consolidate their cases, but those motions are denied.

Both petitioners were responsible for the daily activities of Pony Express Services, LLC. The company provided foster care and related services to persons with mental handicaps in western Virginia and maintained and operated three group homes there. Mr. Martin was the owner while Ms. Szabo was an employee and program manager.

In December 2006, the U.S. Attorney for the Western District of Virginia filed charges against the couple for conspiracy to defraud Medicare, Medicaid and the IRS. Among the charges were that the object of the conspiracy was to enrich the couple by falsely and fraudulently billing Medicaid for residential services not rendered and services not provided in the manner envisioned and required by Medicaid, plus maximizing the couple’s proceeds by utilizing what is called the foster home tax credit [actually referring to IRC section 131] when falsely informing their accountant they resided separately in two of the residential facilities.

The couple filed a plea agreement, acknowledged by the assistant U.S. attorney, in the U.S. District Court for the Western District of Virginia. Within the plea agreement, it states there will be no further prosecution regarding the couple in the Western District of Virginia. The plea agreement is limited to the Western District of Virginia. The plea agreement does not address potential civil tax liabilities or agreements regarding those liabilities. Ms. Szabo and Mr. Martin were each sentenced to 27 months imprisonment and three years of supervised release and paid a joint and several restitution to the U.S. Department of Medical Assistance Services of $173,174.65. They satisfied the judgment.

In separate notices of deficiency to Ms. Szabo and Mr. Martin, dated August 2, 2017, the IRS determined separate liabilities and penalties for each of them regarding tax years 2003 and 2004. The parties timely filed their separate petitions with Tax Court.

Each party filed a separate motion for summary judgment, contending that the plea agreement prevents the IRS from civilly determining, assessing or collecting the deficiencies in income tax or penalties for 2003 and 2004. They also contend that the government did not preserve its rights to pursue the criminal defendants for tax assessments and penalties after the entry of criminal judgment. Even though Mr. Martin’s motion was filed prematurely, the Court determined that it would be refiled anyway so chose to proceed on a substantive basis on his motion.

The Court determined that the plea agreement did not address the civil assessment and collection of taxes and does not bar the IRS from proceeding civilly. The plea agreement does not prevent the IRS from its determination, assessment or collection of tax, penalties, and additions to tax for the years at issue. The Court denied the motions for summary judgment of both petitioners.

Regarding the motions to consolidate, the Court admits the cases have much in common. The Court states the decision for consolidation is best left to the discretion of the trial judge. The Court denied the motions to consolidate without prejudice to the petitioners, allowing them the chance to refile the motions when calendared for trial.

Takeaway: I am not sure whether the petitioners believed their plea agreement would apply to the IRS or United States Tax Court or they were taking a chance on that legal argument, but I would suggest being more familiar with documents like the plea agreement in question before arguing that it is a document controlling for the IRS or the United States Tax Court.

Followup for Ms. March

Docket No. 6161-17 L, Debra L. March v. C.I.R.

I previously wrote about Ms. March regarding Tax Court designated orders here. While the first order there had the issue of how the IRS could reinstate an assessment after potentially being abated, the other order concerned a motion to show cause. Both of the orders this week follow up on that order on the motion to show cause.

Ms. March did not file her tax returns for 2009 and 2010. The IRS audited her for not reporting her income, assessed tax and filed notices of lien against her. She requested a collection due process hearing before IRS Appeals. Appeals issued a notice of determination sustaining the lien filings. Ms. March petitioned Tax Court and the IRS proposed facts and evidence be established as provided in Rule 91(f). They filed a motion for an order to show cause on August 8, 2018. The Tax Court granted the motion by an order on August 10, 2018.

As of this order, Ms. March did not file a response in compliance with the Court’s August 10 order. Instead, she mailed to the Court a document entitled “Amended Petition,” received August 29, 2018. The document does not respond or refer to the proposed stipulation, but alleges defects in how the IRS handled her case.

Since an amended petition cannot be filed as a matter of course, but only by order of the Court in response to a motion for leave in Rule 41(a) (which Ms. March did not file), the Court ordered that it was to be filed as a response to the order to show cause.

The Court orders that the order to show cause is absolute, deeming the facts stipulated regarding her receipt of income and non-filing of the tax returns. She does have the ability to move to be relieved from the deemed stipulations at trial, but would need to present proof of contrary facts.

Her filing stated, “The IRS did not read or address the issues I brought up in my letters about IRS’ failure to issue and mail valid Notices of Deficiency to me.” The Court is unsure whether this statement means that she believes the IRS did not issue valid notices of deficiency or whether she did not receive those notices. As stated above, she would be able to make these arguments at trial but would need to show evidence.

In the Court’s order, it provides that Ms. March is welcome to contact the Chambers Administrator to schedule a telephone conference with the Court and the IRS.

The Court received filings from Ms. March on September 4, 2018, deemed to be a motion for reconsideration of the order above (dated August 31), making absolute the August 10 order to show cause, and a declaration in support of that motion.

Even though Ms. March was a day late in her response, the Court exercised its discretion to treat it as a motion for reconsideration under Rule 161 and addressed its merits. She does not address the issues of her receipt of income or non-filing of returns. Instead, she criticizes how the IRS handled her case and argues that the Tax Court review is limited to the administrative record in a collection due process case (citing Robinette v. Commissioner, an 8th Circuit case).

The Court’s view is that it is not confined to the administrative record in collection due process cases, especially when the case involves a challenge to the underlying liability, pursuant to IRC section 6330(c)(2)(B), resembling a more typical deficiency case. In this instance, the Court of Appeals for the 10th Circuit is the appellate court with jurisdiction (not the 8th Circuit), but the 10th Circuit has not spoken on the issue. Ms. March citied Olenhouse v. Commodity Credit Corp., which is a 10th Circuit case, but it is not a collection due process case, does not relate to tax, and was decided before IRC section 6330 was enacted.

While the Court does not address whether 6330(c)(2)(B) prevents Ms. March from challenging her underlying liability as the IRS states she had a prior “opportunity to dispute such tax liability,” the Court states both parties are permitted to provide evidence outside the administrative record.

As Ms. March did not respond to the proposed stipulations from the IRS, the Court did not vacate the order making the order to show cause absolute and the deemed stipulations still stand.

Additionally, Ms. March explains that she has health problems that would make it difficult for her to appear at trial. She would like the case to be fully stipulated and decided pursuant to Rule 122. She also suggests that the contents of the administrative record be stipulated. The Court does not agree the stipulation should be limited to the administrative record, but encourages the parties to attempt a comprehensive stipulation for the case under Rule 122. That is not an order as the case was not submitted that way yet, but will be addressed if presented that way later. Again, the Court encourages the parties to schedule a telephone conference.

Takeaway: Ms. March has some sophistication as a litigation since she is citing case law. However, her lack of responsiveness to the IRS and the Court do not help her case. Perhaps she was able to address these issues or deal with the stipulations under Rule 122 in time before her September trial date.

More Graev Fallout

Docket Nos. 23621-15 and 23647-15, Nathaniel A. Carter & Stella C. Carter, et al., v. C.I.R., (consolidated cases) available here.

Here are more cases affected by Graev v. Commissioner. The Carters have deficiencies and penalties for 2011 through 2013 while Mr. Evans has deficiencies and penalties for 2011 and 2012.

The Graev decision allowed for Court interpretation of IRC section 6751(b)(1). Specifically, the case held the IRS has a burden of production under section 7491(c) showing compliance with supervisory approval as required under 6751(b). Since the petitioners in these cases would be affected by section 6662 accuracy-related penalties, the IRS filed its motion to reopen the record to admit evidence to establish that the 6751(b)(1) requirements for supervisory approval have been met.

The factors the Court has to examine to determine whether to reopen a record are the timeliness of the motion, the character of the testimony to be offered, the effect of granting the motion, and the reasonableness of the request. The third factor, the effect of granting the motion, is the most relevant.

The IRS seeks to reopen the record to admit declarations of Donald Maclennan, a Supervisory Internal Revenue Agent, and a separate Civil Penalty Approval Form in each case. The petitioners object, stating the exhibits contain inadmissible hearsay. Additionally, one Civil Penalty Approval Form shows a printed date in April 2014, more than a year earlier than Mr. Maclennan’s signature block in May 2015. The two forms call for a signature but show only his printed name. Each of the forms lack justification for his approval.

The Court finds that the forms fall under the exception to the hearsay rule for records of a regularly conducted activity and the declarations fit into evidence that is self-authenticating. The Court admits that the lack of signatures on the forms will go to the weight of the evidence, but are not part of the hearsay evaluation. They show approval by a “Group Manager” and do not explicitly indicate the manager was an “immediate supervisor,” as required under 6751(b)(1). The forms lack evidence of facts necessary for the IRS to meet the required burden. The declarations are meant to bolster the forms but the Court determines that the IRS cannot rely on the declarations for purposes of meeting the burden of production to show the “immediate supervisor” approved the penalty determinations.

Having determined to open the record to allow the IRS to offer evidence that the 6751(b)(1) requirements are satisfied, the Court is allowing the IRS the opportunity to offer admissible evidence or make argument to show the requisite managerial approval. The petitioners have 30 days to conduct discovery regarding whether Mr. Maclennan was Mr. Dickerson’s immediate supervisor (as part of meeting the requirements). The parties may stipulate if they agree by filing a supplemental stipulation of facts. If they do not, either party may move for a supplementary evidentiary hearing to introduce evidence. The IRS may make further argument there are grounds sufficient for the Court to infer Mr. Maclennan’s supervisory status.

The Court grants the IRS motion and received the forms into evidence and the declarations are received into evidence as supporting documents for the forms. The petitioners are ordered to have 30 days to conduct discovery. Either party may move for a supplemental hearing on or before October 9. If neither party requests that hearing, petitioners have until October 19 to notify the court regarding their argument as to Mr. Maclennan’s supervisory role. If notifying the Court, they have until November 9 to file a memorandum of law making that argument.

Takeaway: From my observation, the IRS seemed to be broadly winning the arguments that they met the factors needed to reopen the record to admit evidence in prior cases. In this case, both parties are providing evidence that the Court will evaluate. I think this a balanced approach to weighing the factors regarding reopening the record in a Tax Court case affected by Graev.

 

 

Designated Orders: 8/6/18 to 8/10/18

William Schmidt of the Legal Aid Society of Kansas brings us this week’s designated order post. The case discussed involves a mystery regarding how the IRS made the assessment that led to the filing of the notice of federal tax lien that led to the collection due process case. There may be more orders yet to come in this case. Because the case is scheduled for trial next month in Denver, perhaps Samantha Galvin, another writer of designated order posts and one of the clinicians working in Denver, will have personal knowledge of the case. Keith

For the week of August 6 to 10, there were two designated orders from the Tax Court so this posting will be briefer than usual. It is unclear if this is a week where summer vacations took their toll. Both orders examined are from the same case so the analysis will include all the orders for the week.

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Docket No. 6161-17 L, Debra L. March v. C.I.R.

The Court provided 2 orders in this case starting from IRS Appeals issuing a determination to sustain the filing of the notice of lien for the collection of income tax for tax years 2009 and 2010.

Petitioner had a prior collection due process (CDP) case, Docket No. 10223-14, resulting from a notice of intent to levy. In the prior case the IRS issued a notice of determination sustaining the levy and the petitioner filed a Tax Court petition in which it challenged the validity of the assessment. The parties to that case entered into a stipulated decision on June 25, 2015, that did not sustain Appeals’ determination. The decision document stated that the IRS would abate the liability for tax year 2009 on the basis that the IRS failed to send the statutory notice of deficiency (SNOD) to the petitioner’s last known address. The Court, in the current case, states that it assumes the IRS complied with the decision entered in the prior case and made the abatement.

At issue in this week’s designated order is how the IRS came to have an assessment against the petitioner after the abatement of the prior assessment. The case presents a very curious situation; however, the order does not resolve the mystery but rather seeks to have the parties, particularly the IRS, explain how to resolve it.

At some point after the “presumed abatement” of the 2009 assessment following the first CDP case in Tax Court, the IRS appears to have reassessed the 2009 liability and filed a notice of lien on that 2009 liability. Appeals issued a notice of determination on February 6, 2017. The notice of determination states that the original assessment was abated (due to the wrong address on the notice of deficiency) and the taxpayer was given additional time to file an original tax return. Since the taxpayer continued not to file the return for 2009, the IRS reinstated the assessment. The problem with the verification is that how the IRS reinstated the assessment remains entirely unclear. It seems clear that the taxpayer did not consent to the reassessment by filing a tax return. What remains unclear is what the IRS did to acquire authority to reassess.

The language of the Settlement Officer in the notice of determination contains only a vague statement regarding the basis for the new assessment. For verification, the notice of determination states: “The Settlement Officer verified through transcript analysis that the assessment was properly made per IRC section 6201 for each tax and period listed on the CDP notice.” Ms. March timely petitioned the Tax Court on March 6, 2017 with the new CDP case again contesting the assessed liability.

The Court then analyzes code section 6201. Section 6201(a)(1) authorizes the IRS to assess “taxes…as to which returns…are made” though Ms. March has yet to file a return for 2009. The Court states that the other provisions for making an assessment do not seem to apply beyond the authority for the IRS to determine a deficiency, mail the taxpayer a SNOD, and assess the deficiency upon the passage of 90 days following the mailing (unless the taxpayer files a timely petition with Tax Court). But, the parties stipulated in that prior case that no SNOD was properly mailed, and the notice of determination appears to indicate no SNOD was mailed subsequent to the conclusion of the first Tax Court case.

The Court would like an explanation for the authority the IRS had to “restore the tax assessment.” The Court’s order is for the IRS to file a status report explaining the position about the validity of the 2009 income tax underlying the lien filing at issue in the case.

Takeaway: The IRS looks to have been caught making another bad assessment and then providing an alleged verification that fails to verify the proper statutory procedure for making an assessment. Perhaps they will have a suitable explanation or be able to cite different authority. Either the IRS “reinstated” the assessment without statutory authority for doing so or the Settlement Officer did not know how to write the verification section of the CDP determination and explain a statutory basis for the new assessment. In either case the IRS does not look good but if the IRS simply “reinstated” the assessment as the Settlement Officer describes, it appears the IRS is headed for its second CDP loss with respect to the same taxpayer for the same year for the same problem. Under the circumstances, the IRS attorney might also have noticed this issue before it got in front of a judge a second time. Tough. 

The Court discusses an IRS motion to show cause regarding why proposed facts and evidence should not be accepted as established. This order relates to a routine Rule 91(f) motion requiring a party to stipulate. Because the petitioner is unrepresented, the judge explains in the order how stipulations can be used to include evidence that a self-represented petitioner such as Ms. March would otherwise have to introduce at trial on her own. The judge also explained that Ms. March would not be prevented from introducing additional evidence beyond what was including in the stipulated evidence. The order provides an example of a typical Tax Court order to a pro se taxpayer in which the Court provides a simple, straight-forward explanation of the rules and why the unrepresented individual should comply for their own best interest. While this order uncoupled from Order 1 discussed above would not deserve designated order status, it offers a glimpse of a routine order issued in Tax Court cases to pro se petitioners uncomfortable with the stipulation process for fear of stipulating themselves out of court.

After providing the careful explanation for the benefit of the petitioner, the Court granted the IRS motion to show cause and ordered that the petitioner file a reply on or before August 27. If no response is provided, the Court will issue an order accordingly.

Takeaway: While the Court is reasonable in explaining to an unrepresented petitioner the process of stipulations, the Court also does not stray from the rules or let that delay the upcoming trial (September 24 in Denver).

 

 

Tax Court Jurisdiction and the EITC Ban

We welcome William Schmidt who is normally one of our regular designated order blogging. William’s post today results from a request for help from another designated order blogger, Patrick Thomas, who asked for assistance from his colleagues to do an in-depth analysis on a specific designated order from the week of July 23 to 27. During that week the Tax Court issued a heavy load of designated orders that Patrick turned into a three part series without including the case which is the subject of today’s post. William writes about Docket No. 20967-16, Katrina E. Taylor & Avery Taylor, v. C.I.R. (Order here). He focuses on the Taylor case because it brings back a jurisdictional issue for Tax Court regarding the earned income tax credit (EITC) ban that Les has written about before as is cited below. Keith

To begin with some background on the EITC ban, there have been issues through the years regarding fraud on tax returns claiming the EITC. In response, Congress provided the Taxpayer Relief Act of 1997. Its purpose, according to the Joint Committee on Taxation: “The Congress believed that taxpayers who fraudulently claim the EIC or recklessly or intentionally disregard EIC rules or regulations should be penalized for doing so.” The Act provided for an EITC ban under Internal Revenue Code (IRC) section 32(k). The ban disallows a taxpayer to claim the EITC for 10 years when there claim of the credit was due to fraud (or 2 years for reckless or intentional disregard of rules and regulations, though not due to fraud). There have been issues on how fairly the IRS administers the ban. One example is that it was identified as one of the “Most Serious Problems” in the National Taxpayer Advocate’s 2013 Report to Congress.

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The IRS issued a notice of deficiency to the Taylors regarding the 2013 tax year, listing a deficiency of $14, 186 and an IRC section 6662(a) accuracy-related penalty of $2,837.20. The deficiency results from disallowance of car and truck expenses the Taylors claimed on the Schedule C filed with their Form 1040.

The Taylors timely filed their Tax Court petition and the IRS filed their answer. The IRS followed up with an amended answer, raising two affirmative defenses. First, they raise an IRC section 6663 civil fraud penalty of $10,639.50, asserting the petitioners falsely claimed business-related car and truck expenses to reduce their income to make them eligible to claim the EITC. Second, the IRS raises the 10-year EITC ban pursuant to IRC section 32(k)(1)(B)(I) for improperly claiming the EITC.

To complete the procedural history, the Taylors did not participate further in their Tax Court case, which was to their detriment. They did not respond to the amended answer and the IRS followed with a “Motion for Entry of Order that Undenied Allegations be Deemed Admitted Pursuant to Rule 37(c).” The Court issued an order granting that motion, meaning the Taylors are deemed to have admitted all the statements in the amended answer, including the affirmative allegations with respect to the civil fraud penalty and the 10-year ban on claiming the EITC.

Next, the IRS filed a “Motion to Take Judicial Notice,” which requested the Court take judicial notice of the distances between the Taylors’ home and the various addresses Katrina Taylor reported driving during 2013 for her business activities. The motion asserts that the Taylors’ travel logs are unreliable and overstate the travel distances. The IRS provided Google Maps documents that show the distance and driving times for the routes Mrs. Taylor reported for the business destinations. Since the Taylors did not respond, the Court’s order granted the IRS motion, taking judicial notice of that information as facts, the accuracy of which cannot reasonably be questioned.

The IRS prepared a joint stipulation of facts that the Taylors refused to sign. The IRS filed a “Motion for Order to Show Cause Why Proposed Facts and Evidence Should not be Accepted as Established Pursuant to Rule 91(f).” The Court ordered the Taylors to respond to the motion. Since they failed to respond, the Court issued its order making the Order to Show Cause absolute, meaning the facts and evidence set forth in the proposed stipulation of facts was deemed to be established for the purposes of the case.

Turning to the facts established through the orders, the Taylors reported $105,914 in wages on their 2013 Form 1040, with $55,033 earned by Mrs. Taylor as an employee. The attached Schedule C listed financial data on Mrs. Taylor’s business, which reports no business income. It instead reports advertising expenses of $290 and car and truck expenses of $73,740, resulting in a net loss of $74,030. Also included are a Form 4562, Depreciation and Amortization (Including Information on Listed Property), which states the Taylors represent they used two vehicles for business purposes, with a total of 130,513 business miles. Vehicle 1 was driven 65,212 miles and vehicle 2 was driven 65,301 miles. In response to line 24a, “Do you have evidence to support the business/investment use claimed?” their response was to check the box for “no.” Those business expenses reduced their adjusted gross income to $30,690. Since they had three minor children in 2013, they qualified for an earned income credit of $4,417 based on that income.

The IRS audited the Taylors, focusing on their car and truck expenses. The Taylors supplied two versions of a log purporting to show business miles driven for Mrs. Taylor’s business. The logs were not provided contemporaneously with her travel and state she drove the 130,513 miles on business, driving a 2004 Cadillac truck 41,483 miles and a 2006 BMW 89,030 miles. The Court states these logs are demonstrably unreliable because petitioners traded in the 2004 Cadillac truck with Mrs. Taylor signing an odometer disclosure statement reporting the odometer at time of sale as 102,345 miles while according to the provided logs the December 23, 2013 year end odometer reading was 154,990 miles. Similarly, the BMW’s trade-in odometer disclosure statement was 91,333 miles while the purported logs stated the December 17, 2013, reading to be 186,880 miles.

The Court also believed the log mileage to be inflated. The logs stated Mrs. Taylor drove the Cadillac 1,376 miles and the BMW 701 miles (totaling 2,077 miles) on September 22, 2013. The IRS points out the driving distance from Manhattan to Los Angeles is approximately 2,800 miles and “[a]t a constant speed of 70 miles per hour (“MPH”) it would take 29.7 hours to drive 2,077 miles.” The logs also report trips of 1,200 miles to 1,800 miles for other days.

The Court’s discussion within the order itself focuses on how the petitioners have not been responsive. They failed to plead or otherwise proceed within Rule 123(a). Because of the deemed established facts, the Court grants the IRS Motion for Default Judgment and enters a decision against the Taylors.

In the decision, Judge Jacobs ordered and decided that for 2013 there is a deficiency of $14,186 and an IRC section 6663 civil fraud penalty of $10,639.50 (the IRS sought an IRC section 6662 accuracy-related penalty in the alternative so that is denied as moot). Additionally, Judge Jacobs orders and decides “that the 10-year ban for claiming the earned income credit, pursuant to section 32(k)(1)(B)(I), is imposed as sought in respondent’s amended answer.”

There is no analysis regarding the 10-year ban and whether the Court has jurisdiction to impose it. The closest is a prior mention of the affirmative allegations that “petitioners…should be subject to the 10-year ban on claiming the earned income credit.”

We come back to a jurisdictional issue for the Tax Court. In the Taylor case, the Court had the 2013 tax return at issue. The jurisdictional issue is what authority the Court has with regard to the EITC ban in a case like this. Is the jurisdiction for the year in which the ban arises (2013) or for the years in which the ban will take effect (10 following years, presumably starting with 2014)?

The Tax Court is a court of limited jurisdiction. IRC section 6214(a) states that Tax Court has jurisdiction to redetermine the correct amount of a deficiency at issue. The disallowed refundable credit banned through the EITC ban affects future years that are not before the Tax Court. In fact, IRC section 6214(b) states that the Court “shall have no jurisdiction to determine whether or not the tax for any other year…has been overpaid or underpaid.”

I note that the IRS does have the ability to assert fraud and get facts deemed stipulated in order for the IRS to meet its burden of proof on the issue of fraud. I provide a quote from Console v. Commissioner, T.C. Memo. 2001-32 at *12, aff’d 2003 U.S. App. LEXIS 15535 (3d Cir. 2003): “It is well settled in this Court that the Commissioner may establish fraud by relying upon matters deemed admitted under Rule 90Marshall v. Commissioner, 85 T.C. 267 (1985)Morrison v. Commissioner, 81 T.C. 644, 651 (1983)Doncaster v. Commissioner, 77 T.C. 334, 336 (1981). The Commissioner may also establish fraud by relying on facts deemed to be stipulated under Rule 91(f)Ambroselli v. Commissioner, T.C. Memo 1999-158.” My thanks to Carl Smith for providing this note and citation.

One case to consider is a prior Tax Court case, Ballard v. Commissioner, which included a Tax Court judge’s reluctance to issue an order regarding a 2-year ban on the EITC. Les Book provided prior commentary in Procedurally Taxing here. In that posting, there are links to other posts, including Carl Smith’s discussion of the jurisdictional issue of the EITC ban in the Tax Court. I agree with Les’s view that the Tax Court does not have authority to apply an EITC ban for a year of fraudulent behavior (or reckless/intentional disregard), which could be called a conduct year.

Specifically for the Taylors, I argue that while the petitioners should potentially be subject to the ban, the only year before the Court was 2013. It was within the Court’s authority to find that there was fraud in 2013, but not within their authority to apply an EITC ban for later years.

I am unsure if the Taylors were outmatched in the courtroom. If all of the allegations against them are true, though, I can understand the claims of fraud the IRS made against them. Whether their goal was to inflate business expenses to claim the earned income tax credit or not, the results are unrealistic business miles and mileage logs that do not match. Even if one does not agree with the EITC ban, the ban is an area the IRS has authority to administer. This case does not provide justification that the Tax Court has jurisdiction to administer the EITC ban for later years when 2013 was the conduct year before the Court so went a step too far in ordering the imposition of the EITC ban for the Taylors.

 

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

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

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

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Chai Ghouls

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Whistleblowers and Discovery

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Miscellaneous Short Items

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

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

 

Designated Orders in Krug v. Commissioner, 5/29/18 & 6/13/18

Patrick Thomas and William Schmidt today discuss two designated orders by Judge Halpern in an unusual whistleblower case. The Court seeks further explication of a Social Security Act provision relating to inmate services, which Respondent alleges dooms the petitioner’s claim. Patrick and William take us through the tangle of applicable statutes. Christine

Docket No. 13502-17W, Gregory Charles Krug v. C.I.R. (Order here).

As promised in Patrick and William’s recent designated orders posts, this post looks at Krug v. Commissioner, a whistleblower case assigned to Judge Halpern, and is co-authored by both Patrick and William.

This order stems from Respondent’s motion for summary judgment, which actually resulted in two designated orders: the June 13 order discussed below, and one from May 29. In both orders, the Court is confused by Respondent’s arguments, and as such, declines to dispose of the motion without further argument. The May 29 order sets the motion for a hearing during a trial session on June 4. The later order discusses that hearing, but still reserves judgment until Respondent provides further information.

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Specifically, Respondent asks the Court to uphold the IRS denial of a whistleblower award, because the entity against which the whistleblower complained was not required to withhold employment taxes or federal income tax. Respondent submitted a Form 11369, Confidential Evaluation Report on Claim for Award, which evaluated Petitioner’s administrative claim for a whistleblower award. This form included the following language:

Social Security and Medicare wages are excluded from inmate services under the provision of Section 218(c)(6) of the Social Security Act. The Federal income tax withholding is dependent on the amount of wages paid which is less than the minimum wage. FIT on these wages would be dependent on other income (investment) earned by the inmates, and whether or not they file a joint return. Because of these unknown factors, this claim will be declined.

So, it appears the whistleblower notified the IRS that a prison was not withholding Social Security, Medicare, or Federal income taxes on wages paid to inmates. The IRS denied a whistleblower award claim, noting that the prison has no such withholding requirements.

Judge Halpern does not understand the relevance of the explanation. The Federal income tax reference seems inapplicable, he says, given that petitioner’s claim relates to “employment taxes.” He further notes that though section 218(c)(6) of the Social Security Act “does address services by inmates, we do not understand the relevance of the provision to petitioner’s claim.” In the May 29 order, he asked Respondent to clarify its argument at the June 4 trial session.

Apparently, Respondent’s explanation was insufficient. Judge Halpern notes in the June 13 order that, “as indicated in the transcript of the hearing, the Court was not satisfied with counsel’s explanation of why payments for the services of inmates are not subject to withholding for employment taxes.” Petitioner did not appear for the hearing. In fact, the petitioner has not been responsive to orders beginning February 8. Looking at the docket, there could be an issue of whether the Court has the petitioner’s correct address.

To us, it seems that Judge Halpern and Respondent are talking past each other. Judge Halpern is correct, in that, on its face, section 218(c)(6) of the Social Security Act (42 U.S.C. § 418) has nothing to do with withholding obligations. Rather, Section 218 provides a mechanism through which State and local governments may allow their employees to participate in Social Security and Medicare. Originally, States were not automatically obligated to participate in these programs. After the addition of Code section 3121(b)(7)(F) in 1991, with limited exceptions, all state employees are required to participate in Social Security, including its withholding requirements. Today, all states have a Section 218 agreement with the federal government.

Separately, Code section 3101(a) imposes Social Security and Medicare taxes, which section 3102(a) requires to be withheld from employee wages. Section 3121(b) defines “employment” broadly, with a number of exceptions. An exception exists for any employee of “a State . . . or any instrumentality . . . “. IRC § 3121(b)(7). Importantly, an exception to the exception exists for any states who have entered into an agreement with the federal government under Section 218 of the Social Security Act, or where the employee is “not a member of a retirement system of such State . . .” IRC § 3121(b)(7)(E), (F). As noted above, all 50 states have these agreements, and all state employees are generally—agreement or not—required to withhold these taxes.

And there’s where the rubber meets the road: Inmates of penal institutions are, under Social Security Act section 218(c)(6), excluded from any agreement under that section, as the Service notes. Further, even where no agreement is in force, section 3121(b)(7)(F)(ii) specifically exempts withholding obligations for state employers for wages paid to inmates in a penal institution.

Regarding the withholding of federal income tax, while such a tax might not be strictly characterized as an “employment tax”, employers are nevertheless generally obligated to withhold such taxes from employee wages. Reporting such a failure could charitably fall under the ambit of “employment taxes” when a pro se taxpayer uses this term. And further, section 3401 contains no blanket waiver on the definitions of “wages” or “employment” in mandating withholding obligations under section 3402(a)(1).

So, to us, there appears to be a live issue regarding income tax withholding requirements, but a fairly straightforward argument that no Social Security or Medicare tax withholdings were required. The Service says in the Form 11369 that the employer needed more information to make this determination (other income, marital status, etc.). But isn’t it the employer’s problem that they didn’t collect that information?

We’re also confused why the IRS would make only this argument. A whistleblower award under section 7623 is premised upon the IRS “proceed[ing] with any administrative or judicial action described in [7623(a)] based on information brought to the Secretary’s attention by an individual.” The “administrative or judicial action” could include “(1) detecting underpayments of tax, or (2) detecting and bringing to trial and punishment persons guilty of violating the internal revenue laws or conniving at the same…” If Respondent’s argument is that the prison in question wasn’t required to withhold, then surely the IRS also did not take “administrative or judicial action” to detect an underpayment or other malfeasance. That seems a much stronger argument for upholding the denial.

Further, Judge Halpern, in his second order, advises Respondent’s counsel to review Kasper v. Commissioner, 150 No. 2 (2018), which we’ve discussed before. Kasper holds (1) Tax Court review of a whistleblower award denial is generally limited to the administrative record; (2) the standard of review is abuse of discretion; and (3) the Chenery rule applies, meaning that the Tax Court can only uphold the Service’s decision on the same grounds that the Service itself made the decision.

How does Kasper affect this case? Because the standard of review is now conclusively an abuse of discretion standard in the Tax Court, it’s easier for the Tax Court to uphold the denial of a whistleblower claim.

But we may also be missing a critical fact: did the whistleblower’s claim relate to unpaid wages, as in Kasper? Without access to the other documents in the Tax Court’s docket, we can’t know for sure. If so, then Judge Halpern seems to suggest that regardless of whether a prison is required to withhold Social Security and Medicare taxes for wages paid to inmates, the Court could uphold the decision on the basis that no withholding was necessary, because no wages were paid. But, if that’s the case, why not just order that here? If only Tax Court motions and briefs were publicly accessible, we wouldn’t be left to wonder.

The June 13 order requires Respondent and Petitioner to file a memorandum on or before August 3 addressing the Court’s concerns with the Form 11369’s relevance. In the meantime, the Court has taken the motion for summary judgment under advisement.