The Tax Court’s Tenacious Stance on 280E: Designated Orders 12/17/2018 – 12/21/2018

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Professor Samantha Galvin from University of Denver’s Sturm School of Law brings us this week’s designated orders. The first case demonstrates the tax difficulties facing marijuana dispensaries under the current state of the law. The last one continues Judge Gustafson’s lessons to Chief Counsel attorneys regarding summary judgment motions. In between the court provides another lesson to Chief Counsel attorneys regarding the application of the fraud penalty. Designated orders have come to a halt because of the shutdown. We will restart this series when the Tax Court reopens. In the meantime we are getting some guest posts from the designated order team on other topics. Keith

The Tax Court issued seven orders during the week of December 17, 2018 right before the holidays and the government shut down. The orders not discussed involve: a CDP summary judgment after no documents from petitioner here; whistleblower housekeeping here; a CDP summary judgment after incomplete information from petitioners here; and a penalty issue in a partnership case here.

Below, I discuss a designated order in a medical marijuana case, and in the spirit of the holidays, two orders that reflect the different lengths the Tax Court will take to protect taxpayers.

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Docket No. 23020-17, Superior Organics v. CIR (here)

Marijuana businesses are not often the subject of designated orders and it may be because the Tax Court has firmly held its stance on the application of section 280E, but that hasn’t stopped petitioners from trying to get around it. For those who don’t know, section 280E disallows deductions (beyond the cost of goods sold) incurred in the business of trafficking controlled substances. Marijuana is a controlled substance under the section because it is still classified as a Schedule I drug, despite 33 states and D.C. legalizing it in some form.

Petitioner is an Arizona medical marijuana dispensary and has made fifth amendment related arguments before the Court. I’ve heard them before and so has the Court, and it’s not even the first time the Court has heard it from the tax lawyer representing petitioner when the order was issued (interestingly, petitioner retained new counsel nineteen days after this order was issued). A footnote in the order points out that petitioner’s representative has used the same argument in other cases.

In this designated order the Court is specifically addressing petitioner’s motion in limine and motion for judgment on the pleadings. The motion is liminine requests that the Court find that the burden of proof in applying section 280E is on the IRS and the motion for judgment on the pleadings argues that section 280E is unconstitutional.

At the risk of oversimplifying it, petitioner’s basis for invoking the fifth amendment involves two arguments. First, a taxpayer should not be required to incriminate himself by producing information about income and expenses when the information may establish that the taxpayer was involved in drug trafficking. Second, requiring a taxpayer to disprove they are involved in criminal enterprise is a violation of due process, under Speiser v. Randall, 357 U.S. 513 (1958). The Court says petitioner has mischaracterized Speiser because it dealt with constitutionally protected free speech rights and there is no constitutional protection for drug trafficking.

Typically, and in this case, the Court holds that the taxpayer cannot avoid the burden of proof by invoking the fifth amendment. The 10th Circuit has also held that the IRS’s determination that a taxpayer trafficked in controlled substances for purposes of applying section 280E is not the same as a criminal violation determination under the Controlled Substances Act. (See Alpenglow Botanicals, LLC v. United States, 894 F.3d 1187 (10th Cir. 2018)).

Petitioner has filed previous motions for protective order in this case in an attempt to avoid producing what petitioner calls “incriminating evidence,” and what the Court calls “income and expense substantiation.”

Petitioner cites two burden shifting provision in support of its argument. First, section 7454, which shifts the burden to the IRS on the issue of whether a taxpayer has been guilty of fraud with intent to evade tax. Second, section 162(c), which shifts the burden of proof to the IRS for certain illegal payments.

The Court finds that neither section applies, but the existence of those sections demonstrates that Congress knows how to shift the burden in certain situations and has chosen not to do so here. The Court denies both of petitioner’s motions.

Docket No. 16273-17, Roger H. Durand, II, v. CIR (here)

In a win for petitioner and lesson for respondent, the Court highlights the difference between a section 6663 penalty and a section 6651(f) penalty in this designated order.

This case was already tried in October of 2018 and the parties are in the process of preparing post-trial briefs. The Court addresses IRS’s motion to leave to amend its answer to conform to proof. Petitioner objects.

Petitioner is a reverend who did not timely file for several years beginning in 2006, but eventually filed all years in 2014 and 2015. The IRS issued a notice of deficiency which included a 75% fraud penalty for each tax year under section 6663. Petitioner petitioned the Court, and respondent answered detailing the allegations of fraud and praying that the 6663 penalties be approved.

Neither the deficiency notice nor respondent’s answer referenced the section 6651(f), the “fraudulent failure to file” penalty, but now the IRS wants to amend its answer to include the section 6651(f) penalty – after the trial has taken place and the case has been submitted.

Petitioner argues that different timeframes govern the analysis of whether the penalties should apply and respondent tries to minimize this argument, but the Court sides with petitioner. The Court implies that respondent may not understand the difference between a 6663 and 6651(f) penalty and cites its analysis Mohamed v. Commissioner, T.C. Memo. 2013-255, on this issue.

Section 6663 authorizes a penalty for filing a fraudulent return, and section 6651(f) authorizes a penalty for fraudulently failing to file a return.

Section 6663 can only be imposed if a return is filed, and on that return the taxpayer fraudulently misrepresents the amount of tax due. Under section 6663 the fraud occurs when a return is actually filed, not when it is due.

Section 6651(f) is imposed when a taxpayer deliberately fails to file a return to conceal the existence of income in order to evade tax. Under Section 6651(f) the fraud occurs when a return is due, not when it is actually filed.

The taxpayer’s intent at the appropriate times (date return was due and date of actual filing) is critical to determining if each penalty should be imposed. Because the trial has concluded and the IRS failed to include a section 6651(f) penalty, the reverend never had the opportunity to present facts about his intent at the time the returns were due, which is when the 6651(f) fraud would have occurred, so the Court denies respondent’s motion.

 

 

Docket No. 10936-18, Judith Lee Alston v. CIR (here)

I like highlighting when a judge goes above and beyond to help a pro se taxpayer understand the Tax Court process, because there are many other times when the Court issues a boilerplate order that seemingly lacks any attempt to ensure the taxpayer will understand it. One of the Tax Court’s strengths is the sensitivity that it demonstrates to pro se taxpayers. Perhaps the holiday season was the reason for Judge Gustafson’s extra care, but it is worth noting and commending.

In this designated order, the IRS has moved for summary judgment and the Court denies it. In doing so, the Court explains the necessity of summary judgment to judicial efficiency but also acknowledges that it can be unfair to pro se taxpayers who don’t understand what it means and don’t understand their obligation to respond. In most cases, this unfairness is remedied when the Court issues an order explaining the summary judgment process and ordering the pro se petitioner to respond to the facts and legal arguments in respondent’s motion. Judge Gustafson admits that the usual remedy is not always perfect.

Judge Gustafson gives the IRS some credit for filing the motion well in advance, the motion’s general layout, and for complying with rule 121(b) by supporting factual assertions with declarations and exhibits. But then comes the criticism, the Judge thinks respondent’s 89 paragraph motion would be very difficult for a non-lawyer to understand, because it blends factual assertions with factual rebuttal of anticipated possible counter assertions, and legal argument. He goes on and dissects specific issues with respondent’s motion and provides stern guidance on what the motion should contain and how it should be organized.

In conclusion, he states, “[I]t is not the Court’s responsibility or role to instruct counsel how to prepare filings. But we do have the responsibility of assuring a process that is understandable and fair to the self-represented petitioner. We do not know how to assure such fairness in an order directing petitioner to respond to the instant motion.”

It is likely that the IRS will redraft and refile its summary judgment motion, but the taxpayer received the gift of a little more time from the Tax Court.

 

 

Samantha Galvin About Samantha Galvin

Samantha Galvin is an Assistant Professor of the Practice of Taxation and the Assistant Director of the Low Income Taxpayer Clinic (LITC) at the University of Denver. Professor Galvin has been teaching full-time at the University of Denver since October of 2013 and teaches courses in tax controversy representation, individual income tax, and tax research and writing. In the LITC, she teaches, supervises and assists students representing low income taxpayers with controversy and collection issues.

Comments

  1. Norman Diamond says:

    “Because the trial has concluded and the IRS failed to include a section 6651(f) penalty, the reverend never had the opportunity to present facts about his intent at the time the returns were due, which is when the 6651(f) fraud would have occurred, so the Court denies respondent’s motion.”

    This is a useless victory. There is no statute of limitations on fraud so the IRS can still make a new assertion of a 6651(f) fraud. The only questions will be whether the reverend is allowed a second CDP hearing and a second Tax Court trial for the new penalties when the tax years are the same as before. (I think the 5th Amendment guarantee of due process says yes but no one cares what I think.)

    ===

    “But then comes the criticism, the Judge thinks respondent’s 89 paragraph motion would be very difficult for a non-lawyer to understand, because it blends factual assertions with factual rebuttal of anticipated possible counter assertions, and legal argument.”

    Lucky but funny. After the IRS persuaded Tax Court to block my rebuttal evidence in a Tax Court case, my subsequent complaints in other courts included rebuttals and rebuttal evidence of anticipated possible counter assertions in the complaints. The DOJ complained that the length and disjointedness were very difficult for a DOJ lawyer to understand. (In fact this non-lawyer didn’t do enough of it because I failed to anticipate that the DOJ would overturn the IRS’s acceptance of a refiled return.)

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