Assessment Statute Extension under 6501(c)(8); Changes of Address; and Lessons for Counsel – Designated Orders: December 9 – 13, 2019

My apologies for this delayed post; I had my head so buried in the Designated Orders statistics from our panel at the ABA Tax Section’s Midyear Meeting that I neglected the substantive orders from December. Worry no longer: here are the orders from December 9 – 13. Not discussed in depth is an order from Judge Guy granting Respondent’s motion for summary judgment in a routine CDP case, along with an order from Judge Gustafson sorting out various discovery disputes in Lamprecht, Docket No. 14410-15, which has appeared in designated orders now for the seventh time. Bill and Caleb covered earlier orders here and here.

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As I mentioned during the panel, Designated Orders often resolve difficult, substantive issues on the merits. These orders are no exception. There were two cases that dealt with the deductibility of conservation easements. (Really, there were four dockets resulting in an order disposing of petitioner’s motion for summary judgment from Judge Buch, and one case resulting in a bench opinion from Judge Gustafson.) I’m not going to get into the substance of conservation easements, as clients in a low income taxpayer clinic seldom run afoul of these rules. Interestingly, this is also the first time we’ve seen a bench opinion in a TEFRA case—at least one that was also a designated order.

I must wonder, however, whether the Court strikes the appropriate balance in resolving substantively complex cases, on the merits, in either manner. While neither Judge Buch’s order nor Judge Gustafson’s bench opinion could have been entered as a Tax Court division opinion—as far as I can tell, they do not break any new ground—they could both easily qualify as memorandum opinions. As a practitioner, I find value in the ability to research cases that appear in reporters—precedential or otherwise. Relegating these cases to the relatively unsophisticated search functions found on the Tax Court’s website often makes it quite difficult to efficiently conduct case research.

Perhaps the Court’s new electronic system in July will remedy some of these issues. Nevertheless, any solution that doesn’t integrate with the systems that practitioners utilize to conduct case research—namely, reporters and the third-party services that catalogue and analyze the cases issued in those reporters—strikes me as inferior.

I fully understand and appreciate the value that the Court and individual judges place on efficiently resolving cases; that is no minor concern. I’ve been informed that issuing a memorandum opinion, as opposed to resolving a case through an order or bench opinion, can tack on months to the case.

But individual judges and the Court as an institution ought to carefully consider (1) whether the Court suffers from systemic problems in efficiently issuing memorandum opinions (and whether anything can be done to remedy these problems) and (2) whether the efficiency concern outweighs practitioners’ and the public’s interest in effective access to the Court’s opinions. 

More to come on this point in future posts. But for now, let’s turn to this week’s orders.

Docket No. 13400-18, Fairbank v. C.I.R. (Order Here)

First, a foray into the world of foreign account reporting responsibilities, which Megan Brackney ably covered in this three part series in January. Here, the focus lies not on the penalties themselves, but on another consequence of failing to comply with foreign account reporting requirements: the extension to the assessment statute of limitations under section 6501(c)(8).

Petitioner filed a motion for summary judgment in this deficiency case, on the grounds that the statute of limitations on assessment had long since passed. Petitioners timely filed returns for all of the tax years at issue, but the Service issued a Notice of Deficiency for tax years 2003 to 2011 on April 12, 2018—long after the usual 3 year statute of limitations under section 6501(a).

But this case involves allegations that the Petitioners hid their income in unreported foreign bank accounts. And section 6501(c)(8) provides an exception to the general assessment statute where a taxpayer must report information to the IRS under a litany of sections relating to foreign assets, income, or transfers. If applicable, the assessment statute will not expire until 3 years after the taxpayer properly reports such information to the IRS.

The statute applies to “any tax imposed by this title with respect to any tax return, event, or period to which such information relates . . . .” This appears to be the same sort of broad authority in the 6 year statute of limitations (“the tax may be assessed . . . .”) that the Tax Court found to allow the Service to assess additional tax for the year in question, even if it didn’t relate to the underlying item that caused the statute extension. See Colestock v. Commissioner, 102 T.C. 380 (1994). While the Tax Court hasn’t explicitly ruled on this question, it is likely that it would reach a similar conclusion for this statute.  

Respondent claimed that Ms. Fairbank was a beneficial owner of a foreign trust, Xavana Establishment, from 2003 to 2009, and thus had a reporting requirement under section 6048—one of the operative sections to which 6501(c)(8) applies. Further, for 2009 and 2011, Respondent claimed that Ms. Fairbank was a shareholder of a foreign corporation, Xong Services, Inc.—again triggering a reporting requirement under section 6038 and a potential statute extension under 6501(c)(8). Respondent finally claimed that Ms. Fairbank didn’t satisfy these reporting requirements for Xong Services until June 18, 2015—thus the April 12, 2018 notice would have been timely. Moreover, Respondent claimed, Ms. Fairbank hadn’t satisfied the reporting requirements for Xavana Establishment at all.

It’s important to pause here to note that the reporting requirements under sections 6048 and 6038 are separate from the FBAR reports required under Title 31. While the Petitioners filed an FBAR report for Xong Services, they seem to argue that this filing alone satisfies their general reporting requirements for this interest. That’s just not true; foreign trusts and foreign corporations have independent reporting requirements under the Code, under sections 6048 and 6038, respectively. Specifically, Petitioners needed to file Form 3520 or 3520-A for their foreign trust; they needed to file Form 5471 for their interest in a foreign corporation. And it is failure to comply with these reporting requirements that triggers the assessment statute extension under section 6501(c)(8)—not the failure to file an FBAR (which, of course, would have its own consequences). 

Petitioners claimed that they had, in fact, satisfied all reporting requirements for Xavana Establishment at a meeting with a Revenue Agent on July 18, 2012. But it seems that the Petitioner’s didn’t submit any documentation, such as a submitted Form 3520, to substantiate this. As noted above, they further claim the FBAR filed for Xong Services in 2014 satisfied their reporting requirements. Respondent disagreed, but did allow that the reporting requirements were satisfied later in 2015 when Petitioners filed the Form 5471. 

Because Petitioner couldn’t show that they had complied with the 6038 and 6048 reporting requirements quickly enough to cause the assessment statute to expire, they likewise couldn’t show on summary judgment that the undisputed material facts entitled them to judgment as a matter of law. Indeed, many of the operative facts here remain disputed. Thus, Judge Buch denies summary judgment for the Fairbanks, and the case will proceed towards trial.

Docket No. 9469-16L, Marineau v. C.I.R. (Order Here)

This case is a blast from the past, hailing from the early days of our Designated Orders project in 2017. Both Bill Schmidt and I covered this case previously (here and here). Presently, this CDP case was submitted to Judge Buch on cross motions for summary judgment. Ultimately, Judge Buch rules for Respondent and allows the Service to proceed with collection of this 2012 income tax liability. 

They say that 80% of life is simply showing up. Petitioner had many chances to show up, but failed to take advantage of them here. Petitioner didn’t file a return for 2012; the Service sent him a notice of deficiency. While Petitioner stated in Tax Court that he didn’t receive the notice, he didn’t raise this issue (or any issue) at his first CDP hearing.

Nonetheless, the Tax Court remanded the case so he could raise underlying liability, on the theory that he didn’t receive the notice of deficiency and could therefore raise the underlying liability under IRC § 6330(c)(2)(B)—but Petitioner didn’t participate in that supplemental hearing either!

Back at the Tax Court again, Petitioner argued that not only did he not receive the notice of deficiency, but that it was not sent to his last known address. This would invalidate the notice and Respondent’s assessment. The validity of the notice also isn’t an issue relating to the underlying liability; rather, this is a verification requirement under IRC § 6330(c)(1). So, if the Settlement Officer failed to verify this fact, the Tax Court can step in and fix this mistake under its abuse of discretion standard of review.

Petitioner changed his address via a Form 8822 in 2014 to his address in Pensacola. On June 8, 2015, he submitted a letter to the IRS national office in Washington, D.C., which purported to change his address to Fraser, Michigan. The letter contained his old address, new address, his name, and his signature—but did not include his middle name or taxpayer identification number. The IRS received that letter on June 15.

The Tax Court recently issued Judge Buch’s opinion in Gregory v. Commissioner, which held that neither an IRS power of attorney (Form 2848) nor an automatic extension of time to file (Form 4868) were effective to change a taxpayer’s last known address. We covered Gregory here. (Keith notes that the Harvard clinic has taken the Gregory case on appeal.  The briefing is now done and the case will be argued in the 3rd Circuit the week of April 14 by one of the Harvard clinic’s students.) Similarly, Judge Buch deals in this order with what constitutes “clear and concise” notification to the Service of a taxpayer’s change of address.

Judge Buch held that Petitioner didn’t effectively change his address. Under Revenue Procedure 2010-16, a taxpayer must list their full name, old address, new address, and taxpayer identification number on a signed request to change address. Taxpayers do not have to use Form 8822 in order to change their address, but this form contains all the required information to do so under the Rev. Proc. Because Petitioner failed to include his middle name and taxpayer identification number, the letter was ineffective.

Judge Buch ultimately holds that the letter was ineffective because the IRS received the letter on June 15—three days before the NOD was issued. The Rev. Proc. provides that a taxpayer’s address only changes 45 days after the proper IRS offices receives a proper change of address request. The national office is not the proper office; even if it was, the IRS only had three days to process the request prior to sending out the NOD. The lesson here is that if you know a NOD is coming, you can’t quickly trick the IRS into sending it to the wrong

If that wasn’t enough, Petitioner argued that because the USPS rerouted the NOD to a forwarding address in Roseville, Michigan, the NOD should be invalidated. However, the NOD was valid because Respondent send it, in the first instance, to Petitioner’s last known address prior to any subsequent rerouting.

There being no issue with the NOD’s validity—and because Petitioner didn’t participate in the supplemental hearing—Judge Buch granted Respondent’s motion and allowed the Service to proceed with collections.

Docket Nos. 12357-16, 16168-17, Provitola v. C.I.R. (Orders Here & Here)

The Court seems a little frustrated with Respondent’s counsel in this case. These orders highlight a few foot-faults that counsel—whether for Respondent or Petitioner—ought to be careful not to make.

This case is also a repeat player in designated orders; previous order include Petitioners’ motion for summary judgment from Judge Leyden here and Petitioners’ motion for a protective order here, which I made passing mention of in a prior designated order post.

Regarding the present orders, the first order addresses Respondent’s motion in limine, which asked that the Court “exclude all facts, evidence, and testimony not related to the circular flow of funds between petitioners, their Schedule C entity, and petitioner Anthony I. Provitola’s law practice.” Judge Buch characterizes this as a motion to preclude evidence inconsistent with Respondent’s theory of the case—i.e., that the Schedule C entity constituted a legitimate, for profit business. That doesn’t fly for Judge Buch, and he accordingly denies the motion.

He then takes Respondent to task for suggesting that “The Court ordinarily declines to consider and rely on self-serving testimony.” I’m just going to quote Judge Buch in full, as his response speaks for itself:

The canard that Courts disregard self-serving testimony is simply false. We disregard self-serving testimony when there is some demonstrable flaw or when the witness does not appear credible. If we were to disregard testimony merely because it is self-serving, we would disregard the testimony of every petitioner who testifies in furtherance of their own case and of all the revenue agents or collections officers who testify that they do their jobs properly, because that testimony would also be self-serving.

Ouch. In general though, I appreciate Judge Buch’s statement.  I recall being mildly annoyed reading court opinions that disregard a witness’s testimony because it was “self-serving.” For all the reasons Judge Buch notes, quite a lot of testimony will be self-serving. That’s not, without more, a reason to diminish the value of the testimony. It’s certainly not a reason to prohibit the testimony through a motion in limine. 

The second motion was entitled Respondent’s “unopposed motion to use electronic equipment in the courtroom.” (emphasis added). Apparently, the courthouse in Jacksonville has some systemic issues in allowing courts and counsel access to electronic equipment. Of what kind, the order does not make clear, though many district courts or courts of appeals where the Tax Court sits limit electronic equipment such as cell phones, tape recorders, and other devices that litigants may wish to bring as evidence to court. IRS counsel is likely the best source of knowledge on such restrictions; here, Judge Buch notes that the Court’s already taken care of these matters on a systemic basis for the upcoming trial session.

But Respondent’s counsel again makes a foot-fault here that draws an avoidable rebuke from Judge Buch. Respondent noted in his motion that he “called petitioners to determine their views on this motion, and left a voicemail message. Petitioners did not return this call as of the date of the motion, and as a result, petitioners’ views on this motion are unknown.” 

That’s not an unopposed motion! In Judge Buch’s words again, “The title of the motion (characterizing [it] as “unopposed”) is either misleading or false. . . . Consistent with Rule 50(a), we will treat the motion as opposed.”

Of course, because the Court had already resolved the issue with electronic equipment, Judge Buch denies the motion as moot.

Trial was held on 12/16 and 12/17. Judge Buch issued a bench opinion that held for Respondent, and designated the order transmitting the bench opinion on January 27. That’s Caleb’s week, so I’ll leave it to him to cover the underlying opinion.

Seventh Circuit Affirms Tax Court’s Discretion to Weigh Actual Knowledge More Heavily than Four Positive Factors for Innocent Spouse Relief

Last summer, I alerted PT readers here to an innocent spouse case, Jacobsen v. Commissioner, T.C. Memo. 2018-115, that Keith and I were litigating in the Seventh Circuit on behalf of the Harvard tax clinic.  We took on the appeal of one year (2011) where the taxpayer did not get equitable innocent spouse relief from the Tax Court under section 6015(f) from the unreported taxes on the taxpayer’s former wife’s embezzlement income.  For that year, the Tax Court held that because the former wife was already jailed when the return was filed and because the taxpayer helped a CPA prepare the return, the taxpayer had actual knowledge of the deficiency.  Of course, while actual knowledge is fatal to relief under subsections (b) and (c), it is not supposed to be fatal under subsection (f) equitable relief.  Knowledge (whether actual or reason to know) is only supposed to be one factor of seven factors to consider under subsection (f), as elaborated on by Rev. Proc. 2013-34, 2013-2 C.B. 397.  Under the liberalizing 2013 Rev. Proc., unlike under the earlier Rev. Proc. 2003-61, 2003-2 C.B. 296, actual knowledge was now to be weighed no more heavily than reason to know in the factor analysis.  And, in the case, the Tax Court held that of the remaining factors, four were positive for relief – marital status, lack of significant benefit, compliance with future tax filing and payment obligations, and serious health issues.  So, it struck Keith and me as wrong – and as not consistent with what most Tax Court judges were doing – for the court to have still denied relief in this case.  It seemed to us that the Tax Court had not, in substance, applied the Rev. Proc. (which, concededly is not binding on the court, but which the court generally follows and purported to follow in the case).

Keith and I hoped a reversal of the Tax Court in the Jacobsen case would have a salutary effect on Tax Court judges not to overweigh the actual knowledge factor.  And, this would be the first appeals court to ever have to apply Rev. Proc. 2013-34 (surprisingly).  Then, during briefing of the appeal, Congress enacted the Taxpayer First Act, which amended section 6015(e) to add paragraph (7) providing that the Tax Court should decide innocent spouse cases on a de novo standard and a supplemented administrative record.  Because the amendment applied to pending cases, the Jacobsen Seventh Circuit opinion would also be the first to consider the impact of subsection (e)(7) on appellate review.

Well, we lost. In Jacobsen v. Commissioner, 2020 U.S. App. LEXIS 4544 (7th Cir. Feb. 13, 2020), in a published opinion, the Seventh Circuit upheld the Tax Court’s ruling, though noted that this was a close case and that, had it been the trier of fact (and not employing deferential appellate review), it might have ruled for the taxpayer.

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Given Jacobsen, I am not sure that any court of appeals will ever reverse the Tax Court on a section 6015 ruling against a taxpayer.  My research before the clinic’s taking on the appeal revealed that, while taxpayers occasionally obtained a reversal of the Tax Court under the former innocent spouse provision at section 6013(e) (in effect from 1971 to 1998); see, e.g., Resser v. Commissioner, 74 F.3d 1528 (7th Cir. 1996); no taxpayer since 1998, in 14 tries, had obtained a reversal of the Tax Court under section 6015.  See Asad v. Commissioner, 751 Fed. Appx. 339 (3d Cir. 2018); Nunez v. Commissioner, 599 Fed. Appx. 629 (9th Cir. 2015); Deihl v. Commissioner, 603 Fed. Appx. 527 (9th Cir. 2015); Karam v. Commissioner, 504 Fed. Appx. 416 (6th Cir. 2012); Maluda v. Commissioner, 431 Fed. Appx. 130 (3d Cir. 2011); Greer v. Commissioner, 595 F.3d 338 (6th Cir. 2010); Golden v. Commissioner, 548 F.3d 487 (6th Cir. 2008); Aranda v. Commissioner, 432 F.3d 1140 (10th Cir. 2005); Feldman v. Commissioner, 152 Fed. Appx. 622 (9th Cir. 2005); Alt v. Commissioner, 101 Fed. Appx. 34 (6th Cir. 2004); Doyle v. Commissioner, 94 Fed. Appx. 949 (3d Cir. 2004); Mitchell v. Commissioner, 292 F.3d 800 (D.C. Cir. 2002); Cheshire v. Commissioner, 282 F.3d 326 (5th Cir. 2002); Wiksell v. Commissioner, 2000 U.S. App. LEXIS 5857 (9th Cir. 2000).  The taxpayer losing string continues.

An interesting issue in the Seventh Circuit in Jacobsen was its discussion of the appellate standard of review in light of section 6015(e)(7).  As to what would be “inequitable” under section 6015(f), the IRS argued for abuse of discretion review, and the taxpayer argued for clear error review.  There isn’t much of a difference between the two standards, but (e)(7) was designed to prevent the Tax Court from giving deference to IRS rulings under (f), which had been held though, until Porter v. Commissioner, 132 T.C. 203 (2009), to be reviewed by the Tax Court on an abuse of IRS discretion standard.  In Porter, the Tax Court held it would henceforth decide (f) issues on a de novo standard – the position adopted by statute in (e)(7).  And at least some Tax Court judges had said that the Tax Court does not exercise equitable discretion under (f), but merely makes a factual finding of what would be “unfair”.  Cf. Hall v. Commissioner, 135 T.C. 374, 391-392 (2010) (Thornton and Holmes, JJ., dissenting) (arguing that by using the word “inequitable” in § 6015(f), Congress did not imply the rules of equity practice, but rather only meant that it would be “unfair” to hold the taxpayer liable;  “A request for relief under section 6015(f) is called a request for ‘equitable relief’ not because it is a request for reformation, rescission, specific performance, or accounting, but because to a reasonable decisionmaker at the IRS it would be unfair to hold one spouse jointly liable with another for a particular tax debt.”).  Factual findings are usually reviewed by appellate courts for clear error.  

In Jacobsen, the Seventh Circuit dodged the appellate review standard issue in the following discussion:

Although the parties agree generally that we review the Tax Court’s decisions “in the same manner and to the same extent as we review district court decisions from the bench in civil actions,” 26 U.S.C. § 7482(a)(1); Gyorgy v. C.I.R., 779 F.3d 466, 472–73 (7th Cir. 2015); Resser, 74 F.3d at 1535, they disagree as to whether that means we review the denial of relief under § 6015(f) for clear error or an abuse of discretion.

The parties’ differing views on the standard of review hinge in part on the Taxpayer First Act, legislation that was passed shortly after the parties filed their briefs. See Pub. L. No. 116-25, 133 Stat. 981 (July 1, 2019). As relevant here, § 1203 of the Taxpayer First Act added a new paragraph at the end of § 6015(e) codifying the existing practice of de novo review by the Tax Court of appeals from the denial of innocent spouse relief. Because this addition to § 6015 simply “clarified,” see Pub. L. No. 116-25, § 1203 (“Clarification of equitable relief from joint liability.”), the existing standard and scope of Tax Court review, the Commissioner maintains it has no effect on our standard of review. Thus, argues the Commissioner, denial of relief under § 6015(f) should be reviewed in the same manner as any determination of equitable relief in the district court—for abuse of discretion. See, e.g., Bowes v. Ind. Sec. of State, 837 F.3d 813, 817 (7th Cir. 2016) (explaining general applicability of abuse of discretion standard to equitable determinations).

Jacobsen, however, insists that the Taxpayer First Act confirms his position that we review decisions under § 6015(f) for clear error. Jacobsen explains his reasoning as follows: (1) the Taxpayer First Act makes equitable relief under § 6015(f) mandatory as opposed to discretionary; (2) mandatory relief under subsection (f) “is now the same as mandatory relief under subsection (b),” which also contains an inequity condition; and so (3) Tax Court rulings under subsection (f) should be reviewed under the same standard as subsection (b). Jacobsen finds further support for his position with the fact that subsection (b) is a continuation and expansion of former § 6013(e), which we held in Resser was subject to clear error review, 74 F.3d at 1535.

We are unconvinced, however, that the Taxpayer First Act (which settled only the Tax Court’s standard of review of IRS determinations) sheds any particular light on our standard of review as to relief under § 6015(f), which multiple courts have recognized as for abuse of discretion. See Greer v. C.I.R., 595 F.3d 398, 344 (6th Cir. 2010) (innocent spouse relief under § 6015(b) reviewed for clear error but equitable relief under § 6015(f) reviewed for abuse of discretion); Cheshire v. C.I.R., 282 F.3d 326, 338 (5th Cir. 2002) (same). Fortunately, we need not resolve the issue today, as we would affirm the Tax Court’s decision under either deferential standard.

Slip op. at 9-11 (emphasis in original; some citations omitted).

As to the underlying issue of whether the Tax Court could let actual knowledge outweigh four positive factors for relief, the Seventh Circuit wrote:

Because each of the factors for consideration was either neutral or favored relief, Jacobsen claims the Tax Court must have weighed knowledge more heavily than the other factors, in contravention of Rev. Proc. 2013-34 § 4.03(2)(c)(i)(A). Nothing in the Tax Court’s opinion, however, suggests that it believed knowledge of the embezzled funds necessarily precluded Jacobsen from equitable relief or automatically outweighed the other factors for consideration. Although the 2013 regulations make clear that knowledge is no longer necessarily a strong factor weighing against relief, as Jacobsen himself acknowledges in his brief, they do not prohibit the Tax Court from assigning more weight to petitioner’s knowledge if such a conclusion is supported by the totality of the circumstances. As explained in the Revenue Procedures, “no one factor or a majority of factors necessarily determines the outcome.” Rev. Proc. 2013-34 § 4.03. And although knowledge no longer weighs heavily against relief, nothing in the statute or revenue procedures forecloses the decisionmaker from concluding that in light of “all the facts and circumstances,” § 6015(f), knowledge of the understatement weighs heavily against granting equitable relief. There is thus no reason to believe the Tax Court’s decision was necessarily erroneous because only one of the nonexhaustive factors for consideration weighed against relief.

Jacobsen also suggests it was inappropriate for the Tax Court to factor his “participation in preparing the 2011 return” into its assessment, characterizing it as “another way for the court to extra-count” Jacobsen’s knowledge of the embezzlement. In assessing the role of Jacobsen’s knowledge in his entitlement to equitable relief, the court noted that in addition to Jacobsen’s actual knowledge on account of Lemmens’ criminal conviction and sentence, in 2011 Jacobsen himself provided the tax information to the paid preparer, whereas in previous years Lemmens had always prepared and submitted the tax information. Far from demonstrating that the Tax Court erred, the court’s consideration of his role in preparing the 2011 return demonstrates its commitment to heed the Revenue Procedure’s directive that the seven listed factors merely provide “guides” as opposed to an “exclusive list” and that “[o]ther factors relevant to a specific claim for relief may also be taken into account.” Rev. Proc. 2013-34 § 4.03(2).

It is clear from its opinion that the Tax Court considered the factors relevant to Jacobsen’s specific claim for relief. The court considered Jacobsen’s individual circumstances as it analyzed each of the listed factors. Jacobsen does not argue, nor could he, that the Tax Court misapprehended the facts or otherwise overlooked information relevant to Jacobsen’s claim.

We are sympathetic to Jacobsen’s situation, and recognize that the Tax Court could have easily decided on this record that Jacobsen was entitled to equitable relief under § 6015(f). Indeed, were we deciding the case in the first instance as opposed to on deferential review, we may have decided the case differently. But notwithstanding the existence of many factors favoring relief and only Jacobsen’s knowledge counseling against it, nothing in the record indicates the Tax Court misapprehended the weight to be accorded Jacobsen’s knowledge or treated it as a decisive factor barring relief. Indeed, its discussion of each of the factors as well as the relevance of Jacobsen’s involvement in preparing the 2011 taxes demonstrate that the Tax Court did not engage in a mechanical balancing of the factors where the number of factors favoring relief necessarily counterbalanced the ultimate question of whether it was inequitable to hold Jacobsen liable for the 2011 deficiencies. We thus cannot say the Tax Court either abused its discretion or clearly erred in its denial of relief for 2011.

Slip op. at 16-18 (emphasis in original; some citations omitted).

Based on our research (much of which we incorporated in the briefing in Jacobsen), the Jacobsen case is unusual in letting so many positive factors be outweighed by only one negative factor.  But, if other Circuits are going to be so deferential in reviewing the Tax Court’s weighing of factors, it is hard to imagine any taxpayer ever being able to mount a successful attack on a Tax Court judge’s weighing of the factors.  About the only chance for reversing the Tax Court may be if the Tax Court made a factual error as to whether a particular factor was positive, negative, or neutral for relief.

That brings me to Sleeth v. Commissioner, T.C. Memo. 2019-138.  Like Jacobsen, Sleeth is one of those outlier cases where the Tax Court unusually treated knowledge as outweighing multiple other factors for relief.  Sleeth is an underpayment case, where the taxpayer signed returns showing balances due (two of which were being filed late), but where the taxpayer’s husband, a doctor making $418,000 a year, failed to later fully pay the balances due that initially aggregated, in tax alone, about $354,000.  The Tax Court held that the taxpayer had reason to know that the taxes would never be fully paid because the taxpayer knew that in a prior year, the husband had once used an installment agreement.  As in Jacobsen, the Tax Court in Sleeth held that the taxpayer had not proved she would suffer economic hardship if forced to pay the liabilities, so this factor was neutral.  As in Jacobsen, the court in Sleeth found three other factors favored relief:  marital status, lack of significant benefit, and compliance with later tax return filing and payment obligations.  The main difference between the two cases is that, while Jacobsen had a serious health issue that favored relief, Sleeth did not.

Sleeth had paid counsel in the Tax Court, but she could not afford to pay counsel for an appeal.  The Harvard tax clinic, pro bono, is now representing her in an appeal to the Eleventh Circuit (Docket No. 20-10221).  If the Eleventh Circuit is as deferential as to the weighing of factors as the Seventh Circuit was in Jacobsen, Sleeth will have a hard time in obtaining victory.  However, there are arguments that the Tax Court erred in its holdings with respect to the knowledge and financial hardship factors.  So, it is still possible that Sleeth will break the unbroken string of taxpayer losses in appeals of innocent spouse cases from the Tax Court.  The appellate briefing in Sleeth has only just begun.

Unreal and Real Audits: Surgeon Finds No Relief From IRS’s “Byzantine” Exam Procedures

The recent Tax Court case of Essner v Commissioner highlights a problem when the IRS conducts both a traditional examination of taxpayer’s books and records while simultaneously contacting the taxpayer under its automated underreporter program.

Here is a simplified version of the still somewhat messy Essner facts. In 2013, Essner, a surgeon, inherited an IRA from his mother, who in turn had inherited the IRA from her husband (Essner’s father).  In 2014 Essner took a distribution of over $360,000 from the IRA.  He researched on his own the tax treatment of the distribution and concluded that the distribution was not gross income because it reflected his father’s original investment in the account. Despite Essner’s belief that the IRA reflected a nontaxable distribution, the financial institution that held the IRA issued an information return both to the IRS and Essner reflecting the distribution as taxable. Essner’s 2014 return, however, did not include the distribution as gross income.

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In March and May of 2016, Essner received letters generated from the IRS automated underreporter (AUR) program essentially noting the discrepancy between the income reported on Essner’s return and the income reported by third parties. That discrepancy was attributable to the IRA distribution that Essner did not include as income on his return. In late June of 2016 Essner sent a handwritten letter to the AUR unit saying that he disagreed with the proposed changes. The next letter Essner received from the AUR unit was a January 3, 2017 notice of deficiency reflecting the full amount of the IRA distribution as gross income.

Here is where things get even messier. After Essner sent his letter in response to the AUR notices, but before the IRS sent the notice of deficiency, Essner received a letter from IRS Tax Compliance Officer Joshi saying that the IRS was examining his 2014 federal income tax return.  The letter Joshi sent mentioned that IRS was looking into Essner’s business expenses but did not mention the IRA distribution that the AUR unit had flagged.

The opinion states that Joshi was not aware of the AUR contact and continued with his examination, focusing on expenses. On January 10, 2017, a week after IRS sent Essen a notice of deficiency, Joshi sent an examination report and proposed adjustments. A month later, in February, Joshi sent a revised exam report for 2014. Neither the original or revised report included any income from the IRA distribution. 

On March 10, 2017 Essner sent a letter to Joshi requesting that Joshi send the report to confirm that the IRA distribution was not taxable. Essner received another report and it too did not include the IRA distribution as gross income.

Recall however that the AUR office generated a notice of deficiency reflecting the IRA distribution as gross income. Essner filed a timely pro se petition, arguing initially that the distribution was not gross income. Unfortunately for Essner, at trial he was unable to secure proof of the alleged nondeductible contributions, as well as any prior distributions or withdrawals of those contributions, so he was unable to carry his burden of proof on the issue.

At trial, he also alleged that the IRS actions amounted to a duplicative examination of the same year and tax. While IRS has broad powers to examine tax returns to ensure that the return reflects a taxpayer’s liability, Section 7605(b) contains a general statutory protection against unnecessary or repeat taxpayer examinations for the same tax year. The idea behind 7605(b) is to limit burdens on taxpayers, including time and expense associated with responding to multiple requests for information.

Essner’s argument was that because the AUR contacts and Joshi’s examination ran concurrently, taken together they violated the duplicate exam restriction of Section 7605(b). In addition, he argued that the correspondence showed that “Joshi’s examination was unnecessary (given that it extended past the date when the AUR program generated the notice of deficiency with respect to 2014) and that it required an unauthorized second inspection of petitioner’s books and records (given that Officer Joshi’s examination ran parallel to and appears to have come to positions at odds with the AUR adjustments that underlie the IRS’ position taken in the notice).” 

The IRS argued, as it has in the past, that any contact stemming from AUR is not an examination for purposes of 7605(b) because it derives from a review of third-party records and not the taxpayer’s books and records.

The opinion sympathized with Essner but held that 7605(b) provided no basis for relief on this case:

At the outset, we note that petitioner’s interactions with the IRS–both through the AUR program and his correspondence with Officer Joshi–would be confusing to an ordinary taxpayer. Various offices of the IRS contacted petitioner without coordination, without clarity as to what the other parts were doing, and without providing petitioner a clear explanation as to why the IRS was speaking out of many mouths. A taxpayer ought not to have been subjected to such a byzantine examination. However, we are not empowered to police what ought to have occurred in an examination; we are limited to considering whether section 7605(b), as written, was violated. See Greenberg’s Express, Inc. v. Commissioner, 62 T.C. 324, 327 (1974). (emphasis added)

The opinion continues and notes that 7605(b) does not address contacts that stem from the IRS’s receipt of information returns:

Under section 7605(b), the AUR program’s matching of third-party-reported payment information against petitioner’s already-filed 2014 tax return is not an examination of petitioner’s records. See Hubner, 245 F.2d at 38-39. Therefore, no second examination of petitioner’s books and records could have occurred, regardless of the concurrent actions of Officer Joshi. Additionally, as we have found above, petitioner failed to properly report income from the 2014 distribution from the retirement account, and he has conceded other adjustments for tax year 2014. Therefore, respondent’s examination of petitioner’s 2014 tax return was not unnecessary. While we understand petitioner’s frustration with the process of this examination, we cannot say that a failure to communicate and coordinate within the IRS–standing alone–violates section 7605(b). We therefore agree with respondent. 

Conclusion

The IRS’s failure to coordinate its communications as typified in Essner is likely to generate confusion. It is inconsistent with the right to finality, impinges on a taxpayer’s right to be informed and is in tension with a taxpayer’s right to a fair and just tax system. Carving out from 7605(b) protection “unreal” audits like AUR contacts is an issue that the Taxpayer Advocate Service has repeatedly flagged in its annual reports as a most serious problem. (For some more on the TAS view and IRS disagreement with TAS see the FY 2019 Objectives Report at page 38). 

The opinion in Essner rightly reflects concern with the IRS practice. IRS should revisit the limited rights taxpayers are afforded in unreal audits like AUR correspondence (including no right to Appeals review prior to the issuance of a 90-day letter), and should at a minimum strive to ensure that a concurrent examination sweeps in any issues that are raised in AUR correspondence.  Subjecting taxpayers to inconsistent and uncoordinated communication is far from best practice and creates burdens that are inconsistent with a taxpayer rights–based tax administration and the concerns that underlie Section 7605(b). Absent IRS policing itself perhaps it is time for a legislative fix that more directly addresses the growing importance of unreal audits and the burdens they impose.

Mailing the Collection Due Process Request

The IRS recently released a program manager technical assistant (PMTA) memo entitled Treatment of Incorrectly-addressed CDP Hearing Requests.  This memo reverses the advice of a similar memo written in 2013.  The issue concerns the fate of taxpayers seeking to obtain a Collection Due Process (CDP) hearing who timely mail their CDP hearing request to what the IRS considers to be the wrong office.  In the 2013 advice the IRS took the position that if the “wrong” IRS office got the request to the “right” IRS office before the end of the CDP request period (which differs slightly depending on whether it is a lien or levy case but in both instances is a short window of approximately 30 days from the date the IRS sends the notice), then the taxpayer could have a CDP hearing.  If, however, the wrong office did not get the notice to the right office within the 30-day period, the taxpayer lost the right to have a CDP hearing and would receive only an equivalent hearing.

I wrote an article about this issue in Tax Notes in November of 2018 available here.  The article builds on the work of the tax clinic at Harvard concerning jurisdiction and explains that the 30-day time period to request a CDP hearing is not a jurisdictional time period.  We discussed this issue previously here, here and here.  In the PMTA the IRS essentially agrees with the conclusion that the notice need not be received in the “right” IRS office within the 30-day window, though the PMTA does not address the issue using jurisdictional language in the portion of the PMTA made available to the public.  Perhaps the IRS is concerned that taxpayers might litigate about this issue.  Imagine.

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One of the biggest hurdles facing taxpayers seeking a CDP hearing is the CDP notice.  Not only is the notice that the IRS sends generally not well-designed to give someone notice of an impending deadline impacting their right to go to court, but the notice provided affirmatively confusing instructions concerning where to send the request for a CDP here.  The IRS acknowledged in the PMTA that the notice was not a model of clarity:

This CDP notice can take many forms depending on, for example, the type of collection action (NFTL filing, levy), the issuing component (Automated Collection, Field Collection), and the type of levy (Federal Payment Levy Program, State Income Tax Levy Program). Some notices, like the LT11, serve the dual purpose of informing the taxpayer of their CDP rights and soliciting payment. To facilitate this dual purpose, the notices have one address for submitting the hearing request printed at the top of the first page, and another address for submitting payment printed on a removable payment voucher at the bottom of the first page. These notices are printed double-sided, and the payment address is printed to appear through the cellophane window on the envelope enclosed with the letter. Because the notices are printed double-sided, in addition to appearing on the top of the first page, the mailing address for the CDP hearing request may also be printed on the reverse side of the payment voucher. The payment voucher and CDP hearing request addresses may be the same, but often times they are not. Thus, for this type of notice, the taxpayer can inadvertently mail the CDP hearing request to the payment voucher address simply by inserting the voucher in the envelope backwards. In addition to the LT11, the CP92, CP77/78, and CP90/297 have the payment address printed on one side of the voucher and the mailing address for the CDP hearing request printed on the other side. Other notices, like the Letter 3172, do not solicit payment, but they do have the originating address at the top of the page and the mailing address for a CDP hearing request at the bottom of the page.

So, the IRS suggested giving taxpayers a CDP hearing if the request for the hearing is mailed to the IRS within the appropriate time frame:

Because of the confusion caused by including multiple addresses on current versions of the CDP notices, we recommend that the Service determine timeliness based on the date the request was mailed to the wrong office, so long as the address of the wrong office was shown on the CDP notice (such as the payment voucher address on the LT11 or the originating office on the Letter 3172). This recommendation does not conflict with Treas. Reg. §§ 301.6320-1(c)(2) Q&A-C6 & 301.6330-1(c)(2) Q&A-C6, which state that taxpayers must send the CDP hearing request to “the IRS office and address as directed on the CDP notice.” Any addresses on the notice should be deemed the “address as directed on the CDP notice.” The June 2013 PMTA should no longer be followed.

This change in advice should open up the CDP process for a number of taxpayers who send their request to the wrong place.  This is not necessarily the end of the story about timeliness and the CDP request.  Certainly, if a taxpayer mails the request late but has a good reason for doing so, the late mailing of the CDP request should not act as an automatic bar to obtaining a CDP hearing.  Taxpayers in this situation should look to the arguments regarding jurisdiction and equitable tolling to fine situations in which even a late mailed request could still result in a CDP hearing.

The PMTA is welcome news.  The CDP summit work, described in prior posts here and here, deserves credit for engaging the IRS to make improvements in this area.  I hope that this is one of many improvements that the IRS can make administratively.  I also hope this effort also suggests that the IRS will take a hard look at the CDP notices that it issues and the location for making a CDP request.  The notices need significant restructuring to make them more appropriate vehicles for informing taxpayers of their right to a CDP hearing.  The current notices place far too much emphasis on seeking payment and too little information on the right to request a hearing.  I know that members of the CDP summit would be happy to work with the IRS to help to write more effective notices that protect and preserve taxpayer rights.

Additionally, the IRS could make it much easier to make the request by picking a single point of contact for the nation.  It could create a single fax number such as the one used by the CAF unit.  It could create a single mailing address.  The process of making the request does not need to be complicated.  The IRS can move the information around from the single point of contact to the offices that need the information.  It does this regularly with Tax Court petitions, powers of attorney and other documents.  Doing so would also be consistent with the practices of other federal agencies who have similar types of hearing requests being received.

Kudos to the IRS for taking this step.  Let’s work together to keep up the momentum.

Working Through an Employer’s Failure to File Form W-2 or 1099 with the IRS

We welcome guest blogger Omeed Firouzi to PT. Omeed is a Christine A. Brunswick public service fellow with Philadelphia Legal Assistance’s low-income taxpayer clinic, and he is an alum of the Villanova Law Clinical Program. His fellowship project focuses on worker classification. In this post, Omeed examines a recent case where the taxpayer unsuccessfully sought relief under section 7434 for her employer’s failure to report her compensation to the government at all. Litigation in this area is likely to continue. Christine

Tax season is upon us so I would be remiss if I did not cite fellow Philadelphian Ben Franklin’s famous maxim that “in this world nothing can be said to be certain, except death and taxes.” But whether you are filing your return as soon as possible or at 11:59 PM on April 15, there is one thing that is uncertain for many taxpayers: whether your employer filed an information return.

As we have seen in our clinic at Philadelphia Legal Assistance and more broadly, employers are increasingly not filing income reporting information returns with the Social Security Administration (SSA) and the Internal Revenue Service (IRS). The Internal Revenue Manual, at IRM 21.3.6.4.7.1, describes the proper procedure for IRS employees to follow should a taxpayer not receive an information return. The IRS website also provides tips and tools for how taxpayers should proceed in such situations.

Under the Internal Revenue Code and regulations promulgated under the Code, employers could be held liable – and subject to penalties – for failure to file correct information returns. However, the IRC and its accompanying regulations lack a clearly defined legal recourse for individual taxpayers when the employer fails to file any information return at all. No explicit cause of action exists for workers in this predicament. Recently, a taxpayer in New York unsuccessfully tried to make the case that 26 U.S.C. Section 7434 encompasses this situation.

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The statute states, in part:

If any person willfully files a fraudulent information return with respect to payments purported to be made to any other person, such other person may bring a civil action for damages against the person so filing such return.

This statute has been the subject of several previous Procedurally Taxing posts. As these posts described in detail, courts are in consensus that the statute at least encompasses an employer’s willful misstatement on an information return of the amount of money paid to a worker. The legislative history of Section 7434 reveals that when Congress drafted the legislation in 1996, its authors were concerned with the prospect of “taxpayers suffer[ing] significant personal loss and inconvenience as the result of the IRS receiving fraudulent information returns, which have been filed by persons intent on either defrauding the IRS or harassing taxpayers.” 

The case law is split on whether misclassified taxpayers can use Section 7434 to file suit against their employers for fraudulently filing a 1099-MISC rather than a W-2, if the dollar amount reported is correct. No circuit court has ruled on the issue but most courts have followed the lead of the U.S. District Court for the Eastern District of Virginia and its Liverett decision that found that Section 7434 does not apply to misclassification.

However, one aspect of Section 7434 where there is judicial consensus is that the statute does not encompass the non-filing of an information return.

The U.S. District Court for the Eastern District of New York recently joined the chorus of courts on this issue. In Francisco v. Nytex Care, Inc., the aforementioned New York taxpayer argued that her former employer, NYTex Care, Inc., violated Section 7434 by “failing to report payments made” to the taxpayer and other workers. The facts of the case are straightforward. Taxpayer Herlinda Francisco alleged NYTex Care, a dry cleaning business, “fail[ed] to identify [her] and other employees as employees” by failing to file information returns for tax years 2010, 2011, 2012, 2013, 2014, 2015, and 2016. Francisco filed suit under Section 7434 alleging that NYTex “willfully and fraudulently filed false returns…by failing to report” employees’ income.

The court principally cited Second Circuit precedent, set in Katzman v. Essex Waterfront Owners LLC, 660 F.3d 565 [108 AFTR 2d 2011-7039] (2d Cir. 2011) (per curiam), in dismissing the case. Katzman established that Section 7434 “plainly does not encompass an alleged failure to file a required information return.” In Nytex, the employer “did not report payments made” to the taxpayer and other employees but the court found that Section 7434 was not the appropriate remedy.

More broadly, the Nytex court examined the plain language of Section 7434, its legislative history, and other relevant case law in foreclosing this claim. The plain text of the statute, the court noted, necessitates a filing by definition; there must be a filed information return in order for it to be fraudulent. The court also looked to Katzman’s parsing of congressional intent for guidance; in Katzman, the Second Circuit ruled explicitly that “nothing in the legislative history suggests that Congress wished to extend the private right of action it created to circumstances where the defendant allegedly failed to file an information return.”

Further, the court even relied upon another case the same plaintiffs’ attorney brought in the Southern District of New York. In Pacheco v. Chickpea at 14th Street, Inc., the plaintiff there also brought suit under Section 7434 on the basis of the failure of their employer to file information returns but the Southern District “found [that situation] was not covered by the statute.” Ultimately, the Nytex court granted the Defendants’ motion to dismiss for failure to state a claim upon which relief can be granted because the court found no cognizable claim for alleged failure to file an information return under Section 7434.

The result in Nytex leaves it frustratingly unclear what remedies exist for workers who find themselves in this taxpayer’s predicament. Had the employer here actually filed a 1099-MISC with the IRS, a potential argument could’ve been made about misclassification and whether that is encompassed by Section 7434. There is more division in the courts about that issue as opposed to the question posed in Nytex. Had the employer willfully overstated the amount the taxpayer was paid, the court could’ve found a clear Section 7434 violation, based on the reporting of a fraudulent amount.

Of course, neither of those things happened here. Instead, there is an aggrieved taxpayer ultimately unable to rely on a statute that is both ambiguous and seemingly limiting all at once. Practically, she is left with no clear way to sort out her own tax filing obligations when no information returns were filed. The court interestingly does not identify an alternative course of action, or judicial remedy, the taxpayer could seek.

In relying on congressional intent, the court leaves the reader wondering if Congress ever envisioned that an employer’s failure to file an information return could cause “significant personal loss and inconvenience” to the worker. If it means a frozen refund check as part of an IRS examination, there is certainly loss and inconvenience there. As Stephen Olsen described at length previously, courts have deeply examined the statutory language in terms of whether the phrase “with respect to payments made” only modifies “fraudulent” or if the information return itself could be fraudulent even if the payment amount is correct.

That discussion raises an interesting question as it relates to Nytex: if a court found an actionable claim for non-filing under section 7434, how would it determine whether the failure to file was fraudulent or whether there was willfulness in the non-filing? Since there would be no information return, would the court be forced to look at what kind of regular pay the taxpayer got to ascertain what the information return likely would’ve been?

Then, the court would have to find that there was “willfulness” on the part of the employer, not merely an inadvertent oversight. To make matters more complex, the court would have to likely wrestle with how there could be a willful act in a case where the employer did not even act at all. If a court found willfulness, a potential argument could be that a non-filing is analogous to filing an information return with all zeroes on it thus leading the court to say it is, in effect, fraudulent in the amount.

For now though: what can a taxpayer do in such a situation? When employers fail to provide or file information returns, the IRS recommends that workers attempt to get information returns from their employers. If that fails, the IRS advises workers to request letters on their employer’s letterhead describing the pay and withholding. Should an employer not comply with these requests, the IRS can seek this information from an employer while taxpayers can file Substitute W-2s attaching other proof of income and withholding – such as bank statements, paychecks, and paystubs. If a taxpayer got an information return but the employer never filed it with the government, that might ease the burden on the taxpayer but the IRS will still seek additional verification.

Even then, taxpayers could get mired in lengthy audits and examinations all while waiting for a critical refund check they rely on to make ends meet every year. We have seen this pattern play out in our own clinic and I suspect as it befalls more taxpayers, there may be either a congressional or judicial reexamination of Section 7434 or another effort to address the problem of non-filing of information returns.

Logic Loses in Taxpayer’s Effort to Recover Attorneys’ Fees

We welcome first-time guest blogger Professor Linda Galler to PT. Professor Galler is a co-author of the chapter, “Recovering Fees and Costs When a Taxpayer Prevails” in the forthcoming edition of Effectively Representing Your Client Before the IRS. Among Professor Galler’s many consulting, teaching, and scholarly pursuits, she directs the tax clinic at Hofstra University’s Maurice A. Deane School of Law.

In this post Professor Galler examines a recent decision denying a taxpayer fees and costs against the IRS. (Bryan Camp also covered the case here.) For those galvanized to learn more about qualified offers after reading this post, I recommend guest blogger Professor Ted Afield’s post on nominal offers, and Stephen Olsen’s grab bag of cautionary tales. Christine

Taxpayers rarely recover attorneys’ fees in tax cases despite the existence of a statute specifically providing for such recoveries. The Tax Court’s recent decision in Klopfenstein v. Commissioner, TC Memo 2019-156 (Dec. 9, 2019), is an example of why: the statutory requirements and the manner in which they are interpreted are overly exacting and counterintuitive. Klopfenstein involved a settlement of assessed penalties at Appeals for ten cents on the dollar – a 90 percent reduction in an assessed penalty – clearly raising the question of whether the government’s position in the case was substantially justified. Yet, in an opinion that relied heavily on established precedent, the court concluded that the IRS never took a “position” within the meaning of the statute and therefore that the taxpayer could not recover attorneys’ fees.

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This essay does not argue the merits of recovery in Klopfenstein or in general. Clearly, there are policy arguments on both sides. Rather, the point is to both demonstrate the fruitlessness of seeking attorneys’ fees and to commend the taxpayer’s attorneys for having tried nonetheless.

Mr. Klopfenstein’s court filings describe him as an “investor, investment banker, and merchant banker” who “earned an MBA in finance and accounting from Emory University” and “is licensed as a CPA and as an investment banker.” In 2005, the IRS commenced a tax shelter investigation for 1998 through 2001 with respect to entities that Mr. Klopfenstein controlled. In November 2014, Exam issued a Notice of Proposed Adjustment (“NOPA”) asserting that Mr. Klopfenstein was a material advisor who failed to disclose reportable transactions as required by section 6111. The NOPA referenced more than 24 alleged transactions, which the IRS asserted should have been registered as tax shelters, and proposed penalties under section 6707 in excess of $1.6 million.

Mr. Klopfenstein timely requested that his case be considered by Appeals, which assigned the case to an Appeals Officer (“AO”) in October 2015. The penalties were assessed in March 2016 and the IRS immediately began collection efforts, culminating in the filing of notices of federal tax lien in two states. Meanwhile, the AO held a pre-conference meeting with Mr. Klopfenstein, his attorneys and Exam personnel in June 2016 and a settlement conference in August. A settlement was reached under which Mr. Klopfenstein agreed that he was liable for a section 6707 penalty of approximately $170,000 for 1998 and that he was not liable for penalties in an any other year. The settlement was memorialized in a closing agreement, which was returned to Mr. Klopfenstein, signed, on November 30, 2016. The following month, the IRS abated more than $1.4 million of the assessed penalties, roughly 90% of the original assessment.

On February 27, 2017, Mr. Klopfenstein submitted a request for reasonable administrative costs (attorneys’ fees) under section 7430(a)(1), contending that he was a “prevailing party” and therefore was entitled to an award for attorneys’ fees and costs incurred during the administrative proceeding. The IRS denied the request and Mr. Klopfenstein filed a petition with the Tax Court seeking review of the IRS’s action. Both parties filed motions for summary judgment limited to the question whether Mr. Klopfenstein was a prevailing party within the meaning of section 7430.

A taxpayer may recover costs under section 7430 by satisfying four requirements:

  1. The costs must be incurred in an administrative or court proceeding in connection with the determination, collection, or refund of tax, interest, or penalties;
  2. the taxpayer must exhaust all administrative remedies;
  3. the taxpayer must not unreasonably protract the proceedings; and
  4. the taxpayer must be the prevailing party.

(In addition, only taxpayers who satisfy certain net worth requirements qualify.) The term “prevailing party” is defined in section 7430(c)(4)(A) as the party who has substantially prevailed with respect to either the amount in controversy or the most significant issue or set of issues presented. Given the difference between the penalties asserted and those ultimately agreed upon in the settlement, the IRS agreed that Mr. Klopfenstein had substantially prevailed with respect to the amount in controversy.

Under section 7430(c)(4)(B), a party may not be considered the prevailing party if the government establishes that its position in the proceeding was substantially justified. Section 7430(c)(4)(B) defines the government’s position in an administrative proceeding as its position on the earlier of (i) the date on which the taxpayer received Appeals’ notice of decision or (ii) the date of the notice of deficiency. The court held in the government’s favor, explaining that a party can never be a prevailing party unless the IRS has taken a position that is “crystallized” into either one of those documents. As to the first, Mr. Klopfenstein’s case was settled at Appeals so no decision was issued. As to the second, taxpayers can never recover fees under this prong in proceedings involving assessed penalties, where a notice of deficiency is not issued. Consequently, Mr. Klopfenstein could not have been a prevailing party.

Mr. Klopfenstein’s losing argument was based on the structure of the statute. Section 7430(c)(4)(B) is an exception to the definition of prevailing party in section 7430(c)(4)(B). (Indeed, it is captioned as an exception.) Thus, if Mr. Klopfenstein substantially prevailed with respect to the amount in controversy (which the government conceded), he is the prevailing party unless the government establishes that its position was substantially justified. Logically, in Mr. Klopfenstein’s view, if the government never took a position (which the government also conceded), then Mr. Klopfenstein must be a prevailing party.

Mr. Klopfenstein’s argument is logical, reasonable and consistent with the statutory language. Indeed, a commonsense definition of “prevailing party” in the context of litigation likely would encompass a party whose adversary “lost” with respect to 90 percent of its claim. Thus, whether or not a denial of attorneys’ fees in cases such as this makes sense as a matter of policy, the viewpoint adopted by this court (based though it was on precedent) is awkward at best.

Had the government conceded that it took a position in the case, Mr. Klopfenstein might not have succeeded in recovering fees in any event. Under section 7430(c)(4)(B), attorneys’ fees are not awarded if the government establishes that its position was “substantially justified.” Substantial justification is a relatively low standard. It requires merely that the position have a reasonable basis in law and in fact. Treas. Reg. § 301.7430-5(d).

The best way to overcome the substantial justification hurdle is to make a qualified offer. Simply stated, if the IRS does not accept a taxpayer’s qualified offer to settle a case and the taxpayer receives a judgment that is equal to or less than the offer, the taxpayer is deemed to be the prevailing party; whether the government’s position was substantially justified or not is irrelevant. (The qualified offer rule is set forth in section 7430(c)(4)(E).) Unfortunately for Mr. Klopfenstein, however, the qualified offer rule applies only if a judgment is entered in a court proceeding. Because the case was settled before a court proceeding had commenced, the qualified offer rule did not apply.

Addendum: The Tax Court has jurisdiction to review IRS decisions whether to grant or deny (in whole or in part) requests for attorneys’ fees. Section 7430(f)(2); Tax Ct. R. 271. In docketed cases, the taxpayer must raise the claim during the case itself; res judicata precludes consideration of costs in a subsequent proceeding to the extent that the issue could have been pursued in the earlier case. Gustafson v. Commissioner, 97 T.C. 85 (1991); Foote v. Commissioner, T.C. Memo. 2013-276. Where the matter has been resolved administratively, the taxpayer must file a petition with the Tax Court within 90 days after the date on which the IRS mails a notice of decision. The taxpayer, not the attorney, is the proper party to file the claim. Greenberg v. Commissioner, 147 T.C. 382 (2016).

Disbarment of Attorney by Tax Court Reversed by D.C. Circuit

In Koresko v. U.S. Tax Court, No. 18-1146 (D.C. Cir. 2019) the court reversed the disbarment of Mr. Koresko from the Tax Court and remanded the case so that the Tax Court could give him the opportunity for a hearing before being disbarred, otherwise disciplined or exonerated.  I read the short order from the circuit court remanding this case and became curious why the Tax Court would decline to give him a hearing before taking him off the record of approved attorneys.  So, I had my research assistant pull the underlying documents including the briefs. 

I will link to the documents so that anyone interested in the matter can easily access them.  After quickly reviewing them, I understand what happened at the Tax Court.  I found that the Tax Court was incredibly understanding and postponed the matter over a period of years.  The new opportunity for a hearing is unlikely to change the outcome here, but the case gives a glimpse at the process for those interested.  I wrote about a Tax Court disciplinary proceeding a couple of years ago regarding Aka v. United States Tax Court, 854 F.3d 30, 32 (D.C. Cir. 2017).  Bob Kamman wrote about an order setting a hearing for a disciplinary proceeding. 

Both the Aka case and the case Bob covered involved failures of petitioner’s counsel in proceedings before the Tax Court.  The Koresko case involves the reciprocal disciplinary issue present in the Tax Court when another court or bar disciplines a practitioner. Mr. Koresko did nothing in his practice before the Tax Court to cause the Tax Court to initiate disciplinary proceedings against him the way it did against Mr. Aka. But Tax Court Rule 202 requires that a practitioner notify the Tax Court of any disciplinary action by another court or bar and can base its own disciplinary action on the action of the other venue.  The issue here stems from multiple problems between Mr. Koresko and Pennsylvania, their timing and the timing of his failures to respond to the Tax Court’s offers of a hearing.

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Here is the Tax Court’s announcement of the disbarment of Mr. Koresko and its explanation of the reason for the disbarment.  Here is the Department of Justice brief to the D.C. Circuit which provides the best road map for understanding the case.  Here is Mr. Koresko’s brief to the D.C. Circuit.  Here is the order of the Pennsylvania Supreme Court and the Report and Recommendations of the Disciplinary Board of the Supreme Court of Pennsylvania.  There is more here to read than most will want.  I will summarize the issues, drawing heavily from the DOJ brief.

Mr. Koresko’s initial problem with the PA bar (as far as these proceedings go) concerns actions with respect to an ERISA plan.  Then he gets in trouble relating to the sale of a home owned by he and his wife to the tenant.  When he sold the property he did the legal work for the title policy.  The property had two liens against it.  One lien was satisfied with the proceeds of the sale.  The other lien resulted from a suit against Mr. Koresko.  He contested the validity of this judgment lien; however, he failed to mention it in the title report or to the buyer.  The existence of this lien came to light when the holder of the lien sued Mr. Koresko and the buyer.  Things went downhill from there with a number of his problems with the PA bar stemming from actions in the ensuing litigation.  As with the Tax Court disbarment proceedings, the matter before the PA bar took quite some time.  If nothing else, Mr. Koresko has definite skills in prolonging proceedings.

Here is a description from the DOJ brief:

The action that gave rise to this appeal arose from orders to show cause issued by the Tax Court due to (1) the Pennsylvania Supreme Court’s December 19, 2013 emergency suspension of Koresko’s license to practice of law, premised on misconduct connected to his fiduciary duties under the Employee Retirement Income Security Act of 1974, 28 U.S.C. §§ 1001, et seq., (“ERISA”) with regard to certain employee welfare benefit plans and (2) the Pennsylvania Supreme Court’s September 14, 2015 disbarment of Koresko, premised on “multiple litigation actions by Mr. Koresko from 2008 through 2013 related to the sale of a home by Mr. Koresko and his ex-wife to a tenant.” (A205-06.) It was also based on Koresko’s failure to inform the Tax Court of these and other disciplinary actions. (A205.) It is the Tax Court’s understanding that (in addition to Pennsylvania Supreme Court), the Florida Supreme Court, the United States Supreme Court, and the Eastern District of Pennsylvania have also disbarred Koresko, and that the Third Circuit has indefinitely suspended him. (See In re Koresko, 136 S. Ct. 2535 (2016) (Mem.); Florida Bar v. Koresko, 2016 WL 4143279 (Fla. 2016); A186.)

The DOJ brief also addressed the efforts of the Tax Court to deal with his case:

the Tax Court issued four orders to show cause, outlining precisely the bases for reciprocal discipline and for finding Koresko had violated Tax Court Rule 202(b) and Model Rule 3.4(a) by failing to alert the Tax Court to disciplinary actions taken by other courts. (A7-8; A97-99; A141-46; A184-87.) These orders provided ample notice of the bases for discipline.

The brief detailed the notice provided and the action taken:

the Tax Court offered the following potential hearing dates, with clear notice deadlines:

Order dateOffered hearing dateRequired notice dateCitation
3/19/20147/16/20144/22/2014A7
4/26/20147/16/20146/24/2014A14
6/27/201410/9/20148/15/2014A96
10/6/201412/16/201411/25/2014A99
5/16/20166/28/20166/10/2016A145

The D.C. Circuit’s problem is that although Mr. Koresko did not respond timely to the timeframes set by the Tax Court, the Tax Court focused on his failure to request a hearing in early orders that were based on his suspension from the PA bar and not on the orders issued later after the PA bar disbarred him.  So, his case will go back to the Tax Court which will offer him another opportunity for a hearing.  Assuming that he timely accepts the new hearing, Mr. Koresko then faces the uphill battle to convince the Tax Court that it should not disbar him or take other disciplinary action.  I would not expect the matter to move quickly based on what I have seen so far. 

I am not sure the case offers many lessons, but it does provide insight into the disciplinary efforts of the Tax Court in a reciprocal discipline matter and serve as a reminder that if any readers have friends or acquaintances who encounter disciplinary problems at the local level, they need to advise their friends and acquaintances to notify the Tax Court.  Because the Tax Court is not the only bar with reciprocal discipline, it should also be noted that if you have a problem like Mr. Aka’s that originates in the Tax Court, that problem can impact a practitioner’s ability to practice in other bars to which the practitioner may be a member.  The main lesson from reading bar discipline cases is to avoid doing the things that bring these actions down upon you.  Only a small minority of practitioners go through this process at the Tax Court.  Make sure you are not a member of that minority.

Graev and the Trust Fund Recovery Penalty

The Tax Court is marching through the penalty provisions to address how Graev impacts each one.  It had the opportunity to address the trust fund recovery penalty (TFRP) previously but passed on the chance.  In Chadwick v. Commissioner, 154 T.C. No. 5 (2020) the Tax Court decides that IRC 6751(b) does apply to TFRP and that the supervisor must approve the penalty prior to sending Letter 1153.  Having spoiled the ending to the story, I will describe how the court reached this result. See this post by Bryan Camp for the facts of the case and further analysis.

This is another decided case with a pro se petitioner, in which the petitioner essentially dropped out and offered the court very little, if any, assistance.  The number of precedential cases decided with no assistance from the petitioner continues to bother me.  I do not suggest that the Tax Court does a bad job in deciding the case or seeks to disadvantage the taxpayer, but, without thoughtful advocacy in so many cases that the court decides on important issues, all taxpayers are disadvantaged — and not just the taxpayer before the court.  Clinics and pro bono lawyers have greatly increased the number of represented petitioners in the Tax Court over the past two decades, but many petitioners remain unrepresented. These unrepresented petitioners, by and large, do not know how to evaluate their cases and how to represent themselves, which causes the court to write opinions in a fair number of pro se cases relying on the brief of the IRS and the research of the judge’s clerk in creating a precedential opinion.  Should there be a way to find an amicus brief when the court has an issue of first impression, so that subsequent litigants do not suffer because the first party to the issue went forward unrepresented?

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The real question here is whether the TFRP is a tax or a penalty.  The IRS argues that IRC 6751(b) does not apply to the TFRP because it is a tax.  We know it’s a tax because the Supreme Court has told us so in Sotelo v. United States, 436 U.S. 268, 279 n.12 (1978).  In Sotelo the Supreme Court sought to characterize the TFRP for purposes of bankruptcy.  In bankruptcy getting characterized as a penalty has very negative consequences with respect to priority classification, discharge and even chapter 7 priority of secured claims.  We have written about several code sections that bankruptcy courts have characterized from tax to penalty or vice versa based on the Supreme Court’s analysis in Sotelo.  You can find a couple of those posts here, and here

So, if TFRP acts as a tax for purposes of bankruptcy, should it, could it act as a penalty for purposes of 6751(b)?  While the Tax Court had skirted the issue previously, the Southern District of New York had decided it head on in United States v. Rozbruch, 28 F. Supp. 3d 256 (2014), aff’d on other grounds, 621 F. App’x 77 (2nd Cir. 2015).  In Rozbruch the court held the TFRP a tax that did not require penalty approval under IRC 6751(b).

The TFRP does not seem like the kind of penalty Congress intended when it worried about using penalties as a bargain chip.  The TFRP is the chip.  It imposes on the responsible person or persons the unpaid tax liability of the taxpayer charged with collecting taxes on behalf of the United States, who failed to fulfill that responsibility.  Good reasons exist not to apply IRC 6751(b) in the TFRP context.  The reasons could have made for another contentious Tax Court conference in the Graev Conference Room, but no one at the court seemed up for the fight.

Instead, the Tax Court settles for a straightforward determination that Congress put the TFRP in the penalty sections of the code, Congress called the TFRP a penalty, and it has some features of a penalty to support its label as a penalty.  While acknowledging that the Supreme Court has held that for bankruptcy purposes TFRP will act as a tax, the Tax Court says that does not mean it isn’t a penalty, citing the wilfullness element necessary to impose the TFRP.  It also finds that the assessable feature of the TFRP supports the penalty label.  So, without a decent fight between Tax Court judges, we get the result that the Tax Court finds the TFRP to be a penalty.  This fight may not be over if the IRS wants to bring it up again.  Unlike lots of liabilities that primarily if not exclusively get decided in Tax Court, matters involving the TFRP primarily get decided in district courts.  Only in the CDP context will the Tax Court see a TFRP case.  So, this may not be the end of road for this issue.

Having decided that the TFRP is a penalty, the Tax Court then decided when the “initial determination” occurred.  Relying on its recent opinion in Belair Woods LLC v. Commissioner, 154 T.C. 1 (2020), the Tax Court decided that the initial determination of the penalty assessment was the letter sent by the IRS to formally notify the taxpayer that it had completed its work.  In the TFRP context this is Letter 1153.  Here the IRS had obtained the right approval prior to the sending of this letter and the court upheld the TFRP.

The Court reaches a taxpayer-friendly conclusion that the IRS must obtain supervisory approval prior to the application of this unusual provision and perhaps did not find any judges putting up a fight against that result because it was taxpayer-friendly.  As with most 6751 decisions, it’s hard to say what Congress really wanted in this situations.  The result here does not bother me.  Certainly, the result has logical support, but the opposite result would have logical support as well.  It will be interesting to see if the IRS wants to fight about this further in the district courts or if it will just acquiesce.  At the least the IRS will want to cover its bases by timely giving the approval, even if it thinks the approval is unnecessary.  The first time a large TFRP penalty gets challenged and the approval was not timely given, the IRS will have to swallow hard before giving up the argument entirely.