Another Case Denying Attorney’s Fees; TAS Tries to go to Appeals

The case of Jacobs v. Commissioner, T.C. Memo 2021-51 (see the 39th doc on the docket) demonstrates once again how difficult it is to obtain attorney’s fees in Tax Court cases.  Maria Dooner and Linda Galler, the authors of the excellent chapter on attorney’s fees in the 8th Edition of Effectively Representing Your Client Before the IRS coming out this month and available for order now, wrote a post for us earlier this year in which they displayed the results of a FOIA request showing how infrequently petitioners succeed in obtaining attorney’s fees from the Tax Court.  Their data suggests that out of the approximately 25,000 petitioners each year who file a petition in the Tax Court about 10 will receive attorney’s fees or about .004%. 

I was glad for their research because the other clinics at the Legal Services Center at Harvard routinely obtain attorney’s fees in their litigation with the government, but I have not obtained attorney’s fees since my arrival.  Even though I have explained to them the difficulty of obtaining attorney’s fees in Tax Court cases, my colleagues no doubt simply consider me a slacker.  Maria and Linda provided me with some empirical cover to avoid the slacker label.  This post will not get into the disparity in the ability to win attorney’s fees in Tax Court versus other venues, but it is something to think about.  It’s now been almost a quarter century since Congress last tweaked IRC 7430 adding, among other things, the qualified offer provisions in the Restructuring and Reform Act of 1998 yet petitioners in tax cases still get almost no traction in seeking attorney’s fees.  Is the IRS this good compared to other agencies?

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Professor Jacobs, a former Department of Justice attorney turned professor, author and private attorney, claimed a number of deductions for items related to his various professional pursuits.  The IRS audited his 2014 and 2015 returns via its wonderful correspondence exam process.  Unlike a high percentage of the individuals audited via correspondence, Mr. Jacobs responded and seems to have provided the IRS with quite a lot of documentation regarding his claimed expenses. 

In response, in December 2016, Mr. Jacobs submitted a letter of explanation with 28 pages of documentation…. 

In February 2017, the Memphis Correspondence Exam office informed Mr. Jacobs by letter that the information he had provided was insufficient to substantiate his expenses. On April 3, 2017, the Commissioner issued to Mr. Jacobs a notice of deficiency for the 2014 tax year, which disallowed all the deductions Mr. Jacobs had claimed on Schedule C. Both the letter and the notice were sent to the wrong address.

The April 3, 2017, notice was subsequently rescinded after the Taxpayer Advocate Service (“TAS”) opened a case on Mr. Jacobs’ behalf (and at his [*7] request). The TAS assisted Mr. Jacobs in arguing successfully that he had not been given the opportunity to present further substantiating documents.

Mr. Jacobs then made a new submission to the Memphis Correspondence Exam office. That submission included 24 pages of annotated monthly credit card statements. Most of these pages had been provided previously in Mr. Jacobs’ December 2016 submission, but the annotations were new and were intended to replace highlighting in the prior submission that had not been visible to the Memphis Correspondence Exam office because of the way the materials were submitted. The new submission also included several pages of credit card statements that were not part of the December 2016 submission. After reviewing the additional documents, the Memphis Correspondence Exam office determined once more that the information was insufficient to support Mr. Jacobs’ claimed deductions.

He was in California corresponding with an examiner in Memphis.  When the examiner denied the deductions despite his documentation and written explanations, he protested the denial and appears to have been assigned to the Appeals Office in Memphis.

It should be noted that Mr. Jacobs appears not to have been pleased with the customer service he received from the Memphis correspondence unit:

In January 2018, Mr. Jacobs filed a formal request with the U.S. Treasury Inspector General for Tax Administration (“TIGTA”) for an investigation into alleged misconduct by examiners in the Memphis Correspondence Exam office. The request alleged that the Memphis Correspondence Exam office had made unnecessary and “increasingly burdensome” requests for documentation, had threatened to issue an unwarranted deficiency notice, had summarily rejected Mr. Jacobs’ claimed deductions despite the documentation he had provided, and had “stonewalled” for five months Mr. Jacobs’ request for a managerial conference call. TIGTA opened an active investigation into the Memphis Correspondence Exam office and tracked the status of Mr. Jacobs’ case by initiating correspondence with upper-level management of that office.

Mr. Jacobs was perhaps frustrated with his pen pal relationship with the IRS and sought to meet with an actual person.  In a case with lots of documents this can be especially important as keeping a multitude of documents straight over the phone is challenging.

I digress here for a brief mention of my only encounter with the Memphis Appeals Office which occurred more than a decade ago and involved a Collection Due Process case rather than an examination issue.  The Settlement Officer set a time for the telephonic hearing.  The correspondence was a bit unclear because the conference was set at 10:00 CST for a hearing in June when daylight savings time was in effect but I assumed the SO meant 10:00 CDT and called at that time.  No one answered and I got a generic voice mail message saying that the SO was “away from her desk or on the phone.”  I left a detailed message about the hearing and waited for a call back which did not come.  I was covering for a student who could not attend the hearing due to a bar prep session.  She eventually got through to the SO and set up the hearing for the same time one week later.  I called again at 10:00 the following week, received the same generic voice mail message.  I waited a couple hours and did not receive a call back.  I found this very frustrating.  Even more frustrating is the fact that I had no idea who the person’s manager was or how to reach that unknown person.  I happened to know the director of Appeals from having worked together with her at the Chief Counsel’s office and sent her an email message describing my frustration.  That did cause the SO to reach out to me rather promptly, and we were able to conduct the CDP hearing.  I don’t know if Ms. Jacobs’ experience with the Appeals Office in Memphis mirrored mine but it seems he was frustrated with the remote hearing experience.

Meanwhile, the IRS decided to audit Mr. Jacobs for 2015 and this time did so using the correspondence examination unit in Brookhaven.  This exam started four months before he submitted his request to TIGTA regarding the 2014 exam.  It’s not clear why the IRS would audit the same person with essentially the same issues for the subsequent year at a different location but it did and the audit again resulted in him submitting lots of documentation and the correspondence examiner rejecting his explanation.  After some back and forth which no doubt involved detailed explanations from the correspondence exam unit regarding the legal and factual basis for its determination, he requested a hearing with Appeals regarding the 2015 year as well.

Mr. Jacobs succeeded in having his Appeals case assigned from Memphis to Los Angeles.  He provided the AO with a detailed memo and lots of exhibits.  The AO decided that, in keeping with the judicial role of Appeals, she should not evaluate the factual nature of the evidence but send it back to the correspondence examiners in Memphis.  How wonderful for Mr. Jacobs yet he seemed disappointed with this opportunity for more interaction with the correspondence examiners and requested Appeals assign a new AO or at least send his material to an examiner in LA.  Appeals denied his request.  His material went back to Memphis.  The correspondence unit there surprisingly upheld its earlier decision.  An in person meeting was finally set with the AO in LA who by now also had his 2015 year and lots more correspondence from Mr. Jacobs.

This part of the case is interesting because Mr. Jacobs sought to bring his case advocate from TAS to the Appeals conference.  Appeals said no.  The day before the scheduled in person conference with Appeals the case was reassigned to a new AO.  The Court provided this explanation of the discussion regarding TAS attending the conference:

On November 16, Appeals Officer Guerrero was instructed not to schedule a conference with Mr. Jacobs until after management at IRS Appeals had determined a course of action in response to demands from the TAS to be present at Mr. Jacobs’ conference. As best we can tell, this new course of action was attributable to a memorandum the TAS sent to IRS Appeals on November 7, 2018. That memorandum asked that IRS “Appeals should refrain from holding Mr. Jacobs’ hearing until Appeals’ policy is modified” to permit a TAS representative to attend. Discussions between IRS Appeals and the TAS on this topic ensued.

The case does not get any further into the topic of TAS attending the Appeals conference.  I have never thought of bringing someone from TAS into any conference with the IRS but now I am a little intrigued by what happened here and how the issue was resolved.  I would welcome any comments from readers who have brought TAS representatives to Appeals or to other conferences and what role TAS played in those conferences and whether the TAS presence was helpful.

Meanwhile, because the statute of limitations was drawing close, the new AO requested a waiver of the statute of limitations before he would schedule a hearing based on Appeals policy of not working case too close to the statute date.  It’s possible that Mr. Jacobs was frustrated at this point because he declined to extend the statute of limitations causing the issuance of a notice of deficiency, the filing of a Tax Court petition and the resending of his case to Appeals after the IRS answered.

The AO with whom Mr. Jacobs met after filing his Tax Court petition conceded most of the issues and the Chief Counsel attorney promptly conceded the rest.  So, he had a complete victory after a long an arduous process.  Mr. Jacobs then sought attorney’s fees which is all that this case and this blog post is really about.  The Tax Court said no.  He was not a prevailing party within the meaning of IRC 7430.  Why?  Because all of the problems he had prior to filing his petition really did not matter.  The IRS was still justified in not conceding before the petition because it had never met with him and received a detailed explanation of his justification for the positions he took and, therefore, the IRS was substantially justified in issuing the notice of deficiency.  After the filing of the petition, the IRS relatively promptly conceded the case.  The Court noted:

As the Supreme Court has observed, substantially justified means ‘more than merely undeserving of sanctions for frivolousness.’” United States v. Yochum (In re Yochum), 89 F.3d 661, 671 (9th Cir. 1996) (quoting Underwood, [*26] 487 U.S. at 566). The Commissioner’s position may be substantially justified even if incorrect “if a reasonable person could think it correct.” Maggie Mgmt. Co. v. Commissioner, 108 T.C. at 443 (quoting Underwood, 487 U.S. at 566 n.2). Courts have found that the Commissioner’s position was substantially justified in cases that involve primarily factual questions. See, e.g., Bale Chevrolet Co. v. United States, 620 F.3d 868 (8th Cir. 2010). The fact that the IRS loses a case or makes a concession “does not by itself establish that the position taken is unreasonable,” but is “a factor that may be considered.” Maggie Mgmt. Co. v. Commissioner, 108 T.C. at 443.

This case does not break new ground it simply demonstrates again why only .004% of petitioners obtain attorney’s fees in Tax Court cases.  One could argue that he should have made a qualified offer earlier in the case to knock out the substantial justification argument, but Mr. Jacobs seems to have responded at every turn with substantial evidence.  Does the fact that the IRS correspondence examiners were not equipped to process his arguments mean he should not be compensated for the many hours he spent trying to resolve his case. 

Maybe it’s time for a fresh look at the standards for obtaining attorney’s fees in Tax Court cases.

A Twist on the Last Known Address Issue and an Update on DAWSON

We just had a call in the clinic that highlights another unexpected result of the dysfunction at the IRS resulting from the pandemic. As you probably know one result of the pandemic is that the IRS is taking months, perhaps more than a year, to process 2019 returns filed by paper. The filing of a return is an act that triggers the IRS to change a person’s address. So, by not processing a return, the IRS is slow to record in its system the taxpayer’s new address. That is an unfortunate by product of the pandemic. The delay in processing the return can have a stranger impact in some cases.

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In our case the client had filed a change of address form with the IRS when she moved pre-pandemic. The IRS accepted her change of address form and recorded her new address. Shortly before she filed her change of address form she had submitted her 2019 return using her then correct address but now prior address (and prior address from more than one year ago so no more postal forwarding.)

The IRS took many months to process her paper return. When it did get to her return, the processing of her 2019 return caused the IRS computer to notice that the address on her return was different than her address in its system. So, the computer “updated” her address to her old address. So, even though she properly followed the rules and the IRS followed its rules, the sequencing of the processing of her documents caused the IRS system to have a bad address.

Fortunately, in this case her file was in the hands of an alert Appeals Officer who figured out the problem and is working to get the IRS computer to accept the client’s true last known address. As you can imagine not many taxpayers in this situation will be so lucky as to have a live, alert human looking out for their interest. I bring this up in case other experience a similar difficulty.

A related problem is the time it will take for the IRS to process a return and pick up a new address. With the IRS using the tax return to change addresses, many taxpayers could rely on that system together with postal forwarding to receive IRS correspondence. The Gregory case demonstrates one of the exceptions and argues for use by the IRS of the other address information it receives. What should a taxpayer argue who has submitted a return to the IRS with a new address or submitted any document to the IRS that would change their address but that the IRS does not get to for months because of the pandemic backlog? I don’t have good advice. I am sure the IRS will take the position that it does not have a responsibility to change an address until it actually processes the return. Undoubtedly, there will be situations where the lengthy delays currently occurring will cause problems.

DAWSON and sealed documents

Recently, Judge Holmes issued a lengthy, informative and, as usual, entertaining opinion regarding the valuation of Michael Jackson’s image in a Tax Court case involving his estate. The opinion is public and was published on Tax Notes and other sites almost immediately after its release. If you go to the docket for the case on the Tax Court website, however, you cannot obtain the opinion and you will be told the record in the case is sealed. Some parts of the case were sealed by court order early in the litigation. For a general discussion of sealing the record in a Tax Court case, you can read this post from several years ago by guest blogger Sean Akins. As the Tax Court merged its prior system to DAWSON, it has yet to make the upgrades that will allow the system to recognize the difference between sealed and unsealed documents in a case. So, it is not possible to pull the Estate of Jackson opinion from the Court’s website at this time. It is a public document, however, and you can request a copy of the opinion from the clerk’s office as you can request any document from the court as discussed here. My understanding is that this issue and others are ones which the Court is continuing to fix as it continues to work on DAWSON. In the meantime, it will be impossible to obtain a document through DAWSON in a case in which the Court has sealed a part of the record.

A Motivating Reminder

Nina Olson identified a need, which created a movement and changed the landscape of America’s tax system forever. She started the Community Tax Law Project in 1992 and the Revenue Restructuring Act, (“RRA”), which ushered in a new era for taxpayer advocacy (including the Taxpayer Advocate Service and the role of National Taxpayer Advocate (“NTA”)) was passed in 1998.

The Pittsburgh Tax Review’s Fall 2020 publication focuses on different facets of Nina’s life and career. It features articles from Nina’s esteemed colleagues and friends, including Keith and Les. It is an incredibly inspiring symposium, especially during this time when it’s easy to feel overwhelmed and burnt out. I touch on some of highlights, but each of the articles are worth reading in full- especially if you are an LITC practitioner. The entire publication is available here.

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There were many times reading through the publication that I could envision the energy of the moments. There are gems throughout (even in the footnotes): the car rides shared by Nina and Keith, their remarkable and supportive friendship, the discussions by the Senate Finance Committee about the role of the Taxpayer Advocate in the Department of Treasury’s hierarchy, the growing pains of transforming TAS into what it is today, and the ripple effects Nina has created with her work.

The tribute is an insight into the way that Nina thinks, works, and approaches challenges and it is incredible. Stories about Nina’s profound impact on people (tax practitioners and taxpayers, alike) are interwoven with stories of her profound impact on policies and procedures.

Many of the stories allowed me to revisit the period in my life when I stumbled upon the LITC world and the excitement I felt after learning that I could be the type of lawyer that I had always wanted to be. I could practice tax law, truly help people, and hopefully have a positive impact on the world.

Nina ran a tax preparation and accounting business for nearly as long as she was the NTA, and then went on to graduate from law school only ten years before becoming the NTA.

In an article written by Nina, she reflects on the opportunity to become the NTA and how it aligned with her plans and passion to continue advocating for taxpayers after ensuring that the Community Tax Law Project was well-established and self-sufficient. She acknowledges the work of the teams of people that made her successes possible. She also humbly states that the intention of her article is merely to recount her experience and her thoughts. It is, of course, much more than that- and it is a rare and exciting look at the life experience of a zealous leader.

Nina testified before Congress, before she ever imagined being the NTA, about the role the NTA should play and the need for strong leadership, without realizing that she was describing herself – a self-fulfilling prophecy of sorts. She states, “Little did I know then that I would have that responsibility one day […] the furthest thing from my mind was to become the National Taxpayer Advocate. In 1998, my sole focus was building The Community Tax Law Project.”

Things that many practitioners now take for granted were so hard fought, won, and paved the way for the ability of TAS and LITCs to advocate for taxpayer rights. Any difficulties Nina encountered were transformed into opportunities to learn and improve

The stories contained in the tribute demonstrate Nina’s relentless passion for advocacy, her ability to call the IRS out on its absurdities and remain steadfast to TAS’s purpose and mission, which she helped develop.

Nina recognizes that conventional wisdom typically states to “choose your battles wisely” but that is not possible when it comes to taxpayer rights and being too selective about battles only makes it harder to get things accomplished later.

Some of the stories highlight how Nina’s quick wit is one of her best weapons. For example, Nina reflected on the frustration she felt at the underutilization of Taxpayer Assistance Orders early in her time as NTA. She recalled that, at a TAS training symposium, “A member of the audience approached the microphone and said that many of them had good relationships with IRS employees and issuing a TAO would harm those relationships going forward.”[Nina] was silent for a minute, and then said, “If issuing a TAO will harm that relationship, then you don’t have a ‘relationship’—you have unrequited love.”

And there was the time when an IRS Operating Division advisor had asked her to look at things from his perspective. She countered that it is her job and she is required by law, to look at things from the taxpayer’s perspective, the rest of the IRS can look at it from the IRS’s perspective.

Everything boils down to the impact Nina has had on the lives of America’s taxpayers, which includes all of us. As Caroline Ciraolo writes, “[b}ehind every legal issue is a taxpayer, a family, or a community that will benefit from our efforts,” as Prof. Lipman writes, “the federal income tax system exists for people,” and as Prof. Cords writes, “taxpayer rights are human rights.”

The pandemic has shown us that we are all interconnected, and not caring for the most vulnerable of our population can leave us all more vulnerable. Nina’s work advocating for low-income taxpayer, for credits that help lift children and families out of poverty, and for the Taxpayer Bill of Rights, among other things, helps the most vulnerable and positively impacts us all.

The fight for taxpayer rights never ends and resistance by the powers that be- in the name of cost and efficiency- never wanes, but Nina and what she has created, and continues to create, empowers tax practitioners to feel like we can effectuate real and meaningful change. The tribute to her in the Pittsburgh Tax Review was wonderful and motivational reminder of that.

The Fatty Rule for Post TFA Innocent Spouse Cases? An Early Look at the Otherwise Unavailable Evidence Exception

The Taxpayer First Act changed the scope of review in innocent spouse cases. Rather than allow parties to introduce evidence at trial, as we have discussed (see for example Christine’s post Taxpayer First Act Update: Innocent Spouse Tangles Begin) the TFA restricts the parties to the administrative record. TFA contains two exceptions: when there is evidence that is newly discovered or was otherwise unavailable.  There is considerable uncertainty surrounding this new rule, as well as how the Tax Court will define and apply the newly discovered and otherwise unavailable exceptions.

This past March in Fatty v Commissioner, Judge Holmes issued a bench opinion in an S case that gives an early nonprecedential look at the otherwise unavailable exception. 

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The case itself is a fairly straightforward application of the equitable relief factors arising from an approximately $7,000 reported liability attributable to the withdrawal of funds from Mrs. Fatty’s retirement account. At the time the then-married Mr. and Mrs. Fatty used the money to pay for expenses associated with the purchase a house. They later divorced, and pursuant to the divorce agreement Mrs. Fatty, who retained ownership of the home, was responsible for the tax liability. 

Despite Mr. and Mrs. Fatty entering into and complying with an installment agreement (with Mrs. Fatty paying the monthly amounts) Mr. Fatty sought relief from the joint and several liability. Mrs. Fatty intervened and the case went to trial. 

In normal deficiency cases, and in innocent spouse cases prior to the TFA changes, at trial, Mr. Fatty would have the opportunity to testify and introduce other evidence. In setting up the opinion, Judge Holmes summarized the TFA changes:

Until recently, the scope of review in a Tax Court case involving a request for innocent spouse relief is also de novo. People would come, they’d introduce evidence, and I as a judge would look at it with fresh eyes. Congress has more recently changed that scope of review. Now I am supposed to look at what is called the administrative record. The administrative record consists of all the documents and the evidence that the IRS looked at when Mr. Fatty first applied for relief.

Judge Holmes also explained the two exceptions to the TFA record rule:

I am supposed to look only at the administrative record, with two exceptions. And those two exceptions are evidence that is newly discovered or evidence that was previously unavailable. This is a change in the law, and the Fattys are one of the first cases to come after this change in the law.

Here is where the opinion gets interesting. As I mentioned, the TFA does little to expand upon what either exception means.  As a practical matter, these exceptions will likely be important, especially with pro se taxpayers who may fail to develop a case before the centralized and correspondence based IRS innocent spouse unit.

In Fatty, Judge Holmes takes a very generous view of  the meaning of otherwise unavailable, offering one approach that takes into account the absence of trial like procedures in IS administrative determinations:

However, in this particular case, I just assumed that testimony given under oath and subject to cross-examination, like the testimony given by both Mr. and Mrs. Fatty, is this newly available evidence, because when Mr. Fatty applied for innocent spouse relief, he wasn’t able to give sworn testimony and neither he nor his wife were subject to cross-examination

This approach, if adopted in other cases, leaves open the possibility for witness testimony, given the absence of sworn testimony and the right of cross examination in administrative IS determinations.  

To be sure, it is hard to read too much into this: this is just a bench opinion in an S case and the language discussing the exception is a bit garbled. Judge Holmes notes the limits: “As I said, I’m not deciding this for all cases in the future. This is an S case.” Yet for practitioners this is an important early development. It provides a convincing approach to allow parties to testify despite the TFA record rule limiting the scope to the record below. We will see if the Tax Court adopts it, or whether other Tax Court judges apply it in future nonprecedential opinions. 

What about the Fattys’ case? As with many Judge Holmes opinions he transparently discusses his approach, which is refreshing in a case implicating a multi-factor balancing test.

What I look at, and what I think is the appropriate fulcrum, is the extent to which the economic immunity of a household that files a joint return has been broken down by the actions of the non-requesting spouse in a way that didn’t allow the requesting spouse’s reasonable exit from having joint returns and a joint liability.

The opinion notes that the parties equally enjoyed the benefits of the income and explains that the IRS is not bound by the parties’ divorce agreement. After walking through the factors and emphasizing that Mr. Fatty had remedies under state law if Mrs. Fatty failed to pay on the agreement and the IRS collected from him, Judge Holmes held that Mr. Fatty was not entitled to relief. 

The End of the Line for the Pareskys?

Guest blogger Bob Probasco returns today with perhaps his final update on the Paresky case. Christine

I’ve blogged about the Paresky case before (here, here,  here, and here).  The latest development, and probably the end of the line, came on Friday when the Eleventh Circuit issued its opinion.  The circuit court agreed with the district court, as well as the Second Circuit in Pfizer Inc. v. United States, 939 F.3d 173 (2d Cir. 2019), and the Federal Circuit in Bank of America Corp. v. United States, 964 F.3d 1099 (Fed. Cir. 2020).  District court jurisdiction for “tax refund suits” does not apply to stand-alone suits for additional overpayment interest.

Nothing about the decision was really surprising.  The contrary decision in E.W. Scripps Co. v. United States, 420 F.3d 589 (6th Cir. 2005) was always a strained interpretation of the jurisdictional statutes, and the trend has been moving away from that interpretation over the past few years.  The Eleventh Circuit evidently thought it was an easy case as well; Carl Smith pointed out to me that the decision came only 35 days after oral argument, compared to 17 months for the Pfizer decision.  That’s fast!  But I thought I would offer a few comments as we perhaps close this chapter.

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What was this dispute all about, again?? There are two provisions that might offer district court jurisdiction for a stand-alone case seeking additional interest from the government on tax overpayments.  28 U.S.C. § 1346(a)(1) covers claims for recovery of taxes, that is, tax refund suits.  28 U.S.C. § 1346(a)(2)—the “little” Tucker Act—covers claims against the government under the Constitution, Acts of Congress, regulations, contracts with the government, or non-tort damages.  The little Tucker Act is limited to claims of $10,000 or less, whereas the courts can hear tax refund suits for any amount.  Under 28 U.S.C. § 1491(a)(1), however, the Court of Federal Claims can hear Tucker Act claims for any amount.

Court also have, with very rare exceptions, concluded that a tax refund suit—even if that includes stand-along cases for additional overpayment interest—is subject to the 2-year statute of limitations (from the IRS denial of the administrative claim) in section 6532.  Tucker Act claims, however, fall under the general 6-year statute of limitations (from the date the cause of action accrued, generally when the overpayment was scheduled): 28 U.S.C. § 2401 for district courts or 28 U.S.C. § 2501 for the CFC.

In these cases—Scripps, Pfizer, Bank of America, and Paresky—the taxpayers were arguing that their cases fit under “refund suit” jurisdiction.  And the government was arguing strenuously that their claims only qualified for jurisdiction under the Tucker Act.  Thus, when the amount at issue was over $10,000, the CFC would be the only available forum.

If taxpayers can always go the Court of Federal Claims, why is this important to them??

I think it’s primarily a matter of forum-shopping.  Pfizer’s case involved an issue—interest payable when a refund check is lost and has to be re-issued—for which there was a favorable Second Circuit precedent: Doolin v. United States, 918 F.2d 15, 18 (2d Cir. 1990).  Bank of America’s case, on the other hand, appears to have been filed in Western District of North Carolina to avoid an unfavorable Federal Circuit precedent, specifically, Wells Fargo & Co. v. United States, 827 F.3d 1026 (Fed. Cir. 2016).  (I’m guessing here, but it seems very likely from looking at the pleadings that Wells Fargo would have been a huge incentive to avoid the Federal Circuit.)

For Pfizer and Bank of America, the courts’ decision were not fatal.  Pfizer could still hope for the same result in the CFC; at least, I’m not aware of any negative precedent there.  Bank of America may have lost a significant portion, but not all, of its claim by winding up in the CFC.

The Pareskys, though, were not forum shopping.  In fact, they initially filed suit in the Court of Federal Claims.  But they faced a statute of limitations problem.  By the time they filed suit, the 6-year statute of limitations for Tucker Act claims had expired.  So the CFC dismissed their case for lack of jurisdiction but transferred it to the Southern District of Florida at their request.  A refund suit, for which the statute of limitations had not yet expired, was their only hope.  (The Eleventh Circuit pointed out in a footnote that the Tucker Act statute of limitations had not expired yet when the IRS denied their refund claim, so they still had time to file in the CFC.  And, of course, they could have filed suit even while the refund claim was pending.  Alas, they did not.)

Does this result make sense from a policy perspective?

Debatable.  There are two conflicting policies involved here.  On the one hand, Congress wanted most—and all large—Tucker Act claims to go to the CFC, because claims against the federal government are their area of expertise.  Thus, the $10,000 limit on Tucker Act claims in district court; provide easier access to local courts, but only for smaller cases where the difficulty and expense of litigating in a far-off forum would be relatively harsher.

On the other hand, Congress wanted taxpayers to be able to bring all federal tax refund suits in their local forum.  That may have reflected a judgement that: (a) the relative expertise of the CFC is less of an issue; and (b) there may be a lot more tax refund suits than Tucker Act claims, so it’s better to spread those out. Which of those policies should rule when the suit at issue is for additional interest on federal tax overpayments?  Hard to say.  There are fewer of these cases than tax refund suits, and it may be beneficial to establish precedents that will apply uniformly to all taxpayers.  But the same rationales for district court jurisdiction without a dollar limitation for refund suits might apply to these suits as well.  I doubt if Congress collectively gave it much thought.  If they had, perhaps they would have been comfortable with district courts hearing these cases, just as Pfizer, Bank of America, and the Pareskys wanted.  But we now have three circuit courts that have decided that’s not what Congress enacted.

So, is this really the end of the line for the Pareskys?

They’re really very sympathetic plaintiffs.  The dispute arose out of their losing a lot of money in the Bernie Madoff Ponzi scheme and filing refund claims to recoup taxes because of the loss.  (Rather ironic that Mr. Madoff passed away between oral arguments and the decision, isn’t it?)  This decision is pouring salt on the wound.  But, alas, I don’t see much hope at all for them.  They might ask for an en banc review or file a cert petition with the Supreme Court.  But I think both would likely be rejected.  (DOJ Tax Division might like to see this case go to the Supreme Court, to overturn Scripps, but I seriously doubt if they could convince the Solicitor General to support granting cert.)  And even if an en banc review by the Eleventh Circuit or cert by the Supreme Court were granted, I would certainly expect them to reach the same decision.

As far as the issue in general, without a Supreme Court decision, we may still see some of these cases crop up occasionally in other circuits.  The score is still only 3–1 and if the money involved is enough and precedents dictate that a district court would be a more favorable forum, taxpayers may take a shot at it.  But if the issue comes before any of the nine circuits remaining that still haven’t addressed it, I expect they would wind up agreeing with the Second, Eleventh, and Federal Circuits.

Continuances in the Age of Remote Trials: Designated Orders, October 5 – 9, 2020

Months ago, I heard an interview with the NYU Professor Scott Galloway about what the world may look like post-Covid. One of the main takeaways was to think of the pandemic not as a “change agent,” but rather as “accelerant” of trends that were already underway. I’d say this holds true with the government embrace of technology in tax controversy: from the momentous leap of fax to email, to the ability to sign documents electronically (see posts here and here).

While many of these changes were long overdue and will likely remain post-Covid, not all of these changes are here to stay. Or at least not in their current form. Virtual Tax Court trials are a good example of one such change that will almost certainly not remain as the default but may well continue in some form or another. The ease of access for virtual trials (and thus its ability to efficiently resolve cases) may be too attractive to the Tax Court to abolish it altogether.

One question is how or if such changes may affect motions for continuance. To get a sense of what may happen in the future, let’s take a look at the past. Specifically, two designated orders denying such motions in calendared virtual trials.

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Tax Court Rule 133 provides that continuances are “granted only in exceptional circumstances.” While this may make it seem that continuances are extraordinarily rare, in my experience the Tax Court is generally amenable to them so long as either (1) there is a serious prospect the case will resolve without trial, or (2) the parties can demonstrate they are making progress on the case, which would make for a more resolution (be it by trial or otherwise). When I draft continuance motions, I generally try to hit on those two points, demonstrating why it is in the Tax Court’s interest (ultimately, as a matter of efficiency) to grant the continuance.

If you cannot show that you are actively engaged in the case and making a good faith effort to move things forwards the Tax Court is unlikely to grant a continuance motion. Call me a cynic, but I’d venture there are some petitioners out there that would rather have their case languish than hear what the court has to say about their case.

But perhaps the reason things have stalled are out of your control. In my experience, this sometimes arises from logistical issues in receiving the administrative file from the IRS. As I’ve detailed before, the contents of the administrative file can be a sticky issue, and also directly informs many arguments you may want to raise. (The ABA Tax Section also recently held a free webinar on the topic, which I’d highly recommend.)

Bringing things back to virtual trials, petitioners may be inclined to argue for continuances based on technological issues beyond their control. Though it is generally difficult to argue, ahead of the calendar, that you “anticipate” technological trouble that would preclude attending virtual trials, some of these may be legitimate. Where the parties have time-and-time again failed to engage or exhibit other delay tactics, however, the Tax Court is sure to look with a critical eye on these sorts of arguments. The two designated orders give, I believe, excellent examples of the limits of Tax Court patience in granting continuances.

Let’s start with Griggs v. C.I.R., Dkt. # 18035-16 (order here). First off, glancing at the docket number informs us that this case has been circulating since 2016. For context, at that time very few people on earth knew what a “coronavirus” was, and Barack Obama was handing over the keys to the White House to Donald Trump. Suffice it to say, 2016 was a while ago.

Flash forward to October, 2020 and Mr. Griggs still wants more time to get things in order. And for a while, where it seemed the case may be moving forwards, the Tax Court obliged. A continuance was granted in January 2018 after a motion for partial summary judgment by petitioners was denied. Then another continuance was granted in November 2018. Then partial summary judgment granted to the IRS…

After that, Mr. Griggs seemed less inclined to move things towards a final resolution. First, he makes numerous requests for additional time (not to be confused with continuances: see Rule 25(c)) on filing status reports. Then, almost exactly one month before the case is set for trial, Mr. Griggs moves again for a continuance. His reasons fall within the “circumstances outside my control” category: (1) the law libraries in Oregon are closed because of the pandemic, and (2) the forest fires will (somehow) keep him from attending the trial.

The Tax Court isn’t having it. The first reason is unpersuasive because it is apparently a pure substantiation case, where legal research isn’t really in play. The second reason is unpersuasive because… well, you have to actually explain why all the bad-things happening in the world specifically effect you, rather than just listing off Billy Joel style those bad things in the abstract. Mr. Griggs does not do so.

The motion is denied. Maybe our second petitioner (Ononuju v. C.I.R., Dkt. # 22414-18 (here) has better luck?

From the outset it may appear that Mr. Ononuju has a compelling case for continuance. He lives in Nigeria and, because of the pandemic cannot get a flight into the United States. Of course, since this trial is going to be virtual it doesn’t much matter where he physically is, so long as he has phone or internet access. But perhaps such access is lacking in Nigeria?

Not so, the Tax Court finds -or at least not in Mr. Ononuju’s instance. Some reasons why “I’m in Nigeria” is not sufficient, on its own, to show lack of remote access include (1) he lives in the capital city, which certainly has phone access, and (2) he was able to communicate with the IRS by phone and email while in Nigeria (where he has lived since 2017) up to then. The Tax Court is not swayed and is particularly dismayed that Mr. Ononuju didn’t even try to show up to trial and express his concerns with phone or email access so that arrangements could be made.

In my experience, the Tax Court is very understanding when these issues are expressed in good faith. And reading between the lines, the “good-faith” of Mr. Ononuju seems to be called into question here. Although Mr. Ononuju doesn’t show up for trial, his wife does and testifies that he was presently providing medical care in rural areas to people in need.

How noble! Only the Tax Court doesn’t find her testimony credible, so maybe not. A very brief look at taxes at issue might give some hints as to the credibility gaps.

Mr. Ononuju founded and was president of the non-profit “American Medical Missionary Care, Inc.” Again, how noble! Except, at least according to the IRS, Mr. Ononuju engaged in “excess benefit transactions” under IRC § 4958. I don’t work with non-profit tax issues, but under IRC § 4958(c), these appear to be transactions where someone with control over the non-profit uses the non-profit for undue personal gain. The penalties are stiff: a 25 percent excise tax on the prohibited transaction under the “first-tier,” and a 200 percent(!) second tier excise tax if you don’t correct the excess benefit transaction -which apparently Mr. Ononuju never did. I have no insight on whether these taxes were appropriate, or the merits of the case generally, but things seem to have been unraveling for Mr. Onounju: Michigan revoked his medical license at about the same time the IRS examination appeared to be going on.

The IRS asserted a deficiency of over $1.5 million for 2014. Usually that’s a large enough number to keep people engaged. And though Mr. Ononuju was for a time, that appears to have stopped right when the parties got to fact stipulation. After that, radio silence…

Much of Tax Court litigation occurs without the active involvement of the Tax Court itself. Unlike in federal district court, the parties are mostly entrusted to work out the facts between themselves without formal discovery -or at least try to, before getting the court involved. Trial can then largely be reserved to those factual issues the parties could not (reasonably) agree on. But woe onto those who do not engage in the stipulation process, and then ask the Tax Court to postpone the trial. That the (eventual) trial will be virtual doesn’t really play into that equation.

And so we have yet another denied motion for continuance.

To me, virtual trials will just be an extra tool in the Tax Court toolbox: one that could especially benefit places like Minnesota, where the trials are infrequent. As the Tax Court shifts back to on-site calendars, however, I think the possibility of virtual trials could be reason for the Tax Court to be more comfortable in granting continuances -so long as the petitioner is engaged in the process. Imagine the petitioner shows up to calendar after largely being uncommunicative and makes a motion for continuance that very day. Maybe they have a lot of really good reasons for being uncommunicative, and maybe it seems like their case has some merit. In places like Minnesota, Tax Court judges are in a bit of a bind in those instances. If they grant the motion to continue it might not be set for trial for another 6 months to a year. Usually, the Tax Court puts the case on “status report” track to try and keep the parties engaged in the interim.

Virtual trials could go one step further, particularly for those parties that are actually engaged in the process, and perhaps even more so for those that are linked with pro bono counsel at calendar call. Now, instead of scrambling to put together a case that day or week, theoretically pro bono counsel could make a motion for continuance with the understanding that a virtual trial will be held in two or three months -usually enough time to actually sort things out, without being so far in the distance that one of the parties disappears.

For petitioners like Mr. Griggs and Mr. Ononju where continuances may just be a tactic of indefinite delay, they can and should be denied -virtual trial or not. But for engaged petitioners that just need some more time (or assistance from free counsel), the availability of virtual trials may actually provide more cushion for continuances to be granted -at least from the perspective of efficiently resolving cases.

TEFRA + LCU = Confusion, Part 3

In today’s post Bob Probasco concludes his three-part series on General Mills and the intersection of TEFRA and “hot interest.” Part One can be found here. Part Two, here. Christine

In Part 1, I described the decision by the Court of the Appeals for the Federal Circuit in General Mills, Inc. v. United States, 957 F.3d 1275 (Fed. Cir. 2020), aff’g 123 Fed. Cl. 576. (2015).  The taxpayer’s refund suit sought recovery of $6 million of excessive underpayment interest, but the court dismissed the case based on a jurisdiction issue from a special TEFRA provision.  I thought that the court made a crucial assumption, never clearly stated, as to the conceptual framework for adjustments resulting from a TEFRA proceeding.  Part 2 explained why an alternative framework, which would have supported the taxpayer’s position instead of the government’s, is not only possible but perhaps the best way to think about these issues.  Because the court dismissed the case for lack of jurisdiction, based on the TEFRA provision, we didn’t get a decision regarding the merits issue, concerning whether the IRS has assessed too much interest.  It’s an issue that I had never dealt with before and I think the IRS’s position may be wrong.  That’s what today’s post, Part 3, is about.

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Background

The case involved two sets of tax returns and audits: those for the General Mills (“GMI”) corporate tax returns and those for partnership tax returns for General Mills Cereals, LLC (“Cereals”).  Various members of the GMI consolidated group were partners in Cereals, so the partnership tax returns – and any audit adjustments – for Cereals flowed through to GMI.  The IRS audited the 2002-2003 tax returns (both corporate and partnership) and later the 2004-2006 tax returns (same).  Although there are some slight differences between the audits for those two periods, for simplicity I will focus on the 2002-2003 tax returns.

Audits began for both GMI and Cereals in 2005 for these years.  The IRS issued a 30-day letter for the GMI audit on June 15, 2007, asserting proposed deficiencies of more than $143 million for 2002 and almost $83 million for 2003.  The partners in Cereals entered into settlement agreements in July 2010.  On August 27, 2010, the IRS issued a document described as a “notice of computational adjustment” to GMI, identifying additional underpayments, resulting from the Cereals audit, of about $16 million for 2002 and more than $33 million for 2003.

The IRS assessed additional taxes, penalties, and interest resulting from the Cereals audit in September 2010.  GMI paid all outstanding balances for these years, including interest, on April 11, 2011.  The IRS sent GMI detailed interest computation schedules for these years, apparently for the first time, on April 18, 2011 and April 20, 2011.  The schedules reflected that the IRS began charging a higher underpayment interest on July 15, 2007.  GMI filed refund claims on March 28, 2013, arguing that the interest IRS accrued and assessed was almost $6 million too high.  GMI then filed this refund suit on January 30, 2014.

The Basis for GMI’s Refund Claim – LCU Interest The interest rate for large corporate underpayments (LCU) is governed by section 6621(c), as supplemented by Treas. Reg. § 301.6621-3, which increases the normal underpayment interest rate by 2% for a corporate taxpayer’s underpayments that exceed $100,000.  It was enacted in 1990, as part of the Omnibus Budget Reconciliation Act, and has typically been referred to by practitioners ever since as “hot interest.”  There are two key concepts in determining whether, and when, to apply hot interest: the “threshold underpayment” and the “applicable date.”

Threshold Underpayment

Whether hot interest applies is not, oddly enough, determined by comparing the underpayment balance to $100,000.  The regulation establishes a “threshold underpayment,” a term of art that appears only here.  Hot interest applies if that amount, rather than the underpayment balance, exceeds the $100,000 statutory requirement.  The threshold underpayment is defined as the correct amount of tax (excluding penalties and accumulated interest) less all payments made by the last date prescribed for payment.  Thus, it appears to be a cumulative amount rather than the result of a particular transaction such as an audit.  (But see below regarding “applicable date.”)  Once hot interest is triggered, the higher interest rate would apply to the entire underpayment balance going forward, including interest and penalties and any amounts subsequently assessed.  Under the IRS interpretation, hot interest would apply even if the actual underpayment balance declines below the $100,000 threshold as a result of payments.

The existence of a threshold underpayment is determined only when there is an assessment, not merely because of a proposed deficiency.  (Contrast the determination of the “applicable date” discussed below.)  If the taxpayer receives a 30-day letter or a notice of deficiency for $110,000 but the amount is reduced to $90,000 prior to assessment, the threshold underpayment is only $90,000 and hot interest does not apply.  But even if an amount greater than $100,000 is originally assessed, the regulation states that hot interest will not apply if a subsequent judicial determination reduces the tax liability (and therefore the threshold underpayment) below $100,000.

The regulation doesn’t specifically address whether a subsequent administrative determination reducing the tax liability (e.g., an abatement resulting from a refund claim) would reduce the threshold underpayment, potentially below $100,000.  Based on the definition of the threshold underpayment in the Code, it should – but I haven’t run across a ruling on this specific question.  The IRS has challenged whether an abatement reduces the threshold underpayment but to my knowledge only in the specific context of an NOL carryback.  The IRS lost, in Med James, Inc. v. Commissioner, 121 T.C. 147 (2003), but in that case the reduction from an NOL carryback was asserted as a counterclaim in a deficiency proceeding.  If the abatement had been granted in an administrative determination, the taxpayer might have had to pay and file a refund claim/suit to address the hot interest issue.

Determining the amount of the threshold underpayment is complicated enough that the IRS can easily make mistakes.  But if you look at the amounts above, it’s clear that GMI met the threshold underpayment requirement.  That is only one part of the answer, though.  To determine whether/when hot interest applies, the IRS also must determine the applicable date. 

Applicable Date

Interest on underpayments generally runs from “last date prescribed for payment,” typically the unextended return due date.  The higher rate for hot interest only applies “for periods after the applicable date.”  For assessments subject to deficiency proceedings, the applicable date is 30 days after the earlier of a “letter of proposed deficiency which allows the taxpayer an opportunity for administrative review in the Internal Revenue Service Office of Appeals” (i.e., a 30-day letter) or the notice of deficiency.  That’s section 6621(c)(2)(A).

Section 6621(c)(2)(B)(i) is a special rule that applies to tax assessments not subject to the deficiency procedures; for such underpayments, the applicable date is 30 days after a letter or notice of the assessment or proposed assessment.  This would apply to certain taxes other than income tax.  This category also would include two common situations involving income tax: amounts shown on the original return but not paid on or before the last date prescribed for payment, and summary assessments for “mathematical or clerical errors.”

Although not explicitly addressed in the Code, the regulation includes within the scope of section 6621(c)(2)(B)(i) “underpayments attributable, in whole or in part, to a partnership item.”  For those, the applicable date would be the 30th day after the first letter or notice that notifies the taxpayer of an assessment of the tax.

The Code also identifies three exceptions under which a letter or notice that otherwise qualifies would not establish an applicable date and start hot interest running:

  • A 30-day letter or notice of deficiency that is withdrawn.
  • A 30-day letter or notice of deficiency for which the taxpayer pays the amount in full within 30 days after the letter or notice is sent.
  • Any letter or notice involving “small amounts,” that is, an amount that is not greater than $100,000 (as with threshold underpayment, excluding penalties and interest). 

As with threshold underpayments, the proper determination of the applicable date may be complicated and subject to error.  GMI believed that the IRS applied the law incorrectly and charged hot interest when it should not have.

IRS application and GMI’s argument

Interest at the normal underpayment interest rates generally (with some common caveats) begins as of the filing due date, without regard to extensions, rather than when the IRS made the assessments.  But the increased interest rate for hot interest starts only on the applicable date. What does that mean when there are multiple assessments, including adjustments flowing through from TEFRA audits?

The IRS position apparently is that hot interest starts, for the entire underpayment balance, as of the first applicable date for any component of that underpayment balance.  As noted above, GMI’s corporate audit resulted in a 30-day letter issued on June 15, 2007.  So the IRS interest calculations increased the interest rate starting on July 15, 2007, one month later, for the entire underpayment balance, including that attributable to the computational adjustments from the TEFRA audit.

GMI, on the other hand, read sections 6621(c)(2)(A) and (B)(i) as bifurcating the underpayments for these tax periods.  The portion of the underpayment attributable to the corporate audit and the portion of the underpayment attributable to the TEFRA audit would have separate applicable dates.  Hot interest for the portion of the underpayment attributable to the corporate audit might start as of July 15, 2007.  But the first letter or notice that notified GMI of an assessment of tax from the TEFRA audit was issued on August 27, 2010.  So hot interest for that portion of the underpayment shouldn’t start until September 26, 2010, more than three years later than the applicable date the IRS used. 

I think GMI’s position is certainly a reasonable interpretation.  The Code is, as almost always, ambiguous and the drafters may not even have considered this situation.  GMI’s particular situation, an assessment resulting from a corporate audit followed by an assessment resulting from a TEFRA audit, is not explicitly addressed anywhere in the 4-1/2 pages of regulations either.  There are six examples in the regulations, but none involve this situation.  Indeed, none of the examples even involve a partnership adjustment.

GMI pointed out that section 6621(c)(2)(A) already uses a “the earlier of” comparison between a 30-day letter and a notice of deficiency for which no 30-day letter was issued.  If Congress didn’t want to bifurcate the underpayments in a situation like GMI’s, why not simply include the provision regarding non-deficiency proceedings as 6621(c)(2)(A)(iii) instead of 6621(c)(B)(i)?  

I think it would be possible to carry the argument even further, arguing that hot interest applies only at the level of individual components of the underpayment balance, rather than the entire balance.  Other interest provisions apparently work that way, e.g., the “restricted interest” provisions in sections 6601(c) and 6611(e).  The references in section 6621(c) to letters or notices arising from specific adjustments, rather than to the entire underpayment balance, are very similar to the restricted interest provisions.  That arguably suggests the same approach of applying the special rule to components rather than the entire balance.

That interpretation could also be inferred from the exception in section 6621(c)(B)(iii), under which a letter or notice for a deficiency or assessment less than $100,000 does not start hot interest running.  Before that provision was added in 1997, hot interest would be triggered when the threshold underpayment from two or three separate transactions exceeded $100,000.  That’s reflected in Treas. Reg. § 301.6621-3(d), Example 2, which has not been revised to be consistent with the Code provision as amended in 1997.  What’s the purpose of section 6621(c)(B)(iii)?  Maybe it reflects a determination that hot interest should be applied only to individual transactions over $100,000, rather than a cumulative balance.  And maybe that implies that the applicable date should be determined separately for each of those transactions.

Further support is available from the exception in section 6621(c)(B)(ii), under which a letter or notice for which the taxpayer pays the amount in full within 30 days does not start hot interest running.  That looks very much like an incentive for quick payment, doesn’t it?  But if hot interest applies at the level of the entire underpayment balance rather than individual transactions, the incentive starts looking strange.  There is an extra incentive to pay quickly for the first deficiency/assessment that triggers hot interest, but that extra incentive goes away for the second, third, etc. deficiency/assessment.  Why would that be the case? I don’t recall ever seeing this issue before the Federal Circuit’s decision came out.  The case was filed in the Court of Federal Claims in 2014, and that court ruled in 2015, but I missed those at the time.  To my knowledge, this issue has not been addressed in any other cases.  (If anyone has seen it elsewhere, please let me know!)  So I was eager to see the court’s analysis.  Alas, there was none.  The case was dismissed for lack of jurisdiction, so we’re still waiting for the courts to rule on this issue.

TEFRA + LCU = Confusion, Part 2

In Part Two of this three-part series, Bob Probasco examines the dissenting view in the recent General Mills case out of the Federal Circuit. Part One can be found here. Christine

In Part 1, I described the decision by the Court of the Appeals for the Federal Circuit in General Mills, Inc. v. United States, 957 F.3d 1275 (Fed. Cir. 2020), aff’g 123 Fed. Cl. 576 (2015). The parties’ briefs on appeal can be read here: Opening Brief, Answer, and Appellant’s Reply. The taxpayer’s refund suit sought recovery of $6 million of excessive underpayment interest, but the court dismissed the case based on a jurisdiction issue from a special TEFRA provision.  I thought that the court made a crucial assumption, never clearly stated, as to the conceptual framework for adjustments resulting from a TEFRA proceeding. 

Part 2 explains why an alternative framework, that would have supported the taxpayer’s position instead of the government’s, is not only possible but perhaps the best way to think about these issues.  This case involved the intersection of TEFRA and the complex interest provisions of the Code.  The combination is messy. 

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Brief Recap of the Facts and the Majority’s Position The case involved partnership audits and adjustments for partnership tax returns for General Mills Cereals, LLC (“Cereals”).  Different members of the General Mills (GMI) consolidated group were partners in Cereals, so the tax returns—and any audit adjustments—for Cereals flowed through to GMI.  The IRS audited the 2002-2003 tax returns (both corporate and partnership) and later the 2004-2006 tax returns (same).  Although there are some slight differences between the audits for those two periods, for simplicity I will focus on the 2002-2003 tax returns.

Audits began for Cereals in 2005 for these years.  The partners in Cereals entered into settlement agreements in July 2010.  On August 27, 2010, the IRS issued a “notice of computational adjustment” to GMI, identifying additional underpayments resulting from the Cereals audit, of about $16 million for 2002 and more than $33 million for 2003. 

The IRS assessed additional taxes, penalties, and interest resulting from the Cereals audit in September 2010.  GMI paid all outstanding balances for these years, including interest, on April 11, 2011.  The IRS sent GMI detailed interest computation schedules for these years, apparently for the first time, on April 18, 2011 and April 20, 2011.  The schedules reflected that the IRS began charging a higher underpayment interest rate (“hot interest”) on July 15, 2007.  GMI filed refund claims on March 28, 2013, arguing that the higher interest rate should not have started until September 26, 2010.  It then filed this refund suit on January 30, 2014.

The government argued, and the majority agreed, that the relevant statute of limitations for such refund claims was the six-month period specified in section 6230(c)(2) for challenging erroneous computational adjustments rather than the two-year limitation period of section 6511.  As a result, the refund claims were filed untimely, and the case was dismissed for lack of jurisdiction.

The Dissent

The Federal Circuit’s decision was 2-1.  Judge Newman dissented and would have reversed the dismissal for lack of jurisdiction.  She thought section 6511, rather than 6230(c), applied to these refund claims.  Section 6231(a)(6) defines a computational adjustment as “the change in the tax liability of a partner which properly reflects the treatment under this subchapter of a partnership item.”  She concluded that the “payment of interest is not a ‘tax liability.’”  Further, “partnership item” should not be construed so “‘broadly as to cover claims that depend on the unique circumstances of an individual partner.’” (quoting Prochorenko v. United States, 243 F.3d 1359 (Fed. Cir. 2001)).  Thus, the refund claims were not correcting errors in computational adjustments of a partnership item; they were for refund of an overpayment of interest, to which the two-year limitation period in section 6511 apply.

Judge Newman found no hint in the TEFRA legislative history of any Congressional intent to truncate the two-year limitations period in section 6511.  She also quoted a 2001 Supreme Court case:  “[I]n cases such as this one, in which the complex statutory and regulatory scheme lends itself to any number of interpretations, we should be inclined to rely on the traditional canon that construes revenue-raising laws against their drafter.”

Possible Confusion Regarding the Conceptual Framework?

As I read the majority opinion and the applicable Code sections, it occurred to me that the analysis—as well as the regulation that defined resulting interest as a computational adjustment—rested in part on an assumption about the governing framework.  Specifically, the IRS, DOJ, and Court seem to think of adjustments to the partners’ returns as falling into two categories only:

  • Computational adjustments for which deficiency proceedings are required.  This encompasses (a) those for which partner-level determination are not necessary as well as (b) those for penalties, additions to tax, and additional amounts. 
  • Computational adjustments for which deficiency proceedings are not required.  This encompasses those for which partner-level determinations are not necessary. 

That seems consistent with the structure of former section 6230.  Section 6230(a)(2)(A) provides circumstances under which deficiency procedures apply and section 6230(a)(1) effectively is “everything else.”

The government puts interest in the second category, even though partner-level determinations are necessary.  (They certainly were in this case because the interest computations depended on information that was not part of the TEFRA proceedings.  The notice, and therefore applicable date used by the IRS, were part of the corporate audit.)  The decision to put interest into the second category perhaps was because interest doesn’t fit into the first category, which “shall apply to any deficiency attributable to . . ..”  Interest is not a tax liability and therefore is not included in the definition of deficiency and therefore does not fall within section 6230(a)(2)(A).  Where else can it be?  Only section 6230(a)(1).

But that is only the case if assessments of additional interest are computational adjustments.  The dissent concluded that interest assessments don’t fit within the definition of a computational adjustment.  An alternative framework would be that adjustments to partners’ returns, resulting from a partnership-level proceeding, fall into three categories:

  • Computational adjustments for which deficiency proceedings are required.  This encompasses (a) those for which partner-level determination are not necessary as well as (b) those for penalties, additions to tax, and additional amounts. 
  • Computational adjustments for which deficiency proceedings are required.  This encompasses (a) those for which partner-level determination are not necessary as well as (b) those for penalties, additions to tax, and additional amounts. 
  • Computational adjustments for which deficiency proceedings are required.  This encompasses (a) those for which partner-level determination are not necessary as well as (b) those for penalties, additions to tax, and additional amounts. 

In that case, the six-month period in section 6230(c)(2) only applies to the first two categories.  The third falls under the two-year period of section 6511 for normal refund claims.

This certainly seems as though it could have been what Congress intended.  Before TEFRA, we just had deficiency procedures and interest was not subject to those; it was just assessed after tax was assessed.  Did Congress intend partnership proceedings and computational adjustments to only address the same types of adjustments that deficiency proceedings covered—underlying tax, penalties, additions to tax, and additional amounts?  And then rely on the existing process for assessing interest, which is to simply assess it and require the taxpayer to pay and file a refund claim?  I haven’t done a deep dive into the legislative history, but that seems very plausible to me.  It’s also arguably the best interpretation under the definition of a computational adjustment quoted above in the discussion of the dissent.

There is a technical argument to the contrary that could support the majority’s position. 

  • Section 6601(e)(1) says that references to “tax” shall be deemed also to refer to interest, except for such references in subchapter B of chapter 63 (sections 6211-6216). 
  • So “tax” in section 6230(a)(2)(A) would include interest, but that section doesn’t mention “tax,” it refers to “deficiency”. 
  • And the reference to “tax” in section 6211(a), defining “deficiency,” doesn’t include interest.  Therefore, interest is not part of a deficiency. 

Thus, interest is included in the definition of a computational adjustment in section 6231(a)(6), which has a direct reference to “tax.”  But section 6230(a)(2)(A) has only an indirect reference (through section 6211) to tax, so interest is not included to the category of computational adjustments for which a deficiency proceeding is appropriate. 

But that’s highly technical and formal.  Common sense would say that—for purposes of the TEFRA provisions—if interest is not included in a deficiency for purposes of section 6230(a)(2)(A), it shouldn’t be included in a change to tax liability for the definition of computational adjustment in section 6231(a)(6).

The Court of Federal Claims opinion addressed this question, whether interest is incorporated in the definition of a computational adjustment, in more detail than the Federal Circuit’s decision.  The CFC didn’t rely entirely on the regulation and in fact suggested that would be insufficient by itself.  It cited several cases, some of which addressed a former version of section 6621(c), which increased the interest rate for “tax-motivated transactions” (TMT); the CFC, along with other courts, considered TMT interest analogous to hot interest.  But those cases never addressed the definition of computational adjustment, other than in the regulation.

For example, in N.C.F. Energy Partners v. Commissioner, 89 T.C. 741 (1987), the partnership sought to challenge penalties and TMT interest in its proceeding, although they were not asserted in the final notice of partnership administrative adjustment.  The IRS moved to dismiss those portions of the case for lack of jurisdiction.  The court concluded that additional findings of fact with respect to individual partners would be required, so those issues should not be addressed in the partnership proceeding.  The court did not directly interpret the definition of a computational adjustment, although it seemed to suggest that TMT interest would be addressed in a deficiency proceeding.

In White v. Commissioner, 95 T.C. 209 (1990), the IRS issued a notice of deficiency including TMT interest after the conclusion of the partnership proceeding.  The IRS moved to dismiss the interest determination from the deficiency proceeding.  The court agreed, 13-2 in a reviewed opinion.  That case, however, turned on the question of whether interest was included in a “deficiency.”  The court did not address how a later assessment of interest should be handled, as a computational adjustment or just a normal assessment of interest.

In Pen Coal Corp. v. Commissioner, 107 T.C. 249 (1996), the notices of deficiency had included tax, penalties, additions to tax, and additional amounts and had also determined that hot interest applied, without determining the amount.  The IRS sought to strike the interest determinations from the deficiency proceeding.  The court agreed, following White, but again did not interpret section 6231(a)(6).

Finally, in Olson v. United States, 172 F.3d 1311 (Fed. Cir. 1999), the taxpayers filed refund suits in the Court of Federal Claim.  They argued that various assessments (including TMT interest) resulting from a settlement of a partnership proceeding were invalid because they had received no notices of deficiency.  The CFC granted the government’s motion for summary judgement, concluding that notices of deficiency were not required and noting that no other basis for the refund was asserted.  The Federal Circuit agreed.  There was a brief reference to interest being included in the definition of a computational adjustment, but that mentioned only the regulation with no interpretation of the applicable Code section. 

Practical Considerations

The regulation stating that interest is included in a computational adjustment may have been influenced by an assumption—possibly shared by the DOJ and court—that interest computations are generally straight-forward and easy to verify.  If so, it might seem simplest to include interest in a computational adjustment not subject to deficiency procedures.  As with the allocation of the previously determined change in the underlying tax, errors would be rare but easily detected.  A computational adjustment, even with the abbreviated period within which to file a refund claim, would be a reasonable compromise.

However, while interest calculations for most taxpayers are indeed straight-forward and easy to verify, that is often not the case with large businesses who may have multiple changes to tax liability implicating several different issues of interest calculation.  Sometimes the law is not clear; other times the law is clear, but errors occur frequently.  Specialist firms provide taxpayers with reviews of interest computations to identify potential problems.  That process, however, can take a long time.

This also means that an abbreviated period within which to file refund claims relating to interest is not a good idea from a policy perspective.  The description in the Federal Circuit’s decision suggests that by the time GMI received the April 2011 interest computation schedules it had all the necessary information to identify the basis for a refund claim based on when hot interest rates should apply.  But that was more than six months after the August 2010 notice that the CFC considered the initial notice of computational adjustment.  It was even more than six months after the assessment of interest in September 2010.  I defy anyone to look at a lump sum assessment of interest for a large corporate taxpayer and be able to determine how that amount was calculated.

Even if the Federal Circuit decided that the April 2011 schedules were the initial notice of computational adjustment with respect to interest, six months is still not a lot of time within which to file a comprehensive refund claim covering all interest errors that might have been contained in those computations.  Rushing to file a refund claim based only on the issue concerning hot interest might have risked forfeiting claims based on other issues.

Thus, even if the correct legal determination were that the six-month period to file refund claims applied to computational adjustments relating to interest, it seems like a bad policy choice.

Conclusion  

Between the dissent, the alternative framework for classifying adjustments arising from a TEFRA proceeding, and the practical considerations, there seems to be at least a reasonable argument that interest should not be included in the definition of computational adjustments and not subject to the accelerated refund claim provisions of section 6230(c).  But that’s now what the regulation the IRS wrote say—and challenging the validity of the regulation would be difficult—and that’s not what the Federal Circuit decided.

This concludes the discussion of the TEFRA jurisdictional issue.  Part 3 addresses the substantive issue: exactly when the higher hot interest rate should have started.  It’s a complicated issue in these specific circumstances and, to my knowledge, has not yet been ruled on by any court.