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The issue of how to interpret the statute seemed to be squarely before the court in Ad Investment 2000 Fund LLC v. Commissioner, 142 T.C. 248 (2014).  In a Son-of-BOSS tax shelter case, Judge Halpern considered the Commissioner’s motion to compel the production of opinion letters a law firm issued to the taxpayer.  The taxpayer argued the opinions were protected by the attorney-client privilege.  The Commissioner argued the privilege was waived when the taxpayer put the privileged matter in controversy when the taxpayer argued against application of the accuracy-related penalty.  The taxpayer argued it was not using the opinion letters as part of its affirmative defense but was, instead, making a generalized good faith defense.  Accordingly, it believed the opinion letters were not relevant, at issue, or discoverable.

Under Rule 501 of the Federal Rules of Evidence, the common law governs a claim of privilege.  In turn, the disagreement between the parties turned on the interpretation of the attorney-client privilege.  Thus, the disagreement was an evidentiary issue.

The attorney-client privilege exists to protect full and frank communications between attorneys and their clients.  Upjohn v. United States,  449 U.S. 383 (1981).  However, when a party puts into issue his subjective intent in deciding how to comply with the law, he may forfeit the privilege.

In determining if the party has waived, or forfeited, the privilege, the Tax Court uses a three-pronged test.  The privilege is waived if (1) assertion of the privilege was the result of an affirmative act, such as filing suit; (2) through the affirmative act, the asserting party put the protected information at issue by making it relevant to the case; and (3) application of the privilege would have denied the opposing party access to information vital to his defense.  Johnston v. Commissioner,119 T.C. 27 (2002).

The Tax Court’s three-pronged test was endorsed by the D.C. Circuit Court of Appeals in Sanderlin v. United States, 794 F.2d 727 (D.C. Cir. 1986), but explicitly rejected by the Second Circuit in Pritchard v. County of Erie,  546 F.3d 222 (2d Cir. 2008).  Under Pritchard, to show the privilege was waived, the party had to rely on the privileged advice in claiming the defense (which the taxpayers in Ad Investment 2000 Fund LLC argued they were not doing).

The case before Judge Halpern was appealable to the Second Circuit Court of Appeals.  Under the Golsen rule which resulted from the holding in Golsen v. Commissioner, 54 T.C. 742 (1970), when there is a disagreement among appellate courts, the Tax Court will follow the opinion of the Circuit Court of Appeals to which the case could be appealed.  Or if the appellate court has not yet ruled on the issue, the Tax Court can decide on its own how to interpret the rule.  Thus, the issue seemed to be squarely before the Tax Court:  should it follow the holding of the D.C. Circuit Court of Appeals (as Section 7453 suggested) or follow the holding of the Circuit Court to which the case would be appealed, the Second Circuit (as the Golsen rule states).

Unfortunately, even though the question seemed ripe for resolution, Judge Halpern determined that, because the facts were distinguishable from those in Pritchard, the Second Circuit’s holding was neither controlling nor dispositive.

Not long after Ad Investment 2000 Fund LLC was decided, the PATH Act changed the language of Section 7453 [Pub. L. 114–113, div. Q, title IV, § 425(a), Dec. 18, 2015, 129 Stat. 3125].  During a panel discussion at the ABA Section of Taxation and the Trust and Estate Law Division Joint Fall 2016 CLE Meeting (in Boston), Judge Halpern disclosed he was the primary reason the change was made, and his participation in the change makes sense, given the issue potentially before him in Ad Investment 2000 Fund LLC.  The statute no longer contains a reference to the U.S. District Court for the District of Columbia.  However, even so, there seems to still be disagreement over what the new statutory language means.

I have read a lot of Tax Court cases addressing the rules of evidence (perhaps all of them, to one degree or another) and can offer some thoughts about them.  I am not aware of any case in which the Tax Court turned to the U.S. District Court for the District of Columbia or its Circuit Court of Appeals for guidance on evidentiary issues.  There are a small number of cases where the Tax Court looked to the Circuit Court to which the case would be appealed for guidance.  Most often, the Tax Court decided the evidentiary issue without citing any appellate court authority.  Moreover, there are very few cases in which the appellate court reversed an evidentiary decision made by the Tax Court.

I believe the court will use Golsen, just as it has in the past, to resolve issues where the appellate courts disagree, with no deference to the D.C. Circuit Court of Appeals on evidentiary issues.  It did not show any deference when the statutory language suggested it should, so there is no reason to think it would do so now.

A look at the most recent Tax Court cases bears this out and suggests a new trend.  Unlike past cases, the Tax Court now is citing to district court opinions, often from the jurisdiction to which the case would be appealed, and to relevant appellate court opinions.  Citation to district court opinions makes sense, as it is the trial court that is making the evidentiary decision.  And, to the extent the district court has not been overruled by the appellate court, this law would be the controlling law in the jurisdiction.

For example, in CNT Investors, LLC v. Commissioner, 144 T.C. 161 (2015) the venue for appeal was either the Ninth Circuit or the D.C. Circuit Court of Appeals (the court declined to resolve the issue as the holding would be the same regardless of appellate venue).  The court noted that it may take judicial notice of appropriate adjudicative facts at any stage in a proceeding, citing to Rule 201 of the Federal Rules of Evidence.  It then stated that a court may take judicial notice of public records not subject to reasonable dispute, such as county real property title records.  In support of this position, it cited two California district court opinions.  It further noted that it could rely on electronic versions of public records, citing two district court opinions and an Eighth and Sixth Circuit Court of Appeals opinion.  The cited authority allowed the court to consider the online grantor/grantee records of the county in California that showed the LLC held legal title to four parcels of real property in the county.

In determining where certain LLCs were formed, it looked at the online records in each state and found one LLC was formed in Delaware and one in California.  It noted who was listed on the records as the agent for service of process, the entity’s address, and that there was no indication the LLC had been dissolved.  As the basis for taking judicial notice, it cited to three district court opinions in which such judicial notice-taking was permitted.

In Bunch v. Commissioner, T.C. Memo. 2014-177, in explaining the extent to which the court could take judicial notice of pleadings and court orders in related proceedings, the Tax Court cited to appellate and district court opinions, none of which were in D. C.

In S cases, the judges also seem to be willing to turn to holdings in the local jurisdiction for guidance on admissibility of evidence.  This is a curious development, since the Rules of Evidence generally do not apply to small, or “S” cases.  [IRC § 7463; Tax Court Rule 174(c)]  In Lopez v. Commissioner, the taxpayer possessed notarized written statements from her customers and had presented them to the Commissioner during the audit of her returns.  The taxpayer offered the documents at trial, and the Commissioner objected.  The Tax Court admitted the documents, noting that under New York law, if “a document on its face is properly subscribed and bears acknowledgment of a notary public, there is a ‘presumption of due execution, which may be rebutted only upon a showing of clear and convincing evidence to the contrary,’” citing New York state court opinions.  Because the Commissioner had not offered any evidence to rebut the presumption, the notarized statements were admissible.

It seems most likely that the trend of citing to local authority, or at a minimum district court opinions, will continue, and holdings and differences among federal district courts or appellate courts will become even more important when determining evidentiary issues in the Tax Court.

This change makes a lot of sense. When a case is appealed to a Circuit Court of Appeals, if there is an issue about whether the Tax Court properly admitted (or considered) evidence, the appellate court will rely on its own interpretation of the rules of evidence.  But this is, as a practical matter, what has been happening all along.  A practitioner would be hard-pressed to find a case in which the Tax Court or an appellate court looked to the District of Columbia for guidance on how to apply a rule of evidence.  To the contrary, there are plenty of cases in which the appellate court looked to its own interpretation to resolve an issue.

Where this law-change places the Tax Court is under the Golsen rule [Golsen v. Commissioner, 54 T.C. 742 (1970)]. And this is where it has been all along.  It is just there officially now.

Under the Golsen rule, when there is a disagreement among appellate courts, the Tax Court will follow the opinion of the Circuit Court of Appeals to which the case could be appealed.  Or if the appellate court has not yet ruled on the issue, the Tax Court can decide on its own how to interpret the rule.

Having conflicting rules at the appellate level is nothing new. The Golsen rule’s very existence is built on the fact that the appellate courts often disagree.  What the new statutory amendment does is to officially recognize that such disagreements extend to more than substantive law and that the appellate courts also can take evidentiary differences into consideration.

While evidentiary issues often take a back seat to the substantive issues, it is not unheard of for the evidentiary issue to control the outcome of the case. For example, a number of recent Tax Court opinions have addressed whether the taxpayer was entitled to claim a charitable contribution deduction for donating an easement.  The value of the easement, generally, is determined by comparing the value of the property before the grant to the value after the grant, with the decrease in value being what was given up, or the value of the easement on the property.  At trial, experts provide testimony about the before and after values.

Under Federal Rules of Evidence 702, a party offering the testimony of an expert witness must establish that the witness is qualified as an expert. The court must assess the reliability of proffered testimony before admitting it into evidence, making sure the expert testimony conforms with Daubert v. Merrell Dow Pharmaceuticals, Inc. (finding that trial courts must perform as gatekeepers, excluding unreliable expert testimony) [509 U.S. 579, 590–93 (1993)].

However, in the area of easement valuation, the reliability of some experts was not only called into question, but the experts were accused of aiding in the understatement of tax by overvaluing façade easements. Eventually, the experts entered into a settlement with the IRS, admitting to violating Circular 230 by failing to exercise due diligence in preparing the valuation reports and failing to determine the correctness of their written representations.  [News Release, IR-2014-31] While the experts were not identified, it is unlikely their clients were successful in obtaining the claimed charitable contribution deductions.

Another area of evidentiary tension is in the privileges found under Rule 501, specifically the work-product privilege. In United States v. Textron, Inc. [577 F.3d 21 (1^st Cir. 2009], the IRS requested Textron’s tax accrual work papers. The papers were prepared by its lawyers (and others) to support Textron’s calculation of tax reserves for potential liabilities for further taxes. In turn, Textron claimed it did not have to provide the work papers as they were protected by the work-product privilege.

The work product privilege protects tangible documents, mental impressions, personal beliefs, and other material prepared by an attorney in anticipation of litigation or trial. The scope of protection under the work product privilege is broader than that under the attorney-client privilege. It protects documents prepared in anticipation of litigation if prepared by, or at the direction of, the party’s attorney or the party. To come within the privilege, the taxpayer must demonstrate that the document was created with reference to a specific claim, supported by concrete facts, and likely to lead to litigation. Because the privilege protects only documents prepared in anticipation of litigation, it does not protect documents prepared in the ordinary course of business or for other non-litigation purposes.

Textron was statutorily required to prepare the tax accrual work papers for financial reporting purposes. As part of its analysis, Textron had to consider prospects for litigation related to each position. Nevertheless, the First Circuit held that, because the papers were prepared for financial reasons, and not for use in litigation, they were not protected from disclosure.

The Fifth Circuit previously reached a conclusion similar to the First Circuit [United States v. El Paso, 682 F.2d 530 (5^th Cir. 1982)], finding that tax work papers were not protected by the work-product privilege.

While these controversies over the protection of tax accrual work papers began in district courts, the Tax Court has previously had to grapple with the protection afforded by the work product privilege. Given the lengthy dissent in Textron and lack of guidance from most of the other appellate courts, it is unlikely that this issue has been played out. However, if a similar version of the issue reaches the Tax Court, it is now free to overtly look to the relevant appellate court for guidance on how to resolve this issue. As it will be able to do on all other evidentiary issues.

To determine if the taxpayers were entitled to notice of nonparty subpoenas, the Tax Court looked to the rules.  The Tax Court has its own rules of civil procedure.  (Section 7453 provides that proceedings of the Tax Court be conducted in accordance with such rules of practice and procedure as the Tax Court may prescribe.  These Rules are easily accessible from the Tax Court’s website, see www.ustaxcourt.gov.)

The Court began its analysis where the taxpayers suggested, by considering Rule 21, Service of Papers.  While that Rule did list a number of documents to be filed with the court or served on another party, nonparty subpoenas are not included in the list.  The Court then turned its attention to Rule 147, Subpoenas, and found it contained no notice requirement.

When called upon to interpret its rules, the Tax Court has looked to the Notes of the Rules Committee for any available explanation (see, e.g., Dvorak v. Commissioner, 64 T.C. 846 (1975)).  Where there is no guidance in its own Notes, the Tax Court has looked to cases decided under the Federal Rules of Civil Procedure (FRCP) for guidance on interpretation of similarly-constructed rules (see, e.g., Grant v. Commissioner, T.C. Memo. 1999-115).  Finally, when the Tax Court Rules do not contain the necessary rule, the Court has looked to the FRCP to fill that gap (see, e.g., Settles v. Commissioner, 138 T.C. 372 (2012) (in determining whether review of collection action could be dismissed, the Tax Court looked to the Federal Rules of Civil Procedure) and Brannon’s of Shawnee, Inc. v. Commissioner, 69 T.C. 999 (1978) (when the Tax Court Rules did not contain a provision governing disposition of void decisions, the Tax Court looked to the Federal Rules of Civil Procedure)).  This use of the Federal Rules of Civil Procedure is supported by the Court’s own Rule 1(b), which provides “where in any instance there is no applicable rule of procedure, the Court or the Judge before whom the matter is pending may prescribe the procedure, giving particular weight to the Federal Rules of Civil Procedure to the extent that they are suitably adaptable to govern the matter at hand.”

Undeterred by the lack of a notice requirement in Rule 147, Judge Holmes looked to its history.  At the time it was enacted, the stated goal was to have a rule substantially similar to FRCP Rule 45.  In 1991, a notice requirement was added to FRCP Rule 45.  Even though no similar change had been made to Rule 147, Judge Holmes decided that the rules were intended to be the same: “it’s just an example of the two sets of rules drifting apart over time.”  Accordingly, Judge Holmes concluded that Tax Court Rule 147’s implementation should track that of FRCP Rule 45’s and read the notice requirement into Rule 147.

By Order, Judge Holmes held that, while he would not find the Commissioner violated the rules, he adopted the notification requirement as a modification to the pretrial order.  He granted the taxpayer’s motion to compel; the Commissioner was required to provide all nonparty subpoenas and responses to those subpoenas and give notice of such subpoenas in the future.

But it isn’t just the judges’ application of the rules that might make you scratch your head. There has long been an application issue lurking within the Code section that makes the Federal Rules of Evidence applicable in Tax Court.  Section 7453 provides “the proceedings of the Tax Court and its divisions shall be conducted in accordance with . . . the rules of evidence applicable in trials without a jury in the United States District Court of the District of Columbia.” Tax Court Rule 143(a) echoes this rule: “Trials before the Court will be conducted in accordance with the rules of evidence applicable in trials without a jury in the United States District Court for the District of Columbia.”  This seems to suggest that the Tax Court look to the District of Columbia District Court (and its appellate court), and not the Circuit Court of Appeals to which the case could be appealed, for interpretation of the rules.

This result is in direct contrast to the Tax Court’s Golsen rule.  Under the Golsen rule, when there is a disagreement among appellate courts, the Tax Court will follow the opinion of the Circuit Court of Appeals to which the case could be appealed.  But, what about instances where the appellate courts disagree on the application of a rule of evidence?  Section 7453 was enacted long before the Tax Court adopted the Golsen rule, and a judicial rule cannot take precedence over a statutory provision.

One evidentiary rule where there is disagreement among the appellate courts is Rule 106. If a party introduces a writing or a portion of a writing, the opposing party may require the introduction of any other part of the writing or any other writing that in fairness ought to be considered at the same time.  The conflict between the appellate courts is whether the other part or other writing must satisfy the rules of evidence to be admissible.  Four appellate courts, including the District of Columbia  (and the First, Third  and Seventh Circuits) will admit the other part if fairness requires its admission.  In contrast, four different appellate courts (the Second, Fourth, Sixth, and Ninth Circuits) require the other part or writing to satisfy the rules of evidence before it can be admitted, finding that Rule 106 does not make admissible what is otherwise inadmissible.  Curiously, a case being tried in the Tax Court and appealable to the Second, Fourth, Sixth, or Ninth Circuits would seem to require the Tax Court to apply the contrary interpretation of the District Court of the District of Columbia.

Admittedly, an issue involving Rule 106 arises infrequently and the potential differential treatment is unlikely significant enough to create a demand for change. Rule 301 is at the opposite end of the spectrum.  It is implicated in many more cases and, because it is so intertwined with substantive rules applied by the courts, demonstrates the unworkability of the Golsen rule and Section 7453 operating simultaneously.

The determination made in the notice of deficiency is presumed correct, and, generally, the taxpayer has the burden of proof by a preponderance of the evidence. Rule 301 provides that the party against whom a presumption is directed has the burden of producing evidence to rebut the presumption.  However, the courts have that that if the Commissioner has determined the taxpayer has unreported income, he must introduce substantive evidence linking the taxpayer to the income.  For example, the Commissioner may establish a link between the taxpayer and the alleged business activity that generated the income.  Or he may establish a link between the taxpayer and the unreported income, such as through a source and application of funds analysis, without necessarily making a link to the alleged activity that generated the income.  The appellate courts disagree on whether, to be considered, the evidence used by the Commissioner to establish the link must satisfy the rules of evidence.  In the Second Circuit, a statutory notice of deficiency based on such inadmissible evidence is arbitrary, the notice is not entitled to the presumption of correctness, and the burden of production shifts to the Commissioner.  In the Fourth, Seventh, and Ninth Circuits, inadmissible evidence may be considered in determining if the Commissioner has established the requisite link.

Burden of proof issues can be difficult. Moreover, the substantive opinions of the appellate courts that shift the burden of production to the Commissioner are intertwined with evidentiary rules and there is no easy way to separate the two avenues of analysis.  When is the court making a substantive ruling and when is the court applying the rules of evidence?  More specifically, from the Tax Court’s perspective, when is the Goslen rule applicable and when are the rules from the District of Columbia District Court applicable?  Of course, exasperating the problem is the lack of any tax case arising in the Tax Court that specifically has looked to the District Court of the District of Columbia for assistance in interpreting an evidentiary issue.

On February 11 the Senate Finance Committee marked up 17 miscellaneous tax bills, one of which would provide that the Tax Court apply the federal rules of evidence applicable in the Circuit Court to which the case is appealable.  Not only is it difficult to imagine anyone who would object to the passing of this rule, but the proposed change makes sense.  It would place the Code section in line with what the Tax Court and appellate courts are already doing and make application of the rules of evidence consistent with the Golsen rule.