A Drama in Three Acts: Designated Orders Jan. 13 – 17 (Part One of Three)

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Sometimes I think the Tax Court Judges like giving me extra work by putting really substantive and interesting issues in designated orders. The week of January 13, 2020 was certainly one of those weeks. So much so, that it warrants (at least) three posts on two orders. Let’s start with our familiar friends (Graev and petitioners failing to prosecute) before moving on to new ones (the Accardi doctrine).

Part One: Tax Court, the Commitment to Getting the Right Tax… And Graev. Meyers v. C.I.R., Dkt. # 8453-19 (order here)

On a cold, winter’s eve I recently watched the critically-acclaimed “Marriage Story” on Netflix. Perhaps because I am unmarried and don’t have kids, what I found most compelling about the film was the portrayal of the family law attorneys -specifically, how incredibly different and adversarial their dynamic is from my own experience in tax. I finished the movie feeling uplifted… about my choice to go into tax law. The Meyers bench opinion was a similarly uplifting story: a reaffirmation that the Tax Court (and generally IRS Counsel) care mostly about getting the right amount of tax, and not simply the most amount of tax.

Of course, since this blog focuses on tax rather than romance (and only rarely the twain shall meet), my post will be on the interesting procedural aspects that arise. Luckily, this case provides a few such lessons that are worth taking a look at.

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“Meyers Story” features a husband and wife in deficiency proceedings for, shall we say, “unlikely” deductions that the IRS disallowed. I will note a few of them for the sake of levity: (1) that 94% of their home was a “home office”, (2) that the husband’s remarkably unprofitable model airplane “business” was not subject to the hobby-loss limits, and (3) that his purchase of model airplanes were ALSO deductible advertising expenses for his (again, remarkably unprofitable) real estate “business.” These are but a few of the many improper deductions at play. Somehow, the case went to trial.

And that is where things get procedurally interesting. For this is not the time-worn tale of taxpayers filing a petition and then just moving on in their life. No, petitioners took many more steps than to simply “file-and-forget.” In fact, they almost saw the case to completion. They filed stipulations with the Court. They even showed up to Court and testified… but only for half of the trial.

Because of the numerous issues that had to be hammered out, the trial was set to span two days. The wife was able to wrap up her part on day one, which was helpful since she appears to work a fairly lucrative (six figure) job. The husband, on the other hand (whose sources of income are less clear) only had time on day-one to finish direct questioning: that is, to give his own testimony. He was set to come back on day two to face cross-examination. After reading the tea-leaves, however, Mr. Meyers decided against facing IRS questioning: in his opinion Judge Gustafson had “already made up his mind -it’s going to be a waste of time.” This was expressed in an email to IRS counsel before the second day of trial. The Court called Mr. Meyers and left a message explaining that he was required to show up to Court, but Mr. Meyers ignored it. Accordingly, the IRS moved that the case be dismissed for failure to prosecute and for the imposition of an IRC 6673 penalty.

So what is Judge Gustafson to do? Grant both motions and leave it at that? To appreciate the dilemma(s) facing Judge Gustafson, let’s look at what is supposed to happen when a case is dismissed for failure to prosecute.

Tax Court Rule 123(b) provides that when a case is dismissed for failure to properly prosecute the court may enter a decision against the petitioner. But can that decision (for our purposes, the deficiency amount) be whatever the Court wants? Does it have to be what the IRS wants, and if so is that simply the amount on the Notice of Deficiency?

The statute on point provides guidance, but some wiggle-room. IRC 7459(d) provides that the Court’s dismissal of a case (other than for lack of jurisdiction) “shall be considered as its decision that the deficiency is the amount determined by the Secretary.”

I think that could reasonably be read as “dismissal = affirming whatever is in the Notice of Deficiency” since that would appear to be the IRS determination that led to the case being brought. The code section doesn’t specifically direct that outcome -arguably, “the amount determined by the Secretary” could be more than the Notice of Deficiency if new issues were raised in the Answer, though that gets into hairy “presumption of correctness” issues not at play in Meyers.

However, more often the Tax Court and IRS are willing to enter a decision for an amount less than the Notice of Deficiency when a case is dismissed. As Judge Gustafson notes, “it is the frequent practice of this Court -often at the instance of the Commissioner to dismiss a case for failure to prosecute but to enter a decision in a deficiency amount smaller than what appears in the SNOD.”  Usually, this happens when the IRS has conceded some issues, but, Judge Gustafson notes, that isn’t the only circumstance: “we prefer […] to enter a decision based on the facts demonstrated by the evidence rather than as a punishment.” In other words, even when you have a bad actor that doesn’t prosecute their case and the IRS is standing by the SNOD the Court wants the right amount of tax when there is reason to believe the SNOD may be off.

Getting the right amount of tax rather than the most amount of tax… My eyes aren’t teary, I just have winter allergies.

Of course, the Tax Court does not take lightly the petitioner’s failure to prosecute. Judge Gustafson calls the failure to appear for cross “a most serious offense against the process” in our adversarial system, and does not wish to “reward[] the petitioner for his non-appearance.” But again, that isn’t enough to “punish” the taxpayer with an amount of tax that may be incorrect, so Judge Gustafson walks through the merits as if the case had been seen through to fruition.

Because a lot of the issues come down to the credibility of evidence, and because the petitioners have proven themselves to be extraordinarily non-credible (a little more on that in a moment), the vast majority of deductions are denied. Some deductions, however, are more mechanical. Judge Gustafson has no problem completely disallowing the ridiculous home office deductions, but notes that since 94% of the home mortgage interest payments were attributed to this (i.e. deducted on Schedule C), the petitioners should likely get that foregone 94% as an itemized deduction (i.e. deducted on Schedule A instead).

In sum, the SNOD was likely correct to disallow (almost) all the deductions, but it still didn’t quite get the right amount of tax after that. So we arrive at the procedural fix: what I’d style as a “conditionally” granted motion to dismiss. The IRS’s motion to dismiss is granted but only to the “extent of undertaking to enter decision in amounts of tax deficiencies smaller than those determined in the SNOD[.]” In other words, the case is dismissed, and a decision will be entered, but in an amount determined under Rule 155.

Everything appears to be neatly wrapped up. Except that there were two motions at play, and we have only resolved the motion to dismiss. What about the motion to impose sanctions under IRC 6673?

On the merits of the penalty, there is more to this than just the petitioner failing to show up for day two and taking egregious deductions. Petitioner husband pretty obviously created a fake receipt (one may say, committed fraud on the Court) for a charitable deduction from Habitat for Humanity, by altering the date to make it fall within the tax year at issue. Judge Gustafson doesn’t use the word “fraud,” but instead concludes that the husband “deliberately concocted a non-authentic receipt and tried to make the Commissioner and the Court assume it was authentic.” Fraud-lite, you may say.

Let’s just assume that the behavior and absurdity of the deductions are enough on the merits to warrant a penalty under IRC 6673. Are there any other hurdles that the IRS must clear?

Why yes, there (apparently) is: our old friend Graev and IRC 6751. Like any good story, this provided an unexpected twist. Although the penalty is proposed by motion, orally, at trial, Judge Gustafson finds that it would (likely) need written supervisory approval first. The IRS attorney had, in fact, asked their supervisor about the possibility of moving for an IRC 6673 penalty via email. But the supervisory response was simply “Print these for the court, please.” Cryptic, and apparently not enough to demonstrate approval.

The tax world has been abuzz recently with published opinions on IRC 6751. Procedurally Taxing has covered some here and here. Here, again, we have a designated order as bellwether for an emerging issue: none of the cases have ruled on whether written supervisory approval is needed in this context (i.e. a motion for court sanctions at trial). I fully anticipate that this order will result in either the IRS changing their procedures for such motions, or (less likely, in my opinion) litigating the issue.

Is that the end of the Myers saga? Not quite. In one final twist, we are reminded that the Court could impose the penalties sua sponte (perhaps “nudged” by the IRS motion). And the Court has (conveniently) found that it does not need written supervisory approval for imposing such penalties. See Williams v. C.I.R., 151 T.C. No. 1 (2018).

But in this instance Judge Gustafson decides to let them off with a warning and an indication that the Court may not be so forgiving in the future. A tantalizing cliff-hanger for the possibility of a sequel…

About Caleb Smith

Caleb Smith is Visiting Associate Clinical Professor and the Director of the Ronald M. Mankoff Tax Clinic at the University of Minnesota Law School. Caleb has worked at Low-Income Taxpayer Clinics on both coasts and the Midwest, most recently completing a fellowship at Harvard Law School's Federal Tax Clinic. Prior to law school Caleb was the Tax Program Manager at Minnesota's largest Volunteer Income Tax Assistance organization, where he continues to remain engaged as an instructor and volunteer today.

Comments

  1. Watching films alone at home on wintry nights is not the best route to domestic partnership. As a reminder to those who may know Caleb or other single tax gurus, next week brings us Bachelors Day:

    “…an Irish tradition on Leap Day allowing women to initiate dances and propose marriage. If the proposal was refused the man was expected to buy the woman a silk gown or, by the mid-20th century, a fur coat. The tradition is supposed to originate from a deal that Saint Bridget struck with Saint Patrick. In the United Kingdom, a woman was allowed to propose marriage on Leap Day and if refused the man was obliged to buy her new gloves on Easter Day. In some areas a woman could propose for the entire leap year.”

    It may be true, as Caleb writes, that rarely tax and romance meet. But before that twain leaves the station, I am provoked to mention that I owe two outstanding children and four amazing grandchildren to IRS hiring on the same day, about 47 years ago, a couple people for Taxpayer Service work in a Midwestern city where neither had previously lived. We eventually went our separate ways, but it was fun while it lasted, and beneficial to both our lives and careers.

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