A Trip to the Virgin Islands! And Other Designated Orders, December 2 – 6, 2019

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There will be a panel on designated orders at the upcoming ABA Tax Section Midyear Meeting in Boca Raton, Florida on Friday, January 31. There will be some familiar faces presenting on the panel, including Keith and fellow Designated Order blogger Patrick Thomas, as well as Special Trial Judge Leyden and Rich Goldman from IRS Chief Counsel. 

Not to spoil the surprise, but a couple of things that I plan on speaking about include how designated orders can serve as bellwethers on emerging issues (think Chai/Graev), as well as how they frequently provide teaching moments I can use with my students or in practice. As it so happens, I found two such orders during the week of December 2, 2019: one as a bellwether on the emerging issue of what constitutes proper filing for returns in the Virgin Islands, and one as a teaching moment on why success on a prior year audit doesn’t generally have much (if any) impact on future year audits on the same issue.

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Designated Orders as Bellwethers: What Exactly Does Filing a Return in the Virgin Islands Entail, Anyway? Estate of Marco Musa v. C.I.R., Dkt. # 19216-17 (here)

The word “bellwether” comes from the shepherding practice of attaching a bell to a male ram in a flock of sheep, such ram then leading the flock. Apparently, it assisted shepherds by allowing them to ascertain the direction of the flock (by the sound of the bell) even when out of sight. Designated orders like the Estate of Musa operate similarly: alerting practitioners to issues that may be otherwise out-of-sight (because of a dearth of recent published opinions), while also giving a flavor for the direction the law is going.

When it comes to filing a federal tax return in the continental United States things are generally pretty uncontroversial. That isn’t to say that things don’t occasionally go awry, particularly with whether the paper return was sent to the proper location (an interesting example where the return was sent to the IRS counsel and IRS agent working the case, but not technically proper filing location can be found here) or if the electronically filed return was timely processed (see case here). Generally, however, what goes into actually filing a return is no longer the cause of much controversy.

Things are less straightforward when you are dealing with a return filed in the “organized, unincorporated” U.S. Virgin Islands (USVI). This is especially so if you are not a “bona fide resident” of the USVI, but are in fact a US citizen. In those circumstances, IRC 932(a)(2) provides that you need to file both in the USVI and the US proper.

Whether a return was properly filed is the dispositive issue in this case: if petitioners properly filed (as they claim they did) then the clock on assessment ran its course by the time the IRS got around to commencing deficiency assessment procedures. See IRC 6501. In other words, if the return was filed when Petitioners claim it was it would be a full win for the taxpayer. The IRS concedes as much, setting this showdown in a motion for summary judgment (by petitioners).

So what would it take for Petitioners to win? They advance two separate theories they believe would carry the day: (1) that they filed the returns with USVI, which is enough, at a date that makes the IRS deficiency procedures too late, or (2) that their returns were considered filed when the USVI authorities sent copies of the first two pages of the returns to the IRS.

The first theory can be quickly disposed of, in no small part because of the procedural posture of the order. The order is proceeding under the assumption that the petitioners are not bona fide residents of USVI, because (I assume) no such facts or stipulations have been put forwards establishing that, and in summary judgment the Court must make all inferences favorable to the non-moving party. Because petitioners are assumed not to be bona-fide residents of USVI, IRC 932 applies -and there is already a precedential case in the 11th Circuit (where this would be appealable to) that holds filing just in the USVI in such circumstances is insufficient. See C.I.R. v. Estate of Sanders, 834 F.3d 1269 (11th Cir. 2016).

So petitioners have to win on the second theory: that when the IRS received two pages of their USVI filed return that was sufficient to start the clock. And that is a much thornier issue that was kind-of-resolved in the Tax Court case in Hulett v. C.I.R. (and mentioned briefly here), and kind-of-not-dealt-with in the aforementioned Estate of Sanders in the 11th Circuit. Allow me to explain.

Hulett was a full court-reviewed opinion that involved a lot of difference in opinion among the judges, with a majority opinion on the outcome but a complete fracture (with no majority) on the reason for it. This sort of issue has been covered by Procedurally Taxing before (see the excellent discussion here). The “lead” opinion (of five judges) in Hulett found that the sort of situation here (photocopied pages of the return transmitted from USVI to the IRS) was sufficient to be a filed return starting the clock. Which is the petitioner’s argument. So a win, right?

Well, not quite.

For one (although it isn’t directly relevant to the Tax Court’s ability to follow Hulett here) the Hulett case is currently on appeal to the 8th Circuit. But more important is the treatment by the 11th Circuit of the position adopted in the Hulett “lead opinion.” The 11th Circuit opinion did not directly opine on the Hulett rationale, and it wasn’t (directly) before the court. However, the USVI Government filed as an intervenor in the case and did raise the issue on brief (as did the taxpayer). So the issue was before the Court, perhaps obliquely, in a case where the 11th Circuit found against the taxpayer. But because it was not directly brought up in the 11th  Circuit opinion, Judge Lauber notes that it is unclear if that the taxpayer lost because the 11th Circuit found the argument unpersuasive, or simply not properly presented (i.e. raised only on appeal, and not in the trial court). Note that had the 11th Circuit (directly) ruled on the issue the Tax Court’s position in Hulett would be irrelevant because of the Golsen rule.

So the 11th Circuit hasn’t ruled directly on the issue, Hulett produced a fractured Tax Court decision, and the 8th Circuit has yet to provide either imprimatur or rebuke to the lead opinion (or outcome) of Hulett. What is Judge Lauber to do with this summary judgment motion? Follow the lead opinion of Hulett in the Tax Court? Read Estate of Sanders as a rejection of the Hulett rationale?

Understandably, he opts for “wait-and-see.”

Usually, a motion for summary judgment motion will be denied because there are material facts in dispute. Here, it is more appropriate to say that the motion is denied because the underlying law is in dispute (or, better put, unsettled). Judge Lauber believes that the 8th Circuit opinion on Hulett could, conceivably, affect as persuasive authority what the 11th Circuit would decide on the instant case. Similarly, that decision may also affect what material facts come into play (apparently pertaining to the “intent” to file returns). So, because both the law (and possibly the facts) are still getting sorted out, let’s just wait. The motion for summary judgment is denied without prejudice, and can be refiled when the chips start falling. We’ll just have to wait and listen for the direction the next bellwether tolls… (apologies for belaboring the analogy).

Designated Orders as Teaching Moments: The Limits of Settlement Documents, the Taxpayer Bill of Rights, and Non-Binding IRS Guidance When Faced with Frequent Audit. Matarozzo & Beach v. C.I.R., Dkt. # 19228-14 (here)

I am often tasked with explaining to clients (and occasionally students) the near irrelevancy that an IRS audit (or lack of audit) for a prior year has on the year at issue. Sometimes the client misconstrues a previous lack of audit as a badge of approval: the IRS let me claim my cousin as a qualifying child for the last 4 years, how is it an issue now? Other times you have a situation like the one presented in the above order: the IRS has already audited me on this issue in the past, and I (largely) prevailed: shouldn’t they just leave me alone from here on out?

Answers to that question depend somewhat on the facts of the audit (particularly if the outcome hinged on an issue of law or an issue of fact), but the general take-away is that the IRS can certainly audit you on the same issue in a different year, because your circumstances (and eligibility for the deduction, etc.) may well have changed. Of course, the IRS does not want to commit resources to audits that are likely to result in a no-change or to give the impression of harassing certain taxpayers year-after-year, so there may be internal policy reasons why the IRS would be less likely to audit a taxpayer on a similar issue in a later year in those circumstances. But if you are looking on a legal prohibition on such audits you will be hard-pressed to find them (note that the (very weak) prohibition on multiple reviews of a taxpayer’s books under IRC 7605(b) only applies to multiple reviews on the same taxable year).

In the above case, the petitioner presents three different arguments (and three different sources of authority) for why the IRS should not be able to audit them on a particular issue. The order provides a quick lesson on the drawbacks to each source of authority and argument.

The relevant facts can be easily summarized. In 2014, the petitioners were audited for 2010 and 2011, and filed a tax court petition challenging the ensuing notice of deficiency. Like most tax court cases, the parties eventually settled on all issues. The IRS conceded more than 90% of the deficiency in 2010, and all of the deficiency in 2011. Both parties signed off on the decision document, the Tax Court entered it, and everyone went on their merry way.

And then the IRS went and audited them again in 2016, this time for tax year 2013. (At least they got a break for 2012?)

Interestingly, the taxpayer filed a motion to vacate or revise the decision in their earlier tax court case (i.e. the one that was docketed and resolved years ago by settlement) as a way to try to challenge the audit. The grounds for this challenge were (1) the signed decision document/settlement explicitly precluded the IRS from later audits on the issue, (2) an IRS publication provides that such audits are not allowed, and (3), for good measure, the Taxpayer Bill of Rights abhors such repeat audits.

Let’s quickly learn why each of these arguments is destined to fail -for both the facts particular to the client and the law more broadly.

Beginning with the decision document, the facts cut heavily against petitioner because the terms of the decision document cannot charitably be read to include any prohibition against future audits. Such an agreement simply isn’t included in the signed documents. Maybe Petitioner believed that the prohibition was in the terms and now wants to make the change, but even if the Court wanted to revise the decision they would be unable to do so based on the law, because under IRC 7481(a)(1) the decision was “final” years ago. And, as Judge Gustafson notes, “Unlike the Federal District Courts operating under Rule 60 of the Federal Rules of Civil Procedure [which allows numerous avenues for relief after a final judgment], the Tax Court is bound by that finality rule.” Further, even if the case were vacated on (essentially) contract grounds of invalidity of the settlement (no “meeting of the minds”) the result would be an entirely new deficiency proceeding, not a Court-imposed finding of a new term in the settlement agreement. So no luck there.

But Petitioner also trumpets an IRS Publication that seems to bolster his case: IRS Publication 334. The publication provides that “If we examined your return for the same items in either of the 2 previous years and proposed no change to your tax liability, please contact us as soon as possible so we can see if we should discontinue the examination.” Previously I had no idea the IRS had such a policy. Downright decent of the IRS to offer that.

The problems here is that (1) the language of the publication clearly does not say that the IRS will not audit, but may choose not to audit after a no-change, and (2) the policy apparently doesn’t apply to tax returns with Schedule Cs (which this return did). See IRM 4.10.2.13.1. But more broadly, even if were applicable, I doubt it would matter. At absolute best, the publication would stand for the proposition that the IRS has the power to audit, but has decided in certain circumstances as a matter not to exercise such discretion. But this case is a deficiency proceeding, and is not looking at “abuse of discretion” of the IRS actors. Further, even if it were I don’t think it would get very far. IRS Publication 334 is not an IRB publication, and is unlikely to have any real binding effect on the IRS even as a matter of internal policy. You really can’t rely on such publications for much of anything other than general guidance -or, perhaps, assisting a reasonable cause argument under IRC 6664. So again, no dice.

Lastly, Petitioner raises in broad strokes the argument that the Taxpayer Bill of Rights (TBOR) would not allow for these later audits. The contours of TBOR and their potential legal effect are still being developed. Thus far the Courts are extremely reluctant to give much teeth to the (admittedly broad and sometimes vague) provisions of TBOR. That said, there are certain contexts in which TBOR arguments may supplement or reinforce legal arguments that a Court may entertain. Most likely, those are in cases where the Court is tasked with deciding whether there was an “abuse of discretion” by the IRS. Keith has written about TBOR’s potential quite a bit (see Temple Law Review article here). But this is not such a case, since this is not in a stance where the Tax Court is being asked to review (or has the authority to review) an act of agency discretion. The petitioner is arguing that the IRS is straight-up prohibited from the later audit. And you will need something a bit stronger (say, a contract or, even better, code section) that reasonably gets you there. The broad strokes of TBOR will not suffice, and the Tax Court recites the (in my opinion, debatable) proviso that the TBOR does not “create any taxpayer rights; rather, [it] allude[s] to provisions elsewhere in the Internal Revenue Code.”

No dice, again. But at least we learned a bit about some IRS policies on future audits, and the finality rule of the Tax Court.

Remaining Orders of the Week

For the sake of completeness, a rundown of the remaining orders for the week of December 2, 2019 are as follows:

Tax Protestor That Will Get Penalties If He Keeps Pushing His Luck (Cooper v. C.I.R., here)

Tax Protestor That Gets Hit With Penalties… And is a Familiar Face (see post here) (Walquist v. C.I.R., here). More depth on this fairly familiar theme of designated orders can be found in a previous post here.

Petitioner That Fails to Respond to Summary Judgment Motion… And Loses (Laurent v. C.I.R., here)

Petitioner That Fails to Show Up to Court… And Loses (Davis v. C.I.R., here)

Bench Opinion: Petitioner (Shockingly) Bred Horses Without Profit Motive (Skarky v. C.I.R, here)

Bench Opinion: Petitioner (Shockingly) Has Gain On Sale of Collectibles When He Doesn’t Track Purchase Price (Ferne v. C.I.R., here)

Caleb Smith 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. Kenneth H. Ryesky says

    “The word ‘bellwether’ comes from the shepherding practice of attaching a bell to a male ram in a flock of sheep, such ram then leading the flock.”

    7 C.F.R. § 760.903 — Definitions: … Ram means a male sheep.

    9 C.F.R. §93.400 — Definitions: … Wether. A castrated male sheep or goat.

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