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.

Can You Put a Price on Political Influence? Designated Orders, February 24 – 28, 2020

We don’t usually introduce designated order posts because the team of authors is a part of PT team.  I am making an exception here because I have been following the case that Caleb discusses since he was in law school.  I have written several posts about this taxpayer because he received a tremendous amount of ink from the Philadelphia Inquirer when I was teaching at Villanova.  So, I followed his political demise and criminal trial over a long period of time in my local press.  Then, after following the long arc of the criminal case the matter moved into its tax phase resulting in a jeopardy assessment followed by what must be the slowest jeopardy determination ever. 

This is one of the first cases I blogged back when we started in 2013.  Imagine a jeopardy assessment case where the IRS makes the rare determination of the need to move past the normal assessment process of notice of deficiency followed by a Tax Court hearing in order to quickly make an assessment, file notices of federal tax lien and preserve the government’s position in the taxpayer’s assets.  This is a jeopardy case the IRS took four years to put together.  Now imagine it’s almost seven years after the IRS finally put its jeopardy case together (that’s eleven years after starting to work on the jeopardy case!) and the Tax Court has just denied summary judgment.  The trial and the decision on the liability remain in the future.  That the Tax Court now has its most efficient jurist on the case provides some hope for an outcome before the case reaches an age where it would enter middle school.  I am curious what has happened to the taxpayer’s assets after the district court declined to allow the jeopardy assessment.  If you want to read more about this remarkably slow moving case and my thoughts about the case from several years ago, read the posts here, here, here and here, before starting Caleb’s excellent explanation of the designated order the court entered last month.  Keith

There were three designated orders the week of February 24, 2020, but one stole the show: an order pertaining to former Pennsylvania state Senator Vincent J. Fumo (here). (The remaining two orders can be found here and here.)

Aside from the natural allure of political intrigue (one may fairly say, corruption), the Fumo order was particularly compelling because of its discussion of “collateral estoppel.” For those who remember “collateral estoppel” as something learned in a first-year Civil Procedure course, briefly re-learned for the bar, and then filed away in their brain under “never useful again: going into tax law,” this order may change your mind. Procedurally Taxing has definitely raised the issue before in numerous contexts (see here, here, and here).

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To understand how collateral estoppel plays out in this case, one must first understand the nature of Mr. Fumo and his previous run-ins with the law. For those unfamiliar with the workings of Pennsylvania state politics, a quick google search will bring up numerous stories of varying length and detail on the rise and fall of Mr. Fumo in the halls of political power. At the apex of his power, he certainly seemed to carry a lot of influence. 

And then came the fall. Charges of defrauding both the Pennsylvania State Senate and the non-profit Citizens Alliance for Better Neighborhoods. Mr. Fumo harmed both of these parties in numerous ways, including using their money and services for personal purposes (rather than the public interest purposes he presumably presented). But he also made sure these parties spread the wealth (in self-serving ways), by ensuring payment of “excessive salaries to employees who were promoted solely because of loyalty to [Mr. Fumo].” The Feds brought an indictment with 139 different counts, of which Mr. Fumo was convicted of 137. 

When you have that many indictments, with that powerful a person, you can all-but guarantee there is going to be a lot of litigation. And this case is no exception. For those with Westlaw access, a look at the “history” tab in U.S. v. Fumo gives a taste with 17 separate entries from the district court and court of appeals (3 of which principally concern a party related to the Fumo matter, the aide who destroyed email evidence.). For our purposes, the court decisions that matter most pertained to money, including: (1) a finding that Mr. Fumo had to pay restitution, and (2) a finding against issuing a forfeiture judgment of the property “derived from proceeds traceable to the commission” of the offenses.

As it turns out, the IRS thinks that the first court finding entitles them to summary judgment and Mr. Fumo thinks that the second issue entitles him to summary judgment, both on theories of collateral estoppel. Cross motions ensue, both of which are denied. Let’s see why.

Judge Lauber neatly lays out the test for the application of collateral estoppel in Tax Court: (1) final judgment by court of competent jurisdiction, (2) identical issues from suits, (3) the assertion of collateral estoppel can only be asserted against parties to the prior judgment, (4) the parties must have actually litigated the issues, which were “essential” to the prior decision, and (5) the controlling facts and applicable rules need to be unchanged from the prior litigation. See Atkinson v. C.I.R., T.C. Memo. 2012-226. Oh, and if there are any special circumstances that warrant it, the Court can decide against applying collateral estoppel. 

So where does that go awry here? Let’s start with the easier of the two motions: Mr. Fumo’s.

To Mr. Fumo’s mind, the summary judgment in his favor is appropriate because the IRS is collaterally estopped “by the District Court’s decision not to enter a judgment of forfeiture, from asserting that petitioner received gross income.” Pretty simple, really: if the District Court already ruled I don’t have gross income, you can’t argue I have a deficiency based on omitted income. But is that what the District Court really said in its denial of forfeiture?

Judge Lauber focuses on the “identical issues” prong in dooming this motion. Is the inability to find “proceeds traceable to” specific criminal actions the same as saying there is an inability to find “income” as defined by the Internal Revenue Code? Not quite. One (proceeds) is fairly narrow and demanding, whereas the other (gross income) is extremely broad. The U.S. suit lost its motion for a judgment of forfeiture because they couldn’t sufficiently link specific property to the criminal acts. It is doubtful that the District Court found (or even considered) whether Mr. Fumo’s criminal activity had resulted in “accessions to wealth, clearly realized, over which [Mr. Fumo has] complete dominion.” Commissioner v. Glenshaw Glass Co. 348 U.S. 426 (1955).

Petitioner’s summary judgment motion denied. What about the IRS’s summary judgment motion? This one is a bit less of an easy call.

The IRS really wants collateral estoppel to apply in two ways: (1) to preclude Mr. Fumo from relitigating the fact that he misappropriated benefits from his victims, and (2) to preclude Mr. Fumo from relitigating that the misappropriations constitute taxable benefits as a matter of law.

One of these is a far heavier lift than the other. Or maybe they both are heavy lifts, and it really just depends on exactly what the IRS wants to do with the preclusion. Judge Lauber agrees that “collateral estoppel will prevent [Mr. Fumo] from relitigating numerous facts that were indisputably litigated and resolved against him in the criminal case.” But exactly what facts, and more importantly what legal conclusions they bring about, are not as well defined at the moment. Particularly, the Tax Court is wary of using collateral estoppel (at this point) to get to the heart of what the IRS is asking: preclusion from disputing “the amounts of unreported income[.]” Because ultimately, for summary judgment to make sense here, the IRS would be looking for a knock-out blow: preclusion on issue that the proceeds were taxable, and preclusion on the amount of the proceeds. But do they have enough in the District and Appellate Court records to get there?

Probably not. One overarching issue is Mr. Fumo’s particular brand of corruption. This isn’t a politician just taking bags of money under the table. This is a politician using his influence for personal benefit, often through jobs and salaries that went to other people (loyal to him, of course). The tax consequence of theft or embezzlement is usually straightforward, and the restitution judgments usually align one-to-one with the taxable income. 

Beyond that, the amount of Mr. Fumo’s benefit (to say nothing of his taxable benefit) was clouded even in the deciding courts, because there was a co-defendant. The court of appeals originally suggested up to 96% culpability to Mr. Fumo. The district court, however, ended up at 75% culpability for the restitution award (originally, they only found 50%). How the IRS came to the numbers on their Notice of Deficiency from the restitution award isn’t immediately clear either. The court ordered restitution in the amount of $4,083,802 and the IRS ultimately determined unreported income of $2,133,956, and later amended their answer to increase the amount to $2,304,364. Lots of moving parts and not a lot of science to the numbers, as far as this admittedly poor mathematician can tell. (The IRS says they changed the numbers based on a “different averaging computation,” but that honestly sounds like “fancier guess-work” to me.)

Ultimately, however, the biggest issue remains the nature of the benefits and how inappropriate it is for a summary judgment motion. Judge Lauber sums it up: “there may be disputes of material fact as to whether petitioner derived a dollar-for-dollar benefit from the additional salary received by employees for whom he secured promotions for higher positions.” And where there is a (genuine) dispute of material fact, summary judgment does not result. Collateral estoppel is sure to apply in this case on some (probably many) facts, but at this point not enough to pin-point the amount of taxable income -which is never what the District Court was concerned with in the first place. Assuming Mr. Fumo did not candidly report some of his ill-gotten gains on his tax return, he will owe something: exactly how much, however, may well require yet another trial.

The Costs of Being Too Clever By Half: Designated Orders, January 27 – 31, 2020 Part 2 of 2

In my previous post I provided some in-depth coverage on the designated order stemming from Zhang v. C.I.R. about the definition of a prior “opportunity” to dispute the underlying tax. It is an issue that I would very much like to see raised in more appellate courts, as we in the tax community continue to develop the case law around Collection Due Process. The remaining designated orders from that week do not raise such substantive issues, but nonetheless provide important lessons. Foremost among them, the potential consequences of being “too clever by half” in your tax positions.

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Being Too Clever By Half in with Your Business: Paying Yourself So You Have Income, But No Corresponding Deduction. Provitola, et. al. v. C.I.R., Dkt. # 12357-16 and 16168-17 (order found here)

The Provitola case provides us with a fact situation that could have easily been pulled from a law school exam. At its simplest, petitioner husband has two businesses: one as a lawyer, and one as an inventor. With regards to the inventing business, Mr. Provitola has a B.S. in physics, seven patents, experience in patent law, and an LLC that plans on selling some sort of TV enhancing product. Well, actually Mr. Provitola doesn’t have an LLC: his wife is the sole owner (very little information is provided about her background). Mr. Provitola does, however, have an S-Corp for his law practice which he is the sole owner of, so he isn’t completely missing out on the ownership game.

And, in fact, the legal business Mr. Provitola owns appears to be the more profitable (or at least more active) one. His wife’s LLC was created in 2007, but through 2012 remained pretty much dormant: no expenses or receipts to report. Then, in late 2013, something went off in the mind of Mr. Provitola: he had actually been providing legal services to his wife’s LLC since 2009. In fact, he was due $12,000 per year for those services and sent a bill to his wife’s LLC for $60,000. 

I am happy to say this did not cause marital discord. In fact, the LLC paid $36,000 of the amount owed to Mr. Provitola from its (just created) capital account. The arrangement seemed so happy, in fact, that they basically repeated it in 2014.

Maybe the couple was fine with this arrangement because of how it shaked out on their joint tax return. You might be inclined to see it as a wash: Mr. Provitola has taxable income, whereas his wife has a corresponding deduction. But in fact it worked out a little better for the couple than that, because Mr. Provitola’s business had enough other expenses to pretty much completely offset the income. So really, his business continued to have $0 income and his wife still has a large net operating loss. Quite the fortuitous circumstance, it would seem.

Were this a law school exam, this is where the prompt would be: “Imagine the Provitola’s return is audited and ends up going to Court. You are the IRS attorney: what arguments would you raise for why the Provitola’s should not be allowed to deduct the expenses paid by the LLC?”

The real-life IRS attorney was (somewhat) bound by the SNOD’s rationale, since they didn’t raise alternative arguments in their answer (see Tax Court Rule 36) to the petition. (I’d note that the real-life IRS attorney also made some strained evidentiary arguments that were dismissed in a previous designated order here.) With regards to the SNOD, the IRS took the boilerplate position that the expenses were disallowed because the Provitolas (1) did not establish the expenses were paid/incurred in the years at issue, plus (2) it was not proven that the expenses were ordinary/necessary. In other words, the expenses didn’t in fact happen (as a matter of timing or reality), and even if they did they weren’t statutorily allowable under IRC 162

But the IRS attorney fleshed these positions out a bit (one may say, changed them) as litigation went on. Before Judge Buch, the argument became: (1) the LLC isn’t even a real business at all, so everything having to do with it is a fiction, and (2) even if it was a business, the payments it made were non-deductible start-up expenses. Judge Buch calls these the “substance over form” and “start-up expenditures” arguments, respectively. Query whether the change in argument should result in a burden shift, and what that even entails -see Professor Camp’s article here. For my money, I’d say both arguments fall within the original, extremely broad and vague rationales of the SNOD. A fictitious entity only makes fictitious payments, which would seem to be the equivalent of saying “expenses were not paid/incurred” in tax years at issue. And capitalized start-up expenses are, by definition, not ordinary and necessary under IRC 162 -arguably, a core component of the ordinary and necessary test is to determine whether it must be deducted or capitalized. See C.I.R. v. Tellier, 383 U.S. 687, 689-90 (1966).

Judge Buch resolves this case with a bench opinion, so the correctness or incorrectness of the IRS’s arguments was clear enough without the need for post-trial briefing. With regards to the first argument, Judge Buch finds that the LLC is, in fact, a business under the two-prong test of Bertoli v. C.I.R., 103 T.C. 501 (1994). The LLC was, in fact, created for a business purpose (to sell/market the technology, and the business did carry on that business activity (the facts show a website was created, though not made public, and about a thousand units were actually manufactured, even if none were yet sold). So the “not a real business” argument is going to fail. Good news for the Provitolas!

Or maybe not.

In fact, this is (probably unwittingly) bad news for the Provitolas. Judge Buch notes that if it were true that the LLC was not really a business and all the transactions would be disregarded and there would not be corresponding income to Mr. Provitola’s law firm: the income and deductions would vanish (what I originally would have thought to be the correct outcome, but is not the position taken on the SNOD). But that’s not what happens here. And what happens here is much worse for the Provitolas. 

Since it is, in fact a business, the substance of the payments to Mr. Provitola are respected. But as law students learn in Fed Income Tax I, not every expense is immediately deductible. Some, including “start-up expenses,” must (generally) be capitalized. The question is whether expenses (1) incurred for a business that has not made its website public, (2) had not generated any revenue, and (3) had not even really appeared to have marketed its products at the time of the expense are “start up expenses” or expenses for a going concern. The conclusion reached appears to be an easy one: these are definitely non-deductible start up expenses. (Note that in some circumstances you can deduct start-up expenses under IRC 195, but that there are time-limits and phasing rules for taking that deduction. Professor Camp covers some other niceties with that code section here)

So what does that mean? Effectively, Mr. Provitola has income that he (and his wife) paid him, but no offsetting deduction. Worst of both worlds. Oh, and the Court upheld an IRC 6662 penalty on both years for substantial understatement of tax, in part because Mr. Provitola is an attorney (and admitted to the US Tax Court) so he should have known better.

A somewhat convoluted set of transactions that resulted in the worst possible tax consequences. By “creating” income without creating a corresponding deduction the Provitolas were too clever by half.

Remaining Orders (Quick Hits):

Si v. C.I.R., Dkt. # 18748-18 (order found here

I briefly mentioned a previous order from this case, where the petitioner argued that the Tax Court had no jurisdiction because the SNOD was improperly addressed. The “Tax Court has no jurisdiction” argument won’t fly when you file a timely petition, regardless of where the IRS sent the Notice of Deficiency. So, by anxiously filing their petition on time to raise this procedural argument, the petitioner was too clever by half.

This order makes it a bit clearer to me why the petitioner would be in a hurry to raise that argument: on the merits (the usual substantiation of expenses issue) their case was quite weak. 

Wright v. C.I.R., Dkt. # 21509-18 (order found here)

Rather than the petitioner being too clever by half, here the offending party is Congress. Specifically, the drafters of code section 6015(e)(7). That section was intended to clarify the standard and scope of review in Innocent Spouse cases -an issue that years ago was contentious, but since had been resolved through case law. See Carl’s post here. It is also questionable that it really helps taxpayers at all (interesting outcome, given that it was part of the “Taxpayer First Act.” See posts here and here.

In any event, rather than clarify it has led to a slew of questions from practitioners, the Court, and the IRS. Basically, any and all affected parties. This order stems from Judge Gale asking the IRS for some clarification on how the provision will apply and being unsatisfied with their answer (petitioner appears to not really address the issue at all). It’s almost as if Congress may have benefitted from asking practitioners in the tax community about this provision before enacting it…

Easterwood v. C.I.R., Dkt. # 11485-17S (order found here)

I’m not even going to try to fit the final order under the “too clever by half” theme: it is a page of Judge Leyden lightly admonishing a practitioner for (1) failing to redact, and (2) submitting something illegible. If someone wants to try to fit that order with the week’s theme I’ve selected, your suggestions are welcome in the comment section.

Missed Opportunities… And What Does “Opportunity” Even Mean (to Congress)? Designated Orders, January 27 – 31, 2020 Part 1 of 2

For many, the New Year is a time of opportunity: the power of a new beginning and clean-slate to help us move towards our goals. I’ll admit that I am someone who makes New Year’s resolutions and several months later struggles to remember exactly what they were. In such instances I’ve missed the opportunity to change -to strike when the iron is hot. This post is all about what happens when you fail to act on an opportunity, and what “opportunity” really means… at least in the context of IRC 6330(c)(2)(B). In addressing that issue we will focus entirely on one (very important) designated order from Judge Gustafson in the case of Zhang v. C.I.R., Dkt # 4956-19L (order found here). Because I found this order so important I wanted to devote all of the post to it -Part 2, released later, will cover the remaining orders of the week.

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Because of the procedural posture of the order granting an IRS summary judgment motion, it is a little difficult to parse the facts (i.e. the reality) from the “facts” (i.e. what Judge Gustafson assumes, without deciding, to be true) of the Zhang case. But the “facts” certainly paint a pretty unfair picture for the taxpayer. 

Mr. Zhang runs a restaurant where, not surprisingly, customers pay with credit cards. Credit card companies love these arrangements, since they get transaction fees from the vendor. Consumers (if they don’t carry a balance) love this arrangement because they usually get points or miles. The IRS (probably) also loves this arrangement, because it makes for a paper-trail: specifically, the issuance of Form 1099-K from the credit card processors. (The only people really missing out are those that pay with cash, since the vendor usually passes on the transaction fees to the customer in the form of higher prices. Interesting take found here.)

The paper trail of the Form 1099-K is the root of the problem in this case. Mr. Zhang operates the restaurant through a C-Corporation. Generally, the income from the business (including those reflected on the Form 1099-K) should be reported on the C-Corporation’s return. And that is exactly what Mr. Zhang did: he reported the income on the business’s tax returns, rather than his personal returns. However, the issuers of the Form 1099-K appear to have listed Mr. Zhang (not the C-Corporation) as the recipient of the income… You can probably guess what happens next.

The IRS information matching system (Automated Underreporter, or AUR) prompted the IRS to take a second look at the return.  Mr. Zhang never responded to any of the letters, and attests that he never received the ensuing SNOD (more on that later) so the deficiency was assessed basically through default.

The facts, at this point, are essentially that Mr. Zhang shouldn’t owe the tax the IRS assessed. Judge Gustafson goes so far as to say that the IRS “incorrectly concluded that these payments were unreported income of Mr. Zhang.” 

Thank goodness Congress created Collection Due Process in the 98 RRA. Without it, not only could the IRS levy without judicial review, but Mr. Zhang wouldn’t be able to argue in Court that he doesn’t owe the tax without fully paying it first. Instead, the IRS first had to issue a “Notice of Intent to Levy” giving Mr. Zhang the right to a Collection Due Process (CDP) hearing, which Mr. Zhang dutifully (and timely) requested. 

And here, reader, is where we begin to learn the meaning and value of “opportunity.” Because Mr. Zhang claims he never actually received an SNOD, he would like to use the CDP hearing to dispute the underlying tax. And, assuming that Mr. Zhang did not actually receive the SNOD, he is well within his right to raise that issue. See Kuykendall v. C.I.R., 129 T.C. No. 9 (2007).

Under IRC 6330(c)(2)(B) there appear to be two (conjunctive?) conditions a taxpayer must satisfy to have the right to argue the underlying liability. To wit, a person “may also raise at the hearing challenges to the existence or amount of the underlying tax liability for any tax period if [1] the person did not receive any statutory notice of deficiency for such tax liability or [2] did not otherwise have an opportunity to dispute such tax liability.” (I’ve added the bracketed numbers to make this track a little easier.) From what we know, Mr. Zhang did not actually receive the SNOD and didn’t “otherwise have an opportunity” at this point. Keep that second component in the back of your mind.

To the extent that a CDP hearing actually took place (being extremely informal as they are, it is sometimes difficult to pin-down their moment of consummation), IRS Appeals did not appear to consider the underlying tax issue. They also did not properly schedule a telephonic hearing with the taxpayer in the first place. Judge Gustafson goes so far as to say, based on the (assumed) facts, IRS Appeals “abused its discretion in the handling of Mr. Zhang’s” CDP hearing.

In other words, the Court essentially says that based on the assumed facts this was a pretty poor hearing, and a pretty poor opportunity to argue your underlying tax. I’d argue based on the facts assumed by the Court that it wasn’t really a CDP hearing at all -and why I’d argue that will make a lot more sense by the end of this post. 

But for now, it is critical to note that the underlying tax argument (indeed, no argument) was not raised with the Tax Court after this CDP “hearing.” The IRS issued a Notice of Determination upholding the levy, and Mr. Zhang did not respond.

Failing to exercise your right to judicial review when the IRS abuses its discretion is a textbook “missed opportunity.” And it is a costly one in this case. 

It isn’t clear whether the IRS ever followed through on the levy, but they did later issue a Notice of Federal Tax Lien (NFTL) for the same tax year. And with an NFTL comes essentially the same CDP hearing rights, albeit under IRC 6320

Mr. Zhang again timely requests a CDP hearing, and again raises the underlying tax issue. And if it was an abuse of discretion not to consider it before surely it is now, right?

Wrong.

Now it doesn’t even matter if Mr. Zhang “actually received” the SNOD because of the second clause in IRC 6330(c)(2)(B): you can’t argue if you “otherwise have an opportunity to dispute such liability.” And that “opportunity to dispute” was precisely the first CDP hearing… So IRS Appeals again doesn’t entertain the argument about the underlying liability, but this time on the grounds that he already had an opportunity to do so.

This time, however, Mr. Zhang isn’t taking “can’t argue underlying tax liability” for an answer. He petitions the tax court. If only he had done so with the first hearing…

Judge Gustafson feels for Mr. Zhang (“If the facts assumed here are correct, then Mr. Zhang’s situation is very sympathetic,”) but this is not a court of equity and being sympathetic isn’t enough. Mr. Zhang should have petitioned the court after the first hearing where the IRS presumably abused its discretion by not entertaining his argument about the underlying liability. That was his prior opportunity: when you raise the issue, you better follow through. Now, hoping to return to it, he is barred by the language of IRC 6330(c)(2)(B): what was once an abuse of discretion in the first hearing under the first clause of that provision has now morphed into Appeals correctly applying the law.

Summary judgment to the IRS.

There is a lot going on here, such that I cannot help playing arm-chair lawyer. My biggest qualm is with the quality of the “opportunity” Mr. Zhang received. I think the Court and the Treasury Regulations have really stacked the deck against taxpayers in a way that Congress and even the statute as written do not require.

If Mr. Zhang were to argue that the first hearing never really took place (as I suggested), since there was no phone call (it isn’t clear what else happened) might that be a way out? It would be an uphill battle for sure. The Treasury Regulations go so far as to say that simply receiving the CDP Levy notice is enough to preclude arguing the underlying tax at a later CDP lien hearing… whether you act on it or not. See Treas. Reg. 301.6320-1(e)(3), A-E7. The Tax Court appears to take no issue with that Treasury Regulation definition of prior “opportunity” (see, e.g. Nichols v. C.I.R., T.C. Memo. 2007-5). So maybe no dice on that argument… or maybe it has some life in a different iteration (that I will conclude this post with).

Let’s consider just how bad or ethereal an “opportunity” to dispute the tax can be for it to still be an opportunity. In this case, the assumed facts are that the taxpayer raised the issue, was told by the IRS that they couldn’t raise the issue, and then when they tried to raise it again were told they already had the “opportunity” to do so. Note that IRC 6330(c)(4) specifically lists out what issues are “precluded” from being raised: those that were “raised and considered under a previous hearing” (emphasis added) is the first one listed. To me, the underlying liability was certainly raised, but just as certainly not considered. I’ll talk more about why I think that matters from an administrative law perspective, but I’d note that this designated order did not rely on IRC 6330(c)(4) to reach its conclusion: the underlying liability was “precluded” from being reviewed under IRC 6330(c)(2). 

Intentionally or otherwise, the case law and treasury regulations have turned “prior opportunity” into a landmine-strewn DMZ for taxpayers: the moment you step foot towards the Office of Appeals, you better tread lightly. We have already seen that if you raise the underlying liability with Appeals, even though you have no route to Court at that time, you may be barred from raising the liability at a later CDP hearing under the “prior opportunity” rationale. See Keith’s post here for an excellent review (Note that we’re still waiting on Tax Court to rule on the proposed opinion, which was assigned to Judge Goeke on 11/13/2019.)

A lesson used to be “wait to take the first step.” That is, instead of submitting audit reconsideration and going to Appeals, wait until the CDP hearing. This is obviously a poor use of judicial and administrative resources, but one that I feel practitioners have to keep in mind given the IRS (and Court’s) interpretation of the Treasury Regulations. With Zhang v. C.I.R. one can fairly add “once you’ve taken that first step, you better run with it all the way to Tax Court.” It wasn’t that he failed to insist on his administrative rights when given the chance (e.g. ignoring the first notice of intent to levy, which somehow “precludes” raising the issue later), but that he didn’t insist on his judicial rights to enforce the opportunity he was denied. When Mr. Zhang paused after his first step he stranded himself in no-man’s-land.  

Finally, this case brings up interesting Taxpayer Bill of Rights and -of course- potential administrative law questions. I submit to you the following thought experiment: Assuming the Tax Court gets it right (i.e. the first CDP hearing was an opportunity to dispute the tax), might it nonetheless be an abuse of discretion for the IRS Appeals officer to fail to consider the underlying liability? 

Consider the Treasury Regulations first, which provide in relevant part that “In the Appeals officer’s sole discretion, [they] may consider the existence or amount of the underlying tax liability, or such other precluded issues, at the same time as the CDP hearing.” Treas. Reg. 301.6320-1(e)(3), A-E11. However, the Treasury Regulation goes on to clarify “Any determination, however, made by the Appeals officer with respect to such a precluded issue shall not be treated as part of the Notice of Determination issued by the Appeals officer and will not be subject to any judicial review.” Id. In other words, Appeals can be nice and review the underlying liability when it is otherwise precluded, but their decision to do so (or not do so) can never, ever, be questioned. I take issue both with the Regulation’s definition of the underlying liability as “precluded” in those circumstances, and its attempt to limit the Tax Court’s review (one may say, the Tax Court’s jurisdiction).

First, query whether a regulation can limit the jurisdiction of the Tax Court to review a discretionary act, especially where Congress has specifically granted that Court jurisdiction. That, to me, is the admin law question. As a matter of judicial deference to such a regulation, Carl has written here. You might retort: “it isn’t a really a “discretionary” act that the regulation is forbidding review of: Congress precluded review of the underlying liability in those instances.” I think that is dead-wrong, and a huge problem that the Tax Court and Treasury Regulations have created on their own. 

I read IRC 6330(c)(2) as a list of the issues a taxpayer has the right to raise. If the taxpayer’s situation doesn’t meet the requirements therein, they don’t have the right to raise the issue, but that isn’t to say it can’t be raised altogether (i.e. that it is precluded), only that it is discretionary. This reading, I believe, is bolstered by the fact that just two paragraphs down (6330)(c)(4)) Congress does, in fact, list out what issues cannot be raised under the helpful heading “Certain issues precluded.” Unless the underlying tax was already litigated, or “raised and considered” in a prior CDP hearing (again, emphasis added) it is not a precluded issue. And if it isn’t a precluded issue, and the IRS has the discretion to consider the issue, then I find it odd that the Court is precluded from reviewing that exercise of discretion solely because the agency has essentially shielded itself from review through the issuance of a regulation. I rarely invoke the Constitution in my tax practice, but that seems like a separation of powers issue to me.

Now, let’s talk TBOR. Imagine, as is nearly the case here, an IRS Appeals officer says, “I know you probably don’t owe the tax, but you missed your chance to argue it so we’re going to uphold the lien/levy. The Regulations provide that it is in my sole discretion whether to look at the underlying tax or not, and I’ve decided not to because I don’t have to.” Could TBOR provide a statutory basis for saying this is an abuse of discretion? After all, doesn’t TBOR ensure that the IRS employees should act in accord with the right to “pay no more than the correct amount of tax” (IRC 7803(a)(3)(C))? What is the point of that “right” if not to keep the IRS from collecting more tax than is due based on technicalities? 

Again, it is possible that all of the “facts” here make this case seem a lot worse than the reality. But that is the beauty of the posture of this case, and how it illuminates the legal issues that I, for one, would love to see worked out in a precedential case. 

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

Part Three: Accardi and the IRM

In the previous post on the Orienter designated order we saw petitioners try to argue for abuse of discretion on the grounds that IRS Appeals didn’t follow the IRM in rejecting the Offer in Compromise. Judge Holmes found that IRS Appeals did, in fact, follow the IRM, but in the order opens up a whole other can of worms for practitioners to fuss over: is verifying that the IRM has been followed part of the mandate in IRC 6330(c)(1) that appeals verify “the requirements of any applicable law or administrative procedure” [emphasis added] have been met. In other words, is the IRM part of administrative procedure? This is a hairy and very important topic. I’d expect nothing less from Judge Holmes than to bring administrative law issues to the front. Let’s take a look.

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One may be excused for wondering if the question of the “value” of the IRM hasn’t already been fully established. After all, it is “a well-settled principle that the Internal Revenue Manual does not have the force of law, is not binding on the IRS, and confers no rights on taxpayers.” See, for example, my coverage of the Lecour v. C.I.R. order here  or, more precisely, footnote 16 in Thompson v. C.I.R. 140 T.C. No. 4 (2013). So how does Judge Holmes find some daylight in the issue of whether the IRM creates some sort of obligation upon the IRS visa IRC 6330(c)(1)?

The answer is part due to an administrative law principle called the “Accardi Doctrine” (sometimes alternatively referred to as the Accardi “Principle” if you are scrambling to look it up in law review articles). Doctrine or principle, it is named after the Supreme Court case of United States ex. rel. Accardi v. Shaughnessy, 347 U.S. 260 (1954). That case, which may look both deceptively short and inconsequential to tax (it stems from a writ of habeus corpus), has largely come to stand for the proposition that agencies have to follow their own rules or face having their actions invalidated for abuse of discretion… though exactly which “rules” matter is something of an unsettled question. Is it just notice and comment regulations that Accardi cares about? Is it just for “legislative” regulations (which may or may not be the same question phrased differently)?

The Second Circuit interprets the Accardi doctrine as applying to those rules “promulgated by a federal agency, which regulated the rights and interests of others” as being “controlling on the agency.” Montilla v. INS, 926 F.2d 162, 166 (2nd Cir. 1992). As relevant to the question of whether this is only applicable to “notice and comment” regulations, the Second Circuit in Montilla gives a (blissfully) clear answer: it applies even “where the internal procedures are possibly more rigorous than otherwise would be required and even though the procedural requirement has not yet been published in the federal register.”

So we have the opening, at least in cases appealable to the Second Circuit, that “sub-regulatory” guidance (i.e. guidance that isn’t published in the Federal Register) may nonetheless be binding on the IRS under Accardi. But does this trickle all the way down to the IRM? Maybe, and maybe not (or at least not through Accardi). Judge Holmes doesn’t need to directly answer the Accardi doctrine question here, because he finds that IRS Appeals followed the IRM in any case.

Still, I promise to you, there are lessons to be learned from these unanswered questions that directly touch on the value of the IRM. Those lessons can best be learned by splitting the issue in two: (1) how the Tax Court views Accardi’s application to the IRM, and (2) how the Tax Court applies IRC 6330(c)(1)’s definition of “administrative procedures” to the IRM.

Starting with the Tax Court’s view of Accardi and administrative law, it may come as little surprise that Accardi has been infrequently discussed in earlier cases. Administrative law issues being raised in Tax Court has certainly gained steam in recent years, but it is still something of a rarity, and especially with earlier cases. In fact, when I searched Westlaw for Tax Court cases citing to Accardi I found only five -many of them with basically no discussion of the doctrine.

One of the cases that I believe gives a pretty good indication of the Tax Court’s thoughts on Accardi and the IRM is Capitol Federal Sav. & Loan Ass’n & Subsidiary v. C.I.R., 96 T.C. 204 (1991). In that case, the Court notes that “[a]gencies are not required, at the risk of invalidation of their actions, to follow all of their rules.” OK, so not all rules matter the same. There are different tiers. And what rules may the agency “not follow” without necessarily invalidating their actions? Those that are “general statements of policy and rules governing internal agency operations or ‘housekeeping’ matters, which do not have the force and effect of law.” These would include the IRM and are not “binding” on the agency in the Accardi mold.

In fact, the Supreme Court has (almost) weighed in on that issue in U.S. v. Caceres, 440 U.S. 741 (1979). Though Caceres is a (criminal) tax case that directly implicates the IRM, it doesn’t conclusively answer the question of how Accardi applies to the IRM. The defendant in Caceres wanted evidence of bribery suppressed because the IRS agent procured it without properly following IRM procedures (which the Court maddeningly refers to as “regulations” throughout the opinion). The Court ends up allowing the evidence despite failure to follow the IRM… but notes explicitly that this “is not an APA case.” In other words, it is not looking at whether to invalidate an agency action, but whether a constitutional right was violated. Not quite the same things. And we are really just concerned with whether an agency action should be found arbitrary and capricious, not whether our constitutional rights are (directly) violated.

I take the Tax Court’s attitude in Capital Federal Savings to be that Accardi only applies to legislative regulations, which are those that are meant to carry the force of law (and generally published in the federal register). Unless your Circuit has said something different, the Tax Court is unlikely to treat sub-regulatory guidance as equivalent to a legislative regulation, and thus unlikely to be binding on the IRS through Accardi. This holds especially true if the guidance is purely internal like the IRM. 

Nonetheless, even if Accardi doesn’t apply that doesn’t mean that failure to follow subregulatory guidance can’t lead to a finding of “abuse of discretion.” if the IRS “fails to observe self-imposed limits upon the exercise of his discretion, provided he has invited reliance upon such limitations.” Capital Federal Savings at 217. Accardi might not get you much traction with the Tax Court (though to be sure, you should look to what your Court of Appeals has said on the topic), but that doesn’t mean you still shouldn’t point to sub-regulatory guidance when arguing about abuse of discretion. Indeed, that is generally your best (or only) indication of how the IRS is supposed to exercise their discretion in the first place.

So the IRM and Accardi probably don’t mix. What about the IRM and IRC 6330(c)(1) reference to “administrative procedures?” Here we may actually get somewhere with the Tax Court…

The focal point of this issue is not Accardi, but a different case cited by Judge Holmes (also authored by Judge Holmes): Trout v. C.I.R., 131 T.C. 239 -specifically Judge Marvel’s concurrence. With this analysis we move from the general to the specific: Accardi as a general doctrine about what rules agencies must follow (for my money, only legislative rules), and Trout as what a specific statute requires of the IRS in conducting CDP hearings. Really, it all hinges on the definition of what may be considered “any applicable […] administrative procedure.”

Trout was all about what procedures the IRS must follow when an OIC defaults, which can happen in any number of ways (failing to file and pay on time for the next five years, being among the more common). The IRS usually doesn’t rip up an OIC the moment these events occur, but rather gives the Offeror a chance to cure. Indeed, the IRM generally provides that numerous letters be sent in those instances before terminating the OIC. Just search “potential default” in IRM 5.19.7 to see for yourselves. The lead opinion in Trout addresses the issue mostly from contract law principles of material breach. Judge Marvel, and some later cases, however, put a stronger emphasis on the IRM and what responsibilities the IRS has emanating therefrom.

Judge Marvel is well-aware of the Court’s position that the IRM “do[es] not have the force or effect of law.” But if anything carries the force of law, it is a statute -and here we have a statute that explicitly compels IRS Appeals to verify that “any applicable law or administrative procedure have been met.” IRC 6330(c)(1). Again, any applicable administrative procedure. Might that broad language include the IRM? IRS Chief Counsel seems to have thought so. Judge Marvel notes that Chief Counsel Notice CC-2009-019 provides for IRC 6330(c)(1) that “The requirements the appeals officer is verifying are those things that the Code, Treasury Regulations, and the IRM require the Service to do before collection can take place.” [Emphasis added.] If the IRS’s own attorneys seem to think Appeals needs to verify the IRM was followed, who would argue against them?

In putting the IRM in play, Judge Marvel also puts the spotlight on an issue I have frequently had with IRS Notice of Determinations: the boilerplate recitation that Appeals “has determined that all legal and procedural requirements are concluded to have been met.” This, to me, is fertile ground that practitioners should be looking at whenever they are working with CDP cases: what review has Appeals really done, and have they documented it at all in the administrative file? Judge Marvel’s concurrence was joined by seven other judges, five of whom still sit as judges or senior judges. I do think this line of argument may well find a more receptive audience in the Tax Court than Accardi may. The Court is already willing to use the IRM as a yardstick for determining the IRS’s exercise of discretion (see Moore v. C.I.R., T.C. Memo. 2019-129, for one example). I don’t think it’s asking too much of Appeals to have them actually look at what happened leading up to collection: not every IRM violation should mean that it would be an abuse of discretion to sustain a levy. But failing to look at all, when Congress directs you to, certainly is.

Only not in this case, because as far as we can tell all IRM provisions were followed.

And so our trilogy covering the designated orders for the week of January 13 comes to an end. But as the credits roll, and for the sake of completeness, here are the other orders for the week of January 13 – 17 (and one bonus order)…

Other Orders: “Quick Hits”

Richlin v. C.I.R., Dkt. # 16301-16L (order here)

If you have questions about Treas. Reg. 1.6654-2(e)(5)(ii)(A) and whether you are entitled to the crediting of some payments from an ex (now deceased), this order may just be the thing you’re looking for.

Ramat Associates ,Wil-Coser Associates, A Partner Other than the Tax matters Partner, Et. Al v. C.I.R., Dkt. # 22295-16 (order here)

If you’d like to know about the standards for a motion to strike, this order just may be the thing you’re looking for.

Johnson v. C.I.R., Dkt. # 7249-19L (order here).

If you want to see the IRS get a pretty standard motion for summary judgment correct with Judge Gustafson, this order just may be the thing you’re looking for.

Bonus: Si v. C.I.R., Dkt. # 18748-18 (order here)

This order is actually from the week before the one I am covering, but it was the only one from that week and didn’t warrant a full post. It is an interesting look at the perils of trying to catch the IRS in a potential foot-fault of not sending the SNOD to the correct last known address… which backfires if you actually receive the SNOD with time to petition the Court (as this petitioner clearly did, since they filed a timely petition and then a motion to dismiss for lack of jurisdiction).

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

Today we leave the familiarity of Graev and move into AJAC and administrative law. Without further ado I present:

Part Two: What to Expect When You’re Expecting A Better Deal from Appeals

Some of the most important designated orders are the ones that deal with common situations and fairly unremarkable facts, but raise arguments that rarely make it into published opinions. The order we will be discussing in Orienter v. C.I.R., Dkt. # 20004-13L (order here) is a perfect example. Though I (obviously) appreciate anyone reading my synopsis and analysis of the order, I strongly commend any practitioner that works in tax controversy (and especially collection) to read the order for themselves as well. It is that substantive and that worthwhile.

It is also fairly easy to digest. In just 16 (incorrectly numbered) pages Judge Holmes lays out four discrete issues I will focus on and three more that I won’t. The issues that I believe warrant additional detail are:

  1. How does the Court review the rejection of a multiple-year Offer in Compromise when the Court only has jurisdiction over some of the years contained in the Offer?
  2. How do the IRS “Appeals Judicial Approach and Culture” (AJAC) rules and procedures limit Appeals’ review of the record compiled by the Centralized Offer in Compromise (COIC)?
  3. Does the IRM or any other authority give taxpayers a way to accept an (initially rejected) Offer amount from COIC if the taxpayers end up doing even worse with Appeals?
  4. Is the IRM a source of “administrative procedure” such that a violation of it would be a violation of IRC 6330(c)(1) (that the requirement of “any applicable law or administrative procedure” be met)?

I’ve been at an ABA Tax Section meeting where Judge Holmes said that he would recommend studying administrative law to anyone considering going into tax. These are all interesting questions that bring us to the crossroads of administrative and tax law… Let’s see what Judge Holmes thinks about them.

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To set the scene, Judge Holmes describes matters as getting “complicated” for the taxpayers, though I found this case represent a fairly typical scenario for taxpayers filing an Offer in Compromise. This doesn’t mean that the situation isn’t complicated, only that it isn’t particularly unusual. The main complicating factors were (1) the Orienters had more tax debts they wished to settle than just the years at issue in the CDP Notice, and (2) the Orienters sent their Offer to the IRC COIC unit, rather than to the IRS Appeals Office working the case. Since IRS Appeals really just forwards the Offer to COIC in any case, so long as you let Appeals know that you submitted an Offer it shouldn’t really affect your CDP hearing -other than likely to have it postponed until COIC reaches a preliminary determination. These two factors (multiple years at issue, and especially multiple “levels” of IRS review of the Offer) are what bring us to the interesting legal issues.

Issue One: How does the Court review the rejection of a multiple-year Offer in Compromise when the Court only has jurisdiction over some of the years contained in the Offer?

As we have been told once or twice before, the Tax Court is a court of “limited jurisdiction.” In a CDP case, jurisdiction is limited only to those years that were a part of the CDP hearing (and consequently, those on the Notice of Determination). The CDP hearing and Notice of Determination was strictly for the 2004 tax year, but the Offer was for 2002 – 2005 tax debts. Should the Tax Court only consider the jurisdictional year and ignore the other years, even though those years clearly matter to the Notice of Determination?

I’m not sure what that would really look like, since in filing an Offer you are essentially wrapping all of your tax debts into one liability and arguing your inability to pay that one liability. You can’t really just look at one year in reaching a determination of ability to pay, because you need to look at the tax debt as a whole. Luckily, I don’t have to spend much time thinking about what such limited review would look like because, as Judge Holmes notes, there is already numerous cases (though none that are technically precedential: see post here) on point that allow the Tax Court to consider the full debt (i.e. non-jurisdictional years) in reaching a determination of abuse of discretion for the jurisdictional year.

Should practitioners find themselves dealing with a similar strain of “jurisdictional trap” in CDP hearings, I’d commend them to read this order for the cases cited, and particularly the case of Sullivan v. C.I.R., 97 T.C.M. 1010 (2009) (apologies, couldn’t find a link) that Judge Holmes highlights. While I’ve never had the IRS try to argue that the Tax Court is barred from even considering non-jurisdictional years, the Court’s reasoning in Sullivan for when and why such years can be considered may be helpful, because it brings up the statutory language which could be relevant for far more than just rejected Offers. The most relevant section of Sullivan is:

“This Court is disabled from halting the IRS’s collection of [non-jurisdictional] liabilities, but it is not disabled from knowing about them. In determining whether the rejection of the OICs and the collection […] is appropriate, this Court is authorized (as the Appeals officer was required) to consider ‘any relevant issue relating to … the proposed levy.’ Sec. 6330(c)(2)(A), (d).”

So, as to Issue One, we have a fairly uncontroversial (though helpful and clarifying) answer: the Tax Court can consider the other non-jurisdictional years in order to determine if there was an abuse of discretion for the jurisdictional year in the Offer.

Issue Two: How do the IRS “Appeals Judicial Approach and Culture” (AJAC) rules and procedures limit Appeals’ review of the record compiled by the Centralized Offer in Compromise (COIC)?

It is with Issue Two, I believe, where things start to get slightly away from the ordinary CDP Offer. The Orienters Offer was originally for $25,000. IRS COIC preliminarily recommended rejection of the Offer, but that they might consider it if the amount was bumped up to $65,860 -the amount COIC calculated as the “Reasonable Collection Potential” (RCP). This was unacceptable to the Orienters, so they decided to try their luck with Appeals.

And it does not appear that their luck improved.

In fact, IRS Appeals determined that the RCP was closer to $200,000, and sustained the rejection of the $25,000 Offer, finding that even the special circumstances of the Orienters (who appear to have health problems) would not warrant accepting either the $25,000 or the $65,860 proposed by COIC. The Orienters, now fearing that they had perhaps made the wrong decision in not accepting the $65,860 Offer, tried to have the case sent back to COIC so they could accept that proposal. But they were stymied: IRS Appeals said the case could not be transferred. Eventually, a Notice of Determination reflecting this was issued.

This all comes down to what your options are when IRS Appeals seems to take a harder line than the originating function. Here, the Orienters want to argue that IRS Appeals is essentially barred from behaving as they did, or at least that their behavior is an “abuse of discretion” because it goes against the IRM vis a vis the “AJAC” rules.

Put broadly, AJAC is meant to have Appeals review cases more like a reviewing Court (i.e. limited to specific issues before it, rather than looking for or raising new ones). To the Orienters, this means Appeals was only supposed to review whether enough information was provided to warrant acceptance of an Offer less than $65,860 -not to re-work the Offer or raise new issues. The IRM provides that “[g]enerally, Appeals will sustain a rejection only under the same basis for which the offer was rejected.” (IRM 8.23.4.3(2).) But the basis of the rejection by Appeals was not the same as the basis of rejection by COIC. And so the IRS Appeals officer went against the AJAC principles embodied in the IRM, and thus abused its discretion.

The IRS, however, frames the issue a bit differently: the only issue was whether the Offer of $25,000 should be accepted or the levy sustained. Oh, and the IRS Appeals officer did follow the relevant IRM provisions (for example, 8.22.7.10.6) in either case.

Judge Holmes sees the issue as hinging on what the meaning of the phrase “same basis” is in this context. If IRS Appeals did reject on “the same basis” as COIC, then there isn’t really an issue because IRS Appeals followed the IRM (more on what the consequence to not following the IRM could be in the next post, since it brings up some really interesting admin law points).

So what was is the “basis” for rejection at issue here? Judge Holmes thinks it would be too narrow to define the issue in the way the Orienters want. The question is simply whether an Offer should be accepted for $25,000  i.e. the Offer put forth and rejected. This amount was admittedly less than the RCP, and the discount was arrived at on the grounds of “special circumstances” (always difficult to quantify in exact dollars). When IRS Appeals reviewed the file and recalculated the RCP, Appeals wasn’t “raising new issues” but really just determining if they believed the $25,000 offer should actually be accepted (if Appeals didn’t take a second look at RCP, it isn’t immediately clear what they would be doing in Appeals to begin with). In finding that RCP + Special Circumstances did not equal $25,000 Offer, they were rejecting on the same basis as COIC -even if they reached a different amount they thought may be reasonable.

Thus, we conclude Issue Two: No AJAC violation. So no abuse of discretion on those grounds. On to the largely related Issue Three…

Issue Three: Does the IRM or any other authority give taxpayers a way to accept an (initially rejected) Offer amount from COIC if the taxpayers end up doing even worse with Appeals?

So maybe IRS Appeals didn’t violate AJAC. But is there another way the Orienters can get back to that (now-enticing) COIC number of $65,680? Let’s look a little bit more at how that number was memorialized, to understand what legal meaning it may carry.

When COIC proposes a rejection of an Offer, it will send a few spreadsheets walking through its calculation of RCP and, usually, a page of boilerplate about how they “considered” special circumstances but that they didn’t warrant accepting the Offer proposed. Sometimes when special circumstances are raised and considered the IRS may “suggest” an alternative Offer amount they may be willing to accept. Such appears to be the case with the Orienters. The question is how much “value” that suggestion of $65,680 holds.

There are a long line of cases that essentially treat Offers under contact principles. Which seems to make sense, since (1) it is loaded with contractual terms governing performance (e.g. filing and paying on time for five years), and (2) it is literally called an Offer in Compromise, with offer and acceptance being fundamental to the formation of a contract.

In this case, the Orienter’s would like to characterize that $65,680 as a counter-offer, which they are free to accept. Judge Holmes is not buying this: the COIC letter (which usually states “rejection”) was only that -a rejection. It was not a counteroffer, because “a mere inquiry regarding the possibility of different terms […] is ordinarily not a counter-offer.” Restatement (Second) of Contracts Sec. 39 (1981). In Judge Holmes’ words, the “$65,860 was never on the table – it wasn’t even in the oven.”

Further, even if the Orienters were able to characterize the rejection letter as a counter-offer (I believe the language of the letter said COIC “could not even consider an Offer of less than $65,680” which certainly makes it seem like a suggestion, and not a set term), they would probably not prevail on contract grounds. And that is because, lest we forget, the Orienters pretty clearly rejected the supposed counter-offer by going to Appeals. And once you reject, you can’t just “go back” now that you regret it.

So, no luck to the Orienters on trying to find some sort of authority for their proposition that they should be allowed to accept the “counter-offer” of $65,680. But does that mean the Orienter’s are doomed? Tune in for part three where we will look at one final (and very interesting) line of argument that explicitly puts administrative law and the IRM in the crosshairs.

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

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…

How to Accelerate Collection in CDP: Designated Orders, December 30 – January 3

It was an interesting week for designated orders on collection due process (CDP) cases, with orders that really demonstrate the upsides and downsides to CDP protections. Professor Bryan Camp has sometimes referred to CDP as “Collection Delay Process” (as he notes here). Two of this week’s orders are illustrative of how the IRS might accelerate getting to collection where the petitioner appears to just be delaying for the sake of delaying, whereas one order reaffirms the purpose and value of judicial review when there may be a genuine issue of the proper collection actions. We’ll start with the IRS tactics for getting to collection when the taxpayer appears to be delaying just for delay’s sake.

read more…

Tactic One: Motion to Levy While the CDP Case is Pending. Squire v. C.I.R., Dkt. # 13308-19L: (order here)

This was one of those rare orders that is covered (albeit briefly) by Tax Notes Today (found here, paid subscription required). So what is going on in this case that makes it TNT worthy? At first blush, not much: it looks like so many other CDP cases we have covered on these hallowed pages: the taxpayer didn’t provide any financials or collection alternatives during the hearing, the IRS doesn’t believe the underlying liability is properly at issue, and so the case should be resolved. Usually we would see that in a summary judgment motion. But that is where this case separates itself from the pack: the IRS isn’t moving for summary judgment, but actually wants to move forward with levy while the CDP case is pending (i.e. docketed). (Also perhaps setting this case apart is that the petitioner is apparently a well-known attorney…)

Generally, levy (for any taxable year at issue) is prohibited while a CDP hearing (or appeal therefrom) is pending. See IRC 6330(e)(1). However, the prohibition on levy does not apply if (1) the underlying tax is not at issue, and (2) the IRS shows good cause why levy should go forward. IRC 6330(e)(2). Thus, in a “Motion to Permit Levy” the IRS will need to show those two things: the issue isn’t the underlying tax and there is a good reason to allow the levy to proceed right now, rather than after the Court (presumably) upholds the IRS Appeals determination that a levy is warranted.

We’ve seen the IRS struggle a bit through summary judgment motions in the past. How do they do on the Motion to Permit Levy?

Not too well.

First off, petitioner claims (apparently without any support) that the underlying taxes were put at issue in the Collection Due Process hearing. But Judge Leyden doesn’t even need to consider that issue, because even if the IRS did meet that element they’d fail on “good cause.” Judge Leyden acknowledges that “good cause” is a slippery term, but cites to Burke v. C.I.R., 124 T.C. 189 (2005) for some examples of where good cause to allow a levy may be found: essentially, where the taxpayer uses CDP to bring up frivolous arguments or needlessly delay collection.

The IRS thinks that the petitioner is very much in the game of needlessly delaying collection. And this is because this taxpayer seems to always end up in Tax Court -having filed four CDP petitions (including the instant case) in the last eight years. This pesky petitioner just keeps insisting on CDP and losing (or at least losing two of the four times: one is still pending, i.e. the order at issue, and the Court does not explicitly reference the outcome in the fourth).

But is constantly insisting on your rights the same as needlessly delaying collection? That is a bridge too far for Judge Leyden, especially given the paltry record for the docketed case. It is not yet clear that, in this present case, the petitioner has no leg to stand on and evidence would show that it is all a delay tactic. The record shows that the petitioner self-reported the tax due, and participated in the CDP hearing. The record does not show (or at least the IRS hasn’t put forth evidence) that frivolous arguments have been made, so the argument seems to boil down to “this person keeps losing. And they should know better (subtext: the petitioner in this case is an attorney, apparently at one point quite well known, who has run into some ethical issues in the past), so it is a delay tactic.”

I’m sympathetic to the IRS’s concern in this case, since it appears that petitioner keeps losing for the same uncorrected issue: failing to pay estimated taxes (compliance being a prerequisite for essentially every collection option). But I’m not sympathetic to the way the argument was presented. Where the IRS wants to accelerate collection by levying during a CDP case, they need to do better by: (1) properly showing the underlying tax isn’t at issue (in this case, the only exhibit to the motion was IRS certificates of assessment, which just don’t go far enough to prove the underlying tax isn’t/couldn’t be at issue); and (2) putting the administrative record before the Court so they can actually see the arguments that were raised in the CDP hearing, and then have some idea if they are frivolous. I think the IRS particularly failed with the latter, since (arguably) the administrative record could also show that the underlying tax wasn’t raised in the hearing and thus would not be properly at issue. The administrative record is (increasingly) critical in non-deficiency cases, which can hurt the IRS just as easily as it can hurt the taxpayer if it is not properly developed.

Tactic Two: Summary Judgment Done Right. Peele v. C.I.R., Dkt. # 5447-19L (order here)

In Peele we have another serial CDP user (more accurately, “abuser”) but a different outcome -this time a success for the IRS on the more traditional motion for summary judgment. From Judge Gustafson’s stern rebuke to the petitioner (warning of potential IRC 6673 penalties in the future) this may have actually been a better vehicle for the motion to permit levy than the previously discussed Squire case. So how did we get here?

Ms. Peele appears to be one of those individuals that loves filing complaints/petitions, but not taking essentially any other action to address the problem. Her failure to act begins by failing to file a tax return for the year at issue (2012), resulting in an SFR. She later filed a CDP hearing request for the resulting Notice of Federal Tax Lien but it was upheld by Appeals. Undeterred, Ms. Peele filed a Tax Court petition… and then did not show up in court or respond to a summary judgment motion. Astoundingly, the Tax Court granted the IRS summary judgment motion.

But Ms. Peele was not going to let these losses get her down. So she appealed the Tax Court decision to the 4th Circuit Court of Appeals. Where her case was dismissed for… any guesses? That’s right: failure to prosecute.

All this time, effort, and wasted judicial resources on the 2012 taxes she never filed… and it isn’t over. Remember, the chronology I just walked through was from a Notice of Federal Tax Lien (docketed here). The designated order for the week still involves the 2012 taxes, but from a Notice of Intent to Levy.

So has Ms. Peele changed in the intervening years? Is the threat of a levy enough to prompt her to action beyond just filing in court? For those debating human nature, this one can be chalked up as a win in the “people don’t change” column.

Again, Ms. Peele makes every timely request necessary for Court jurisdiction, but does nothing thereafter: a timely CDP request that she fails to follow through on (i.e. skips the hearing) and a timely petition to Court that she fails to follow through on (i.e. fails to respond to the IRS motion for summary judgment).

So a petitioner that was very likely only using CDP to delay can delay no longer: summary judgment is granted. It is not immediately clear to me that a motion to permit levy in this case would have gotten to quicker collection for the IRS but my bet is it would have had a greater chance of success than Squire because no reasons exist for the court to review (she didn’t participate in the hearing) and that, coupled with her history, strongly suggests a “delay” purpose.

But Wait! CDP CAN Be a Valuable Check on the IRS. Lecour v. C.I.R., Dkt. # 22905-18L (order here)

So we’ve had two previous cases where the IRS seemed to reasonably believe the petitioner was just trying to delay collection through CDP. Is that all CDP is? One intricate delay tactic? Maybe not… This final order stands for the value of CDP as a check against IRS collection personnel.

The Lecour’s (husband and wife) are represented by counsel, and appear to have been fairly well engaged with the IRS throughout the CDP process. Namely, they submitted financials and specifically proposed a payment alternative (in this case, an installment agreement) for their rather sizeable 2013 and 2014 balances (totaling approximately $96,000).

Paying down a $96,000 bill, even over the course of many years, can be a difficult task for many. Here, the petitioners sought to alleviate this difficulty by proposing an installment agreement that began with lower monthly payments in the first year ($500/month), and then ramped up after that ($1,500/month). The reasoning behind this proposed structure was to give the petitioners time to restructure their living expenses so that they could afford to pay more in the second year and onwards. 

Of course, we wouldn’t be here unless the IRS had a problem with this proposal. And the IRS problem is one we’ve seen before: namely, that they believed the monthly amounts could be higher because their reported income should be higher and some of their necessary expenses should be lower.

Although some installment agreements for relatively low balances must be accepted as a matter of law (see IRC 6159(c)) the general rule (applicable in this case) is that the IRS has fairly broad discretion to enter into an agreement (see IRC 6159(a), noting the permissive language). Still, it is not boundless discretion, and installment agreements like these are exactly the sorts of cases where I appreciate the ability to get Court review rather than have the entirety of the decision rest in the IRS’s hands.

Of course, even with judicial review on proposed collection alternatives, taxpayers are often in a tough spot. As Judge Panuthos notes, review of collection alternatives involve an abuse of discretion standard and the Tax Court will not “substitute our judgment for that of the IRS, recalculate a taxpayer’s ability to pay, or independently determine what would have been an acceptable collection alternative.” That would appear to signal an uphill battle for the petitioner in this case. But perhaps there is hope… in the Internal Revenue Manual (IRM).

From the beginning it bears noting that the IRM does not create taxpayer rights and is not binding on the IRS (or the Tax Court). See, e.g. Thompson v. C.I.R., 140 T.C. No. 4 (2013) at footnote 16 for a list of cases on that point. In other words, it is not law.

However, the IRM does provide guidelines as to what the IRS’s policy is on the sort of financial analysis at play in nearly all collection cases. In other words, it provides some sort of yardstick for the Tax Court to consider how the IRS decided to exercise its discretion in collection: if the IRS completely ignores its own policy (reflected in the IRM) and doesn’t provide a reason why, that is a pretty good sign of “abuse of discretion.”

A couple things that the IRM provides in cases like this are (1) the permissive ability of the IRS to have provide the one-year “reorganization” period requested by petitioner (see IRM 5.14.1.4.1(2)) and (2) guidelines on allowable expenses (especially national and local standard expenses) in determining income that could be put towards the tax liability. If you deviate from those IRM provisions, you’d better clearly explain why.

And therein lies the problem for the IRS’s summary judgment motion. It just isn’t clear enough from the Notice of Determination (or record thus far) the exact reasoning for the number the IRS arrived at. If the numbers were clearly linked to the IRM positions (again, not binding) just saying so may well be reason enough. But where they aren’t following the IRM (or it isn’t clear that they are) you have an open question of whether the IRS employee was properly exercising discretion, or just doing their own thing -something CDP is likely intended to prevent.

And, thanks to Court review not operating as a rubber stamp on the IRS’s determination, you have protection before collection can take place. In the instant case, the IRS’s summary judgment motion is denied (effectively slowing down the collection action IRS hopes to accelerate) while the facts can be better determined, preventing potentially unaffordable or catastrophic levy. In other words, sometimes the process works.

Final Orders of the Week

For posterity’s sake, there were two other (essentially identical) designated orders from December 30 – January 3 in Giambrone v. C.I.R. They dealt with a motion for a protective order from a non-party to the suit and can be found here and here.

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

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)