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.

Asking the Court to Let You Change Your Mind: Designated Orders September 9 – 13, 2019 (Post Three of Three)

In the previous coverage of the weeks designated orders we looked at how to ask the Court to change its mind via a motion to reconsider (or the very similar motion to vacate or revise). In this final post on the designated orders from the week of September 9, we look at when you can ask the Court to let you change your mind….

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Kurdziel Junior, et. al v. C.I.R., Dkt. # 21186-12 (order here)

This order comes in the aftermath of another interesting substantive case, but one where the substantive issues were largely addressed elsewhere in a memorandum opinion and covered by Professor Bryan Camp here.

The opinion determined whether Mr. Kurdziel engaged in an activity for profit and found in the IRS’s favor that Mr. Kurdziel’s WWII plane flying was actually a hobby, thereby disallowing the losses he claimed. But while the opinion determined all of the substantive issues at point, it did not reach a determination on the final deficiency amount, which is something that Court has to do. Instead of doing that all at once, the Court opted (as it often does) to have the parties determine those computations via Rule 155.

Sometimes genuine computational disputes arise at the Rule 155 stage. Sometimes, however, one party tries to relitigate or raise new issues at the computation stage. The Court tends not to allow that, particularly when the issues could and should have been raised earlier. See Keith’s post here. In the above order, the IRS just now realized it made some mistakes that were in the Form 5278 accompanying the Notice of Deficiency (wayyy back in the process… this case was petitioned in 2012). You can get a sense for how much patience Judge Holmes has for the IRS motion to file an amended answer to fix the errors: “now [the IRS] wants to make [changes] — after discovery, after trial, after even the posttrial briefing –[.]”

A first question that one might have is “why doesn’t the IRS have to raise this in a motion for reconsideration? Isn’t the matter over with?” And the answer (or at least part of the answer), is that the IRS wants to raise new issues, not have the Court reconsider the issues it decided. And the IRS has to do this by an answer, and the Court still has jurisdiction to redetermine a deficiency greater than the amount on the Notice, if the matter is raised before the Court enters a final decision.

We are late in the game for the IRS to be bringing up new issues, but we are not too far gone. In this instance, trial has passed and an opinion has been issued, but no final decision has yet been entered. Judge Holmes cites to two cases (Sun v. C.I.R., 880 F.3d 173 (5th Cir. 2018) and Henningsen v. C.I.R., 243 F.2d 954 (4th Cir. 1957)) for the proposition that the IRS could still, then, try for increased deficiencies under Rule 41

Of course, just because the Court can allow the party to amend its answer doesn’t mean that it will. Or at least, not for all of the changes the IRS wants.

It may then surprise some readers that Judge Holmes, in this case, actually does allow some of the proposed changes to be made. From the outset it should be noted, however, that all of the changes the IRS asks for can be best understood as mathematical and not conceptual: they don’t really involve new legal arguments. Rather, the mathematical changes flow (you guessed it) mathematically from the changes that were properly at issue in the case.

Tax laws and deductions are often interconnected by taxable income or AGI “phase-outs.” A change to one part of the return frequently has an effect on another. If I fail to report $500K in income, the Notice of Deficiency might only assert that I have an additional $500K of taxable income, but a side-effect may be that I lose the Child Tax Credit I claimed because I am now “too rich” for it (usually, in my experience, the Notice of Deficiency also accounts for these mathematical changes).

In this case the increase to petitioner’s taxable income (which the Court determined by disallowing the “hobby loss”) would or should result in a phase-out of the losses he can claim on his rental real estate. Even though that wasn’t put directly at issue in the Notice of Deficiency (or answer), this side-effect apparently was raised in the trial and largely acknowledged by petitioner’s counsel. Judge Holmes has no qualms about allowing those changes to be made now.

But asking for changes that would come as a surprise, even if they are still mostly mathematical changes, is one step too far. Apparently, the IRS also failed to properly add in gross receipts from the flying (hobby) to the taxpayer’s income -as best I can tell, all they did was deny the loss. This would have not only increased taxable income, but have reduced some itemized deductions subject to the 2% floor (at IRC 67 and in effect during the pre “Tax Cuts and Jobs Act” year at issue here). This issue was never raised in trial, or at any other point, until this motion. Judge Holmes has no patience left for finding these late mistakes (for which the IRS offers no excuse other than “we just didn’t notice it”) and denies that portion of the motion. This case has been around since 2012, after all: it is time to move on.

And so shall we.

Getting to “Yes” When the Court’s Already Said “No”: Designated Orders September 9 – 13, 2019 (Post Two of Three)

In the second of three posts covering the designated orders from September 9 – 13, we will take a look at petitioners that refuse to take “no” for an answer… even if they are eventually stuck with it. While most people (lawyer and layman alike) are aware of the ability to appeal a lower court decision to a higher one, few are familiar with the processes for asking the court to reconsider its own decision. Fortunately for those with the curiosity to learn more on this topic, we were blessed with three designated orders in one week which deal with exactly that phenomenon.

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Asking the Court to “Change Its Mind,” Three Flavors of a Motion to Reconsider: Hurford Investment No. 2 Ltd. v. C.I.R., Dkt. # 23017-11 (order here)

Asking an appellate court to reverse a lower court is generally a difficult proposition -by some accounts the lower court is upheld roughly 90% of the time. If I had to bet, I’d say that asking the lower court (in this case, the Tax Court) to essentially reverse itself (that is, reconsider its decision) is even less frequently availing. There are really three grounds for the Tax Court to reconsider its decision: (1) manifest error of law or facts, (2) intervening change in controlling law, or (3) newly discovered evidence. 

Although petitioners may be hesitant to phrase it as such, many appear to make their motions based on the theory that the court manifestly erred on the law or facts. I imagine petitioners don’t exactly emphasize that point because the accusation of being manifestly wrong about a core component of your job as a judge (determining facts and applying the law) is perhaps not the easiest foot to start a motion on. 

Perhaps that is why petitioners in Hurford Investments try to flavor their motion to reconsider as a “change in the prevailing law.” And not completely without reason. The Hurford case is all about trying to get attorney’s fees after making a qualified offer under IRC 7430(g). The Tax Court held (as one of two grounds for denying the fees) that because the suit was a TEFRA proceeding the qualified offer rule doesn’t apply.

But wait! Haven’t we seen a qualified offer result in attorney’s fees with a TEFRA proceeding before? Why yes we have, in a post about BASR here.

BASR is the reason why this motion comes before Judge Holmes: the original denial took place before BASR was affirmed in an appellate court. The only problem is that BASR took place in the Federal Court of Claims -and as Judge Holmes drops in the first footnote, no Tax Court case can ever be appealed to the Federal Court of Claims, so it can never control the Tax Court under the Golsen rule. Since the BASR decision isn’t, to Judge Holmes’s mind, a change in the prevailing law, the only way Hurford can succeed is if Judge Holmes committed a manifest error of law or fact. Perhaps not surprisingly (though you can read the order if you’d like more details as to why) Judge Holmes finds that no such error was committed. In fact, Judge Holmes need not even address the conflicting BASR rationale (though he does anyway, explaining why he continues to disagree with the Federal Circuit Court) because regardless of whether qualified offers apply to TEFRA proceedings as a rule, the qualified offer in this instance would fail.  

And the reason for that ultimately comes down to the terms of the qualified offer that Hurford made. Under the Treasury Regulations, a qualified offer must (a) fully resolve the taxpayer’s liability for the adjustments at issue, and (b) must only pertain to those adjustments. See Treas. Reg. 301.7430-7(c)(3). In the Hurford offer there were (apparently) other items beyond what was contained in the FPAA that the petitioners sought to address. That, by itself, ruins it as a “qualified” offer. It is at that point your run-of-the-mill settlement offer.

So while it was a valiant effort by the taxpayers in Hurford to attempt to get the Tax Court to change its mind, it ultimately went the way of so many other motions to reconsider: denial. Though the petitioner tried for the “change in prevailing law” flavor, Judge Holmes said it tasted more like “manifest error in law or fact.” It wasn’t the only designated order of Judge Holmes that week to make such a denial, and on essentially the same grounds (see Mancini v. C.I.R., Dkt. # 16975-13, order here.)

But what of the third flavor, “new evidence?” For that, unfortunately, no designated orders came out the week of September 9, 2019 that would directly touch on it, though one came close enough.

The Third Flavor of a (Kind-Of) Motion to Reconsider: Ansley v. C.I.R., Dkt. # 388-18L (order here)

The motion put forward by the pro se petitioner in this case was apparently done in a letter, and not correctly characterized when filed. As the Tax Court is wont to do when unrepresented parties want to ask something of the Court, but aren’t sure the proper Court jargon, Judge Urda determines that the letter should be treated as a “motion to vacate or revise” pursuant to Rule 162 -which is quite similar to a motion to reconsider under Rule 161. The general reasons for granting such a motion look familiar, though are perhaps a bit broader than the motion to reconsider: mistake, newly discovered evidence, fraud, or “other reasons justifying relief.” (Judge Urda cites to, among other sources, Taylor v. C.I.R., T.C. Memo. 2017-212 for these standards.)

The petitioner in Ansley isn’t quite saying that there is newly discovered evidence, but really that the evidence in the record has changed -that is, that the petitioner’s financial circumstances that led to the IRS upholding a levy determination are now significantly different than they were when the decision was reached. Generally, that is a fair ground for remand to Appeals (when the case is still on-going) as it dovetails with IRC 6330(d)(3). However, in this case Judge Urda sees no reason to vacate the decision because (1) the petitioner doesn’t actually provide sufficient information to show a material change in his circumstances, and (2) he doesn’t really need the Court for the relief he’s after: IRS Appeals has retained jurisdiction, so he can still go to them with an Offer, or whatever other collection alternative he hopes to propose. 

I’ll admit that as someone that deals with a fair amount of Collection Due Process cases, the fact that IRS Appeals has “ongoing jurisdiction” (Judge Urda’s words) under section 6330(d)(3) after the hearing (more importantly, after an adverse Tax Court decision) isn’t of that much comfort to me. But since I have never had a Tax Court decision uphold a levy determination, I accepted that I may just be out-of-practice with the benefits of Appeals’ retained jurisdiction. So I looked further into exactly what retained jurisdiction would mean for the taxpayer. This led me to more questions than answers.

The IRM on point (8.22.9.17) provides some guidance for when taxpayers may invoke a “retained jurisdiction” hearing.  Essentially all of routes require exhausting other routes with the IRS before getting back to Appeals, so it isn’t quite as if the petitioner in Ansley could just return to Appeals with a new Offer (it would be a bit off if you could). In Mr. Ansley’s case, he would have to go through the “CAP” procedure (see Publication 1660) first.

But perhaps worse, even if you have changed circumstances (one of the grounds for retained jurisdiction), the IRM provides that “the ONLY issues considered are those from the original Appeals determination” and that new issues should be sent to CAP. IRM 8.22.9.17(3). To me this means that a taxpayer that originally requested an installment agreement or currently not collectible could not, after things go really badly, now propose an Offer in Compromise in a retained jurisdiction hearing. Maybe that is a moot point, since you can get to Appeals in that case just by filing an Offer in Compromise through the normal channels (and then appealing it, if need be). Which leads to my main question…

Does retained jurisdiction by Appeals really provides any additional protection (or shortcut) to Appeals that the taxpayer wouldn’t otherwise have? To me, it appears that it is only of any use where Appeals makes a determination and then Collection decides to somehow ignore it -in IRM speak, where collection does not “implement Appeals determination” (we’ve previously written on the potential perils of trusting a determination letter to be carried out here). Even then, however, you have to try to work it out with Collection management first. I suppose that’s something… but to me, not a whole lot.

Again, however, I have never directly dealt with a retained jurisdiction hearing, so I may be off. If anyone out there has experience, I appreciate any shared wisdom in the comments.

Fun Substantive Tax Issues, From the Procedural Point of View: Designated Orders September 9 – 13, 2019 (Post One of Three)

There were five designated orders in the second week of September, and some of them were fairly substantial (one was even covered in Tax Notes). In fact, they were substantive enough to warrant three separate posts. This first of three will focus on the same order covered by Tax Notes. Since this blog focuses on procedure (and the Tax Notes coverage was mostly pertaining to the interesting “substantive” tax issues) we’ll be taking a look at it from a different angle.

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Substantive Issues in Designated Orders: A Different Perspective. Conyers v. C.I.R., Dkt. # 13969-18 (order here)

Conyers involves a fact situation you are likely to encounter on a Fed. Income Tax I exam. The petitioner was awarded a brand-new car after winning a local car dealers competition for high school seniors excelling (or apparently just showing up 100% of the time) in class. The petitioner didn’t actually enter the competition (her name was entered by the school), but that didn’t stop her from accepting the 2016 Jeep Renegade. And who can blame her? 

Conversely, however, who can blame the IRS for saying “you’re going to have to pay tax on that” after they get tipped off to the transaction via a 1099-MISC. Students and practitioners alike may think to themselves “non-taxable gift!” at this point and run through the troublesome “Duberstein” tests.

Judge Buch, however, does a wonderful job of walking through the difference between a non-taxable gift under IRC 102 and a taxable “prize or award” under IRC 74, and why this falls into the latter. I highly commend reading the order for those that are interested in the history and substantive niceties of IRC 74 (and why it came about as a result of the frequent confusion between “gifts” and “prizes”). I get the feeling that it is because of that analysis that Tax Notes Today covered the case (fairly obviously, no free links available to that). 

However, as a Tax Procedure blogger something else caught my eye in reading this, which was that it was disposed of in a motion for summary judgment. Judge Buch convincingly comes to a conclusion on the merits (that this Jeep Renegade is, in fact, a taxable prize). But that by itself does not resolve the case or mean that summary judgment is appropriate. And that is because there a second issue lurking behind the legal conclusion of whether the Jeep Renegade is a gift or taxable award: even if it is taxable, how much is the Jeep Renegade worth? That is much more of a question of fact, which generally ruins summary judgment motions.

Petitioner raises the issue of valuation in her objection to summary judgment, but Judge Buch disposes of it in one rather short paragraph: “Ms. Conyers claims a genuine dispute exists as to the value of her car. But Ms. Conyers provides only her bare allegation and does not provide an alternate valuation of any evidence of erroneous valuation by the Commissioner. Ms. Conyers may not rest on mere allegations or denials.”

So the question becomes, how far does one have to go to raise a genuine dispute of material fact that cannot be resolved in summary judgment? 

We’ve seen that a self-serving affidavit may be enough to defeat a motion for summary judgment, in the right circumstances. See Keith’s post here. That case involved the FRCP 56 not Tax Court Rule 121, but because the rules are essentially identical the analysis should remain the same: both allow for affidavits to be used in opposition, so long as they are based on personal knowledge and set forth facts that would be admissible in evidence. 

It isn’t immediately clear if any affidavit was filed in opposition to the summary judgment motion, though the docket listing “exhibits” to the petitioner’s response and Judge Buch’s reference to Ms. Conyer’s “allegation” lead me to believe that it is likely. If so, the question shifts to what the affidavit would need to contain to defeat the motion. Judge Buch says it needs to be more than just a denial of the IRS’s position, and then seems to imply that it also needs to affirmatively provide either (1) a correct valuation, or (2) evidence that the IRS’s valuation is incorrect. Saying just “the IRS’s valuation is wrong” would not meet that requirement -it would simply be an “allegation or denial” of the moving party’s pleading, which Rule 121(d) forbids. So, had petitioner’s affidavit provided “I think the car is worth [x]” (i.e. an affirmative valuation) that would appear to be enough to preclude summary judgment.


Of course, you can’t just pick a number out of the air to defeat summary judgment and then swear in an affidavit that the number is correct based on your personal knowledge. That would clearly be an affidavit “made in bad faith” under Rule 121(f), which opens up a lot of collateral issues (like possibly having to pay the other side’s attorney fees, being subject to contempt, or otherwise disciplined by the Court).

But what if you are convinced that the car is worth less than the IRS’s valuation, but haven’t had the time to come up with an affirmative valuation of your own (that you could swear to in the affidavit)? Are you out of luck just because the IRS pushed the issue with a summary judgment motion? 

Possibly not. Rule 121(e) provides exceptions to providing an affidavit like the one Judge Buch would seem to require when such “affidavit or declaration [is] unavailable”. This rule allows the Court to find a genuine dispute of material fact if the non-moving party could only be expected to put the facts at issue through cross-examination or through information from a third party that cannot (yet?) be secured. The Court also may deny the motion or provide a continuance to get an affidavit, as the circumstances demand. 

Because it does not appear that petitioner, in this case, could provide an affidavit that really put the value of the car at issue (other than by saying “the IRS is wrong”) Rule 121(e) may have been the only saving grace… And even that may have been fleeting. Since the car was brand new, and presumably was going to be sold at a set price by the dealership, arguing a value apart from what the dealership reported to the IRS was going to be an uphill battle. Maybe an appraiser could say the dealership marked it up too much. Maybe the taxpayer could testify that this specific car (and not the model generally) had some defects that should lower the value. But the petitioner had to say something credible on those matters, and if it was based on personal knowledge it isn’t clear why they couldn’t have been in an affidavit in opposition (that is, it isn’t clear why they’d need more time under Rule 121(e)). 

And so this interesting case ends in summary judgment against the petitioner, as the IRS was entitled to judgment as a matter of law. Though the final finding necessary for summary judgment (no genuine issue of material fact) only warranted one paragraph in the order, hopefully this post elucidates how much may lurk behind that.  

Lazy Mid-Summer Tips and Traps: Designated Orders August 12 – 16, 2019

It was a fairly lax mid-August week at the United States Tax Court. There were only three (non-duplicative) designated orders issued. One was a common example of the taxpayer simply not giving the IRS anything to work with in a CDP hearing and won’t be discussed (found here). The other two, however, provide a few useful tips and traps of general application worth noting.

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What Time-Zone Determines Timely (Electronic) Filing? NCA Argyle LP, et. al. v. C.I.R., Dkt. # 3272-18 (order here)

One of the more interesting tidbits from this week’s designated orders was buried in a footnote. The order above mostly dealt with an objection to the IRS’s motion for a deposition that (petitioners felt) came way too late to be fair (i.e. one month before trial). But it isn’t the timing of IRS’s motion that is interesting, but the timing of the petitioner’s objection. 

When the IRS moved to compel depositions the Court ordered petitioners to file any response by August 14. I’m assuming this case involves big dollars, because petitioners are partnerships and LLCs represented by expensive law firms in California. Those law firms are probably very busy, with lawyers working very late hours. So they figured they’d electronically file their response on August 14th at 10:04 pm… Western time.

And why not? The “Practitioners’ Guide to Electronic Case Access and Filing” stated (but has since been changed as a result of this order) at page 42 that “A document is considered timely filed if it is electronically transmitted no later than 6:00 a.m. Eastern time on the day after the last day for filing.” [Emphasis added.] In other words, the petitioners had almost six more hours to get their response in, if you take the practitioner’s guide seriously.

Alas, in the hierarchy of legal authority the “Practitioner’s Guide” is a step below Tax Court Rule 22. That rule states (effective November 20, 2018) that “A paper will be considered timely filed if it is electronically filed at or before 11:59 p.m., eastern time, on the last day of the applicable period for filing.” [Emphasis added.] Petitioner’s response was filed 10:04 p.m. the day of the filing deadline… but only on western time. We live in an east coast dominated country (take it from a mid-westerner). In the time-zone that matters, the response was late by a solid hour and five minutes. 

As a side-bar, it is important that other courts have different rules than the Tax Court. For example, as discussed here one preliminary difference is that Federal District Court determines the effective date of a complaint based on receipt, and not when it is mailed. Second, other courts (including Federal District Courts not located in Washington D.C.) are unlikely to set a deadline of 11:59 Eastern Time. The Federal District Court for Minnesota provides that an electronic document is timely if submitted “prior to midnight on its due date.” See page 4 of the ECF User Guide here. Though a time-zone is not provided (which midnight are we talking about?) one would surmise the Central Time zone, since the next rule covering timely paper filing sets the deadline at 5:00 p.m. Central Time on the due date. These rules from the ECF User Guide comport with the Federal Rules of Civil Procedure, which provide that for calculating the “last day” you generally look to the time zone in the court you are filing with. See FRCP Rule 6(a)(4).

So, bringing it back to Tax Court, is the West Coast law firm response thrown out for being filed out of time? Judge Buch is not one to stand on such formalities, stating that “no one was prejudiced by the 65 minute delay” and allowing it to stand.

Nonetheless, while this slight timeliness issue does not end up causing any problem for the parties in this case, it is important to recognize how different it would be if the deadline at issue was “jurisdictional.” As both Carl and Keith have extensively written about, based on the Tax Court’s current interpretation of the law, Judge Buch’s hands would be tied: deprived of jurisdiction, he would also be deprived of the ability to excuse the timeliness issue (say, for lack of prejudice, or more likely equitable tolling).   

Who To Ask For Help: Tax Court Isn’t a One-Stop Shop. Crawford v. C.I.R., Dkt. # 4318-18L (order here)

We have previously seen that the Tax Court is reluctant to stand-in as a federal district court on FOIA issues (see post regarding Cross Refined Coal, LLC here) or dismiss a case where it is up to the bankruptcy court to amend the stay (see post regarding Betters v. C.I.R., here). In the above order we have a similar issue involving the enforcement of a federal district court injunction. 

Essentially, the petitioner in this case has received informal Tax Court assistance (that is, no entry of appearance under Rule 24) from someone the IRS doesn’t much care for. And likely for good reason: the individual assisting the petitioner is associated with the Williams Financial Network, currently under indictment for a $5 million fraud scheme. The IRS accordingly has enjoined all individuals associated with that entity from “representing people before the IRS.” Of course (or as sometimes needs to be explained to taxpayers), the Tax Court is not the IRS so those individuals are not (technically) prohibited from representing petitioners before the Tax Court if they otherwise meet the requirements of Rule 200

(As an aside to new tax court practitioners, don’t overly concern yourself with the reference to a “periodic registration fee” in the rules to practice. Once, in a fit of stress, I called the Tax Court to see if I was current on the fee (I couldn’t ever remember paying) and was told they hadn’t actually required it for decades.)

It isn’t clear if the individuals associated with the Williams Financial Network meet the requirements of Rule 200 (I’d bet they don’t), but that isn’t really the problem. The problem is that the IRS asks the Tax Court to essentially make up rules and exercise power it probably doesn’t have: that is, the IRS asks Judge Buch to order that the individuals helping the petitioner be prohibited from doing so when the case is remanded to IRS Appeals. Judge Buch declines to do so: the Tax Court wasn’t the court that issued the injunction, and the Tax Court has no rules on who can represent people before the IRS, just who can represent them before the Tax Court. 

In other words, if Williams Financial Network violates the district court injunction it’s not the Tax Court’s problem, and not their place (or power) to fix it. 

Sticker Shock and Settling on the Issues: Designated Orders, July 15 – 19

There were five designated orders for the week of July 15, three of which were perfunctory decisions in collection due process cases where the petitioner “filed and forgot” -in other words, after filing the petition, the taxpayer stopped doing much of anything to advance their case or respond to court orders. For the curious, those orders are here, here, and here. The remaining two orders appealed to my dual professional obligations: lessons in working with clients and teaching tax law. We’ll begin with one of the messy issues that arise in working with clients in tax controversy: backing out of settlement.

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Stipulated Issues and Sticker Shock: Kirshenbaum v. C.I.R., Dkt. # 10135-17S (order here)

The parties in this case have agreed on virtually everything, and even signed a stipulated settlement… and yet now the Kirshenbaums are having second thoughts. Why might that be? When the (fairly simple) issues are settled, the amount of tax that results is almost entirely a matter of math. My bet is that the Kirshenbaum’s had second thoughts when the numbers flowing from the stipulated words began to coalesce. A sticker-shock on the tax that would be due… and a sudden (futile) desire to renege. As an attorney, it demonstrates the two different languages you have to speak in settling tax matters: dollars and cents to the client, issues and law to the IRS. The last thing you want is the client backing out of settlement, wanting to argue issues with little merit, because they now realize that the merits mean they will owe more than they’d like.

The Kirshenbaum’s situation demonstrate how quickly taxes and penalties can cascade when there are errors on the return, and the return was late filed. To begin with, for late filers the “failure to file” penalty (IRC 6651(a)(1)) is a much quicker way to increase your bill than just filing on time without paying: the penalty accrues at a 5% monthly rate (to a maximum of 25%) rather than the 0.5% rate for failing to pay. Further, the amount of tax that the failure to file penalty is multiplied against is the amount “required to be shown on the return” (i.e. not necessarily the amount you actually report), so a later audit can retroactively bump up your penalty quite a bit. 

There is really no benefit I can think of to filing late, even if you are going to get late payment penalties. Perhaps the Kirshenbaum’s had a legitimate reason for filing late (though to get out of the penalties for “reasonable cause,” you generally need a really good reason, and demonstrate that you exercised “ordinary business care and prudence.” See Boyle v. C.I.R., 469 U.S. 241 (1985) and Les’s post on issues in the e-file age).

In any event, the Kirshenbaum’s return was both filed late and filled with easily detectable errors. The first easily detected error was a matter of calculation: the amount of taxable social security they reported (note that this wasn’t an instance of omitting social security income, but listing an amount received, and a corresponding “taxable” amount that doesn’t add up). That error was (presumably) fixed through IRC 6213(b)(1) “math error” authority. But then, on second (likely automated) look, the IRS also noticed that the return completely omitted roughly $38,006 of retirement distributions. A notice of deficiency was issued showing the increased tax, as well as increased failure to file penalty, along with an IRC 6662(a) penalty for good measure. That added up to a bill likely over $12,000, which the Kirshenbaums were not going to take lying down.

And their fight may actually have saved them some money, but only with regards to the IRC 6662 penalty. The other issues were largely foregone conclusions: if the additional retirement distribution was received and omitted by the Kirshenbaums, there would be additional tax due on it, as well as an increase in their taxable social security benefits simply as a matter of cold math. Since it was fairly clear that the additional retirement distributions were received (and taxable), the IRS and the Kirshenbaums were able to stipulate all of the issues, with the IRS conceding the IRC 6662 penalty (perhaps in good faith, perhaps because of a procedural infirmity). The Kirshenbaums signed the stipulation of settlement, thus avoiding the need to appear at calendar. All that remained was the decision document with a calculation of the deficiency (per Rule 155).

But when that calculation was done, the Kirshenbaums wanted to backtrack and argue the very issues they had stipulated to. The Tax Court was not having it: “They entered into an agreement, and we will hold them to their word.” Further, as Judge Gustafson alludes, there doesn’t really appear to be a “serious dispute to maintain about the matters[.]” The Kirshenbaums are grasping, agreeing that they received the retirement proceeds but picking fairly arbitrary amounts to treat as taxable. The Court isn’t going to play that game, especially after you fail to show up at trial after agreeing to all the issues. 

The most “difficult” clients I have are the ones that agree to the issues but want me to try to get the IRS to knock a few more dollars off the deficiency purely as a matter of negotiation. When the merits aren’t clear and there are hazards of litigation, there can be some wiggle room (see IRM 35.5.2.4). But where the correct outcome is clear there is really no “art of the deal” magic that can be done. This reality, I think, cuts against the popular conception of what lawyers do in back-room negotiations. At its worst, it can lead to clients wanting to back out of settlement when the issues are clear, as they were in the Kirshenbaum’s case. For an interesting and more detailed look at when settlement becomes binding, including when the IRS unexpectedly backs out, I highly recommend Keith’s piece here.

Bench Opinions, Substantive Law, and Innocent Spouse: Mayer v. C.I.R., Dkt. # 23397-17S (order here)

The crew at Procedurally Taxing have blogged about the value and nuances of S-cases and bench opinions before: here, here, and here. Keith has also written about bench opinions in more detail here. In the above order we have a bench opinion on an innocent spouse case that presents some interesting, though clearly not precedential, substantive application of IRC 6015(b) and (c). Because bench opinions are non-precedential (and not reviewed), the Judges sometimes appear more willing to bite on general equity concerns (even if they don’t present their opinions with that explicit rationale). To me, this opinion had some hints of that, and possibly even gets the law itself a bit wrong. 

The relevant facts can be boiled down to the following: husband (the requesting “innocent” spouse, in this case) and wife want to buy a house. To pay for it, they have to rely on their 401(k)s. Husband decides to borrow against the 401(k), whereas wife just takes a straight withdrawal. Wife pretty much controls the finances, including preparing the tax returns. When it comes time to file, wife omits the 401(k) withdrawal. Husband “paid little or no attention to the return” and signs it. The legal question at issue seems pretty straightforward: did the husband have “reason to know” of the understatement of tax by omitting the 401(k) withdrawal? He clearly knew she received money (i.e. knew of the transaction): is that enough for him to have “reason to know” of the understatement?

Judge Buch says “no, the husband did not have reason to know” because he was “not aware that there was an understatement,” since he did not really pay attention to the return when he signed it. Judge Buch also finds the other elements of IRC 6015(b) are met, including equity concerns, because “there is no indication that [the husband] benefitted in any way from [the 401(k) withdrawal].” 

I question both of those conclusions, but my bigger issue (as I’ll get to) is the legal reasoning applied to IRC 6015(c). For now, I’d say that I find it curious that in this case the husband appears to benefit from “paying little or no attention to the return” rather than asking reasonable questions… like whether his wife borrowed or withdrew the money he knows she took from her 401(k). See Treas. Reg. 1.6015-2(c). Similarly, I find it a bit charitable to say that he did not benefit from the withdrawal, when it went towards the purchase of their marital home. But perhaps there were other facts I am unaware of (including what happened to the home after the fact) that could better lead to those conclusions. 

Still, while there may be additional facts not referenced in the opinion that led to the decision (and the intervening ex-wife may also not have advanced her case well), the application of the law under IRC 6015(c) was a bit more troublesome to me. Generally, IRC 6015(c) relief is easier to get than relief under IRC 6015(b), because under (b) the requesting spouse can’t have “reason to know” of the understatement, whereas under (c) the requesting spouse can’t have “actual knowledge” of the item giving rise to the deficiency. The IRS bears the burden of proof in showing “actual knowledge” of the requesting spouse, which only makes the relief that much easier to come by. 

Judge Buch finds no “actual knowledge” of the item leading to the deficiency in this case because, again, the husband “was not aware that [his wife] took a premature distribution [rather than a loan] from a retirement account.” But is the fact the husband didn’t know (without asking) whether it was a loan and not a taxable distribution relevant, if he clearly knew that she received the money leading to the deficiency? And that is where I believe there was an error in the legal analysis.

Quoting King v. C.I.R., 116 T.C. 198 (2001), Judge Buch describes actual knowledge as “actual knowledge of the factual circumstances which made the item unallowable as a deduction.” He also directs readers to Treas. Reg. 1.6015-3(c)(2)(B) to further bolster the proposition. 

And Judge Buch is correct, as far as deductions go. But the “erroneous item” in this case is not a deduction: it is an omission of income. In fact, one paragraph above the treasury regulation cited to is a completely different standard for omitted income: “knowledge of the item includes knowledge of the receipt of income.” Treas. Reg. 1.6015-3(c)(2)(A). Both King and the regulation cited appear inapposite. In fact, much of King is spent discussing another precedential Tax Court case, Cheshire v. C.I.R, 115 T.C. 183 (2000) that expressly found you don’t need to know the tax consequences of an omitted retirement distribution to have “actual knowledge” of the item. Cheshire seems close to being on all-fours with the husband’s matter. King expressly reaches a different conclusion for actual knowledge of deductions, while preserving Cheshire’s actual knowledge of omitted income inquiry. 

Conceptually, I think there is a pretty good reason to hold taxpayers to a higher standard in relief from omissions of income than improperly taken deductions. I would say this is in part because income is presumably taxable, whereas deductions, as we are frequently told, are matters of legislative grace. In other words, you don’t have to be a tax expert to suspect that income should be on a return, whereas you do have to be closer to an expert to know if most deductions are really allowable.

To me, the innocent spouse husband got a far better deal than he would have if this were not a bench opinion. Apart from not being reviewed by other judges, bench opinions are given without the benefit of briefing from the parties (apart from, perhaps, pre-trial memoranda, which are generally optional in S-Cases like this one). I’d hope that IRS counsel would have hammered home on the distinction between omitted income and erroneous deductions if this were briefed. I am generally a fan of bench opinions when it involves simple questions of fact (and have been on the receiving end of a favorable Buch bench opinion in the past.)

I tell my tax procedure students that innocent spouse is about as far from typical tax law as you can get -that it usually involves equity and factual determinations far more than most other provisions in the Code. It is also fairly convoluted, as a matter of statute and regulation, because “innocent spouse” comes in three flavors. This bench opinion, perhaps, illustrates how easy it is to get tripped up on all the flavors and permutations even as a tax law expert. 

Application of IRC 6015, and particularly equitable relief under IRC 6015(f) is still being developed by the courts (and in some ways, by Congress in the Taxpayer First Act (see post here)). I believe the Court should have found “actual knowledge” from the requesting spouse in the above order, thus ruling out IRC 6015(c) relief. Since “actual knowledge” would necessarily meet the IRC 6015(b) “reason to know” standard, one would think that the only remaining avenue for relief would be “equitable relief” under IRC 6015(f) (Judge Buch found that the taxpayer was eligible for both (b) and (c), which both rules out and makes unnecessary relief under IRC 6015(f)). However, as noted in a previous post, the Tax Court appears to have taken a position that effectively makes “actual knowledge” a trump card, or at least far too heavily weighted as a factor, that may even preclude relief under IRC 6015(f). Keith and Carl have been working with that issue (the interplay of actual knowledge and equitable relief) in a case that is presently before the 7th Circuit. I naively hope that a decision is reached before I teach my class on innocent spouse relief this fall.

Things That Happen to Your Tax Court Case When You File Bankruptcy or Your Judge Retires: Designated Orders, June 17 – 21

There were six designated orders for the week of June 17 – 21, of which three are worth going into detail on. The remaining three orders can be found here, here, and here. The orders that will be addressed raise some interesting issues with the interplay of bankruptcy and collection due process cases, as well as what happens when the judge that heard your case retires before rendering a decision.

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Does Dismissing a Collection Due Process Case Violate the Automatic Stay of Bankruptcy? Betters v. C.I.R., Docket # 8386-17L (here)

One of the most powerful provisions in the bankruptcy code is the automatic stay at 11 U.S.C. 362. Violating the stay can lead to claims (whether successful or not) of damages and attorney’s fees against the IRS (as Keith blogged here). The automatic stay essentially gives whomever files bankruptcy some “breathing room” from creditors while sorting things out by pausing (or preventing) most collection actions (see Keith’s post on the effect of the automatic stay and a notice of federal tax lien, here). One specific thing that the automatic stay touches is “the commencement or continuation of a proceeding before the United States Tax Court […] concerning the tax liability of a debtor who is an individual for a taxable period ending before the date of the order of relief” through the bankruptcy court. See 11 U.S.C. 362(a)(8). 

In the order above, the taxpayer filed his Tax Court petition in response to a Collection Due Process determination (that presumably would have upheld a levy action). People who have unpaid taxes frequently have other unpaid debts, and a few years later while the case was still pending in Tax Court the taxpayer filed a petition with the U.S. Bankruptcy Court. Now the taxpayer wants to get out of Tax Court and just deal with the whole thing in Bankruptcy Court. And the IRS has no objection to going that route.

The question is whether the Tax Court can dismiss the case without violating the stay, even if both parties want that result. The answer, according to Chief Special Trial Judge Carluzzo, hinges on the application of Settles v. C.I.R., 138 T.C. 372 (2012). Both the IRS and the petitioner say that Settles applies, such that the case can be dismissed. Judge Carluzzo, however, disagrees.

In Settles, the taxpayer had a collection case he wanted dismissed, while he had a bankruptcy case with a stay still in effect. The Tax Court allowed the voluntary dismissal of the case. The one (big) difference: in Settles the bankruptcy court had already adjudicated the merits of the tax liabilities, and all that was left were non-tax creditors. And that difference is enough for Judge Carluzzo to say that no voluntary dismissal is presently allowed: if you want to dismiss the case, take it up with the bankruptcy court to have them modify the stay.  

So even though the parties want it dismissed, Judge Carluzzo’s hands are tied. I’d note in passing that if the case were a deficiency proceeding, and not a collection action, the option of voluntary dismissal would be more obviously unavailing: once you invoke the Tax Court’s jurisdiction in a deficiency case there is no way out absent a determination by the Tax Court. Compare Estate of Ming v. Commissioner, 62 T.C. 519 (1974) with Wagner v. Commissioner, 118 T.C. 330 (2012).

The other order that involved bankruptcy (Wilson v. C.I.R., dkt. # 25218-18SL (order here)) deserves much less explication, but serves as a warning for taxpayers that think bankruptcy is a cure-all for tax debts. It is another collection action where the petitioners filed bankruptcy involving the tax years at issue, but in this instance the bankruptcy case was over well before the Tax Court order was issued. However, because the tax debts at issue were for returns that were due within three years of the bankruptcy petition they were non-dischargeable in Chapter 7 (see 11 USC 523(a)(1)(A) and 11 USC 507(a)(8)). The Bankruptcy court puts things in plain English for the taxpayer in their “Explanation of Discharge,” which included the sentence “Examples of debts that are not discharged are […] debts for most taxes.” Because one of the two arguments the petitioners want to make is that the debts were discharged in bankruptcy, and because the other argument has already been fixed by the IRS (applying a payment to the correct year) there is nothing left at issue. Summary judgment ensues.

What Happens When the Tax Court Judge Hearing Your Case Retires? Zajac III v. C.I.R., dkt. # 1886-15. (order here)

Judge Chiechi retired effective October 19, 2018 (see press release here). As indicated by the docket number, however, this case has been going on since 2015. The trial took place in early February, 2018 and briefs were submitted in May, 2018. One might ask how much is left to be done in this case (which has a somewhat unusual +100 filings with a pro se party). But the petitioner wants a second-go at the trial. And since the case involves witness credibility determinations the standard it to allow a new trial unless the parties either agree they don’t want to, or (sometimes) if the petitioner fails to ask.

How far will that new trial get the petitioner? If I had to bet, I’d say it is only delaying the inevitable. Why may it be of limited use? Consider the following: 

First, Judge Gale is quick to remind the parties of the “law of the case doctrine.” That doctrine is often raised when a case is on appeal, and stands for the proposition that “when a court decides on a rule of law, that decision should continue to govern the same issues in subsequent stages of the same case.” Christianson v. Colt Indus. Operating Corp., 486 U.S. 800, 816 (1988). As Judge Gale explains, in this context it means that “a successor judge generally should not, in the absence of exceptional circumstances, overrule a ruling or decision of the initial judge.” In other words, whatever Judge Chiechi or other judges in the case have already ruled on, Judge Gale isn’t likely to overturn. And at this point, as I alluded to earlier with the +100 filings on the docket, there have been quite a few rulings. 

Second, one of the legal arguments that the petitioner wants to make (and use a new trial to establish) pretty clearly has no traction. Perhaps unsurprisingly, it is a penalty issue that raises the specter of Graev. The petitioner wants to put the IRS supervisor that approved the penalty on the witness stand. One may wonder why the supervisor’s testimony is necessary, when all that is required is written approval under IRC § 6751(b)(1). Indeed, there has already been some case development on this point: see Raifman v. C.I.R., T.C. Memo. 2018-101, Ray v. C.I.R., T.C. Memo. 2019-36, and Alterman v. C.I.R., T.C. Memo. 2018-83, all of which provide some detail to the general rule that the Tax Court isn’t going to “look behind” a document to the reasoning or motives of the penalty approval by the supervisor. The petitioner in this case apparently wants to show that the IRS agent had a conflict of interest and, consequently, the manager shouldn’t have given supervisory approval. That is a lot like looking at the reasoning and motives of the supervisory approval, and I doubt it would succeed regardless of what the questioning elicits. In truth, if the IRC 6662(a) penalty is so ill-conceived, the taxpayer should have some other pretty obvious defenses apart from procedural infirmities… like reasonable cause or simply not having a substantial understatement (or not acting negligently) in the first place. 

But the petitioner isn’t just casually throwing the “conflict of interest” argument around: he has gone so far as to sue the IRS agent in Federal District Court under a Bivens action. That case was dismissed with prejudice. If I were a government employee that was sued by an individual taxpayer I’d probably be pretty upset too… only it appears that the suits were filed after the penalties were already proposed.

The final reason why I’m not so sure the new trial will get to a different outcome than whatever was already coming: this is a case almost entirely about determining the proper amount of self-employed income and expenses. While testimony (particularly credibility) definitely matters in such cases, the most important evidence is usually documentary. There have already been five submissions of stipulated facts and roughly 80+ exhibits. Those are in the record and aren’t going to be changed. Documents don’t always tell the whole story, and credibility determinations matter when those documents are being explained. But at this point most of the work in this 4 year-old case is, thankfully for Judge Gale, likely done.

A Tale of Two (Types of) Taxpayers: Designated Orders May 20 – 24

I always try to look for a theme running through the disparate designated orders I cover. Sometimes one readily presents itself, as it did the penultimate week of May: broadly speaking, the different ways that well-represented and unrepresented taxpayers use (one may uncharitably say, waste) the Court’s time. The four designated orders of the week give a perfect glimpse into the differing tactics and consequences that well-heeled, fully-lawyered taxpayers face compared to the more common “tax protestors.” We’ll begin with examining the latter.

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(Potential) Consequences to Tax Protestor Arguments: Sanctions and Penalties

Procedurally, there isn’t too much novel going on in the two tax protestor cases. Both are collection due process cases where the taxpayer isn’t arguing for a collection alternative, but just repeating tax protestor rhetoric about taxes being illegal or immoral in some sense. 

As usual, the Court has given both parties more than a few opportunities to get things right (Judge Leyden even went so far as to have her case once remanded to Appeals to confirm penalty approval under IRC § 6751). Also as usual, there are some moments of levity in the Court’s recounting of the reasons why the petitioners believe they shouldn’t have to pay taxes. A few of the highlights:

From the Harris v. Commissioner order, a “sovereign citizen” style protestor:

  1. No taxes owed because the IRS is actually a trust domiciled in Puerto Rico
  2. No taxes owed because petitioner “revoked” his “election” to be a U.S. Citizen taxpayer
  3. No taxes because nothing in the Internal Revenue Code applies to “natural persons,” (unlike, presumably, the rest of us fakers).

From the Cotter v. Commissioner order, a “religious duty not to pay tax” style protestor who stopped paying taxes in 2009 (I wonder what led her to believe the government became evil at that point…):

  1. I’ll pay taxes (gifts from “The People” for God’s glory) but I won’t pay “tribute money to extend The Devil’s Kingdom on earth” 
  2. I can’t pay taxes because “I cannot give God’s money for foolish, wicked, wasteful evil practices.”

Ok. So a lot of nonsense from both pro se parties. The Court and the IRS’s time have been sufficiently wasted. And for the petitioners there are consequences to these actions, though the consequences are procedurally distinct. 

For Mrs. Cotter, the consequence is a penalty of $5000 because her reason for requesting the CDP hearing was designated a frivolous position by the IRS under Notice 2008-14. It therefore meets the rules of a “frivolous submission” under IRC § 6702(b)

Mrs. Cotter only owed $348 going into the CDP hearing: she now owes over 14 times that because of the reasons she put forward for not having to pay taxes (even more mind-boggling, since she made a payment of $1,826 with the original return). These are real-life costs for conveniently reading “render unto Caesar” with an addendum of “unless you don’t like Caesar.”

For Mr. Harris, there are no IRC § 6702 penalties because his original CDP request actually specified potentially legitimate reasons for the hearing: in particular, that he never received a notice of deficiency. Rather, it is all of Mr. Harris’s behavior once he is before the Court that leads to a penalty on IRS counsel’s motion under IRC § 6673. Judge Halpern grants the motion and awards a penalty of $15,000. Ouch.

Of course, the Court doesn’t just issue $15,000 penalties to pro se taxpayers for the fun of it. Mr. Harris has been warned numerous times by the Court, resulting in two previous Court decisions (here and here), and is a serial non-filer. The Court has previously found that Mr. Harris has “attempted to turn the IRS and this Court into a mockery for his shopworn tax-protestor rhetoric.” It is unclear why Mr. Harris continues to make these obviously ineffective arguments (he is apparently a West Point graduate, so one may think he would know better) but if it is a hobby, it is fast becoming an expensive one.

Potential Consequences to Hardball Practices: Losing the Court’s Favor: Cross Refined Coal, LLC v. C.I.R., Dkt. # 19502-17

From unrepresented taxpayers we move to very-lucratively represented taxpayers with eight (!!!) attorneys on the case from both Mayer-Brown and Skadden. The Court has only slightly more patience for the positions and use of time by lawyers in this case than that of the unrepresented taxpayers. 

The Cross Refined Coal case actually provided two designated orders the week of May 20th. Both resulted from motions made by the petitioner: a motion for discovery (here) and a motion to strike (here). Both also resulted in, shall we say, stern language from Judge Gustafson almost entirely denying the motions. We will begin with the motion to compel discovery to see why Judge Gustafson was not impressed. 

Usually when I see the Court denying a motion to compel discovery it is because the parties haven’t exhausted informal discovery before asking the court to step in (see Rule70(a)). Here, however, the issue is not with the procedure, but with the contents of the discovery request -I too was a little baffled by what the taxpayer was hoping to get out of the documents.

The case revolves around what I can only imagine to be immensely valuable “refined coal” tax-credits claimed by the taxpayer but disallowed by the IRS for 2011 and 2012. Apart from the aforementioned stature and number of attorneys on this case, one may surmise the dollars at issue based on the amount of IRS attention the issue has received. In 2017, the IRS issued a Technical Advice Memorandum (TAM 201729020) that explained why the IRS was (soon thereafter) going to disallow the credits in a Notice of Final Partnership Administrative Adjustment. A year later, the IRS issued a Chief Counsel Memorandum (CCM AM2018-002) that provided further explanation and analysis for analyzing the rather complex transactions at hand, providing that for other taxpayers (i.e. not Cross Coal) with other different facts, the credits may be allowed. It is the TAM and CCM that is at the heart of this discovery dispute.

Petitioner wants basically everything that the IRS used to reach its conclusions in the CCM and TAM, going so far as proposing to conduct a deposition of an IRS designee concerning the CCM meaning and terms. They also served admissions regarding the conclusions in the TAM and CCM, with questions about “what Congress intended” in enacting the statute at play, IRC § 45(e).

Completely devoid of any understanding of IRC § 45(e), I still couldn’t help but feel like all of the requested information focusing on the genesis and reasoning of the CCM was largely irrelevant to the Tax Court case at hand. Judge Gustafson, apparently, felt that way as well, and describes his consternation this way:

“The court will not adjudicate the correctness of the CCM. […] If the CCM was factually unsupported and legally without merit, that would not help Cross; and if instead the CCM was factually impeccable and legally brilliant, that fact would not help the Commissioner. Consequently, Cross’s efforts in discovery to learn more about the background of the CCM are misdirected.”

Because the taxpayer is represented by such sophisticated counsel, I found myself second-guessing my original impulse that this was obviously a flawed discovery request. I thought something I wasn’t seeing must be going on. What was lurking in the background, it appears, was a simultaneous FOIA dispute. Since the taxpayer is already running into roadblocks with FOIA, wouldn’t it just be more efficient to have the Tax Court fix the issue now, rather than wait for further litigation in the FOIA suit?

Judge Gustafson is not amenable to the proposal of taking work away from other (proper) court venues, and saves his most critical language for the idea: “today we must decline to overlook the palpable irrelevance of the requests at issue and must decline to become, in effect, a proxy for a district court adjudicating a FOIA dispute (in which context relevance is not an issue). We will not use the resources and authority of the Tax Court to compel disclosures extraneous to our proper business.”

And so the motion to compel is not surprisingly denied.

If one feels some frustration from Judge Gustafson at the use of the court (and parties) time in that order, it is amplified in a second order issued two days later on the same docket. This time the order concerns the petitioner’s motion to strike, and this time it is frustration with the uncharitable positions the petitioner is taking.

Again, this circles around discovery. The parties were originally supposed to serve requests for documents no later than January 30, 2019. As some may recall, there was a government shutdown from December 22, 2018 through January 25, 2019. Shortly after the month-long government shutdown hit, but after the January 30 deadline, the IRS requested a continuance of the case and all pretrial deadlines. The Tax Court said, effectively, “how about you two work together to adjust your pretrial schedule, recognizing that it isn’t the IRS’s fault they were locked out of the building?”

But the parties couldn’t come to an agreement: petitioners maintained that document requests made by IRS a few weeks after the shutdown were not timely, and they weren’t budging. This led to some acrimony and motion practice between the parties, with the IRS arguing that petitioners were taking a “hardline” approach and questioning, among other things, their good faith in the process. 

Which brings us to the actual motion to strike. 

Petitioners appeared offended by the IRS’s characterization of the issue, and note that they have always reserved their timeliness objection. Judge Gustafson agrees that the timeliness objection has been reserved, but beyond that asks “is there really any reason to file a motion to strike on those grounds?” In Judge Gustafson’s words, “[w]e think that the pending motion to strike was not a good expenditure of petitioner’s counsel’s time and that it required from the Court attention that would have been better spent on the remaining motions to compel.” 

Ouch. 

But if that doesn’t hurt enough, Judge Gustafson also lets drop that a loss on the untimeliness objection is likely coming down the pike. Sometimes the fine line of being a zealous advocate and playing hardball comes with consequences -perhaps, of losing some favor with the Judge. 

Invalidating an IRS Notice: Lessons and What’s to Come from Feigh v. C.I.R.

A few weeks ago, the United States Tax Court decided Feigh v. Commissioner, 152 T.C. No. 15 (2019): a precedential opinion on a novel issue involving the Earned Income Tax Credit (EITC) and its interplay with an IRS Notice (Notice 2014-7). The petitioners in the case just so happened to be represented by my clinic, and the case just so happened to be a A Law Student’s Dream: fully stipulated (no pesky issues of fact), and essentially a single (and novel) legal issue. Because the opinion will affect a large number of taxpayers, I commend those working in low-income tax to read it. What I hope to do in this blog post is give a little inside-baseball on the case and, in keeping with the theme of this blog, tie it in a bit with procedural issues.

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Posture of the Case

I frequently sing the praises of Tax Court judges in working with pro se taxpayers. This case provides yet another example. My clinic received a call from the petitioners less than a week before calendar. Apparently, the Tax Court (specifically Judge Goeke) had recognized that this was a novel issue of law and suggested to the low-income, pro se petitioners that they may benefit from contacting a Low-Income Taxpayer Clinic for help with the briefing.

By the time the client contacted me (again, only a few days before calendar) the IRS had moved for the case to be submitted fully stipulated under Rule 122. The Court had not yet ruled on the motion but I mostly found the stipulations unobjectionable (with one minor change, which the IRS graciously did not object to). Rather, what concerned me was the fact that it was designated as an “S-Case.” I wanted this case to be precedential, and I wanted to be able to appeal –neither of which are possible for S-Cases. See IRC § 7463(b). Yes, the Court can remove the designation in its own discretion (see post here), but I didn’t want to leave anything to chance. After consulting with my clients the first order of business was to move to have the S designation removed -which again saw no objection from the IRS. Now the table was set for briefing on the novel issue.

What’s At Issue?

I’m going to try hard not to dwell on the substantive legal issues in this case, important though they are. Nevertheless, an ever-so-brief primer on what was going on is necessary.

Our client (husband and wife) received Medicaid Waiver Payments for the services the wife provided to her disabled (non-foster) child. From conversations with local VITA organizations I already anecdotally knew that some people received these payments, but since taking this case on I have come to appreciate exactly how vast the Medicaid Waiver program is. For our client, the Medicaid Waiver Payments were made in the form of rather meager wages (a little over $7,000) that were subject (rightly or wrongly) to FICA. They were the only wages my clients had. When my clients went to file their income tax return, however, it looked like they were getting a fairly raw deal: namely, missing out on an EITC and Child Tax Credits cumulatively worth almost $4,000. Why? Because in 2014 the IRS decided that these Medicaid Waiver Payments were excluded from income as IRC § 131 “Foster Care” payments.

An exclusion from income sounds to most taxpayers like a good thing: it’s always better to have less taxable income, right? But the tax code is a complicated animal, and for lower-income taxpayers the exclusion of wages was actually a curse: to be considered “earned income” for both the EITC and Child Tax Credit (CTC), wages must be “includible” in income. By the IRS’s logic, this meant that you must exclude your $7,000 Medicaid Waiver Payment (with a tax benefit of $0 in some cases) and couldn’t thereafter “double-benefit” by also getting the EITC/CTC for those excluded wages.

It doesn’t quite seem fair for those who saw little or no tax benefit from the exclusion.

It seems even less fair when you consider that those who would actually phase out of the EITC (say, by receiving a large Medicaid Waiver Payment over $52,000, which has happened) not only would get a larger tax benefit from the exclusion, but could still potentially get the EITC if they had other wages (say, from the other spouse). Theoretically, a couple making $100,000 could get the EITC in this case if the greater portion of the income were Medicaid Waiver Payments. This would be the case because such payments would be disregarded for EITC eligibility calculation altogether. Probably not what Congress (or even the IRS) had in mind.

My clients felt like they should do something about this unfairness. So they did: they took both the exclusion of IRS Notice 2014-7 and the EITC based on the excluded wages. This of course led to a notice of deficiency and culminated in the precedential Feigh decision.

Our Legal Arguments

Because of our client’s novel stance, we had two points we had to make for our client to win: (1) that the wages could be included in income, and (2) basically, that was it. We wanted to make it a simple statutory argument: If the wages could be included, then they were “includible,” and that was all that was required of the EITC under IRC § 32(c)(2)(A)(i).

As to the first point -whether the payments could (maybe, should) be “included” in income- history was on our side. Prior to 2014 courts and the IRS agreed that such payments had to be included in income. Payments for adopted or biological children clearly did not meet the statutory language of excluded “Foster Care Payments” under IRC § 131. The only thing that changed in the intervening years was the IRS issuance of Notice 2014-7: there was no “statutory, regulatory, or judicial authority” that could anchor the change in treatment. As we argued, the IRS essentially transformed “earned income” into “unearned income” on its own. And that sort of change is a massive bridge too far through subregulatory guidance.

We won on that first issue handily. The Court noted that “IRS notices –as mere statements of the Commissioner’s position—lack the force of law.” Then, the Court applied Skidmore deference (see Skidmore v. Swift & Co., 323 U.S. 134 (1944)) to see whether the interpretation set forth by IRS Notice 2014-7 was persuasive.

It was not.

And the IRS could not, through the notice, “remove a statutory benefit provided by Congress” -like, say, eligibility for the EITC. That sort of thing has to be done through statute. For administrative law-hawks, the Tax Court reigning in the IRS’s attempts to rule-make without going through the proper procedures is probably the bigger win. (As an aside, I’m not entirely positive even a full notice-and-comment regulation could do what Notice 2014-7 tries to: I don’t think any amount of deference would allow a reading of IRC § 131 the way Notice 2014-7 does.)

So we cleared the first hurdle: the IRS can’t magically decree that what was once earned income is no more through the issuance of subregulatory guidance. But what of the second hurdle -the fact that our client undeniably did not include the wages in gross income?

Courts have (rightly) treated the terms “allowable” and “allowed” differently, as well as “excludible” vs. “excluded” in previous cases. The breakdown is that the suffix “able” means “capable of” whereas the suffix “ed” means “actually occurred.” See Lenz v. C.I.R., 101 T.C. 260 (1993). Coming into this case I was keenly aware of this distinction because of a law review article I read while writing a chapter on the EITC for Effectively Representing Your Client Before the IRS. Indeed, it was that aspect of the EITC statutory language (and not my familiarity with Notice 2014-7 or Medicaid Waiver Payments) which made me want to take this case from the beginning. I feel compelled to raise the value of that law review article (James Maule, “No Thanks, Uncle Sam, You Can Keep Your Tax Break,”) because so many law professors joke that no one reads law review articles, or that most articles are impractical (no comment on the latter).

Consistently with the distinction of “allowed” vs. “allowable,” the Court has previously ruled on the nuance of “included” vs. “includible.” See Venture Funding, Ltd. v. C.I.R., 110 T.C. No. 19 (1998). “Included” means it was reported as income, “includible” means that it could/should be reported in income. Since the Tax Court already found that we met the first hurdle (our client could include the payments in income and Notice 2014-7 can’t take that away), we were in the clear: it was “includible.”

And so our client has excluded income and the earned income credit derived from it… Impermissible double-benefit, you (and the IRS brief) say?

I disagree. Not only does treating excluded payments as earned income apply the statutory language correctly, and more in line with what Congress would want, I contend that it is the better way to protect the integrity of the EITC. To see why this is you have to look again at how the EITC is calculated, and how the phase-out applies. In so doing we see that the real problem would be in disregarding excluded income altogether.

The Integrity of the EITC

The EITC is means tested, but it calculates the taxpayers means through two separate numbers: (1) “earned income” and (2) “adjusted gross income (AGI).” See IRC § 32(a)(2) and (f).  Excluded income isn’t reflected in AGI, so people with high amounts of excluded income might escape the AGI means testing prong of the EITC -unless the excluded income is specifically caught through other IRC 32 provisions like limits on investment income or foreign income exclusions. (Note that excluded alimony payments post TCJA would not be incorporated in the means testing.)

However, if excluded income like Medicaid waiver payments is considered “earned income” (that is, if we don’t require that earned income be “included”) then people with large amounts of excluded earned income do begin to phase out under the “earned income” means testing prong. In other words, it more appropriately reserves the credit only for those who working and are (truly) of limited means, while denying it to those who (truly) are not. I think Congress would approve. I’d also note that the exclusion is necessarily worth more to higher income earners than to lower-income earners -and frequently worthless to EITC recipients, many of whom may not actually have a tax liability at all (thus providing a $0 benefit to the exclusion).

Finally, I’d note (and did in the brief) that Congress has essentially addressed this problem of excluded earned income before -only with non-taxable Combat Pay. A little history is helpful on that point.

For the majority of the EITC’s existence (from 1978 to 2001), earned income actually didn’t have to be “includible” in gross income. Then, in an effort to make the credit easier to compute (not an effort to limit eligibility), Congress added the includible requirement as part of the Economic Growth and Tax Relief Reconciliation Act of 2001. Mostly, Congress made this change because it wanted information returns to give taxpayers (and the IRS) all the information needed for calculating the EITC.

Unfortunately, this meant that active duty soldiers receiving combat pay (which is a mandatory statutory exclusion, and thus not “includible” under IRC § 112) could not treat that pay as qualifying for the EITC. A GAO report noted that this was likely an unintended consequence (see page 2), that accrued the bulk of the benefits to those that made the most money. The Congressional fix was IRC § 32(c)(2)(B)(vi), which allows taxpayers to “elect” to treat excluded combat pay as earned income (it still isn’t taxed). Congress had to make this change to fix an unintended consequence of their own (statutory) making. However, it would be absurd (we argued) to require Congress to fix an unintended consequence wholly created by the IRS through Notice 2014-7.

What Happens Next?

I’ve been in contact with the local VITA providers in my community that see Medicaid Waiver Payments on the front lines -apparently fairly frequently. Their main question is a practical one: what do we tell taxpayers now? The IRS VITA guidance before had been “you can’t get credit for those payments towards the EITC.” In the aftermath of Feigh, can they both exclude and get credit now (as my client did)?

That is an excellent question, which brings up some excellent procedural issues (finally: I promised I’d get to them). The main issue is whether the IRS may now consider Notice 2014-7 completely moribund, such that there is no exclusion period and the Medicaid Waiver Payments must be included. The Court noted that the IRS did not raise the argument that the payments should be includible in income for my client, so it was conceded. But is the IRS stuck with that position now? Can the IRS take a position that is contrary to its own published guidance? What if that guidance is essentially invalidated?

The best case on point for this sort of situation may be Rauenhorst v. Commissioner, 119 T.C. 157 (2002). In that case, the IRS essentially said it wasn’t bound by its own guidance (in that instance in the form of a Revenue Ruling) when the Commissioner took a litigating position directly contrary to it. After receiving something of a slap-down from the Tax Court, the IRS issued Chief Counsel Notice CC-2003-014 (sorry, I couldn’t find any free links), which provided that “Chief Counsel attorneys may not argue contrary to final guidance.” Final guidance includes “IRB notices” (i.e. notices that are published in the Internal Revenue Bulletin), which Notice 2014-7 was.

Further, it does not appear to matter that Feigh essentially invalidated Notice 2014-7. The Chief Counsel Notice specifically includes a section headed “Case law invalidating or disagreeing with the Service’s published guidance does not alter” the rule that Chief Counsel shouldn’t take a contrary position that is unfriendly to taxpayers. In other words, so long as IRS Counsel follows the CC Notice, they should continue to let taxpayers exclude the Medicaid Waiver Payments… And since they’ve already lost on whether those excluded payments are earned income, it is perhaps best of both worlds for taxpayers moving forwards.


Perhaps. But I’m not sure I’d bet the farm on the IRS following the Chief Counsel’s Notice in all cases (and especially for taxpayers working with IRS agents or appeals, rather than Counsel).

But the final procedural point I want to make takes the long-view of things: which is that this never should have happened in the first place, because the IRS never should have overstepped its powers by issuing Notice 2014-7 masquerading as substantive law without, at the very least, following the rigorous notice and comment procedures required of substantive regulations. Had the IRS done so the tax community could well have seen this before the regulation was finalized and it could have been addressed. This may echo from my soapbox, but Notice 2014-7 undoubtedly caused real harm to some of the most vulnerable taxpayers. I know from conversations in the tax community that many low-income earners lost out on a credit they rightfully deserved. I don’t think for a second that was the intention of the IRS when they issued Notice 2014-7. Nor does Judge Goeke in the opinion (see footnote 7).

But, again, tax is a complicated animal: legislating new rules should not be done lightly. Procedure, in other words, matters.