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.

With Great (Tax) Knowledge Comes Great(er) Barriers to the Reasonable Cause Exception. Designated Orders, November 4 – 8, 2019

It was a busy week at the Tax Court, with six designated orders. The orders that weren’t issued by Judge Buch were fairly unremarkable: a tax protestor avoiding (for now) an IRC 6673 penalty here and an order granting summary judgment to the IRS in a Collection Due Process case where the petitioner failed to submit information at the hearing here. Two of Judge Gustafson’s orders were essentially duplicates (same issue, different tax years) dealing with a partnership squabbling over tax settlement terms that are more beneficial to some partners than others (here and here). I was most interested by the lessons that could be found in Judge Buch’s orders, however, and thought that they provided an interesting lesson on the interplay of IRC 6662 and taxpayers of varying sophistication. Deep dive below the fold…

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Getting out of the IRC 6662 Accuracy Penalty: Being a Tax Preparer vs. Relying on a Tax Preparer: Jacobi v. C.I.R., Dkt # 17490-17 (here) and Atala v. C.I.R., Dkt. 9620-18 (here)

Both of Judge Buch’s orders were bench opinions, and both involved (among other things) whether an accuracy penalty should be imposed against the taxpayers. In one of the cases it is easy to sympathize with the taxpayer -in the other, not so much. And yet even the sympathetic taxpayer ends up no better off than the unsympathetic taxpayer with regards to the accuracy penalty… I found this result interesting (perhaps even incorrect) for reasons I will detail later. 

Let’s start with the easy case: Jacobi, where the taxpayer was a CPA that ran his own tax business. Mr. Jacobi’s return is a mess (as one example, he reported almost $60,000 in “cost of goods sold” for his accounting firm, $40,000 of which he tried to double-count as legal fees on a later amended return), and he should clearly know better. He also literally won a +$1M lottery and took a position that the winnings should be taxed at lower capital gains rates than what us working stiffs pay on our ordinary income. This is not a sympathetic taxpayer. But let’s run through his potential avenues for avoiding an IRC 6662 penalty anyway.

First, one may try to attack the penalty on purely procedural grounds -that is, the infamous requirement of supervisory approval under IRC 6751. This opinion doesn’t actually address whether there was supervisory approval for the penalty, and it is unclear whether it was raised or conceded as an issue. PT has covered these sorts of concerns here and here. For now, let’s just assume that there was supervisory approval and it was properly entered into evidence, thus denying the procedural attack for Mr. Jacobi.

Where the IRS asserts an IRC 6662 penalty for “substantial understatement” (6662(b)(2)) a second argument one can make is that their understatement simply wasn’t “substantial” to begin with. This “mistaken identity” argument is largely a numbers game, with the goal of getting the understatement under “the greater of” 10% of the total tax that should have been on the return, or $5,000, whichever is larger. IRC 6662(d)(1)(A).

Even if you can’t do this by prevailing on the merits, you can still do it if you show that a portion of your understatement had either “substantial authority” for your (wrong) position, or you adequately disclosed your position and had “reasonable basis” for it. IRC 6662(d)(2)(B). Basically, your error is removed from the size of your total “understatement” if you meet either of those exceptions. Because Mr. Jacobi’s tax return didn’t adequately disclose “the relevant facts” for his position that the lottery winnings were capital gains, he would need to show “substantial authority” (which is more demanding than “reasonable basis”) to avoid the IRC 6662(b)(2) penalty attributable to that error.

So what authority did Mr. Jacobi rely on for his lottery position, and is that authority “substantial?” You be the judge: for the novel idea that lottery winnings are capital, not ordinary, income Mr. Jacobi apparently relied on a passing conversation with a (now deceased) CPA. The Treasury Regulation on point (Treas Reg. 1.6662-4(d)(3)) provides a whole list of what sources taxpayers can rely on for substantial authority. Not surprisingly, “passing conversation with CPA” doesn’t make the list. Especially when, as Judge Buch notes, “even a cursory search (if one occurred) would have revealed that ““There is no question that lottery payments in the first instance were ordinary income.”” (Quoting Clopton v. C.I.R., T.C. Memo. 2004-95.)

Because there (apparently) are no procedural issues and the understatement is “substantial” under IRC 6662(b)(2) the only remaining hope Mr. Jacobi has left is to argue “reasonable cause” for the mistake under IRC 6664(c). The opinion doesn’t actually address reasonable cause at all (it is unclear if it was raised by the taxpayer, which it would need to be as an affirmative defense). In any event, it’s probably safe to say that it doesn’t exist to excuse Mr. Jacobi’s errors: unsympathetic and sophisticated taxpayers face an uphill battle on reasonable cause.

To better understand the reasonable cause exception, it is instructive to look at the second bench opinion issued by Judge Buch: one that appeared to involve a (more) sympathetic and less-tax-savvy taxpayer: Atala v. C.I.R.

Ms. Atala’s tax situation in 2014 invokes a number of thorny issues: her filing status; community property income; substantiation issues with charitable donations; unreimbursed business expenses; and substantiation issues with her own side-business. This is close to a “greatest-hits” compilation from the National Taxpayer Advocate’s perennial “Most Litigated Issues” list.

This does not appear to be a case of the taxpayer creating the problem all on their own (for example, by just making up charitable donations). In this case, Ms. Atala appears to have lived with her husband until November 2014; frequently was required to travel for work; could substantiate cash contributions to charity (in the amount of $8050) but didn’t have an itemized receipt for her non-cash donations. For almost every issue that went against Ms. Atala there appeared to be at least some mitigating factor (or rationale) for why the mistake may have happened. And on top of all of that, Ms. Atala relied on a tax return preparer to sort these things out in filing her 2014 return. But apparently the return still got things wrong. So much so, in fact, that an IRC 6662 penalty for substantial understatement was imposed. 

But might Ms. Atala have a case for the “reasonable cause” exception where Mr. Jacobi, CPA, did not? One may be inclined to think so. 

“Reasonable cause” is essentially an equitable relief provision. The statute asks whether the taxpayer acted “in good faith” and the regulation provides that “Generally, the most important factor is the extent of the taxpayer’s effort to assess the taxpayer’s proper tax liability.” Treas. Reg. 1.6664-4(b)(1)

As we are told ad nauseum “taxes are hard,” so innocent mistakes are likely to be made. It seems punitive to impose a penalty on mistakes made by taxpayers making a good faith effort to get it right. And to some degree you can find this intuitive notion taking hold in court decisions, where it appears judges are loath to penalize pro se petitioners appearing to be caught in the web of our tax code. I even recall at a previous ABA Tax Section conference one Tax Court judge providing a general rule where if it took two pages to explain the law at hand and why the taxpayers application of it was incorrect, the judge was less likely to uphold an accuracy penalty. 

Beyond general equitable notions of “trying your best,” a particular safety-valve has developed through court decisions where taxpayers rely on a tax return preparer. The leading case is Neonatology v. C.I.R., 115 T.C. 43 (2000), which provides a list of factors for when reliance on a tax professional might get you out of an IRC 6662 penalty, broken down generally as: (1) was the advisor competent enough to reasonably rely on, (2) did the taxpayer provide enough information to the advisor, and (3) did the taxpayer actually (in good faith) rely on the advisor? Mr. Jacobi probably didn’t do so in good faith… and there are perhaps questions whether this supposed conversation ever even occurred with the now-deceased CPA. So Neonatology is probably unavailing for him. What about for Ms. Atala?

The court’s analysis on that point is a bit confusing to me, and it never directly addresses Neonatology. In Judge Buch’s words, “Although Ms. Atala used a return preparer, the deficiencies principally relate to a failure to substantiate expenses, and she testified that she provided the information that was reported to the return preparer. Ms. Atala did not establish reasonable cause for her understatement.” I take Judge Buch’s reasoning to be that you don’t get a free pass by just giving numbers to a tax preparer without anything more. However, I think that may be a bit uncharitable. The facts show that the tax preparer never actually asked for any proof of the expenses -and that at least some of the expenses (the substantial cash charitable deductions) did end up being substantiated. Perhaps this is a way of saying “you gave some information, but not enough information to rely on the tax preparer in good-faith” (prongs 2 and 3 of Neonatology argument).

But I am also surprised at the penalty for another reason. At least some of the underlying deficiency results from the Court’s finding that Ms. Atala was not entitled to claim her minor niece and nephew as dependents.

Normally this would be unremarkable. Except that this is not a case where a taxpayer just puts a related individual on their return that they have had nothing to do with. Rather, the facts here show that Ms. Atala lived with her niece and nephew in the tax year and provided their housing. Those facts show (or strongly suggest) all of the key tests met to be a qualifying child: age (the niece and nephews are minors), relationship (niece and nephew suffices), and residency. The only test remaining is support… and here I actually think Judge Buch gets the law wrong. 

Judge Buch finds the elements I quoted to be met, but nevertheless does not find that the niece and nephew are qualifying children. This is because Ms. Atala “did not show that she provided support for her niece and nephew aside from providing housing, as required by section 152(c)(1)(D).”

The problem is that section 152(c)(1)(D) says something quite different than that the taxpayer must show they supported their qualifying child. What it actually says is that a qualifying child is an individual that “has not provided over one-half of such individual’s own support[.]” [emphasis added]. In other words, the test is whether the child supported themselves. It is (mostly) immaterial who the support came from so long as it wasn’t the minor supporting themselves. Over half the support could have been provided by Santa Claus, Ms. Atala, or a friendly neighbor. In all cases the support test would be met with regards to Ms. Atala. Minors don’t usually support themselves, so I rarely have to quibble with the IRS on this point. But here it appeared to be a difference-maker. 

This is particularly important because one of the main benefits Ms. Atala was seeking was the Child Tax Credit, which (unlike the Earned Income Credit)  you can receive even if Married Filing Separate (which is what Ms. Atala’s filing status would be, since she appears ineligible for Head of Household). In 2014, this could have shaved off a solid $2,000 of tax. Or at the very least, shave off the accuracy penalty associated with that understatement.

Finally, recall that this was a bench opinion -which, being non-reviewed and non-precedential, would seem to be ideal for equitable arguments and sympathetic taxpayers. And though I am not privy to all of the facts and circumstances of the case, that the penalties were upheld in a bench opinion contributed to my surprise. To me, it looked like an instance where with the right advocacy Ms. Atala may have had a strong case to get out of the penalty -or even get some of the credits related to her niece and nephew that she originally claimed.

The Perils of Waiting on a Summary Judgment Motion: Designated Orders, October 7 – 11, 2019

It was a light week for designated orders, with only two being issued. Since one of them was a fairly perfunctory take-down of a petitioner’s argument that the Affordable Care Act is unconstitutional (here), we’ll devote the entirety of this post to the second order. And though that order itself doesn’t break any new ground, it gives us a chance to look at the confluence of two topics that frequently arise on these august pages: primarily, Collection Due Process and summary judgment.

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American Limousines, Inc. v. C.I.R., Dkt. # 4795-18L (order here)

One of the goals of my tax clinic is for students to learn how to manage deadlines and multiple clients. With regards to deadlines, I tell my students (1) if you need more time, you should tell me sooner than later, and (2) borrowing from something told me by a fellow professor, the closer you get to the deadline the better the final product better be. To me, the order in American Limousines exemplifies the perils those two pieces of advice are meant to forestall. 

The Collection Due Process (CDP) hearing in American Limousines should be about as straightforward as they get: no tricky issues about whether petitioner is precluded from arguing the underlying liability (see here, among many others), no deep dives into the record about whether a Notice of Deficiency was properly mailed (here), no questions about application of payments (here). Nope, just your typical argument between the taxpayer and the IRS about how much they can afford to pay. 

The IRS thinks that the issues have been sufficiently hammered out in the CDP hearing and there was no abuse of discretion, setting the table for its summary judgment motion.

And yet the motion is denied. And because of this, a trial is quite likely.

Background

It didn’t have to be this way. 

Granted, there is quite a fair sum of money at issue in this case: $1,170,103 in unpaid employment taxes. The two sides are also quite far apart in their estimations of how much can be paid via an installment agreement. Petitioners proposed $2,000 a month -the most (actually more than) they say they could possibly afford. If interest rates were zero the liability would be fully paid after a mere 70 years -presumably when limousines are all self-driving. Of course, absent an explicit agreement to extend the collection statute, the IRS only has 10 years from the date the tax was assessed (see IRC 6502(a)(2)), so this plan is really a proposal to the IRS to let a lot of the debt go unpaid after the CSED stops (a “partial pay” installment agreement, in IRS parlance: see IRM 5.14.2). But hey, the IRS would get $2K a month for a while, which is better than nothing -nothing being the other proposal put forward by the petitioner (in the form of Currently Not Collectible).

The IRS isn’t opposed to the idea of an installment agreement, only on slightly different terms. Rather than $2,000 the IRS believes that an acceptable amount is in the ballpark of $22,877 a month. The difference between the two sides, it appears, mostly boils down to what should and should not be considered in the calculation of expenses and income. 

When the IRS looks at 4 months of financial statements, they believe there is money to be found. Money that can be put to back taxes. For starters, the money paid to the owner ($202,800 per year), and the somewhat artificial loss from “noncash depreciation” ($412,224 per year) could allow the company to continue to operate while paying the back taxes. Taking these numbers at face value, it would mean that petitioner has $51,252 to put towards back taxes every month. But the IRS isn’t that naive about the profitability of the limo business, so they allow an “annualized loss” of $65,953. Then, to account for “tight margins,” the IRS basically cuts in half what would otherwise be the amount of money left over each month. The result: $22,877 per month. That is the lowest they are willing to go.

But petitioner has a ready answer for this: “you forgot the $506,148 yearly principal payment I make on my fleet! And drivers tips are expenses! And limousines are a seasonable business [apparently]! And all of these are disputes about material facts, so no summary judgment!”

But is the petitioner correct? Are those the sorts of issues that can’t be addressed in a summary judgment motion in a collection due process hearing?

The IRS Motion for Summary Judgment

The IRS wanted to keep it simple in its motion for summary judgment: “Look Judge, here are the four paragraphs of reasoning Appeals provided for proposing a vastly higher monthly payment and sustaining the levy. There is no abuse of discretion in the reasoning and the outcome, so let’s just move along. Further, the Court is confined to the administrative record in reviewing the Appeals determination because of the Robinette, which should make this all-the-more summary-judgment appropriate.”

(As a side-note, potentially an important one, I couldn’t quite make-out why the IRS was arguing that Robinette applied since the case is taking place in Maryland, which would be in the 4th Circuit. As I understand it, the 4th Circuit isn’t one that follows the Robinette 8th Circuit decision. So either the IRS is mistaken that the Court should be bound by the administrative record, or they are pushing it in the hopes that they get the 4th Circuit to rule on the issue. Or, I suppose less exotically, the appellate court for American Limousines actually is one of the Robinette following circuits, and petitioners simply chose Maryland as their place of trial. See IRC 7482(b) and Les’s post here.)

The Court’s Response to the IRS Motion

One might wonder why the issues raised by petitioner in the objection to summary judgment weren’t already hammered out in the Appeals hearing, and are not therefore part of the administrative record. After all, questions about what is and is not necessary expenses seems like the very essence of what Appeals and the petitioner should have been arguing over, in a hearing that solely looked at collection alternatives.

And yet, here we are.

In the immortal words of Cool Hand Luke (actually, the Captain) what we have here is a failure to communicate. Judge Halpern refuses to grant the motion because it isn’t entirely clear what the parties’ positions really are: does the IRS object to Petitioner bringing up these installment agreement calculation arguments as being outside the administrative record? Are these arguments (and the facts relied on) outside the record? Were they properly addressed by Appeals if they were raised?

The boilerplate explanation for the purpose of summary judgment is to “expedite litigation and avoid unnecessary and expensive trials.” (Frequently, Florida Peach Corp. v. C.I.R., 90 T.C. 678 (1988)) is cited to for this proposition.) Query whether this motion for summary judgment would advance that purpose. A timeline may be helpful to see why not.

On May 30, 2019 the Court set trial for October 28, 2019. Three months later, on August 29, 2019, the IRS filed its motion for summary judgment on -essentially two months before trial. Under the Tax Court rules, this is a timely motion for summary judgment, but the absolute latest you can make it without the Court’s leave. See Tax Court Rule 121(a). One problem with such a late motion is that it doesn’t give the Court a lot of time to consider both the motion and any objection before the parties would be in Court anyway -potentially obviating the purpose of “avoiding unnecessary trials.”

And because not everything is properly sorted out in this motion (as is often the case), it makes the most sense to Judge Halpern to have the parties explain the issues at trial. This case has actually been kicking around the Tax Court docket since March 2018. After an initial remand to Appeals (on the IRS’s own motion), it was restored to the general docket more than a year ago -September 25, 2018. Then, from roughly December 2018 through the end of August, 2019, the case appears more-or-less dormant. At least from the perspective of the Tax Court docket… there is almost always other work between the parties going on beyond the scenes.

To be fair, it appears that more of the confusion in this case comes from petitioner’s objection than the IRS motion for summary judgment. Why is petitioner advocating for a $2,000 a month payment plan when they also claim they have negative cash-flow? Does the petitioner really think the error was denying Currently Not Collectible? Is the petitioner raising arguments based on what is in the administrative record? There really isn’t time to sort this out before trial would take place (roughly 2 weeks later), so continuing down the summary judgment path just doesn’t make much sense.

It is strange to me that it took the IRS this long to make the motion. Usually in CDP cases where the issue is collection, and not the underlying liability or attacks on assessment the IRS attorney’s role is essentially limited to a Summary Judgment machine. The IRM for counsel in CDP cases basically gives two instructions: (1) try to resolve the case on a pretrial motion, likely summary judgment (see esp. IRM 35.3.23.1(1) and IRM 35.3.23.8.3) and/or (2) file a motion to remand if it looks like Appeals isn’t giving you the record you need to succeed (see IRM 35.3.23.7).

In this case, the IRS had previously filed a motion to remand, way back on May 11, 2018. I’m inferring that a supplemental notice of determination was issued late in 2018, because the Court ordered the IRS to file another answer in December. This means the table should have been set for a motion for summary judgment shortly thereafter. But because the motion wasn’t filed “sufficiently in advance of trial” (like the IRM tells its attorneys to do), it was met with rejection. 

It should be noted that in the not-too-distant past the Tax Court deadline to file a motion for summary judgment simply provided that it should be made “within such time as not to delay the trial.” (See footnote 1 for Rule 121(a).) There is reason to believe that this change came about in part because of research conducted by Keith and Carl, which raised concerns about how (needlessly) long many collection cases took to reach resolution. (See “Tax Court Collection Due Process Cases Take too Long,” 130 Tax Notes 403 (Jan. 24, 2011).)  Because the petitioner may not care about the case dragging on in levy cases (generally, their goal is simply not to pay the tax anyway), the onus is really on the IRS to make appropriate summary judgment motions as early as possible when it is clear that trial isn’t needed. There isn’t much of a reason for the government to wait in such cases, and waiting only increases the likelihood of failure for exactly the reasons present in American Limousines.

Again, as I tell my students, if you wait until the last second it better be perfect. And this motion wasn’t.

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.