Disbarment of Attorney by Tax Court Reversed by D.C. Circuit

In Koresko v. U.S. Tax Court, No. 18-1146 (D.C. Cir. 2019) the court reversed the disbarment of Mr. Koresko from the Tax Court and remanded the case so that the Tax Court could give him the opportunity for a hearing before being disbarred, otherwise disciplined or exonerated.  I read the short order from the circuit court remanding this case and became curious why the Tax Court would decline to give him a hearing before taking him off the record of approved attorneys.  So, I had my research assistant pull the underlying documents including the briefs. 

I will link to the documents so that anyone interested in the matter can easily access them.  After quickly reviewing them, I understand what happened at the Tax Court.  I found that the Tax Court was incredibly understanding and postponed the matter over a period of years.  The new opportunity for a hearing is unlikely to change the outcome here, but the case gives a glimpse at the process for those interested.  I wrote about a Tax Court disciplinary proceeding a couple of years ago regarding Aka v. United States Tax Court, 854 F.3d 30, 32 (D.C. Cir. 2017).  Bob Kamman wrote about an order setting a hearing for a disciplinary proceeding. 

Both the Aka case and the case Bob covered involved failures of petitioner’s counsel in proceedings before the Tax Court.  The Koresko case involves the reciprocal disciplinary issue present in the Tax Court when another court or bar disciplines a practitioner. Mr. Koresko did nothing in his practice before the Tax Court to cause the Tax Court to initiate disciplinary proceedings against him the way it did against Mr. Aka. But Tax Court Rule 202 requires that a practitioner notify the Tax Court of any disciplinary action by another court or bar and can base its own disciplinary action on the action of the other venue.  The issue here stems from multiple problems between Mr. Koresko and Pennsylvania, their timing and the timing of his failures to respond to the Tax Court’s offers of a hearing.

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Here is the Tax Court’s announcement of the disbarment of Mr. Koresko and its explanation of the reason for the disbarment.  Here is the Department of Justice brief to the D.C. Circuit which provides the best road map for understanding the case.  Here is Mr. Koresko’s brief to the D.C. Circuit.  Here is the order of the Pennsylvania Supreme Court and the Report and Recommendations of the Disciplinary Board of the Supreme Court of Pennsylvania.  There is more here to read than most will want.  I will summarize the issues, drawing heavily from the DOJ brief.

Mr. Koresko’s initial problem with the PA bar (as far as these proceedings go) concerns actions with respect to an ERISA plan.  Then he gets in trouble relating to the sale of a home owned by he and his wife to the tenant.  When he sold the property he did the legal work for the title policy.  The property had two liens against it.  One lien was satisfied with the proceeds of the sale.  The other lien resulted from a suit against Mr. Koresko.  He contested the validity of this judgment lien; however, he failed to mention it in the title report or to the buyer.  The existence of this lien came to light when the holder of the lien sued Mr. Koresko and the buyer.  Things went downhill from there with a number of his problems with the PA bar stemming from actions in the ensuing litigation.  As with the Tax Court disbarment proceedings, the matter before the PA bar took quite some time.  If nothing else, Mr. Koresko has definite skills in prolonging proceedings.

Here is a description from the DOJ brief:

The action that gave rise to this appeal arose from orders to show cause issued by the Tax Court due to (1) the Pennsylvania Supreme Court’s December 19, 2013 emergency suspension of Koresko’s license to practice of law, premised on misconduct connected to his fiduciary duties under the Employee Retirement Income Security Act of 1974, 28 U.S.C. §§ 1001, et seq., (“ERISA”) with regard to certain employee welfare benefit plans and (2) the Pennsylvania Supreme Court’s September 14, 2015 disbarment of Koresko, premised on “multiple litigation actions by Mr. Koresko from 2008 through 2013 related to the sale of a home by Mr. Koresko and his ex-wife to a tenant.” (A205-06.) It was also based on Koresko’s failure to inform the Tax Court of these and other disciplinary actions. (A205.) It is the Tax Court’s understanding that (in addition to Pennsylvania Supreme Court), the Florida Supreme Court, the United States Supreme Court, and the Eastern District of Pennsylvania have also disbarred Koresko, and that the Third Circuit has indefinitely suspended him. (See In re Koresko, 136 S. Ct. 2535 (2016) (Mem.); Florida Bar v. Koresko, 2016 WL 4143279 (Fla. 2016); A186.)

The DOJ brief also addressed the efforts of the Tax Court to deal with his case:

the Tax Court issued four orders to show cause, outlining precisely the bases for reciprocal discipline and for finding Koresko had violated Tax Court Rule 202(b) and Model Rule 3.4(a) by failing to alert the Tax Court to disciplinary actions taken by other courts. (A7-8; A97-99; A141-46; A184-87.) These orders provided ample notice of the bases for discipline.

The brief detailed the notice provided and the action taken:

the Tax Court offered the following potential hearing dates, with clear notice deadlines:

Order dateOffered hearing dateRequired notice dateCitation
3/19/20147/16/20144/22/2014A7
4/26/20147/16/20146/24/2014A14
6/27/201410/9/20148/15/2014A96
10/6/201412/16/201411/25/2014A99
5/16/20166/28/20166/10/2016A145

The D.C. Circuit’s problem is that although Mr. Koresko did not respond timely to the timeframes set by the Tax Court, the Tax Court focused on his failure to request a hearing in early orders that were based on his suspension from the PA bar and not on the orders issued later after the PA bar disbarred him.  So, his case will go back to the Tax Court which will offer him another opportunity for a hearing.  Assuming that he timely accepts the new hearing, Mr. Koresko then faces the uphill battle to convince the Tax Court that it should not disbar him or take other disciplinary action.  I would not expect the matter to move quickly based on what I have seen so far. 

I am not sure the case offers many lessons, but it does provide insight into the disciplinary efforts of the Tax Court in a reciprocal discipline matter and serve as a reminder that if any readers have friends or acquaintances who encounter disciplinary problems at the local level, they need to advise their friends and acquaintances to notify the Tax Court.  Because the Tax Court is not the only bar with reciprocal discipline, it should also be noted that if you have a problem like Mr. Aka’s that originates in the Tax Court, that problem can impact a practitioner’s ability to practice in other bars to which the practitioner may be a member.  The main lesson from reading bar discipline cases is to avoid doing the things that bring these actions down upon you.  Only a small minority of practitioners go through this process at the Tax Court.  Make sure you are not a member of that minority.

Graev and the Trust Fund Recovery Penalty

The Tax Court is marching through the penalty provisions to address how Graev impacts each one.  It had the opportunity to address the trust fund recovery penalty (TFRP) previously but passed on the chance.  In Chadwick v. Commissioner, 154 T.C. No. 5 (2020) the Tax Court decides that IRC 6751(b) does apply to TFRP and that the supervisor must approve the penalty prior to sending Letter 1153.  Having spoiled the ending to the story, I will describe how the court reached this result. See this post by Bryan Camp for the facts of the case and further analysis.

This is another decided case with a pro se petitioner, in which the petitioner essentially dropped out and offered the court very little, if any, assistance.  The number of precedential cases decided with no assistance from the petitioner continues to bother me.  I do not suggest that the Tax Court does a bad job in deciding the case or seeks to disadvantage the taxpayer, but, without thoughtful advocacy in so many cases that the court decides on important issues, all taxpayers are disadvantaged — and not just the taxpayer before the court.  Clinics and pro bono lawyers have greatly increased the number of represented petitioners in the Tax Court over the past two decades, but many petitioners remain unrepresented. These unrepresented petitioners, by and large, do not know how to evaluate their cases and how to represent themselves, which causes the court to write opinions in a fair number of pro se cases relying on the brief of the IRS and the research of the judge’s clerk in creating a precedential opinion.  Should there be a way to find an amicus brief when the court has an issue of first impression, so that subsequent litigants do not suffer because the first party to the issue went forward unrepresented?

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The real question here is whether the TFRP is a tax or a penalty.  The IRS argues that IRC 6751(b) does not apply to the TFRP because it is a tax.  We know it’s a tax because the Supreme Court has told us so in Sotelo v. United States, 436 U.S. 268, 279 n.12 (1978).  In Sotelo the Supreme Court sought to characterize the TFRP for purposes of bankruptcy.  In bankruptcy getting characterized as a penalty has very negative consequences with respect to priority classification, discharge and even chapter 7 priority of secured claims.  We have written about several code sections that bankruptcy courts have characterized from tax to penalty or vice versa based on the Supreme Court’s analysis in Sotelo.  You can find a couple of those posts here, and here

So, if TFRP acts as a tax for purposes of bankruptcy, should it, could it act as a penalty for purposes of 6751(b)?  While the Tax Court had skirted the issue previously, the Southern District of New York had decided it head on in United States v. Rozbruch, 28 F. Supp. 3d 256 (2014), aff’d on other grounds, 621 F. App’x 77 (2nd Cir. 2015).  In Rozbruch the court held the TFRP a tax that did not require penalty approval under IRC 6751(b).

The TFRP does not seem like the kind of penalty Congress intended when it worried about using penalties as a bargain chip.  The TFRP is the chip.  It imposes on the responsible person or persons the unpaid tax liability of the taxpayer charged with collecting taxes on behalf of the United States, who failed to fulfill that responsibility.  Good reasons exist not to apply IRC 6751(b) in the TFRP context.  The reasons could have made for another contentious Tax Court conference in the Graev Conference Room, but no one at the court seemed up for the fight.

Instead, the Tax Court settles for a straightforward determination that Congress put the TFRP in the penalty sections of the code, Congress called the TFRP a penalty, and it has some features of a penalty to support its label as a penalty.  While acknowledging that the Supreme Court has held that for bankruptcy purposes TFRP will act as a tax, the Tax Court says that does not mean it isn’t a penalty, citing the wilfullness element necessary to impose the TFRP.  It also finds that the assessable feature of the TFRP supports the penalty label.  So, without a decent fight between Tax Court judges, we get the result that the Tax Court finds the TFRP to be a penalty.  This fight may not be over if the IRS wants to bring it up again.  Unlike lots of liabilities that primarily if not exclusively get decided in Tax Court, matters involving the TFRP primarily get decided in district courts.  Only in the CDP context will the Tax Court see a TFRP case.  So, this may not be the end of road for this issue.

Having decided that the TFRP is a penalty, the Tax Court then decided when the “initial determination” occurred.  Relying on its recent opinion in Belair Woods LLC v. Commissioner, 154 T.C. 1 (2020), the Tax Court decided that the initial determination of the penalty assessment was the letter sent by the IRS to formally notify the taxpayer that it had completed its work.  In the TFRP context this is Letter 1153.  Here the IRS had obtained the right approval prior to the sending of this letter and the court upheld the TFRP.

The Court reaches a taxpayer-friendly conclusion that the IRS must obtain supervisory approval prior to the application of this unusual provision and perhaps did not find any judges putting up a fight against that result because it was taxpayer-friendly.  As with most 6751 decisions, it’s hard to say what Congress really wanted in this situations.  The result here does not bother me.  Certainly, the result has logical support, but the opposite result would have logical support as well.  It will be interesting to see if the IRS wants to fight about this further in the district courts or if it will just acquiesce.  At the least the IRS will want to cover its bases by timely giving the approval, even if it thinks the approval is unnecessary.  The first time a large TFRP penalty gets challenged and the approval was not timely given, the IRS will have to swallow hard before giving up the argument entirely.

Graev and the Reportable Transaction Penalty

In Laidlaw’s Harley Davidson Sales, Inc. v. Commissioner, 154 T.C. No. 4 (2020) the Tax Court addresses the need for supervisory approval and the necessary timing of supervisory approval when the IRS imposes the reportable transaction penalty under IRC 6707A.  We will discuss the mechanics of the penalty below, but this is a really harsh penalty and setting the scene deserves some attention.  When I say harsh, I do not mean to imply that the penalty should not exist or that the IRS improperly imposed it here or elsewhere.  The harshness of this penalty derives from the amount of the possible penalty.  We discussed this penalty in the context of the Flora rule in the case of Larson v. United States where the IRS assessed a penalty of about $163 million against Mr. Larson and others for failing to disclose a reportable transaction.  See the discussion of Larson here and here.  So, the ability of 6751(b) to provide a basis for removing this penalty if the IRS failed to follow the proper procedures for supervisory approval could make a huge dollar difference to certain taxpayers.

The Laidlaw case also deserves attention for the procedural posture of the case at the time the Court makes its decision here.  Note that petitioner filed this case in the Tax Court in 2014 and that the tax year at issue is fiscal year 2008.  Remember that in 2008 no one paid attention to IRC 6751(b).  The issue comes up here in the context of Collection Due Process (CDP) many years after the IRS made the assessment.  The IRS must verify the correctness of its assessment in the CDP process.  Here, the CDP process offers the taxpayer the opportunity to raise an issue and obtain court review it otherwise would not have.  How many other penalties assessed long ago before anyone paid attention to IRC 6751(b) might CDP prove as the place where penalties go to die?  Since Graev brought 6751 to everyone’s attention, the number of times the IRS will fail to get the appropriate supervisory approval will be quite low; however, many penalties exist on the books of the IRS from 10 years ago that were imposed at a time when the IRS did not pay careful attention to the supervisory approval rule or have court guidance on when the approval must occur.  Taxpayers with old penalties who might pay those penalties should make certain to raise the supervisory approval issue through CDP, audit reconsideration or whatever procedural avenues remain open.

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Laidlaw participated in a listed transaction and did not disclose that participation on its tax return.  Subsequent to filing its return for fiscal year 2008, Laidlaw did send to the IRS Form 8886 amending its return and reporting the participation.  A revenue agent examined Laidlaw’s 2008 return and concluded that because it did not include the reportable transaction on the original return, the 6707A penalty applied.  The revenue agent made the initial determination as that phrase is used in 6751 by sending a 30-day letter.  This letter did not contain the approval of the revenue agent’s supervisor.  A month after sending the 30-day letter the revenue agent’s supervisor did approve the assertion of the 6707A penalty.

Laidlaw appealed the assertion of the penalty.  After only two years, Appeals sustained the decision to impose the penalty leading to an assessment of the penalty in 2013.  The penalty was assessed in mid-September, and the notice of intent to levy was sent in mid-November.  The short period of time between the assessment and the notice of intent to levy shows the difference in the way the IRS treats assessments against entities compared to individuals, where the time period between assessment and the notice of intent to levy would have been two or three months longer, because the notice stream for individuals is four letters instead of two. 

Upon receiving the notice of intent to levy, the IRC 6330 notice, Laidlaw timely requested a CDP hearing.  In the CDP hearing the Appeals employee notified Laidlaw that it could not challenge the merits of the 6707A penalty because it had an opportunity to do so administratively by going to Appeals before the assessment of the penalty.  (Read the Larson case above or the discussion of CDP cases tried by Lavar Taylor if you want to know more about the inability to litigate the large penalties imposed under 6707A.)  The Appeals employee did not verify that the supervisor had properly approved the penalty.  Of course, at the time of the verification process in this case, the timing of the supervisory approval did not enter the minds of many people inside or outside of Appeals.  What’s important here is that, even though the right to a merits review of the 6707A did not exist, that right exists separately from the obligation under IRC 6330(c)(1) of the Appeals employee to verify the correctness of the assessment.  The verification requirement serves here as a powerful remedy for the taxpayer.

The IRS argued in this case that the supervisory approval did not need to come before the issuance of the 30-day notice but only before the making of the assessment.  No need to go into the tortured language of 6751 and why the IRS or anyone might question the timing of the assessment for those who regularly read this blog.  For anyone wondering why the IRS would not immediately concede the issue, put Graev into the search box of the blog and read the myriad opinions on 6751 trying to parse its meaning.

While the IRS argument might have merit, the Laidlaw case follows the decisions in Clay and in Belair (see discussion of that case here) in which the Tax Court seeks to finally create a bright line for when approval must occur.  Laidlaw seeks to apply that same bright line test to 6707A.  In applying that bright line, Laidlaw looks to the first formal pronunciation by the IRS of the desire to impose the penalty.  That bright line occurs with the sending of the 30-day letter.  At the time the IRS sent that letter it lacked the approval of the revenue agent’s immediate supervisor.  Therefore, the penalty here fails.

Ringing in the New Year with Another Graev Case

On January 7, 2020, the Tax Court issued a TC opinion in Frost v. Commissioner, 154 T.C. No. 2 (2020).  This case presents another permutation of the issues raised in Graev and is another case decided on this issue in which petitioner handled the case pro se, although Mr. Frost has been an enrolled agent for 25 years.  The opinion says that before he became an enrolled agent he performed collections work as an IRS revenue agent.  He would have been a most unusual revenue agent if he performed collection work, so I assume that he was a revenue officer.  Whether he was a revenue officer or revenue agent, working five years or more for the IRS in either position can chart a path to receiving the enrolled agent designation without taking the difficult test to become an enrolled agent. This background indicates that he was not the usual pro se taxpayer though he may have lacked experience in the Tax Court.  His knowledge of the tax system comes back to haunt him in the end.

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The underlying issues in the case concern business expenses and a loss reported on an LLC in which he had a controlling interest.  Though we do not care about his underlying tax issues, the court obviously must and it goes through the case and statutory law governing the proper deduction of business expenses, before arriving at the conclusion that, despite his extensive and long-standing experience preparing tax returns, petitioner failed to present any evidence in support of his expenses and failed to comply with the strict substantiation requirements of IRC 274(d).  He sounds very much like many clients of the tax clinic. 

Similarly, with respect to the loss claimed from his LLC, his failure to establish his adjusted basis torpedoed his chances of winning this issue.  It’s hard to know with proof issues whether his failure was one of lack of understanding the necessary information he needed to place before the court (or the IRS during the administrative phase) or simply the claiming of tax benefits he was never entitled to in the first place.

He made arguments about the notice of deficiency and why he was selected for audit.  I imagine he pointed out there were many taxpayers more deserving of being audited than him, etc., etc.  The court disposed of this argument citing Greenberg’s Express, Inc. v. Commissioner, 62 T.C. 324 (1974) and a few of the other from thousands of cases it could have chosen to knock down this cry for help based on perceived fairness issues.

Now, the court gets to the meat of the case for our purposes and looks at the penalties imposed upon him.  It points out that the IRS bears the burden of production with respect to the penalties, which requires the IRS to come forward with sufficient evidence showing the appropriateness of imposing the penalties.  This includes showing that IRC 6751(b) compliance occurred.  The court walks through the various burdens on the IRS when taxpayer challenges penalties the IRS proposes to impose and discusses the requirements of IRC 7491(c).  It then turns to 6751(b) and notes that here the IRS “produced no evidence of written supervisory approval of the initial determination of section 6662(a) accuracy-related penalties for 2010 and 2011.”  I am a bit confused why the IRS did not concede this issue if it had nothing to show approval of the penalties for these two years.

It’s a different story for 2012.  The IRS does have a signed penalty approval form signed by the revenue agent’s immediate supervisor over a year before the issuance of the notice of deficiency.  The court finds that the introduction by the IRS of the approval form signed before the notice of deficiency satisfies the burden of production on the IRS.  The burden then shifts to petitioner to show evidence suggesting that the approval was untimely.  The court notes in footnote 6 that in Graev it reserved “the issue of whether the Commissioner bears the burden of proof in addition to the burden of production.  We reserve that issue here as well because placement of the burden of proof here… would not change the outcome.  Here, Mr. Frost came forward with no evidence to contradict the supervisory approval for 2012.

Mr. Frost did not claim or put on any evidence that the formal notice of the imposition of the penalty preceded the approval of the penalty.  So, the court turned to the balance of the burden on the IRS as established in Higbee v. Commissioner, 116 T.C. 438 (2001).  This burden requires showing that the penalty should apply in this situation.  Here the IRS showed that the understatement of tax by Mr. Frost exceeded $5,000 and that the IRS correctly calculated the penalty based on the understatement.  It was then up to Mr. Frost to show that he had reasonable cause for the underpayment.  Mr. Frost put on evidence of his brother-in-law’s health issues during the year at issue, but he has the problem that he has lots of tax experience.  The court expects more from him than it would expect from someone who had not been working in the tax system for 40 years and finds his excuses inadequate to meet his burden of showing reasonable cause and good faith.

Frost does not break as much new ground as some of the other recent TC opinions on 6751 but it does do a nice job of laying out what the court expects of each party when they engage in penalty litigation.  I don’t know why the IRS was holding on to 2010 and 2011 as penalty years if it lacked the managerial approval.  Surely, by this time it knew that it must have the approval or fail.  The docket number is from 2015 so perhaps at the time this case was submitted a few years ago, the Graev case had not become clear.  That’s my guess.  When it takes close to five years between the time a case starts until it reaches opinion, intervening legal opinions can change what the IRS might have argued when the case started.

Belair Woods – The Ghouls Continue

In the recent case of Belair Woods, LLC v. Commissioner , 154 T.C. No. 1 (2020) the Tax Court once again goes into its court conference room to have a discussion about the fallout from the Graev opinion and IRC 6751(b).  Because Congress is really slow and has been sitting on his reappointment for a long time, neither the court nor we as consumers of the court’s opinions have the benefit of Judge Holmes’s views on the most recent iteration of a procedural statute written by someone with no background in tax procedure.  This post is dedicated to him and his coining of the term ‘Chai Ghouls’ to describe the many situations the Tax Court would face in trying to provide meaning to this statute.  So, the court is once again tasked with making sense out of nonsense. 

The court deeply fractures, again, over what to do with this statute, and this time it is deciding when the IRS must obtain supervisory approval of the decision to impose the penalty.  The taxpayer argues that the approval must come at the first whiff of the imposition of the penalty, because even at the earliest stages, mention of the imposition of a penalty can cause the penalty to be used as a bargaining chip and that’s what Congress seemed to be wanting to prevent.  This is a logical argument and persuades almost half of the voting judges.  Judge Lauber, writing for a plurality, picks a later time period – the issuance of a formal notification and finds that the IRS had obtained the appropriate approval by that point (for most of the penalties in contention.)

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The case involves a TEFRA partnership.  Normally, in a TEFRA partnership, the IRS issues a 60-day letter (much like the 30-day letter outside TEFRA) and finally an FPAA (the ticket to the Tax Court that is the basis of this case).  Here, the IRS got managerial approval of the penalty before the 60-day letter, which showed a penalty.  Problem is that about two years earlier, the agents had sent a calculation of the potential 60-day letter income adjustments (including showing the penalty) to the partners and suggested a conference to discuss what was effectively this proposed 60-day letter.  But, the agents did not obtain penalty approval before sending this pre-60-day letter. 

Judge Lauber plus seven judges hold that it is time to create as bright a line as possible, citing United States v. Boyle, 469 U.S. 241, 248 (1985) (bright-line rule for late-filing penalty in the case of filing agents), and that the required approval moment should be when a penalty “is embodied in the document by which the Examination Division formally notifies the taxpayer, in writing, that it has completed its work and made an unequivocal decision to assert penalties.”  In this case, the pre-60-day letter was just a proposal.  It was not the critical moment.  Judge Lauber cites the opinion in Kestin v. Commissioner, 153 T.C. No. 2, at slip op. pp. 26-27 (2019), for the similar proposition that a letter suggesting section 6702 penalties might be applied if the taxpayer does not correct a frivolous return is also not a critical moment for managerial approval under section 6751(b).

In a separate concurring opinion, Judge Morrison writes:

 “On the facts of this case, I agree with the opinion of the Court that the 60-day letter was the initial determination to impose the penalties. However, I do not agree with any suggestion in the opinion of the Court that the initial determination to impose the penalties may only be ‘a formal written communication to the taxpayer, notifying him that the Examination Division has completed its work and has made a definite decision to assert penalties.’”

Judge Gustafson and six dissenters agreed with the taxpayer that the pre-60-day-letter was the critical moment for managerial approval of the penalty on these facts. Thus, only 8 of the 16 judges voted for the proposition that the initial determination to impose the penalties may only be ‘a formal written communication to the taxpayer, notifying him that the Examination Division has completed its work and has made a definite decision to assert penalties’”. It appears that there is still no bright line — at least one than can be cited outside the TEFRA partnership context of Belair Wood.

Bryan Camp has written an excellent post on this case which can be found here.  I agree with Bryan’s analysis and will not rehash why it’s a good analysis, but anyone interested in this issue should read his post.  Bryan concludes that Judge Lauber’s reasoning makes the most sense.  Because Bryan does such a good job of explaining the case and the various reasons behind the decisions made by judges on this issue, I want to focus on another issue.  Why doesn’t Congress understand what assessment means, and why doesn’t it fix an obvious mistake, instead leaving Tax Court judges to scratch their heads and spend inordinate amounts of time bonding in a conference room?

When I teach assessment, I almost always poll my students by asking how many of them have ever had taxes assessed against them.  Almost no students raise their hands admitting to such a terrible tax gaffe.  They think, like most people and certainly like most members of Congress, that an assessment is a bad thing.  In reality, assessment is a neutral act of recording a liability on the books and in most instances is a good and important act, because it is a necessary predicate to obtaining a refund of federal taxes.

The Congressional misunderstanding of assessment comes through loud and clear in IRC 6751(b).  I will circle back to IRC 6751(b), but before doing so, I want to spend a little time with an even greater screw-up by Congress in misusing the term ‘assessment’.  The greater example I want to offer is found in Bankruptcy Code 362(a)(6) passed in 1978 as part of the new bankruptcy code adopted that year.  This code replaced the bankruptcy code of 1898 which had been substantially updated in 1938.  The adoption of the new bankruptcy code in 1978 followed almost a decade of debate and discussion.

One of the primary features of the bankruptcy code is the automatic stay.  The stay protects the debtor and creditors from aggressive creditors who might seek self-help and reduce the property available to all creditors or property available to the debtor through the exemption provisions.  The stay is a good thing.  Congress placed the stay in BC 362 and in paragraph (a) enumerated 8 different things impacted by the stay.  Because the stay does not stop everything, Congress inserted in paragraph (b) a list of (now) 28 actions not stopped by the stay.  So, what went wrong?

Bankruptcy code 362(a)(6) provides:

Except as provided in subsection (b) of this section, a petition filed under section 301, 302, or 303 of this title, …, operates as a stay, applicable to all entities, of—

(6) any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case under this title;

If BC 362(a)(6) stays any act to assess that arose before the commencement of the case, then it stops the IRS from assessing the liability reflected on a return for a year that ended before the filing of the bankruptcy case.  We have had years since 1978 when over 1.5 million new bankruptcy cases were filed.  The vast majority of those cases were filed by individuals.  A decent percentage of those cases were filed during the first 3 and ½ months of the year and most of those returns sought refunds.  So, how could the IRS send to these individuals in distress their tax refund when it could not assess the liability?  Keep in mind also that in 1978 we were still in an era of paper filing.  So, the IRS would need to set these returns to the side to be processed once the stay lifted, and they would sit in rooms in the Service Centers around the country waiting for the stay to lift, so the IRS could perform the simple act of assessment and then send out the tax refund.

You can imagine that debtors in this situation did not really want to hear about the problem Congress created with the language of 362(a)(6) prohibiting assessment as though making the assessment was a bad thing.  The IRS faced a choice of what to do to avoid potentially tens of thousands of stay lift motions that would really be unnecessary if the statute were worded properly to reach its intended result.  Sixteen years later, in 1994, the IRS finally convinced Congress to amend BC 362(b)(9) to permit assessment in this circumstance.  The statutory language creating the stay on assessment still exists in 362(a)(6) as a lasting testament to Congressional misunderstanding of assessment, but finally the IRS did not have to stack returns in rooms in the Service Centers in order to move cases along.

Because it took over 15 years for problems in IRC 6751(b) to come to everyone’s attention, perhaps under the timeline of BC 362(a)(6) we still have another decade or more before Congress will get around to fixing its mistaken understanding of assessment in 6751.  The Congressional sentiment of stopping the IRS from using penalties as a bargaining chip makes sense and is probably bipartisan.  With help from the tax community, Congress could make amendments that would allow courts and the IRS to properly administer the statute. We could wish, however, that it will recognize the problem more quickly this time.  In the meantime, the court conference room at the Tax Court will continue to get plenty of use as the court tries to make sense of nonsense.

Imposing the Frivolous Return Penalty

At the end of last summer, the Tax Court issued a TC opinion on the issue of imposing the frivolous return penalty of IRC 6702.  In that opinion it also discussed, inevitably, the impact of Graev on this particular penalty.  We should have covered this case closer to the time it came out.  Several subsequent opinions have cited to it.  This post seeks to correct the omission and make you all aware of Kestin v. Commissioner, 153 T.C. No. 2 (2019).

This case provides yet another example of how friendly the Tax Court is to petitioners.  Of course, statistically, the Tax Court rules most of the time for the IRS; however, it generally gives the taxpayers ample opportunities to make their case.  Mrs. Kestin did not appear for the trial of her case but that did not stop the court allowing her to participate in post-trial briefing and for holding, in part, in her favor despite the position she took on her amended return.

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Mrs. Kestin got off to a good start, from a tax perspective, in 2014.  She timely filed a joint return with her husband reporting her wages of over $155,000 from which she was withheld.  Something happened there after that caused her to lose faith with the tax system.  In September 2015 she submitted an amended return which the Tax Court describes as frivolous and which the IRS identified as frivolous for purpose of imposing the IRC 6702 penalty.  The amended return reported a zero liability accompanied by a narrative that I would describe as tax protestor language, together with a request for a refund of all of the money withheld from her in 2014.

The IRS sent her correspondence pointing out that her amended return could result in the imposition of the IRC 6702 penalty and giving her a chance to avoid the penalty by correcting the frivolous filing.  Unfortunately, she doubled down on her newfound position by sending a letter pointing out the IRS was wrong and attaching a copy of the original amended return.  She did not stop there but sent five more letters to the IRS explaining her position, each one attaching a copy of the amended return.  The IRS imposed a new penalty assessment each time it received one of her missives.

To assist in collecting the sizable liability resulting from the imposition of all of these $5,000 penalties, the IRS filed a notice of federal tax lien and that provided her with the opportunity to request a Collection Due Process (CDP) hearing which she did.  In the CDP hearing she sought, inter alia, to contest the imposition of the penalty on the merits.  Faithful readers know it is hard to raise merits issues regarding assessable penalties because taxpayers have typically had a prior opportunity to go to Appeals before the imposition of the assessable penalty at issue; however, Appeals will not hear frivolous arguments, so she got to raise the merits in her CDP case.

The court imposed the 6702 penalty on the original filing of the amended return and says that Mrs. Kestin agrees with that penalty except for some procedural differences.  The focus then turns to the six times she mailed a copy of the frivolous return to the IRS and it imposed additional penalties.  In a 6702 case, the issue is not what is a return – as the court has discussed many times going back to the Beard case – but what purports to be a return.  When she mailed in the additional six documents she marked them as copies.  The court found that because these documents were marked as copies they did not purport to be returns.  The court points out that the statute does not address whether copies might trigger the penalty and neither do the regulations or prior case law.  On the facts here, it holds that the six copies she sent in her follow up correspondence did not purport to be returns and cannot form the basis for imposition of the penalty.  While the decision is important, and certainly important for Mrs. Kestin, the fact pattern here may be a narrow one although a couple of subsequent opinions discussed below may suggest otherwise.

Having removed all but one of the penalties based on the lack of the filing of documents purporting to be a return, the court then moved to the now inevitable inquiry concerning supervisory approval.  The IRS conceded that the penalty here was not calculated by electronic means and required supervisory approval.  Next, the court turned to Letter 3176C sent by the IRS to Mrs. Kestin warning her that if she did not correct the amended return asserting the frivolous position, the IRS intended to impose the 6702 penalty.  Was this letter the “initial determination” of the penalty that required supervisory approval prior to mailing?  The court finds that the sending of this letter did not mark an initial determination because at the time of sending this letter it remained to be seen whether the penalty would apply.

After acknowledging the strange language of the statute that does not fit the situation, the court found this letter served to warn the taxpayer rather than to determine the penalty liability.  Because it gave the taxpayer the opportunity to avoid the penalty by correcting the submission, the initial determination could not occur until after the proffered period of retraction.  The actions of the IRS did not seek to use the letter as a bargaining chip but rather as an opportunity to avoid imposition.  Kestin is one of several cases decided in the past few months on the issue of initial determination including the severely split decision in Belair Woods, LLC v. Commissioner, 154 T.C. No. 1 (2020) (though Judge Gustafson dissents in Belair Woods after penning Kestin because he perceives a distinction between the situations.)  The decision here appears generally consistent with the other decisions and in some respects foreshadows their outcome.

In the short time since the Kestin opinion the Tax Court has had several additional opportunities to address the issue of frivolous penalties and taxpayer submissions.  In Smith, the taxpayer sent an objectionable original return.  She sent at least one copy of that return with later correspondence (can’t tell yet how many).  Her case was tried (without her showing up) and post-trial briefs were filed. Then, both Graev III and Kestin came down.  In an order from August 30, 2019, Judge Halpern invited additional briefing from the parties by mid-September concerning the application of both opinions.  Only the pro se taxpayer filed a supplemental brief.  The case is awaiting decision, which may be further held up pending the Kestin appeal (see discussion below.)  In Luniw, a bench opinion from Judge Carluzzo served Nov. 20, 2019, the taxpayer was hit with three 6702 penalties.  One was for his original return.  Then the IRS wrote back proposed changes to the return causing the taxpayer to generate essentially the same return and sent it again to the IRS.  Later the taxpayer sent a second copy of the return to the IRS.  Judge Carluzzo applies Kestin and holds that only the last document is not subject to a penalty. Finally, in Jaxtheimer, the taxpayer filed his 2013 return three separate times, reporting zero wages and zero tax owed. Upon each instance, the IRS assessed 6702 penalties. Judge Pugh upheld only the first instance of the penalty assessment, citing Kestin and finding that there was insufficient evidence to determine that the two later-filed returns were not copies.

Mrs. Kestin raised a few other issues which the court brushed away with relatively little fanfare.  The most important of these lesser issues concerns the adequacy of the notice of determination.  She argues that the notice fails because it describes two occasions of frivolous action when the IRS sought to impose seven penalties.  Citing to its earlier opinion in First Rock Baptist Church Child Dev. Ctr. v. Commissioner, 148 T.C. 380, 387 (2017), blogged here, the court holds that if the notice contains enough information to allow the taxpayer to understand the matter at issue and does not mislead it satisfies the statutory requirement.

We blogged about the Kestin case prior to its decision here, here, and here.  This may not be the last time we blog about it.  The IRS filed a notice of appeal in the 4th Circuit on Wednesday, January 8.  I am mildly surprised that it is appealing this case because the circumstances seem pretty narrow; however, the three subsequent opinions citing to Kestin suggest my view of the universe of frivolous cases may just be too limited.  From the perspective of the IRS, the amount of effort to handle a copy of a frivolous document probably closely equals the amount of time it takes to handle a document that purports to be a return.  So, it may want to argue that the decision does not follow the intent of the statute.  It seems like it could get where it wants to go with a regulation, but I do not know what drives this decision.  To my knowledge Mrs. Kestin continues to pursue this matter pro se.  If anyone has a significant interest in the issue and feels the Tax Court got it right, perhaps an amicus brief would be of assistance to her.

Is the One Day Late Interpretation of Bankruptcy Code 523 Finally Headed to the Supreme Court?

After the passage of the 2005 amendments to the bankruptcy code an issue developed concerning the discharge of taxes on late filed returns.  The 2005 amendments resulted from the appointment of a commission in 1994 to look into needed changes to the bankruptcy code after almost two decades of experience with the code.  The commission appointed a subcommission to look into the tax issues impacting bankruptcy matters.  The commission and the subcommission did excellent work fairly quickly and turned their recommendations over to Congress.  Congress struggled to come to closure on the recommendations stemming from this effort.  Finally, in 2005, about eight years after the recommendations came forward, Congress passed comprehensive legislation reforming the bankruptcy code.  One of the big issues on the tax piece of the recommendations concerned the need to address the many taxpayers who filed bankruptcy seeking relief but who had neglected to file their tax returns over numerous years.

Congress addressed the delinquent return filing in numerous code sections including a new and unnumbered code section at the end of BC 523(a) concerning the discharge of taxes for non-compliant taxpayers.  For some reason it chose not to put a number or a letter before this paragraph but simply stuck the new paragraph onto the end of 523(a).  Having made life difficult for everyone seeking to cite to the new material, Congress went further by making this unnumbered and unnamed subparagraph difficult to understand.  I have written numerous blog posts on the interpretation of this section including one last October.  For a sampling of the posts, see here, here, here and here.  In some I predicted that this issue would be resolved in the Supreme Court if Congress did not fix the language of the statute.  Since no one expects Congress to fix anything, this means it’s up to the Supreme Court to resolve the language.  In the recent decision of Massachusetts Department of Revenue v. Shek, — F.3d __ ( D.C. Docket Nos. 5:18-cv-00341-JSM; 6:15-bkc-08569-KSJ) (11th Cir. Jan. 23, 2020) a perfect conflict case has arisen.  The opportunity for a Supreme Court resolution seems quite possible though by no means certain.

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The Massachusetts Department of Revenue (MA DOR) is now the litigant in cases before the First and the Eleventh Circuits with the circuits reaching opposite conclusions.  Five years ago, in the case of Fahey v. Massachusetts Department of Revenue, 779 F.3d. 1 (1st Cir. 2015), the First Circuit interpreted the last paragraph of BC 523(a) to mean that if a taxpayer filed a return late, even one day late, the taxpayer could never discharge the tax liability for that year.  In reaching this conclusion the First Circuit joined two other circuits in holding that the plain language of the statute required this result.

Since the Fahey case, other circuits have demurred when given the opportunity to adopt the one-day rule.  No decision has yet reached the Supreme Court.  The Eleventh Circuit’s decision creates a clear conflict.  It not only specifically considers and directly rejects the decisions of three circuit courts but does so with a plaintiff who was also the litigant in the First Circuit’s decision. 

MA DOR filed a claim in the bankruptcy of Mr. Shek for unpaid taxes for a year in which he did not timely file his state tax return.  MA DOR did not receive full payment of its claim in the bankruptcy case and instituted collection action against Mr. Shek after the lifting of the stay and the granting of the discharge.  Mr. Shek opposed the collection action of MA DOR, arguing that the discharge eliminated the liability and that the actions of MA DOR violated the discharge injunction.  MA DOR countered that he filed his tax return late for the period at issue and BC 523(a) excepted this liability from discharge because of the late filed return.  The litigation started in the bankruptcy court and has now moved on to a circuit court decision.

The Eleventh Circuit looked carefully at the language of the paragraph added in 2005 to determine if it could find a meaning different than the meaning of the three circuits and to find a meaning consistent with the language of BC 523(a)(1)(B).  With the help of an amicus brief from University of Michigan law professor John Pottow, the Eleventh Circuit found a way to interpret the new paragraph in a way that did not result any late filing automatically creating an exception from discharge.

The language added in 2005 sought to provide a definition of the term “return” which was not previously defined in the tax code or the bankruptcy code.  The Eleventh Circuit described the new language as follows:

In 2005, Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”), which for the first time added a definition of “return” to the Code. The definition states:

For purposes of this subsection, the term “return” means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements). Such term includes a return prepared pursuant to section 6020(a) of the Internal Revenue Code of 1986, or similar State or local law, or a written stipulation to a judgment or a final order entered by a nonbankruptcy tribunal, but does not include a return made pursuant to section 6020(b) of the Internal Revenue Code of 1986, or similar State or local law.

11 U.S.C. 523(a)(*).

The Eleventh Circuit described the dispute as follows:

The dispute in this case concerns the first sentence of the hanging paragraph’s definition of “return”, which provides that a “return” for purposes of § 523 means “a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements).” DOR raises two arguments in an attempt to demonstrate that Shek’s putative return, which was filed seven months late, does not qualify as a “return” under § 523(a)(*). First, DOR argues that the return did not satisfy “applicable filing requirements” because it did not comply with Massachusetts’ April 15th tax return deadline. Second, and relatedly, DOR argues that the “applicable nonbankruptcy law” here is Massachusetts law, and that Massachusetts defines a “return” by reference to its timeliness. We address each argument in turn.

In analyzing this argument, the Eleventh Circuit conceded that MA DOR’s argument had some merit:

DOR’s syllogism—a return must comply with “applicable filing requirements,” and a filing deadline is an “applicable filing requirement,” so a return that does not meet its deadline has not complied with “applicable filing requirements”—has some force to it….  We do not, however, agree that the phrase “applicable filing requirements” unambiguously includes filing deadlines….  But it is not obvious that this is the interpretation Congress intended in drafting the hanging paragraph. Notably, this understanding of the word “applicable” would add little to the phrase “applicable filing requirements” that the phrase “filing requirements,” standing alone, would not already encompass. We must strive, if possible, to give meaning to every word of the Code.

The Court then turned to the argument made by Professor Pottow:

He notes that the Supreme Court, in interpreting a different section of the Code, has described “applicable” as meaning something different from “all”; it requires an analysis of context and typically means “appropriate, relevant, suitable or fit.”….  The amicus argues that the “appropriate, relevant, suitable or fit” filing requirements are those concerning what constitutes a return. For example, “applicable” filing requirements could refer to considerations like a return’s form and contents—aspects of the putative return that have a material bearing on whether or not it can reasonably be described as a “return”—but not to more tangential considerations, like whether it was properly stapled in the upper-left corner, or whether it was filed by the required date. This approach makes common sense; in a definition of what constitutes a “return,” it makes sense that the term “applicable” would relate to matters that are relevant to the determination of whether the document at issue can reasonably be deemed a “return.”

The Court describes both the MA DOR and the amicus arguments as plausible interpretations of the language of the statute.  Given that both are plausible, the argument made by the amicus makes the most sense because it provides the most harmony with the other parts of BC 523.  The Court points out that the MA DOR makes BC 523(a)(1)(B)(i) almost a legal nullity and that as a practical matter almost no factual situations exist that prevent this outcome because so few taxpayers agree to the substitute for return by creating a 6020(a) return.  The court had previously analyzed that the only way the MA DOR argument really worked was in situations in which the taxpayer filed a form 6020(a) return.  The court also noted that the IRS did not agree with MA DOR’s interpretation of the statute.  The court concluded:

We think it is deeply implausible that Congress intended § 523(a)(1)(B)(ii) to apply only in such a handful of cases despite no such limitation appearing in that provision itself. It would be a bizarre statute that set forth a broad exclusion for discharge of tax return debts, but limited the application of that exclusion via an opaque and narrow definition of the word “return.” It would be even stranger to enact the broad exclusion in § 523(a)(1)(B)(ii), only to later amend the statute, not by changing the text of § 523(a)(1)(B)(ii) itself, but with a different definitional provision that would cabin § 523(a)(1)(B)(ii) into applying only to the “minute” number of § 6020(a) returns. If Congress had intended this result, it could have achieved it in a much less abstruse manner simply by stating in § 523(a)(1)(B)(ii) itself that that section applied only to § 6020(a) returns.

I agree with the Eleventh’s Circuit’s interpretation of the correct way to read the statute.  After it disposed of the main argument, the Court still had to deal with an argument based on the statutes in Massachusetts.  While acknowledging that this also was a close case, the court rejected the specifics of the Massachusetts statute as a basis for not excepting the liability from discharge.

So, will MA DOR take this case to the Supreme Court and if it will, what will the Supreme Court do?  MA DOR may decide to stick with the bird in the hand.  It has the decision it wants in the First Circuit where the vast majority of persons owing MA DOR reside.  If it files a cert petition, it risks losing the argument and losing a major legal source for keeping open its assessments after a bankruptcy discharge.  Because of this possibility, MA DOR may take a pass on the opportunity to go to the Supreme Court.  The upsides do not outweigh the possible downsides.

On the other hand, many Massachusetts taxpayers live outside of Massachusetts.  Allowing the decision to stand allows these persons to discharge their taxes when persons still living in the state (or at least in the First Circuit) remain liable.  Massachusetts may feel that it is best to have a definitive answer.  If Massachusetts did file a cert petition, it is very possible that the solicitor general would lend a voice to granting cert because of the impact of this issue on the IRS (and potentially other parts of the federal government.)  Those living in circuits in which the issue is already decided will have their own views as well.  People in the Ninth Circuit will not want to roll the dice on the chance that the Supreme Court could reverse their current situation.

Welcome, Baby Galvin!

Perfectly timed for our emphasis on designated orders, Bridget Merrily Galvin arrived on Sunday, January 19th, weighing 6 lbs., 10 oz. We are excited for Bridget’s parents and looking forward to a new blog reader in a few years. Samantha is taking a sabbatical from blogging for the next three months. Exciting news.