Leslie Book

About Leslie Book

Professor Book is a Professor of Law at the Villanova University Charles Widger School of Law.

Death of Taxpayer Extinguishes Claims for Wrongful Collection and Failure to Release Lien

The recent case of Pansier v United States addressed whether a taxpayer’s death extinguishes claims for improper collection and failure to release a lien. In deciding that the taxpayer’s death extinguished the claims, a federal district court focused on the text of Section 7432 and 7433 and the analogous statue applicable to damages for improper IRS disclosures of tax return information, as well as the principle that waivers of sovereign immunity are narrowly construed.

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A summary of the facts tees up the issue in the case. In 2017, the US sued in federal court and sought a judgment for Gary Pansier’s unpaid 1995 through 1998 assessed federal tax liabilities and for Joan and Gary Pansiers’ 1999 through 2006 and 2014 assessed federal tax liabilities. The Pansiers then filed for bankruptcy. The Pansiers then filed a separate lawsuit alleging that the statute of limitations on Gary’s 1996-98 liabilities had expired prior to the government’s collection suit. In that suit they sought approximately $28,000 in damages under Section 7432 for the IRS failure to release a federal tax lien and under Section 7433 for the IRS’s alleged unauthorized collection activities, both of which related to Gary’s separate 96-98 liabilities. 

While the Pansiers’ suit under Sections 7432 and 7433 was pending, Gary passed away. Joan filed a motion to substitute claiming that she as the surviving spouse was the sole representative and proper party in the action. The government filed a motion to dismiss, claiming that she was not the proper party, given that the alleged improper collection actions and failure to release the tax lien only pertained to Gary’s sole tax liabilities, even though some of the collection action reached marital property under Wisconsin law. 

The court agreed with the government. In reaching its decision the court looked to both statutes and their reference to the particular taxpayer:

Section 7432 provides that, when an officer or employee of the IRS “knowingly, or by reason of negligence, fails to release a lien . . . on property of the taxpayer, such taxpayer may bring a civil action for damages against the United States.”  (emphasis added). And Section 7433 states that, when an officer or employee of the IRS recklessly or intentionally, or by reason of negligence, “disregards any provision of [ Title 26], or any regulation promulgated under [ Title 26], such taxpayer may bring a civil action for damages against the United States.”  (emphasis added).

A the court notes, there is longstanding law where courts have routinely dismissed Section 7432 and 7433 claims where a party claims that improper IRS collection activities were undertaken to satisfy a spouse’s tax liability. 

The somewhat more difficult issue was whether Gary’s claims survived his death, and would allow the court under the Federal Rules of Civil Procedure to substitute Joan for Gary.  FRCP 25 provides the following: 

If a party dies and the claim is not extinguished, the court may order substitution of the proper party. A motion for substitution may be made by any party or by the decedent’s successor or representative. If the motion is not made within 90 days after service of a statement noting the death, the action by or against the decedent must be dismissed.

Pointing to the narrow language in 7432 and 7433 that allows claims only for “such taxpayer” the government opposed the motion. In deciding against Joan, the court noted that there were no cases it found that directly addressed the issue, but that courts have applied similar language in 7431 and refused to allow a substitution when the claim involved an alleged improper disclosure of tax return information. That statute also restricts suits for improper disclosure and provides:

If any officer or employee of the United States knowingly, or by reason of negligence, inspects or discloses any return or return information with respect to a taxpayer in violation of any provision of Section 6103 such taxpayer may bring a civil action for damages against the United States in a district court of the United States.

There is case law on the survivability of 7431 claims. For example, in US v Garrity,  a district court case from 2016, the government sought to collect a civil penalty from the estate of a taxpayer (as an aside whether a penalty survives death and can be collected is an important issue, one I discussed years ago in Death, Taxes and Civil Penalties: Does the Taxpayer’s Death End IRS’s Ability to Collect Penalties?, which Stephen Olsen and I discuss further in Saltzman & Book ¶7B. That issue has gotten lots of attention in recent years due in part to FBAR and other potentially large penalties). The estate in Garrity counterclaimed and sought damages under 7431 due to alleged improper IRS disclosure of return information. In deciding against the estate, the court stated that “[g]iven the clear text of the statute and the strict construction of waivers of sovereign immunity,” …”the private cause of action in Section 7431 is limited to claims brought by taxpayers whose return information has been disclosed.”

In deciding against allowing a substitution, the district court in Pansier looked to the case law under Section 7431 as well as the longstanding principle that waivers of sovereign immunity are to be narrowly construed against the government.  As such, the court granted the government’s motion to dismiss. While the government may pursue the estate for any tax liability, and even for possible civil penalties, this case shows that the government enjoys special status and is free from any consequences from alleged misconduct in collecting those taxes when the taxpayer was alive.

US v Sanmina: Attorney Client Privilege and Work Product Protections

US v Sanmina involves a long running discovery dispute. At issue is whether a taxpayer’s disclosing two memoranda created by in house tax counsel led to the waiver of various privilege claims. The Ninth Circuit held that Sanmina did not expressly waive work-product protection merely by providing the memos to outside counsel but it impliedly waived the privilege when it subsequently used the counsel report to support a worthless stock deduction that IRS was reviewing in audit. The important opinion highlights waiver in the context of both attorney client privilege and work-product protection. 

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Facts and Procedural Background

I have previously discussed the discovery dispute here and here. On its 2009 tax return, Sanmina had claimed about a half billion in a worthless stock deduction in one of its subsidiaries. The purportedly worthless subsidiary had two related party receivables with an approximate $113 million book value. Notwithstanding the healthy book value, Sanmina claimed that the FMV of the receivables was zero.

IRS examined Sanmina’s tax return and sent an information document request for documents that supported the deduction. Sanmina gave to IRS a valuation report from DLA Piper (DLA Report), its outside counsel. That report (not surprisingly) supported the taxpayer’s view that the receivables had no fair market value.

Included in the DLA Report was a footnote that referenced but did not describe internal memos that Sanmina’s in house tax counsel had prepared, one in 2006 and the other in 2009.

IRS asked for those two in house memos; Sanmina resisted, leading the IRS to summons them and bring an enforcement action when Sanmina did not comply.

In 2015, the district court held that both in house memos were protected by attorney client and work product privilege and that the “mere mention” of the memos in the DLA Report did not amount to the party’s waiving the privilege.

The government appealed, and in 2017 the 9th Circuit remanded the case “for the district court to review the 2006 and 2009 memos in camera to determine whether the documents requested by the government are privileged to any degree” and “retain[ed] jurisdiction over this appeal.” 

After some more procedural wrangling the 9th Circuit modified its remand, leaving the district court to decide (1) whether the memoranda are privileged in the first instance and (2) whether such privilege was waived. 

On remand the district court reviewed the documents in camera and in a more detailed discussion explained that the memoranda are protected by the attorney-client privilege and attorney work-product doctrine but also found that the privileges were “waived when Sanmina disclosed the memoranda to DLA Piper to obtain an opinion on value, then turned over the valuation report to the IRS.” 

Sanmina appealed that finding, and while both parties for purposes of the appeal agreed that the documents were covered by the attorney client privilege and work product protection they disagreed as to whether Sanmina’s disclosing either the in house memos to DLA Piper or the DLA Report to the IRS resulted in a waiver of either the attorney client privilege or work product doctrine.

Ninth Circuit Agrees With Lower Court on Existence of Privilege But Not on Work Product Waiver

With that by way of background, we can address the main takeaways from the most recent opinion. A starting point to the opinion is the 9th Circuit’s reminder that, because the parties agreed that the memos were subject to both attorney client privilege and work product protection, to order disclosure the court had to find that there was waiver of both privileges. 

The Court Finds that There Was a Waiver of the Attorney Client Privilege When Sanmina Gave the Memos to DLA Piper

This is a key part of the opinion. In reaching its conclusion that there was a waiver, the opinion notes that there are several ways to waive the attorney client privilege, including by express and implied waiver. An express waiver occurs when a party voluntarily discloses documents to third parties. 

Even in the absence of an express waiver, a court can find an implied waiver when a party puts the lawyer’s performance at issue during the course of litigation. As the opinion notes, implied waiver rests on a fairness principle, which

is often expressed in terms of preventing a party from using the privilege as both a shield and a sword. . . . In practical terms, this means that parties in litigation may not abuse the privilege by asserting claims the opposing party cannot adequately dispute unless it has access to the privileged materials. 

Closely related to implied waiver is subject matter waiver, where “voluntary disclosure of the content of a privileged attorney communication constitutes waiver of the privilege as to all other such communications on the same subject.” 

The district court had found that Sanmina’s providing the two in-house memos to DLA Piper amounted to an express waiver, based on its finding that Sanmina had sought non legal advice from DLA as to the valuation of the stock rather than legal advice.  

Whether a party engaging tax counsel is seeking legal advice or non legal advice comes up in a variety of contexts. Even assuming one can cleanly draw a line where tax advice crosses to legal advice, an engagement such as the one with DLA Piper often spans multiple purposes, especially when the tax position is intertwined with valuation issues. The 9th Circuit addressed the subtleties of that inquiry, and noted that courts both within and outside the circuit have approached a “dual-purpose” inquiry differently, with some courts looking to see if the primary purpose of the relationship was for legal advice and others having “transported the ‘because of’ test from the work-product context, and looked to “the totality of the circumstances” to determine “the extent to which the communication solicits or provides legal advice or functions to facilitate the solicitation or provision of legal advice.” 

After acknowledging that there was no decided path in the Ninth Circuit to resolve the issue, the opinion was able to sidestep it, essentially concluding that it could find no clear error with the lower court’s finding that Sanmina’s engagement with DLA had a non legal purpose:

Despite some evidence that Sanmina may have had a “dual purpose” for sharing the Attorney Memos to DLA Piper, the district court’s finding that Sanmina’s purpose was to obtain a non-legal valuation analysis from DLA Piper, rather than legal advice, was not clearly erroneous because it was not “illogical, implausible, or without support in the record.” 

Waiver for Attorney Client Privilege Differs From Waiver of Work Product Protection

After deciding that there was an express waiver for attorney-client privilege purposes, the opinion disagrees with the lower court’s approach that had essentially analyzed waiver with respect to attorney-client privilege and work product in the same way. As the opinion notes, because there was no dispute that the in house memos were both attorney-client communications and protected attorney work product, to order disclosure the court had to find that Sanmina waived both privileges. 

That allowed the panel to discuss how express waiver differs in the context of attorney work-product, with the circumstances warranting an express waiver in the work product context more narrow. The key is that unlike in attorney client privilege waiver analysis, in work product cases it is not sufficient to disclose to a third party; that third party must also be an adversary. The Sanmina opinion explored the distinction: 

[T]he overwhelming majority of our sister circuits have espoused or acknowledged the general principle that the voluntary disclosure of work product waives the protection only when such disclosure is made to an adversary or is otherwise inconsistent with the purpose of work-product doctrine—to protect the adversarial process. 

In framing the issue the court looks to United States v. Deloitte LLP, 610 F.3d 129, 140 (D.C. Cir. 2010): 

Addressing whether Deloitte was a “potential adversary” to Dow, the D.C. Circuit framed the relevant question as “not whether Deloitte could be Dow’s adversary in any conceivable future litigation, but whether Deloitte could be Dow’s adversary in the sort of litigation the [work-product documents] address.” Id. at 140. In concluding “that the answer must be no,” the court noted that, in preparing the work product, “Dow anticipated a dispute with the IRS, not a dispute with Deloitte,” and the work product concerned tax implications that “would not likely be relevant in any dispute Dow might have with Deloitte.” Id

While it was easy for the Sanmina opinion to conclude that DLA Piper was not an adversary (after all it engaged DLA to help with its tax reporting), the opinion notes that courts have expanded the inquiry to see if the work product could be considered disclosed because the actions substantially increased the chances that an adversary would obtain the documents.

The opinion helpfully situates this latter inquiry as part of a “conduit” analysis. In other words, a party cannot avoid a finding that there was an express waiver of the attorney work product doctrine if it was reasonable to expect that the third party would not keep the documents confidential and disclosure to the third party increased the odds that an adversary would get access to the documents. Leaning on the DC Circuit, the court frames the conduit inquiry as follows:

As to the “conduit to an adversary” analysis, the D.C. Circuit noted that its prior applications of the “maintenance of secrecy” standard have generally involved “two discrete inquiries in assessing whether disclosure constitutes waiver.” The first inquiry is “whether the disclosing party has engaged in self-interested selective disclosure by revealing its work product to some adversaries but not to others.If so, “[s]uch conduct militates in favor of waiver” based on fairness concerns. The second inquiry is “whether the disclosing party had a reasonable basis for believing that the recipient would keep the disclosed material confidential.” 

The government argued that DLA should be viewed as a conduit because the DLA Report “was intended for disclosure to interested tax authorities” and any “expectation of confidentiality was therefore absent.”  

In the Ninth Circuit’s view the government take on the conduit analysis was lacking because it failed to focus on the underlying in house counsel documents: 

The relevant inquiry, however, is not whether Sanmina expected confidentiality over the DLA Piper Report. It is whether Sanmina “had a reasonable basis for believing that [DLA Piper] would keep the [Attorney Memos] confidential” In the process of producing its valuation analysis. Deloitte, 610 F.3d at 141. That Sanmina shared the Attorney Memos with DLA Piper to obtain a valuation report for the IRS does not necessarily mean that Sanmina knew or should have known that the resulting DLA Piper Report would disclose or make reference to its attorney work product. If anything, Sanmina’s enlistment of DLA Piper’s assistance in anticipation of litigation with the IRS indicates a “common litigation interest” between Sanmina and DLA Piper insofar as the Attorney Memos are concerned. 

What About the Disclosure of the DLA Report to the IRS?

The above discussion focuses on Sanmina’s possible waiver arising from its providing the in house memos to DLA Piper. A separate issue is whether Sanmina’s turning over the DLA Report to the IRS itself constituted a waiver of the work product protection. This issue turns on whether the DLA Report, which identifies and cites to the existence of the memos in a footnote but does not describe their contents, is enough to conclude that there is waiver of work product protection over the identified documents. 

The opinion notes that the position that disclosure requires some elaboration on the content of documents is both intuitive and supported by case law. Yet that was not enough for the court to conclude that there was no waiver. To fully analyze the issue, the opinion draws on the differences between express and implied waivers:

As we have recognized in the attorney-client privilege context, there is a difference between express and implied waivers. This framework is also applicable in the context of work-product protection, where an express waiver generally occurs by disclosure to an adversary, while an implied waiver occurs by disclosure or conduct that is inconsistent with the maintenance of secrecy against an adversary. 

Drilling down deeper into the issue, the court sets out the relevant task for the court: 

Thus, the focal point of our waiver inquiry is whether, under the totality of the circumstances, Sanmina acted in such a way that is inconsistent with the maintenance of secrecy against its adversary in regard to the Attorney Memos. More broadly, we must ask whether and to what extent fairness mandates the disclosure of the Attorney Memos in this case.

The key consideration is the relationship between the party seeking to maintain the confidentiality and the overall adversary process. On this last point the opinion highlights that Sanmina could have chosen to substantiate its worthless stock deductions with documents or evidence that did not reference the attorney memos, but it chose to reveal their existence when it gave the IRS the DLA Report:

Assuming that Sanmina reasonably expected confidentiality over the Attorney Memos when sharing them with DLA Piper, this expectation became far less reasonable once Sanmina decided to disclose to the IRS a valuation report that explicitly cited the memoranda as a basis for its conclusions. In doing so, Sanmina increased the possibility that the IRS, its adversary in this matter, might obtain its protected work product, and thereby engaged in conduct inconsistent with the purposes of the privilege.

After finding that the actions amounted to waiver, the court then refined its analysis even further, noting that the next step is to focus on the scope of the waiver “which must be ‘closely tailored . . . to the needs of the opposing party’ and limited to what is necessary to rectify any unfair advantage gained by Sanmina from its conduct.” 

That led the court to distinguish between differing parts of the in house counsel memos: 

Based on Sanmina’s overall conduct, Sanmina has implicitly waived protection over any factual or non-opinion work product in the Attorney Memos that serve as foundational material for the DLA Piper Report. However, the IRS provides no reason why the scope of this implied waiver should encompass the opinion work product contained in the Attorney Memos. Besides its general argument the Attorney Memos are needed to understand the DLA Piper Report, the IRS does not explain why the “mental impressions, conclusions, opinions or legal theories” of Sanmina’s in-house attorneys are specifically at issue or critical to its assessment of the deduction’s legal validity. Hickman v. Taylor, 329 U.S. 495, 508 (1947). 

As such, the court held that the IRS was not entitled to parts of the in house memos that contained the internal lawyers’ discussion of the legal issue, as that “may potentially undermine the adversary process by allowing the IRS the opportunity to litigate ‘on wits borrowed from the adversary’ in a future legal dispute with Sanmina. Hickman, 329 U.S. at 516 (Jackson, J., concurring). 

Conclusion

The opinion closes by ordering disclosure of the factual portion of the lawyers’ memos, all to be accomplished by a remand that will require the district court to determine which portions of the memos involve factual work product.  Sanmina will still be able to keep from the IRS its lawyers’ mental impressions, opinions, and legal theories.  As Jack Townsend has discussed in a recent blog post, the opinion highlights the difference between factual and opinion work product, and it remains difficult to force disclosure of true legal analysis. The devil, however, is in the details, and the district court will have to carefully distinguish between fact and legal analysis. Perhaps that too will lead to more litigation—all of course as predicate to a possible challenge to the merits of the deduction. 

Court Rules Against Government in CARES Litigation Challenging Statute’s Denial of Payments to Mixed Status Couples

Earlier this year MALDEF filed a lawsuit in federal district court in Maryland on behalf of US citizens who were denied the COVID stimulus benefits under Section 6428 because they filed a joint return with spouses who use an ITIN. In response to a government motion to dismiss the suit, earlier this week in Amador v Mnuchin a federal district court in Maryland ruled against the government and allowed the suit to proceed to the merits.

The case is one of a handful of lawsuits that is challenging CARES’ failure to benefit mixed status couples and one of a number of other legal challenges to the CARES legislation. [Disclosure: I am co-counsel on two such cases, one challenging the IRS’s failure to rapidly and effectively distribute economic impact payments to the eligible children of parents and caretakers who do not file federal income tax returns and the other challenging the  exclusion of U.S. citizen children from the benefits of emergency cash assistance based solely on the fact that one or both of their parents are undocumented immigrants.] 

All of the cases raise interesting tax procedure issues, and many raise important constitutional law issues. In this post, I will discuss the tax procedure issue relating to sovereign immunity that Amador implicates, and save for another day the standing and the constitutional issues.

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The Amador suit targets CARES identification requirements that effectively deny any EIP or later 6428(a) credit to taxpayers who file a joint return and are married to someone with an ITIN rather than a social security number. The complaint alleges that CARES discriminates against mixed-status couples because it treats them differently than other married couples, in violation of the Constitution, including the Fifth Amendment guarantees of equal protection and due process. The government filed a preliminary motion to dismiss the lawsuit on a number of grounds, including that 1) the government had not waived sovereign immunity, 2) the plaintiffs failed to establish standing, and 3) the plaintiffs’ constitutional arguments failed to state valid claims for relief. The district court ordered an abbreviated and accelerated briefing on the government’s motion.

In Amador, of most immediate relevance for tax procedure was the government’s argument that the plaintiffs’ suit should be dismissed because it failed to establish a waiver of sovereign immunity. Absent a waiver, sovereign immunity shields the federal government and its agencies from suit. In a nutshell the government argued that the plaintiffs had to wait until the filing of a 2020 tax return or separate refund claim and the passage of six months or the denial of the refund claim before bringing suit to challenge Congress’ decision to not allow payments under Section 6428 to US citizens who are married to undocumented immigrants. In other words, the placement of Section 6428 in the Code meant, according to the government, that the taxpayers had to exhaust through normal refund procedures after or with the filing of a 2020 tax return to get a court to pass on the merits of the constitutional challenge. 

In response, the plaintiffs argued that they were not seeking a tax refund, and as a result they did not need to go through the typical refund process. Instead, they argued that their suit seeks injunctive and declaratory relief, with the APA serving as the source for the waiver of sovereign immunity.

Where in the APA is the source for a waiver? 5 U.S.C. § 702 provides that  “[a]n action in a court of the United States seeking relief other than money damages and stating a claim that an agency . . . acted or failed to act . . . shall not be dismissed nor relief therein be denied on the ground that it is against the United States or that the United States is an indispensable party.” 

The government in response argued that 5 USC § 704 provides a backstop against using the APA as a source for challenging the CARES provisions because it authorizes review of agency action under the APA only if “there is no other adequate remedy in a court.”  In other words, what 5 USC § 704 provides is that the APA does not generally displace procedures that provide a specific means to challenge a particular agency action. This, along with the Anti-Injunction Act, is why most challenges to tax law, including allegations that IRS/Treasury failed to comply with APA procedural requirements in rulemaking, have traditionally been shoehorned into the normal baskets of deficiency cases or refund cases (though as we have discussed in PT the Supreme Court in CIC will likely be addressing the AIA’s role in insulating IRS practice from pre-enforcement scrutiny). 

This gets us back to the government’s view in Amador that the individuals had an alternate remedy that served to defeat the APA’s separate source of jurisdiction for the suit. The court disagreed with the government and held that the APA did serve as a waiver of sovereign immunity, looking to the nature of the EIP and the absurdity of requiring exhaustion for a benefit that Congress sought to deliver as rapidly as possible:

Forcing plaintiffs to exhaust their administrative remedies would be an “arduous, expensive, and long” process, Hawkes, 136 S. Ct. at 1815-16, that serves none of the goals underlying § 7422. Before plaintiffs could challenge § 6428(g)(1)(B), they would first have file a 2020 tax return, which they cannot do until 2021. Then, plaintiffs would have to wait until the IRS invariably denies their request for a refund in the amount of the CARES Act payment, because they are ineligible per § 6428(g)(1)(B). Once that happens, plaintiffs would have to file an administrative claim with the IRS, asking it to reconsider its position. But, here too, the IRS will reject plaintiffs’ claim, citing § 6428. Thus, administrative exhaustion under § 7422 is guaranteed to be an exercise in futility because there is no possibility that it could provide plaintiffs with relief. See Cohen v. United States, 650 F.3d 717, 732 (D.C. Cir. 2011) (en banc) (concluding that the § 7422 was not an adequate alternative to APA where administrative exhaustion could not remedy plaintiff’s complaint). This Kafkaesque scenario is at odds with the very purpose of the impact payments—to assist Americans grappling with the economic fallout of a public health catastrophe. (emphasis added)

In addition, the court held Congress did not explicitly create a separate path to challenge the payment of EIP, given that Section 7422 presupposes a recovery of tax that had been previously collected or assessed:

Plaintiffs do not seek the recovery of any monies wrongfully “assessed” because they do not allege that the IRS improperly calculated their tax liability. See Hibbs v. Winn, 542 U.S. 88, 100 (2004) (“As used in the Internal Revenue Code (IRC), the term ‘assessment’ involves a ‘recording’ of the amount the taxpayer owes the Government.”). Nor do plaintiffs complain of taxes wrongfully “collected.” Instead, they challenge the discriminatory effect of a refundable tax credit under the First and Fifth Amendments.

In finding that there was no previous assessment or collection, the court suggested that refund procedures for the EIP itself were likely inappropriate in the first instance:

Certainly, the mismatch between the plain language of § 7422 and the nature of plaintiffs’ suit does not support the finding that Congress intended § 7422 to replace the APA. In fact, if anything, it leaves the Court “doubtful,” Bowen, 487 U.S. at 901, that § 7422 can serve as a statutory basis for plaintiffs to challenge § 6428(g)(1)(B). (citation omitted).

Conclusion

Amador now proceeds to the merits, though the opinion notes that due to the accelerated briefing on the preliminary issues the government may re-raise the procedural challenges later, including at the likely next summary judgment stage.

While this is a preliminary decision and not directly addressing the merits, the Amador district court’s discussion of the relationship between Section 6428(g), Section 7422 and the APA is significant. It reflects a growing judicial recognition that the mere placement of a benefit in the tax code does not mean that procedures ill-designed to accommodate the financial reality of Americans and the actual nature of the Code-based emergency benefits should serve to bar a court’s review of good faith constitutional challenges. The issues that the Amador suit raises are serious and the stakes are very high. Traditional paths for challenges to tax statutes should not serve as a bar to effectively shield suspect legislation from judicial review.

Exhaustion Can Be Exhausting

For taxpayers seeking a refund in federal district court or the Court of Federal Claims, it is black letter law that those courts only have jurisdiction if taxpayers timely file a proper refund claim with the IRS. In addition to filing the claim, to get into court taxpayers must either wait six months or file after receiving a claim disallowance. The disallowance (if issued) triggers a back-end limitation of two years to bring the suit.

Trakhter v US, a recent case from federal district court in California, highlights a number of the ways taxpayers may fail to satisfy the refund claim pre-requisites to get in court. 

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The case involved an audit that included a bank deposit analysis that resulted in IRS claiming the taxpayers Lenny Trakhter and Natalya Malakhova underreported over $350,000 in income from their construction company on their 2008 return. While the facts are skimpy in the opinion, IRS issued a notice of deficiency and the taxpayers did not file a Tax Court petition. It resulted in an assessment and ultimately an April 5, 2018 IRS levy of over $160,000.

In April of 2019, the taxpayers filed a request for audit reconsideration. After a few months passed with no word from the IRS, taxpayers’ counsel contacted IRS, which told counsel that it had no record of receiving the reconsideration. The taxpayers’ counsel resubmitted the audit reconsideration in July of 2019.

Still having not heard about the audit reconsideration, in February of 2020, counsel submitted a Form 843, Claim for Refund and Request for Abatement. In April of 2020, still having heard nothing from the IRS on the audit reconsideration or the Form 843, counsel filed a complaint in federal court seeking a refund. The government promptly filed a motion to dismiss for lack of jurisdiction.

The court granted the motion to dismiss. First, it held that the taxpayers failed to wait the required six months before filing suit. In reaching that conclusion, the opinion noted that the complaint was filed less than two months from the filing of the Form 843. The opinion highlights the relevant dates for the six-month rule.  Even if six months had elapsed at the time the court entertains the motion to dismiss, the key time check is at the complaint’s filing. In addition, the opinion notes that the taxpayers failed to file the correct form for the refund claim, which under the regulations is a Form 1040X and not a Form 843 when requesting a refund of individual income taxes.

In addition to filing the wrong form, the opinion noted that the form was not properly signed. The counsel submitted the Form 843 with an accompanying letter and POA. The regulations require that either the taxpayer or counsel sign the request under penalties of perjury. The mere inclusion of a POA with the claim, even if properly executed, “does not fulfill the penalty of perjury requirement” for the claim itself.

The oversights led to the court’s dismissing the lawsuit. I suspect at this point counsel will submit, if it has not already, a properly executed Form 1040X. What about the statute of limitation requirement that the taxpayers submit a refund claim within two years of the tax payment? After all, the levy was in April of 2018.  I suspect at this point the taxpayers would be able to argue that their prior submissions were part of an informal claim for refund, and the now properly completed 1040X would perfect the informal claim, which while not in proper form, was at least submitted before the two-year period elapsed. In the absence of the IRS denying the now perfected refund claim, taxpayers will have to wait six-months after submitting the 1040X and try again. Since the court’s dismissal is without prejudice, the taxpayers should eventually be able to get their day in court, though not nearly as quickly as they likely expected.

Center for Taxpayer Rights Files Amicus Brief in Support of CIC in Supreme Court

Readers are likely familiar with CIC v IRS, which we originally discussed back in 2017 when a federal district court in Tennessee dismissed a suit that a manager of captive insurance companies and its tax advisor had brought that sought to invalidate IRS disclosure obligations on advisors and participants in certain micro captive insurance arrangements. Having made its way through a Sixth Circuit opinion affirming the district court and a colorful and divided denial of a request for an en banc hearing, the Supreme Court granted cert earlier this spring. 

This week the Center for Taxpayer Rights, under the leadership of Nina Olson, filed an amicus brief in support of CIC, with Keith, Carl Smith, and Meagan Horn of Thompson & Knight LLC, on behalf of the Harvard Tax Clinic, and I, all as counsel for the Center.

The issue in the case involves whether the Anti Injunction Act (AIA) shields the IRS’s information gathering requirements issued in IRS Notice 2016-66 from APA scrutiny outside traditional tax enforcement proceedings. The Sixth Circuit reasoned that the presence of a potential penalty for failing to comply with the Notice that would be assessed in the same manner as taxes shielded the IRS from pre-payment APA review. 

The case provides an opportunity to explore the reach of the AIA in light of a number of recent developments, including the 2015 Supreme Court opinion in Direct Marketing Association v Brohl and recent scholarship from Professor Kristin Hickman and Gerald Kerska calling into question whether the AIA should bar pre-enforcement challenges.

Our brief requests that the Supreme Court reverse the decision of the Sixth Circuit because in our view it improperly restricts taxpayers from challenging certain IRS requests for information in situations where the taxpayer is not bringing suit to contest the underlying merits of the tax liability. 

In our brief, consistent with the mission of the Center for Taxpayer Rights, which is dedicated to furthering taxpayers’ awareness of and access to taxpayer rights, we highlight the potential negative effect that the Sixth Circuit’s approach may have for a wide spectrum of taxpayers, including low income taxpayers. To bring that point home we explore past IRS practices requiring information from refundable credit claimants and the possible harm that future information reporting efforts could have on participation and the welfare of low income taxpayers .

As we discuss in the brief, we believe that the Sixth Circuit’s holding is inconsistent with the Court’s holding in Direct Marketing Ass’n v. Brohl:

[Direct Marketing] demonstrates that the AIA’s reach is limited with respect to challenges to requests for information by taxing authorities. The Internal Revenue Service cannot avoid this limitation by threatening taxpayers with a penalty if they do not comply with the rule-making (even if such penalty is “assessed and collected in the same manner as taxes” under the Code). If the Sixth Circuit’s overly broad interpretation stands, low-income taxpayers will be subjected to potentially severe adverse effects. The IRS will hold the unilateral right to shield their rule-making from APA scrutiny by choosing to include the right to impose a potential penalty for noncompliance. The low-income taxpayer will be at the mercy of the IRS in these circumstances with no practical ability to contest the rule-making authority of the IRS without first violating the rule established by the IRS and then paying the full amount of the penalty imposed.

The case is teed up for the fall term, and there will likely be many amicus briefs filed in the coming days.

Update: late yesterday CIC filed its opening brief, emphasizing that challenges to tax reporting requirements that are backstopped by penalties should not implicate the AIA. The brief explores the implications of Direct Marketing, questions whether the presence of an assessable penalty should meaningfully distinguish the case from Direct Marketing, argues that the Sixth Circuit’s holding furthers neither the interest of the APA or the AIA, and considers the practical consequences of an approach that prevents challenges until after a potentially sizable penalty is assessed.

For readers interested in a nuance, I note that CIC’s brief raises an issue that lurks below the main issue, namely whether the AIA is a jurisdictional statute or merely a claim processing rule (see page 23). That issue is teed up because CIC argues that the principle that jurisdictional rules should be clear merits a finding that it should be able to bring the challenge. The brief does not, however, concede on the issue that the AIA is jurisdictional , and in so doing refers to a concurring opinion by now Justice Gorsuch in the 2013 Tenth Circuit Hobby Lobby opinion. I explore the issue of whether the AIA is jurisdictional in the upcoming update to Chapter 1.6 in Saltzman Book IRS Practice and Procedure. The issue of whether the AIA is jurisdictional may be more important if the Supreme Court affirms the Sixth Circuit.

Clients’ Identities and the IRS Summons Power

The recent Fifth Circuit case of Taylor Lohmeyer v U.S. explores the limits of the attorney-client privilege in the context of the IRS using its John Doe summons powers seeking the identity of a law firm’s clients the firm represented with respect to offshore transactions. The case provides a useful opportunity to explore the general rule that the attorney client privilege does not extend to client identity and fee arrangements, as well as a limited exception that would allow the privilege to exist when disclosure of the client identity would effectively disclose the nature of the client communication. 

In this post, I will summarize the circuit court opinion, as well as highlight briefs addressing the law firm’s request for a rehearing en banc.

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Taylor Lohmeyer involves the IRS’s serving a John Doe summons on the law firm seeking the identity of “John Does”, who were U.S. taxpayers

who, at any time during the years ended December 31, 1995[,] through December 31, 2017, used the services of [the Firm] … to acquire, establish, maintain, operate, or control (1) any foreign financial account or other asset; (2) any foreign corporation, company, trust, foundation or other legal entity; or (3) any foreign or domestic financial account or other asset in the name of such foreign entity.

According to a declaration by an IRS revenue agent, the IRS sought the information because it was familiar with a taxpayer who used the firm’s services in an effort to avoid US income tax:

[The prior IRS] investigation “revealed that Taxpayer-1 hired [the Firm] for tax planning, which [the Firm] accomplished by (1) establishing foreign accounts and entities, and (2) executing subsequent transactions relating to said foreign accounts and entities”. Additionally, “[f]rom 1995 to 2009, Taxpayer-1 engaged [the Firm] to form 8 offshore entities in the Isle of Man and in the British Virgin Islands” and “established at least 5 offshore accounts so [Taxpayer-1] could assign income to them and, thus, avoid U.S. income tax on the earnings”. “In June 2017, [however,] Taxpayer-1 and his wife executed a closing agreement with the IRS in which they admitted that Taxpayer-1 … earned unreported income of over $5 million for the 1996 through 2000 tax years, resulting in an unpaid income tax liability of over $2 [m]illion.”

In seeking to quash the summons, the law firm argued that the identity of its clients was protected by the attorney client privilege because the identifying information itself was tantamount to disclosing confidential client communication.

In finding that the exception did not apply and rejecting the law firm’s petition to quash, the Fifth Circuit relied on general precedent that explored the exception in cases that did not involve the IRS, as well as the few cases exploring the exception in the context of IRS investigations. The Fifth Circuit framed the discussion by noting that the few cases that have allowed shielding clients’ identity do so by not expanding the reach of the attorney-client privilege; the cases emphasize that the exception is a subset of the privilege itself. As such a client’s identity is shielded “only where revelation of such information would disclose other privileged communications such as the confidential motive for retention”. Citing In re Grand Jury Subpoena for Attorney Representing Criminal Defendant Reyes-Requena, 913 F.2d 1118, 1124 (5th Cir. 1990), the opinion emphasized that:

the privilege “protect[s] the client’s identity and fee arrangements in such circumstances not because they might be incriminating but because they are connected inextricably with a privileged communication—the confidential purpose for which [the client] sought legal advice”. Reyes-Requena II, 926 F.2d at 1431 (emphasis added).

The firm argued that the IRS’s request for client identities was “connected inextricably” with the purpose for which its clients sought advice. In rejecting that argument, the opinion explored the Third Circuit case of United States v. Liebman, 742 F.2d 807  (3d Cir. 1984). In Liebman, the Third Circuit sought the identity of a law firm’s clients.  The IRS had issued a John Doe summons to the firm seeking the identity all clients who paid fees over a three-year period in connection with the acquisition of certain tax shelters.

The Third Circuit held that the identity of the clients was protected by the attorney client privilege:

If appellants were required to identify their clients as requested, that identity, when combined with the substance of the communication as to deductibility that is already known, would provide all there is to know about a confidential communication between the taxpayer-client and the attorney. Disclosure of the identity of the client would breach the attorney-client privilege to which that communication is entitled

Liebman and Taylor Lohmeyer are facially similar. One key difference though was that the affidavit of the revenue agent in Liebman tipped the IRS’s hand and revealed that the IRS itself linked the identity of the clients with the specific legal advice that the firm itself gave to the clients:

The affidavit of the IRS agent supporting the request for the summons not only identifies the subject matter of the attorney-client communication, but also describes its substance. That is, the affidavit does more than identify the communications as relating to the deductibility of legal fees paid to Liebman & Flaster in connection with the acquisition of a real estate partnership interest, App. at 116a-121a. It goes on to reveal the content of the communication, namely that “taxpayers … were advised by Liebman & Flaster that the fee was deductible for income tax purposes.” App. at 117a. Thus, this case falls within the situation where “so much of the actual communication had already been established, that to disclose the client’s name would disclose the essence of a confidential communication ….” See United States v. Jeffers, 532 F.2d 1101, 1115 (7th Cir. 1976) (and cases cited therein).

The Fifth Circuit in Taylor Lohmeyer highlighted this distinction. Unlike in Liebman, 

the “agent’s declaration did not state the Government knows the substance of the legal advice the Firm provided the Does. …Rather, it outlined evidence providing a “reasonable basis”, as required by 26 U.S.C. §7609(f), “for concluding that the clients of [the Firm] are of interest to the [IRS] because of the [Firm’s] services directed at concealing its clients’ beneficial ownership of offshore assets”. The 2018 declaration also made clear that “the IRS is pursuing an investigation to develop information about other unknown clients of [the Firm] who may have failed to comply with the internal revenue laws by availing themselves of similar services to those that [the Firm] provided to Taxpayer-1”. (Emphasis added.)

Following the adverse circuit court opinion, the Taylor Lohmeyer firm has filed a petition for an en banc rehearing. The American College of Tax Counsel Board of Regents submitted an amicus brief in support of the petition (disclosure: Keith and I are members of the ACTC but did not participate in the amicus filing). 

In submitting its petition, the Taylor Lohmeyer firm emphasized that the panel failed to explore fully circuit precedent, especially United States v. Jones, 517 F.2d 666 (5th Cir. 1975), which it believed supported the privilege applying even in the absence of a declaration that did not definitively tie the request to the firm’s substantive legal advice. The ACTC brief’s main substantive point emphasizes that the summons request should be thought of as covered by the exception flagged in Liebman because the summons is “premised upon the IRS’s purportedly knowing the motive of clients in engaging Taylor Lohmeyer.” (page 11). The ACTC brief states that “[b]ecause the summons at issue requires the Firm to provide documents that connect specific clients with specific advice provided by the Firm, compliance with the summons effectively requires testimony by the Firm regarding that advice.”

In essence both briefs minimize the importance of explicit substantive tax issue that the agent identified in his declaration in support of the summons in Liebman and ask the court to consider the context of the request in Taylor Lohmeyer, which in their view inexorably links the request to the substance of the advice. 

Some Concluding Thoughts

There is more to the briefs, including a detailed discussion of circuit precedent in the petition and the ACTC’s distinguishing of the Seventh Circuit’s United States v. BDO Seidmananother case the Fifth Circuit relied on, and a policy argument alleging that an undisturbed Taylor Lohmeyer opinion will “impose a discernible chill over the attorney-client relationship between taxpayers and tax counsel.” But the key part of the briefs is the point that courts should consider the overall context of the IRS request and not limit the privilege to circumstances when an agent says aloud in a declaration what was driving the request for the client identities.

My colleague Jack Townsend blogged this case when the Fifth Circuit issued its opinion this past spring, and we are discussing it in the next update to the Saltzman and Book treatise (Jack is a contributing author). As he noted in his blog, in Taylor Lohmeyer the IRS request for information “was not connected to ‘identified specific, substantive legal advice the IRS considered improper;’ rather, the request asked for documents of clients for whom the Firm established, maintained, operated or controlled certain foreign accounts, assets or entities, without limitation to any specific advice the Firm rendered, so that it was ‘less than clear . . . as to what motive, or other communication of [legal] advice, can be inferred from that information alone.’

The ACTC suggests that even without the agent’s declaration explicitly referring to the legal advice the law firm purportedly provided the request itself implicates the legal advice in such a way that the identity itself should be protected. This approach, if accepted, would extend the exception in tax cases in a way that other courts have not embraced, at least not in cases that solely focus on the tax consequences of the unknown clients. 

Perkins Case Raises Variance and Issue Preclusion In Context of Taxation of Native Americans

The case of Perkins v United States raises interesting procedural issues, including collateral estoppel (also known as issue preclusion) and variance. Earlier this month a federal district court judge adopted the magistrate judge’s recommendation to deny the government’s motion for summary judgment in a refund suit involving a Native American tribe member who along with her husband ran a trucking and gravel extraction business. 

The magistrate’s recommendation situates the dispute: 

The federal income taxation of American Indians is not a sexy topic.” John Lentz, When Canons Go to War in Indian Country, Guess Who Wins? Barrett v. United States: Tax Canons and Canons of Construction in the Federal Taxation of American Indians, 35 Am. Indian [pg. 2018-5250] L. Rev. 211, 211 (2011). Neither is gravel. Yet the two topics have come together in this case to present a question that no prior case has had to answer directly. When Indians extract gravel from Indian land through an Indian-owned sole proprietorship, is the resulting income exempt from federal income tax based on treaties that promise the “free use and enjoyment” of land or protection from “all taxes”? And even if the Court answers in the affirmative, have plaintiffs Fredrick Perkins (“Fredrick”) and Alice J. Perkins (“Alice”) made enough of a showing of business income and expenses that treaty protection would make a practical difference on their 2010 federal income tax return? 

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The substantive issues relate to the Canandaigua Treaty and the Treaty of 1842. Native Americans, like other citizens, are subject to tax on income unless a treaty provides otherwise.  The Perkins and the IRS have been fighting about whether the treaties exempt income they earned in their gravel business in 2008, 2009 and 2010. The 2008 and 2009 years were the subject of a deficiency case in Tax Court. In 2018 the Tax Court, in a reviewed opinion that generated a dissent by Judge Foley, held that the treaties did not exempt their income from the gravel business from US income tax. The Perkins have appealed that decision to the Second Circuit. 

The 2010 year is the subject of a refund suit in federal court in New York. The magistrate’s recommendation, adopted by the district court judge last month, explicitly disagrees with the Tax Court’s analysis and finds that the treaties do provide an exemption for the income though the taxpayers’ entitlement to a refund awaits a jury trial that would establish the amount of tax exempt gravel income and allocable expenses. 

This creates the somewhat odd situation where two different courts have reached differing views on the same substantive issue with respect to the same taxpayer. 

Rather than dig into the substantive treaty issue in this post I will discuss the procedural issues that last month’s federal district court opinion raises.

Issue Preclusion (Collateral Estoppel)

In federal district court, the government pointed to the Tax Court decision in its favor. In doing so, the government argued that the taxpayers should be prevented from relitigating the same issue, basing its argument on collateral estoppel. That doctrine prevents parties from relitigating an issue that has been previously litigated and subject to a final determination. The district court disagreed, noting that there has yet to be a final decision, given that the Perkins appealed the Tax Court decision and that the decision “does not become final until a petition for certiorari is denied, the time to file such a petition expires, or the Supreme Court issues a mandate.”

In addition, the district court noted that the magistrate’s recommendation preceded the Tax Court opinion, and collateral estoppel prevents litigation in a subsequent case.

Variance

One other procedural issue in the case warrants highlighting.  In objecting to the magistrate’s report, the government raised variance. The variance issue arose because during discovery the government established that the Perkins’ failed to report fully gross receipts from the part of the business that the parties agreed was not covered by the treaties’ exemption.  The Perkins responded by acknowledging the underreporting but also establishing that they underclaimed expenses relating to the taxable portion of the business.

As a refresher, the variance doctrine means that the argument raised in a refund suit must have been made in the claim. As the district court noted, the “variance doctrine does not require exact precision; if the issue raised in court is derived from or is integral to the ground timely raised in the refund claim, it `may be considered as part of the initial ground.” (internal cites omitted).

The refund claim the Perkins submitted focused on the application of the treaties and whether the treaties exempted a portion of their income from the gravel business: 

As enrolled members of the Seneca Nation of Indians (the “Nation”), the taxpayers have been given permission by the Nation to sell gravel from [the] property on the Nation’s territory, in exchange for royalty payments made to the Nation. Under the Supremacy Clause, the [IRS] may not tax income derived directly from the land protected by federal treaties. The taxpayers correctly reported these sales as exempt from federal taxation. The IRS, however, determined the income to be taxable. Taxpayers have paid the taxes and now seek a refund.

In rejecting the government’s variance argument, the district court emphasized that the Perkins’ were not basing their claim to a refund on their entitlement to deduct expenses, and they had properly teed up the treaty issue in their claim:

Cutting through all the back and forth, the crux of the plaintiffs’ claim is that their gravel income was improperly taxed. That issue was fully presented in their refund claim to the IRS. The IRS had a full opportunity to investigate all aspects of their claim for a refund; as the plaintiffs observe, however, the IRS chose not to “examine the 2010 income or business expenses, and did not request or review any receipts, statements, workpapers, or other records.” 

Because the plaintiffs’ theory as to why they are entitled to a refund has not changed, their claim is not barred by the variance doctrine. And the fact that the IRS has now come up with a new reason why the plaintiffs were taxed in the correct amount (or even less than they should have been) does not change that.

While the Perkins’ claim did not identify their entitlement to deduct expenses, the expenses themselves were not the reason why the Perkins’ claimed to have made an overpayment:

Stated another way, the plaintiffs are not now alleging a new reason why they are entitled to a refund; rather, they are responding to the defendant’s argument why they are not. The plaintiffs claimed that they were due a refund for reason A. The defendant responded that even if the plaintiffs were correct about A, they had no claim because of B. The plaintiffs then said that the defendant was wrong about B because of C. That does not mean that the plaintiffs are raising A and C in support of their claim; rather, they are raising A and using C as a response to defense argument B. That is not a variance by any definition.

Conclusion

The longstanding dispute for the 2010 year now moves to trial.  For the 2008 and 2009 years, the Second Circuit heard oral argument earlier this spring. The earlier years involved deficiencies of hundreds of thousands of dollars. The 2010 year involves just under $7,000.  The disparity in amounts at issue likely explains why the Perkins decided to bifurcate the cases, as the Flora full payment rule likely left Tax Court as the only forum for 2008 and 2009.  As a practical matter, the outcome of the live Second Circuit case will control whether the treaties promise of the “free use and enjoyment” of land insulates the Perkins from income tax on the earnings from their gravel extraction business.

Oakbrook Land Holdings v Comm’r: A Follow-Up Post Exploring the Impact of Administrative Law on Validity of Tax Regulations

Oakbrook Land Holdings v Commissioner is the latest salvo in the Tax Court’s effort to apply administrative law to the process and substance of tax regulations. Concerning the validity of Reagan-era tax regulations, the opinion eats up 128 pages and includes concurring and dissenting opinions that squarely reject the majority’s approach to evaluating whether the regulations comport with requirements under the Administrative Procedure Act (APA). 

Guest contributor Monte Jackel discussed the case and its multiple opinions a couple of weeks ago. In this post, like Monte’s excellent post, I focus on whether IRS/Treasury (hereinafter just IRS) failed to do what is required under the APA’s notice and comment process. I am choosing to omit nuance, including 1) the relationship between procedural challenges and substantive challenges to regulations embodied in Step Two of the Chevron analysis, a topic I explore in detail in Chapter 3 in Saltzman and Book, and 2) whether the concurring opinion is correct in its view that the statute alone is enough to put the kibosh on the deduction without getting into the muddy administrative law issues that the case raises.

This post is a follow up to Monte’s post. My goal is to situate the issue within the APA, and in particular its discussion as to what is required when there are challenges to legislative rules.

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At ultimate issue in Oakbrook is whether the taxpayer was entitled to a charitable deduction under Section 170 (the accompanying memorandum decision concludes no).  To set the stage I will summarize the main statutory and regulatory concepts.  I will conclude today’s post by discussing the case’s possible significance for future procedural challenges to regulations and potentially other IRB guidance that may in fact be a legislative rule.

Legal and Factual Background

When donating property other than money, the charitable deduction is equal to the property’s fair market value at the time the donor makes the gift.  When donating noncash property, the Code generally prohibits a charitable contribution deduction when the donor fails to donate the entire interest in the property. 

There is a statutory exception to the requirement that a donor transfer the entire interests for “qualified conservation contributions” like easements over a portion of land involved in this case. One of the statutory requirements for qualified conservation contributions is that the done uses the contributed property exclusively for conservation purposes. In discussing that requirement, the Code provides that a donation will not be treated as made exclusively for conservation purposes unless “unless the conservation purpose is protected in perpetuity” (the “perpetuity rule”).

Now that we have situated the broad statutory scheme let’s focus on how IRS put some flesh on the perpetuity rule. Three years after the statutory rules for conservation easements came about in 1980 in the Tax Treatment Extension Act, IRS proposed regulations. One of the items in the proposed regulations addressed how to satisfy the perpetuity rule with the reality that circumstances may change and prevent a property’s use for conservation purposes. Recall that conservation purpose is not perpetual if the donee organization that holds the easement is unable to carry on the conservation purpose.

To allow satisfaction of the perpetuity rule, the proposed regulations and final regs required that the contract between the donor and donee provide that the proceeds of a sale of be used in a manner consistent with the conservation purposes and that the proceeds split in a way that reflected the proportionate fair market value of the easement relative to the whole property at the time of the donation. The proposed regulations, and the final regulations which essentially adopted the proposed regs’ approach to divvying up sale proceeds after a judicial extinguishment of the easement, did not take into account any investments or improvements that the donor could have made following the contribution, notwithstanding that the donor’s actions might account for post-contribution changes in market value.

After issuing the proposed regulations, IRS received over 90 comments.  As the regulations addressed issues other than the perpetuity rule only one commenter criticized the proposed regs’ failure to address how a donor’s improvements might account for increasing the value of the land. In finalizing the regulation, the preamble stated that IRS considered all of the comments it received but did not specifically address the critical comment that addressed donor improvements. IRS made some minor tweaks to the perpetuity rule regulations (that is the way the regs required a proportionate division in a sale following a judicial extinguishment) and made other changes to other provisions in the final regs, which it discussed in the regulations’ preamble published in a Treasury Decision.

What Does the APA Require For Issuing Tax Regulations?

Before I discuss the opinion, I quote from Saltzman and Book, IRS Practice & Procedure ¶3.02[2][a], Historical Classification of Regulations, where treatise Contributing Author Greg Armstrong and I discuss how the APA intersects with the tax regulation process:

Before embarking on a consideration of the categorization of Treasury Regulations….the only types of rules that are specifically referred to in the APA are interpretative rules, policy statements, and rules of agency organization and practice. Those categories are not defined, but rather are listed as exceptions to the notice and comment procedures (discussed at IRS Practice & Procedure ¶ 3.02[3] The Drafting Process).

In the treatise, we discuss how the APA does not mention the term legislative rules. For many years, the IRS and most in the tax academy (including one of my mentors and the original author of IRS Practice & Procedure, Michael Saltzman) have generally thought of tax regulations that were issued pursuant to the general authority to issue rules under Section 7805 as interpretative (or the more modern interpretive) rules that did not require agency to use the APA’s notice and comment process under 5 USC § 553. (For an even deeper dive into this see Bryan Camp’s Duke Law Journal article A History of Tax Regulation Prior to the Administrative Procedure Act; Leandra Lederman’s 2012 article on fighting regs and judicial deference also has an excellent discussion of the historical classification of regs).

As we discuss in the treatise, the understanding that most tax regs were interpretative was rooted in part on the notion that Congress could not delegate its constitutional duty to make law to the executive. In time, the nondelegation doctrine lost force (though is on the comeback trail), and, as academics like Kristin Hickman have emphasized, the consequences for failing to comply with Treasury regulations include sanctions and have both practical and legal effects. In part due to the persuasive writing of Professor Hickman, the consensus has shifted and the modern view shared by most but not all is that Treasury regulations, whether promulgated under the Code’s general authority or a specific grant within a substantive statute, are legislative rules that require the IRS to comply with the notice and comment requirements in the APA (as I mentioned the term legislative rule has no home in the APA but over time courts and commentators began referring to them as such because of their reputation to carry the force of law).

What are the APA’s notice and comment requirements? As the opinion summarizes, to “issue a legislative regulation consistently with the APA an agency must: (1) publish a notice of proposed rulemaking in the Federal Register; (2) provide “interested persons an opportunity to participate * * * through submission of written data, views, or arguments”; and (3) “[a]fter consideration of the relevant matter presented,* * * incorporate in the rules adopted a concise general statement of their basis and purpose.”

The primary procedural issue in Oakbrook was whether the IRS satisfied the third requirement, which I will refer to as the consideration requirement though it is best thought of as two related requirements, that the agency a consider the comment and show its consideration by explaining the choices it made. 

What are the consequences if a court finds that the IRS failed to satisfy the notice and comment requirements? Under the APA a court is required to invalidate agency action if the agency failed to satisfy them because it would be “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” Whether IRS satisfied the consideration requirement is, as Monte discussed, where the majority, concurring and dissenting opinions parted ways.  All the opinions agreed that the regs at issue were legislative (As an aside, I note and expand in the treatise that the issue of whether an agency rule, including IRS IRB guidance, is legislative involves dense administrative law case law. The majority opinion in this case adds a slightly different gloss on that issue compared to what the Tax Court said in its last major opinion on the issue, SIH Holdings v Comm’r, with the emphasis in this opinion on the regulations imposing a requirement that is “not explicitly set forth in the statute”).

The Majority Opinion’s Approach to Whether the IRS Considered Comments and Explained Itself Adequately

The opinion’s discussion of the consideration requirement notes that while the court itself cannot provide an agency explanation for the agency’s choices it will “uphold a decision of less than ideal clarity if the agency’s path may reasonably be discerned.” (citing Bowman Transp., Inc. v. Ark.-Best Freight Sys., Inc., 419 U.S. 281, 285 (1974)). This sweeps in the Supreme Court’s 1983 State Farm decision: for agency action to satisfy the arbitrary and capricious standard, the agency action “must be the product of ‘reasoned decision-making,’ and the agency must, at the time it takes the action being reviewed, provide a reasoned explanation for why it made the particular decision it did.”

In finding that the IRS’s actions were adequate in this case, the majority notes that the preamble discussed the IRS’s efforts at effectuating Congressional policy choices and that the preamble flagged “that ‘[t]he most difficult problem posed in this regulation was how to provide a workable framework for donors, donees, and the * * * [IRS] to judge the deductibility of open space easements,’ inviting public comments on this and other points.”

Finding the general statement in the preamble that it considered all comments important, the opinion also notes that the preamble discussed the seven groups of comments it received and that it was not required to address all of the comments. The opinion also notes that IRS clearly considered the judicial extinguishment rule, pointing to the changes in the final regs in response to some of the comments IRS received.  

What about the absence of specific discussion of the comment on donor improvements? In the majority’s view, that was insufficient find invalidate the reg. It gets to that conclusion by framing the one comment as essentially insignificant:

Only one of the 90 commenters mentioned donor improvements, and it devoted exactly one paragraph to this subject. That commenter, NYLC, was concerned about facade easements on historic structures, as opposed to “perpetual open space easements,” with which Treasury was chiefly concerned

Moreover, the majority opinion suggests that a comment may be considered significant (and thus likely requiring the agency to address to pass muster) if the comment offers proposed remedies and in this case the commenter “offered no suggestion about how the subject of donor improvements might be handled; it simply recommended “deletion of the entire extinguishment provision.”

In finding that the IRS also complied with its requirement to provide a concise general statement of the regulation’s basis and purpose, the opinion notes that the failure to discuss its rationale in not changing the final regs to reflect value issues stemming from donor improvements was not grounds for invalidating the reg: 

[That] provision represented one subparagraph of a regulation project consisting of 10 paragraphs, 23 subparagraphs, 30 subdivisions, and 21 examples. No court has ever construed the APA to mandate that an agency explain the basis and purpose of each individual component of a regulation separately.

Adding some support for its conclusion, the majority notes that context matters, looking to things like the subject matter of the regs and the nature of the comments received: 

The broad statements of purpose contained in the preambles to the final and proposed regulations, coupled with obvious inferences drawn from the regulations themselves, are more than adequate to enable us to perform judicial review. We find that Treasury’s rationale for the judicial extinguishment rule “can reasonably be discerned and * * * coincides with the agency’s authority and obligations under the relevant statute.”

Future Implications

As Monte suggests in his post, the majority opinion provides guidance for those submitting comments on regs, as the “case seems to indicate that a comment letter should state that the issue is material, fully discuss the issue, and propose a practical alternative if one is available.”

What about future courts confronting procedural challenges? Monte’s post does an excellent job of highlighting how the concurring and dissenting opinions approach the issue of a regulation’s procedural validity under the APA. As the concurring and dissenting opinions emphasize, the 2012 Federal Circuit case Dominion Resources is an example of a court invalidating a tax regulation on procedural grounds. Future litigants unhappy with way that regulations apply to their positions will be taking aim at the process and looking at this opinion to help frame their arguments.

One thing that is clear is that cases applying the APA to agency issuance of legislative rules is that an agency need not respond to all comments it receives. The key is whether the comment is significant, a term that is hard to pin down, though the dissenting opinion attempts to provide guidance. Building on the majority opinion’s discussion that a comment is more likely to require agency response if it offers an alternative, the dissent refines that by requiring the comment “identify a specific and objective issue created by the language of the proposed rule and give some explanation for why that language is troublesome.” Framed as the what and why test , i.e., “(1) what is the problem; and (2) why is it a problem?” the dissent notes that agencies are not required to speculate or offer hypotheticals on their own.

It remains to be seen how other courts will address challenges to regulations that predate the more modern Treasury practice of throwing the kitchen sink in preambles, though the SIH Holdings case (also involving decades old regs, though in that case there were no comments as an excellent Tax Prof post from Bryan Camp discussed) suggests that courts are hesitant to apply today’s more exacting standards to regulations that were issued decades earlier. As the majority opinion highlights at times the Tax Court has upheld regulations even in the absence of a stated purpose if the basis and purpose were obvious.

The concurring opinion in Oakbrook emphasized the inadequacy of the preamble to the final reg (e.g., only two pages in the face of hundreds of pages of comments, and hours of public comments at a hearing) and Home Box Office, an important DC Circuit case from the late 1970s, that discussed the benefit to agency rulemaking when there is a dialogue between an agency and commenters making significant points in the rulemaking process. The concurring opinion also rightly notes when promulgating the reg in this case the IRS likely “was simply following its historical position that the APA’s procedural requirements did not apply to these types of regulations.”

In concluding that the reg failed to satisfy the APA’s procedural requirements, the concurring opinion ends by citing language from a Supreme Court case noting that the reasoned explanation requirement is “not a high bar but an unwavering one.” (citing Judulang v Holder).

Oakbrook suggests that the bar may be lower for longstanding tax regulations, and highlights the way that these challenges arise in deficiency cases rather than at a time closer to the rule’s promulgation. Of course that makes no sense, but that takes us to other issues and how perhaps it is time to allow a more orderly challenge to IRS guidance outside the traditional tax controversy process.