Leslie Book

About Leslie Book

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

When is a Case Settled? When a Taxpayer Sends a Check (No) And When a Taxpayer Sends a Letter Reflecting Agreement With US Attorney (Yes)

Disputes with the IRS often involve negotiations and correspondence regarding settlement. Two recent cases involving unrepresented taxpayers demonstrate that at times the taxpayers may not fully understand the consequences of corresponding with the government. In many instances courts will turn to contract principles to examine whether the correspondence can demonstrate that the parties have a binding settlement agreement.

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In Longino v Commissioner a taxpayer sent a check and cover letter to the IRS essentially saying that if IRS cashed the check it agreed with him that he owed no additional money to the IRS. IRS cashed the check but also sought to collect on an assessment that stemmed from a case that the taxpayer lost in Tax Court. In this post I will explain how the taxpayer’s unilateral actions did not constitute a settlement, even when the IRS cashed the check.

In this case, Mr. Longino filed two tax returns for 2006, a 1040 and an amended return on October 17, 2007, a few days after filing the original return. IRS processed the returns separately. The amended return requested a refund of approximately $1,396, which the IRS sent to Mr. Longino, who cashed the check. IRS also examined Mr. Longino’s original 2006 tax return and proposed a deficiency of about $39,000, as well as an accuracy-related penalty.

Years later, in 2013, after Longino had filed a petition challenging the proposed deficiency but prior to the Tax Court rendering a decision, IRS also sent a letter to Mr. Longino informing him that he was not entitled to the $1,396 refund he claimed on the 1040X. Mr. Longino responded with a letter and included a check to the IRS for the $1,396. The letter also asked the IRS to “confirm…that we are now concluded on this tax return issue and we won’t have any more issues with IRS on that year.”  He asked the IRS to return the check to him uncashed if the IRS disagreed with him.

IRS ignored the letter, assessed the tax (it can do so when there is a Tax Court petition filed under Section 6213(b)(4)), and cashed the check. The deficiency case proceeded to trial. Mr. Longino lost. IRS attempted to collect on the unpaid assessed deficiency and filed a notice of federal tax lien. Longino filed a CDP request claiming that his letter and the IRS cashing of the $1396 check meant that he no longer had a liability for 2006. He argued that the cashing of the check in light of his letter demonstrated that the matter was resolved. He raised no other issues in the CDP request. Appeals disagreed and Mr. Longino petitioned the Tax Court again, essentially asking that the collection action was unwarranted because there was no liability.

The Tax Court disagreed, noting that he tried his deficiency case in Tax Court and lost; while there may be settlement of a Tax Court case through offer and acceptance, that was not present here. In addition, notwithstanding his letter to the IRS, and the IRS’s cashing of the check, the Tax Court held that there was no settlement as a result of his unilateral correspondence with the IRS Service Center:

Nor did petitioner reach a settlement with the IRS employee with whom he exchanged correspondence in May 2013. That correspondence occurred after we had issued our opinion in his deficiency case but before we entered our decision. The IRS service center employee with whom he corresponded did not offer to settle any tax liability. The IRS simply sent him a bill for $1,396, and he paid that bill.

The opinion cites a line of cases that establishes that submission of a check to the IRS and IRS cashing of the check is not enough to show that there was assent to the offer to settle the matter.

For good measure, the opinion notes that even if the IRS employee who reviewed the letter and authorized cashing the check were attempting to settle the case on behalf of the IRS, that employee lacked the authority to do so.

Taxpayers in Bauer Do Not Want Correspondence to Be Treated as a Settlement

The Longino case is to be contrasted with the Bauer case  out of the district court in Arizona, also decided last month. In this case the taxpayers owed over $800,000 to the IRS, and the government brought a collection suit. Federal liens attached to the property of the husband and wife; the main property was a principal residence owned by the husband but which the wife had some interest in due to her funding some of the renovations on the house.

The US attorney assigned to the case and the taxpayers themselves spoke directly after the government filed its complaint. They began settlement negotiations and the US attorney sent a letter with a proposed deal essentially requiring the Bauers to get a $250,000 home equity loan and pay that money to the government within 6 months. In exchange the government would withdraw its order of foreclosure and foreclosure claim and subordinate its liens. In addition, the letter set forth the understanding that after the payment of the $250,000 the parties would be free to negotiate the payment of the balance that was owed.

The US attorney asked the Bauers to review the letter, sign the letter and return it to him. By the terms of the letter, the letter stated that it was not an offer or acceptance of an offer; instead, by signing the letter and returning it to the government it would constitute an offer from the taxpayers, which the government would then “consider and act on the settlement offer once it has received [their] signature making the offer.”

The letter also spelled out that the Bauers did not have to agree to return the letter but if they did not do so the government would pursue summary judgment.The Bauers returned the letter and also forwarded a copy of the letter to the US attorney with the subject matter of the email noted as “agreement.”

Unfortunately for the Bauers they had a change of heart and shortly after sought to renege on the deal. In part, it appeared that they were unable to secure a $250,000 loan, and were only able to get a commitment for about half of that.  The Bauers sent an email saying they were not honoring the deal. The US filed a motion seeking to enforce what it claimed was a binding agreement.

The court agreed with the US and issued an order granting the motion to enforce. In doing so, the court reviewed settlement principles and held that the parties had entered into a binding contract.  In response to the motion the Bauers argued that they were coerced into entering into the agreement and the agreement was predicated on the government’s misrepresentations about the loan (namely that the Bauers could secure the financing). As to the US attorney’s views about the viability of the loan, the court stated that under contract principles a recipient of another party’s opinion  “is not justified in relying on the other party’s assertion of opinion because the recipient has as good a basis for forming his own opinion”). Further, the court noted that the Bauers should have independently investigated the possibility of getting financing before signing the letter:

Rather than taking Mr. Stevko’s advice as a guarantee that they would be able to secure adequate financing on the home, Defendants could have used their own knowledge about the market value of their home and looked into that question for themselves. They did not inquire about loans with banks until after making the offer to the United States and did not seek to withdraw from the agreement once they discovered they could not secure more than $126,000 from such a loan.

As to the claim that they were coerced, the opinion notes that the US attorney’s statement that if the Bauers did not enter into the agreement the government would pursue summary judgment did not in itself amount to coercion. Contract principles are clear that a party’s threat of civil process does not amount to duress unless that is done in bad faith. There was nothing to suggest bad faith in this case.

Conclusion

Taxpayers when interacting with the IRS or the government may be uncertain of the impact of what they are doing. Unilateral actions such as a notation on a check and cover letter may be sufficient to designate a payment for some purposes but are not enough to settle a case.  A signed letter reflecting an agreement that the taxpayer and the government attorney negotiated is quite different and the government can seek a court order that will require the taxpayers to abide by the terms of a settled case.

 

 

Session on Tax Implications of Gig Economy At Tax Policy Center

On October 23 there was a conference at the Tax Policy Center on Taxing the Gig Economy. There were two panels, one on the size and scope of the gig economy and the other on tax administration issues.

Here is a link for those who would like to listen to the event. I recommend the entire conference, which runs about 2 hours and 40 minutes. The first part of the panel lays out the data around the size of the gig economy, including a slide deck presented by Michael Udell that lists out trends in self-employment income over the past thirty years. The part that I found most interesting was the discussion of tax administration issues that begins at about 1 hour and nine minutes into the session.

The tax administration panel consisted of Dave Williams, Chief Tax Officer at Intuit, Nina Olson, National Taxpayer Advocate, Caroline Bruckner, a professor at American University who has written extensively on tax issues in the gig economy, and Pooja Kondabolu, who is the Senior Tax Policy Manager at Airbnb. It was moderated by Howard Gleckman, a senior fellow at Brookings.

A few of the highlights of the discussion included Intuit’s Dave Williams perceptively commenting on the lack of knowledge around tax issues among many of the service providers (e.g., Lyft drivers, Airbnb hosts), and how in the current environment many of the service providers simply do not know what they do not know. Professor Bruckner’s prior work Shortchanged lays out in great detail some of the difficulties facing sellers and service providers. Professor Bruckner recently testified in the Senate on some the issues she discussed on the panel (written testimony here). At the panel, she spoke about the possibility of changes to information reporting and dates for estimated payments to help people comply.

The National Taxpayer Advocate spoke about how the IRS could make the system better by facilitating compliance through a better and targeted use of technology for those who enter the tax system after getting an EIN, with things like wizards, email reminders about estimated taxes and the possibility of salient online account portals that could actually be used to help people comply.

What stood out to me in the discussion is how challenging some of the compliance issues are for self-employed taxpayers generally, and how there are many differing ways to improve the outcome. None of the measures alone however can work.

The Storm on the Horizon Over Disclosure of President Trump’s Tax Returns

As someone who while updating the Saltzman and Book treatise can spend hours on a footnote massaging a development relating to some obscure aspect of the mindnumbing complexities of Section 6103, I smirked last night listening to national reporters cite the Code section and discuss whether Democratic control of the House means that President Trump’s federal income tax returns will finally see the light of day.

Before I discuss that (and point readers to some excellent discussions of the issue), it is noteworthy that there has not been a leak of those returns, a testament I think to the professionalism of the IRS and the strong culture of confidentiality that agency employees afford to confidential tax return information. And while we try to steer clear of politics on Procedurally Taxing, I am pretty skeptical about the public’s interest (but not the public interest) in the issue: case in point was the resounding thud that accompanied the outstanding article in the NY Times investigating the Trump family’s efforts to transfer considerable wealth from the President’s father to the President and his siblings while paying as little transfer taxes as possible and using tactics that went well beyond the norms associated with acceptable estate planning.

To the issue of the day. Here is Section 6103(f)(1):

Upon written request from the chairman of the Committee on Ways and Means of the House of Representatives, the chairman of the Committee on Finance of the Senate, or the chairman of the Joint Committee on Taxation, the Secretary shall furnish such committee with any return or return information specified in such request, except that any return or return information which can be associated with, or otherwise identify, directly or indirectly, a particular taxpayer shall be furnished to such committee only when sitting in closed executive session unless such taxpayer otherwise consents in writing to such disclosure.

Under Section 6103(f)(4)(A), any return submitted to one of the tax committees mentioned in (f)(1) may then be released to the full House or the Senate, or both. Professor George Yin has been in front of this issue, and in a 2015 article in the Tax Lawyer he suggests that this effectively allows for public release of the returns, assuming that there is some legitimate legislative purpose associated with the inquiry.

Professor Andy Grewal has addressed some of these issues in two posts on the Notice and Comment blog; his first post in 2017 notes that the President may have a constitutional defense to releasing the returns along the lines that an inquiry for purely political purposes may exceed the legislature’s exercise of its legitimate powers.  In a post last month Professor Grewal raises the President’s possible use of Section 6103(g) in revenge to obtain tax returns from members of Congress (many of whom have not made their tax returns public).

There is very little law associated with these provisions. That is about to change. A number of Democrats in the House have publicly said that if they took control of the House they would press for release of the returns. In today’s partisan times, it is difficult to see someone from the other side of the aisle doing things for anything but partisan interests. As Professor Grewal notes, all of this is a bit unseemly, and to some extent the public confidence in the tax system, which depends in no small part on the belief that the tax system is not political, is likely to be the big loser when all is said and done.

 

District Court Finds that Sanmina Waived Privilege Claims For Memos That Tax Counsel Prepared

Earlier this year in Ninth Circuit Defers on Important Privilege Waiver Case I summarized US v Sanmina Corp, a Ninth Circuit opinion that remanded a case to the district court to consider whether by disclosing the existence of purportedly protected documents the taxpayer waived various privilege claims it asserted with respect to memos that its in house tax counsel prepared. Earlier this month a federal district court in California issued an order holding that the taxpayer waived its privilege claims. The issue is important, especially for corporate taxpayers with layers of advisors touching different parts of a transaction or position taken on a tax return.

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As background, and as I repeat from my January post, the case arose out of Sanmina’s 2009 tax return, when it claimed about a half billion dollars in a worthless stock deduction in one of its subsidiaries. The purportedly worthless sub 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 zilch.

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, its outside counsel. That report (not surprisingly) supported the taxpayer’s view that the receivables had no fair market value. Included in the report was a footnote that referenced internal memos that Sanmina’s tax counsel had prepared, one in 06 and the other in 09.

IRS asked for those two memos; Sanmina resisted, leading to IRS to summons them and bring an enforcement action when Sanmina did not comply. In 2015, the district court held that both memos were protected by attorney client and work product privilege and that the “mere mention” of the memos in the DLA Piper valuation report did not amount to the party’s waiving the privilege.

The Ninth Circuit reversed and remanded the matter back to the district court, and specifically asked that the district court judge examine the documents in camera so it could provide a “more informed analysis” of the waiver claims.

[As  an interesting aside, the case has been festering for almost four years; the magistrate judge who originally wrote the order that the government appealed, Paul Grewal, has moved on to Facebook where he is Deputy General Counsel.]

After some additional back and forth with the Ninth Circuit about the scope of the remand, the district court has now issued its opinion. In brief fashion, the district court agreed with the taxpayer that the documents were subject to both attorney client privilege and work product protection, but it found that the privileges were waived in light of the DLA Piper valuation report for two main reasons:

  • When Sanmina gave the memos to DLA Piper it did so not with the hope of getting legal advice but for the purpose of getting a valuation for the stock of one of its subs; and
  • In any event when it gave the DLA Piper report to IRS it waived privilege for any of the materials that Piper used to reach its valuation, as the report explicitly stated that it based its conclusions (at least in part) on the two memoranda that were at issue.

Sanmina had attempted to minimize the DLA Paper’s report reliance on the memos, pointing to a Ninth Circuit case Tennenbaum v Deloitte and Touche that suggested that disclosing the existence of the memos was not tantamount to disclosing the contents themselves. The opinion’s framing of DLA Piper as relying on the memos (aided by the in camera review the Ninth Circuit suggested) led the court to reject that argument:

[In Tennebaum], our court of appeals held that a promise to waive privilege is not, in itself, a waiver, rather, it is disclosure that triggers waiver. Id. at 341. The court noted that waiver is rooted in notions of “fundamental fairness” and that its principal purpose is “to protect against the unfairness that would result from a privilege holder selectively disclosing privileged communications to an adversary, revealing those that support the cause while claiming shelter of the privilege to avoid disclosing those that are less favorable.” Id. at 340.

Here, Sanmina wishes to do just that. Sanmina relies on DLA Piper’s determination supporting a $503 million stock deduction, but it avoids disclosing the very foundational analysis that informed its conclusion. DLA Piper acknowledged that it based its conclusions on the memoranda in question. Thus, it would be fundamentally unfair for Sanmina to disclose the valuation report while withholding its foundation.

Conclusion

While the taxpayer may appeal this order, it serves as a cautionary tale for taxpayers who rely on both in house tax counsel and outside advisors. Valuation issues often are at the heart of many disputes with the IRS (and other parties) but when a client leans on outside advice for valuation and those advisors disclose their use of documents prepared in house it creates a road map for a waiver argument for the documents that would otherwise be protected from disclosure.

Altera Oral Argument Live Stream Available Now

We have covered the Altera opinion extensively. The oral argument in the Ninth Circuit is being live streamed here

The argument started today at 5PM EDT. On my stream it can be found at about 7 minutes and 52 seconds in.

UPDATE: The above video link is no longer active; a link to a recording of the video is here and the audio alone is here

Professor Kwoka Sues IRS and Explains the Path of FOIA in Two Recent Important Law Review Articles

Kwoka v IRS is a FOIA case from a federal district court in the District of Columbia. The case involves Professor Margaret Kwoka, one of the leading scholars of government secrecy in general and FOIA in particular. In the lawsuit, Professor Kowka is seeking records that categorize FOIA requests IRS received in 2015, including the names and organizational affiliations of third-party requesters and the organizational affiliation of first-party requesters. The IRS provided some of the information she sought, but not all of it.

In this post I will briefly describe Professor Kwoka’s research project and turn to the particular suit that generated last month’s opinion.

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Professor Kwoka teaches at the University of Denver Strum School of Law. Her recent research focuses on FOIA and how it has strayed from its main purpose of allowing third party requesters (like the press and non profits) holding government accountable.  A 2016 article in the Duke Law Journal, FOIA, Inc.  chronicles the growth at some agencies of commercial FOIA requests, that is requests that are primarily motivated by commercial interests of the requesters. A 2018 article in the Yale Law Journal, First-Person FOIA, highlights the rapid growth in FOIA cases from people or their lawyers or other representatives seeking information about their particular case, often to use in other litigation or administrative actions. It is these FOIA cases that are made by so called first person requesters.

The First-Person FOIA article has particular resonance for people interested in tax administration, as practitioners and taxpayers frequently turn to FOIA to learn more about their case as they challenge an IRS determination. The article looks at agencies like the Department of Veterans Affairs and Social Security Administration and Professor Kwoka demonstrates that a “significant amount of first-person FOIA requesting serves as a means for private individuals to arm themselves when they are subject to governmental enforcement actions or seek to make their best case for a government benefit.”

First-Person FOIA makes the case that while FOIA provides a vehicle for people to get needed information about their cases it has significant shortcomings when used for that purpose. The article does not minimize the need for access to information; she suggests solutions for individual access outside of FOIA, including expanding individuals’ online access to information and limited administrative discovery. Yet Kwoka argues that while “these requests represent legitimate efforts by private individuals to obtain information about themselves, they serve largely private, not public interests.” That, as Kwoka notes, has led some observers to question FOIA’s value and perhaps will have the unintended effect of reducing its role as helping the public keep government accountable, a goal that seems as important today as it did in the post-Watergate era when sunshine laws like FOIA took root as one way to keep government accountable.

That takes us to the lawsuit that Professor Kwoka filed to get more information so she could properly catalogue the FOIA requests IRS received in FY 2015. In her study Kwoka sought information about requesters from 22 different agencies; only six gave her the information she needed; three provided the information in publicly available form on their websites. IRS was one of seven agencies that provided some information but due to withholdings or redactions Professor Kwoka could not use it in her study. That is what led to her suing the IRS to get more specific information about the FOIA requesters and their affiliations. In particular in her FOIA request, she sought “[t]he name of the requester for any third-party request (for first-party requests I accept this will be redacted)” and “[t]he organizational affiliation of the requester, if there is one.”

In the suit IRS relied on Exemptions 3 and 6 to withhold the names of the third party requesters and the organizational affiliations of the first and third party requesters. Exemption 3 essentially requires IRS to withhold information that is exempted from disclosure under another statute—the biggie in tax cases is the general restriction on release of taxpayer information in Section 6103. Exemption 6 allows an agency to withhold “personnel and medical files and similar files the disclosure of which would constitute a clearly unwarranted invasion of personal privacy.”

With respect to its Exemption 3 defense, IRS argued that need not reveal the names or organizational affiliations of FOIA requesters because doing so could “reveal protected tax information including, but not limited to[,] the identity of a taxpayer.”   As part of its defense IRS pointed to the online log of FOIA requests that it maintains (see for example its FY 2015 log).  The IRS argued that if Kwoka obtained the names and organizational affiliation of third-party requesters, she could cross-reference that information with the online log and deduce the identities of the taxpayers.

The opinion pushed back on this, noting firstly that the topics the log lists are vague and more importantly  the “IRS’s conclusion does not follow from its premises.”

Even armed with the information she requests and the publicly accessible FOIA log, in most cases Kwoka could not know with any certainty the identity of particular taxpayers. Neither the log nor the information Kwoka requests generally reveals the target of a FOIA request—i.e., the person whose tax records the requester is seeking. Thus, for third-party requests in which a requester submits a request for someone else’s information, knowing the name and organizational affiliation of the requester (from her own FOIA request) in conjunction with the topic of the request (from the publicly accessible log) would not reveal the identity of the target of the request.

The requests for the organizational affiliations of the first-party requesters was a somewhat more nuanced issue, but there too the court sided with Kowka over the IRS argument that exemption 3 allowed a blanket excuse to withhold on all of the requested information:

In most cases, the same is true for first-party requesters who request their own tax return information. Kwoka concedes that the IRS can redact the names of first-party requesters, see FOIA Request; she asks only for their organizational affiliations. But because most organizations have many affiliated individuals, knowing a requester’s organizational affiliation—even in conjunction with the topic of the request—would not ordinarily reveal the identity of the requester (and thus the identity of the taxpayer). There may be a few exceptions where, for example, a particular organization has only one affiliate, or where a topic listed in the publicly accessible FOIA log is so specific (in contrast to the majority of the entries) that it would, in conjunction with the requester’s organizational affiliation, effectively reveal the first-party requester’s identity. See Def.’s Reply at 8 (arguing that “a FOIA request made by the owner of an individually held or closely held company, in concert with the subject of the request, would be enough to reveal the identity of the individual making the request”). Kwoka also concedes that “[w]here an individual requests tax records about the organization that is identical to the individual’s organizational affiliation as recorded in the IRS’s records, … the organizational affiliation would be subject to redaction.”

The opinion moved on to Exemption 6, which employs a balancing test and allows agencies to withhold certain information when disclosing it would result in a “clearly unwarranted invasion of personal privacy.”  IRS argued that it could rely on Exemption 6 for a blanket witthhoding of the requested information For reasons similar to its rejection of Exemption 3, the court disagreed with the IRS:

For many of the same reasons the IRS is not entitled to a blanket invocation of exemption 3, it is not entitled to one under exemption 6. The IRS argues that “third-party FOIA requesters in this case [would] be subject to harassment, stigma, retaliation, or embarrassment if their identities were revealed” and that “[t]he average citizen has ample reason not to want the world to know that someone else has used the FOIA to obtain information regarding his federal tax liabilities, or his tax examination status.” But, as explained above, in most cases, revealing the organizational affiliations of first-party requesters and the names and organizational affiliations of third-party requesters would not reveal the targetof the request. Moreover, FOIA requesters “freely and voluntarily address[] their inquiries to the IRS, without a hint of expectation that the nature and origin of their correspondence w[ill] be kept confidential.” Stauss v. IRS, 516 F. Supp. 1218, 1223 [48 AFTR 2d 81-5617] (D.D.C. 1981)…

Conclusion

The case continues, as the court concluded that the IRS could not rely on Exemptions 3 and 6 to provide a categorical denial of Professor Kwoka’s request though it may in specific instances rely on those exemptions as a basis for redacting or withholding information.

Kudos to Professor Kwoka for her important research and her efforts to uncover more information about the nature of FOIA requests across the government.

OPR Imposes Monetary Penalties For Enrolled Agent Who Misled Potential Clients

I am catching up on developments over the past few months that slipped through the cracks as Stephen, Keith and I gear up for the next update for the Saltzman & Book IRS Practice & Procedure treatise. One item from this summer involves an Office of Professional Responsibility press release describing a settlement that included monetary penalties on a practitioner for misconduct relating to false claims in connection with tax services.

Circular 230 prohibits tax practitioners from using communication that contains false, fraudulent, coercive, misleading or deceptive statements. It also prohibits practitioners from using false or misleading solicitations to procure business. The release discusses how the practitioner misled potential clients in an effort to attract business.

In this case, the practitioner created false advertising designed to mislead potential clients to believe the firm successfully helped thousands of taxpayers and employed multiple attorneys, enrolled agents, CPAs and former IRS employees. In fact, the practitioner is an enrolled agent and the only Circular 230 practitioner at the firm.

The false advertising was also intended to mislead potential clients to believe that hiring a private firm was virtually their only hope of resolving their tax issues due to alleged widespread misconduct by IRS employees. The advertising also falsely inflated the chances of tax relief for clients by inflating the percentage of clients receiving offers in compromise (OIC) and claiming none of these OICs were above a small percentage of outstanding tax.

The settlement agreement with the practitioner included five years of probation and a 12-month suspension of practice before the IRS if the probation is violated. The release notes that the undisclosed amount of the monetary penalty was based on a percentage of the gross income from the misconduct.

OPR plays an important part in ensuring the integrity of tax practitioners. One of the most interesting  articles that I read in the past year or so was former Director of OPR Karen Hawkins’  2017 Griswold lecture published in Volume 70 of the Tax Lawyer (which Keith now edits in his role as Vice Chair-Publications at the ABA Tax Section) where she forcefully discussed the problems facing the Office Of Professional Responsibility and the many holes in the current version of Circular 230. For those interested in tax administration, I recommend a careful read.

One of the points Ms. Hawkins raised in the Griswold lecture was that starting in about 2014 the OPR no longer was releasing ALJ and Appellate Authority disciplinary opinions. As the article explains this change arose due to the 2014 discovery that earlier legal advice erroneously concluded that OPR could release those opinions without violating Section 6103. The article makes the point that this change has contributed to making the OPR less visible.

The press release describing the settlement in this matter included that the sanctioned practitioner allowed for the release of certain information relating to the violation; in the absence of a settlement it appears that the disciplinary opinions are not accessible to the public, an outcome that is far from ideal.

One other point in the settlement is worth emphasizing. The imposition of monetary penalties in OPR proceedings is relatively uncommon; in the 2017 Griswold lecture Ms. Hawkins notes that was invoked only once since 2004 legislation authorizing it.  I am not sure if the 2018 release is indicative of a change in policy that is contributing to OPR imposing monetary sanctions. The OPR ability to impose monetary penalties is somewhat controversial; Ms. Hawkins makes the case that it has an unwanted effect of further intertwining Circular 230 with the Internal Revenue Code civil penalty regime—one of the many problems she identifies in the lecture.

 

IRS Revenue Agent Entitled to Relief from Joint Liability

A recent summary opinion in Tax Court highlights some of the procedural twists that can turn in cases where an ex seeks to challenge a former spouse’s entitlement to relief from joint and several liability.  The case has some added interest because the spouse seeking and getting relief is an IRS revenue agent.

As guest poster Professor Scott Schumacher discussed a few years ago, some times tax cases turn into a “he said she said” dispute. In the tax context, he said/she usually involve cases with disputes over credits or deductions determined with reference to attachment to children and in innocent spouse cases when former spouses disagree about the other’s entitlement to relief from joint and several liability.

Merlo v Comm’r is a recent Tax Court case that involves the latter scenario.  In this case, the ex-husband (Mr. Merlo) is an IRS revenue agent. He prepared the return, and his former spouse (Ms. Nelson) claimed that he had knowledge of $4,629 of disability income she received and they omitted from their 2011 joint return, which was filed on extension in October 2012, when the soon to be divorced Merlos were separated.

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The joint return omitted the disability income that had been reported on a W-2. IRS picked up the omission, and issued a stat notice. Mr. Merlo petitioned Tax Court, asserting Section 6015(c) relief as an affirmative defense to the deficiency based on his lack of knowledge of Ms. Nelson’s receipt of the disability income. IRS granted him relief from the liability. Ms. Nelson joined the Tax Court case as an intervenor, and she argued that Mr. Merlo should not be entitled to relief because he had knowledge of her omitted disability income and that he intentionally left it off the return to cause her problems with the IRS.

This involves Section 6015(c), which generally allows a separated or divorced spouse to elect to limit the liability for any deficiency assessed with respect to a joint return to the portion of the deficiency that is properly allocable to the electing individual under Section 6015(d).

Section 6015(c)(3)(C) denies relief to the electing spouse if it is shown that he or she “had actual knowledge, at the time such individual signed the return, of any item giving rise to a deficiency (or portion thereof) which is not allocable to such individual under subsection (d)”

One of the challenges for the IRS in these cases is that the burden on showing actual knowledge rests with the IRS, and the level of proof the Commissioner needs to establish is a preponderance of the evidence. Here, the Commissioner conceded the issue and agreed that Mr. Merlo did not have actual knowledge of the existence of the disability income.

So how does the court address the issue of burden of proof when the IRS agrees that one of the exes is entitled to relief but the other does not?  The opinion notes that the “[c]ourt has resolved this problem by determining whether actual knowledge has been demonstrated by a preponderance of the evidence as presented by all three parties.”

Typically I suspect that Counsel attorneys let the ex spouses duke it out at trial. That is what seemed to happen in this case, with Ms. Nelson testifying that her ex knew about the omitted disability income and Mr. Merlo claiming that the first time he heard about it was when the IRS sent correspondence after they filed the return.

This required the court to dig into the circumstances of the joint filing. As is not unusual with freshly separated and a soon to be divorced couple the communications between the two were not ideal—the opinion notes that Ms. Nelson moved out of the marital residence in May of 2012 and they “seldom spoke, lived in separate households, and communicated primarily through their divorce counsel.”

The 2011 return was on extension and as the October filing deadline neared Mr. Merlo presented evidence that demonstrated to the court that he did not know about the disability income that was left off the return, including a series of emails and a text message and the existence of separate bank accounts. The messages include an exchange where Ms. Nelson proposed to correct the return after a draft return Mr. Merlo prepared included as a gross amount of Ms. Nelson’s income the disability income and about $1,182 in wages from another source, Ethan Allen:

Early on the morning of October 15, 2012, the due date for filing the 2011 return, Mr. Merlo emailed Ms. Nelson the draft Federal return and draft Michigan return for her to review for accuracy. Ms. Nelson responded by text, informing Mr. Merlo that he had misstated her wages from Ethan Allen on the draft returns as equal to $5,811 rather than $1,182, the correct figure. Mr. Merlo, now believing the draft returns to be incorrect, revised them by reducing Ms. Nelson’s wage income from $5,811 to $1,182, a $4,629 difference. Mr. Merlo thereafter emailed Ms. Nelson a revised draft Form 1040 worksheet for her to review at 7:20 a.m. The worksheet listed the Merlos’ wage income as $108,045, consisting of $106,863 in wages from the Department of the Treasury and $1,182 in wages from Ethan Allen.

The opinion noted that a text message from Ms. Nelson specifically identified the wage income she had received from Ethan Allen and made no mention of any disability income, resulting in Mr. Merlo changing the return to reflect only Ms. Nelson’s $1,182 in wages and not the taxable disability income.

Ms. Nelson also testified that her ex had a copy of the W2 that showed the disability income; that would have meant that he had the knowledge necessary to defeat the relief he was seeking.

The opinion then provides more context as to why the court sided with Mr. Merlo’s version of the facts:

Ms. Nelson testified that when she moved out of the marital residence she left copies of all of her Forms W-2, including those from Ethan Allen and Prudential [Prudential is the source of the disability payments], in a tax file maintained there by Mr. Merlo, retaining the originals for herself. Her testimony is uncorroborated, and it is contradicted by Mr. Merlo’s contemporaneous email of October 12, 2012, in which he stated that he did not have a Form W-2 from her. Moreover, we are not persuaded that Mr. Merlo, an IRS revenue agent, would have prepared worksheets that listed Ms. Nelson’s Ethan Allen wages as $5,811 if he in fact had copies of her Forms W-2 showing that her wage income, while in total equal to $5,811, actually consisted of $1,182 from Ethan Allen and $4,629 from Prudential. Finally, we note that Ms. Nelson, having been provided Mr. Merlo’s worksheet accompanying the draft Federal return that made no mention of the Prudential income, had ample opportunity to alert Mr. Merlo to the omission but failed to do so, even though by her own admission she had the originals of the Forms W-2 that had been issued to her. Her silence tended to confirm Mr. Merlo’s belief that he had merely overstated her Ethan Allen wages in the worksheet and had not omitted income from another source.

Conclusion

Spousal relief and intervenor cases in particular are often tough cases. Context matters greatly. In this case, Mr. Merlo’s work as a revenue agent contributed to the court’s conclusion that it found his version of the facts more likely to be true, as the opinion noted that given his “familiarity with IRS procedures, it is not reasonable to believe he deliberately failed to report Form W-2 income for which he had actual knowledge, as he would have been aware that he was creating the same problems with the IRS for himself as Ms. Nelson speculates he intended to cause for her.”