First Circuit Finds Anti-Injunction Act Does Not Bar Challenge to IRS’s Use of John Doe Summons That Gathered Taxpayer’s Virtual Currency Transactions

In a major decision that considers the implications of last year’s CIC Services opinion the First Circuit in Harper v Rettig has held that the Anti-Injunction Act (AIA)  does not bar a constitutional challenge to IRS’s use of its John Doe Summons authority that allowed it to obtain information about a taxpayer’s virtual currency transactions.

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IRS has been actively using its John Doe summons powers to get taxpayer information from virtual currency exchanges. One of those cases involved a summons on Coinbase as part of an investigation into the reporting gap between the number of virtual currency users Coinbase claimed to have and the number of U.S. bitcoin users reporting gains or losses to the IRS during 2013 through 2015.

After Coinbase refused to comply, the government moved to enforce the summons. Following a skirmish about the scope of that summons, and a district court’s decision to allow a third party to intervene under Federal Rule of Civil Procedure 24, the court issued an order enforcing the summons. I discussed some of the procedural skirmishes a few years back in A PT Anniversary and Court Finds IRS Summons on Coinbase Suggests an Abuse of Process.

Fast forward a few years. IRS has been using the information it received to contact taxpayers it believes have failed to properly report their income from the virtual currency transactions.  One of those taxpayers was James Harper. IRS sent Harper a letter that informed him of the requirements for reporting virtual currency transactions. It helpfully told him if he believed he had not accurately reported such transactions, he should file amended or delinquent returns. The letter also warned that if he had not “accurately report[ed his] virtual currency transactions,” then he “may be subject to future civil and criminal enforcement activity.”

Shortly after receiving the letter Harper filed suit in a federal district court in New Hampshire. One aspect of the suit involved a request for injunctive and declaratory relief, alleging that the IRS unlawfully obtained his financial information from virtual currency exchanges in violation of the Fourth and Fifth Amendments.

The District Court held that the AIA deprived the court of subject matter jurisdiction over the taxpayer’s claims for injunctive and declaratory relief. 

Harper appealed and claimed that the AIA did not bar his suit because his suit pertained to the information gathering function of IRS activity, rather than the assessment or collection process.

The government and district court distinguished CIC Services, noting that in that case the plaintiff sought to avoid the economic burdens of providing information about other taxpayers to the IRS and challenged its legal obligation to do so. According the government, and unlike in CIC Services, Harper “simply does not want the IRS to possess information bearing on his tax liability.”

Back when the Supreme Court issued its opinion in CIC Services PT had many posts that discussed the uncertain boundaries of that opinion, and whether courts may apply it more broadly than the circumstances of that challenge. See for example Bryan Camp in Supreme Court Reverses the Sixth Circuit in CIC Services – Viewpoint and my post Further Initial Thoughts on CIC Services.

In a relatively brief opinion, the First Circuit reversed, finding that CIC Services and the earlier Direct Marketing opinion opened the door to Mr. Harper’s challenge because the summons authority and IRS activities to enforce the summons “clearly fall with in the category of information gathering, which the Supreme Court has distinguished from acts of assessment and collection.” As such, the court held that Harper’s suit “challenges the IRS’s information-gathering authority and the Anti-Injunction Act limits our jurisdiction only in suits involving assessment and collection.”

The government sought to distinguish CIC Services and argued that the purpose of Harper’s suit was to restrain IRS assessment and collection power. According to the government

the substance of the suit’ is directed at the alleged harm of having the IRS retain and use information about [appellant]’s virtual currency transactions for use in determining [his] compliance with his income tax obligations,” and “[t]he ‘relief requested’ is the expungement of information that would allow the IRS to do so.” (Emphasis added.) See CIC Servs., 141 S. Ct. at 1589 (“In considering a ‘suit[‘s] purpose,’ [courts] inquire not into a taxpayer’s subjective motive, but into the action’s objective aim — essentially, the relief the suit requests.”)

The First Circuit disagreed:

As the Court observed in CIC Services, however, “[t]he Anti-Injunction Act kicks in when the target of a requested injunction is a tax obligation — or stated in the Act’s language, when that injunction runs against the ‘collection or assessment of [a] tax.'” Id. at 1590. Here, the target of the requested injunction is the IRS’s continued retention of appellant’s personal financial information, which appellant alleges the IRS acquired in violation of the Constitution and 26 U.S.C. §7609(f)

Drilling even deeper into the nature and purpose of the AIA vis a vis the relief Harper sought, the court viewed his suit as not attempting to limit IRS’s ability to redetermine his tax:

Contrary to the IRS’s suggestion that appellant’s suit is “a ‘preemptive’ suit to foreclose tax liability” (which would be barred by the Anti-Injunction Act), this suit, like the suit at issue in CIC Services, “falls outside the Anti-Injunction Act because the injunction it requests does not run against a tax at all.”  Rather, “[t]he suit contests, and seeks relief from, a separate legal” wrong — the allegedly unlawful acquisition and retention of appellant’s financial records. Like the plaintiff in CIC Services, appellant “stands nowhere near the cusp of tax liability,”  and “the dispute is [not] about a tax rule,” where “the sole recourse” in light of the Anti-Injunction Act “is to pay the tax and seek a refund,.” 

Conclusion

This case is remanded back to the district court to consider whether Harper has stated a claim on which relief can be granted. That is an uphill battle. The IRS appears to have lawfully obtained the information through the summons process, but this interim victory is important as it reflects at least one circuit’s view that courts are to liberally apply CIC Services and not limit it to situations when third parties are challenging IRS’s information reporting obligations.

DC Circuit Blesses IRS’ Glomar Defense In Long Running FOIA Dispute

Back in 2018, in District Court Allows IRS to Use Glomar Defense In FOIA Suit Seeking Whistleblower Info I discussed one of the many installments of the litigation between Thomas and Beth Montgomery and the IRS.  The case involved the Mr and Mrs Montgomery’s desire to see documents that shed light on how IRS had gotten wind of their partnerships that threw off mostly phony losses.

Late last month, the DC Circuit Court of Appeals affirmed the district court.

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The Montgomery family’s partnership transactions attracted the attention of the IRS, leading to a Fifth Circuit opinion finding that most of the partnerships were shams but that one had a legitimate business purpose.  The finding that one partnership was legitimate led the Montgomerys to initiate separate refund suits that the IRS ultimately settled, leading to an almost $500,000 refund.  

The Montgomerys filed a FOIA claim because they wanted to unearth how the IRS came to scrutinize the transactions, with a particular interest in finding out if there was an informant.

In asserting a Glomar defense to the Montgomery request for documents pertaining to whistleblower forms, the IRS refused to either confirm or deny the existence of the records requested.

As I discussed in my original post, the Glomar defense originates from the Cold War and the CIA wanting to keep secret its efforts to uncover a sunken Soviet submarine:

In certain circumstances, […] an agency may refuse to confirm or deny that it has relevant records. This “Glomar response” derives from a ship, the Hughes Glomar Explorer, about which the CIA refused to confirm or deny the existence of records. See Phillippi v. CIA, 546 F.2d 1009, 1011 (D.C. Cir. 1976). Such responses are appropriate only when “`confirming or denying the existence of records would’ itself reveal protected information.” Bartko v. DOJ, 62 F. Supp. 3d 134, 141 (D.D.C. 2014) (quoting Nation Magazine v. U.S. Customs Serv., 71 F.3d 885, 893 (D.C. Cir. 1995)).

When the government raises a Glomar defense, it still needs to tether the defense to one of the nine statutory FOIA exemptions. In Montgomery, the IRS asserted Exemption 7(D).

Exemption 7(D) excludes from disclosure “records or information compiled for law enforcement purposes, but only to the extent that the production of such law enforcement records or information could reasonably be expected to disclose the identity of a confidential source … [who] furnished information on a confidential basis.” 5 U.S.C § 552(b)(7)(D).

As the DC Circuit described, the district court was “persuaded by the IRS’s explanation that it asserted a Glomar Response because a confirmation of the existence or absence of whistleblower documents in a particular case may lead a savvy requester to the very whistleblower himself. “

In sustaining the district court, it rejected a variety of estoppel type arguments that were premised on prior government admissions that no informant existed. That admission was not sufficient to estop the government from asserting a Glomar defense because it was not quite precisely what was at stake in the FOIA litigation:

The issue of the existence of a confidential informant…is not the same as the issue confronting us now; namely, whether the IRS possesses any documents pertaining to a confidential informant… Indeed, the documents requested by the Montgomerys…include such items as award applications and reportable transaction forms.. As the IRS and the district court correctly point out, the IRS does not pay awards for every form submitted to it.

The key point that the DC Circuit made was that “documents pertaining to a potential whistleblower can exist regardless of whether a whistleblower himself exists” any prior admission about the absence of an informant should not serve as a basis to assert collateral or judicial estoppel or otherwise serve to waive its right to assert a Glomar defense.

As to the merits of the underlying Glomar claim, the Montgomerys argued that the 7(D) exemption was not properly at play, claiming that the exemption only runs to the identity of the whistleblower and any information that the whistleblower provided, rather than their mere existence.

The DC Circuit squarely rejected that argument:

We disagree. Exemption 7(D) permits the IRS to withhold information that “could reasonably be expected to disclose the identity of a confidential source.”

Noting that the whistleblower regs require the IRS to use its best efforts to protect a whistleblower’s identity, the IRS’s policy to neither confirm nor deny the existence “makes sense”:

If the IRS only asserts Glomar when whistleblower records exist, and gives a negative answer when no records exist, savvy requesters would both (1) recognize that a Glomar Response indicates the positive existence of whistleblower documents; and (2) may well be able to deduce the identity of a potential whistleblower himself, the very information the IRS is required to protect. This is especially true when the pool of potential whistleblowers is very small, leading a revenge-seeking requester to narrow down the informant with relative ease. Far from violating FOIA’s statutory scheme, the IRS’s Glomar Response to FOIA requests for whistleblower documents aligns with the purpose of Exemption 7(D) and the duties of the IRS to protect whistleblower identities.

Conclusion

For those with a keen interest in FOIA , I recommend reading the opinion, which includes a discussion of when it is appropriate for the government to overcome the presumption of confidentiality for informants, the nature of district court in camera review, and the adequacy of the IRS’ search for other records that the Montgomerys wanted.  To that end and for an even deeper dive, in Saltzman and Book Chapter 2, Taxpayer Access to Information, we have an extensive FOIA discussion, covering materials that are not subject to IRS disclosure as well as myriad FOIA procedural issues.

As I discussed when blogging the 2018 opinion, this case is a significant victory for the IRS and paves the way for future Glomar responses in FOIA cases where someone is seeking information to determine if there was an informant that led to an IRS investigation.

Latest Round in PTIN Litigation With District Court Finding For Government In Steele v US

Longtime readers may recall a series of blog posts discussing the class action litigation challenging the IRS’s statutory authority to charge a fee for PTIN issuance and renewal. After an initial plaintiff victory in district court, the DC Circuit Court of Appeals held that the IRS was within its authority to charge the PTIN fees but remanded the case to determine whether the amount charged was excessive. For more on the DC Circuit opinion, as well as prior rounds in the skirmish, see In Major Victory for IRS DC Circuit Upholds IRS Annual Filing Program.

Late last month in the latest round in Steele v US the district court issued an order on discovery issues. The order includes some strong language about both parties, but the order reflects a decisive government win though the case awaits a resolution on the merits.

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The latest issue concerns the plaintiffs’ motion to compel discovery about the creation and implementation of the original PTIN program. The government alleged that some of the requested information was protected by the deliberative process privilege. In addition, the court considered the sufficiency of government’s responses to interrogatories.

As to deliberative process, as the opinion describes, that privilege protects from discovery “advisory opinions, recommendations and deliberations comprising part of a process by which governmental decisions and policies are formulated.” To benefit from it, the party asserting the privilege must demonstrate that the information is predecisional and deliberative.

The opinion nicely summarizes DC Circuit law on the substance and means for the government to assert deliberative process. It requires proof that the requested document was part of assisting an agency decisionmaker in making the decision, rather than supporting a decision that was already made.

In addition, case law provides the following three elements to benefit from the privilege:

  • A formal claim of privilege by the head of the department possessing control over the requested information,
  • An assertion of the privilege based on actual personal consideration by that official, and
  • Details regarding the information for which the privilege is claimed, along with an explanation why it properly falls within the scope of the privilege.

The major issue that the plaintiffs raised with respect to the government’s assertion of deliberative process was that the government failed to assert the privilege with sufficient detail, instead relying on “boilerplate descriptions” of the withheld documents. The remedy that the plaintiffs sought was discovery of every document withheld solely under the deliberative process privilege.

In strong language, the court disagreed. Calling the proposed remedy “incredible” the court criticized the motion for failing to evaluate the documents and asserted privilege on their own terms:

Plaintiffs’ compact motion shuns individual analysis of the documents in question, instead taking a blanket approach where one bad privilege log entry spoils the bunch.

The order also held that it was  “insincere of plaintiffs to argue that the government has failed to meet its burden in asserting the privilege for every privilege log entry” given that the given the declaration by the IRS’s Deputy Associate Chief Counsel that provided “details why twenty-six of the log entries were withheld.”

The order also included snippets of the government’s privilege log, which in its view also provided sufficient description beyond boilerplate. Some of the included details identified the contractor working with the IRS in setting up the PTIN program, the date, the topic, and who in the government was the intended recipient.  While some of the government’s language was repetitive, the order found that the government met its burden in establishing the elements for the privilege.

While there may have been a question as to whether the government was entitled to rely on deliberative process with specific documents the plaintiffs’ failure to drill down individually was fatal:

Because plaintiffs did not produce “a set of objections that identifies each log entry” that they challenge and because this Court cannot agree that each log entry is insufficient—especially given Goldman’s accompanying declaration—plaintiffs are essentially asking this Court to engage in an entry-by-entry analysis of the privilege log to evaluate whether the government has fulfilled its burden.

The second category of information in this discovery dispute related to interrogatories about the amount of time that IRS employees spent on PTIN-related tasks.  The government argued that the requests were irrelevant and in any event asked for information that the government did not in fact have. As to relevance, information about time spent could be helpful in establishing that the original fees in the PTIN program were excessive, and the court found that the low relevance bar was easily met. 

Unfortunately for the plaintiffs, however, the government prevailed on this challenge. As the order described, the plaintiffs were not really looking for an order forcing a response, but were in fact looking for an order requiring a “different response.”

The government has already provided plaintiffs with numerous declarations from various employees regarding staffing and PTIN work, including some time allocation breakdowns.  However, not all employees kept contemporaneous time records. The government contends that if the information sought by plaintiffs is not included in those materials already provided, it does not exist. 

The court chided the government, stating it “should have stated the nonexistence of this information more clearly in their actual interrogatory answers, instead of in their response to plaintiffs’ letter alleging deficiencies.” Despite that deficiency, the court declined to compel any additional responses, and agreed that “forcing employees and former employees to produce a detailed record of time spent on PTIN tasks over the last ten years based on memory alone is absurd.”

Conclusion

With this round over for now, the case slowly marches towards a resolution, though perhaps other more targeted discovery challenges await. In the meantime, a couple of years ago IRS reworked the PTIN user fees (see IRS Announces New PTIN User Fee in Proposed Regulations), with the fee now at $35.95 for initial applications and renewals. 

No Reasonable Cause For Failing To Include $238,000 From Information Return Sent To Old Address

Back in 2013, I wrote about Andersen v Comm’r, a summary opinion where a taxpayer failed to include $28,000 of W-2 income but was not subject to a 20% civil penalty for substantially understating income. In Andersen, the Tax Court held that there was reasonable cause for the omission and the taxpayer acted in good faith.

These types of cases are notoriously fact intensive. Whether the taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis. Courts, based on the regulations, examine the pertinent facts and circumstances, including the taxpayer’s knowledge, education, and experience, as well as the taxpayer’s reliance on professional advice.

In Andersen, the taxpayers were sympathetic, with a long history of tax compliance, a consistent recordkeeping practice, and a longtime competent tax preparer. The preparer testified about why he reasonably believed that his clients had retired and would not have had wage income. In finding that the taxpayers had established reasonable cause and good faith, the Tax Court acknowledged that it was an “exceptionally close case” but held that no penalties applied.

Contrast Andersen with last week’s LaRochelle v. Commissioner, another summary opinion involving a failure to include income reported on an information return.

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The facts in LaRochelle were not nearly as sympathetic as Andersen. The amount at issue was $238,000 from an IRA distribution in 2017. In 2016, the taxpayers had moved from DC to Florida but still owned a DC residence. They set up US Postal Service mail forwarding. They recalled receiving the $238,000 IRA distribution but not the 1099-R, which had been sent to their DC address.

The husband was sophisticated; he was “professionally engaged in more than ten business partnerships”, including one where he was in charge of day to day operations, including recordkeeping.  The taxpayers used a tax return preparer ( I assume a lawyer, though not clear from the opinion), who also represented the taxpayers in Tax Court (uh oh, see below).

The opinion itself is fairly straightforward. After discussing why the substantial understatement penalty is “determined by an IRS computer program without human review” and “automatically calculated through electronic means” it held that under Tax Court precedent it is exempt from the Section 6751 written supervisory approval requirement (for a different view on that, see Caleb’s discussion in Walquist Harms The Poor: Revisiting Supervisory Approval For Accuracy Penalties.)

The summary opinion also concludes that the taxpayers had not established that they were entitled to a reasonable cause good/faith defense. Failure to receive an information return is not enough to insulate a taxpayer from a penalty, especially when, as here, the taxpayer admits to recalling having received the money, especially a lot of money.

The taxpayers also argued that their use of a preparer justified excusing the penalty. The use of a preparer alone is not enough to establish that the taxpayers’ reliance amounted to good faith/reasonable cause:

Mr. LaRochelle did not explain what was meant by petitioners’ relying upon Mr. Lander to handle their tax return

Moreover, as the opinion notes, a failure to provide necessary information is fatal to a good faith/reasonable cause defense predicated on reliance on a competent tax return professional.

Concluding Thoughts

Tax Court Rule 24(g)(2)(A) generally provides that “[c]ounsel may not represent a party at trial if the counsel is likely to be a necessary witness within the meaning of the ABA Model Rules of Professional Conduct.” The opinion notes that Judge Leyden apprised the parties of the rule, and that the taxpayers stated that their preparer was not likely to be a necessary witness.  While it would not have mattered in this case had the preparer testified, it is almost always a bad idea, and a conflict of interest, to have the taxpayers’ return preparer represent the taxpayer at trial.

For taxpayers with numerous information returns, it would be prudent to set up an online account with IRS. On extension, the preparer and taxpayer can easily access all of the information returns, even those that a taxpayer may not have physically received.

Of course, all of this nonsense could be avoided if the IRS provided taxpayers with a government sourced online filing platform that could access information that the IRS has received from third parties. That day may be coming, as I discussed this past May in Momentum Possibly Building for IRS To Provide Online Filing Options For Taxpayers, but for now we have a back end process where a taxpayer who omits an item has to go through a post filing automated underreporter program and possible disputes as to whether there is enough justification to avoid a penalty. Sad.

Hat tip on this case to Ed Zollars, whose post in Current Federal Tax Developments alerted me to this case. Ed’s work is terrific, and I recommend readers subscribe. As Ed notes, many taxpayers mistakenly believe that the hiring of a preparer means that taxpayers can avoid responsibility.

Ed notes the responsibility that preparers have to correct clients about that misperception:

But tax professionals need to be aware of this belief on the part of their clients that merely hiring the professional and dropping off the documents they decided were relevant means the return they get back will contain no errors. It is important to remind clients that it is their responsibility to provide all relevant information for their return and to make use of tools the professional may provide…

Circuit Court Holds That LLC Distinct From Its Agent For Purposes of Criminal Referral Exception To Summons Power

In Equity Investment Associates v US the 4th Circuit considered the limits of the IRS summons power when there is a criminal investigation that relates to but does not directly involve a business entity. The case involved an LLC that donated a conservation easement. The IRS was examining the LLC while there were simultaneous criminal investigations of the LLC’s accountants/tax return preparers and other alleged co-conspirators.

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Under Section 7602(d), the IRS is barred from issuing a summons “with respect to any person if a Justice Department [criminal] referral is in effect with respect to such person.”

Under the BBA partnership audit procedures, Jack Fisher was Equity’s partnership representative. Equity was 80% owned by Southeast Property. In turn, Southeast Property was controlled by its managing member, Inland Capital Management, which Fisher managed.

The IRS issued a summons to Equity’s bank. IRS gave notice of the summons to Equity, which sought to quash that summons, arguing that a Justice Department criminal referral was already in effect for Equity or one of its agents (Fisher). In opposing the motion to quash and requesting that the court order enforcement of the summons, the DOJ submitted a declaration from an IRS Supervisory Special Agent who attested that there was no criminal referral for Equity. 

Equity’s tax return preparers had previously pleaded guilty to conspiring to defraud the United States for selling, along with co-conspirators, “investments” in fraudulent syndicated conservation-easement tax shelters. The government was also conducting a criminal investigation of Fisher, who was subsequently indicted for crimes related to the fraudulent syndicated easement scheme.

Does The Criminal Investigation and Prior Referral of Equity’s Agent Serve to Bar A Summons on Equity?

Equity’s argument was premised on using the definition of person in Section 7343, which states that for purposes of chapter 75 of the IRC, a person “includes an officer or employee of a corporation, or a member or employee of a partnership, who as such officer, employee, or member is under a duty to perform the act in respect of which the violation occurs.” Chapter 75 deals with crimes, offenses and forfeitures (Section 7201 through 7345).

Unfortunately for Equity, the prohibition on IRS summons power when a criminal referral is in place is in Section 7602, and that Code section is within Chapter 78, which deals with civil examinations and encompasses Section 7601 through Section 7655. There is no specific definition of person either in Section 7602 or Chapter 78.

In the absence of a specific definition, the general Code definitional provisions in Section 7701 apply:

Section 7701(a)(1) states that “[w]hen used in [Title 26], where not otherwise distinctly expressed or manifestly incompatible with the intent thereof . . . [t]he term ‘person’ shall be construed to mean and include an individual, a trust, estate, partnership, association, company or corporation.” § 7701(a)(1). That definition does not consider members, officers, or employees of a business entity to be a part of the same “person” as the business entity itself. By omitting officers, members, and employees from the personhood of business entities in § 7701(a)(1) but including those same people in the definition it adopted for § 7343, Congress made an express decision that “person” for purposes of § 7602 only means the business entity itself.

Equity also argued that even if Section 7701 applied, its definition is non-exclusive in the list of entities that count as a person. As such it asked the court to find that the “statute’s specific reference to only the business entities themselves is thus not exclusive because agents of a business entity are “otherwise within the meaning” of the term “person.”

The court disagreed, finding that person is “not naturally read to suggest both a business entity and its officers, members, and employees.”

And for the final nail in the coffin, the opinion considered how the general summons power in Section 7602(a) refers to entities and their agents in a manner reflecting their distinct status:

Indeed, § 7602‘s text shows that the statute considers business entities as distinct persons from their agents. Under § 7602(a)(2) “the Secretary is authorized . . . [t]o summon the person liable for tax or required to perform the act, or any officer or employee of such person.” If “person” already included the officers and employees of a business entity, there would have been no reason for Congress to have provided for “any officer or employee of such person” in § 7602(a)(2), and Equity’s preferred definition as applied to § 7602(a)(2) would create surplusage.

Was There a Referral For Equity?

The opinion also considered the district court’s denial of an evidentiary hearing concerning whether there was a Justice Department referral addressing Equity as an entity. As the opinion notes, a referral is not a generalized suspicion of criminal activity. It occurs only when (1) the IRS recommends a person to the Attorney General for prosecution or (2) the Justice Department requests a taxpayer’s information from the IRS.

Absent Equity introducing evidence that reflected an actual referral to the Justice Department with respect to Equity, the court declined to remand for an evidentiary hearing. The opinion sweeps in the Clarke standard for when in a summons challenge a district court should allow a hearing:

Equity’s other evidence only suggests that the government believed that Equity had committed a crime. However, suspicion and even criminal investigation does not prevent the IRS from issuing a summons. The IRS can continue to avail itself of the summons power until it crosses the “bright line” of making a Justice Department referral. See Morgan, 761 F.2d at 1012. It is evidence of “specific facts or circumstances” suggesting a Justice Department referral, not generalized suspicion, that Equity must rely on to meet its burden. See Clarke, 573 U.S. at 249.

Conclusion

Our blogging colleague Jack Townsend also discusses the opinion here. As Jack notes, this case reflects fairly straightforward holdings. As usual, Jack makes interesting observations, and for readers with a deeper interest I recommend a read.

Equity Investment Associates is generally consistent with other caselaw reflecting that an entity is distinct from the owners for summons purposes, an issue that may arise when an individual may have or wish to assert a privilege even though a summons is directed to a business entity. It is also yet another case reflecting the IRS focus on conservation easement and inflated charitable deductions. The opinion also discusses in a straightforward way how the use of an an entity treated as a partnership for tax purposes makes the easement donation scheme available to others by passing the corresponding deduction through to its members, thus spreading the claimed tax benefit to investors.  

APA Provides No Basis To Compel IRS To Provide Access To Appeals

Add Rocky Branch Timberlands v US to the list of interesting cases invoking the APA to challenge IRS actions.  As the case shows, the APA can be a taxpayer’s friend, but it is does not provide the means to get a court to second guess what the court believes are decisions that are solely committed to the agency’s discretion.

The case involves yet another audit of taxpayers claiming conservation easement deductions. The taxpayers, subject to the not quite dead TEFRA partnership audit procedures, initially refused to extend the SOL on assessment. With the three-year period coming close, the IRS issued a Notice of Final Partnership Administrative Adjustment (FPAA). The taxpayers changed their mind about the extension, and sent a signed 872-P extension form to the audit team and sought review before Appeals. IRS declined to sign the 872-P and refused to revoke its FPAA. The taxpayers sued, asking the court to order the IRS (1) to rescind the FPAA and (2) to sign the Form 872-P that would extend the time to assess, all with the hope of getting before Appeals and not having to take the case to Tax Court.

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The government filed a motion to dismiss for lack of jurisdiction.

The court quickly found in favor of the government. As to the taxpayer’s request to rescind the FPAA, the court noted that the Anti Inunction Act prevented the court from ordering an injunction that would restrain assessment.  The Supreme Court has carved an exception to the AIA when there is no adequate remedy and the plaintiff shows that the government could not prevail. Here, the opinion notes that the FPAA did in fact trigger a separate remedy: the chance to challenge the denial in Tax Court, one in which the taxpayer through the tax matters partner had in fact done.

As to the demand that IRS sign the extension/Form 872-P, the court looked to the APA, noting that while it waives sovereign immunity there is no basis for a court to gain jurisdiction if the decision is committed solely to the agency’s discretion. In addition, there is no jurisdiction if the agency decision is not final. Both of these exceptions have a fair bit of nuance described in Saltzman and Book, IRS Practice & Procedure in our soon to be revised but still really good discussion of the APA.

But there was not much nuance presented here. As to not being final agency action:

The IRS’s decision not to sign the Form 872-P, and thereby decline to extend the statutory period, was not a final agency action within the meaning of [5 U.S.C] § 704.  Rather, it was an intermediary and procedural step leading up to the issuance of the FPAA and did not alter Plaintiffs’ rights or obligations.  The IRS’s decision not to sign the Form 872-P did not alter the limitations period.

As to discretion, the court similarly dismissed the taxpayer’s argument:

The IRS’s decision not to extend the statutory period was also discretionary.  Plaintiffs identify no requirement that the IRS agree to an extension, and the Court is aware of none.  To the contrary, the law provides the statutory period may be extended only upon agreement by the taxpayer and the IRS.  See 26 U.S.C. § 6501(c)(4); Feldman v. Comm’r, 20 F.3d 1128, 1132 (11th Cir. 1994).  This provision clearly provides the IRS discretion—co-equal to a taxpayer’s discretion—as to whether it will extend the statutory period.  It is strange that Plaintiffs would deny the IRS the same discretion is previously exercised in the very same review. 

A somewhat more interesting issue involved the taxpayer’s argument that the court should give some teeth to IRC 7803(e)(4), which as part of the Taxpayer First Act provides that review by Appeals (renamed Independent Office of Appeals) “shall be generally available to all taxpayers.”

As the taxpayer had sought access to Appeals prior to the issuance of the FPAA, the opinion noted that the request was moot in light of its decision to find that the AIA precluded the IRS from rescinding the FPAA. For good measure, the opinion stated that the APA would not help, as the discretion to decline to provide access to Appeals was solely vested in IRS. In finding that this was committed to the agency’s sole discretion, the court accepted the government’s analogy settlement power generally, as it is settled law that an agency’s decision to settle (or not) is solely a matter for agencies to determine.  

The opinion also concluded that the point in time that the taxpayers sought relief in the form of Appeals consideration, prior to the issuance of the FPAA, was merely an interim step in the agency process, and thus not final agency action.

Conclusion

The taxpayers have challenged the IRS’s denial of their deduction in Tax Court, so it is not as if they are without recourse to independent review on the merits. And the taxpayers’ initial refusal to sign the extension contributed to their problems. Add to the mix that there is not a lot of sympathy around those claiming easement deductions.

Yet, access to Appeals is a fundamental part of tax administration and embedded in the Taxpayer Bill of Rights. The language in this opinion, as well as other cases we have blogged about (including the Facebook case I discussed here)have held that access to Appeals is something that IRS can allow, or not allow, for essentially any reason. The TFA provides protections for taxpayers denied access to Appeals following the issuance of a stat notice.  Prior to that time, IRS controls the process, and the APA will likely not help.

IRC Levy Exemption for Disability Payments Ends Once Funds Hit Bank Account

The IRS’s levy powers are broad but not unlimited. One of the categories of payments that is protected from levy is disability payments relating to military service. The IRS has consistently argued that if a veteran receives disability payments and those funds comprise some or all of the money in a bank account, an IRS levy can reach those funds, unless the taxpayer can establish some other exemption.

Last year in Death and Taxes Keith discussed how “generally, the IRS takes the position that money in a bank account is fair game for its levy no matter what source, protected from levy or not, generated the funds in the bank account.” In his post Keith discussed that despite that general rule IRS decided to take an administrative pass on levying funds in a bank account if the funds in the account include money received by the taxpayers as COVID-19 Funeral Assistance funds provided by FEMA. A while back I discussed a 10th Circuit case that hinted at perhaps a disagreement with the IRS view that it could in fact levy on a veteran’s disability payments once they hit the account.

Earlier this month the Fifth Circuit in US v Charpia had occasion to revisit the issue of tracing, in a slightly different procedural path than typical cases we discuss.

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Charpia had pled guilty to defrauding the Government.  Part of the sentencing included restitution of over $900,000. The district court issued an order of garnishment and Charpia appealed the garnishment order, claiming statutory exemptions for certain funds in her bank account.  Charpia’s bank account had about $65,000 due to a lump sum disability payment that related to her military service.

This all implicated Section 6334(a)(10) because the Mandatory Victims Restitution Act cross-references the IRC exemption for service related disability payments.

As I discussed a while back in Tenth Circuit Raises Possible Defense to IRS Levying Bank Account with Veteran’s Disability Payments Section 6334(a)(10) prevents levy on “any amount payable to an individual” relating to military disability payments. (Note that the same language exempts unemployment compensation and workers compensation). The Fifth Circuit noted that there is not a lot of caselaw on the meaning of “amount payable” but in finding for the government it distinguished other exemptions that extend more broadly to amounts “payable to or received by” an individual, such as the 6334(a)(9) exemption for wages. Moreover the Charpia opinion noted that the few cases that interpreted the (a)(10) exemption looked to a plain Black’s Law meaning of the term payable, which is an amount “[c]apable of being paid” or “suitable to be paid” rather than funds that had been paid and were sitting in an account.

Conclusion 

It was not a complete loss for Charpia, however. As an alternate argument, she leaned on the Consumer Credit Protection Act (CCPA), which provides a 25% cap on “aggregate disposable earnings of an individual for any workweek which is subjected to garnishment.”

The court held that the only reason why Charpia did not receive her disability payments periodically was because the government initially denied her request and she received a lump sum payment to make up for payments that “otherwise would have been paid periodically. ” As such, the court held that the partial exemption under the CCPA applied, and the government was only entitled to seize 25% of the funds in her account. 

While this was a partial victory for Charpia, it has limited use for traditional tax cases. The CCPA would not apply to a matter where the IRS were seeking to levy on the account, rather than the government seeking to collect under the Mandatory Victims Restitution Act,  because IRC 6334(c) provides that notwithstanding any other law, the only exemptions on the IRS’s levy power are found in IRC 6334(a)

Update on CIC Services And More On The Legislative vs Interpretive Rule Difference

This is an update on the CIC Services litigation. Following the March 2022 decision where a federal district court granted CIC’s motion for summary judgment and vacated the IRS Notice, the government filed a motion for reconsideration. It did not challenge the underlying merits determination that the IRS violated the APA by issuing the Notice without notice and comment. Nor did it challenge the court’s order to set aside the Notice. Instead, it challenged the court’s decision to order the IRS to return documents and information furnished to the IRS by nonparties pursuant to the Notice.

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The court granted the motion and last week issued a revised order that retracted its mandate that the IRS return the nonparty documents. It did so because CIC’s lawsuit was not brought on behalf of nonparties and was not a class action lawsuit:

Despite possessing a procedural device to assert claims and request injunctive relief on behalf of similarly-situated nonparties, CIC did not do so. As a result, while nonparty taxpayers and material advisors necessarily benefit from CIC successfully demonstrating that the Notice must be set aside and are no longer be required to produce documents and information pursuant to the Notice, CIC does not have any basis to seek affirmative injunctive relief requiring the IRS to return documents to nonparty taxpayers and material advisors.

Despite finding that the court originally overstepped its authority when it ordered the IRS to return what it had received pursuant to the invalidated notice, the court still could not resist taking shots at the IRS for what it perceived as the IRS’s unjust enrichment from issuing a notice that was procedurally invalid:

To be sure, this determination operates as a windfall to the IRS in that it allows the IRS to retain documents and information it was not entitled to collect from nonparty taxpayers and material advisors. If this were simply a matter of determining an equitable result, the IRS would have to return all documents and information produced pursuant to the Notice, especially considering the Sixth Circuit’s observations [ed: citing the circuit in the CIC case] that the IRS has a history of APA noncompliance.

A Different Take On Whether The IRS Was Required to Use Notice And Comment Procedures

One final point addressing whether a reg or IRB guidance requires notice and comment under the APA. I commend readers to a contrarian discussion from Jack Cummings, who, in a letter to Tax Notes [$], and in related work that he and Jack Townsend have separately undertaken (see, e.g., Townsend, The Report of the Death of the Interpretive Regulation Is an Exaggeration for a deep dive into the issue), argue that courts and many current academic takes are off the mark.  In Cummings’ letter to Tax Notes, he disagrees with the Sixth Circuit in Mann (and other courts) that held that a reg or IRB guidance is deemed legislative and thus requires notice and comment under the APA because not complying with the rule might lead to a penalty or higher taxes. This, to Cummings, proves too much:

But to begin, instead, with the fact that the person owed tax or penalty as a result of the rule, could make every tax rule legislative. Each tax rule has some negative effect on taxpayers.

Under the APA, agency rulemaking is not required to be issued using the notice and comment procedures if the rule is interpretative (or sometimes referred to as interpretive). For decades, IRS, Treasury, and practitioners have thought that most guidance Treasury or IRS issues pursuant to its general rulemaking authority under Section 7805(a) was not required to be issued using notice and comment procedures under 5 USC § 553(b). That historical view was the consensus at the time of the passage of the APA in the mid-20th century.

What constitutes an interpretative rule? Cummings argues that the inquiry should focus more on the statute that triggered the IRS guidance as compared to the possibility of penalties if one chooses not to comply. In Mann and CIC Services, that takes us to Section 6707A and its trigger for reporting on transactions that have a potential for tax avoidance or evasion.

From Cummings’ letter:

It’s reasonable to interpret section 6707A to mean that Congress understood the section’s standard as too vague for taxpayers to enforce on their own. So Congress gave the IRS discretion to select among more or less abusive transactions the ones that should be reported. That’s a grant of legislative rulemaking authority.

In contrast, if the statutory language were capable of interpretation off a starting point that was not hopelessly vague, Cummings would have held that the rule was interpretative (and not required to be issued with notice and comment).

More from Cummings:

If the statute says, in effect, “We’re unsure what the rule should be, so you write it,” then the rule is legislative. If the statute says, for example, that a taxpayer can deduct ordinary and necessary business expenses, and then the agency wrote a regulation stating its views on those words, those views would normally be considered to be interpretive.

So, while Cummings’ approach would not have led to a different conclusion in CIC Services (or Mann), it leads to finding the rule legislative on a different rationale. It would matter a lot in other cases when courts and the agency have to determine whether IRS is required to use notice and comment, and the rule has a statutory starting point capable of agency interpretation.

With colleagues Rochelle Hodes and Greg Armstrong, we are in the process of revising the considerable APA content in an extensive rewrite of Chapters 1 and 3 of Saltzman and Book, IRS Practice and Procedure (the first part of the rewrite on subregulatory guidance will be released this summer). This issue, among many others, will generate heavy discussion, as the relevance of administrative law principles in tax cases continues to become one of the key issues in tax procedure and tax administration.