Designated Orders: 7/9/18 to 7/13/18

William Schmidt from the Kansas Legal Aid Society brings us this weeks designated orders. Three orders in cases involving the Graev issue keep that issue, no doubt the most important procedural issue in 2018, front and center. As with last week, there is an order in the whistleblower area with a lot of meat for those following cases interpreting that statute. Keith

For the week of July 9 through July 13, there were 9 designated orders from the Tax Court. Three rulings on IRS motions for summary judgment include 2 denials because there is a dispute as to a material fact (1st order based on employment taxes here) (2nd order involves petitioners denying both having a tax liability and receiving notice of deficiency for 2012 here) and a granted motion because petitioner was not responsive (order here). What follows are three orders where Judge Holmes takes on Chai ghouls, an exploration of a whistleblower case, and two quick summaries of cases. Overall, the Chai ghoul cases and whistleblower case made for a good week to read judicial analysis.

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Chai Ghouls

All three of these are orders from Judge Holmes that deal with Chai and Graev issues. The first two discussed were later in the week and had more analysis. As you are likely aware, the Chai and Graev judicial history in the Tax Court has led to several current cases that need analysis regarding whether there was supervisory approval regarding accuracy-related penalties, as required by Internal Revenue Code section 6751. In each of these cases, the IRS has filed a motion to reopen the case to admit evidence regarding their compliance with 6751(b)(1).

  • Docket Nos. 11459-15, Hector Baca & Magdalena Baca, v. C.I.R. (Order here).

The Commissioner filed the motion to reopen the record to admit the form. The Bacas couldn’t tell the Commissioner whether or not they objected to the motion. When given a chance to respond, they did not object. The Bacas did not raise Code section 6751 at any stage of the case (petition, amended petition, trial, or brief). The Commissioner conceded 6662(c) (negligence or disregard) penalties because the only penalty-approval form found is the one for 6662(d) (substantial understatement) penalties.

The Court’s analysis sets out the standard for reopening the record. The evidence to be added cannot be merely cumulative or impeaching, must be material to the issues involved, and would probably change the outcome of the case. Additionally, the Court should consider the importance and probative value of the evidence, the reason for the moving party’s failure to introduce the evidence earlier, and the possibility of the prejudice to the non-moving party.

The Court then analyzes those elements set out above. For example, the Court finds the penalty-approval form to be properly authenticated nonhearsay and thus admissible. Ultimately, the Commissioner had less reason to anticipate the importance of section 6751 because it was following Chai and Graev that it was clarified the Commissioner had the burden of production to show compliance with 6751 when wanting to prove a penalty.

In this case, the Court states because the Bacas did not object to the accuracy-related penalties, that is some excuse for the Commissioner’s lack of diligence. Additionally, the Court concludes that it can’t decide the Bacas would be prejudiced because they never said they would be.

Takeaway – Respond when the court requests your opinion or you may suffer consequences that could have been avoided if you had raised your hand and notified the court of your concerns.

  • Docket Nos. 19150-10, 6541-12, Scott A. Householder & Debra A. Householder, et al., v. C.I.R. (Order here).

This set of consolidated cases differ from the Bacas’ case because of an objection submitted by the petitioners. Arguments by the petitioners begin that the record should not be reopened because the Commissioner’s failure to introduce evidence of compliance with 6751(b)(1) shows a lack of diligence, and the Commissioner doesn’t offer a good reason for failing to introduce the form despite possessing it when trying the cases. They argue they would be prejudiced by reopening the record because they have not had a chance to cross-examine the examining IRS Revenue Agent on their case. They argue the form is unauthenticated and that both the declaration and the form are inadmissible hearsay.

Again, the form is found to be admissible nonhearsay. Regarding the authentication argument, the IRS recordkeeping meets the government’s prima facie showing of authenticity. The Court brings up that the Revenue Agent in question was a witness at trial that the petitioners did cross-examine, it’s just that they did not have section 6751 in mind at the time. In fact, the Court reviews a set of questions the petitioners listed and finds that those answers likely would not have helped them so comes to the conclusion that they would not be prejudiced by admitting the form.

Overall, both parties should have been more diligent to bring up section 6751. Since they did not, the lack of diligence on the Commissioner’s part is counterbalanced by the probative value of the evidence and the lack of prejudice to the petitioners if the record were reopened to admit the form.

Takeaway – The IRS is not the only party on notice of the Chai and Graev issue. Petitioners bear responsibility to raise the issue of supervisory approval just as the IRS has a responsibility to show proper authorization of the penalty. The court seems to be shifting a bit from prior determinations.

  • Docket Nos. 17753-16, 17754-16, 17755-16, Plentywood Drug, Inc., et al., v. C.I.R. (Order here).

These consolidated cases also deal with the 6751 accuracy-related penalties and the IRS motion to reopen the record to admit penalty-approval forms. While the petitioners originally disputed the penalties, they conceded penalties on some issues but did not want to concede penalties on others. As a result, they did not object to the Commissioner’s motion. The Court did not grant the motion regarding penalties determined against the corporate petitioner as it would not change the outcome of the case. In Dynamo Holdings v. Commissioner, 150 T.C. No. 10 (May 7, 2018), the Court held that section 7491(c)’s burden of production on penalties does not apply to corporate petitioners, so that, in a corporate case, where the taxpayer never asked for proof of managerial approval and so did not get into the record either a form or an admission that no form was signed, the taxpayer had the burden of production on this section 6751(b) issue and had failed. For the penalties determined against the individual petitioners, the Court granted the motion since they did not raise any objections.

In all three cases, the Court orders to grant the IRS motion to reopen the record to admit the penalty-approval form attached to the motion (with the exception of the denial of the application to Plentywood Drug, Inc.).

Comments: I must admit when Judge Holmes mentions Chai ghouls in his orders it makes me think of Ghostbusters (Chai ghoul bustin’ makes him feel good?). In looking over these three cases, it seems to me they have the same result no matter what the petitioners did. It is understandable when the petitioners never objected to the penalties or the approval form. However, the Householders objected and still got the same result. Perhaps I am more sympathetic to the petitioners, but the reasoning also does not follow for me that petitioners would not be prejudiced by admitting a form that allows them to have additional penalties added on to their tax liabilities. 

Whistleblowers and Discovery

Docket No. 972-17W, Whistleblower 972-17W v. C.I.R. (Order here).

By order dated April 27, 2018, the Court directed respondent to file the administrative record as compiled by the Whistleblower Office. Petitioner filed a motion for leave to conduct discovery, the IRS followed with an opposing response and the petitioner filed a reply to respondent’s response. On June 25, the Court conducted a hearing on petitioner’s motion in Washington, D.C., where both parties appeared and were heard.

Internal Revenue Code section 7623 provides for whistleblower awards (awards to individuals who provide information to the IRS regarding third parties failing to comply with internal revenue laws). Section 7623(b) allows for awards that are at least 15 percent but not more than 30 percent of the proceeds collected as a result of whistleblower action (including any related actions) or from any settlement in response to that action. The whistleblower’s entitlement depends on whether there was a collection of proceeds and whether that collection was attributable (at least in part) to information provided by the whistleblower to the IRS.

On June 27, 2008, the petitioner executed a Form 211, Application for Award for Original Information, and submitted that to the IRS Whistleblower Office with a letter that identified seven individuals who were involved in federal tax evasion schemes. The first time the petitioner met with IRS Special Agents was in 2008 and several meetings followed. The IRS focused on and investigated three of the individuals listed on petitioner’s Form 211 following those initial meetings.

The first taxpayer (and I use that term loosely for these three individuals) was the president of a specific corporation. In 2013, that individual was convicted of tax-related crimes including failing to file personal and corporate tax returns due in 2006, 2007, and 2008. This person received millions of dollars in unreported dividends (from a second corporation, also controlled by this individual). This individual was ordered to pay restitution of $37.8 million.

The second individual was the chief financial officer of the corporation. This person received approximately $13,000 per month from the corporation in tax year 2006 but failed to report that as taxable income, and did not file a tax return in 2007. After amending the 2006 tax return and filing the 2007 tax return, the criminal investigation ended. The Revenue Officer assessed trust fund recovery penalties for the final quarter of tax year 2006 and all four quarters of tax year 2007. This taxpayer filed amended tax returns for 2005 and 2006 in March 2009 and filed delinquent returns for 2007 and 2008 in July 2010. The IRS filed liens to collect trust fund recovery penalties of approximately $657,000 and income tax liabilities of $75,000 for tax years 2005 and 2006.

The third individual was an associate of the first two but had an indirect connection with the corporation. This taxpayer had delinquent returns for 2003-2011 and there was a limited scope audit for tax years 2009 and 2010. The IRS filed tax liens for unpaid income taxes totaling approximately $2.4 million for tax years 2003 to 2011.

For each of the individuals, the IRS executed a Form 11369, Confidential Evaluation Report, on petitioner’s involvement in the investigations. For taxpayer 1, the IRS Special Agent stated that all information was developed by the IRS independent of any information provided by petitioner. For taxpayer 2, the form includes statements the Revenue Officer discovered the unreported income and petitioner’s information was not useful in an exam of the 2009 and 2010 tax returns. For taxpayer 3, the form states the taxpayer was never the subject of a criminal investigation (which is inconsistent with the record) and that petitioner’s information was not helpful to the IRS.

The petitioner seeks discovery in order to supplement the administrative record, contending the record is incomplete and precludes effective judicial review of the disallowance of the claim for a whistleblower award. Respondent asserts the administrative record is the only information taken into account for a whistleblower award so the scope of review is limited to the administrative record and petitioner has failed to establish an exception.

The Court notes the administrative record is expected to include all information provided by the whistleblower (whether the original submission or through subsequent contact with the IRS). The Court’s review of the record in question is that it contains little information, other than the original Form 211, identifying or describing the information petitioner provided to the IRS. While the record indicates that there were multiple meetings concerning the three taxpayers, there are few records of the dates and virtually no documents of the information provided. The Court agreed with the petitioner that the administrative record was materially incomplete and that the circumstances justified a limited departure from the strict application of the rule limiting review to the administrative record.

The Court states the petitioner met the minimal showing of relevant subject matter for discovery since the administrative record was materially incomplete and precluded judicial review. The information petitioner seeks is relevant to the petitioner’s assertion that the information provided led the IRS to civil examinations and criminal investigations for the three taxpayers and led to the assessment and collection of taxes that would justify an award under section 7623(b). The IRS did not deny petitioner’s factual allegations and did not argue the information sought would be irrelevant so failed to carry the burden that the information sought should not be produced.

The Court limited petitioner’s discovery to three interrogatories concerning conversations with a Revenue Officer and two Special Agents, two requests for production of documents concerning notes and records of meetings with those three individuals.

Petitioner sought nonconsensual depositions if the IRS did not comply with the interrogatories and requests for production of documents. Since the Court directed the IRS to respond to the granted discovery requests, it is premature to consider the requests for nonconsensual depositions at this time. The footnote cites Rule 74(c)(1)(B), which calls that “an extraordinary method of discovery” only available where the witness can give testimony not obtained through other forms of discovery.

Respondent is ordered to respond to those specific interrogatories and requests for production of documents by August 17, 2018.

Comment: On the surface, this step forward looks to be a win for the petitioner as there seems to be a cause and effect that justifies a substantial whistleblower award. I discussed the case with an attorney with a whistleblower case in his background who commented that to get a whistleblower award the whistleblower had to be the first one to make the reporting and the information had to be outside public knowledge (though that was outside the tax world). From his experience, the government made it difficult to win a whistleblower award and I would say that looks to be the case here.

Miscellaneous Short Items

  • The Petitioner Wants to Dismiss? – Docket No. 11487-17, Gary R. Lohse, Petitioner, v. C.I.R. (Order here). Petitioner files a motion to dismiss for lack of jurisdiction, stating the notice of deficiency is not valid. The judge denies his motion because there is a presumption of regularity that attaches to actions by government officials and nothing submitted by the petitioner overcomes that presumption.
  • Petitioner Wants a Voluntary Audit – Docket No. 24808-16 L, Tom J. Kuechenmeister v. C.I.R. (Order here). Petitioner filed a motion for order of voluntary audit, also claiming that the IRS was negligent in allowing the third party reporter to issue the forms 1099-MISC for truck driving. As Tax Court is a court of limited jurisdiction, the Court cannot order the IRS to conduct a voluntary audit. While the petitioner was previously warned about possible penalties up to $25,000, this motion was filed prior to the warning so no penalty assessed for this motion. Petitioner’s motion is denied.

Takeaway: Each time here, the petitioner does not understand the purpose of the Tax Court. The petitioners may have come to a better result by treating Tax Court motions as surgical tools rather than as blunt weapons.

 

When Can An Entity Be Subject to Return Preparer Penalties?

I have been reading a lot of opinions discussing misbehaving tax return preparers. The IRS has a heavy arsenal it can deploy against those preparers short of criminal sanctions: civil penalties, injunctions and disgorgement are the main tools, all of which we have discussed from time to time. A recent email advice that the IRS released  explores when an entity that employs a return preparer can also be subject to return preparer penalties.

One way to think about the uptick in actions against return preparers is that the IRS has taken Judge Boasberg and others to heart when IRS lost the Loving case a few years ago.

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Part of the reason Judge Boasberg (later affirmed by the DC Circuit) tossed the IRS return preparer scheme out was that the IRS approach to including return preparation within 31 USC § 330 (which authorizes the Secretary to regulate “the practice of representatives of persons before the Department of the Treasury” )seemed to disregard or minimize the existing powers the IRS had to combat bad egg preparers:

Two aspects of § 330’s statutory context prove especially important here. Both relate to § 330(b), which allows the IRS to penalize and disbar practicing representatives. First, statutes scattered across Title 26 of the U.S. Code create a careful, regimented schedule of penalties for misdeeds by tax-return preparers. If the IRS had open-ended discretion under § 330(b) to impose a range of monetary penalties on tax-return preparers for almost any conduct the IRS chooses to regulate, those Title 26 statutes would be eclipsed. Second, if the IRS could “disbar” misbehaving tax-return preparers under § 330(b), a federal statute meant to address precisely those malefactors—26 U.S.C. § 7407—would lose all relevance.

As Judge Boasberg flagged, a key aspect of the IRS power to police return preparers is civil penalties under Title 26. Section 6694(b) provides a penalty for a preparer’s willful or reckless misconduct in preparing a tax return or refund claim; the penalty is the greater of $5,000 or 75% of the income derived by the tax return preparer from the bad return/claim.

The recent email advice from the National Office explored the Service’s view on whether the IRS can impose a 6694 penalty on the entity that employs a misbehaving return preparer as well as the individual return preparer who was up to no good.  The advice works its way through the statutory and regulatory definitions of return preparer under Section 6694(f), which cross references Section 7701(a)(36) for the definition of “tax return preparer.”

Section 7701(a)(36) provides that “tax return preparer” means any person who prepares for compensation, or who employs one or more persons to prepare for compensation, tax returns or refund claims.

The regs under Section 6694 tease this out a bit. Treasury Regulation § 1.6694-1(b) provides the following:

For the purposes of this section, ‘tax return preparer’ means any person who is a tax return preparer within the meaning of section 7701(a)(36) and § 301.7701-15 of this chapter. An individual is a tax return preparer subject to section 6694 if the individual is primarily responsible for the position(s) on the return or claim for refund giving rise to an understatement. See § 301.7701-15(b)(3). There is only one individual within a firm who is primarily responsible for each position on the return or claim for refund giving rise to an understatement. … In some circumstances, there may be more than one tax return preparer who is primarily responsible for the position(s) giving rise to an understatement if multiple tax return preparers are employed by, or associated with, different firms.

Drilling deeper the advice also flags Reg § 1.6694-3(a)(2), which sets out when someone other than the actual return preparer may also be on the hook for the 6694 penalty:

  1. One or more members of the principal management (or principal officers) of the firm or a branch office participated in or knew of the conduct proscribed by section 6694(b);
  2. The corporation, partnership, or other firm entity failed to provide reasonable and appropriate procedures for review of the position for which the penalty is imposed; OR
  3.   The corporation, partnership, or other firm entity disregarded its reasonable and appropriate review procedures though willfulness, recklessness, or gross indifference (including ignoring facts that would lead a person of reasonable prudence and competence to investigate or ascertain) in the formulation of the advice, or the preparation of the return or claim for refund, that included the position for which the penalty is imposed.

In the email, the Counsel attorney points to the above reg for the conclusion that  its “interpretation of Treasury regulation § 1.6694-3(a)(2) is that generally, the entity (corporation, partnership, or other firm entity) that employs a tax return preparer will simultaneously be subject to the penalty under section 6694(b) only if the specific conditions set forth in the regulation are met. Otherwise, only the individual(s) that is primarily responsible for the position(s) on the return or claim for refund that gives rise to the understatement will be subject to the penalty.”

The email does refer to a district court opinion case (affirmed by the Sixth Circuit) from a few years ago, US v Elsass, where the court found that the owner of an entity was a “tax return preparer” for the purposes of the return preparer penalty provisions. In that case, the owner was the sole owner and personally prepared a substantial number of the returns at issue and was in its view the moving force on the positions (a theft loss/refund scheme).

The upshot of the advice is that absent circumstances similar to Elsass, or the presence of conditions 1 and either 2 or 3 above in Reg 6694-3(a)(2), an entity that employs return preparers itself is likely not subject to penalties. That conclusion suggests that return preparers should be careful to document and review procedures that are in place to ensure that an employed preparer has supervision and, of course, to make sure that management follows those procedures.

Recent Tax Court Case Highlights CDP Reach and Challenges With Collection Potential (and a little Graev too)

I read with interest Gallagher v Commissioner, a memorandum opinion from earlier this month.  The case does not break new ground, but it highlights some interesting collection issues and also touches on the far-reaching Graev issue.

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First the facts, somewhat simplified.  The taxpayer was the sole shareholder of a corporation whose line of business was home building and residential construction.

The business ran into hard times and was delinquent on six quarters of employment taxes from the years 2010 and 2011. IRS assessed about $800,000 in trust fund recovery penalties under Section 6672 on the sole shareholder after it determined he was a responsible person who willfully failed to pay IRS. IRS issued two notices of intent to levy including rights to a CDP hearing. The taxpayer timely requested a hearing, and the request stated that he sought a collection alternative.

After the taxpayer submitted the request for a CDP hearing the matter was assigned to a settlement officer (SO). There was some back and forth between the SO and the taxpayer, and the taxpayer submitted an offer in compromise based on doubt as to collectability for $56,000 to be paid over 24 months. After he submitted the offer, IRS sent a proposed assessment for additional TFRP for some quarters in the years 2012 and 2014.

The SO referred the offer to an offer specialist. Here is where things get sort of interesting (or at least why I think the case merits a post). The specialist initially determined that the taxpayer’s reasonable collection potential (RCP) was over $847,000. That meant that the specialist proposed to reject the offer, as in most cases an offer based on doubt as to collectability must at least equal a taxpayer’s RCP, a figure which generally reflects a taxpayer’s equity in assets and share of future household income.

Before rejecting the offer, the specialist allowed the taxpayer to respond to its computation of RCP. The taxpayer submitted additional financial information and disputed the specialist’s computation of the taxpayer’s equity in assets that he either owned or co-owned.  That information prompted the offer specialist to revise downward the RCP computation to about $231,000 after the specialist took into account the spouse’s interest in the assets that the taxpayer co-owned and also considered the impact of the spouse on his appropriate share of household income.

Following the specialist’s revised computations, the taxpayer submitted another offer, this time for about $105,000. Because it was still below the RCP (at least as the specialist saw it), she rejected the follow up offer, which led the IRS to issue a notice of determination sustaining the proposed levies and then to the taxpayer timely petitioning the Tax Court claiming that IRS abused it discretion in rejecting his offer and sustaining the proposed levies.

So what is so interesting about this? It is not unusual for taxpayers to run up assessments and to then disagree with offer reviewers on what is an appropriate offer and to differ on RCP. RCP calculations are on the surface pretty straightforward but in many cases, especially with nonliable spouses, illiquid assets and shared household expenses (as here) that calculation can be complex and lead to some differences in views.

In addition, the opinion’s framing of the limited role that Tax Court plays in CDP cases that are premised primarily on challenges to a collection alternative warrants some discussion. The opinion notes that the Tax Court’s function in these cases is not to “independently assess the reasonableness of the taxpayer’s proposed offer”; instead, it looks to see if the “decision to reject his offer was arbitrary, capricious, or without sound basis in fact or law.” That approach does not completely insulate the IRS review of the offer (or other alternative) from court scrutiny, and in these cases it generally means that the court will consider whether the IRS properly applied the IRM to the facts at hand. While that is limited and does not give the court the power to compel acceptance of a collection alternative, it does allow the court to ensure that the IRS’s rejection stems from a proper application of the IRM provisions in light of the facts that are in the record and can result in a remand if the court finds the IRS amiss in its approach (though I note as to whether the taxpayer can supplement the record at trial is an issue that has generated litigation and differing views between the Tax Court and some other circuits).

That led the court to directly address one of the main contentions that the taxpayer made, namely that the specialist grossly overstated his RCP due to what the taxpayer claimed was an error in assigning value to his share of an LLC that owned rental properties.  This triggers consideration of whether it is appropriate to assign a value for RCP purposes to an asset that may in fact also be used to produce income when the future income from that asset is also part of the RCP. The IRM addresses this potential double dipping issue but the Gallagher opinion sidesteps application of those provisions because the rental properties did not in fact produce income, and the offer specialist rejection of the offer, and thus the notice of determination sustaining the proposed levies, was not dependent on any income calculations stemming from the rental properties.

The other collection issue worth noting is a jurisdictional issue. During the time the taxpayer was negotiating with the offer specialist, IRS proposed to assess additional TFRP for quarters from different years that were not part of the notice of intent to levy and subsequent CDP request:

Those liabilities [the TFRP assessments from quarters that were not part of the CDP request] were not properly before the Appeals Office because the IRS had not yet sent petitioner a collection notice advising him of his hearing rights for those periods.  In any event, the IRS had not issued petitioner, at the time he filed his petition, a notice of determination for 2012 or 2014. We thus lack jurisdiction to consider them. [citations omitted]

Yet the taxpayer in amending his offer included those non CDP years in the offer. The Gallagher opinion in footnote 5 discusses the ability of the court to implicitly consider those non CDP years in the proceeding:

We do have jurisdiction to review an SO’s rejection of an OIC that encompasses liabilities for both CDP years and non-CDP years. See, e.g., Sullivan v. Commissioner, T.C. Memo. 2009-4. Indeed, that is precisely the situation here: the SO considered petitioner’s TFRP liabilities for 2012 and 2014, as well as his TFRP liabilities (exceeding $800,000) for the 2010 and 2011 CDP years, in evalu- ating his global OIC of $104,478. We clearly have jurisdiction to consider (and in the text we do consider) whether the SO abused his discretion in rejecting that offer. What we lack jurisdiction to do is to consider any challenge to petitioner’s underlying tax liabilities for the non-CDP years.

This is a subtle point and one that practitioners should note if in fact liabilities arise in periods subsequent to the original collection action that generated a collection notice and a consideration of a collection alternative in a CDP case. Practitioners should sweep in those other periods to the collection alternative within the CDP process; while those periods are not technically part of the Tax Court’s jurisdiction they implicitly creep in, especially in the context of an OIC which could have, if accepted, cleaned the slate.

The final issue worth noting is the opinion’s discussion of Graev and the Section 6751(b) issue. While acknowledging that it is not clear that the TFRP is a penalty for purposes of the Section 6751(b) supervisory approval rule, the opinion notes that in any event the procedures in this case satisfied that requirement, discussing and referring to the Tax Court’s Blackburn opinion that Caleb Smith discussed in his designated orders post earlier this month:

We found no need to decide that question because the record included a Form 4183 reflecting supervisory approval of the TFRPs in question. We determined that the Form 4183 was suffic- ient to enable the SO to verify that the requirements of section 6751(b)(1) had been met with respect to the TFRPs, assuming the IRS had to meet those requirements in the first place.

Here, respondent submitted a declaration that attached a Form 4183 showing that the TFRPs assessed against petitioner had been approved in writing by …. the [revenue officer’s] immediate supervisor…. In Blackburn, we held that an actual signature is not required; the form need only show that the TFRPs were approved by the RO’s supervisor. Accordingly, we find there to be a sufficient record of prior approval of the TFRPs in question.

Frivolity, CDP Remands, Proving A Return Filed, and Untimely Refund Claims: Designated Orders 4/30 – 5/4/2018

Professor Patrick Thomas brings us the latest installment as we continue to play catch up on some interesting designated orders. Les

 This week’s orders bring us, yet again, a few taxpayers behaving badly (the interminable Mr. Ryskamp graces the pages of this blog yet again), a bevy of Graev-related orders on motions to reopen from Judge Carluzzo (all granted), three orders from Judge Jacobs, and a few deeper dives.

First, Judge Buch exercises the Tax Court’s ability to remand CDP cases for changed circumstances. Judge Ashford reminds us of the potential power of dismissing a deficiency case for lack of jurisdiction due to an untimely Notice of Deficiency—along with the proof needed to achieve such a result. Finally, Judge Holmes handles a motion to vacate due to petitioner’s inability to obtain a refund from the Tax Court.

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 Special Trial Judges Wield the Section 6673 PenaltyDocket Nos. 12507-17 L, Rader v. C.I.R. (Order Here); Docket No. 3899-18, Ryskamp v. C.I.R. (Order Here)

In Rader, Judge Panuthos granted respondent’s motion to dismiss for failure to state a claim in the CDP context. It’s relatively rare for the Tax Court to hear or grant such motions in CDP cases. When a petition is timely and properly filed, the Court usually decides, at minimum, whether the Settlement Officer “verifi[ed] … that the requirements of any applicable law or administrative procedure have been met”, as is required under section 6330(c)(1)—even where the petitioner doesn’t raise that issue or participate in the administrative hearing or Tax Court proceeding.

In contrast, here Judge Panuthos never reaches the merits (despite a timely filed request for a CDP hearing and timely filed petition) because the petition itself didn’t really say anything of substance.  Indeed, Judge Panuthos characterized it as containing “little more than pseudo-legal verbiage; references to [Code] sections and citations of tax cases, accompanied by petitioner’s questionable interpretations of those Code sections and case holdings; and accusations of fraud on the part of the IRS.”

The petition did try to challenge the underlying tax liability for 2012, noting that the Substitute-For-Return was inappropriate. Judge Panuthos gives a short recitation of why individuals are obligated to pay federal income tax, and why the Service has authority to assess tax via an SFR. (Not that he was required to; petitioner had already challenged his underlying liability, unsuccessfully, in a deficiency case, and so was barred from litigating the issue here). He then grants the motion to dismiss.

Finally, Judge Panuthos assesses, on the Court’s own motion, a $5,000 penalty under section 6673 for asserting “frivolous and meritless arguments”. Apparently, Mr. Rader has been assessed such a penalty in four (four!) separate deficiency dockets, including the one giving rise to this CDP matter. I’m not sure if another penalty will set him on the straight and narrow—but at this juncture, not issuing a penalty simply isn’t an option.

In Judge Guy’s order, Mr. Ryskamp is at it again. As we reported last month, Mr. Ryskamp attempted to acquire CDP jurisdiction by writing “Notice of Determination” on top of a Letter 2802C for 2017, and filed a petition with that letter on January 5, 2018. (The Letter 2802C indicates to a taxpayer that they submitted incorrect information to their employer on Form W-4). Judge Guy dismissed that case for lack of jurisdiction, warning him about the section 6673 penalty in an order dated March 23, 2018. In another post, we notedthat Mr. Ryskamp did the same thing with a LT16 notice (for those keeping score at home, still not a Notice of Determination), which Judge Gustafson quickly dismissed (though without the 6673 warning).

Now, Mr. Ryskamp filed a petition dated February 23, 2018, again attaching a letter related to withholding compliance, which he had requested from the Service. Judge Guy issued an Order to Show Cause why the case shouldn’t be dismissed for lack of jurisdiction; Mr. Ryskamp responded that the Court should regardless answer the following question: “What are a taxpayer’s substantive collection due process rights?”

Bad answer—or, question. Judge Guy dismisses the case for lack of jurisdiction. Additionally, he imposes a $1,000 penalty under section 6673, noting that Mr. Ryskamp was previously warned about the penalty four years earlier, and had been subject to two other case dismissals upon similar grounds. Judge Guy didn’t yet reference his earlier order regarding the Letter 2802C (perhaps because the Order to Show Cause was filed a day beforethe earlier order was issued).

What IRS notice will next reach the Tax Court as Mr. Ryskamp seeks to acquire jurisdiction of his substantive due process arguments? Time—and ever-increasing 6673 penalties—will likely tell. In the meantime, however, the Ninth Circuit will deal next with Mr. Ryskamp; he filed a Notice of Appeal on May 4. Mr. Ryskamp should take a look at section 6673(b)(3), which allows for the Service to assess and collect as a tax any sanctions he receives in a Court of Appeals.

Remanding for Changed Circumstances in a CDP Hearing Docket No. 1801-17 L, Rine v. C.I.R. (Order Here)

Turning the tables, Judge Buch encounters a relatively sympathetic taxpayer in Rine, where the petitioner is mired in the collection of a Trust Fund Recovery Penalty under section 6672. In the CDP hearing, Mr. Rine rejected the Settlement Officer’s proposed $914 per month installment agreement, and upon issuance of a Notice of Determination sustaining the levy, petitioned the Tax Court.

While Mr. Rine actively participated in the CDP hearing—submitting a Form 433-A with expenses well in excess of his income—it seems the Settlement Officer substantially adjusted his figures. Ultimately, she concluded that Mr. Rine had at least $914 per month in disposable income, and that he’d need to sell some assets (stock, life insurance, and his 401(k)) before that could occur. He alleged that these assets had already been fully leveraged to finance his struggling former business.

Meanwhile, this business, which originally incurred the employment taxes at issue, had already entered into a bankruptcy plan to repay the liability (or more likely, some portion of the liability). Throughout this litigation, it paid $10,000 per month (which eventually mooted one of the tax periods before the Court in Pine, as it became paid in full). Mr. Rine argued that the liability was being paid under the bankruptcy plan, and so the IRS shouldn’t collect from him personally.

Respondent filed a motion for summary judgment, arguing that there was no abuse of discretion in sustaining the levy, because Mr. Rine rejected the proposed Installment Agreement. In response, Mr. Rine repeated the arguments above, and noted that his wife had recently suffered from an accident, reducing her income; his own medical conditions had also deteriorated, increasing his expenses. Judge Buch holds that no abuse of discretion occurred, because the SO considered the information petitioner provided, verified applicable legal and administrative requirements, and engaged in the CDP balancing test.

But that was the extent of Judge Buch’s analysis. As such, I’m left with a number of questions: (1) how did the SO arrive at a $914 per month income surplus, where Mr. Rine’s submissions deviate so substantially? (2) Was her calculation valid? (3) What’s the total liability, and how quickly would the liability be paid under the bankruptcy plan alone? While the latter question is not determinative, it’d be helpful to have seen more analysis of whythe SO’s calculation was not arbitrary and capricious. From the facts alone (expenses far exceeding income; fully leveraged assets), a colorable case could be made that the decision was indeed arbitrary and capricious.

Nevertheless, Mr. Pine lives on to fight another day. Because of the changed circumstances for both Mr. and Mrs. Pine, Judge Buch remands the case to Appeals—though he notes that it’s up to Mr. Pine to provide evidence of his new situation.

Conflicting Evidence Finds Jurisdiction Docket Nos. 17507-14, 3156-13, Peabody v. C.I.R. (Order Here)

Our next order comes from Judge Ashford, who denies petitioner’s motion to dismiss for lack of jurisdiction. Petitioners alleged that the Service issued their Notice of Deficiency too late, and therefore, had blown the assessment statute of limitations under section 6501(a).

Interestingly, this motion to dismiss was made pursuant to a timely filed petition; in the ordinary course, petitioners move to dismiss for lack of jurisdiction where the taxpayer never received the Notice of Deficiency. They then allege that the Service failed to send the Notice to their last known address. The Service responds with its own motion to dismiss for lack of jurisdiction, but on the basis that the petition is untimely. Either way, the Tax Court finds a lack of jurisdiction, but the prevailing party obtains a judgment as to whythe Court lacks jurisdiction. If no proper Notice of Deficiency was issued, then the Service must respect that judgment and cannot thereafter proceed to assess or collect the underlying tax.

In contrast, the Peabodys received the Notice and timely filed a petition. Strike one against the success of their jurisdictional motion to dismiss.

The dispute here centers on whenthe Peabodys filed their 2009 income tax return. All agree they received an extension of time to file until October 15, 2010. If they filed the return on that date, then the statute under 6501(a) would have expired on October 15, 2013. A Notice of Deficiency issued on July 10, 2014 would be too late.

But was the return filed on October 15, 2010? The Service introduced a 2009 return that bore a stamped date of October 31, 2011, petitioners’ signatures, and handwritten dates of October 13, 2010.  The date on the paid preparer signature line was October 18, 2011. The envelope, which was sent to the IRS service center in Austin, bore a postmark date of October 28, 2011. Under these facts, a filing date of October 31, 2011 causes the statute to run on October 31, 2014—3 years after filing (note that the filing date for returns received after the deadline is the date of IRS receipt, not when the taxpayer mailed it).

Petitioners’ story is quite different. They argue that this purported “return” was not, in fact, their original 2009 federal income tax return. In their version, the return was prepared, picked up, signed, and mailed to the IRS campus in Fresno all on October 15, 2010. To support these allegations, they included an email, invoice, and filing instructions from their return preparer; a copy of the first two pages of their 2009 tax return; and sworn declarations from both Mr. Peabody and their tax return preparer.

The email seems to show that the return was sent from the preparer to Mr. Peabody on October 15, 2010. The return has a handwritten date of October 15, 2010 next to petitioners’ signatures, though the tax preparer did not sign. Mr. Peabody’s statement avers that he mailed the return the same day using the pre-addressed envelope from his return preparer. It also notes that, as to the Service’s return allegedly received on October 31, 2011, Mr. Peabody mailed a second return in response to a letter from the IRS, which requested a copy of the return; their preparer, according to them, printed it on October 18, 2011, and they sent it on its way. The preparer’s statement noted only that he prepared the return, and that the Peabodys picked it up on October 15, 2010 and mailed it.

This caused the IRS to pile on. Respondent submitted a sworn statement of the Revenue Agent who conducted the audit and a certified copy of Form 4340, Certificate of Assessments, Payments, and Other Specified Matters. The RA began the audit in August 2012, and requested a copy of the return, which was provided in early 2013 (thus, petitioners’ statement that he sent a copy of the return in 2011 seems suspect). At no time, according to the RA, did the Peabodys challenge the timing of the 2009 return filing. The Form 4340 showed an extension of time was filed, but that no return was filed until October 31, 2011.

Finally, Mr. Peabody replied with another sworn statement, noting that he was told during the audit that he was a victim of ID theft, which had caused his 2009, 2011, and 2012 returns to be rejected. He also noted that he believed the SOL had expired, justifying his refusal to extend the assessment statute for 2009.

Judge Ashford finds jurisdiction, and validates the Notice of Deficiency, relying on the self-serving nature of petitioners’ testimony, along with the unexplained discrepancies between the Service’s return (signed on October 13, 2010 and filed October 31, 2011) and the petitioners’ (signed on October 15, 2010 and filed on October 15, 2010). Further, the petitioners alleged in their petition that the return was filed on October 10, 2010. Judge Ashford also notes in a footnote that even if petitioner was an ID theft victim, this hurts his claim; the Service rejects returns that it believes are from an ID thief. (Interestingly, she also chides the IRS for assessing a failure-to-file penalty under section 6651(a) if the Peabodys are indeed ID theft victims). As such, the petitioners fail to carry their burden; weighed against the evidence the Service produced, especially the Form 4340, it appears more likely than not the only valid return is the one the IRS received on October 31, 2011. Indeed, the Form 4340 notes that the Service sent notices on July 25, 2011 and September 19, 2011, strongly suggesting the Service either rejected or didn’t receive the earlier return (and perhaps it’s that second notice to which petitioners responded with the “copy” of the return). This all puts the Service’s Notice of Deficiency well within the assessment statute.

Motion to Vacate for Bygone Refunds Docket Nos. 21366-14, 23139-12, 23113-12, Dollarhide v. C.I.R. (Order Here)

I was really hoping that with a name like “Dollarhide”, this would be a tax evasion case of some variety.

I mean, come on. Dollarhide? It’s just too good.

Alas, the Dollarhides seem like fairly honest taxpayers tripped up by the refund statute of limitations. We briefly covered these dockets in an earlier postfrom March. In that order, Judge Holmes granted the Service’s motion to enter a decision, finding that the refund statute of limitations barred the petitioners’ refund claim. Under section 6513(b), their withholding for 2006 was treated as paid on April 15, 2007; to make matters worse, it seems the Dollarhides paid excess Social Security tax—which likewise is claimable as a credit and treated as paid on April 15, 2007. But they filed their return on February 3, 2011, more than three years thereafter. Accordingly, the payment on April 15, 2007 was not claimable under section 6511(b)(2).

Now, the Dollarhides filed a motion to vacate or revise the decision under Rule 162. They argued that, had they known they couldn’t receive a refund, they would not have agreed to the stipulation of settled issues, upon which the Court based its decision. This document presumably includes a stipulation that the 2006 return was filed on February 3, 2011. The Tax Court rules here track the Federal Rules of Civil Procedure; FRCP 60(b) governs motions for relief from judgment, and the Dollarhides attempt to shoehorn this matter into FRCP 60(b)(3), which allows relief for fraud, misrepresentation, or misconduct by an opposing party.

That argument doesn’t fly with Judge Holmes. He notes that a mere failure to state something is not fraud, misrepresentation, or misconduct, at least where the untold statement could have been discovered with a little diligence. The Dollarhides, according to Judge Holmes, could have indeed discovered a clear legal issue like this.

Secondly, the Dollarhides argue that they didn’t file a 2006 return, because the Revenue Agent handling the corporation’s audit requested their 2006 individual return. From the order, we can’t tell whetherthat return was indeed submitted to the RA. Judge Holmes notes that no individual audit occurred for 2006. If the Dollarhides are telling the truth, and the return was indeed submitted to the RA, I’m not sure it matters that no individual audit was conducted. See above, however, for difficulties in proving whenor howa return was filed.

Finally, the Dollarhides didn’t raise the overpayment in their petition. Because the stipulation of settled issues indeed “resolved all issues in the case” (the refund claim not being an issue), any misrepresentation to the IRS wasn’t material.

But even if the Dollarhides found their way past the barriers to granting a motion to vacate, they’d still have great difficulties on the merits. If the Dollarhides could have proven that the return was somehow filed beforethe IRS alleges (perhaps with the Revenue Agent), they might have had a shot. It doesn’t look like any such evidence was presented, either with the motion or elsewhere in this case. As such, Judge Holmes denies the motion and ends this case.

Evidence, S-Cases, and Collection Due Process Review. Designated Orders 4/23/2018 – 4/27/2018

Professor Caleb Smith from the University of Minnesota Law School presents this week’s edition of Designated Orders; in addition to thinking about the challenges of substantiating expenses (and how the world shifts starting in 2018 for unreimbursed employee expenses), the post considers a healthy dose of Graev/Chai issues, a topic that Caleb discussed in a well-attended panel at the recent ABA Tax Section meeting. Les

It was a prolific week for designated orders from April 23 through April 27, with 10 issued. Here are the highlights:

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The Benefits of an S-Case: Morgan v. C.I.R., Dkt. # 7695-17S (here)

We begin with an order addressing a very common issue: substantiating business expenses, particularly of the dreaded IRC 274 variety.  This designated order and bench opinion from Judge Carluzzo is a good example of the power (and limitations) of an S-Case when you have a fairly sympathetic taxpayer situation.

When a taxpayer clearly has expenses but kept poor records (worse, no records) it strikes many as extremely unfair that they should be fully disallowed any deduction of those expenses. Sometimes taxpayers can rely on Cohan in those circumstances. But, as has been discussed by Professor Bryan Camp elsewherethe Cohan doctrine only goes so far: especially with “listed” expenses. A Tax Court Judge may well believe that you had (otherwise) deductible expenses, but disallow any deduction because you didn’t meet substantiation requirements. That is the law, after all, and the law is what a Judge must apply, even in S-Cases.

So what good are the relaxed rules of an S-case for substantiation (rather than strictly evidence) issues?

I think Morgan gives a good taste of why an S-case still has value in such instances. It has less to do with evidence, and more to do with S-cases being non-precedential. Here, the taxpayer arguably meets the strict substantiation requirements of IRC 274… but just barely, if not without some charity from Judge Carluzzo. I am not so sure such treatment would be afforded in a regular (potentially precedential) case.

The taxpayer in Morgan worked in asbestos remediation. His job is exactly the sort that requires frequent travel and has no regular place of employment: on any given day, Mr. Morgan would receive his marching orders (“go remove the flooring from 123 Main Street”) and head on his way. Over the course of the year he went to about 25 different locations, some which were fairly far from his residence (up to 58 miles away). Mr. Morgan kept track of the dates and locations of travel, occasionally accompanied by the name of the customer, on loose-leaf paper. He then calculated the mileage by plugging the information into MapQuest.

Is that good enough under IRC 274? There are at least a couple reasons to think not.

First the IRS calls into question just how “contemporaneous” these records really are, apparently having elicited some questionable testimony to that point during cross-exam. Judge Carluzzo notes this as a “serious concern,” but ultimately decides that the records are still “reliable enough.”

Then, and most importantly, there is the legal question of whether the records actually show deductible mileage in the first place. Because Mr. Morgan had no regular place of employment, his travel from home to a temporary site would be deductible (rather than commuting) mileage ONLY if the temporary site was “outside of the metropolitan area” that Mr. Morgan lived in. The records as submitted show mileage and location, but apparently not whether that location was “outside of the metropolitan area where the taxpayer normally lives and works.”

Judge Carluzzo could, at this point, say the records aren’t enough: the taxpayer has the burden of proof to show that they are entitled to the deduction, showing that they traveled outside the metro area they normally live and work in is an element of the deduction, and they failed to show demonstrate that. I think in a non-S Case that may well have been the outcome. Instead, Judge Carluzzo finds that it would “be unfair to deny the entire deduction because we lack that specific information.” His creative (and I’d say fair) solution is to infer that mileage logs showing a distance greater than 40 miles are likely outside of the metro area, and therefore allowed. Not a perfect solution, but an equitable one. He leaves it to the IRS and the petitioner to recalculate the deductible expenses based on that understanding (I question how much, if any, will actually be deductible thereafter, since Mr. Morgan was an employee that will have to deduct the mileage as a miscellaneous itemized expense subject to the 2% AGI floor. Note also that beginning this year, regardless of how wonderful Mr. Morgan’s records are (or if all locations are outside the metro) he will not be allowed any deduction since the “Tax Cuts and Jobs Act” completely eliminated it.)

In any event, Morganshows the ability of S-cases to allow for equitable solutions where taxpayers are caught between fairly esoteric law and the general notion that such law, if strictly applied, would appear to result being taxed on more net income than you really had. The S-case designation won’t save you from IRC 274, but it just may give you more wiggle room thereafter.

As an aside, the rule that the temporary work location must be “outside” the metro area has never sat particularly well with me. The metro area requirement is written nowhere in statute but was put forth by the IRS in Rev. Rul. 99-7as a way for determining personal vs business mileage. The need to promulgate somesort of distinction between non-deductible personal (commuting) expense and “away from home” deductible mileage is understandable given the vagaries of the Code on that issue. I’m just not so sure using “metropolitan area” as the touchstone strikes a desired balance between administrative workability and fairness.

On the “administratively workable” side, it seems odd to use the somewhat mushy “metro area” (nowhere further defined) rather than, say, just a set number of miles from the taxpayer’s actual residence. Similarly, on the “fairness” side it seems to penalize those that live in large metro areas (for example, Los Angeles). Is it really less of “commuting” if the new job location is across a river/state line 10 miles away in a rural area versus across town but 60 miles away? What if you live at the edge of the “metro area?”

Apparently, these are the thoughts that keep me awake at night…

Filling Out the Contours of GraevWeaver v. C.I.R., Dkt. # 262-15S (here) and Collins v. C.I.R., Dkt. # 9650-14 (here)

For those needing their weekly fix of Chai (more accurately Graev, but that doesn’t work as a pun) Judge Ashford and Judge Halpern provide the fix.

By way of extremely brief background, after Graev III the burden of proof is on the IRS to show supervisory approval of penalties under IRC 6751. These two orders don’t break any new ground on that issue, but do provide useful primers on a hot issue that practitioners need to be aware of.

With Collins, we see the usual (and likely to be dwindling) arguments on whether the Tax Court should reopen the record for cases with one foot in the Graev (that is those that took place before Graevwas decided but remained open after Graev III). These cases are, of course, finite and largely coming to an end, so in a sense have mostly historical value. However, they may also provide some insights to petitioners in future sure-to-be frequent fights over evidentiary proof of supervisory approval under IRC 6751.

Collins provides the usual script, with Judge Ashford punctuating a few keys points. First, the usual: IRS moves to reopen the record because they didn’t originally introduce evidence of supervisory approval of a penalty on the very-reasonable ground that at the time the Court had hitherto said they didn’t need to. Second, the petitioner tries very hard to come up with a reason why the IRS shouldn’t now be allowed to reopen the record. Third, the Tax Court says, “we have discretion to open the record, and petitioner’s reasons not to just aren’t good enough.”

In future IRC 6751 litigation, the IRS shouldn’t need to reopen the record to introduce evidence of supervisory approval: Graev IIImakes clear they should do that upfront. Nonetheless, where the IRS seeks to submit into evidence a Civil Penalty Approval Form that purports to show proper supervisory approval under IRC 6751, the petitioner will need to think critically about what arguments they may still be able to make to show a failure of IRC 6751 compliance. Collinsprovides a little insight on what those arguments may be and their likelihood of success.

First, it is clear that objecting to the introduction of a Civil Penalty Approval Form on hearsay grounds won’t work. The exception offered by the IRS and readily accepted by Judge Ashford is FRE 803(6) often referred to as the “business records rule.” That is enough for the IRS to carry the day on hearsay objections, though frankly I think it is more than the IRS actually needs.

Judge Ashford takes as a given that the Civil Penalty Approval Form is “inadmissible hearsay” absent an exception applying. I’m not so sure that is correct: how is it that the IRS could have a legal requirement under IRC § 6751 to show “written approval” and yet the written approval itself be inadmissible hearsay absent exception? I think most law students taking evidence would similarly find that result puzzling, though begrudgingly accept it because hearsay doctrine is mostly incomprehensible. However, for the student sticking with that initial reaction (“it seems wrong that this would generally be hearsay”), I think they may be on to something.

Without going into too great depth, I will say that I think the Civil Penalty Approval Form may not be hearsay at all because it has “independent legal significance.” The IRS is offering the form essentially because the IRS has to, as an element of its case, much in the same way that contract and defamation cases necessarily have to introduce out-of-court statements. If those statements were treated as hearsay (thus requiring an exception for admissibility) many would likely fail because they weren’t business records, etc. To me, the crux of the issue is simply “does written approval exist?” and the IRS Civil Penalty Approval Form is submitted for that purpose. That is arguably a “non-hearsay use” of the Civil Penalty Approval Form and should therefore not be evaluated as hearsay needing an exception for admission.

And this gets to the second point: what are you really trying to argue when the IRS offers a Civil Penalty Approval Form? In Collins, the objection was really about the authenticityof the document -not whether it purports to show supervisory approval. The IRS included a statement from the supervisor that signed the document attesting to its authenticity. Because Judge Ashford approached the Civil Penalty Approval Form as hearsay admissible only under FRE 803(6), this statement (or something similar) is required as certification under FRE 902(11)and thus admissible (and sufficient, in this case to show that the form was authentic).

The authentication argument (as well as the hearsay argument) in Collinsis a loser, and I believe will almost always be a loser in future cases absent extremely bad actors in the IRS. So what can we take from Collins? To me, it is the primacy of the written document in IRC 6751 cases. As a taxpayer, saying “I don’t trust it,” probably won’t work. But, there are other rules of evidence (and tactical approaches) that may.

IRS records can be pretty bad at times. My assumption is that, moving forward, where the IRS cannot provide ANY written approval of the penalty they will concede the issue or argue no approval is needed under IRC 6751(b)(2). But the more interesting cases may be where the IRS has some written record that, taken as a whole, seems to show supervisory approval -but not a clear, single “Civil Penalty Approval Form.” In those cases I think the rules of evidence give practitioners new potential methods for attack. The question of “why isn’tthere a single approval form?” comes to mind. If that is the “regularly conducted activity” of the IRS (under FRE 803(6)), absence of those regular entries seems all the more important (and testimony from the IRS about the absence would appear to be admissible under FRE 803(7). I have seen the IRS provide any number of different forms of “written approval” (including what seem to just be case notes) for the penalty. If it is the practice to have an actual, standard approval form, one might hold the IRS’s feet to the fire when they fail to do so and instead try to provide other corroborating (written) evidence. I daresay in these circumstances, litigants may need to reacquaint themselves not only with hearsay but also the best evidence doctrines.

I’m sure such issues will play out to the delight of the Tax Court in the not so distant future.

The second designated order involving Graev again brings up problems that will soon be relics of history. Although the order doesn’t break much new ground, Judge Halpern does provide a helpful timeline of the Graev/Chai saga, as well as a reference to a far-less-frequently cited case that touches on IRC § 6751 pre-Chai: Legg v. C.I.R., 145 T.C. 344. I assume the reason Legg did not result in the firestorm Graev has is because Legg found that the requirements of IRC § 6751 were met by the IRS, and didn’t touch whether they were applicable in the first place: everything in Legg hinged on whether the approval was part of the “initial determination.”

The Weaver situation blissfully will soon be a thing of the past. Weaver had its trial after Chai, but before Graev I. The briefing was completed after the second Circuit reversed Chai, but before the Graev III about-face. The question posed by Judge Halpern, as it so often has been, is “How does Graev III affect this case?” Since the case was not yet decided when Graev III was decided, I assume the answer will be that the IRS needs to comply with IRC 6751 (with a motion to reopen the record) or the penalty falls under the automated exception of IRC 6751(b)(2).

Insisting a Little Too Much on Your Day in Court: Ryskamp v. C.I.R., Dkt. # 20628-17 (here)

When you frequently comb through the US Tax Court orders archive some names begin to seem familiar. Ryskamp is one such name, and the accompanying order illustrates why. The order itself is fairly routine: taxpayer wants to get into Tax Court on a CDP case without having the proper “ticket”:  that is, a Notice of Determination (or letter that should be a notice of determination). Rather, Mr. Ryskamp has only Notice LT16, which he attempts to pass off as a Notice of Determination. This is akin to trying to get into a Hamilton by presenting an expired bus ticket. And the Court is not having it. And for good reason.

This does not appear to be a taxpayer that is (justifiably) confused about the limits of Tax Court jurisdiction -what IRS letters serve as tickets and what IRS letters don’t. Rather, Mr. Ryskamp ALREADY had petitioned (and had his day in court) for nearly all of the years at issue after a previous CDP hearing and judicial review. But that happened in 2014… perhaps Mr. Ryskamp forgot, or believed he had a new opportunity?

Doubtful: he appealed his original CDP case to the D.C. Circuit in 2015. Then, losing on appeal, Mr. Ryskamp petitioned the Supreme Court in 2016 (cert denied, as one might expect).

So why does Mr. Ryskamp believe the Tax Court should now, at long last, once more hear his arguments about why he shouldn’t pay his 2003, 2005, 2006 and 2009 taxes? Because, Mr. Ryskamp asserts, “when a petition raises substantive due process arguments, the Tax Court must address them.” Interesting premise, although he could not have picked a less amenable (or appropriate) forum to make them in.

One feels for both the IRS, Judge Guy, and frankly honest taxpayers everywhere in cases like these: resources are wasted addressing inane and time-consuming arguments by serial tax-delinquents. It is easy enough for Judge Guy to resolve this issue (the boilerplate “Tax Court is a court of limited jurisdiction” does the trick), but simply finding in favor of the IRS/dismissing the case does not seem a full remedy. Depending on one’s constitution, readers may feel a twinge of retributive justice was later served Mr. Ryskamp,in the form of a $1000 penalty for challenging a collection action for the “2018 tax year” (somehow). A tip of the hat for my Designated Orders colleague William Schmidt for directing me to that outcome.

Odds and Ends: Remaining Designated Orders

How to Compel Discovery

Judge Jacobs issued two orders: onedenying a pro se petitioner’s motion to compel discovery from the IRS (presumably because they did not try to use informal means of discovery first), and onegranting the IRS’s motion to compel discovery from the taxpayer (after fairly extensive attempts to utilize informal means of discover). They don’t provide too much insight on the issues, but are a reminder of the Tax Court imperative to use informal methods of discovery as much as possible.

How Not to Move for Summary Judgment:Lamprecht v. C.I.R., Dkt. # 14410-15 (here)

Knowing when is appropriate to move for summary judgment can be difficult even for trained attorneys. Through denying a pro se petitioner’s motion in Lamprecht, Judge Gustafson lays out a few more helpful tips. In Lamprecht, one of the petitioner’s wanted SJ against the IRS, and explicitly “assumed” that the Tax Court (or IRS) was already aware of the relevant facts thus far developed. If your SJ motion really just says “Judge, you’ve heard us talk enough by now, you know what is relevant and what isn’t, please make your decision,” it is not likely to pass muster. Perhaps you are right, and all the relevant issues/facts have been established… but it is your responsibility to show what those are and (equally importantly) why they mean you should win. As Judge Gustafson writes, “the task of extracting from prior filings “the facts in this action that are relevant to [a summary judgment] motion” and then the task of searching the record to see whether those alleged facts can be supported by materials in the record” are the responsibility of the moving party.

Miscellany

Two designated orders from Judge Carluzzo (a bench opinion finding against a taxpayer that never showed up for trial here, and an order amending a caption here) are not discussed. There is an additional order addressing waiver of CDP rights; that will serve as a standalone post at a later time.

Designated Orders: 4/16- 4/23

Guest blogger William Schmidt from Legal Services of Kansas brings us the designated order post from a few weeks ago as we continue catch up on this feature. Today’s post looks at burden of production, debt cancellation and the somewhat unusual reference to trial by battle. Les

This week provides 7 designated orders.  The batch includes some short items of note, a followup on a previous case, a focus on cancellation of debt/insolvency, and a bit of creative writing.  The first order grants the motion for summary judgment from the IRS since the petitioner was non-responsive (Order and Decision here).  Another finds that the case is moot, since the liability was satisfied and the proposed levy is unnecessary.  Judge Panuthos goes beyond the call of duty by providing an explanation for the petitioner in response to his assertions (Order of Dismissal Here).  The third has the petitioner making unfounded claims of misconduct by IRS personnel and requesting a continuance.  Since the petitioner previously received a continuance and had filed for bankruptcy (staying the Tax Court case), which was pending for a year before being dismissed without objection, the Court denied petitioner’s request for continuance (Order Here).

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Further Followup on Mr. Kyei

Docket # 9118-12, Cecil K. Kyei v. C.I.R. (Order of Dismissal and Decision Here).

I previously wrote about Mr. Kyei’s case here and here.  In brief, Mr. Kyei had filed bankruptcy multiple times and one automatic stay from a bankruptcy case potentially voided a settlement agreement with the IRS.  Previously, the Tax Court ordered the IRS to address the issue of burden of production as to the penalty for 2010.  Mr. Kyei was to file a response to their supplement for the previously filed motion to dismiss.

The IRS supplement stated they could not meet the burden of production and conceded the penalty of $2,614.80 for 2010.  Mr. Kyei did not respond.  The Court ordered that there were deficiencies in tax for Mr. Kyei for 2008 and 2010 based on the notices of deficiency.  All other amounts, including the 2009 deficiency and all three years of penalties were reduced amounts.  In total, the 2008 deficiency was $15,518.00, with a 6662(a) penalty of $1,551.80 and a 6651(a)(1) penalty of $4,017.40.  The 2009 deficiency was $7,830.00 and 6662(a) penalty of $783.00.  The 2010 deficiency was $26,148.00 and there were no listed penalties.

Cancellation of Debt and Insolvency

Docket # 15337-16S, Kamal Rashad Ellis v. C.I.R. (Order Here).

Docket # 25294-16S, Terry Thomas Woods v. C.I.R. (Order and Decision Here).

Based on these two orders, I thought I would give a spotlight to some issues regarding cancellation of debt income and insolvency.

The first is based on a bench opinion by Judge Buch.  In the opinion, Mr. Ellis testified regarding his Discover cards.  He had at least 3 different Discover credit cards and there were two Form 1099-C forms reported to the IRS by Discover Financial Services for two of those cards.  Based on $7,347 of cancellation of debt income, that brought $2,058 of additional tax for Mr. Ellis for 2013 so he filed a petition with Tax Court.  Mr. Ellis testified he did not receive the 1099-C forms and could not find his Discover Card records because of a house fire.  He also testified he previously disputed at least 3 charges in 2006 on one of his cards.  Because Mr. Ellis did not provide testimony that sufficiently disputed the cancellation of debt income, the Court found in favor of the IRS.

The second order also concerns cancellation of debt.  Mr. Woods defaulted on a car loan with GM Financial.  The company cancelled the debt and issued to him a Form 1099-C for $7,559, which was not included on petitioner’s 2014 tax return.  The notice of deficiency was for tax of $1,132.  After Mr. Woods filed a petition with Tax Court, the parties eventually conferred enough for the IRS to send him decision documents on July 20, 2017.  He did not respond and when the IRS called him on September 20, 2017, his stated he “completely forgot about it.”  After that point, petitioner was unresponsive.  The IRS filed a motion for summary judgment, which the Court granted, deciding the deficiency in tax due for 2014 was $1,132.

I make note of the Court’s discussion of cancellation of debt income and the insolvency exception.  To begin, cancellation of debt income is included in a taxpayer’s gross income.  An exception is if the discharge of debt occurs when the taxpayer is insolvent.  A taxpayer is insolvent to the degree that liabilities exceed the fair market value of assets.  The amount of income excluded by virtue of insolvency is not allowed to exceed the actual insolvency amount.  Since Mr. Woods did not provide anything to prove his insolvency, the Court had to include the full cancellation of debt income in his gross income as stated by the notice of deficiency.

Takeaway:  In my experience, Form 1099-C, bringing cancellation of debt income, can be devastating to low income clients.  IRS Publication 4681 details ways to exclude cancellation of debt income.  I use the insolvency worksheet (on page 6 of IRS Publication 4681 for tax year 2017) to assist my clients.  They fill out the worksheet by listing their debts and the fair market value of assets as of the date the debt was cancelled (not today’s value!).  Then, they are to use IRS Form 982, by checking the box for line 1b, and using line 2 to list the smaller amount of the debt cancelled or the amount the client was insolvent.  It may be necessary to amend a tax return to attach this form to a client’s tax return.  Overall, this method will reduce or eliminate the cancellation of debt income and its related tax liability.  This could significantly improve your client’s financial situation.

And Now For Something Completely Different

Docket # 25781-12 L, Estate of Jeanette Ottovich, Deceased, Randy Ottovich, Harvey Ottovich, and Karen Rayl, Executors v. C.I.R. (Order Here).

This order is rather mundane – the parties need to file a status report on the probate proceedings.  It is the footnote that is noteworthy, partly because it is longer than the order itself – in fact, it is 120 words, as compared to the 116 word order (your count may vary).  The footnote is next to the phrase “there are only two issues left for the parties to battle over,” which allows for Judge Holmes to engage in creative writing that I will quote in its entirety for your appreciation:

“We stress this is a metaphor, although we also note that today is the exact bicentennial of the last trial by battle in the English-speaking world.  See the onomastically excellent for our Court Ashford v. Thornton, 1 B & Ald. 459 106 E.R. 149 (1818) (Ashford declined battle; Thornton possibly got away with murder and ended up in Baltimore); see also “No ‘Game of Throne’ Throwdown,” Staten Island Advance (March 28, 2016) (NY Sup. Ct.) (acknowledging trial by battle still available in New York State). (The case should be better known by tax lawyers for the opinion of Lord Chief Justice Ellenborough: “it is our duty to pronounce the law as it is, and not as we may wish it to be”).

Larson Part  2: Absence of Prepayment Judicial Review Is Not a Constitutional Defect

Carl Smith’s earlier post on Larson v United States discussed Larson’s argument that the Flora rule should not apply to immediately assessable civil penalties under Section 6707. Larson also argued that the absence of prepayment judicial review violated his 5th Amendment procedural due process rights.

I will briefly describe the procedural due process issue and the Second Circuit’s resolution of the issue in favor of the government.

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Larson’s argument Larson was straightforward: the absence of judicial prepayment review of the 6707 penalty violated his right to procedural due process, a right embedded in the 5thAmendment. The 5thAmendment provides that no person shall be . . . deprived of life, liberty, or property, without due process of law . . . .”  Stated differently, Larson argued that the right to challenge the penalty prior to payment at Appeals was not enough to meet constitutional due process standards. Taking the constitutional gloss off of it, as the opinion states, Larson felt that the process “just wasn’t fair.”

The Second Circuit disagreed in a fairly brief discussion of the issue, and in so doing reminds us that while courts have pushed back on tax exceptionalism in many areas, when it comes to viewing the adequacy of IRS procedures in a due process framework tax is different.

At its heart, the protections associated with procedural due process, notice and hearing, are about minimizing the risk of the government making a mistake and depriving a person of a protected interest—in this case property. In finding that the process adequate, the Larson opinion leaned on caselaw that had its pedigree in 17thcentury England which had established that when assessing and collecting taxes the sovereign is entitled to rely on summary pre-payment and assessment procedures backstopped by the right to post payment judicial review.

That case law was based on the notion that potentially interposing a hostile judiciary between the taxpayer and the fisc was just too risky; taxes, after all, are the lifeblood of the government, and if the government makes a mistake in assessing a tax, a taxpayer can get justice by bringing a refund suit.

Of course, in our modern tax system, Congress has repeatedly stepped in and provided statutory protection to allow prepayment review in many cases. The US Tax Court exists in large part to soften the impact of the lack of meaningful due process protections associated with a determination of liability. The ability to pay a divisible portion of a tax and sue for refund, as well as CDP’s opportunity to challenge a liability in certain circumstances, all soften the blow of the exceptional view of tax cases.

As Carl mentioned the 6707 penalty is not divisible, and we have discussed the limits of CDP providing a forum for challenging the penalty.

This brings us to Larson’s constitutional challenge.  As Larson and others have argued, much has happened since the Supreme Court first blessed the assess first pay later constitutionality of the US tax system in the latter part of the 19thand early part of the 20thcentury. A number of meaningful Supreme Court cases, such as Goldberg v Kelly, provided that in most instances, the norm should be more defined pre-deprivation review. Most creditors are no longer entitled to rely on post payment judicial protections to ensure that a debtor’s interests are protected. In Mathews v Eldridge, the Supreme Court instructed courts to consider three factors when faced with a due process claim: (1) “the private interest that will be affected by the official action”; (2) “the risk of an erroneous deprivation of such interest through the procedures used, and the probable value, if any, of additional or substitute procedural safeguards”; and (3) “the Government’s interest, including the function involved and the fiscal and administrative burdens that the additional or substitute procedural requirement would entail.

In concluding that Larson did not have a successful procedural due process claim, the court did acknowledge that the Mathews factors were instructive and did in fact apply those factors to Larson’s facts. That  is more than some courts have done with tax cases, where some opinions state that since the time of King Charles the sovereign is entitled to rely on summary assessment procedures, and leave it at that.

In applying Mathews, the opinion stated that on balance while Appeals might not have afforded a perfect process the taxpayer did get a major reduction in the penalty assessment, and, in any event, the government interest in tax cases is “singularly significant”:

Larson’s interest is not insignificant; the IRS has imposed onerous penalties that Larson claims he cannot pay. But, as we previously noted, the IRS Office of Appeals review resulted in a substantial reduction of Larson’s penalties. No review is perfect and Larson offers no record‐based criticism of how the appeal was conducted. We are satisfied that the current procedures effectively reduced the risk of an erroneous deprivation and gave Larson a meaningful opportunity to present his case. Indeed, the Seventh Circuit recently observed that the IRS Office of Appeals “is an independent bureau of the IRS charged with impartially resolving disputes between the government and taxpayers,” and that “Congress has determined that hearings before this office constitute significant protections for taxpayers.” Our Country Home Enters., Inc., 855 F.3d at 789. Lastly, the governmental interest here is singularly significant due to the careful structuring of the tax system and the Government’s “substantial interest in protecting the public purse.” Flora II, 362 U.S. at 175. Considering all three factors, our Mathewsanalysis weighs in the Government’s favor. Therefore, application of the full‐payment rule to Larson’s § 6707 penalties does not result in a violation of Larson’s due process rights.

Observations and Conclusion

The opinion leans heavily on Appeals’ role, both in terms of how Congress has emphasized Appeals’ importance to the tax system (an issue front and center in the Facebook litigation we have discussed) and how Appeals reduced the penalties at issue in the case by $100 million.  The opinion heavily weighs the government’s interest without thinking on a more granular level as to what the government interest is. For example, what is the government’s interest in summary process for this penalty? What additional burdens or risks would the government face by allowing for judicial review of the penalty? I also would have liked to have seen a more robust discussion of the individual’s interest and a bit more on the structural deficiencies with Appeals as a resolution forum relative to a judicial forum.

To be sure, due process is not a one size fits all analysis. And as a comment to Carl’s post notes perhaps Larson is not the most sympathetic of taxpayers. Yet, over time, our tax system has changed to reflect an increased sense that taxpayers should have the right to challenge an IRS assessment without having to full pay the liability. Congress has also added significant civil penalties that are immediately assessable; that progression has been piecemeal and could stand to use some reform that might also consider the procedural aspects of challenging those penalties.

Norms with respect to individual protections and taxpayer rights are changing as well. Perhaps the appropriate remedy here is a statutory fix to CDP that would allow for Tax Court review of the penalty and possible refund of any amount paid in a CDP proceeding. That would more closely align collection due process with the 5thAmendment notion of due process.

 

Larson Part I Post: Full-Payment Rule of Refund Suits Held to Apply to Assessable Penalties

Frequent contributor Carlton Smith discusses last month’s Larson v United States out of the Second Circuit. The Larson opinion situates civil penalties in the context of the Flora full payment rule, the APA, the 5th Amendment’s procedural due process protections and the 8th Amendment’s prohibition on excessive fines. Today’s post looks at the Flora full payment issue. Future posts will address the other issues. Les

In Flora v. United States, 357 U.S. 63 (1958) (“Flora I”), and, again, in an expanded opinion at 362 U.S. 145 (1960) (“Flora II”), the Supreme Court held that a jurisdictional predicate to a district court or Court of Federal Claims suit under 28 U.S.C. § 1346(a)(1) for refund of an income tax deficiency is full payment of the tax deficiency.  In oral argument in a later Supreme Court case, Laing v. United States, 423 U.S. 161 (1976), the Solicitor General’s office made clear its position that Flora’s full payment requirement only applies where the taxpayer could have, instead, petitioned the Tax Court to contest the deficiency prepayment, but chose not to.  A recent opinion, Larson v. United States, 2018 U.S. App. LEXIS 10418 (2d Cir., Apr. 25, 2018), involved a tax shelter promoter penalty assessed under section 6707 – one of the many “assessable” penalties that Congress has enacted since Flora that may be assessed without first allowing prepayment review in Tax Court through a notice of deficiency.  In Larson, the DOJ argued contrary to what the SG’s office did in Laing, and the Second Circuit accepted this changed position – holding that the Florafull payment requirement also applies to assessable penalties for which there is no possibility of Tax Court prepayment review through deficiency procedures.

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Larson Facts

The facts of Larson were as follows:  Larson was criminally convicted in connection with promoting several tax shelters.  The IRS later decided to impose assessable penalties under section 6707 for the promoters’ failure to file the necessary form under section 6111 (Form 8918) with the Office of Tax Shelter Analysis in Ogden, Utah alerting the IRS to the shelters.  Under section 6707 at the time (though not currently), the penalty under section 6707 was calculated as 1% of “the aggregate amount [that taxpayers] invested in such tax shelter”.

The IRS proposed to assess penalties of $160 million on a collection of promoters (including Larson), jointly and severally.  This means that the “aggregate amount invested”, according to the IRS, was $16 billion.

Other promoters paid the IRS about $100 million toward the penalty.  Larson contested the $160 million penalty at Appeals, arguing that the amount actually invested in the shelters in cash was only about $700 million, meaning the total penalty should be $7 million.  The rest “invested” was through notes that the courts had now held to be bogus for income tax purposes, so he argued that they were bogus, as well, for purposes of calculating the penalty.  (Of course, the taxpayers must have used those bogus notes to inflate their bases for purposes of claiming deductions far beyond the cash they invested.)

Appeals did not agree with Larson’s argument for lowering the penalties to $7 million, though it did give him credit for the penalties already paid by other promoters, reducing what Larson owed to about $60 million.

Larson District Court Suit

Larson paid $1.4 million toward the penalties, filed a refund claim, and then sued for a refund in the district court of the Southern District of New York.  It is not clear why he paid $1.4 million, but it appears that he thought the section 6707 penalty was “divisible”, and that $1.4 million was enough payment of a divisible tax to give the court jurisdiction.  In a footnote in Flora II, the Supreme Court said that full payment would not be required if a divisible tax was involved — a footnote that many people take advantage of with respect to section 6672 responsible person penalties (which have been held to be divisible).

In his suit, Larson argued that he had made a sufficient jurisdictional payment to commence suit, but that, even if he did not, the court had alternative jurisdiction under the Administrative Procedure Act, mandamus, Due Process, and because the size of the penalty violated the Eight Amendment’s excessive fines clause.

Unfortunately for Larson, shortly after he commenced his suit, the Federal Circuit held in Diversified Group Inc. v. United States, 841 F.3d 975 (Fed. Cir. 2016), that the section 6707 penalty was not divisible, so Flora IIrequired full payment in order to commence a refund suit.  The district court in Larson cited and followed Diversified Group, also rejecting all the other bases for jurisdiction that Larson alleged.  Larson v. United States, 2016 U.S. Dist. LEXIS 179314 (SDNY 2016).  Stephen did a prior post on both Diversified and the Larson district court opinion.

This post will not address the other grounds alleged for jurisdiction, but Les will be doing a later post on at least one of those other grounds.

Larson Appellate Arguments

 In his Second Circuit Appeal, Larson repeated all of his arguments for why the district court had jurisdiction, but abandoned his argument that section 6707 penalties are divisible.  Rather, Larson’s main argument was now that Flora II did not require full payment in a case like section 6707 penalties where no prepayment review was available in the Tax Court through a notice of deficiency.  Larson also argued that he couldn’t afford to pay the roughly $60 million left to make full payment, so requiring him to make full payment would leave him without a practical remedy for judicial review.

Flora II

Flora II expanded upon the opinion in Flora Iand corrected a significant misstatement in the earlier opinion.  Hereafter, I will discuss only Flora II.  In Flora II, the IRS had sent the taxpayer a notice of deficiency for income tax.  He did not file a Tax Court petition, but rather paid part of the deficiency, filed a refund claim, and brought suit for refund in district court. The Supreme Court held that a jurisdictional predicate to a refund suit under 28 U.S.C. § 1346(a)(1) is full payment of the tax.  But, the way it got to this holding was curious.

The statute being interpreted first appeared in the Revenue Act of 1921.  But, the court found that, even though there were statutory antecedents, with regard to whether full payment is required for a refund suit, the actual “statutory language . . . is inconclusive and legislative history . . . is irrelevant”.  Flora II, 362 U.S. at 152.

So, the Court then turned to three subsequent enactments of Congress to conclude that section 1346(a)(1) required full payment:

  • The establishment of the Board of Tax Appeals in 1924, which allowed taxpayers to contest deficiencies without prepayment, seemed to be done with the assumption that the Board was needed because refund suits concerning deficiencies otherwise required full payment.
  • In 1935, Congress amended the Declaratory Judgment Act (28 U.S.C. § 2201) to prohibit declaratory judgments “with respect to taxes”. The Court noted that if full payment were not required, then nothing would stop a taxpayer from paying $1, filing a refund claim, and suing for a refund. The latter would effectively be a suit for a declaratory judgment.
  • The adoption of section 7422(e), which provides that, if a refund lawsuit is underway when the taxpayer receives a notice of deficiency for the same taxable year, the taxpayer may either continue the suit in district court or move it to the Tax Court, but not litigate simultaneously in both courts.The Court concluded that the logic of not requiring full payment for a refund suit would be that a taxpayer could simultaneously conduct a deficiency suit in the Tax Court and a refund suit in the district court – a situation that section 7422(e) does not contemplate.

The Flora II court concluded with the following observation:

A word should also be said about the argument that requiring taxpayers to pay the full assessments before bringing suits will subject some of them to great hardship.  This contention seems to ignore entirely the right of the taxpayer to appeal the deficiency to the Tax Court without paying a cent.  If he permits his time for filing such an appeal to expire, he can hardly complain that he has been unjustly treated, for he is in precisely the same position as any other person who is barred by a statute of limitations.

362 U.S. at 175 (footnote omitted).

Laing

Laing v. United States, 423 U.S. 161(1976), involved income tax termination and jeopardy assessments under section 6851 and 6861 at a time when those sections did not state that the IRS must issue a notice of deficiency in connection with making such assessments.  The IRS had made such an assessment and argued that it was not required to issue a notice of deficiency before or after the assessment.

At the oral argument, the Solicitor General’s Office assured the Court that there would be no problem with the FloraII full payment rule, since Flora II did not require full payment if no deficiency notice could be sent to the taxpayer.  Here is a portion of the SG’s office oral argument that was quoted to the Second Circuit on page 6 of the Larson reply brief:

What this Court held in Flora was that under general circumstances a taxpayer cannot bring a refund suit until he has paid the full amount of the assessment.  In reaching that decision, the Court painstakingly went through the legislative history in connection with the creation of the Board of Tax Appeals, and there were indications going both ways as to what Congress really intended.  But I think that the really operative portion of the Chief Justice’[s] opinion in Flora was the fact that there the taxpayer had another remedy.  He could have gone to the Tax Court, and that made all the difference in Flora . . . .

For those interested, attached are all the briefs filed in Larson:  the appellant’s brief, the appellee’s brief, the reply brief(which contains the entire Laing oral argument transcript as an addendum), and an amicus brieffiled by the tax clinics at Harvard and Georgia State.  I believe that Keith will be doing a further post about what the amicus brief discussed.

The majority in Laing held that the IRS was required to send a notice of deficiency, so it did not reach the issue of whether Flora II required full payment for a refund suit in the absence of the possibility of receiving a notice of deficiency.

But, Justice Blackmun (joined by Chief Justice Berger and Justice Rehnquist) wrote a lengthy dissent in which he argued that no notice of deficiency was required in connection with a termination or jeopardy assessment.  However, he concluded that the taxpayer could bring suit in district court without full payment of the assessment.  After quoting part of the quote that I have quoted above from Flora II, Justice Blackmun wrote:

This passage demonstrates that the full-payment rule applies only where a deficiency has been noticed, that is, only where the taxpayer has access to the Tax Court for redetermination prior to payment.  This is the thrust of the ruling in Flora, which was concerned with the possibility, otherwise, of splitting actions between, and overlapping jurisdiction of, the Tax Court and the district court.  Where, as here, in these terminated period situations, there is no deficiency and no consequent right of access to the Tax Court, there is and can be no requirement of full payment in order to institute a refund suit.

423 U.S. at 208-209 (citation omitted).

Larson Second Circuit Ruling

In its opinion in Larson, the Second Circuit held that Flora II required the full payment of the section 6707 penalty before a refund suit could be brought.  It quoted the passage from Flora IIthat I have quoted above, yet argued that the availability of Tax Court deficiency review was not critical to the holding of Flora II.  The Second Circuit wrote:

While it is true that Flora I and Flora II acknowledge the existence and availability of Tax Court review, see Flora I, 357 U.S. at 75–76; Flora II, 362 U.S. at 175, Tax Court availability was not essential to the Supreme Court’s conclusion in either opinion.  The basis of the Flora decisions is that when Congress enacted § 1346(a)(1) it understood the statute to require full‐payment to maintain “the harmony of our carefully structured twentieth century system of tax litigation,” not that the full‐payment rule only applies when Tax Court review is available. Flora II, 362 U.S. at 176–77.

Slip op. at 10.

The Larson court did not acknowledge that the government had changed position as to the applicability of the full payment rule between Laingto Larson.  The Larson court did quote Justice Blackmun’s statements from his dissent in Laing, but noted:  “Justice Blackmun’s view did not garner majority support.  No subsequent majority of the Supreme Court has adopted that understanding of the statute.” Slip op. at 12 n.8.

As more evidence that full payment was required to commence the section 6707 refund suit, the Second Circuit noted that other assessable penalties have been enacted by Congress since Flora II with specific provisions that allow for payment of 15% before a refund suit can be commenced.  (“[O]ur reading is supported by Congress’s decision to provide partial payment review for other assessable penalties, but not for § 6707. See 26 U.S.C. §§ 6694(c), 6703(c).”  Slip op. at 8.)

After rejecting the other bases alleged by Larson for jurisdiction (which I won’t discuss here), the court concluded that this is a problem for Congress, writing:

We close with a final thought.  The notion that a taxpayer can be assessed a penalty of $61 million or more without any judicial review unless he first pays the penalty in full seems troubling, particularly where, as Larson alleges here, the taxpayer is unable to do so.  But, “[w]hile the Flora rule may result in economic hardship in some cases, it is Congress’ responsibility to amend the law.”  Rocovich v. United States, 933 F.2d 991, 995 (Fed. Cir. 1991).

Slip op. at 22.

Observations

The most surprising thing about the Larson opinion, to me, is that this issue of Flora’s application to assessable penalties has not been litigated before – i.e., until about 60 years later.  But, then most assessable penalties are either severable, require only 15% payment to commence suit, or are rather nominal in amount, so there were few in a position to argue that a full payment requirement to commence an assessable penalty refund suit was neither required by Flora II nor economically practicable.

The second most surprising thing is that both Flora II and Larson defend their statutory interpretation exclusively by reference to understandings of later Congresses when legislating.  I have always read that one is not to pay much attention to what later Congresses think a statute means.

But, ultimately, I was not surprised at the Larson ruling, and I don’t think Keith was either. I refer people to my statutory proposal made some years ago:  “Let the Poor Sue for a Refund Without Full Payment”, Tax Notes Today, 2009 TNT 191-4 (Oct. 6, 2009).  Although my proposal was designed primarily for the poor, it would help Larson (assuming that he gets himself on an installment agreement or in currently not collectible status first).  The opinion in Larson just underscores the need for a legislative fix.