IRS’s “Trust Me, it Wasn’t Yours” Defense Doesn’t Fly, Designated Orders 3/11 – 3/15/2019

There were only two orders designated during the week of March 11. The most interesting of the two contains the quote from where the title of this post originates and is potentially a step in the right direction for the whistleblower petitioner. The second order (here) was a bench opinion for an individual non-filer.

In Docket No. 101-18W, Richard G. Saffire, Jr. v. C.I.R. (order here), Judge Armen is not impressed with IRS’s dodgy behavior. The IRS objected to petitioner’s previously filed motion to compel the production of documents, so petitioner is back before the Court with a reply countering that objection. Based on the iteration of what parties have agreed upon and what the record has established, it seems as though the IRS dropped the ball while reviewing petitioner’s whistleblower claim.

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Petitioner is a retired CPA from New York and his whistleblower claim involved an investment company (the target taxpayer), a related entity (the advisor) and allegations of an improperly claimed tax exempt status. The claim was received in January of 2012. After it was submitted, but before it was formally acknowledged, petitioner also met with IRS’s Criminal Investigation Division.

In June 2012, the IRS determined that the claim met the procedural requirements under section 7623(b) and the ball was then passed to the IRS’s compliance function to determine whether the IRS should proceed with an exam or investigation.

In August two attorneys from IRS’s counsel’s office in the Tax Exempt and Government Entities (TEGE) Division, as well as a revenue agent from the TEGE Division, held a lengthy conference call with petitioner at the IRS’s request. According to petitioner, none of the IRS employees acted as though they had heard about the target taxpayer, its advisor, or issues raised by the claim previously. After the call, the IRS requested additional information which petitioner provided at the beginning of September 2012.

A technical review of the claim was completed at the end of September 2012, and the ball was again passed, this time to an IRS operating division for field assignment.

This is where the ball was apparently dropped as far as the claim itself was concerned. For five years petitioner did not receive any concrete information about the claim other than the fact that it was still open, but during that time petitioner learned from public information sources that a large amount of money was collected from the target taxpayer and that the SEC collected more than $1 million from the advisor.

Then in September 2017 petitioner received a preliminary denial letter followed by a final determination denying the claim because the IRS stated the issues raised by petitioner were identified in an ongoing exam prior to receiving petitioner’s information, petitioner’s information did not substantially contribute to the actions taken and there were no changes in the IRS approach to the issue after reviewing petitioner’s information.

Petitioner petitioned the Court. Three months later the Court granted the parties’ joint motion for a protective order allowing respondent to disclose returns, return information and taxpayer return information (as defined in section 6103(b)(1), (2) and (3)) related to the claim.  

Then petitioner requested the administrative file and five categories of documents related to the case. The IRS provided the administrative file, but it was heavily redacted and a large portion of the unredacted parts consisted of copies of the petitioner’s submission. IRS Counsel also sent information on three of the five categories, but it said that two of the categories of documents (regarding the exam of the target taxpayer and its advisor and communications between the IRS and SEC) were outside the scope of the administrative file, irrelevant to the instant litigation and were protected third-party information under section 6103.

IRS acknowledges that section 6103(h)(4)(B) permits disclosure in a Federal judicial proceeding if the treatment of an item on a taxpayer’s return is directly related to the resolution of an issue in the proceeding.

This is where the IRS’s “trust me- it wasn’t yours” defense comes into play. The IRS says the information does not bear on the issue of whether petitioner is entitled to an award because respondent did not use any of petitioner’s information. In other words, the IRS refuses to show the petitioner what information it used to investigate and collect from the target taxpayer, because it wasn’t the petitioner’s information that was used. The IRS also argues that the petitioner’s request is overbroad and unduly burdensome.

The Court finds this explanation insufficient and grants petitioner’s motion to compel discovery (with some limitations) finding that most of the documents that petitioner requests are directly relevant to deciding whether petitioner is entitled to a whistleblower award, and therefore, discoverable. The Court suggests that the information petitioner requests should be disclosed pursuant to section 6103(h)(4)(B). The Court allows respondent to redact some information (mainly, identifying information about the alleged second referral source), but orders respondent to provide an individual and specific basis for each redaction.

It’s a little odd that IRS has been so reluctant to provide the petitioner with information, but it doesn’t necessarily suggest that the reason is because petitioner is in fact entitled to an award. Now that the Court has intervened, hopefully the information will provide petitioner with a satisfactory answer as to why the IRS denied his award. 

Qualified Offers for Wealthy Taxpayers, Looking Behind the Notice of Determination, and Unlawful Levies in CDP – Designated Orders: March 4 – 8, 2019

This week brings five designated orders (technically six, but Judge Gale’s two orders granting Respondent’s motion to dismiss for lack of prosecution in Maldonado are practically identical). I analyze three cases below. In the other case, Judge Guy granted Respondent’s motion to dismiss for lack of jurisdiction in a deficiency case.

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Docket Nos. 10346-10, 28718-10, 5991-11, Metz v. C.I.R. (Order Here)

Judge Holmes returns, as last time, to a motion for administrative and litigation costs under section 7430. The underlying decision was released last year (T.C. Memo. 2015-54) and the parties agreed recently to the precise deficiencies, leaving only this issue outstanding.

Thankfully, none of the TEFRA difficulties that plagued us last time are present today. Judge Holmes also notes that no dispute exists regarding whether a “qualified offer” was made, or whether that amount exceeded the deficiencies actually determined for 2004 and 2005. He also notes that, while taxpayers must exhaust their administrative remedies to claim fees under 7430, Respondent never raised that argument except for 2008 and 2009.

Instead, the net worth requirement under IRC § 7430(c)(4)(A)(ii) bedevils the Court this time. It is ultimately fatal to a claim for fees on any of the tax years. The net worth requirement applies equally to ordinary claims for fees and also to claims premised upon a qualified offer.

 Section 7430 itself contains no explicit net worth requirement, but references the general federal fee shifting statute under 28 U.S.C. § 2412. That statute defines a “party” eligible for fee shifting as “an individual whose net worth did not exceed $2,000,000” or “any owner of an unincorporated business, or any partnership, corporation, association, unit of local government, or organization, the net worth of which did not exceed $7,000,000 at the time the civil action was filed.” 28 U.S.C. § 2412(d)(2)(B).

So, to win fees, Petitioners must be “an individual whose net worth did not exceed $2,000,000 at the time the civil action was filed” or meet the separate $7 million requirement for businesses, if it applies. Petitioners declared in their motion for costs that, at the time of filing the petition, their collective net worth was between $2 million and $4 million.

What limit applies to taxpayers filing a joint federal income tax return? Section 7430(c)(4)(D)(ii) states that “individuals filing a joint return shall be treated as separate individuals for purposes of [the net worth requirement].”  As it turns out, however, there’s much more to the story than meets the eye.

The first question, then, is what limits apply to Petitioners? Petitioners argued that Mrs. Metz was entitled to a $7 million limit, because she was an owner of an S corporation, not the general $2 million limit for individuals. Judge Holmes quickly dispatches this argument; it is the partnership, corporation, or other entity itself that must petition for costs under 7430 to be subject to the $7 million limit. While an “owner of an unincorporated business”, such as a sole proprietorship, could qualify as an individual, Mrs. Metz’s S corporation was incorporated.

But even accepting that the $2 million limit applies, do Petitioners really get a $4 million limit? A prior case, Hong v. C.I.R., holds that the net worth requirement isn’t violated if each spouse, individually, has a net worth below $2 million, but a joint net worth above $2 million. What if one spouse has $3 million and the other $500,000? Does one qualify, but not the other?

Turns out, this is a tricky issue. Hong was decided before Congress inserted section 743)(c)(4)(D)(ii) into the Code. And after Hong, Treasury issued a regulation attempting to overrule it. 26 C.F.R. § 7430(f)(1), T.D. 8542, 1994-29 I.R.B. 14. (“individuals filing a joint return shall be treated as 1 taxpayer.”) Unhelpfully, that regulation only concerned itself with administrative costs, rather than litigation costs. But in 1997, Congress passed the provision in 7430(c)(4)(D)(ii) that treats taxpayers separately. Treasury didn’t get around to conforming the regulation to the statute until 2016; Judge Holmes notes that Petitioners aren’t attempting to rely on this latter regulation, either.  Judge Holmes further questions whether Congress in 1997 attempted to adopt Hong, or simply decided to adopt an aggregate $4 million cap; the latter is supported by a direct quote in the legislative history, which the 2016 regulation adopted.

So, Judge Holmes ends up raising a litany of questions that, while interesting, are somewhat irrelevant to resolution of this case. He finds that the current regulation (applying a $4 million joint net worth limit) didn’t apply when these cases were filed. The old regulation doesn’t apply, because Congress overrode it in 1997 in some respect. And because Hong hasn’t been overruled andit finds a separate $2 million per person net worth requirement, Judge Holmes must defer to that decision. (Judge Holmes also notes that legislative history indicating a preference for a $4 million joint asset requirement cannot override Hong.) As such, he holds that Petitioners have a $2 million net worth requirement each.

Next, Judge Holmes must decide whether Petitioners’ assets exceed the $2 million limit, looking at each Petitioner individually. What counts in the “Net Worth” definition? Congress included more non-statutory language in the legislative history stating that “[i]n determining the value of assets, the cost of acquisition rather than fair market value should be used.” But that’s just non-binding legislative history right?

Both the Ninth Circuit and the Tax Court have issued precedential decisions applying a cost of acquisition value, consistent with the legislative history, rather than a fair market value. United States v. 88.88 Acres of Land, 907 F.2d 106, 107 (9th Cir. 1990); Swanson v. C.I.R., 106 T.C. 76, 96 (1996). So while the legislative history might not be binding, the Tax Court’s own precedent, and the Ninth Circuit’s precedent under the Golsen rule, surely is. 

I will spare readers the level of detail into which Judge Holmes delves to value the Metz’s assets. Suffice to say, Petitioners suffered heavy losses that substantially reduced the fair market value of their assets, to a level where both Petitioners would likely have satisfied the net worth requirement. Under a cost of acquisition valuation (which does allow for certain deductions from the cost alone, such as depreciation), however, both Petitioners have over $4 million in assets each.

Judge Holmes indicates a discomfort with this result as a policy matter, concluding:

There is also an old saw uncertainly attributed to Ambrose Bierce that defines stare decisis as “a legal doctrine according to which a mistake once committed must be repeated until the end of time.”

But because the Tax Court must defer to its precedent, Judge Holmes denies the motion for costs due to Petitioners’ failure to meet the net worth requirements.

As an aside, this case may also represent the first judicial shout-out to the Designated Orders crew. Judge Holmes, in defining the law applicable to Petitioners during the relevant time, notes:

We happily leave the herculean chore of cleaning this stall to any tax proceduralists whose interest in the field is strong enough to impel them to read our nonprecedential orders. But we need do only a quick hosedown.

I’m not sure how I feel about our blog series being compared to intense equine waste management. But as they say, all press is good press.

Docket No. 388-18L, Ansley v. C.I.R. (Order Here)

Judge Urda issued his first designated order in Ansley, and it contains quite the message to Respondent’s counsel.

Respondent filed a motion for summary judgment in this CDP case back in November. In the meantime, the parties held a conference call. Among other items, Petitioner alleged that Respondent levied his Social Security income while his Tax Court case was ongoing. Indeed, Petitioner provided a letter from Respondent’s counsel admitting that the Service had levied Petitioner’s Social Security from February 2018 until November 2018 (totaling nearly $2,200) to satisfy one of the years at issue in the Tax Court case. The letter also noted that the Service eventually issued Petitioner a refund last December.

This is a problem for Respondent, as section 6330(e)(1) prohibits levies after a CDP request is filed in response to a notice of intent to levy. The Service’s conduct here seems fairly egregious; the case was filed in July 2017 in the Tax Court. And because no motion to dismiss for lack of jurisdiction was filed, presumably the CDP request was timely submitted long before this point. The record is unclear on whether the underlying case was in Automated Collection Systems or with a Revenue Officer. So either the Service’s computers were not properly coded or the RO made an egregious error. 

On a closer look, however, we can understand how this could happen. Originally, Petitioner filed a letter on June 5, 2017 with the Tax Court, which the Court docketed at 12702-17L as an imperfect petition for tax years 2012, 2013, and 2014. But the Service hadn’t yet issued a Notice of Determination for those years. So, Respondent filed a motion to dismiss for lack of jurisdiction, which the Court granted on January 10, 2018.

However, in that same order, the Court noted that Petitioner had submitted another letter on July 24, 2017—after the Notice of Determination was issued. As the Tax Court received that letter within 30 days of the Notice of Determination, the Court—in January 2018—filed the letter as a new petition, docketed at 388-18, relating back to the letter’s date, July 24, 2017.

Levies started soon thereafter in February 2018.  One potential explanation is that the Service’s computers simply saw that the levy prohibition from docket 12702-17L had been removed. And because of the unorthodox way in which the new levy prohibition in docket 388-18L arose, they didn’t pick it up. Another could be that the Notice of Determination was listed in Petitioner’s 2012 account transcript as having been issued on September 26, 2017—not July 18, 2017, as it actually was. So perhaps the Service never picked up that a Petition was filed in the first place. The Court and Respondent’s counsel believe that the first explanation is correct, as explained in this order. Respondent’s counsel further assured Judge Urda that this unlawful levy was an “isolated error.”

However, Petitioner sent the Court another set of documents late this February, which included a levy notice for 2012, 2013, and 2014, dated May 18, 2018 to Petitioner’s employer—a separate levy from the Social Security levy previously disclosed.

To sort this out, Judge Urda orders (1) that Respondent may not levy on Petitioner for 2012 through 2014 while this case is pending; (2) that Respondent’s counsel file Petitioner’s Account Transcripts for 2012 through 2014 with the Court; and (3) that Respondent file a status report clarifying a number of uncertainties remaining in this matter, including when Respondent’s counsel first knew that a levy notice was sent to Petitioner’s employer. On March 18, Respondent’s counsel filed a reply. Unfortunately, I cannot access the reply’s text without traveling to Washington, D.C. or shelling out 50 cents per page for a copy of the reply.

Docket No. 9671-18L, Denton v. C.I.R. (Order Here)

Finally, another CDP case, this time from Judge Gustafson. Here, Respondent filed a motion to dismiss for lack of jurisdiction as to the two tax years at issue: 2005 and 2015. Judge Gustafson dismissed 2015; that year just came out of IRS Appeals on a Notice of Determination—long after the petition in this case was filed. Judge Gustafson advised Petitioners to file a new petition should he wish to litigate that year.

For 2005, the Service both issued a notice of intent to levy and filed a notice of federal tax lien. For the levy, Respondent argued the Court lacked jurisdiction because Petitioners did not timely request a CDP hearing. Specifically, Respondent stated that it issued the notice on February 5, 2009, making any CDP request due on March 9, 2009. Also in the record was an envelope from Petitioner to the Service dated March 18, 2009. On this evidence alone, Respondent’s argument seems strong.

But complicatedly for Respondent, they acknowledge that a CDP hearing occurred during 2017 and 2018, and that both 2005 and 2015 were considered. The Service then issued a “Notice of Determination” listing 2005 in May 2018. That’s quite a delay from when the Notice of Intent to Levy was purportedly issued.

Delay or not, Judge Gustafson notes that ordinarily, the Tax Court does not look behind a Notice of Determination based on “facts regarding procedures that were followed prior to the issuance of the notice of determination rather than on the notice of determination itself.” Lunsford v. C.I.R., 117 T.C. 159, 163 (2016). If that’s true, then the Court could, Judge Gustafson suggests, have jurisdiction over 2005. He necessarily implies, therefore, that that is so, even where the Service presents evidence indicating that the CDP hearing request itself was untimely. Therefore, Judge Gustafson denied the motion without prejudice as to 2005.

The Service also filed a NFTL for 2005, which by its terms required a response by April 2, 2009. The Court notes that evidence of a CDP request exists in the envelope dated March 18, 2009, so it’s not clear from the record that no request was filed. The Court also dismissed Respondent’s alternative argument that the lien self-released 10 years after filing. While true, taxpayers may request collection alternatives or other relief in response to a NFTL through a CDP hearing. Because the record was unclear on those points, Judge Gustafson likewise denied the motion to dismiss as to the 2005 lien hearing.

Getting to Meaningful Court Review in Collection Due Process Cases: Designated Orders, February 25 – March 1, 2019

There were three designated orders for the final week of February 2019, and all of them concerned Collection Due Process (CDP) cases. Two of the orders (Savanrola Editoriale Inc. here and McDonald here feature the time-honored determination that it is not an abuse of discretion for the IRS to sustain a collection action when the taxpayer refuses to provide financial information or otherwise take any part in CDP hearing. The orders are not particularly novel in that regard, but they do provide a good contrast to the third order where the Court actually finds against the IRS and remands to Appeals.

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Since abuse of discretion is a fairly vague standard, even the easy cases can be useful. Savonrola involves a taxpayer that wanted to challenge the underlying tax liability leading to the notice of federal tax lien (NFTL). However, apart from requesting a CDP hearing (blaming a faulty 1099-Misc for the liability) and then petitioning the court after receiving the determination sustaining the NFTL, it does not appear that the taxpayer engaged in the process much at all. The order does not reference any content from the CDP hearing itself, and it is not clear if the taxpayer engaged in the one that was offered. At the very least, the taxpayer does not appear responsive to the Tax Court once the petition was filed -the case was on the verge of being dismissed for failure to respond to an order to show cause. Because the taxpayer made no showing (and raised no argument) that they should be able to argue the underlying liability under IRC 6330(c)(2)(B) the Court had an easy time disposing of the case.

In McDonald the taxpayer did engage a bit more, but still not enough to give themselves a chance of winning on review. Here, the taxpayer apparently wanted to enter an installment agreement but had been unable to (which can happen to the best of us). However, the taxpayer had a back-year tax return that was “rejected” (that is, not-processed) by the IRS which complicated matters. At the CDP hearing, IRS Appeals was understandably unwilling to set up an installment agreement without that return being properly filed. Appeals also requested a Form 433-A for the installment agreement -the reasonableness of that request depending a bit more on the terms of the installment agreement being proposed. In response, the taxpayer sent an unsigned 2015 return and a Form 433-A lacking supporting documentation. When the signature and supporting documents were not forthcoming after multiple requests, Appeals rejected the installment agreement request and issued a determination sustaining the levy. As can be guessed, based on the failure of filing compliance alone, the Court had very little trouble finding there to be no abuse of discretion.

One can read the frequent, easy cases of Savonrola and McDonald to mean simply that the taxpayer will lose if they don’t comply with IRS requests during CDP hearings. But there is a deeper lesson to be learned: the Court needs something to look at to see how IRS discretion was exercised. By failing to comply or otherwise engage with the IRS during the hearing, you are building a record for review that can only ask one question: was it a reasonable exercise of discretion for the IRS to request the information in the first place? Almost (but importantly not always) the Court will find requests for unfiled tax returns or financial statements are not unreasonable and, by consequence, there was no abuse of discretion for the IRS to sustain the collection action when the requests were not complied with.

The important difference is that taxpayers may succeed even without providing requested information if they have readily engaged in the process. By so doing, they create a record for the Court to review and, possibly, come to a determination that discretion, properly exercised, would not require the information. The most famous of these cases is Vinatieri v. C.I.R.. In Vinatieri, the taxpayer provided a Form 433-A and demonstrated serious financial hardship and medical issues during the CDP hearing, but acknowledged that she had unfiled tax returns. The financial hardship was obvious, as was the fact that it would be exacerbated by levy. The IRS policy (that back year returns must be filed before releasing a levy under IRC 6343(a)(1)(D)) was not so obvious, and blindly following it was an abuse of discretion. Ms. Vinatieri was, it should be remembered, a pro se low-income petitioner with serious health issues. She is the prototypical taxpayer that CDP is meant to protect before disastrous levies take place. Nonetheless, it is not clear she would have prevailed (especially not in a “record-rule” jurisdiction) had she not engaged with the IRS at the hearing.

CDP hearings can also help the more affluent (and represented) taxpayers on non-equitable grounds -and again, engaging is key. Sometimes, a taxpayer may not have to comply with an IRS request for information by adequately showing that the information is unnecessary -for instance, where updated financials are cumulative, because the real issue is a matter of law (See the earlier designated order from McCarthy v. C.I.R., here). When you turn the inquiry into a question of law (not always an easy, or possible task with low-income taxpayers) you change the Court’s rubric. And that is exactly what happens in the third and final designated order of the week

Tax Court to IRS: High School Math Rules Apply. Show Your Work or Face Remand. McCarthy v. C.I.R., Dkt. No. 21940-15L (here)

We’ve blogged briefly about Mr. McCarthy before. The case boils down to whether the petitioner or a trust is the real owner of two pieces of property. If petitioner owns it his collection potential should be upwardly adjusted and the IRS rejection of his Offer in Compromise (or partial pay installment plan) likely constitutes a reasonable exercise of discretion. The issue, then, is mostly legal: does the trust own the property, or is the trust merely the petitioner’s “nominee”?

When the issue before the Court is a question of law, the vagueness of “abuse of discretion” goes largely out the window. It is always an abuse of discretion to erroneously interpret the law at issue (See Swanson v. C.I.R., 121 T.C. 111 at 119 (2003)). McCarthy, however, involves a slightly different lesson: it isn’t necessarily that the IRS erroneously interpreted the law (thereby reaching the wrong determination). It is that the IRS didn’t sufficiently back up the determinations it did reach.

The IRS tried to determine whether the petitioner was the true “beneficial owner” of the properties in the trust by analyzing how the petitioner and trust actually treated the property. The first property at issue (the “Stratford” property) was rented out to a corporation (American Boiler) that was apparently controlled by the petitioner. American Boiler made rental payments to the trust for many years, though in apparently inconsistent amounts.

The IRS believed this string of relationships, peculiar circumstances, as well as the fact that there was no written lease agreement between American Boiler and the trust, adds up to nominee. But the Court sees some gaps between those circumstances and the ultimate conclusion. The Court characterized the argument as “inviting us to speculate that petitioner caused the Trust to use in some fashion for its own benefit the rental income it received from American Boiler.” In other words, the IRS hasn’t adequately shown how they get from point A to point B, and their failure to show their work is fatal. The Tax Court “will not indulge in such speculation.”

The IRS fares no better with the second piece of property (the “Charlestown” property). This time, the IRS inferences seem even more threadbare. The trust (with petitioner as trustee) purchased the Charlestown property. The IRS argues that it was “reasonable for [the Settlement Officer] to have inferred that the funds to purchase the Charlestown property must have come from petitioner.” Unfortunately, there are other beneficiaries (apart from petitioner) of the trust that may have led to other contributions to it, even aside from the aforementioned rental income the trust received. Accordingly, the Court finds no basis for the IRS determination that petitioner was the beneficial owner of the Charlestown property as well.

The point isn’t that the IRS was clearly wrong that the trust was not the nominee of the petitioner (it may very well be his nominee: he hasn’t exactly been a “good actor” in other tax matters –the first footnote of the order mentions his involvement in a criminal tax case).  The point is that the IRS did not do its job in showing how they reasonably came to that conclusion apart from general inferences, which was the issue put before the Court. The taxpayer here may well be the polar opposite of Ms. Vinatieri: represented by counsel, likely affluent (at one time or another), and without the cleanest of hands. But like Vinatieri, (and unlike McDonald or Savonrola) they succeeded by engaging in the process and presenting a question (and record) the Court could reasonably rule in their favor on.

Several Things You Should Avoid With Your Taxes: Designated Orders 2/18/19 to 2/22/19

Designated Orders:  Several Things You Should Avoid With Your Taxes (2/18/19 to 2/22/19)

While there was a flood of designated orders immediately after the government shutdown ended, that was the height of the wave.  This week is at low tide for the number of designated orders because there are only four orders to discuss.  While there aren’t too many items of substance to discuss, each order has some interesting points on what to avoid with the IRS or Tax Court.

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There’s a Limit on Tax Benefits for Education

Docket No. 2805-18S, Tanisha Laquel Saunders v. C.I.R., available here.

In the past, one of my jobs involved taking questions from tax professionals, doing research, and providing written responses concerning their tax situation.  During that time, I answered several questions concerning tax situations for students.  I grew familiar with IRS Publication 970, Tax Benefits for Education, and used that as a starting point to answer several questions for what would be allowed on particular tax returns.

If you were to read through IRS Publication 970, a theme that you would find is that the IRS does not allow an individual to use the same qualified education expenses to claim multiple tax benefits.

That is the background for the case in question, which comes to us by a bench opinion from Judge Carluzzo.  The petitioner was a full-time student at Los Angeles Pierce College.  She received a Pell Grant to pay tuition and related educational expenses, with the remainder going to personal and living expenses.  The petitioner chose to exclude from her income the portion of the Pell Grant used for qualified education expenses.  This is a correct tax treatment of a Pell Grant with regard to qualified education expenses.

Where the petitioner went wrong is that she also decided to use those expenses for an education credit.  The bench opinion only refers to the education credits allowed under Internal Revenue Code (IRC) section 25A.  While the type of credit is not named, it was likely an American Opportunity Credit since the petitioner claimed both a nonrefundable and a refundable portion of the credit.

The judge does “congratulate and commend petitioner on pursuing her formal education”, but that does not prevent him from applying the law to the case.  The judge sustains the IRS disallowance of the section 25A education credit, deciding in favor of respondent.

Takeaway:  You are not allowed to double-dip when it comes to education-related tax benefits on the same expenses.  Perhaps the petitioner could have used better tax planning by making the Pell Grant full taxable and then taking an American Opportunity Credit.  Where she got caught by the IRS was where she excluded the Pell Grant from income, but also claimed the education credit.  A taxpayer just cannot get two or more tax benefits from the same education expenses.

 

The Petitioner’s Representative

Docket No. 14578-18SL, Barry J. Smith v. C.I.R., available here.

I don’t have too much to say on this case.  It is another example of a petitioner with a Collection Due Process (CDP) case who did not do much before the IRS filed a motion for summary judgment, leading to a decision for the IRS.

What caught my eye was a paragraph on the petitioner’s history.  It stated that the petitioner’s representative asked for additional time to provide financial materials on the date that they were due (and got an extension).  Next, when the settlement officer attempted to contact the representative for the scheduled telephone conference, there was no answer.  The settlement officer left a message, stating no information had been received and a notice of determination would be issued sustaining the proposed levy.  Later that day, the representative called back, explaining that his paralegal had been out.  The representative indicated he planned to speak with petitioner the next day and hoped promptly to get back to the settlement officer with the required information.  Nothing further was heard from the petitioner or his representative and no materials for consideration were submitted.

Takeaway:  While we do not have the full story, my read on the situation is that the petitioner’s representative might also have been at fault.  Whether that is the case or not, it is best if a petitioner’s representative helps the petitioner instead of adding to the case history of non-responsiveness to the IRS.

 

How Not to Deal With Tax Fraud

Docket No. 1395-16 L, Harjit Bhambra v. C.I.R., available here.

The IRS issued a Collection Due Process determination to sustain the filing of a notice of federal tax lien for restitution-based assessments and fraud penalties related to tax years 2003 and 2004.  Petitioner appealed to the Tax Court. The Tax Court granted an IRS motion for summary judgment with respect to the restitution so what was at issue in this order was petitioner’s liability for the fraud penalties (the petitioner was able to have a CDP hearing regarding his liability because the liability was not subject to deficiency procedures).  The Court issued an order remanding the case to IRS Appeals for a supplemental hearing where the petitioner could raise a challenge to the determination of the fraud penalties.

The Appeals Officer then sent a letter scheduling a telephone conference and the petitioner replied with his own letter.  That letter demanded an in-person hearing that he would record, plus he also made inflammatory statements, such as “that the IRS agents are well qualified liars that cannot be trusted for any reason” and the District Court judge in his criminal trial is a “reckless buffoon”.  Again, he submitted no evidence against the civil fraud penalties.  After a telephone conference, the petitioner again did not submit anything to refute the penalties.

In the IRS supplemental notice of determination, Appeals found the Examiner was correct to assert IRC section 6663 penalties because all or part of the underpayment was due to fraud, the petitioner was criminally convicted per IRC section 7206(1) and 7206(2) for making a false tax return, and he presented no new evidence why he is not liable for the penalties.

After receiving the parties’ status reports and the supplemental notice of determination, the Tax Court tried to reach out to the parties to see how to proceed.  They were unsuccessful in December 2018, which was followed by the government shutdown, with no success reaching the petitioner at the beginning of February 2019.  On February 11, petitioner did not answer his phone at the agreed-upon time.  In response to attempts to reschedule the call on February 13, petitioner responded:  “I’m working on February 13, 2019, and vacationing from 2-14-19 to March 8, 2019, please send me in writing whatever the [judge] has for this case.”

In this order, the judge’s response is:  “We will take petitioner up on his invitation.  We assume that, in asking for us to send whatever we have in writing, petitioner seeks no further hearing and has no argument to make.”  The judge sees no reason why decision should not be entered for the IRS to continue with collection of the restitution amount and the civil fraud penalties for 2003 and 2004.  The petitioner is ordered to show cause on or before March 19, 2019, why there should not be a decision entered as described.

Takeaway:  I always find that politeness and responsiveness go a long way to helping a court case.  The petitioner might not have avoided a decision against him, but it would not have hurt.

 

“No Trade or Business” or Cause for Alarm

Docket No. 8724-18 L, Jeffrey P. Heist v. C.I.R., available here.

Mr. Heist owned and operated US Alarm Systems, an alarm system installation and servicing business.  For 2013 and 2014, he worked as a sole proprietor and filed a Schedule C on his tax returns to report his income.  For 2015, Mr. Heist conducted his business through an S corporation and reported that income on Part II of Schedule E on his tax return.  He had no other source of income than that alarm system business during those years.  During those years, his customers used forms 1099-MISC to report payments they made to the business.

Mr. Heist filed tax returns for those years with a CPA on September 1, 2016.  He reported either net profit on Schedule C or S corporation income on Schedule E, respectively, along with tax and penalties (including self-reported estimated tax penalties).  He did not make estimated tax payments, had no payments as offsets against the tax or penalties and did not submit payment with the returns.

The IRS processed the returns and the amounts owing went unsatisfied, so the IRS sent a notice of intent to levy and notice of lien filing.  This prompted him to amend his tax returns for the years in question.

How did Mr. Heist choose to amend those returns?  He reduced his income, tax and penalties to zero for all three tax years.  In support, he attached “corrected” Forms 1099-MISC he created, purporting to “correct” to zero the amounts of income paid by the customers of his alarm system business.

What is Mr. Heist’s justification for these amendments? His main argument is that he and US Alarm Systems performed no “trade or business” activities as defined in USC Title 26 Section 7701(a)(26).  That defines the term “trade or business” to include performance of the functions of a public office, which Mr. Heist reads to exclude any other activities. The order cites multiple Tax Court Memorandum Opinions that have found this argument to be baseless and frivolous.

Not surprisingly, the IRS deemed the amended returns frivolous and invalid, eventually assessing frivolous return penalties under IRC 6702(a).  The IRS sent new notices of intent to levy and of filing a federal tax lien, and Mr. Heist requested a CDP hearing.  In the request, he states:  “I submitted simple arithmetic and sworn rebuttals to erroneous information returns and bad ‘payer’ data sent to IRS by those I contracted with for the years in question.  I made no claims for refund, overpayment or credit.  I simply require the record be corrected.”

Mr. Heist was not asking for money from the IRS, so what’s the harm, right?  Mr. Heist maintained at the telephone hearing and throughout the administrative process that he did not submit a frivolous return justifying any penalties.  Other things he did not do were request any collection alternatives, provide any documents in support of alternatives, or argue that the tax lien should be withdrawn.

On April 25, 2018, the IRS issued a Notice of Determination sustaining the penalty assessments, the notice of lien, and the proposed levy.  Mr. Heist timely appealed to the Tax Court, maintaining the same arguments.  The IRS filed a motion for summary judgment which the petitioner opposed.

The Court analyzed the case and found that the frivolous return penalties were justified and the settlement officer did not abuse her discretion.  The IRC 6702 penalties are $5,000 for each of the three tax years at issue.  The IRS’s motion for summary judgment was granted because there was no genuine dispute of material fact.

In addition, the Court advised the petitioner of IRC section 6673(a)(1), which authorizes the Tax Court to impose a penalty up to $25,000 when it appears proceedings have been instituted or maintained primarily for delay or that a position is frivolous or groundless.  The IRS did not seek such a penalty and the Court decided not to impose it sua sponte.  However, the Court warns Mr. Heist that they may not be so forgiving if he returns in the future to advance frivolous and groundless arguments.

Takeaway:  Mr. Heist originally had a tax liability over $20,000.  For some reason, he got it in his head to amend those returns and change the Forms 1099-MISC as if everything filed with the IRS for 2013 to 2015 related to his business did not exist.  This bright idea didn’t quite double his IRS debt, but brought $15,000 more in IRS penalties and a stern warning from the Tax Court about further penalty if he returned there again with frivolous arguments.  Let this serve as an example of actions to avoid with the IRS and the Tax Court.

A Burden of Proof Primer and Two Trips into the TEFRA Thicket – Designated Orders: February 4 – 8, 2018

The Tax Court designated nine orders this week; we’ll discuss three here. The others included two fairly routine orders granting motions for summary judgment in CDP cases; another reminder that parties can’t use Rule 155 computations to alter substantive litigated issues; a cryptic order from Judge Carluzzo in a case we previously covered, which seems to suggest that these pro se petitioners disagreed with Judge Carluzzo’s denial of their motion to dismiss for lack of jurisdiction; and a pair of orders from Judge Leyden, one of which warns of a section 6673 penalty.

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Docket Nos. 15265-17S, 25142-17S, Pagano v. C.I.R. (Order Here)

Judge Carluzzo issued a bench opinion in Pagano, upholding Respondent’s changes to Petitioner’s 2014 and 2015 income taxes in a Notice of Deficiency, along with an increased deficiency that Respondent desired after the NOD was issued. Petitioners made this all the easier on Respondent when they failed to appear for trial.

While the opinion is run-of-the-mill, it provides a useful distinction between the various burden of proof rules that can apply in Tax Court. Usually, Petitioner bears the burden of proof—including the burden of producing evidence and the ultimate burden of persuasion—in any Tax Court case. The Notice of Deficiency is “imbued with a presumption of correctness”; in other words, if Petitioner puts on no evidence, then Respondent’s changes in the NOD are upheld.

This dynamic shifts, however, where (1) Respondent raises a “new matter” that is outside the scope of the Notice of Deficiency, or (2) the NOD provides for an adjustment based on unreported income. In the former case, because the new matter was not contemplated at the administrative level, Respondent must both raise the issue and provide foundational evidence to support such an adjustment. For unreported income, the Tax Court has repeatedly held (as Caleb Smith discussed previously) that Respondent cannot rely on a “naked assessment” regarding unreported income. Otherwise, taxpayers are forced to prove a negative. Instead, Respondent must first link the taxpayer to an income producing activity.

In Pagano, the substantive issues included overstated Schedule C deductions for 2014 and 2015, and understated Schedule C income for 2015.

The Petitioners lose on the deductions for both years under the general principle that the petitioner carries the burden of proof. Missing trial is a good way to fail to carry that burden.

In contrast, Respondent had some work to do on its adjustment for understated Schedule C income—not much work, but Respondent needed to do more than simply showing up to trial, sitting on its hands, and saying “we win.” Nevertheless, Respondent still wins. Because Respondent introduced evidence to connect Petitioners to an income producing activity—namely, Petitioner’s tax preparation business—its adjustments regarding unreported income were likewise upheld. It helped that Respondent also seems to have provided evidence to justify the underlying adjustments, but I’m not sure that would have been necessary with absent petitioners.

Finally, Respondent seems to have concluded that the Service’s earlier bank deposit analysis on unreported income was somewhat off. Therefore, Respondent sought an increased deficiency from that reported in the NOD. Here too, Judge Carluzzo finds that Respondent satisfied its independent burden in raising this new matter, through the bank deposit analysis that Respondent entered into evidence, along with a revenue agent’s testimony.

 

Docket No. 23017-11, Hurford Investments No. 2, Ltd. v. C.I.R. (Order Here)

This order from Judge Holmes comes on a motion for extension of time to file a motion to reconsider Judge Holmes’ prior order denying Petitioner’s motion for reasonable litigation and administrative costs under Rule 231. That order, which Judge Holmes issued on December 21, 2018 and did not designate, disagreed with the Court of Federal Claims’ decision in BASR Partnership v. United States, 130 Fed. Cl. 286 (2017), that partnerships could submit Qualified Offers under section 7430(c)(4)(E)(i). In this order, Judge Holmes explains his disagreement with the Court of Federal Claims in detail.

Hold on a second. Did an undesignated order just create a split of authority between the Tax Court and the Court of Federal Claims?

Well, not necessarily. Orders are, under Tax Court Rule 50(f), non-precedential. Other judges in the Tax Court might reach a different result. Of course, a partnership shouldn’t expect to return to Judge Holmes with an identical argument and hope to win; he’s likely to apply the same logic as in Hurford Investments.

After losing their motion for fees and costs, Petitioners planned to move for reconsideration. But their counsel knew that the decision in BASR Partnerships—which the Service appealed to the Federal Circuit—would soon be forthcoming. Indeed, the Federal Circuit issued their opinion on February 8, as we covered here. So, Petitioners moved on January 17 for an extension of time to file their motion for reconsideration, such that the Tax Court could consider any subsequent opinion from the appellate court.

Judge Holmes denied the motion for an extension of time, noting that there were alternative grounds for decision, which the Federal Circuit was unlikely to reach. I initially had some trouble seeing that argument. The grounds for decision were (1) that Hurford wasn’t a prevailing party in the traditional sense because Respondent’s litigating position was substantially justified, and (2) that Hurford couldn’t make a Qualified Offer as a matter of law. Presuming the first point is correct (a fair assumption, given the novelty of the underlying case), the Court must still find that Petitioner was prevented from submitting a qualified offer. Let’s take a look at the statute and Judge Holmes’ analysis.

Section 7430 authorizes reasonable litigation costs where the taxpayer is the “prevailing party,” which means (1) that the taxpayer won a litigated case, and (2) that the IRS litigating position was not “substantially justified.” See I.R.C. § 7430(c)(4)(B). However, a taxpayer can avoid the “substantially justified” provision if the taxpayer submits a “qualified offer”, as defined in the statute, and if “the liability of the taxpayer pursuant to the judgment in the proceeding . . . is equal to or less than the liability of the taxpayer which would have been so determined if the United States had accepted a qualified offer . . . .” I.R.C. § 7430(c)(4)(E)(i).

In turn under section 7430(g), a “Qualified Offer” is:

  • A written offer;
  • Made by the taxpayer to the United States;
  • During the qualified offer period;
    1. Beginning on the date the first letter of proposed deficiency which allows the taxpayer an opportunity for administrative review is sent
    2. Ending on the date which is 30 days before the date the case is first set for trial;
  • Specifies the offered amount of the taxpayer’s liability;
  • Is designated at the time it is made as a qualified offer for purposes of section 7430; and
  • Remains open during the period beginning on the date it is made and ending on the earliest of the date the offer is rejected, the date the trial begins, or the 90th day after the date the offer is made.

However, section 7430(c)(4)(E)(ii) provides that a qualified offer isn’t available in “any proceeding in which the amount of tax liability is not in issue….” Judge Holmes previously found that this was such a case. The ultimate tax liability is not calculated at the partner level in a TEFRA proceeding; instead, the tax liability of the partners is separately calculated, and can depend upon individual circumstances independent of those addressed in the TEFRA proceeding.

Further, Judge Holmes found that Hurford Investments wasn’t even a “taxpayer” under section 7430, because it has no ultimate tax liability that is calculated, and so couldn’t even make an offer as required under 7430(g)(2).

Similarly, Judge Holmes suggests Petitioner didn’t comply with section 7430(g)(4), which requires taxpayers to specify the amount of the taxpayer’s liability.  Hurford Investments couldn’t have done so, Judge Holmes suggests, because they had no liability as a partnership.

Finally, the regulation interpreting this section requires the taxpayer to “clearly” make their qualified offer, and also requires that it be “with respect to all of the adjustments at issue” and “only those adjustments.” 26 C.F.R. § 301.7430-7(c)(3). Judge Holmes seems to state that because offered the adjustments at the partnership level flow through to the partners—i.e., that Hurford Investments’ proposal wasn’t limited to only its tax liability, but extended to their partners—this wasn’t a proper “qualified offer” under the regulation.

This latter point must be the “alternative grounds” upon which Judge Holmes denied the motion for an extension of time. All other grounds that Judge Holmes rejected stem from the premise that Hurford Investment didn’t have a tax “liability” and, relatedly, that the tax liability cannot be at issue in a TEFRA proceeding.

As it happens, the Federal Circuit issued their opinion shortly after this order, after which Petitioner filed a motion for reconsideration. We’ll continue to wait and watch this not-yet-ripe split of authority develop.

 

Docket No. 10201-08, BCP Trading and Investments v. C.I.R. (Order Here)

Finally, this order provides an example of the Court addressing a gap in the rules in an interesting context. Judge Holmes decided this TEFRA case in 2017 (T.C. Memo. 2017-151). Turns out, an indirect partner didn’t participate in that litigation. When parties to a partnership action settle, Rule 248(b)(4) requires Respondent to move for entry of decision; the Court then must wait 60 days to see if any nonparticipating party objects to the settlement. The Rule exists to provide the nonparticipating, though very affected, party one last shot to participate in final disposition of the case.

There’s no similar rule, however, where the case is litigated. Indeed, the equity interests are somewhat different here, since the Court is ultimately calling the shots. In this case, the participating parties did agree on the “language of the decisions”—which I take to mean the decision documents that will ultimately resolve this docket after Judge Holmes decided the substantive issues in 2017.

So, it appears, the parties and Judge Holmes felt that this nonparticipating party needed a chance to voice its opinion on this final decision. As such, the Court served the proposed decision on the partner (an estate), and issued an order to show cause why the Court shouldn’t enter that decision. They used the procedures in Rule 248(b)(4), and so provided the estate with 60 days to respond.

The estate responded and filed a motion for leave to intervene. Petitioner consented to the motion, but Respondent objected, arguing that the motion was untimely and otherwise inappropriate on the merits.

Judge Holmes finds that the motion to intervene was timely; it was timely made in response to the bespoke procedure that the parties created in this case to provide the estate with notice and an opportunity to respond. Even though the motion would be untimely under Rule 245 (which generally governs motions to intervene in TEFRA cases), Respondent had already agreed to these new procedures in this case.

On Respondent’s second argument, however, the estate loses. The estate sought to raise the very same argument that the Court had rejected when the participating parties brought it: that the statute of limitations on assessment barred any additional liability. Thus, Judge Holmes found that the estate didn’t qualify for mandatory intervention, as the participating partners had adequately represented the partners’ collective interests. Permissive intervention was, accordingly, also inappropriate, where relitigating that sole issue would “only further delay its conclusion.”

Lesser Known Nuances of Innocent Spouse Relief, Designated Orders 2/11/2019 – 2/15/2019

During the week of February 11, 2019, Judge Buch designated a bench opinion in an innocent spouse case that highlights some lesser known nuances of the conditions and factors analyzed (Docket No. 24737-17L, Traci Newburn v. C.I.R (order here)).

These nuances are likely not new to more seasoned practitioners but may be helpful for those starting out or those who have not handled many innocent spouse cases.

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The case itself involves a petitioner, the requesting spouse, who is a widow. Her late husband had a schedule C business that fixed and maintained the fire repression systems in commercial kitchen hoods and filters. Petitioner was not meaningfully involved in the operation of the business. The returns showed balances which were never paid, so petitioner requested equitable relief under section 6015(f).

Section 6015(f) requires the analysis of threshold conditions, and then a decision is made after analyzing the factors found in either the streamlined conditions or facts and circumstances test. The list of factors is found in Rev. Proc. 2013-34, but the Court routinely points out that it is not bound by the factors, only considers them to be guidelines and makes its decision based on the totality of the facts and circumstances. I won’t go on and reiterate all there is to know about innocent spouse relief, but instead focus on a few lesser known considerations addressed in the bench opinion.

The first lesser known nuances the Court identifies relate to one of the threshold conditions, specifically the seventh condition, which states, “absent certain enumerated exceptions, the tax liability from which the requesting spouse seeks relief is […] an underpayment resulting from the non-requesting spouse’s income.”

The nuances are found in the “enumerated exceptions.” While the record supports the fact that petitioner was not involved in the operation of the business, it is less clear whether petitioner had an ownership interest in the business because she was listed as a 50% owner on some of the tax returns. The Court points out that a requesting spouse may still meet the threshold condition if the ownership interest is solely due to the operation of community property law or was nominal. Petitioner and her late husband resided in a community property state, so the Court thinks that may be the reason for 50/50 ownership delineation listed on the returns. The Court also relies on petitioner’s testimony that she was not aware she owned an interest and was not involved in the business’s operations to decide that her ownership was nominal, and she satisfies this condition.

The next lesser known nuance is in the analysis of marital status, which is a factor found in the streamlined conditions and the facts and circumstances test. Generally, the factor favors relief if the requesting spouse and non-requesting spouse are considered not married due to divorce or legal separation. But where the non-requesting spouse has died, the requesting spouse is considered not married under Rev. Proc. 2013-34 if “the requesting spouse was not an heir to the non-requesting spouse’s estate that would have had sufficient assets to pay the liability.”

The Court here notes that the estate did not have sufficient assets to pay the liability, and therefore, petitioner is treated as not being married for purposes of the marital status factor.

The Court moves on to analyze the knowledge factor (which is also a factor found in the streamlined conditions and in the facts and circumstances test.) The knowledge factor is applied differently depending on whether the case involves an understatement or an underpayment. There can be cases where both an understatement and an underpayment are at issue, and in such cases both knowledge tests must be applied. In addition, the knowledge factor can be satisfied either with actual knowledge or a reason to know.

This case is an underpayment case, so the analysis is whether petitioner had knowledge or reason to know the balance would not be paid. The Court finds that petitioner did not have actual knowledge about whether the balance would be paid but did have reason to know it would not be paid. She had reason to know because she knew that she and her husband were experiencing financial difficulties around the time the returns were filed. They had recently sold their house in a short-sale and cut back on household expenditures.

The final nuance is found in compliance (which is only a factor in the facts and circumstances test). Compliance isn’t simply filing all required tax returns, but the compliance must also be in good faith. Filing several years’ worth of returns right before the trial, like petitioner did, is not complying in good faith.

After reviewing the above-mentioned factors, their lesser known nuances and examining the totality of the facts and circumstances, the Court denies petitioner relief in the designated bench opinion.

The Disappointed “Whistleblower” Tries Again

Docket No. 8179-17W, Robert J. Rufus v. C.I.R. (order here)

The last time we saw Mr. Rufus was in July of 2018 (see my previous post on this case here), when the Court granted summary judgment to the IRS. But the ever-persistent petitioner and his counsel are back with a motion to reconsider part of his case related to his supplemental claim.

The supplemental claim was about amended returns that the target filed, on which the target claimed bad debt deductions. With respect to this claim, the IRS’s position was that they “had not proceeded with an administrative or judicial action based on petitioner’s information.” This was determined by the administrative record and found not to be an abuse of discretion in the original opinion.

In support of his motion for reconsideration, petitioner argues several things, including that the Court made a substantial factual error, petitioner did not have enough opportunity to engage in discovery and that the information he provided was not tainted.

While petitioner argues he was still in the process of discovery when summary judgment was granted, he does not argue that he has newly discovered evidence – which would have potentially helped his motion for reconsideration. The Court takes issues with the fact that petitioner (who is, again, represented by counsel) did not raise this issue when responding to the IRS’s motion for summary judgment, so it finds he cannot raise it now.

The Court finds petitioner’s second referenced argument to be irrelevant. The revenue officer mistakenly thought the information petitioner provided was tainted so she documented the fact that she did not audit the return based on that information. The Court finds that this supports IRS’s argument, and does not support granting a motion for reconsideration – which puts an end to petitioner’s hope for a whistleblower award in this case.

The three remaining orders designated during the week of February 11 were all designated by Judge Carluzzo. In one order he denies the IRS’s motion to compel the production of documents because he surmises that petitioners’ failure to respond means they don’t have the substantiation required for their case, so compelling them to produce it will not change anything (here). In another order (here) he reinforces the Court’s arguably incorrect stance that a notice of determination is jurisdictional and not subject to equitable tolling  (see my previous post on this topic here). And in the final designated order, Judge Carluzzo grants the IRS’s motion to dismiss for lack of jurisdiction in a case where the petition was filed three years late with audit reconsideration documents attached (here).

Getting To Summary Judgment: The Art of Framing the Issue as a Matter of Law. January 28 – February 1 Designated Orders (Part One)

We welcome Professor Caleb Smith from the University of Minnesota writing today about designated orders that might also have been Tax Court opinions.  Each of the three case he discusses has a meaty order deciding the case at the summary judgment stage.  These opinions cause me to wonder what distinguishes a case when it comes to writing an opinion which will get published and one that will not.  Parties researching the issues presented here will need a significant amount of diligence to find the Court’s orders in these case.  Having gone to significant effort to reach the conclusions in these cases, it would be nice for the Court to find a way to make its thinking more transparent.  Keith

There was something of a deluge of designated orders after the shutdown, so in order to give adequate time to each (and to group them somewhat coherently) I decided to break the orders into two posts. Today is post one, which will focus on some of the interesting summary judgement orders.

At the end of January there were three orders involving summary judgment that are worth going into detail on as they bring up both interesting procedural and substantive issues. However, in keeping with the theme (and title) of this blog, focus will mostly be kept on the procedural aspects. Those interested in the underlying substantive law at issue would also do well to give the orders a close read.

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Big Value, BIG Tax? H R B-Delaware, Inc. & Subsidiaries v. C.I.R., Dkt. # 28129-12

We begin with how to get summary judgment in the rarest of places: a valuation question. Judge Holmes begins the order with a note almost of incredulity on the petitioner’s motion for partial summary judgment: “The motion calls for the application of old case law to a half-century old contract, and seeks a ruling that there is no genuine dispute about a material fact — valuation of intangible assets — that is only rarely capable of decision through summary judgment.”

So, how do you get to summary judgment on a valuation issue -which by default tends to be a “material fact” at issue between the parties? Argue that the real material facts are already agreed upon such that a particular value results as a matter of law. How that works in this case is (briefly) as follows:

The “H R B” in petitioner’s caption is referring to the well-known tax preparation service H&R Block -and more specifically, the franchisees of national H&R Block. (Also for your daily dose of tax trivia, H&R Block apparently stands for/is named after Henry and Richard Bloch.) That the petitioners are franchisees of H&R Block is important because the case pretty much entirely deals with the valuation of franchise rights. At its core, the IRS is contending that the franchise rights of petitioner were worth about $28.5 million as of January 1, 2000, and the petitioner is arguing their franchise rights were worth… $0.

The valuation of the franchise rights on January 1, 2000 matters (a lot) because the petitioner converted from a C-Corp to an S-Corp effective of that date. I don’t deal with these conversions in practice (ever), but one of the lessons imprinted upon me from Corporate Tax lectures was that you can’t just jump back-and-forth without tax consequences. In particular, when you convert from subchapter C to subchapter S, you may contend with “unrecognized built-in gain (BIG)” consequences under IRC 1374(d)(1) later down the line. Essentially, you may have “BIG” tax if (1) at the time you convert from C to S you have assets with FMV in excess of your adjusted basis and then (2) you sell those assets within 10 years of conversion. Here, petitioner converted from C to S in 2000, and then sold all its assets back to H&R Block (national) in 2008 (i.e. within 10 years of conversion).

Petitioner reported BIG tax of roughly $4 million on the 2008 return, which apparently included tax on the franchise rights self-report to be worth at about $12 million. But the IRS did the favor of auditing the H&R Block franchisee, which led to a novel realization during litigation: the tax return was wrong in valuing the franchise rights at almost $12 million. It should have been $0.  In other words, petitioner may have vastly over paid their taxes.

Back to the procedural aspects. How do we get to summary judgment on this valuation issue? The IRS argues you can’t because what we are dealing with (valuation) is a contested factual determination. Essentially, this implies that wherever valuation is at issue summary judgment is de facto inappropriate.

Petitioner, on the other hand, argues that the valuation at issue here (of the franchise rights) flows as a matter of law from the undisputed facts as well as some rather old case law. Specifically, petitioner points to Akers v. C.I.R., 6 T.C. 693 (1946) and the slightly more modern Zoringer v. C.I.R., 62 T.C. 435 (1974). Petitioner argues that under these cases (1) where an intangible asset is nontransferable, and (2) terminable under circumstances beyond their control, and (3) the existing business is not being transferred to a third party, the value of the intangible asset is $0 as a matter of law. Because the undisputed facts (namely, the contract in effect at the time of the conversion) show elements one and two, and because this case does not involve the transfer of the business to another party, the value of the franchise rights must be $0.

And Judge Holmes agrees. There can be no genuine dispute about the value of the franchise rights based on the undisputed facts and controlling law. Summary judgment is therefore appropriate. A BIG win for the petitioner in what appeared to be an uphill battle.

There is, frankly, a lot more going on in this case that could be of interest to practitioners that deal with valuation issues, BIG tax, and the like. But, as someone that focuses on procedure, I want to make one parting observation on that point. Although petitioner’s counsel did a wonderful job of researching the applicable tax law, note how the pre-litigation work also plays a large role in this outcome.

As a sophisticated party with a high-dollar and complicated tax issue, there is no doubt in my mind that this case resulted only after lengthy audit (the tax at issue, after all, is from 2008 and the petition was filed at the end of 2012). One of the things that (likely) resulted from the audit was a narrowing of the issues: it wasn’t simply a disagreement about petitioner’s intangible assets broadly, it was a disagreement about the franchise rights specifically. This is critically important to the success of the summary judgment motion.

One argument the IRS raises is that the motion should fail because it isn’t clear which intangible assets are even at issue (the petition just assigns error to the valuation of the intangible assets broadly). But petitioner is able to point to the notice of deficiency and Form 886-A that resulted from the audit, and which clearly states that the dispute is about the value of the “FMV of the Franchise Rights.” In other words, the IRS only put the franchise rights as the intangible asset at issue in the notice of deficiency, so it is necessarily the only intangible asset at issue in the case (barring amended pleadings from the IRS). And, for all the reasons detailed above, the franchise rights have a value that can be determined to be $0 as a matter of law, thus allowing for summary judgment.

Consistency in Law, or Consistency in Fact?: Deluca v. C.I.R., Dkt. # 584-18

In Deluca the Court is faced with another motion for summary judgment by the petitioner, again involving fairly convoluted and fact-intensive law: tax on prohibited transactions under IRC 4975. In the end, however it isn’t IRC 4975 that plays a starring role in the order, but the statute of limitations on assessment and an ill-fated IRS argument about the “duty of consistency.”

The agreed upon facts are fairly straightforward. Petitioners established a regular IRA, and then converted it to a Roth in 2010. The Roth IRA maintained an account with “National Iron Bank” presumably in Braavos (just kidding). The Roth IRA repeatedly made loans to petitioner from 2011 – 2016. Unfortunately, loans between a Roth IRA and a “disqualified person” are a big “no-no.” See IRC 4975(c)(1)(B) and IRC 4975(e)(2). When the creator and beneficiary of an IRA engages in a prohibited transaction the IRA essentially ceases to be. See IRC 408(e)(2)(A). Since petitioner definitely engaged in prohibited transactions in 2014, the IRS issued a notice of deficiency for that tax year finding a deemed distribution from the Roth IRA of almost $200,000.

Those of you paying close attention can probably see where the issue is. The first prohibited transaction took place in 2011. An IRA is not Schroedinger’s Cat: it either is or isn’t. In this case, it ceased to be in 2011, which is when the distribution should have been taxed. Presuming there was no fraud on the part of the petitioners (and that they mailed a return by April 15, 2012), the absolute latest the IRS could hope to issue a Notice of Deficiency for that tax year would be April 15, 2018 (i.e. six years after the return was deemed filed, if it was a substantial omission of income: see IRC 6501(e). We are currently in 2019, so this spells trouble for the IRS.

But perhaps the IRS can avoid catastrophe here, in what appears (to some) to be an unfair result. The petitioners were never taxed on the prohibited transaction that took place in 2011 (they did not report it on their return), and now they are taking the position that the transaction took place then? What about consistency? Maybe the IRA is like Schrodinger’s cat after all: not really dead, but not really alive, but somewhere in-between because no one thought to look into it until 2014?

Fairness and the duty of consistency certainly seem to go hand-in-hand. The Tax Court has described the “duty of consistency” as “based on the theory that the taxpayer owes the Commissioner the duty to be consistent in the tax treatment of items and will not be permitted to benefit from the taxpayer’s own prior error or omission.” Cluck v. C.I.R., 105 T.C. 324 (1995). Generally, the elements of a taxpayer’s duty of consistency are that they (1) made a representation or reported an item for tax purposes in one year, (2) the IRS relied on that representation (or just let it be), and (3) after that statute of limitations on that year has passed, the taxpayer wants to change their earlier representation. Id. In Deluca, the IRS may argue the taxpayer (1) represented that the IRA still existed/that there was no prohibited distribution in 2011 (or any year after), (2) the IRS acquiesced in that position by leaving the earlier returns unaudited, and (3) only now that the ASED has passed does the taxpayer say there was a prohibited transaction. Seems like a reasonable argument to me.

Alas, it is not to be. Under the Golsen rule, because the case is appealable to the 2nd Circuit, that court’s law controls. The Second Circuit has held (way back in 1943, in an opinion by Judge Hand I find somewhat difficult to parse) that in deficiency cases the duty of consistency only applies to inconsistencies of fact, not inconsistent positions on questions of law. Bennet v. Helvering, 137 F.2d 537 (2nd Cir. 1943). Why does that matter? Because summary judgment is all about framing the issue as a matter of law, not fact.

Was Petitioner inconsistent on a matter of fact or a matter of law? On all of the returns (and in repaying the loans to the IRA) petitioner has appeared to have treated the IRA consistently as being in existence. Petitioner, in other words, has consistently behaved as if the “fact” was that the IRA was in existence. Because of the intricacies of IRC 408 and 4975, however, that fact was mistaken (even if treated consistently). As a matter of law the IRA ceased existing in 2011. And (apparently) petitioner is free to presently take the legal position that the IRA ceased existing in 2011 while also implicitly taking the (inconsistent) position that it did exist on that tax return.

If your head is spinning you are not alone.

However, if this appears to be an unfair result and sympathize with the IRS’s position, there is at least some concern to be aware of. Judge Thornton succinctly addresses one issue lurking behind the IRS’s position: “To adopt respondent’s position would essentially mean rewriting the statute [IRC 408(e)(2)] to postpone the consequences of prohibited transactions indefinitely into the future, depending on when the IRS might happen to discover them.” In other words, the cat would be neither alive or dead until and unless the IRS decided to take a look. The duty of consistency would almost write the assessment statute of limitations out of existence under such a reading.

Uncharted Waters of International Law: Emilio Express, Inc. Et. Al, v. C.I.R., Dkt. 14949-10

Two wins on two taxpayer motions for summary judgment: might the government go 0 for 3? As a matter of substantive law, Emilio Express, Inc. is probably the most compelling order of the three. It is also the only one where the IRS makes a cross-motion for summary judgment -and wins.

The substantive law at issue is well-beyond my expertise (I’m not in the “international-tax cloister” that Judge Holmes refers to while helpfully describing what “competent authority” means). I highly recommend that those who so cloistered, and particularly those that regularly work with Mexican tax issues, give this order a closer look. It appears to be an issue of first impression.

But, again in keeping with the procedural focus of this blog, we will focus on the cross motions for summary judgment. Again, we will look at the framing of the motions, and the facts established to understand why the petitioner’s motion for summary judgment was doomed, and the IRS’s was ultimately successful.

The consolidated cases in this order involve a C-Corporation (later converted to S-Corp.) “Emilio Express” as well as individual tax return of the sole shareholder, Emilo Torres Luque. Mr. Torres was a Mexican national and permanent resident of the United States. Mr. Torres did essentially all of his business moving cargo between Tijuana and southern California -the latter being where he appeared to live.

The gist of the issue is that the petitioner is arguing he owes no US Tax because he was (1) a resident of Mexico under the terms of the relevant US-Mexico treaty, (2) Mexico accepted his tax returns as filed for the years at issue, and (3) on their understanding of the treaty, their income should only be taxed by Mexico (in whatever amount Mexico determines) and not “double-taxed” by the US. Apart from needing to be correct on their understanding of the substantive law, for petitioner to prevail this motion for summary judgment they would have to show that there was no genuine issue of material fact.

The factual questions surrounding Petitioner’s residency matters because it is critical to how they frame the legal argument: as their argument goes if their residency is in Mexico, then the fact that Mexico accepted their tax returns means they are not subject to US income tax. The immediate problem is that determining their residency is a highly factual inquiry, with a lot of contested aspects. Everyone is in agreement that under the terms of the treaty petitioner is a “resident” of both the US and Mexico. There are additional rules under the treaty for determining “residency” where the taxpayer is, essentially, a dual-resident. Here, the petitioner needed to show that he had a “permanent home” in Mexico. Unfortunately, there was a legitimate question about exactly that matter raised by the IRS. And since that was a material fact that would need further development, petitioner’s summary judgment motion can be disposed of without even getting to whether the law would be favorable.

So how does the IRS prevail on a summary judgment motion if, as just stated above, there was a genuine issue on material fact? Because the IRS’s (winning) argument makes that fact (residency) immaterial.

As the IRS frames the issue, the residency of the petitioner (Mexico or US) is irrelevant: the law at issue really just concerns whether the individual is subject to double-taxation. In this case, the petitioner had no Mexican tax liability (the accepted returns had a $0 liability) so regardless of residency under the treaty, petitioner could be subject to US tax. The thrust of the treaty is all about double-taxation, which is the key issue here and can be resolved (based on the other agreed-upon facts) without delving into whether or not the petitioner owned a home in Tijuana. He didn’t owe Mexican tax under Mexican law. He does owe US tax under US law. Case closed.

All very interesting stuff. Again, if you work with international tax (and particularly Mexican-American tax) I recommend giving the order a closer look for the substantive issues at play.

Designated Orders: Bench Opinions and the Designated Orders Panel (12/24/18 to 12/28/18)

With the holidays and the beginning of the government shutdown, there were not many designated orders during the week of December 24 to December 28, 2018. In fact, Judge Carluzzo provided our lone orders, two bench opinions from Los Angeles to close out the year. Both of these bench opinions involve petitioners that seem to try Jedi mind tricks to convince the IRS that a letter they sent is actually different than what it appears to be.

Since it is a light week, I am also going to give an account of the designated orders panel from last month’s Low Income Taxpayer Clinic (LITC) grantee conference.

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Bench Opinion 1

Docket Nos. 10878-16 and 7671-17, Luminita Roman, et al., v. C.I.R., available here.

Luminita and Gabriel Roman, the petitioners, appeared unrepresented in Tax Court and Luminita spoke on their behalf. Their argument is that the notices of deficiency issued to them were not valid and the Tax Court does not have jurisdiction in their cases. In fact, neither notice of deficiency was valid because they were not authorized by an individual with the authority to issue the notices of deficiency. In their view, each notice was generated by a computer, and computers have not been delegated authority by the Commissioner to issue notices of deficiency. The petitioners cited Internal Revenue Manual provisions as support. Judge Carluzzo states: “In that regard, we wonder if petitioners are confusing the authority to issue a notice of deficiency with the mechanical process of preparing, creating or printing one, but we doubt that we could convince petitioners to recognize that distinction.”

Judge Carluzzo goes through the analysis, noting the necessity for a valid notice of deficiency for Tax Court jurisdiction. Next, he states that the lack of a signature does not invalidate a notice of deficiency and the notices in question were issued by offices or officers of the IRS authorized to do so. Overall, the petitioners failed to meet their burden of proof that the notices of deficiency were invalid and their motions must be denied.

Takeaway: This was a bad argument to make in Tax Court. Without any proof that a notice of deficiency is invalid, an argument like this is a long shot at trying to stop the IRS. It is better to argue the deficiency or other merits of the case than to make a claim that a notice issued by the IRS is invalid because they used computers.

Bench Opinion 2

Docket No. 25370-17SL, Roy G. Weatherup & Wendy G. Weatherup v. C.I.R., available here.

The petitioners appeared unrepresented in Tax Court, though Roy Weatherup is an attorney. As background, the Weatherups made payments on a tax liability for tax year 2012. After financial hardships, they submitted an Offer in Compromise that was rejected. During the period when the offer was pending, the couple continued to make payments on the liability. Following the rejection letter, the IRS issued a notice that their 2012 liability was subject to levy. The liability amount listed in that notice was computed as though the offer had not been accepted.

The Weatherups were eligible to request a Collection Due Process (CDP) hearing and did so. In the hearing, they took the position that their liability was fully paid due to the Offer in Compromise they submitted. They state the rejection letter does not satisfy the requirements of Internal Revenue Code section 7122(f). Since their view was that the offer was not rejected within 24 months from the date of submission, the offer was deemed accepted. In their view, the IRS rejection letter was only a preliminary rejection letter.

In their view, the rejection failed to take into account their financial hardship at the time and was otherwise inequitable, leading to an abuse of discretion. Even though they were invited to do so by the settlement officer, they chose not to submit a new Offer in Compromise.   They also did not propose any other collection alternative to the proposed levy.

Judge Carluzzo finds that the rejection letter meets the requirements of IRC section 7122(f) and was issued within the requisite 24-month period. He disagreed that it was a preliminary rejection letter because it meets the specifications of a rejection letter for an offer.

Since their offer was rejected, the liability remained with the IRS. Because the petitioners did not provide an alternative during the CDP hearing, there was nothing further to review. The expectation that the settlement officer would review the Offer in Compromise was misplaced as that was not the subject of the CDP hearing.

Judge Carluzzo granted the IRS motion for summary judgment, noting that the Weatherups would still be eligible to submit a new Offer in Compromise.

Takeaway: Again, the petitioners have taken an incorrect view of IRS procedure and based their arguments in Tax Court around it. While the IRS does issue preliminary determinations in innocent spouse cases, those are clearly designated “PRELIMINARY DETERMINATION.” The IRS does not issue such notices regarding an Offer in Compromise so it is an error to expect one there. Even if the IRS had issued a preliminary rejection letter for their offer, why did the Weatherups then act as if the liability disappeared? This is another case where the petitioners needed to get their facts straight before they presented their arguments to the judge.

The Designated Orders Panel at the LITC Grantee Conference – December 4, 2018

For the LITC Grantee Conference, both Samantha Galvin and I were contacted to present on “Recent U.S. Tax Court Designated Orders.” Since that was half of the group that rotates through the blog postings on this website, we contacted Caleb Smith and Patrick Thomas to see if they would like to be included on the panel. Caleb was busy with organizing and moderating for the Low-Income Taxpayer Representation Workshop that would take place the day before the panel, but Patrick Thomas agreed to join the panel to discuss designated order statistics that he previously wrote about on this site here.

Keith Fogg introduced the panel, speaking about the nature of designated orders and the decision to start featuring designated order analysis on Procedurally Taxing since no other venues were paying attention to designated orders. Samantha and I alternated the beginning portions with Patrick finishing on the statistical analysis.

I began by introducing the designated orders group and Samantha talked about the nature of designated orders, comparing them with non-designated orders and opinions. She next spoke about the limited availability of designated orders through the Tax Court website (possibly available 12 hours on the website and then no longer searchable as a designated order) and showed the audience where the orders are available on the website.

Samantha spoke about lessons for taxpayers, saying that they should avoid being tax protesters because of potential section 6673 penalties. Also, taxpayers should respond in a timely fashion and they bear the burden of proof for deficiency and CDP cases.

I followed up on Samantha’s lessons for taxpayers. I reminded the group that the Tax Court does not have jurisdiction over petitions that are not timely filed. I talked some about nonresponsive petitioner issues as I had here. Basically, petitioners that do not know court procedure and represent themselves in court are likely doing themselves a disservice. Petitioners also need to respond to court filings, substantiate their claims and have organized documents to submit to the IRS. I used some examples from recent designated orders for actions petitioners should avoid.

Next, Samantha turned to lessons for IRS and taxpayer counsel, looking at motions for summary judgment (following Rule 121, that there must be a genuine dispute of material fact to defeat the motion, with a reminder that the motions can be denied). She reminded the audience that communication between the parties is key, and that developing a comprehensive administrative record by writing letters to Appeals with everything discussed about the case is a helpful practice. Finally, it is best to follow informal discovery procedures and to treat a motion to compel as a last resort.

I tried to give a capsule judicial history of Graev v. Commissioner and Chai v. Commissioner, touching on the IRS penalty approval process. I noted that Judge Holmes gave factors for the standard for reopening the record which are that 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 prejudice to the non-moving party.

Two months later, Judge Halpern used different factors. He stated the factors the Court has to examine to determine whether to reopen a record are the timeliness of the motion, the character of the testimony to be offered, the effect of granting the motion, and the reasonableness of the request. The third factor, the effect of granting the motion, is the most relevant.

It was my question why there are two different sets of factors the Tax Court uses to determine whether to reopen a record in these IRS penalty approval cases.

I also provided the standard for whistleblower cases, noting that the petitioners are not very successful in succeeding at Tax Court. 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.

Patrick then discussed the designated orders statistical analysis project. The project reviewed 525 unique orders between May 2017 and October 2018 (623 total orders, with duplicate orders in consolidated cases). During the presentation he spoke about the utility of designating orders (such as the speed to designate an order compared to publishing an opinion). From there, he looked at which judges predominantly use designated orders and the types of cases and issues conducive to designated orders. Patrick focused on a one year period (4/15/17 to 4/15/18), with 319 unique orders. For the breakdown regarding types of cases, judges and more, I recommend you go to the link above to view Patrick’s work.

Patrick had several takeaways to conclude the panel. First, a substantial number of judges (13) do not designate orders or seldom designated orders. Do those judges substantially issue more opinions? Are their workloads substantively different from those who issue more designated orders?

Second, three judges (Gustafson, Holmes and Carluzzo) accounted for nearly half of all designated orders. Why is there such a disparity between these judges and the rest of the Court?

Third, judges issued only 112 bench opinions during the research period. That was a small amount compared with the overall number of cases (2,244 cases closed in April 2018 alone). Of the 112 bench opinions, only 26 (23%) were designated. Judges might consider designating those orders so they highlight their bench opinions to the public.

Last, there is a disparity between small cases on the docket (37% of all cases) and designated orders in small tax cases (12.85% of all designated orders). Are small cases simply too routine and less deserving of highlighting to the public?

Later in the week, we found out more information from the judges themselves. There is a process when submitting a Tax Court order electronically where a judge selects that the order becomes designated. Some judges find the process more expedient than the published opinion process. One judge I spoke with did not find too much value in our study of designated orders but was glad we were able to gain from the process.