Third-Party Production of Tax Returns

When must a third party produce in litigation a federal tax return that it possesses? This question has risen to the attention of national media in recent months, as litigants in multiple ongoing lawsuits currently seek the production of President Trump’s tax returns. For example:

  • See Trump v. Vance, ___ F.3d ___, 2019 WL 5687447 (2d Cir., Nov. 4, 2019) (affirming the District Court’s refusal to enjoin enforcement of a grand jury subpoena from the Manhattan District Attorney directed to President Trump’s accounting firm)
  • See also Trump v. Mazars USA, LLP, 940 F.3d 710 (D.C. Cir., Oct. 11, 2019) (upholding as valid and enforceable a legislative subpoena issued by the House Committee on Oversight and Reform to President Trump’s accounting firm)
  • Trump v. Deutsche Bank AG, 2019 WL 2204898 (S.D.N.Y., May 22, 2019) (denying motion for preliminary injunction to prevent Deutsche Bank AG and Capital One from complying with a legislative subpoena from the House Committee on Financial Services and the Permanent Select Committee on Intelligence)
  • Committee on Ways and Means, U.S. House of Representatives v. U.S. Dep’t of the Treasury, Docket No. 1:19-cv-01974 (D.D.C.) (ongoing litigation seeking President Trump’s tax returns and related IRS administrative files from Treasury)

These cases deal with weighty issues of the separation of powers, executive privilege, and with the Vance decision, the appropriate balance of power between federal and state government.

Stripping all of those weighty issues away still leaves us with serious private concerns. Section 6103 provides that the government must keep a tax return confidential (subject to numerous exceptions). The public, writ large, generally thinks of returns as private, confidential documents. So when must a third party (for example, a tax return preparer, accounting firm, or tax attorney) produce a tax return?

In this post, Matthew Bradley, a 3L at the Notre Dame Law School, walks us through the recent (albeit less widely covered) case of Anyclo International v. Cha out of the U.S. District Court for New Jersey. His writeup nicely captures the competing privacy and informational concerns and how the District Court balances them. – Patrick

Litigation is usually driven by one thing—money. Because of this driving force, the financial situation of the defendant is frequently at issue—after all, you can’t get blood out of a turnip. One way to learn a bit more about the defendant’s financial status is to read their tax return. Since a return can be a great source of very personal information it is no surprise that litigants are not usually willing to turn over a copy of the document to their adversary. Then again, litigants are not usually willing to turn anything over to the other side. So, the question becomes when a discovery request for tax returns is permissible. The remainder of this post will look at the procedure of getting such a return and will draw on the recent case of Anyclo v. Cha, No. 18-5759, 124 AFTR 2d 2019-5203 (D.N.J. Sept. 3, 2019), for purposes of illustration.

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Anyclo International is a clothing manufacturer that markets its clothing to the United States. It hired Cha to market its products to the New York metropolitan area. Cha and Anyclo decided that Anyclo should have a branch office in the US, so they decided to form a corporation in New York that would be wholly owned by Anyclo. Anyclo wired Cha $10,000 for seed money to start the office, and Cha told Anyclo that he had successfully incorporated the business as a New York corporation. According to the complaint, Cha submitted fictitious documents to Anyclo in order to show operating costs and requested reimbursement for such expenses. Additionally, the complaint alleges that Cha skimmed (or otherwise withheld) money received from purchasers before sending the funds to Anyclo headquarters.

On March 26, 2019, Daniel Cho (the defendant’s CPA) was subpoenaed. The subpoena commanded the production of “[a]ll communications (electronic and otherwise) with [the defendants] as it relates to Anyclo USA, Inc. and/or Mojo Moto, LLC. Copies of all documents prepared for the benefit of [the same].” Counsel for the defendants moved to quash the portion of the subpoena that would require the disclosure of the personal tax returns of the individual defendants. In the motion to quash, defense counsel argued that the “court should not authorize disclosure solely because the credibility of the defendants may be impeached. A defendant’s credibility is at issue in almost any case. If the Court accepts that the tax returns could adversely affect credibility, then in almost every case a party’s tax information would be discoverable. This would . . . constitute an unreasonable intrusion into a defendant’s privacy.” Defense counsel also explained that “the Plaintiff’s own records can be the source of its prima facie proof of loss.”

In its response to the motion to quash, Plaintiff’s counsel noted that the defense’s theory is, at least partially, based on the entitlement of the Defendant to certain monies as compensation. According to the Plaintiff’s counsel: “Given that YS Cha’s entire defense in this matter is based upon an accounting of his personal income and business expenses, his tax returns are clearly relevant. . . . Indeed the individual tax returns of the Defendants will show how they classified these payments contemporaneously with the parties’ dealings. The entire crux of this matter is whether the monies received, transferred, and/or withheld by Defendants are stolen funds, rental payments, income, salary, reimbursements, or otherwise.”

This sequence of events set up the question for the United States District Court: When can production of a party’s tax return(s) be compelled under the rules of discovery?

Generally, the Federal Rules of Civil Procedure allow parties to “obtain discovery regarding any nonprivileged matter that is relevant to any party’s claim or defense and proportional to the needs of the case, considering the importance of the issues at stake in the action, the amount in controversy, the parties’ relative access to the relevant information, the parties’ resources, the importance of the discovery in resolving the issues, and whether the burden or expense of the proposed discovery outweighs its likely benefit.” FRCP 26(b)(1). The information sought does not need to be admissible to be discoverable. Id.

However, this broad discovery rule stands in stark contrast to IRC § 6103, which places limits on the disclosure of returns and return information. This section notes that such returns and return information “shall be confidential.” The section goes on to list the specific exceptions for when the government (or certain people who received the tax return from the IRS) can disclose such returns. However, of course, there is a difference between confidentiality and privilege.  Hanks v. Zenner, 2000 U.S. Dist. LEXIS 13201, *8 (W.D. La.) (“Although tax returns are not privileged documents, courts have been reluctant to order their routine disclosure as a part of discovery.”).  If tax returns were privileged, rather than merely confidential, they could not be compelled to be turned over. Moreover, IRC § 6103 proscribes only governmental disclosures of a tax return; in Anyclo, the plaintiff has requested that the taxpayer disclose his own return. 

Yet, despite the technical inapplicability of IRC § 6103 and the non-privileged nature of tax returns, courts are still reluctant to order their disclosure. The idea behind the reluctance is that unless confidentiality is guaranteed, taxpayers are less likely to accurately report all of their taxable income or to claim all legally available tax benefits. De Masi v. Weiss, 669 F.2d 114, 120 (3d Cir. 1982) (citing Payne v. Howard,75 F.R.D 465, 469 (D.D.C. 1977)).

When a court considers whether to compel disclosure of a tax return, it conducts a balancing test. On one side, the court weighs the privacy interest of the individual whose returns are in question. On the other side, the court is “required to balance a number of factors, including plaintiff’s need for the information, its materiality, and its relevance.” Id. Unfortunately, balancing tests are rarely easy to understand and generally cannot be applied in a mechanical fashion. This impediment is yet another reason why discovery costs so many resources, particularly money and time.

Because there are not many reported cases to establish the procedure when a tax return is sought, we turn to how the United States District Court for the Eastern District of Pennsylvania handled the issue. This case is not properly considered to be a seminal case with regard to the issue, but it provides a bit of guidance in the absence of well-established case law. In it, the court begins its analysis with two questions: (1) is the tax return relevant to the subject matter of the action; and (2) is there a compelling need for the return because the information is not otherwise readily obtainable. Jackson v. Unisys, Inc., 2009 U.S. Dist. LEXIS 121716, *4-5 (E.D.P.A. 2009). “The party seeking the discovery at issue bears the burden of establishing its relevance . . . while the party resisting discovery bears the burden of establishing other sources for the information.” EEOC v. Princeton Healthcare Sys., 2012 U.S. Dist. LEXIS 65115, *61-62 (D.N.J. 2012) (citing Jackson v. Unisys, Inc., 2009 U.S. Dist. LEXIS 121716 (E.D.P.A. 2009).  Even if it is demonstrated that the tax returns contain some relevant information, they “are protectable from discovery as confidential documents if the party seeking protection demonstrates good cause to uphold its expectation of confidentiality, as well as the availability of reliable financial information from other sources.” Farmers & Merchants Nat’l Bank v. San Clemente Fin. Group Sec., 174 F.R.D. 572, 585 (D.N.J. 1997). Accordingly, “[w]here the taxpayer has placed . . . financial information into dispute, the tax returns may contain relevant information. The probative value of such information must be weighed against the policy of confidentiality of tax return information, taking into account the alternative sources from which reliable financial information may be obtained.” Id. (internal citations omitted).  

Once relevancy of the tax return is established, the court will turn to the question of whether there is a compelling need for the return. “Good cause for the production of income tax returns is not shown when the movant has the information sought or can obtain it with little difficulty through other methods.” EEOC at *62 (citing Blakey v. Continental Airlines, 1997 U.S. Dist. LEXIS 22067 (D.N.J. 1997)). One way a subpoena for a tax return might be defeated on this element is by providing other documents, such as copies of W2s or 1099s, to the party seeking the subpoena. This can allow reconstruction of tax returns with less sensitive information (e.g., no social security numbers of children, no non-relevant income, etc.).

Overall, the party seeking to obtain the tax return is facing an uphill battle. Courts are quite reluctant to grant the request if there is any feasible way of obtaining the information needed that does not require the disclosure. In Anyclo, however, the Court held that “Defendants’ tax returns are relevant” because “the contemporaneous treatment of monies allegedly paid to support [Anyclo’s branch office’s] business operations on Defendants’ individual tax returns may support or undermine each parties’ contentions.” Anyclo, slip op. at 5.Further, the court found that “it does not appear . . . that the same information discoverable in Defendants’ individual tax returns is discoverable by other means.” Id. Accordingly, the court denied the defense motion to quash.

So, what is the lesson to learn from this case? In short, it is that tax returns are protected from discovery but not immune from it if one can prove (1) relevancy and (2) a compelling need. Of course, the procedural protection afforded to tax returns is given on the back side (a subpoena has to be challenged). Perhaps it would be better to provide this protection at the front end and require a motion to be made to the court beforehand (much like a request for a mental or physical examination under Rule 35). Such a requirement would help protect unsophisticated litigants from intrusive discovery. Yet, that is not the rule. If you have the resources to challenge a subpoena, you might very well win, but there is no absolute guarantee of protection. 

A Journey Through Rule 81(i) – Designated Orders: August 19 – 23, 2019

There were only four orders this week. The first and most interesting order explores Rule 81, which governs the taking and use of depositions in the Tax Court. Two CDP orders and a tax protester in a deficiency case round out this week’s orders.

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Docket  Nos. 16634-17L, 15789-17, Raley v. C.I.R. (Order Here)

This short order from Judge Buch strikes from the record Respondent’s lodging of a document entitled “Respondent’s Designation of Deposition Testimony To Be Used At Trial.” Judge Buch characterizes Respondent’s filing as “an attempt to put into the evidentiary record of this case a deposition of a non-party taken pursuant to a stipulation under Rule 81(d) . . . .” For those practitioners who don’t often take depositions in cases before the Tax Court (myself included), a brief review of Rule 81 is called for.

Rule 81 provides that a party may take depositions only where (1) the parties agree to do so under Rule 81(d), or (2) the party seeking the deposition applies for permission from the Court under Rule 81(b). Compared to Rule 30 of the Federal Rules of Civil Procedure, which requires an application only in limited circumstances, the Tax Court has much more discretion under its Rules to allow an unconsented deposition. But here, the parties stipulated, and so didn’t need Court permission to take the deposition.

Now we have a deposition. But what can we do with it? Rule 81(i) governs use of the deposition in the Court. Rule 81(i) is analogous, but not identical, to FRCP 32.

At the trial . . . any part or all of a deposition, so far as admissible under the rules of evidence applied as though the witness were then present and testifying, may be used against any party who was present or represented at the taking of the deposition or who had reasonable notice thereof, in accordance with the following provisions:

1. The deposition may be used by a party for the purpose of contradicting or impeaching the testimony of the deponent as a witness;

2. The deposition of a party may be used by an adverse party for any purpose;

3. The deposition may be used for any purpose if the Court finds: (A) That the witness is dead; (B) that the witness is at such a distance from the place of trial that it is not practicable for the witness to attend, unless it appears that the absence of the witness was procured by the party seeking to use the deposition; (C) that the witness is unable to attend or testify because of age, illness, infirmity, or imprisonment; (D) that the party offering the deposition has been unable to obtain attendance of the witness at trial, as to make it desirable in the interests of justice, to allow the deposition to be used; or (E) that such exceptional circumstances exist, in regard to the absence of the witness at the trial, as to make it desirable in the interests of justice, to allow the deposition to be used.

So, to summarize, the deposition may be used in three circumstances: (1) impeaching the deponent as a witness at trial; (2) for any purpose, if the deponent is a party; and (3) purposes related to the unavailability of a witness at trial, including death, distance, inability to attend or compel attendance, or other exceptional circumstances.

Here, Respondent, according to Judge Buch, simply attempted to put the entire deposition into the record. That won’t work, because Respondent didn’t even identify how Respondent intended to use the deposition. Without at least this, the Court has no basis to determine whether the deposition will be permissibly used under Rule 81(i).

Respondent’s counsel didn’t take this lying down. A week later, Judge Buch issued a subsequent order in this case. The parties held a conference call with Judge Buch, and explained that the deponent would be unavailable for trial—one of the reasons a deposition can be used, for any reason, under Rule 81(i)(3). Judge Buch accordingly vacated the August 21 order, retitled Respondent’s filing of the deposition as a “Motion Under Rule 81(i),” and ordered the parties to stipulate to the admissibility of so much of the deposition as possible. That stipulation was filed on September 6, and the Court accordingly granted Respondent’s motion under Rule 81(i) on September 18.

Docket  Nos. 5227-18L, 4986-18L, Koham v. C.I.R. (Order Here)

This CDP case from Judge Buch involves petitioners who don’t appear sympathetic. The liability arose from the taxpayer’s self-assessment of income tax liabilities on returns they filed for 2013 and 2014. The taxpayers filed an OIC, but listed “patently excessive” expenses (e.g., $9,500 for housing expenses). In the interim, the Service filed a NFTL, and so Petitioners elected to pursue the OIC through the CDP procedures.

The settlement officer calculated a monthly net income for the taxpayers of $987, after reducing their monthly expenses to the IRS collection standards amounts. The SO found a reasonable collection potential of $312,361—far greater than the corresponding tax liability of $35,117 and dwarfing petitioners’ offer of $2,500.

The SO offered a streamlined installment agreement of $332 per month (i.e., the total liability divided by 72 months). But Petitioner didn’t accept it and the SO issued a Notice of Determination that sustained the NFTL. Petitioners proceeded to the Tax Court, arguing in their response to Respondent’s eventual motion for summary judgment that the SO made a “blanket rejection” of the OIC.

There was simply nothing here for the Court—or frankly, the IRS—to work with. Petitioners provided no evidence of an IRS error with the expense calculation to lower the “reasonable collection potential”; no purported special circumstances that would justify acceptance of an offer for less than the reasonable collection potential; and no further allegations (e.g., that the SO failed to verify all applicable statutory and procedural requirements). They complained of the SO’s “blanket rejection” of the OIC; instead it seems the SO considered the circumstances and rejected the OIC for a fair reason. Pro se CDP litigants should take note: your reasons for seeking reversal must be well-grounded in the facts and law.

Docket  No. 24599-17L, Marra v. C.I.R. (Order Here)

Another CDP case, this time from Chief Special Trial Judge Carluzzo. Respondent filed a motion for summary judgment, while Petitioner moved to remand the case to IRS Appeals. The primary issue is whether Petitioner may challenge the underlying liability pursuant to IRC § 6330(c)(2)(B). Respondent objects because they believe Petitioner did not raise the underlying liability during the CDP hearing itself, and is therefore precluded from raising that issue before the Tax Court. See Giamelli v. Commissioner, 129 T.C. 107, 112-13 (2007). Petitioner responded that, in fact, he raised the issue in a Form 1127, Application for Extension of Time for Payment of Tax Due to Hardship, which he allegedly submitted during the CDP hearing.Judge Carluzzo notes a further disagreement to whether Petitioner had reasonable cause for failure to pay the underlying liability, in addition to the liability itself.

Because Judge Carluzzo finds there to be a continuing dispute regarding the underlying liability, he denies Respondent’s motion for summary judgment, because genuine issues of material fact remain in dispute (though the order does not detail precisely what facts are material or in dispute).

Further, Judge Carluzzo denies Petitioner’s motion to remand—likely because the issue centers on the underlying liability. If the Court finds that Petitioner did raise the underlying liability at the hearing, then the Court may consider it de novo without need for remand. See Sego v. Commissioner, 114 T.C. 604, 610 (2000). If not, then it’s a moot point anyway. In any case, remand doesn’t make sense here.

Docket No. 322-19, Barfield v. C.I.R. (Order Here)

Finally, Judge Guy defeats a classic tax protester tactic. In an earlier proceeding, Petitioner alleged an issue regarding tax year 2015. But at that time, the Service hadn’t issued a notice of deficiency for 2015. So, Respondent moved to dismiss for lack of jurisdiction as to 2015, which the court granted.

Later, the Service did issue a notice of deficiency for 2015. Petitioner asked the Tax Court for review, and filed a motion for summary judgment, arguing that the earlier proceeding had dismissed the 2015 tax year, and thus, was res judicata as to this new proceeding. Respondent filed a motion for judgment on the pleadings in response. 

Judge Guy parries this tax protester’s attempt to nullify the Service’s notice of deficiency and grants Respondent’s motion for judgment on the pleadings. Because Petitioner didn’t allege any errors or facts with respect to Respondent’s notice—aside from the baseless res judicata argument—Judge Guy found that “the petition . . . fails to raise any justiciable issue.” Judge Guy also warns petitioner about the section 6673 penalty, but does not impose one. A review of the case’s docket suggests that Petitioner heeded Judge Guy’s warning, as there have been no further filings in this docket. 

Designated Orders – Discovery Issues, Delinquent Petitioners, and Determination Letters (and some Chenery): August 13 – 17

Designated Order blogger Caleb Smith from University of Minnesota Law School brings us this week’s installment of designated orders. Based on reader feedback we are trying to put more information about the orders into the headlines to better assist you in identifying the cases and issues that will be discussed. Keith

Limitations on Whistleblower Cases and Discovery: Goldstein v. C.I.R., Dkt. # 361-18W (here)

Procedurally Taxing has covered the relatively new field of “whistleblower” cases in Tax Court before (here, here and here are some good reads for those needing a refresher). Goldstein does not necessarily develop the law, but the order can help one better conceptualize the elements of a whistleblower case.

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The statute governing whistleblower awards is found at IRC § 7623. In a nutshell, it provides for awards to tipsters (i.e. “whistleblowers”) that provide information to the IRS that result in collection of tax proceeds. The amount of the award is generally determined and paid out of the proceeds that the whistleblowing brought in. On this skeletal understanding, we can surmise that there are at least two things a whistleblower must do: (1) provide a good enough tip to get the IRS to act, and (2) have that action result in actual, collected money.

Goldstein, unfortunately, fails on the second of these grounds. Apparently, his tip was just good enough to have the IRS act (by initiating an exam, proposing a rather large amount due), but not good enough to go the distance and result in any proceeds: Appeals dropped the case as “no change” largely on “hazards of litigation” grounds. And since whistleblower awards are paid out of proceeds, and the proceeds from the tip here are $0, it stands to reason that Mr. Goldstein was not in for a big payday.

So why does Mr. Goldstein bring the case? Because Mr. Goldstein believes there actually were proceeds from the tip and wants to use the discovery mechanisms of Court as a way to get to the bottom of the matter. Or, somewhat as an alternative, Mr. Goldstein wants to use discovery to show that there should have been proceeds collected from his tip.

The Court is not persuaded by either of these arguments, but for different reasons.

The question of whether the tip “should have” led to proceeds (in this case, through the assessment of tax and penalties as originally proposed in exam) is not one the Court will entertain, for the familiar reason of its “limited jurisdiction.” As the Court explained in Cohen v. C.I.R. jurisdiction in a whistleblower case is only with respect to the Commissioner’s award determination, not the “determination of the alleged tax liability to which the claim pertains.” Arguing that the IRS should have assessed additional tax certainly seems like a look at the alleged tax liability and not the Commissioner’s award determination. So no-go on that tactic.

But the question of whether the IRS actually received proceeds that it is not disclosing -and whether a whistleblower can use discovery to find out- is a bit more interesting. Here, Judge Armen distinguishes Goldstein’s facts from two other whistleblower cases that did allow motions to compel production of documents from the IRS: Whistleblower 11099-13W v. C.I.R., and Whistleblower 10683-13W v. C.I.R..

These cases, in which whistleblowers were able to use discovery to compel production both had one simple, critical, difference from Mr. Goldstein’s case: in both of those cases, there was no question that the IRS had recovered at least some proceeds from the taxpayers. In the present case, there were no proceeds, and so an element of the case is missing… and thus is dismissed.

Of course, in the skeletal way I have summarized Mr. Goldstein’s case it all sounds quite circular: Mr. Goldstein thinks there were proceeds, the IRS says there weren’t, and the Court says “well, we’d let you use discovery to determine the amount of proceeds if there were any. But the IRS says there aren’t any, so we won’t let you use the Court to look further.” In truth, the IRS did much more in Goldstein than just “say” there weren’t any proceeds. The IRS provided the Court with exhibits and transcripts detailing that there were no proceeds, because the case was closed at Appeals.

Also, to be fair to Mr. Goldstein, the reports were significantly redacted (they do deal with a different taxpayer, after all, so one must be wary of IRC § 6103, but not to an extent that causes Judge Armen much worry. And it will take more than a “hunch” for the Court to allow petitioners access to the Court or use of discovery powers.

From the outset of a whistleblower case (that is, providing the “tip”) the IRS holds pretty much all the cards. Here, it appears that the tip could well have ended up bringing in proceeds: at least it was good enough that the examiner proposed a rather large tax. Appeals reversed on “hazards of litigation” grounds –not exactly a signal that they completely disagreed some proceeds could ensue. But the whistleblower, at that point, has no recourse in court to second-guess the IRS decision.

End of an Era? Bell v. C.I.R., Dkt. # 1973-10L (here)

I am often impressed with how far the Tax Court goes out of its way to be charitable to pro se taxpayers. I am also often impressed with the Tax Courts patience. This isn’t our first (or second) run-in with the Bells, though hopefully it is the last (at least for this docket number and these tax years). As the docket number indicates, this collection case has been eight years in the making. Like Judge Gustafson, I will largely refrain from recounting the history (which can be found in the earlier orders) other than to say that the Bells have appeared to vary between dragging their feet and outright refusing to communicate with the IRS over the intervening years. This behavior (kind-of) culminated in the Court dismissing the Bell’s case for failing to respond to an order to show cause.

And yet, they persisted.

Even though the case was closed, the Bell’s insisted on their “day in court” by showing up to calendar call in Winston-Salem while another trial was ongoing. And rather than slam the door, which had been slowly closing for the better part of eight years, the Court allowed the Bells to speak their part during a break in the scheduled proceedings. The assigned IRS attorney, “naively” believing that merely because the case was closed and removed from the docket they would not need to be present, now had to scramble and drive 30 miles to court.

Of course, the outcome was pretty much foreordained anyway. The Bell’s wanted to argue now that they had documents that would make her case. Documents that never, until that very moment in the past eight years, were shared with the IRS or court. The Court generously construed the Bell’s comments as an oral motion for reconsideration (which would be timely, by one day). And then denied the motion, via this designated order.

And so ends the saga… or does it?

In a tantalizing foreshadowing of future judicial resources to be wasted, Judge Gustafson notes that the Bells have previously asked about their ability to appeal the Court’s decision. We wish all the best to the 4th Circuit (presumptively where appeal would take place), should this saga continue.

One can be fairly impressed with the generosity and patience of the Judge Gustafson in working with the pro se parties of Bell. Tax law is difficult, and Tax Court judges frequently go out of their way to act as guides for pro se taxpayers through the maze. But that patience is less apparent where the party should know better -particularly, where the offending party is the IRS…

Things Fall Apart: Anatomy of a Bad Case. Renka, Inc. v. C.I.R., Dkt. # 15988-11R (here)

It is a good bet that the parties are sophisticated when the case deals with a final determination on an Employee Stock Ownership Plan (ESOP). It is an even better bet if the Judge begins the order with a footnote that “assumes the parties’ familiarity with the record, the terms of art in this complicated area of tax law, and the general principles of summary-judgment law.” Needless to say, this is not the sort of case where either of the parties could ignore court orders, show up at calendar after the case was closed, and be allowed to speak their part.

And of course, neither parties go quite that far. However, both procedurally and substantively the arguments of one party (the IRS) fall astoundingly short of the mark.

The IRS and Renka, Inc. are at odds about whether an ESOP qualified as a tax-exempt trust beginning in 1998. The IRS’s determination (that it is not tax-exempt) hinged on the characterization of Renka, Inc. as also including a second entity (ANC) as either a “controlled group” or “affiliated service group.” If this was so, then Renka, Inc.’s ESOP also must be set up to benefit additional employees (i.e., those of ANC), which it did not.

I am no expert on ESOPs, controlled groups, or affiliated service groups, and I do not pretend to be. But you don’t have to be an expert on the substantive law to see that the IRS is grasping. Here is where procedure and administrative law come into play.

The Notice of Determination at issue is for 1998. Although the determination also says the plan is not qualified for the years subsequent to 1998, it is really just looking at the facts in existence during 1998, reaching a determination about 1998, and saying that because of those facts (i.e. non-qualified in 1998), it continues to be non-qualified thereafter. But the critical year of the Notice of Determination is 1998: that is the year that Renka, Inc. has been put on notice for, and it is the determination that is reached for that year that is before the Court. So when the Commissioner says in court, “actually, Renka, Inc. was fine in 1998, but in 1999 (and thereafter) it wasn’t qualified” there are some big problems.

The biggest problem is the Chenery doctrine. Judge Holmes quotes Chenery as holding that “a reviewing court, in dealing with a determination or judgment which an administrative agency alone is authorized to make, must judge the propriety of such action solely by the grounds invoked by the agency.” SEC v. Chenery Corp. (Chenery II), 332 U.S. 194 (1947). The IRS essentially wants to argue that the Notice of Determination for 1998 is correct if only we use the facts of 1999… and apply the determination to 1999 rather than 1998. The Chenery doctrine, however, does not allow an agency to use its original determination as a “place-holder” in this manner. Since all parties agree the ESOP met all the necessary requirements in 1998 (the determination year), the inquiry ends: the Determination was an abuse of discretion.

This is one of those cases where you can tell which way the wind is blowing well before reaching the actual opinion. Before even getting to the heart of Chenery, Judge Holmes summarizes the Commissioner’s argument as being “if we ignore all the things he [the Commissioner] did wrong, then he was right.” And although the IRS has already essentially lost the case on procedural grounds (i.e. arguing about 1999 when it is barred by Chenery), for good measure Judge Holmes also looks at the substantive grounds for that argument.

Amazingly, it only gets worse.

First off, the IRS relies on a proposed regulation for their approach on the substantive law (i.e. that the ESOP did not qualify as a tax-exempt trust). Of course, proposed regulations do not carry the force of law, but only the “power to persuade” (i.e. “Skidmore” deference). And what is the power to persuade? Essentially it is the same as a persuasive argument made on brief. Judge Holmes cites to Tedori v. United States, 211 F.3d 488, 492 (9th Cir. 2000) as support for this idea.

As an aside, I have five hand-written stars in the margin next to that point. I have always struggled with the idea that Skidmore deference means anything other than “look at this argument someone else made once: isn’t it interesting?” It is not a whole lot different than if I (or whomever the party is) made the argument on their own in the brief, except that the quote may be attributed to a more impressive name.

But if there is something worse than over-relying on a proposed regulation for your argument, it would be over-relying on a proposed regulation that was withdrawn well before the tax year at issue. Which is what happened here, since the proposed regulation was withdrawn in 1993. Ouch.

Finally, and just to really make you cringe, Judge Holmes spends a paragraph noting that even if the proposed regulation was (a) not withdrawn, and (b) subject to actual deference, it still would not apply to the facts at hand. In other words, the thrust of the IRS’s substantive argument was an incorrect interpretation of a proposed regulation that was no longer in effect. No Bueno.

There was one final designated order that I will not go into detail on. For those with incurable curiosity, it can be found here and provides a small twist on the common “taxpayers dragging their feet in collections” story, in that this taxpayer was not pro se.

 

Designated Orders: 6/26 – 6/30/2017

Professor Patrick Thomas of Notre Dame Law School writes about  last known address, discovery and whistleblower issues in this week’s edition of Designated Orders. Les

 Last week’s designated orders were quite the mixed bunch: a number of orders in whistleblower cases; a last known address issue; and a discovery order in a major transfer pricing dispute between Coca Cola and the federal government. Other designated orders included Judge Guy’s order granting an IRS motion for summary judgment as to a non-responsive CDP petitioner; Judge Holmes’s order on remand from the Ninth Circuit in a tax shelter TEFRA proceeding; and Judge Holmes’s order in a whistleblower proceeding subject to Rule 345’s privacy protections.

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Last Known Address: Dkt. # 23490-16, Garcia v. C.I.R. (Order Here)

In Garcia, Judge Armen addresses whether the Service sent the Notice of Deficiency to Petitioner’s last known address. As most readers know, deficiency jurisdiction in the Tax Court depends on (1) a valid Notice of Deficiency and (2) a timely filed Petition. Failing either, the Tax Court must dismiss the case for lack of jurisdiction. If the Petition is not timely filed in response to a validly mailed notice of deficiency, the taxpayer is out of luck; the Service’s deficiency determination will stick. The Service can also potentially deprive the Court of jurisdiction through failure to send the Notice of Deficiency to the taxpayer’s last known address by certified or registered mail under section 6212, though the Court will have jurisdiction if the taxpayer receives a Notice of Deficiency that is not properly sent to the last known address and timely petitions. While a petitioner could be personally served with a Notice of Deficiency, this rarely occurs.

Perhaps counterintuitively for new practitioners, the remedy for this latter failure is a motion to dismiss for lack of jurisdiction. Unlike a jurisdictional dismissal for an untimely petition, this motion can substantially benefit the taxpayer. A successful motion will require the Service to re-issue the Notice to the proper address—or else otherwise properly serve it on the taxpayer. If the Service fails to do so within the assessment statute of limitation under section 6501, no additional tax liability may be assessed. This motion is thus a very powerful tool for practitioners in the right circumstances.

Here, the Court dealt with two motions to dismiss for lack of jurisdiction: the Service’s based on an untimely petition, and Petitioner’s based on failure to send the Notice to the last known address. Petitioner had sent multiple documents to the Service, and the Service to the taxpayer, as follows:

 

Date Sender Document Address
February 25, 2015 Petitioner 2014 Tax Return Twin Leaf Drive
April 2015 Petitioner 2011 Amended Return Brownfield Drive
October 30, 2015 Petitioner Power of Attorney Twin Leaf Drive
November 10, 2015 IRS Letter 1912 re: 2014 Exam Brownfield Drive
February 12, 2016 Petitioner 2015 Tax Return Brownfield Drive
March 8, 2016 IRS 2014 Notice of Deficiency Brownfield Drive
October 17, 2016 IRS Collection Notice re: 2014 Brownfield Drive

 

Judge Armen held that the Service did send the Notice to the proper address, despite the ambiguities present here. Petitioner argued that because his attorney had filed a Form 2848 with the Twin Leaf Drive address after he filed his 2011 Amended Return, the Form 2848 changed the last known address to Twin Leaf. The Notice of Deficiency wasn’t sent to that address; ergo, no valid notice.

But Petitioner’s filed his 2015 return using the Brownfield Drive address, prior to issuance of the Notice of Deficiency. Petitioner argued that the regulations governing the last known address issue requires both (1) a filed and (2) properly processed return. Reg. § 301.6212-2(a). In turn, Rev. Proc. 2010-16 defines “properly processed” as 45 days after the receipt of the return. Because the Notice was issued before this “properly processed” date (March 28), the last known address, according to Petitioner, should have been the Twin Leaf Drive address as noted on the most recent document filed with the Service: the October 30, 2015 Form 2848.

Judge Armen chastises petitioner for “using Rev. Proc. 2010-16 as a sword and not recognizing that it represents a shield designed to give respondent reasonable time to process the tens of millions of returns that are received during filing season.” Further, Judge Armen assumes that the Service actually processed the return much quicker (“Here petitioner would penalize respondent for being efficient, i.e., processing petitioner’s 2015 return well before the 45-day processing period….”

I’m not sure that the facts from the order support that conclusion. There is no indication of when Petitioner’s 2015 return was processed by the Service such that they could use it to conclusively determine the last known address. Judge Armen seems to avoid this issue by assuming (perhaps correctly) that the return was processed before the Notice of Deficiency was issued. Unless certain facts are missing from the Order, this seems like an assumption alone.

If the Service did not have the 2015 return on file, or had sent the Notice prior to February 12, 2016, then they would have waded into murkier waters. As Judge Armen alludes to, the Service does not view a power of attorney as conclusively establishing a change of address. Rev. Proc. 2010-16, § 5.01(4). The Tax Court has disagreed with this position previously. See Hunter v. Comm’r, T.C. Memo. 2004-81; Downing v. Comm’r, T.C. Memo. 2007-291.

Discovery Dispute Regarding Production of Documents and Response to Interogatories: Dkt. # 31183-15, The Coca-Cola Company and Subsidiaries v. C.I.R. (Order Here)

Judge Lauber denied a portion of the Service’s request to compel the production of documents and responses to interrogatories in the ongoing litigation regarding Coca-Cola’s transfer pricing structure. I’d do our reader’s a disservice by touching transfer pricing with a ten-foot pole. Rather, I’ll focus on the discovery issue at play.

Regarding the motion to compel production of documents, the Service had sought “all documents and electronically stored information that petitioner may use to support any claim or defense regarding respondent’s determination.” The parties had previously agreed to exchange all documents by February 12, 2018. Coca Cola argued that by demanding all such documents presently, the Service was attempting to get around the pretrial order.

Judge Lauber agreed with Coca Cola, especially because certain claims of privilege were unresolved, and expert witness reports and workpapers had not yet been exchanged. In essence, Coca Cola was unable to provide “all documents” upon which they might rely at trial, as they were unable to even identify all of those documents presently due to these unresolved issues. Judge Lauber cautioned Coca Cola, however, to avoid an “inappropriate ‘document dump’” on February 12, by continuing to stipulate to facts and to exchange relevant documents in advance of this date.

The motion to compel response to interrogatories centered on private letter rulings that Coca Cola received under section 367 (which restricts nonrecognition of gain on property transfers to certain foreign corporations). The Service wanted Coca Cola to “explain how the [section 367 rulings] relate to the errors alleged with respect to Respondent’s income allocations” and “identify Supply Point(s) [Coca Cola’s controlled entities] and specify the amount of Respondent’s income allocation that is affected by the transactions subject to the [section 367 rulings]”. While Coca Cola had already identified the entities and transactions relevant to the section 367 rulings, and had provided a “clear and concise statement that places respondent on notice of how the section 367 rulings relate to the adjustments in dispute”, the Service apparently wanted more detail on how precisely the private letter rulings were relevant to Coca Cola’s legal argument.

Coca Cola, and Judge Lauber, viewed this request as premature. Nothing in the Tax Court’s discovery rules require disclosure of legal authorities. Moreover, Judge Lauber cited other non-Tax Court cases holding that such requests in discovery are impermissible. Any disclosure of an expert witness analysis was likewise premature, at least before the expert witness reports are exchanged.

Whistleblower Motions: Dkt. # 30393-15W Kirven v. C.I.R. (Orders Here and Here)

Two orders came out this week in this non-protected whistleblower case. Unlike Judge Holmes’s order mentioned briefly above, we can actually tell what’s going on in this case, as Petitioner has apparently not sought any protection under Rule 345. Chief Judge Marvel issued the first order, which responded to petitioner’s request for the Chief Judge to review a number of orders that Special Trial Judge Carluzzo had previously rendered. Specifically, Petitioner desired Chief Judge Marvel to review the denials of motions to disqualify counsel, to strike an unsworn declaration from the Service, and to compel interrogatories and sanctions.

While the Chief Judge has general supervisory authority over Special Trial Judges under in whistleblower actions under Rule 182(d), Chief Judge Marvel denied the motion, given that these motions were “non-dispositive”.

The second order by Judge Carluzzo did resolve a dispositive motion for summary judgment. Perhaps we shall see a renewal of a similar motion before Chief Judge Marvel in this matter.

The Service had initially denied the whistleblower claim due to speculative and non-credible information. Additionally, however, an award under the whistleblowing statute (section 7623(b)) requires that the Service initiated an administrative or judicial proceeding against the entity subject to a whistleblowing complaint. Further, the Service needs to have collected underpaid tax from that entity for an award, as the award is ordinarily limited to 15% of the amount collected. Neither of those occurred in this matter, and on that basis, Judge Carluzzo granted the motion for summary judgment, upholding the denial of the whistleblowing claim.

This case again reminds pro se petitioners to attend their Tax Court hearings and respond to the Service’s motions for summary judgment. The Petitioner did not attend the summary judgment hearing, because (according to her) the hearing regarded both the Service’s motion for summary judgment as well as her motion to compel discovery. Whatever her reason for not attending the hearing or responding to the motion, all facts provided by the Service were accepted, and the Court assumed there was no genuine dispute as to any material facts: a recipe for disaster for the non-movant in a summary judgment setting.