Policing the Settlement; Policing the Case

A recent order in the case of Englemann v. Commissioner, Dk. No. 10528-20 shows the role Tax Court judges play in reviewing settlements.  This case was brought to my attention by the ever observant Bob Kamman who laments the loss of the designated order practice of the Tax Court where we might have seen this order and might have gotten some further insight into what happened here.

The taxpayer and the IRS have reached a settlement regarding the amount of the deficiency.  Ordinarily when that happens a grateful Tax Court receives the decision document signed by the parties and the judge assigned to the case, or the Chief Judge if no specific judge is assigned, signs the decision document thus ending the case.  This seems like a routine way to resolve a case.  Everyone agrees and everyone goes home happy (well maybe not exactly happy but satisfied with the outcome’s correctness.)

Here, the Tax Court rejects the settlement between the parties.  The brief order from the Chief Judge states:

On April 27, 2021, the Court received from the parties in the above-docketed matter a Proposed Stipulated Decision purporting to resolve this litigation. However, review shows that the decision provides for a deficiency amount in excess of that set forth in the underlying notice of deficiency for the 2016 taxable year. Conversely, an increased deficiency does not appear to have been pled or otherwise stipulated in the record herein.

The premises considered, and for cause, it is

ORDERED that the Proposed Stipulated Decision, filed April 27, 2021, is hereby deemed stricken from the Court’s record in this case.

This may seem to the parties as a harsh rebuke but it is part of the Court’s role in a case.  I am unsure if the order here qualifies as a “bounce” but Chief Counsel’s Office used to keep records of the number of bounces an office received – bounces being documents rejected by the court because something was wrong.  Having a high bounce rate was not a good thing.

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We don’t know why the taxpayer has agreed to a deficiency in an amount greater than the liability listed in the notice of deficiency.  One assumes that the taxpayer could agree to a greater amount for many good reasons but the Tax Court will not allow this to happen until the parties, or presumably the IRS, files a formal motion with the Court seeking an increased deficiency in an amount equal to or greater than the amount in the stipulated decision and the Tax Court decides that it is okay for the IRS to seek an increased deficiency.  This seems like a bit of overkill given that the parties have already signaled their agreement to the amount but this is the way the Tax Court plays it.  Here, the Court appears to serve the role of officious policeman but most petitioners are pro se and perhaps the Court wants to make sure that the IRS is not taking petitioner for a ride and the action here keeps the signature of the judge in line with the governing statute.

The first sentence of section 6214(a) provides: 

Jurisdiction as to increase of deficiency, additional amounts, or additions to the tax

Except as provided by section 7463, the Tax Court shall have jurisdiction to redetermine the correct amount of the deficiency even if the amount so redetermined is greater than the amount of the deficiency, notice of which has been mailed to the taxpayer, and to determine whether any additional amount, or any addition to the tax should be assessed, if claim therefor is asserted by the Secretary at or before the hearing or a rehearing.

While it may seem harsh to police the case in this way, the court is right in policing the settlement as a jurisdictional issue in the absence of a motion by the IRS to amend its answer and seek a larger deficiency.

The Tax Court has also policed a settlement where the court thought that the petition was filed late, but the IRS hadn’t mentioned the late filing.  One case where that happened was Williams v. Commissioner, Docket No. 24954-17 (dated Jan. 26, 2018)   In Williams, the IRS responded to the order by filing a motion to dismiss, which the Tax Court granted.

The Tax Court plays a similar role in many cases in which the IRS does not act but the Court decides on its own what must occur.  The most common occurrence of the Court acting in this manner exists in cases in which the Court polices its jurisdiction.  In briefs filed regarding the litigation over the jurisdictional nature of the statutes providing entry into the Tax Court, the Tax Clinic at the Legal Services Center at Harvard has commented on the role the Tax Court plays in deficiency cases and whether this is how we want to use judicial resources.  In the amicus brief supporting the recently failed cert petition in the case of Northern California Small Business Assistants, Inc. v. Commissioner, cert denied May 6, 2021, the clinic wrote:

The Tax Court Needlessly Expends Considerable Judicial Resources Each Month Incorrectly Policing the Filing Deadline as a Jurisdictional Issue.

Many taxpayers might be affected by a ruling that the Tax Court’s deficiency jurisdiction filing deadline is not jurisdictional (whether or not the filing deadline is also subject to equitable tolling). In the fiscal year ended September 30, 2018, taxpayers filed 24,463 Tax Court petitions. IRS Data Book, 2018 at 62 (Table 27), available at www.irs.gov. These petitions were under about 20 different jurisdictions of the Tax Court. The Tax Court’s position is that the filing deadline of any petition in the Tax Court, under any of its jurisdictions, is a jurisdictional issue for the court. Tax Court Rule 13(c) (“In all cases, the jurisdiction of the Court also depends on the timely filing of a petition.”). (Parenthetically, the D.C. Circuit, which hears all appeals of Tax Court whistleblower actions under § 7623(b)(4), has overruled the Tax Court and held that the filing deadline for such an action is not jurisdictional and is subject to equitable tolling under current Supreme Court authority. Myers v. Commissioner, 928 F.3d 1025 (D.C. Cir. 2019).)

Three jurisdictions of the Tax Court comprise the vast bulk of its petitions (deficiency, CDP, and innocent spouse), but it has long been the case that deficiency petitions make up the overwhelming majority of all petitions filed. Harold Dubroff & Brant Hellwig, “The United States Tax Court: An Historical Analysis” (2d Ed. 2014) at 909 (Appendix B). The Dubroff & Hellwig book is the semi-official history of the Tax Court, available at a link on the “History” page of the court’s website. “Over 75 percent of the petitioners who file with the Court are self-represented (pro se).” U.S. Tax Court Congressional Budget Justification Fiscal Year 2021 (Feb. 10, 2020) at 22, also available at a link on that “History” page.

Because the Tax Court does not publish statistics breaking down filings under each of its jurisdictions, and because that court also does not separately identify in statistics cases dismissed for lack of jurisdiction, in order to get a sense of how many cases in the court each year might be affected by a ruling on whether the deficiency petition filing deadline is jurisdictional, the Center reviewed, using the Tax Court’s DAWSON online system (available on the Tax Court’s website), 1% of a randomly-chosen sample of dockets filed during the fiscal year ended September 30, 2018. The year ended September 30, 2018 was chosen simply to allow likely enough time for jurisdictional issues to be raised and disposed of in all cases. The 245 dockets reviewed were numbers 10001-18 through 10245-18 (as to which petitions were filed between May 21 and 24, 2018, inclusive). Of those 245 dockets, 24 were not deficiency cases.3 Of the remaining 221 dockets that comprised deficiency cases, 38 (17% – i.e., 38/221) were dismissed for lack of jurisdiction. However, there were multiple grounds for the 38 dismissals for lack of jurisdiction:

Number of CasesDismissal Reason
25Failure to pay filing fee
10Late filing
1Failure to file proper amended petition
1No original signature on petition
1Tax paid before notice of deficiency issued

In only one of the 10 dockets where the case was dismissed for late filing was there any suggestion of facts which might give rise to equitable tolling. In Lavery v. Commissioner, Docket No. 10026-18 (order dated Jul. 18, 2018), it appears that there may have been a timely filing in the wrong forum (i.e., a timely mailing to the IRS, instead of the Tax Court).

This review shows that floodgates would not open if equitable tolling were allowed to excuse the late filing of a modest number of deficiency petitions each year.

The greater practical effect of a ruling that the Tax Court’s deficiency suit filing deadline is not jurisdictional would be to benefit taxpayers where the IRS attorneys in the case either had omitted to notice the possible late filing of a petition or had deliberately decided not to argue that a petition was late and so forfeited or sought to waive the late filing argument. As this Court has noted, “[t]he expiration of a ‘jurisdictional’ deadline prevents the court from permitting or taking the action to which the statute attached the deadline. The prohibition is absolute. The parties cannot waive it, nor can a court extend that deadline for equitable reasons.” Dolan v. United States, 560 U.S. 605, 610 (2010) (citation omitted). In contrast, if a filing deadline is not jurisdictional, it is subject to forfeiture and waiver (whether or not it is subject to equitable tolling or estoppel).

Every month, the Tax Court dismisses multiple deficiency cases only because the filing deadline is currently treated as jurisdictional and so the Tax Court judges, sua sponte, police late filing. The court’s position that the filing deadline is jurisdictional necessitates that judges examine the files in every case for late filing – the judges not being able merely to rely on the IRS to raise all late filing issues. When a judge suspects that a petition in a particular case was filed late, but the IRS attorneys have made no argument to that effect, the judge issues an order to show cause why the case should not be dismissed for lack of jurisdiction. In November and December 2019 (typical recent pre-COVID-19 months), the Tax Court issued orders to show cause to dismiss deficiency petitions for untimely filing four and eight times, respectively.4 All 12 such taxpayers lost their chance to have their deficiencies litigated in the Tax Court only because the judges treated the filing deadline as jurisdictional. If, as the Center believes, the filing deadline is not jurisdictional, judges have been investing considerable resources over the years engaging in needless policing.

Judges do not merely police jurisdiction in the middle of a case, but also when a case settles. About once a month, some taxpayer and the IRS settle a case on the merits and submit to the Tax Court a proposed stipulated decision setting forth the amount of the deficiency, but the Tax Court judge refuses to sign the decision until the parties show cause why the case should not instead be dismissed for lack of jurisdiction on account of a late filing of the petition that the IRS had not noticed. (The decision in the Tax Court is analogous to the judgment in a district court case.) An example of a show cause order issued in this situation is that in Williams v. Commissioner, Docket No. 24954-17 (dated Jan. 26, 2018).

A further example of overuse of judicial resources is where the IRS agrees with the taxpayer that a petition was timely filed, but the Tax Court takes the time to conclude that the petition was not timely filed. For example, in Tilden v. Commissioner, 846 F.3d 882 (7th Cir. 2017), rev’g T.C. Memo. 2015-188, the parties were initially in disagreement over whether a deficiency petition had been timely filed under the rules of § 7502. Section 7502 provides a timely-mailing-is-timely-filing rule applicable to Tax Court petitions. The initial dispute was about which provision of regulations under the Code section applied to the case. By the time the Tax Court wrote its opinion, however, the parties agreed that the petition was timely filed. However, the Tax Court disagreed and dismissed the petition for lack of jurisdiction as untimely. The Tax Court could not merely accept the IRS’ concession that the filing was timely because of the Tax Court’s position that the deficiency suit filing deadline is a jurisdictional issue.

In the Seventh Circuit, both parties again argued that the filing was timely. This led the judges at oral argument, sua sponte, to wonder whether they had to decide the § 7502 issue, since, if the filing deadline at § 6213(a) was not jurisdictional, the government was waiving any untimeliness argument, which was the government’s prerogative. The judges asked the attorneys for each side whether the filing deadline in § 6213(a) is jurisdictional under recent Supreme Court case law, but the attorneys did not know about such case law. Then, two of the judges gave their tentative views that the § 6213(a) filing deadline appeared not to be jurisdictional. See Marie Sapirie, “News Analysis: Will the Seventh Circuit Unsettle Tax Court Timing Rules?”, Tax Notes Today (Oct. 24, 2016) (“ ‘This appears to be a timing rule, but timing rules aren’t jurisdictional,’ [Judge] Easterbrook said. [Chief Judge] Wood observed that for at least the last decade, the Supreme Court has been telling courts not to ‘put everything in the jurisdictional box’ because many rules that may have previously been carelessly referred to as jurisdictional are really claims processing rules. ‘If it’s a claims processing rule, it’s just a fact. You can concede it. The world doesn’t come to an end, and the case goes on,’ Wood said.”). After the oral argument, the parties in Tilden submitted supplementary briefs on the issue of whether the § 6213(a) filing deadline is jurisdictional under current Supreme Court case law. The judges then changed their minds and, in their opinion, held the filing deadline jurisdictional and then proceeded to reverse the Tax Court on the § 7502 issue.

In sum, too much judicial time is being needlessly spent in policing late filing only because of the lower courts’ misunderstanding of how this Court’s presumption that filing deadlines are no longer jurisdictional applies to the deficiency filing deadline.

Of course, what the tax clinic describes as incorrect policing is not incorrect in the eyes of the Tax Court and other courts that have determined certain entry statutes to be jurisdictional in nature.  Whether correct or incorrect, the Tax Court does look at documents in several settings to make sure those documents do what the Court thinks is allowed.  When it views a document as going too far, it steps in even where the parties have not acted or have acted contrary to the “correct” action.

A Twist on the Last Known Address Issue and an Update on DAWSON

We just had a call in the clinic that highlights another unexpected result of the dysfunction at the IRS resulting from the pandemic. As you probably know one result of the pandemic is that the IRS is taking months, perhaps more than a year, to process 2019 returns filed by paper. The filing of a return is an act that triggers the IRS to change a person’s address. So, by not processing a return, the IRS is slow to record in its system the taxpayer’s new address. That is an unfortunate by product of the pandemic. The delay in processing the return can have a stranger impact in some cases.

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In our case the client had filed a change of address form with the IRS when she moved pre-pandemic. The IRS accepted her change of address form and recorded her new address. Shortly before she filed her change of address form she had submitted her 2019 return using her then correct address but now prior address (and prior address from more than one year ago so no more postal forwarding.)

The IRS took many months to process her paper return. When it did get to her return, the processing of her 2019 return caused the IRS computer to notice that the address on her return was different than her address in its system. So, the computer “updated” her address to her old address. So, even though she properly followed the rules and the IRS followed its rules, the sequencing of the processing of her documents caused the IRS system to have a bad address.

Fortunately, in this case her file was in the hands of an alert Appeals Officer who figured out the problem and is working to get the IRS computer to accept the client’s true last known address. As you can imagine not many taxpayers in this situation will be so lucky as to have a live, alert human looking out for their interest. I bring this up in case other experience a similar difficulty.

A related problem is the time it will take for the IRS to process a return and pick up a new address. With the IRS using the tax return to change addresses, many taxpayers could rely on that system together with postal forwarding to receive IRS correspondence. The Gregory case demonstrates one of the exceptions and argues for use by the IRS of the other address information it receives. What should a taxpayer argue who has submitted a return to the IRS with a new address or submitted any document to the IRS that would change their address but that the IRS does not get to for months because of the pandemic backlog? I don’t have good advice. I am sure the IRS will take the position that it does not have a responsibility to change an address until it actually processes the return. Undoubtedly, there will be situations where the lengthy delays currently occurring will cause problems.

DAWSON and sealed documents

Recently, Judge Holmes issued a lengthy, informative and, as usual, entertaining opinion regarding the valuation of Michael Jackson’s image in a Tax Court case involving his estate. The opinion is public and was published on Tax Notes and other sites almost immediately after its release. If you go to the docket for the case on the Tax Court website, however, you cannot obtain the opinion and you will be told the record in the case is sealed. Some parts of the case were sealed by court order early in the litigation. For a general discussion of sealing the record in a Tax Court case, you can read this post from several years ago by guest blogger Sean Akins. As the Tax Court merged its prior system to DAWSON, it has yet to make the upgrades that will allow the system to recognize the difference between sealed and unsealed documents in a case. So, it is not possible to pull the Estate of Jackson opinion from the Court’s website at this time. It is a public document, however, and you can request a copy of the opinion from the clerk’s office as you can request any document from the court as discussed here. My understanding is that this issue and others are ones which the Court is continuing to fix as it continues to work on DAWSON. In the meantime, it will be impossible to obtain a document through DAWSON in a case in which the Court has sealed a part of the record.

Accepting Gifts from the IRS: Ethical Considerations (Part Two)

Previously, we discussed the two categories of IRS “gifts” that taxpayers cannot accept: clerical gifts and purely computational gifts. We left, however, with the cliffhanger that computational gifts may become “conceptual” gifts, which attorneys often can accept. Today, we’ll look closer at what a conceptual gift is and whether it is what was at issue in the Householder case (covered here).

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Conceptual Gifts

Each step away from the strictly arithmetic computational gift takes you closer to the conceptual. Facts and circumstances are critical in determining which category the gift best falls into. So much of tax calculation involves the interplay of disparate statutes and facts, which may or may not have been explicitly covered in the settlement and negotiation. What first appears to be a matter of computation can often be a matter of concept: for example, the failure of the IRS to raise an issue that at first seemed ancillary but ultimately is determinative.

For example, imagine you are settling a deficiency case where your client filed their return late. Both parties have agreed on the deficiency amount, but never really discussed (or settled on) the exact date the return was filed. The IRS prepares a settlement document that reflects the deficiency agreed on but has a lower IRC § 6651(a)(1) late-filing penalty than you expected. Is this a computational error or a conceptual error?

At first blush, failure-to-file penalties seem like basic arithmetic: essentially, you look at the total amount of tax that should have been reported (and paid) and multiply that by 5% for each month the return is late. In the above hypothetical you’ve reached a determination of the amount of tax that should have been reported when you settled on the deficiency amount. But it isn’t clear that you ever discussed or determined exactly when the return was filed -that is, how late the return is, and by consequence how many months the penalty applies. That value could be subject to reasonable dispute. Exactly when a return is “filed” can be contentious. If the return was truly “late-filed” the issue would be when the IRS received it… but even that date isn’t always clear, especially post-Fowler (see coverage here).

Reverse engineering the late-filing penalty calculations may help in this case: how many months does the penalty amount proposed by the IRS equal? Is it a mathematically impossible number under the statute? (IRC § 6651(a)(1) rounds each fraction to a full month, so if you are 32 days late it is the equivalent of two months.) If so, it is likely a computational error.

Likely a computational error. But not definitely.

Again, conceptual errors may linger behind even the most seemingly mathematical mistakes. The IRS could conceivably have decided on a penalty amount that doesn’t immediately appear to add-up. For example, maybe the parties agree that the return was three months late, but the IRS believes there are significant hazards of litigation on a “reasonable cause” argument. In that case, the IRS may settle on a penalty that doesn’t otherwise make mathematical sense: a penalty of only 60% of the amount due for a three month-late return, accounting for the 40% chance that the petitioner may prevail on a reasonable cause argument in court.

The thing is, as a matter of negotiation the IRS pretty much always has discretion to settle on dollar amounts that won’t “make sense” in a winner-takes-all application of the Code. Left unbounded, the unscrupulous tax attorney could always say, “it wasn’t an arithmetic error: they were just scared I might win!” This line of argument should not always be availing. Whether an attorney can shoehorn a computational error into the conceptual category depends on the facts and circumstances of the case at issue, and the actual conduct of the parties in reaching their settlement.

First though, it is important to recognize why tax attorneys may be so tempted to categorize gifts as “conceptual” in the first place. The biggest reason? These are the gifts you can (in some sense, “must”) accept from the IRS. They are (generally) client confidences that do not raise to the level of misrepresentation to the court. Unless the client wants you to disclose the issue, you shouldn’t. Admittedly, different people in the tax world have different views on your responsibilities to the client and tax administration more broadly. The 2020 Erwin Griswold Lecture gives an interesting overview of the opinions of some prominent tax personalities on that point.

ABA Statement 1999-1 uses the example of a Schedule C deduction to illustrate. In the example the parties eventually agree that the deduction should be allowed, but counsel for the taxpayer believes (secretly) that the deduction likely should be due to passive activity under IRC § 469, and therefore wouldn’t benefit the client. The IRS doesn’t raise this issue, and neither does counsel. ABA Statement 1999-1 advances this as a “conceptual” error: counsel must not disclose unless their client expressly consents to their doing so.

To me, this is a roundabout way of asking whether the conceptual error might not be an “error” at all. As the ABA Statement notes, passive activity issues are highly factual and “subject to some reasonable dispute.” That seems less like a conceptual “error” on the IRS’s point, and more like a conceptual “weakness.” In the ABA’s example the wiggle room is in the reasonable dispute on a highly factual question of law. But that isn’t always how conceptual errors work, particularly when you “know” the key facts at issue.

For example, imagine the IRS audits your client claiming their niece as a qualifying child for the Earned Income Tax Credit. All the IRS is putting at issue is whether the niece lived with your client. Later in the process, you learn that the real problem with your client’s return is that they are legally married and needs to file married filing separate (which disallows the EITC). The IRS, however, doesn’t think to raise this issue. Note that this is essentially what happened in Tsehay v. C.I.R., discussed here. Even though that may be a “conceptual” error you still are not completely off the hook. I would argue that you cannot enter a decision with the court failing to correct that mistake. Recall your obligations to the court under MRCP 3.3 and note especially Rule 3.3(a)(2): the prohibition on failing to disclose adverse controlling legal authority.

In sum, the only time you may be completely free is where it is a conceptual “weakness” rather than an outright error: those instances where you could argue “maybe, just maybe, it wasn’t a mistake at all.” Let’s see if that’s what happened with the Householders.

As Applied to the Householders

The gift to the Householders was in the form of a very messy Notice of Deficiency. Most pertinently, it involved the transformation of a gain (reported by the taxpayer) into a rather large, favorable loss that never seems to have been claimed by the taxpayer at all. The Notice of Deficiency explanation illustrates the confusion: “It is determined that the amount of $317,029 claimed on your return as a loss resulting from the sale of your business is allowable.” The problem is that loss was not claimed on the return.

How did this mistake come to be? Was it from dueling legal theories for calculating the gain on the sale? I am operating from imperfect information, but the order would suggest otherwise. The working theory is that the IRS revenue agent was looking at an unsigned Form 1040 that had been submitted during examination negotiations, and not the actual Form 1040 that had been filed.

One may be tempted to call this a “clerical” mistake: a typo transposing numbers from the actual filed return and one that was just floating in the revenue agent’s file. But one can also imagine facts that would shift this into the world of “conceptual” errors. If there was a return floating around the revenue agent’s file that took the position there was a $317,029 loss, it is conceivable that the IRS simply agreed with that position. How are you to know if the IRS agreement was inadvertent? More facts would certainly be needed surrounding the transaction at issue to determine if it were a conceptual or clerical error.

A core question Householder raises is whether by filing a petition and invoking the power of a tribunal (and thus MRPC Rule 3.3), you are under any sort of obligation to correct errors on a Notice of Deficiency: computational, clerical, or otherwise.  A secondary question is whether silence on such a mistake is the same as prohibited “misrepresentation” to the court. I don’t think it is always so simple as to say “it’s not my job to fix the IRS’s mistakes.”    

In any event, by the time Householder gets to the Tax Court, Judge Holmes is essentially handcuffed in getting to the right number. Particularly where settlement is done on issues rather than bottom line numbers, it appears that silence on an error concerning how those issues will ultimately “add up” under Rule 155 computations is not going to be upset by the court. See Stamm Int’l Corp. v. C.I.R., 90 T.C. 315 (1988).

But that’s not what this foray into ethics is all about. This is not about what the Tax Court can do, but what a tax attorney should do under their professional obligations. I certainly do not have enough facts to know whether Householder involved conceptual, computational, or clerical mistakes. I do know that these sorts of gifts raise all sorts of ethical issues and are not as fun to receive as one may think.

Accepting Gifts from the IRS: Ethical Considerations (Part One)

Previously, I wrote about the strange case of Householder v. C.I.R (here). As a refresher, the Householders tried to take about half-a-million dollars in nonsense deductions for their horse breeding/leasing “business,” and the Tax Court disallowed them. This, of course, resulted in a $0 deficiency after running Rule 155 computations.

Wait, what?

Yes, that’s right: there was no deficiency for the Householders even after “losing” on a half-million dollar deduction because the IRS made a serious mistake in their Notice of Deficiency. Essentially, the IRS “gifted” the Householders a tax loss unrelated to the one at issue before the court. In the previous post we mostly looked at whether the IRS could take back or otherwise undo their gift. This time, we’ll look at ethical considerations for counsel in accepting these gifts.

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It took all my willpower not to name this blog “Emily Post’s Guide to Accepting Gifts From the IRS.” However, the real concerns for counsel in these situations are less matters of etiquette and more the competing obligations of confidentiality with your client and candor to the court.

As a human in the world, I might think morality dictates I should tell the IRS of an erroneous “gift” so they can (presumably) rescind it. But as a lawyer in the world, professional rules dictate otherwise- something that may be thought of as a “loophole” in morality. (I can’t help myself: I was a philosophy major with a focus on applied ethics and I’m still paying off those loans. Any reference I can make to something I learned in undergrad eases the pain.)

Without being able to heavily rely on our gut moral compass, it can be difficult to know what is required of you as a lawyer on ethical issues. Lawyers have to think in terms of what “is or isn’t” in accordance with the Model Rules of Professional Conduct (MRPC). And even within the constrained universe of the MRPC it can be difficult to know what your ethical responsibilities are: as the Minnesota Rules of Professional Conduct state, these are “rules of reason.” See MRPC “Scope” [14]. In most situations attorneys must work backwards from the general principles of the MRPC to arrive at an answer.

Fortunately, there is an ABA Statement almost directly on point for the sorts of issues at play in Householder. This is ABA Statement 1999-1.The money quote from that statement is as follows:

“A client should not profit from a clear unilateral arithmetic or clerical error made by the Service and a lawyer may not knowingly assist the client in doing so. This is not the case, however, if the computational error is conceptual, such that a reasonable dispute still exists concerning the calculation.”

The ABA Statement creates a typology of “gifts,” each with different characteristics and ethical considerations. The differences are important primarily in how they determine what duties you owe the client, the IRS, and the court. Those different varieties are (a) computational gifts, (b) clerical gifts, and (c) conceptual gifts. Let’s take a look at each before figuring out which one the Householders received.

Clerical Gifts

Let’s begin with the easiest one to classify and respond to: clerical gifts. These can be thought of as typos, and they are not the sort of gifts you are allowed to accept. If my client and the IRS settle on a refund of $1,000 and the IRS types up a decision document accidentally listing a refund of $100,000 my role is clear: Let the IRS know of the mistake. I don’t even need to consult my client on that. The decision document would be entered in court and failing to correct this mistake would be in violation of my duty of candor to the court. MRPC 3.3.

You might be thinking to yourself, “but what about your duty to the client? Shouldn’t they get the final say as to whether to accept this payday since the mistake is a client confidence?”

Not so. Where the court is involved, such client confidences are explicitly overruled by MRPC 3.3(c). In fact, because you’d already reached a settlement amount with the client and IRS, you don’t even need to disclose the issue to your client: you have implied authority to make the fix on your own. See MRPC 1.6(b)(3). As we’ll see with the other varieties of gifts, this issue of maintaining a client confidence can be a serious sticking point.

If the matter didn’t involve entering a decision document in court (and therefore candor towards a tribunal), the answer may be different. In that case, you’d want to have a long chat with the client about the criminality of cashing a government check they aren’t entitled to. And as a tax lawyer you’d probably want to drop the case because of Circular 230 concerns. But that isn’t what we’re dealing with for the purposes of this blog. For now, playing the role of Emily Post, if the IRS gives you a clerical gift, one must politely say “I could never accept such generosity.”

Computational Gifts

Computational gifts may be “squishier” than clerical gifts and entail a broader range of mistakes. On one end of the spectrum the mistake may be simple arithmetic: 2 + 2 = 5. This isn’t a far-cry from a clerical mistake, and identical ethical considerations apply: you cannot accept such generosity, and you must disclose (if in court). Most of the time, however, the arithmetic isn’t so cut-and-dry. What if the issue isn’t failure to correctly add two numbers, but failure to consider a code section that would introduce another variable to the equation? In other words, what if the correct computation is 5 + 3 x 0 but the IRS doesn’t recognize a law providing the zero multiplier, and only adds 5 + 3? Computational, to be sure, but not strictly so…

Which leads us to the final category: “Conceptual Gifts.” These are the gifts attorneys want to receive from the IRS, because in some circumstances they can actually accept them. Was the Householder’s erroneous Notice of Deficiency one such conceptual gift? We’ll take a deeper look at what exactly distinguishes conceptual gifts from purely computational ones in the next post.

Does the Golsen Rule Apply to Tax Court Rules?

For many years the Tax Court did not concern itself with circuit court precedent in deciding cases and decided cases as it thought best.  The leading case for the Tax Court’s thinking on this issue was Lawrence v. Commissioner, 27 T.C. 713 (1957), decided based on the nationwide jurisdiction of the Tax Court and the desire for uniform application of federal tax laws, which caused the creation of Court almost a century ago:

One of the difficult problems which confronted the Tax Court, soon after it was created in 1926 as the Board of Tax Appeals, was what to do when an issue came before it again after a Court of Appeals had reversed its prior decision on that point. Clearly, it must thoroughly reconsider the problem in the light of the reasoning of the reversing appellate court and, if convinced thereby, the obvious procedure is to follow the higher court. But if still of the opinion that its original result was right, a court of national jurisdiction to avoid confusion should follow its own honest beliefs until the Supreme Court decides the point. The Tax Court early concluded that it should decide all cases as it thought right.

The downside of that practice was that it forced petitioners or the IRS with favorable circuit court precedent to file an appeal and obtain an easy victory in the circuit court overturning the decision of the Tax Court.  Eventually, the Tax Court decided that making taxpayers and the IRS engage in a two-step process to reach an outcome already dictated by circuit precedent did not make sense and it announced a change in its practice in the case of Golsen v. Commissioner, 54 T.C. 742 (1970).  Reversing the Lawrence decision, the Tax Court held:

we think that we are in any event bound by Goldman since it was decided by the Court of Appeals for the same circuit within which the present case arises. In thus concluding that we must follow Goldman, we recognize the contrary thrust of the oft-criticized case of Arthur L. Lawrence, 27 T.C. 713. Notwithstanding a number of the considerations which originally led us to that decision, it is our best judgment that better judicial administration. requires us to follow a Court of Appeals decision which is squarely in point where appeal from our decision lies to that Court of Appeals and to that court alone.

Fifty years later the Tax Court still follows Golsen and even if the Tax Court has issued a precedential opinion on an issue, the Tax Court will follow the precedent of the circuit to which the case will be appealed.  For that reason, the place where the taxpayer resides at the time of filing the petition can have an outcome-changing impact.

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While the Tax Court has bowed to the will of circuits in the cases it decides, does or should the same recognition of authority apply to the rules it creates?  If the Tax Court has a rule that conflicts with circuit precedent, should the Tax Court follow the circuit precedent in writing its rules?  You might question how the Tax Court can write rules that reflect varying precedent among the circuits.  Certainly, writing a set of rules that vary based on circuit precedent would be challenging and in most rules unnecessary, but what about rules that apply to cases appealable to only one circuit?  If every case the Tax Court decides will go to one circuit, shouldn’t the rules of the Tax Court follow the law of the circuit rather than the position of the Tax Court?  Such a view of the rules would seem faithful to the precedent in Golsen.  It would also alert parties practicing before it of the law that would be applied in a given situation, rather than having a rule that could mislead practitioners or the 70% of petitioners who file pro se.

Tax Court Rule 13(c) provides:

Timely Petition Required: In all cases, the jurisdiction of the Court also depends on the timely filing of a petition.

The Court may not need a rule that states a legal conclusion, but if it has such a rule and if the Golsen rule applies to the Court’s rules, it would seem that Tax Court Rule 13(c) should recognize that in two of the types of cases it describes in Rule 13(b) the jurisdiction of the Court does not depend on timely filing.  Certainly, timely filing is very important but in whistleblower cases and in passport cases timely filing is not a jurisdictional prerequisite.  We have discussed the decisions in the D.C. Circuit on the jurisdictional issue, holding that timely filing is not a jurisdictional prerequisite here and here

Since the appeal of any whistleblower case or passport case from the Tax Court would go only to the D.C. Circuit under the catchall language at the end of IRC 7482(b)(1), it would seem that precedent from that circuit would control the outcome of a Tax Court case regarding jurisdiction under the Golsen rule.  If it would control the outcome of a Tax Court case in which the Court was writing an opinion, why wouldn’t the circuit court precedent also control the Tax Court rules?

Tax Court Rule 155 and Gifts from the Service

From time to time it can feel as if the IRS is giving your client a bit of a gift. It could be in the form of the IRS settling on weak arguments -perhaps with inflated fears over the “hazards of litigation” the facts present (see post here). It could also be in the form of the IRS informing your client of deductions or credits they are eligible for but never actually claimed -something I have seen in practice on numerous occasions.

But the IRS may also make an inadvertent “gift,” less charitably described as an “error.” And when this happens in your client’s favor it raises all sorts of ethical and legal issues. This post will focus only on the legal issues, and particular the timing of the IRS’s “gift” and when the IRS is no longer able to take it back. These valuable and interesting lessons were issued as (presently on hiatus, but hopefully to be revived) Designated Orders the week of September 7, 2020…

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The designated order at issue stems from a rather old and interesting case: Householder v. Commissioner, Dkt. # 6541-12 (order here). The Tax Court issued its findings of facts and an opinion on the case way back in August, 2018 (T.C. Memo. 2018-136, here). From that time until the order above, however, no decision could be entered because the parties could not agree on their Tax Court Rule 155 computations. Note that in deficiency cases the Tax Court is required to issue a decision that directly addresses the amount (if any) of the deficiency -which isn’t always done through the opinion. This exact issue was very briefly discussed in the only other designated order of the week, Hopkins v. C.I.R., Dkt. # 19747-19 (order here).

Nonetheless, when the Tax Court issues an opinion that addresses all the substantive legal issues the final deficiency should be a fairly simple matter of math. As we have seen before (see Keith’s post here) when dealing with Rule 155 there is little room for gamesmanship, and even less room to raise new issues. Ultimately, as we’ll see, that latter concern dooms the IRS. But before getting there let’s take a second to ponder all the work that went into this case prior to the decision finally being rendered.

The Householders are highly educated, wealthy and successful. Scott Householder is adept with financial planning, and Debra Householder, in addition to having a Ph.D. in psychology, has a lifelong affinity for horses and horse riding. So it seems a perfect marriage of passions and proclivities when they are approached with an investment opportunity involving horse breeding and leasing…

If you’ve ever read any tax case on “hobby-losses” (the colloquial term for the IRC § 183 prohibitions) you probably know where this is going. Rich people apparently love horses. For some it may be genuine (like Debra’s). For others it may be because horses tend to generate (potentially) tax-deductible business losses. It is also almost always the case that the IRS wins in arguing that these losses are not actually businesses with a profit motive, but instead hobbies. This is true even though Congress has created a less demanding presumption for showing a “business motive” specifically pertaining to the “breeding, training, showing, or racing of horses.” IRC § 183(d).

The mechanics of the Householder’s arrangement was a bit more complex than the usual “rich-people owning horses and pretending it’s a business” scheme, but not by much. The entity that pitched and ran the horse-leasing enterprise (“ClassicStar”) to the Householders yielded at least five separate Tax Court decisions where no loss was allowed because the horse breeding/leasing was not engaged for profit. If anything, the ClassicStar scheme is more bald-faced and upfront as a tax scam than most. I encourage people to read the facts of the opinion: ClassicStar all-but-asks the Householders “how much of a loss do you want?” in multiple years.

Yes, ClassicStar advised that the Householders take all sorts of business-like steps with this investment (create an LLC or S-Corp! have a separate bank account just for this business! spend 100+ hours on meetings and such!), but the writing is on the wall: this is a sham, and almost certainly not a business that is being operated for profit by the Householders. As but one more in a long line of examples, the Householders didn’t even know what specific horses they’d be breeding/leasing when they paid the money: knowing the horse you’re forking over hundreds of thousands of dollars for is usually something you care about when trying to make money. Bad facts (there are many more in the opinion, including that one of the horses was castrated and thus not particularly suited for breeding), make for very dim prospects of deducting the expenses.

But it goes beyond the IRS just auditing the Householders on a bad hobby loss. ClassicStar was eventually raided by the IRS and completely shut down. Some of the ripple effects included $200 million in tax fraud charges and $65 million in damages to certain defrauded investors. This was a widespread scam, and it did end up costing a lot of other people quite a bit of money on what they appeared to genuinely believe was an investment opportunity.

But what about for the Householders, who only ever really seemed to care about generating inflated tax losses in the first place? Almost incredulously, the Householders continued to argue in Tax Court that they were engaged in the business for profit. But Judge Holmes has no problem shooting this down: the system works!

Almost. Hold that thought for now.

There is an alternative argument that the Householders make, which is that the money they paid to ClassicStar should be deductible as a “theft loss” in 2006 when it became clear they could not get their “investment” back.

I want to pause to consider the chutzpah of this argument. Imagine you spend approximately $500,000 on a complete scam, that you know is a scam, but have been assured that the scam will generate $2 million in tax losses. It later turns out that the scam generates $0 in tax losses… because it is a scam. You want your $500K back from the scam artist but, having been shut down by the IRS for being a scam artist, they have no money left to pay you with. Should you get to take a loss of the $500K as a “theft” because the scam was exactly what it sounded like: a scam?

The Tax Court, again, says “no” though for different reasons. There was also an exchange of stock in this case, and the Householders want to argue that it was worth very little, due to “discounts in marketability.” The Householders are likely wrong on this as a matter of fact, but they also raise this issue too late: for the first time, on brief. Judge Holmes determines that the Householders didn’t really “lose” the money they put down in the first place. If anything, they likely came out slightly ahead. You need to lose something to have a theft loss, and the Householders didn’t lose anything here. So no business deduction and no theft loss: the only real issues in play. The system works!

Not quite. For, as we will see, despite their ludicrous legal arguments and return positions the Householders end up having no deficiency. A gift from the Service. This is where we arrive at the designated order, several years later.

I’ve noted before how important it is to “raise all of your arguments” (here). Petitioners must be wary of failing to assign error to items in a Notice of Deficiency they would like to dispute. Generally failing to do so means that it is conceded (Tax Court Rule 34(b)(4)), unless (1) you amend the petition, or (2) are able to argue that it was tried by consent. See Tax Court Rules 41(a) and (b) respectfully.

But the IRS runs similar risks. In this respect, it is helpful to conceptualize the Notice of Deficiency (NOD) as the IRS’s complaint. If the IRS fails to raise an issue in a NOD, they can generally add it to the “complaint” later, with the Court’s consent. However, even if the Court allows, this carries the potential complication that IRS position does not have the presumption of being correct -as it would if it were included on the NOD. See Welsh v. Helvering, 290 U.S. 111 (1933) and Tax Court Rule 142(a).

The IRS gift to the Householders goes one step further than that usual, fairly excusable mistake. Rather than forgetting to bring up an issue in the NOD, the IRS actually creates a new, very taxpayer friendly one. Somehow, likely in a mix-up of papers, the IRS agent drafting the NOD gave the Householders a loss of $317,029 (on an issue that had nothing to do with the horse fiasco), where the Householders had actually reported a gain of $145,000.

The Householders, on seeing this gift in the NOD, kept their mouths shut. In other words, they didn’t assign it as an error on their petition. This effectively meant that the numbers were conceded, and not properly before the court. Note, again, the IRS could have recognized this at numerous points up to the trial and properly raised the issue. But the IRS was in tunnel-vision mode with this case and didn’t see their own error on the NOD.

By the time it becomes obvious that there was a mistake the train had left the station. All the parties had left to do was run through the computations based on the items as reflected in: (1) the original return items that weren’t challenged in the NOD, (2) the NOD as conceded or agreed upon, and (3) the unagreed items as determined by the Tax Court. The magical gift of converting a $145,000 gain into a $317,029 loss was in the second category: agreed upon by the parties, as evidenced by the NOD and the lack of any mention of it in the pleadings, stipulations, or any other point of the trial up until the awkward moment the IRS had to add things up and find that their win in court resulted in a $0 deficiency.

I feel for IRS Counsel seeing this far too late and trying desperately to find a way to the right outcome. Valiantly, the Service tries a motion for reconsideration (Rule 161), but to no avail. These motions are pretty uphill battles in any case (see Keith’s post here), but a motion for reconsideration is not appropriate for instances where the Court didn’t make a mistake, but you did. For more, you can see my post on the three usual “flavors” of a motion to reconsider here.

So at the end of the day through the Householders agreeing to accept the IRS gift they walk away with no deficiency in case where the Court found they took some absolutely nonsense deductions. A pretty unsatisfying outcome for everyone but the Householders I’m sure. But likely the correct one as a matter of Tax Court procedure.

In a follow up post I’ll look a bit further at a question that may be on people’s minds: Can you, as an attorney, ethically accept that kind of a gift from the IRS in a court proceeding?

Tax Court Forum Shopping Reminder

Several years ago I wrote a post focused on the choice petitioners have when filing a Tax Court petition and how that choice could impact the outcome of their case.  I wrote the post because the Tax Court had entered a precedential decision in the case of Rand v. Commissioner, 141 T.C. 12 (2014), determining that the IRS could not impose the IRC 6662 penalty for understatement on taxpayers who overclaimed the earned income tax credit since the overstatement of the credit was not an understatement of tax.  The IRS disagreed with the decision initially and indicated a desire to continue litigating the issue.  A similar situation had occurred earlier when the Tax Court issued a precedential opinion in Lantz v. Commissioner, 132 T.C. 131 (2009), striking down the innocent spouse regulations interpreting IRC 6015(f) to impose a two-year time limit after the initial collection action on requesting innocent spouse relief.

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In these situations, my suggestion in the post was to elect the small tax case procedure, if it was available, and the Tax Court would follow its precedent, resulting in an automatic victory for the petitioner. To go this route, you must not only qualify for small tax case procedure but also be in a circuit that does not have adverse precedent on the issue, since the Tax Court inexplicably follows the Golsen rule in deciding small tax cases as discussed in an article by Carl Smith “Does the Tax Court’s Use of its Golsen Rule in Unappealable Small Tax Cases Hurt the Poor?” Carl pointed out in his article that the Golsen rule by which the Tax Court adopted the rule of following the precedent of the circuit to which a Tax Court case would be appealed does not logically follow when a case cannot be appealed to the circuit court. By their very nature, small tax cases are cases entirely within the jurisdiction of the Tax Court. The Tax Court reversed its prior precedent in adopting Golsen in order to keep petitioners who lost at the Tax Court from simply appealing and obtaining a reversal in circuits where the Tax Court and the circuit court disagreed. If a case cannot be appealed to the circuit court, no need exists for following circuit precedent, yet the Tax Court applies Golsen anyway.

Given the Tax Court’s application of the Golsen rule, choosing the small tax case route does not make sense if the taxpayer lives in a circuit where adverse precedent exists. If no circuit precedent exists in the circuit where the taxpayer resides at the time of filing the Tax Court petition, then the Tax Court follows its own precedent. If it has a precedential opinion on its books, you know the outcome of the case, which makes choosing the small tax case route the logical choice for qualifying taxpayers.

This brings me back to the discussion at the end of the post on Friday, March 19. The discussion focused on the Tax Court’s decision in Sutherland v. Comm’r, 155 T.C. No. 6 (2020) and the apparent disagreement of the IRS with the Tax Court’s decision regarding the administrative record in innocent spouse cases. The situation in Sutherland presents another example of the value of electing small tax case status once the Tax Court has issued a precedential opinion on an issue. A high percentage of innocent spouse cases will qualify for small tax case status. Going that route gives you certainty if you fit within the facts of Sutherland.

Even if you do not elect small case status at the outset of the case as about 50% of petitioners do, you can make the election later in the case with leave of court. Pursuant to Tax Court Rule 171 you must make the election prior to the start of trial. You can expect to face some opposition from the IRS if you are making the election in a situation which will result in automatic loss for the IRS, but the IRS does not have many good arguments for opposing your request.

I have heard some practitioners say they always elect regular case status. Doing so ignores the what can be a winning strategy in situations like Rand, Lantz and Sutherland. The IRS has the right to keep litigating in Tax Court after obtaining a losing opinion on an issue, because it can set the issue up for a fight in the circuit courts where it might overturn the precedential decision of the Tax Court, as it did in Lantz. Conversely, taxpayers have the right to choose a Tax Court “forum” that prevents the IRS from getting to circuit court. Pay attention to the situations when this strategy could create an easy victory for your client.

Tax Court Disbarments

The last week of February finds your bloggers mired in other writing projects and demands of work causing suspension of daily production this week.

The Tax Court issued notice of disbarment and suspension for five practitioners and one of the cases deserves note because we have written about it previously.  All five of the cases involve reciprocal discipline meaning that the practitioner engaged in behavior that caused their home state to discipline them and the Tax Court’s action piggybacks on the state decision.  All of the cases involve failure of the practitioner to alert the Tax Court that they were disciplined by their state bar. 

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The Tax Court rules require that practitioners alert the Tax Court of any disciplinary action by another court or bar.  These cases suggest that notifying the Tax Court of disciplinary proceedings elsewhere is not at the top of the list for individuals subject to disciplinary proceedings.  Three of the five cases involve no response from the practitioner to the Tax Court after notification by the Tax Court of concerns about the disciplinary proceedings against them.  Here, is a typically line from these three orders:

The Court has received no response from Mr. Altman. Furthermore, Mr. Altman’s right to a hearing is deemed waived as he did not advise the Court in writing on or before November 9, 2020, of his intention to appear at a hearing concerning his proposed discipline.

In the case of Eric Bopp, he did not timely respond but did respond.  He had been suspended by Louisiana.  The Tax Court reprimanded him for failing to notify it but did not suspend him from practice or disbar him.  His case provides a good argument for responding rather than ignoring the Tax Court.  Perhaps the three who ignored no longer wished to practice before the Tax Court and did not find it worth their time to engage in correspondence with the Tax Court about the effect of their state bar discipline on practice before the Tax Court.  Mr. Bopp’s result demonstrates the benefit of corresponding.

The case of most interest and the one with the longest analysis by the Tax Court is that of John Koresko.  I wrote about his case previously here.  Mr. Koresko was disciplined by Pennsylvania back in 2013.  You can read about the reasons for this disbarment in the prior post if you are interested, but the disbarment related to actions he took as an attorney on cases.  The Tax Court started corresponding with him about this in 2014.  As per usual, he had not informed the Tax Court of his disciplinary problems.  He also did not respond to an order issued by the Tax Court.  After the issuance of the order by the Tax Court:

On July 22, 2016, the Court received a letter dated July 7, 2016, from Mr. Koresko asserting that he did not receive the May 10, 2016 Order as he had been incarcerated in solitary confinement since May 6, 2016, for contempt of court. By Order dated September 30, 2016, the Court stayed the proceedings in this case.

 Eventually, Mr. Koresko took his Tax Court disbarment matter to the D.C. Circuit which vacated the Tax Court’s order of disbarment and remanded the case so that he could have the hearing promised in the May 10, 2016 order.  The case came back to the Tax Court about the time it shut down because of the pandemic.  The Memorandum Sur Order issued by the Court in this case recounts the various actions taking place during the pandemic in order to give him a hearing.

[on] December 21, 2021, the Court received a letter from Mr. Koresko in which he waived his right to a hearing and stated: “I respectfully request that you accept my proposal and agreement to accept discipline short of disbarment.” He expressed regret for his actions that led to his disbarment in Pennsylvania and admitted that he made a terrible mistake of judgment. His response explained that his “unduly aggressive behavior in the litigation was wrong” and “the charged offenses were worthy of discipline.”

The Tax Court accepted this letter as a waiver of his right to a hearing, his admission of misconduct and his agreement to discipline short of disbarment.  It concluded that the appropriate remedy was suspension from practice before the Tax Court until further ordered.

I don’t know enough about Tax Court disciplinary proceedings to have a guess as to how difficult it will be for Mr. Koresko to have the suspension lifted.  He placed enough value on his admission to Tax Court to appeal to the D.C. Circuit.  So, he may come back to the Tax Court at some point and allow us the opportunity to see what it takes to have a suspension lifted.  He has avoided disbarment from the Tax Court.  The lessons to be drawn from these five cases are lessons that apply in almost any case before a court.  Courts do not like to be ignored.  Communicating with the court can bring a better outcome than ignoring it.  Early communication is better but even communicating late is better than not communicating at all.