Designated Orders in Krug v. Commissioner, 5/29/18 & 6/13/18

0 Flares 0 Flares ×

Patrick Thomas and William Schmidt today discuss two designated orders by Judge Halpern in an unusual whistleblower case. The Court seeks further explication of a Social Security Act provision relating to inmate services, which Respondent alleges dooms the petitioner’s claim. Patrick and William take us through the tangle of applicable statutes. Christine

Docket No. 13502-17W, Gregory Charles Krug v. C.I.R. (Order here).

As promised in Patrick and William’s recent designated orders posts, this post looks at Krug v. Commissioner, a whistleblower case assigned to Judge Halpern, and is co-authored by both Patrick and William.

This order stems from Respondent’s motion for summary judgment, which actually resulted in two designated orders: the June 13 order discussed below, and one from May 29. In both orders, the Court is confused by Respondent’s arguments, and as such, declines to dispose of the motion without further argument. The May 29 order sets the motion for a hearing during a trial session on June 4. The later order discusses that hearing, but still reserves judgment until Respondent provides further information.


Specifically, Respondent asks the Court to uphold the IRS denial of a whistleblower award, because the entity against which the whistleblower complained was not required to withhold employment taxes or federal income tax. Respondent submitted a Form 11369, Confidential Evaluation Report on Claim for Award, which evaluated Petitioner’s administrative claim for a whistleblower award. This form included the following language:

Social Security and Medicare wages are excluded from inmate services under the provision of Section 218(c)(6) of the Social Security Act. The Federal income tax withholding is dependent on the amount of wages paid which is less than the minimum wage. FIT on these wages would be dependent on other income (investment) earned by the inmates, and whether or not they file a joint return. Because of these unknown factors, this claim will be declined.

So, it appears the whistleblower notified the IRS that a prison was not withholding Social Security, Medicare, or Federal income taxes on wages paid to inmates. The IRS denied a whistleblower award claim, noting that the prison has no such withholding requirements.

Judge Halpern does not understand the relevance of the explanation. The Federal income tax reference seems inapplicable, he says, given that petitioner’s claim relates to “employment taxes.” He further notes that though section 218(c)(6) of the Social Security Act “does address services by inmates, we do not understand the relevance of the provision to petitioner’s claim.” In the May 29 order, he asked Respondent to clarify its argument at the June 4 trial session.

Apparently, Respondent’s explanation was insufficient. Judge Halpern notes in the June 13 order that, “as indicated in the transcript of the hearing, the Court was not satisfied with counsel’s explanation of why payments for the services of inmates are not subject to withholding for employment taxes.” Petitioner did not appear for the hearing. In fact, the petitioner has not been responsive to orders beginning February 8. Looking at the docket, there could be an issue of whether the Court has the petitioner’s correct address.

To us, it seems that Judge Halpern and Respondent are talking past each other. Judge Halpern is correct, in that, on its face, section 218(c)(6) of the Social Security Act (42 U.S.C. § 418) has nothing to do with withholding obligations. Rather, Section 218 provides a mechanism through which State and local governments may allow their employees to participate in Social Security and Medicare. Originally, States were not automatically obligated to participate in these programs. After the addition of Code section 3121(b)(7)(F) in 1991, with limited exceptions, all state employees are required to participate in Social Security, including its withholding requirements. Today, all states have a Section 218 agreement with the federal government.

Separately, Code section 3101(a) imposes Social Security and Medicare taxes, which section 3102(a) requires to be withheld from employee wages. Section 3121(b) defines “employment” broadly, with a number of exceptions. An exception exists for any employee of “a State . . . or any instrumentality . . . “. IRC § 3121(b)(7). Importantly, an exception to the exception exists for any states who have entered into an agreement with the federal government under Section 218 of the Social Security Act, or where the employee is “not a member of a retirement system of such State . . .” IRC § 3121(b)(7)(E), (F). As noted above, all 50 states have these agreements, and all state employees are generally—agreement or not—required to withhold these taxes.

And there’s where the rubber meets the road: Inmates of penal institutions are, under Social Security Act section 218(c)(6), excluded from any agreement under that section, as the Service notes. Further, even where no agreement is in force, section 3121(b)(7)(F)(ii) specifically exempts withholding obligations for state employers for wages paid to inmates in a penal institution.

Regarding the withholding of federal income tax, while such a tax might not be strictly characterized as an “employment tax”, employers are nevertheless generally obligated to withhold such taxes from employee wages. Reporting such a failure could charitably fall under the ambit of “employment taxes” when a pro se taxpayer uses this term. And further, section 3401 contains no blanket waiver on the definitions of “wages” or “employment” in mandating withholding obligations under section 3402(a)(1).

So, to us, there appears to be a live issue regarding income tax withholding requirements, but a fairly straightforward argument that no Social Security or Medicare tax withholdings were required. The Service says in the Form 11369 that the employer needed more information to make this determination (other income, marital status, etc.). But isn’t it the employer’s problem that they didn’t collect that information?

We’re also confused why the IRS would make only this argument. A whistleblower award under section 7623 is premised upon the IRS “proceed[ing] with any administrative or judicial action described in [7623(a)] based on information brought to the Secretary’s attention by an individual.” The “administrative or judicial action” could include “(1) detecting underpayments of tax, or (2) detecting and bringing to trial and punishment persons guilty of violating the internal revenue laws or conniving at the same…” If Respondent’s argument is that the prison in question wasn’t required to withhold, then surely the IRS also did not take “administrative or judicial action” to detect an underpayment or other malfeasance. That seems a much stronger argument for upholding the denial.

Further, Judge Halpern, in his second order, advises Respondent’s counsel to review Kasper v. Commissioner, 150 No. 2 (2018), which we’ve discussed before. Kasper holds (1) Tax Court review of a whistleblower award denial is generally limited to the administrative record; (2) the standard of review is abuse of discretion; and (3) the Chenery rule applies, meaning that the Tax Court can only uphold the Service’s decision on the same grounds that the Service itself made the decision.

How does Kasper affect this case? Because the standard of review is now conclusively an abuse of discretion standard in the Tax Court, it’s easier for the Tax Court to uphold the denial of a whistleblower claim.

But we may also be missing a critical fact: did the whistleblower’s claim relate to unpaid wages, as in Kasper? Without access to the other documents in the Tax Court’s docket, we can’t know for sure. If so, then Judge Halpern seems to suggest that regardless of whether a prison is required to withhold Social Security and Medicare taxes for wages paid to inmates, the Court could uphold the decision on the basis that no withholding was necessary, because no wages were paid. But, if that’s the case, why not just order that here? If only Tax Court motions and briefs were publicly accessible, we wouldn’t be left to wonder.

The June 13 order requires Respondent and Petitioner to file a memorandum on or before August 3 addressing the Court’s concerns with the Form 11369’s relevance. In the meantime, the Court has taken the motion for summary judgment under advisement.

William Schmidt About William Schmidt

William Schmidt joined Kansas Legal Services in 2016 to manage cases for the Kansas Low Income Taxpayer Clinic and became Clinic Director January 2017. Previously, he worked on pro bono tax cases for the 3 Kansas City metro area Low Income Taxpayer Clinics. He records and edits a tax podcast called Tax Justice Warriors and is now an adjunct professor for Washburn University School of Law.


  1. The whistleblower in this case has a colorful history, if the top hits from a Google search are reliable evidence. His interest in inmate taxation apparently stems from his status as a former Texas CPA (as stated in his own website) and a recently-released federal prison inmate (Bureau of Prisons, register number 15503-075, Age 73, released on 12/15/2017). He has sued a number of federal judges, from the Supreme Court on down. And a November 2016 online article about him from Law360 begins,

    “Counsel for a man convicted of plotting to kill a state judge urged the Ninth Circuit on Thursday to toss his conviction for threatening to shoot the assistant U.S. attorney who prosecuted him.”

    This might have been the distraction that caused Judge Halpern to refer on June 11, 2018 to his order of “May 29, 2008,” rather than 2018.

    Mr. Krug also filed a Tax Court petition in 2012 involving his own taxes. That case was dismissed because no notice of deficiency had been issued by IRS.

    Since he is probably concerned with federal prisons, the discussion of state Section 218 agreements may be irrelevant. (I also wondered whether this case might involve local jails, or private correctional institutions, but those issues shall await another whistleblower.)

    All I know about Section 218 agreements is what I have learned from my clients’ W-2 forms. As the linked website explains, “These agreements allow the States, if they desire, to provide Social Security and Medicare Hospital Insurance (HI) or Medicare HI-only coverage for public employees. . . .certain States and all interstate instrumentalities are authorized to divide a retirement system based on whether the employees in positions under the retirement system want coverage. Under the divided vote referendum, only those employees who vote “yes” and all future employees who become members of the retirement system will be covered. Members who vote “no” are not covered as long as they maintain continuous employment in a position within the same public retirement system coverage group.”

    So, for example, here in Arizona, most police and firefighters covered under the Public Safety Retirement System do not pay Social Security taxes. They do pay Medicare taxes. However, some county employees who are covered by this pension plan, do pay Social Security taxes.

    Teachers contribute to the Arizona State Retirement System, but also pay Social Security taxes. In other states, though — for example, Texas and Illinois — teachers do not pay Social Security taxes (and of course, collect less in benefits, which are adjusted to take into account their public pensions). This is all based on “elections” or “referendums” that were made decades ago but apply to all employees, including those newly hired.

  2. Norman Diamond says

    “If only Tax Court motions and briefs were publicly accessible, we wouldn’t be left to wonder.”

    They are, for 50 cents per page. For some people that’s a hardship, but other people just have to decide if they want to be left to wonder.

  3. Bob Kamman says

    Are you old enough to remember the advertising slogan, “Ask the man who owns one”? Do you remember what company used it? When it comes to inmate taxation, I suggest “ask the man who’s been there.” I found this January 2018 answer to a Quora website question from someone who described himself as a “self reformed habitual criminal”:

    “There are two different types of “legal” income available for prisoners.
    1) You can get paid a token sum, usually much less than five bucks a day, for some kind of institutional work assignment. Laundry, Kitchen, Yard maintenance, Building maintenance, Janitorial, taking certain educational programs. . . .
    2) Some, not all, institutions have industry jobs where an outside business contracts with the prison system to employ prisoners at minimum wage jobs while incarcerated.
    That income is taxed in the same manner that any free street income is taxed.
    The prison unit will generally take a substantial portion of the remainder for room and board, a portion of the remainder is applied to any fines or court ordered restitution, or if there are no fines or court ordered restitution, then the portion is deposited into a general victim restitution fund. A portion of the remainder equal to the amount that inmates are allowed to spend on commissary is deposited into the inmates commissary account for commissary purchases.
    The remainder is placed in a frozen account pending release.
    Once a set amount has been deposited to the frozen account, the inmate can request to use any sum over that amount, either for special purchases that are allowed by the unit from designated civilian vendors, sent to a family member, or transferred to your commissary account. . . .
    If you are no longer incarcerated at tax time, then you must either have an address on file for the W-2 to be mailed to, or specifically request a W-2 “from the business who had the contract.”
    I worked at some type of paying institutional assignment for my entire Nebraska prison sentence,
    except for 30 days in the hole for bouncing another inmates head off the wall when I caught him trying to break into my locker, and six months at a minimum wage ($5.15 at the time) industry job just prior to my release.
    I walked out with around $2700 and a final check due at the end of the month of around $300.
    Failed to file a return and thus did not receive a refund, but the amount of SS credited to my IRS account later reflected sufficient income to earn two of the four available quarterly credits to my IRS account to qualify for certain later benefits.”

    Another answer, from 2015, posted by a “Big Sister” at a nonprofit, adds:

    “Inmates who work inside the prison are paid at a rate of $0.10 / hour, in NC. It’s probably not very different in other states. Over a 2080 work-hour year, that is $208.
    When inmates achieve work-release status, they are usually placed in minimum wage jobs. In NC, that’s $7.25/hour. On a 40 hour week, that would amount to $14,000, give or take. Taxes will be withheld from that check the same way any other non-work-release employees taxes are withheld.
    In addition, once an inmate goes on work-release, they are charged room and board at the prison. In 2004 or so, this was $80/week.”

    The advertising slogan? It was Packard, until they stopped making cars in 1958.

  4. Norman Diamond says

    ‘or if there are no fines or court ordered restitution, then the portion is deposited into a general victim restitution fund.’

    So the prisoner gets deprived of a larger amount of property than the court ordered? Since there’s no 5th Amendment any more, why not just execute the person and avoid all unnecessary troubles?

Comment Policy: While we all have years of experience as practitioners and attorneys, and while Keith and Les have taught for many years, we think our work is better when we generate input from others. That is one of the reasons we solicit guest posts (and also because of the time it takes to write what we think are high quality posts). Involvement from others makes our site better. That is why we have kept our site open to comments.

If you want to make a public comment, you must identify yourself (using your first and last name) and register by including your email. If you do not, we will remove your comment. In a comment, if you disagree with or intend to criticize someone (such as the poster, another commenter, a party or counsel in a case), you must do so in a respectful manner. We reserve the right to delete comments. If your comment is obnoxious, mean-spirited or violates our sense of decency we will remove the comment. While you have the right to say what you want, you do not have the right to say what you want on our blog.

Speak Your Mind