Reasonable Litigation Costs and Motions to Exclude: Designated Orders 10/28/19 to 11/1/19

Motions to Exclude Expert Testimony
Docket No. 23444-14, Palmolive Building Investors, LLC, DK Palmolive Building Investors Participants, LLC, Tax Matters Partner v. C.I.R., Order available here.

This first order deals with two IRS motions in limine to exclude from evidence at trial the expert testimony and reports of two experts for petitioner. The Court denies both motions with prejudice.

For the first expert, the IRS argues the report fails to provide sufficient reasoning to support its conclusions and that the report should either be excluded in its entirety or that the expert’s direct testimony be limited “so he cannot use that testimony to expand on his report’s limited explanations to cure its obvious deficiencies”. The Court does not conclude that the expert ‘disregarded relevant facts or exaggerated values to incredible levels’ to reject the report. Instead, the IRS has the ability at trial to cross-examine the expert’s testimony and present contrary evidence.

For the second expert, the IRS argues that the report provides legal conclusions and analysis and should be excluded in its entirety (or redact such conclusions or analysis). Also, Part II should be characterized not as rebuttal but an opening report because it addresses new matters rather than rebutting specific items raised in the IRS’s expert reports, making it untimely for submitting such a report. As a cure, the Court gives the IRS opportunity to submit surrebuttal to address arguably new matters raised no later than December 2.

Takeaway: This case involves advanced litigation, but illustrates tactics involved regarding expert testimony and reports at trial. Certainly, there are guidelines for what may be included in expert reports and the adverse party at trial will do what they can to keep the reports within those guidelines.

For further details from Procedurally Taxing, there are blog posts on the same case here and here regarding the downsides of having a bad appraisal report.

If you would like to do further research on appraisal reports, here are several sources:
• Estate of Elkins v. Comm’r, 140 T.C. 86 (2013), aff’d & rev’d in part, 767 F.3d 443 (5th Cir. 2014) (discounting the valuation of artworks due to the fractional interests held in them by decedent’s children)

• Crimi v. Comm’r, T.C. Memo 2013-51 (excusing petitioner’s failure to comply with the qualified appraisal regulations for charitable contributions due to reasonable reliance on his CPA)

• Estate of Mitchell v. Comm’r, 2011 Tax Ct. Memo LEXIS 93 at *34-41 (analyzing the comparable artworks used by expert witnesses and agreeing with the estate’s valuation of two paintings instead of the IRS’s “unreasonably high” valuations)

• Estate of Noble v. Comm’r, 89 T.C.M. 649 (2005) (finding that a sale of stock of a closely-held corporation occurring subsequent to an appraisal was the appropriate method of valuation)

• Bond v. Comm’r, 100 T.C. 32 (1993) (holding that taxpayers “substantially complied” with the appraisal regulations and thus were entitled to a charitable contribution deduction)

• Neely v. Comm’r, 85 T.C. 934 (1985) (finding that an ordinarily prudent taxpayer should have known that an appraisal of contributed art was a substantial overvaluation).

• Glenn Dixon, The Secretive Panel of Art Experts That Tells the IRS How Much Art Is Worth, Washington Post (Dec. 7, 2017)

• Anne-Marie Rhodes, Valuing Art in an Estate: A New Perspective, 31 Cardozo Arts & Ent. L.J. 45 (2012).

Keith is on a panel presentation in February on appraisals so we are reaping the benefits of his research.

Motion for Award of Reasonable Litigation Costs
Docket No. 14429-18, Paul Edwin Johnson & Susan H. Johnson v. C.I.R., Order and Order and Decision available here.

On their 2015 tax return, the Johnsons did not report information from a Form 1099-R from Equity Trust Company (ETC) that stated Mr. Johnson received a gross distribution of $20,000 and taxable income of $20,000. In addition, ETC reported on Form 5498, IRA Contribution Information, that Mr. Johnson made a rollover contribution of $141,233 to an IRA during tax year 2015. The forms described did not identify the dates the distributions were made or the date Mr. Johnson made the rollover contribution. Although the Johnsons attached other Forms 1099-R to their tax return, the ETC forms were not attached to their 2015 tax return.

The IRS sent a Notice CP2501 requesting additional information related to the discrepancies. The Johnsons sent their own letter requesting documents, but did not provide any documents of their own related to the ETC transactions.

The IRS later issued a Notice CP2000, proposing changes to the 2015 tax liability including an additional tax of $40,429, an accuracy-related penalty of $8,086, and interest of $2,818. The IRS proposed to increase the Johnsons’ taxable income to include a $20,000 taxable distribution from ETC and a $141,793 IRA distribution from Riversource (one of the Forms 1099-R attached to their 2015 tax return).

The Johnsons responded with a letter alleging that Mr. Johnson received a retirement distribution of $141,000 in 2015 and deposited that amount into another retirement account. They did not provide any documentation for the rollover contribution or ETC distribution.

The IRS issued a notice of deficiency determining the same adjustments originally proposed in the Notice CP2000. The Johnsons again responded with a letter claiming the IRA distribution was not taxable because of the rollover without providing documentation.

The Johnsons filed a timely petition with the Tax Court for redetermination and represented themselves.

IRS counsel referred the case to the IRS Office of Appeals, who recommended that the IRS settle the case with no adjustments to the Johnsons’ tax liability. The parties filed with the Court an agreed decision (which the Court treated as a joint stipulation of settled issues) that resolved all issues in the Johnsons’ favor.

Two weeks later, Mr. Johnson filed a motion for reasonable litigation costs seeking an award of $13,486 that includes $71 for out of pocket expenses (postage and the $60 Tax Court filing fee), $3 for mileage expenses, $3,709 for preparation and filing expenses, and $9,703 for disputing the purported accuracy-related penalty. The IRS opposed that motion by the Johnsons.

In a footnote, the Court explains that the majority of the expenses do not constitute “reasonable litigation costs” as defined by Congress in IRC 7430(c)(1)(A) and (B). As a result, the Court limited its consideration to the claim for an award of $71 (the postage expenses and filing fee).

In order to be awarded a judgment for reasonable litigation costs in connection with a court proceeding under IRC section 7430, a taxpayer must (1) be the prevailing party, (2) have exhausted administrative remedies with the IRS, and (3) not have unreasonably protracted the proceedings.

The IRS conceded that the Johnsons did not unreasonably protract the proceedings. The parties have at issue whether the Johnsons exhausted their administrative remedies, but it does not reach that point.

In order to be a prevailing party, the taxpayer must (1) substantially prevail with respect to either the amount in controversy or the most significant issue or set of issues presented and (2) satisfy applicable net worth requirements. The taxpayer will ultimately fail to qualify as the prevailing party if the IRS position is shown to have been substantially justified.

The IRS concedes the two elements for the Johnsons to be the prevailing party, but contend their position in this case was substantially justified.

To establish their position as substantially justified, the IRS must show their position was “justified to a degree that could satisfy a reasonable person” or that the position has a “reasonable basis both in law and fact.” The relevant question is “whether [the IRS] knew or should have known that the position was invalid at the offset.” Generally, the position of the United States in a judicial proceeding is established in the answer to the petition.

The Court’s analysis starts with the IRS receiving the third-party information regarding Mr. Johnson’s retirement transactions and being justified in seeking clarification. The Johnsons should have records of those transactions to provide to the IRS. Their failure to provide that documentation led to the issuance of the notice of deficiency. Because the Johnsons did not provide evidence regarding a timely and proper rollover contribution in 2015, the Court finds that the IRS position in the case was substantially justified and denies Mr. Johnson’s motion for reasonable litigation costs.

Takeaway: Even though their request was reduced from $13,486, they did not even get an award of $71 from the Tax Court! This case certainly illustrates the difficulties for a petitioner to take an unstructured approach to receive reasonable litigation costs in a Tax Court case and failing in the attempt to overcome the high burden of proof regarding IRS knowledge.

The Knudson case discussed in this Procedurally Taxing post provides the path to success on fees. To overcome the substantial justification hurdle, a taxpayer must almost always make a qualified offer. The Knudson case holds that a concession by the IRS does not keep the taxpayer from obtaining fees in the situation of a qualified offer. Further PT posts on qualified offers are here and here. Christine also provided me an example of a rare case here where the court found that the IRS position was not substantially justified.