Attorney Fraud Resulting in Tax Court Decision; Can It Be Corrected? How? (10/16/18; 10/17/18)

This article caught my attention today:  Bruce Vielmetti, Former Foley & Lardner partner suspended for falsifying documents in IRS audit of Carmex family (Journal Sentinel 10/16/18), here.  The opening paragraph says:

A former Foley & Lardner partner was suspended two years Tuesday by the state Supreme Court for lying to the IRS during an audit of two wealthy estates connected to a major area business.  

So, I went to the Wisconsin Supreme Court opinion which is here.  I offer the the pertinent portions relevant to the issue I address here as to whether and how the IRS can correct a tax under-assessed because of a Tax Court decision induced by fraud.

¶6 While working at the Foley firm, Attorney Wiensch provided estate planning services to a husband and wife who were owners of a privately owned business corporation. Attorney Wiensch prepared a trust under the terms of which the husband and wife were the trust donors and their children were the trustees and beneficiaries. Attorney Wiensch drafted an  Installment Sale Agreement, pursuant to which the husband sold most of his stock in the company to the trust in exchange for a promissory note in an amount in excess of $50 million based on the appraised value of the stock sold. The purpose of the stock sale was to transfer wealth to the clients' children, via the trust, free of gift and estate taxes and to ensure that any future appreciation of the stock held by the trust would not become part of the husband's estate. 

¶7 Transactions structured like the stock sale are reviewed by the Internal Revenue Service (IRS) to determine if the promissory note is a bona fide debt, or if the transaction should be treated as a taxable gift, or if transferred assets should be included in the seller's gross estate for purposes of determining the estate tax liability. Strategies used by estate planning professionals to minimize the risk of an IRS challenge to transactions such as the stock sale have included the use of personal guarantees by trust beneficiaries of a certain percentage of the sale price, often ten percent, or of a defined value formula clause that automatically adjusts valuation of the transferred assets based on a final determination by the IRS or a court. 

¶8 The husband died first, and pursuant to his estate plan, ownership of his remaining shares in the company passed to his wife as the surviving spouse. Attorney Wiensch was retained to represent the husband's estate. Attorney Wiensch prepared the estate tax return for the husband's estate and filed it with the IRS. The IRS audited the husband's estate tax return, as well as other gift tax returns filed on behalf of the clients for years prior to the husband's death.  

¶9 An IRS estate tax attorney served as the examiner for the IRS in conducting the audit. The IRS attorney corresponded with Attorney Wiensch in an effort to obtain information material to the audit. In September 2012, in response to requests from the IRS attorney, Attorney Wiensch sent the IRS copies of an Installment Sale Agreement, a Collateral Pledge Agreement, and a Guaranty of Specific Transaction. Attorney Wiensch represented to the IRS that the Installment Sale Agreement memorialized the terms of the stock sale and that the Collateral Pledge and Guaranty related to the stock sale. The copy of the Installment Sale Agreement Attorney Wiensch sent to the IRS in September 2012 contained a defined value formula clause. Attorney Wiensch altered and misdated the Installment Sale Agreement he sent to the IRS in September 2012. He did not prepare this document contemporaneously with the stock sale. The Installment Sale Agreement the husband actually executed on an earlier date did not contain the defined value formula clause.

Justice Kavanaugh in the Federal Tax Procedure Book (10/6/18)

I thought in view of the elevation of Judge Brett Kavanaugh to Justice of the Supreme Court, I would include some of my many citations to him in the Federal Tax Procedure book.  The following are from the working draft for the 2019 editions (Student and Practitioner) which may be somewhat different from the 2018 editions.

[On Calling Balls and Strikes]

Consider Justice Roberts' famous statement in his confirmation hearings that “Judges are like umpires. Umpires don’t make the rules, they apply them;” his job, he proclaimed, as a judge and prospective Supreme Court Justice was to call “balls and strikes.” Continuing the baseball metaphor, however, a leading jurist, Justice Brett Kavanaugh, says:

[T]he current situation in statutory interpretation, as I see it, is more akin to a situation where umpires can, at least on some pitches, largely define their own strike zones. My solution is to define the strike zone in advance much more precisely so that each umpire is operating within the same guidelines. If we do that, we will need to worry less about who the umpire is when the next pitch is thrown.” fn

fn Brett M. Kavanaugh, Book Review: Fixing Statutory Interpretation, 119 Harv. L. Rev. 2118, 2121 (2016).

* * * *

[Kavanaugh on Justice Scalia's impact on statutory interpretation]

Justice Scalia’s impact on statutory interpretation by focus on the text of the statute, to the exclusion of external sources, has been described as effecting a “a massive and enduring change in American law.” Brett M. Kavanaugh, Fixing Statutory Interpretation, 129 Harv. L. Rev. 2118 (2016) (the article is a book review of Robert Katzmann, Judging Statutes (Oxford Univ. Press 2014) (which advocates a broader approach to interpretation, including specific use of legislative history); Justice Kavanaugh strongly defends Scalia’s approach to statutory interpretation).

* * * *

[Discussing textualism and its constitutional counterpart "orginalism"; this is in a footnote]

Judge Kavanaugh, Supreme Court Nominee, on Constitutional and Statutory Interpretation (Including Chevron) (9/8/18)

This week's confirmation hearings for Judge Kavanaugh, Trump's nominee to the Supreme Court, covered some issues that are near and dear to tax procedure enthusiasts.  Two are:

1.  Originalism.  

Judge Kavanaugh pronounced that originalism is “constitutional textualism, meaning the original public meaning of the constitutional text.”  So, as articulated, that would be the public meaning at the time the constitutional provision in issue was included in the constitution.  That is a stark statement of originalism.  In fact, originalism has many shades, some of which permit other considerations in interpreting the constitutional text.  For example, Judge Kavanaugh himself qualified his definition by saying that the original public meaning is “informed by history, tradition and precedent.” I think he means that he is willing to consider something that may not be exactly the original public meaning.  I think that, with that caveat, all justices and perhaps all judges are originalists.

I transcribed the quotes in the above paragraph from the video clip Will Baude, The Best Parts of the Kavanaugh Hearing (The Volokh Conspiracy 9/5/18), here.

Since the analog for originalism is textualism, I have revised my discussion in the working draft for the next edition of the Federal Tax Procedure Book.  Most of the revisions are to some footnotes, so I include the text and some of the footnotes at the end of this blog.

2.  Chevron.

Judge Kavanaugh is not a fan of Chevron deference to agency interpretations.  I generously quoted and cited from Judge Kavanaugh's article, Brett M. Kavanaugh, Fixing Statutory Interpretation, 129 Harv. L. Rev. 2118 (2016) ,in my paper IRS Guidance – Rulemaking and Deference to IRS Statutory Interpretation, here,, so I won't get into that right except to note that, at the end of the article, I discussed the political / ideological winds against Chevron, concluding that ridding statutory interpretation of Chevron deference may be a bad idea whose time has come.  If Chevron meets its end or substantial retreat, I am sure Judge (presumably then Justice Kavanaugh) will make his contribution.

I also recommend to readers this informative commentary posted during the hearings:  Cary Coglianese, The Ambiguity in Judge Kavanaugh's Chevron Critique (The Regulatory Review 9/6/18), here.  A key excerpt:

Despite his overarching criticism of Chevron, Judge Kavanaugh does acknowledge that actually “Chevron makes a lot of sense in certain circumstances”: 

It affords agencies discretion over how to exercise authority delegated to them by Congress. For example, Congress might assign an agency to issue rules to prevent companies from dumping “unreasonable” levels of certain pollutants. In such a case, what rises to the level of “unreasonable” is a policy decision. So courts should be leery of second-guessing that decision. The theory is that Congress delegates the decision to an executive branch agency that makes the policy decision, and that the courts should stay out of it for the most part. That all makes a great deal of sense. 

Perhaps senators and the rest of us will be forgiven for thinking that what makes great sense to Judge Kavanaugh sounds an awful lot like the Chevron doctrine.

EXCERPTS FROM WORKING DRAFT OF THE NEXT FTPB EDITION (EXPECTED SUMMER 2019):

Ninth Circuit Withdraws Altera Opinions (8/7/18; 8/13/18)

The Ninth Circuit has withdrawn its opinions in Altera Corp. et al. v. Commissioner, ___ F.3d ___, 2018 WL 3542989, 2018 U.S. App. LEXIS 20524 (9th Cir. 2018), here., The withdrawal is by a one-sentence order dated 8/7/18 here.  The one sentence is:  "The Opinions filed July 24, 2018, are hereby withdrawn to allow time for the reconstituted panel to confer on this appeal."  There is no indication that there will be a need for oral argument, but, I suppose, Judge Graber could make the decision on that.  (That would mean that Judge O'Malley of the Court of Appeals for the Federal Circuit would have to make another trip to San Francisco.)

The reconstituted panel consists of the two on the original panel--Judges Thomas and O'Malley, and a new one, Susan P. Graber, substituted for the deceased Judge.  Readers will recall that the earlier opinions were split with Judge Thomas holding for the Government and Judge O'Malley holding for the taxpayer.  The earlier opinions were issued with the deceased judge, Judge Reinhardt, having indicated his agreement with Judge Thomas prior to death, so Judge Thomas' opinion was the majority opinion.  I presume the reconstitution was caused by the issuance of the opinions after the death of Judge Reinhardt and the commotion that resulted from issuance of the deciding vote after death.

For the write up on the original up see Developments - Federal Tax Procedure Book 2018 Editions and Altera (Federal Tax Crimes Blog 7/25/18; 7/27/18), here.

I am sure that there will be much speculation on which way Judge Graber will decide.  For those with the time and interest in such speculations, perhaps a good place to start is her Wikipedia page here.  She was appointed by President Clinton.

Addendum 8/13/18 10:22AM:

SSRN Posting of Article on IRS Guidance -- Rulemaking and Deference (8/2/18)

SSRN has posted for review and download my article on IRS Guidance.  titled IRS Guidance – Rulemaking and Deference to IRS Statutory Interpretation. Townsend, John A., IRS Guidance – Rulemaking and Deference to IRS Statutory Interpretation (July 27, 2018). Available at SSRN: https://ssrn.com/abstract=3212060`.

The Abstract is:

This article deals with one of the key intersections of federal tax law and administrative law: IRS rulemaking. The IRS makes rules that affect the public through regulations and subregulatory guidance. I first discuss the IRS process for issuing such guidance and the principal forms the IRS uses. I then discuss the administrative law concept of deference to agency statutory interpretations. In administrative law, the two key regimes for deference are Chevron deference and Skidmore deference. Chevron deference requires the court to defer to an agency interpretation in formal guidance when the statutory text being interpreted is ambiguous and the agency interpretation is a reasonable interpretation even though the court believes there is a more reasonable interpretation. In the IRS context, Chevron deference applies to Treasury Regulations. Skidmore deference requires the court to defer to an agency interpretation in subregulatory guidance to the extent that the interpretation is persuasive. (That Skidmore formulation may sound a bit odd, but I get into that in the article.)  

The nonmainstream discussion in the article has two interrelated components: First, Chevron does not apply to legislative regulations. Legislative regulations are regulations, exemplified in the tax area by the consolidated return regulations under § 1502, where Congress delegated to the IRS the power to make the law. Second, Chevron does apply to interpretive regulations--regulations which interpret the statutory text. Some authors assert that, if Chevron deference applies to give the interpretation the force of law, then the regulation is a legislative regulation with the APA requirements for legislative regulations--promulgation in the Federal Register and prospective application only. The same argument, presumably, would apply if Skidmore or any other deference is given to an IRS interpretation in subregulatory guidance, because by conferring deference the interpretation has the force of law. I disagree with those authors. I assert that a court adopting--deferring to, if you will--an agency interpretation of ambiguous statutory text does not transform interpretation into legislative rulemaking under the APA. Hence, for such agency interpretations promulgation in the Federal Register is not required and the interpretations can apply retroactively. The IRS usually does issue its formal interpretations in regulations subject to notice and comment, so that is not a key difference. But, IRS interpretive regulations can and often do have retroactive effect.

Additional Notes:

1.  This article started with the related discussion in the 2017 Editions of the Federal Tax Procedure Book.  It was too long for the intended audience of that book, so I excerpted that discussion and shortened the discussion of the topics for the book.  The more summary discussion in the Book is at pp. 37-69 of the Student Edition and pp. 53-94 of the Practitioner Edition.  Readers interested in the subject might first want to review the more summary discussion, particularly in the Practitioner Edition with footnotes.

2.  I substantially revised the longer discussion which I excerpted from the 2017 Book and, hopefully improved on it as I made it even longer.  Those interested in more detail than offered in the Book will find it here.

3.  I do discuss toward the end of the article the current political climate where Chevron deference has become a scapegoat for all the perceived ills of the administrative state.  My own view is that Chevron deference and its related deference forms (Auer and Skidmore) may not be perfect but offer a better framework for dealing with interpretations of complex statutory systems Congress expects agencies to administer.  Nonetheless, as I conclude the article, "But with these cross-currents of politics, repeal of Chevron may be a bad idea whose time has come."

Here is the Table of Contents for the Article:

Ninth Circuit Calls Rejects Midco Transaction Twice Blessed by Tax Court (7/29/18)

In Slone v. Commissioner, ___ F.3d ___, 2018 U.S. App. LEXIS 20602 (9th Cir. 2018), here, the Ninth Circuit rejected the Midco variant.  The Midco variant itself has subvariants but this example illustrates the basic idea:

A, an individual, owns Corporation X.  Corporation X has assets of $100 with a basis of $10.  There is a built in gain of $90, with a potential tax of $30.  Corporation X is worth, therefore, $70.  Corporation X sells its assets for $100.  Corporation X then has cash of $100, no liabilities except a tax of $30 that will be reported if nothing else happens.  Corporation X is still only worth $70.  So, Corporation Y purchases the Corporation X stock from A for $85 which it finances with the Corporation X cash (the cash moves around incident to the closing, but the $85 in essence comes from the Corporation X cash).  A and his advisors are not real sure why Corporation Y would offer more than the assets are worth.  Corporation Y hints that he has some technique (perhaps tax attributes) that would permit Corporation X to avoid the tax on the sale of the corporate assets.  Immediately after that closing, once the temporary financing for the Corporation X stock is paid off $85 of Corporation's X cash, Corporation X then has $15 cash.  Corporation X buys a bullshit tax shelter for $5 to avoid reporting the gain and the resulting $30 tax.  Corporation Y then takes the net $10 cash as its profits for structuring the transaction.  When Corporation X's bullshit tax shelter is rejected on audit two years later, the IRS assesses the $30 tax plus penalties and interest. Corporation X has no assets to pay the resulting tax, penalties and interest.  Corporation Y is not around to pay. 

Most of the Midco transactions are more complex than that, but when the veneer is peeled back, that is basically it.

The IRS in this situation wants the tax and will look to all involved to get it.  The IRS will look to A and assert transferee liability under § 6901.  A's defense is that he is not a transferee from Corporation X under the transferee liability provisions.  In furtherance of that argument, A will claim that he did not know the tax would not be paid.  He just thought that, magically, the buyer had some technique to avoid having to pay the tax. 

Here is what the Court said (cleaned up):

Reasonable actors in Petitioners' position would have been on notice that Berlinetta intended to avoid paying Slone Broadcasting's tax obligation. Berlinetta communicated its intention to eliminate that tax obligation, and Slone's leaders and advisors, despite their suspicions surrounding the transaction, asked no pertinent questions. In Berlinetta's earliest solicitations to Slone Broadcasting, Berlinetta marketed its ability to pay the shareholders a premium on account of its ability to eliminate the company's tax liabilities. Berlinetta's affiliate company, Fortrend, wrote in a letter to Jack Roberts, Petitioners' longtime accountant, that Fortrend could pay a premium purchase price because of its ability to "resolve liabilities at the corporate level." This proposal raised justified suspicions in Slone Broadcasting's leadership. Mr. Slone, the company's president, testified that upon learning that an entity wanted to purchase Sloan Broadcasting, after it had already been effectively sold to Citadel, he asked Jack Roberts, "can that be done?" Unsure, Roberts replied, "well, I'm going to find out." 

That Berlinetta provided little information regarding how it would eliminate Slone Broadcasting's tax liability, coupled with the structuring of the transactions, provided indications that would have been hard to miss. Slone Broadcasting's advisors understood that the transaction made sense from Berlinetta's perspective only if Slone Broadcasting's tax liability were eliminated. This deal was, after all, an uneven cash-for-cash exchange in which Berlinetta paid Petitioners most of what Slone Broadcasting should have paid in taxes. Yet Petitioners' retained counsel testified that when he and Jack Roberts asked for details, Berlinetta told them "it was proprietary, it was a secret, and it was theirs, and we weren't going to be a party to it, and I said fine." And in a lengthy memo retained counsel prepared in November of 2001 analyzing the subject of potential transferee liability, counsel wrote that Berlinetta would distribute almost all of Slone Broadcasting's cash to repay the loan used to finance the deal. The memo never analyzed how Berlinetta could legally offset Slone Broadcasting's taxable gain from the asset sale. The memo merely concluded that Petitioners would not be liable as transferees of the proceeds of Slone Broascasting's asset sale if the Commissioner successfully challenged the entity's attempt to offset the tax liability. 

The Tax Court misinterpreted Petitioners' suspicions and Berlinetta's reassurances to mean Petitioners lacked actual or constructive knowledge of the tax avoidance purpose of the scheme. This record establishes that the Petitioners were, at the very least, on constructive notice of such a purpose. In reaching a contrary conclusion, the Tax Court confused actual and constructive notice, in effect allowing Petitioners to shield themselves through the willful blindness the constructive knowledge test was designed to root out. It is clear that Petitioners' stock sale to Berlinetta, in which Berlinetta assumed Slone Broadcasting's tax liability, and Berlinetta paid Petitioners an amount representing the net value of the company after the asset sale and most of the amount that should have been paid in taxes on that asset sale, operated in substance as a liquidating distribution by Slone Broadcasting to Petitioners, but in a form that was designed to avoid tax liability. Slone Broadcasting's distribution to Petitioners was thus a constructively fraudulent transfer under the Arizona UFTA. Petitioners are liable to the government for Slone Broadcasting's federal tax obligation as "transferees" under 26 U.S.C. § 6901.
REVERSED and REMANDED for entry of judgment in favor of the Commissioner.

D.C. Circuit Reverses the Tax Court on Chevron Application (7/28/18)

This week was not a good week for the Tax Court in the Courts of Appeals.  I have not attempted a complete survey of all Tax Court appeals in the Courts of Appeals or the percentage won/loss for this past week.  But here are three dramatic reversals.

• Altera Corp. et al. v. Commissioner, 145 T.C. 91 (2015), here, rev’d ___ F.3d ___, 2018 WL 3542989, 2018 U.S. App. LEXIS 20524 (9th Cir. 2018), here.  Altera was a Government win on appeal.  I have written on the Ninth Circuit reversal:  Developments - Federal Tax Procedure Book 2018 Editions and Altera (7/25/18; 7/27/18), here.
• Good Fortune Shipping SA v. Commissioner, 138 T.C. ___ No. 10 (2017), here, rev'd  ___ F.3d ___, 2018 U.S. App. LEXIS 20880 (D.C. Cir. 2018), here.  Good Fortune was a Government loss on appeal.  I write on this below.
• Slone v. Commissioner, T.C. Memo. 2016-115, here, rev'd ___ F.3d ___, 2018 U.S. App. LEXIS 20602 (9th Cir. 2018), here.  Slone was a Government win on appeal.  I may write on Slone in a later blog.

I write in detail today on Good Fortune.  Good Fortune, like Altera, was a Chevron driven outcome.  Chevron and its ramifications (including deference generally) has occupied a good deal of my time having recently completed an article titled IRS Guidance – Rulemaking and Deference to IRS Statutory Interpretation (currently under submission to SSRN).

The issue in Good Fortune was whether Good Fortune's use of bearer shares -- a type of shares always suspect to parties (including Governments) wanting to know who owns foreign corporations -- precluded it from the tax benefit it sought.  The Code provision said that the benefit was not available if 50% or more of the owners of the stock of the foreign corporation is owned by residents of a country that did not provide reciprocal benefits.  The regulations provided that bearer shares could not be counted whether or not they were owned by otherwise qualifying shareholders.  The problem was that the Regulations provided a qualifier -- bearer shares not counted -- that the statute did not provide.

The Tax Court held under the Chevron Framework that (i) the statute was ambiguous on the issue of bearer shares for this test (Congress had not spoken), therefore getting past Step One, and (ii) that the IRS regulations' interpretation was "reasonable because it provided certainty and resolved the difficult problems of proof associated with establishing ownership of bearer shares." (quote cleaned up).

Applying the same Chevron Framework the Court of Appeals reached a different conclusion.  First, it did not resolve the issue of whether the statute was sufficiently ambiguous to permit the IRS to interpret the stock ownership requirement.  Finding of ambiguity is essential in Chevron Step One to permit Chevron space in which the agency can provide a reasonable interpretation. Rather, the Ninth Circuit assumed that the statute was ambiguous.  Second, moving to Step Two on that assumption, the Ninth Circuit said that, based on the reasons the IRS articulated (such as they were) for the exclusion of bearer shares, the Regulation was not reasonable and therefore failed Step Two.

The Court said (cleaned up) the following (blending Step One into Step Two):

Even if § 883 grants the IRS significant discretion to establish how to prove ownership, it hardly authorizes the agency to categorically deny consideration of a recognized form of ownership based on only a single, undeveloped statement that it is difficult to reliably track the location of a given owner. If the IRS found that the transferable nature of bearer shares made substantiation impossible, we might conclude that the 2003 Regulation reasonably implemented that finding. Indeed, a kind of stock that is entirely impossible to track might not constitute a form of ownership contemplated by § 883(c)(1). But the IRS has never made (much less adequately supported) such an absolute claim of impossibility with regard to bearer shares. The IRS's interpretation instead appears to rewrite § 883(c)(1) to require not only valid ownership, but ownership that is not difficult to track. Even if this regulatory amendment to § 883 is not unambiguously foreclosed by the statute's language, its unsubstantiated treatment of ownership comes close to violating the plain language of the statute—indicating that the 2003 Regulation is unreasonable at Chevron Step Two.