Thursday, March 26, 2015

Court Rejects Duty of Clarity Argument Where IRS Had Provided Clarity (3/26/15)

In Bombardier Aero. Corp. v. United States, 2015 U.S. Dist. LEXIS 34801 (D. Tex. 2015), here, Bombardier Aerospace Corporation ("BAC") was a  provider of "management services to aircraft owners and leaseholders of fractional interests in aircraft (collectively, "Aircraft Owners") through its Flexjet program."  BAC was compensated by various fee arrangements, including monthly management fees ("MMF") for certain fixed costs -- "costs associated with ownership of the aircraft, such as insurance, inspection, crew salaries, crew training, aircraft hangaring, and scheduling costs."  The other fees BAC charged were variable operational costs dependent upon use.

Section 4261, here, imposes an excise tax on "taxable transportation."  In this discussion this is sometimes referred to as the "FET."  BAC paid the tax on the required the users to pay it the tax on the variable services and remitted those payments to the IRS.  BAC did not collect the tax from users to pay on the MMF and thus did not initially remit those taxes to the IRS.  In two prior audits, the IRS did not require MMF to pay the FET.  During the audit in question, however, the IRS determined that BAC was liable for the FET.  BAC paid a portion of the tax and sued for refund.  The Government counterclaimed for the balance.

The tax in question was not BAC's tax - it was the user's.  In cases where a collection agent is required to collect and pay over another person's tax, Section 6415(a), here, permits the collection agent to maintain a refund suit provided that the collection agent has either refunded the collected tax to the taxpayer upon whom it was imposed or obtained the consent of that taxpayer to obtain the refund.  Of course, the taxpayer -- the user -- had never paid the portion of the tax BAC paid, so BAC could not meet the first requirement.  And BAC had not obtained the consent of the taxpayers, so BAC failed procedurally to meet that requirement for a refund.  (There is some discussion of the issue of when the consent procedural requirement must be met, but I don't want to discuss that issue in this blog.)

I focus here on certain arguments that BAC made as to IRS past practice and IRS's failure to assert the tax in prior audits of BAC.

BAC's first argument was that the IRS was precluded "by the Duty of Clarity from recovering FET on MMF."  I don't recall that I had encountered the alleged "Duty of Clarity" before.  Apparently subsumed in this rubric was the following specifics:

Eric Segall Blog on On Judicial Candor, Judge Posner, and the Supreme Court (3/26/15)

Eric Segall posted this blog on the Dorf on Law Blog:  On Judicial Candor, Judge Posner, and the Supreme Court (Dorf on Law 3/23/15), here.  I think readers of this blog might be interested in it. The whole blog entry is very short.  Offer selected snippets as as teasers to read the whole blog entry:

On Judicial Candor:
Agreement broke down, however, when we discussed what level of candor we should expect from judges in general and the Supreme Court in particular. I argued that it is inappropriate for the Supreme Court to hide behind standard and misleading methods of constitutional interpretation such as precedent, text, and historical analysis when we all know (per our acceptance of the realist critique) that decisions are generated more by what Judge Posner calls “priors” and what I call values writ large, than by legal doctrine. This problem is more pronounced at the Supreme Court than other courts because the Justices choose the hardest cases, there is the most at stake, and there is no effective review of their decisions. 
Judge Posner argued strenuously that I was holding judges in general and the Supreme Court in particular to a standard of candor that we do not place on members of Congress, the President, and other public officials. Judge Posner stated that we know politicians are not candid about the reasons motivating their political choices and we should not be surprised that judges do the same. Judge Posner did distinguish between affirmatively lying, which judges should not do, and not disclosing the true bases of decisions, which he felt was inevitable.
So, Judge Posner is a  proponent that judges can lie, so long as they do not affirmatively lie.  (OK, I pulled a snippet and that is unfair; read the whole blog entry.)

On Originalism (Real or Feigned):
I argued that federal judges are governmental officials appointed for life who exercise coercive power over us and the rule of law requires they tell the litigants and the public the true reasons for their decisions (as best they can). For example, I have argued that Justices Scalia and Thomas quite clearly do not follow an originalist methodology across huge portions of constitutional law and they should stop pretending that they do. Judge Posner suggested that it is quite possible they think originalism drives their decisions and their failure to own up to the priors that actually generate their decisions is based more on a lack of self-reflection than bad faith. I quibbled that since just about everyone outside the Court agrees doctrine does not really drive decisions, that lack of self-reflection on the part of the Justices was a bit alarming. Professor Chen, who earlier in the discussion made a similar point, was sympathetic to this suggestion.

Is the Word "Taxpayers" Politically Loaded (3/26/15)

Tax Professionals commonly refer to the U.S. tax paying public as "taxpayers."  The word (and its singular iteration, "taxpayer') is strewn, perhaps unthinkingly, around in judicial opinions.  We even do that when those "persons"/"taxpayers" opt out of the U.S. tax system or some part of it.  Does the word diminish the fact that when the "taxpayer" is an individual, it ignores the humanity of the person or the importance of the person -- not the taxpayer -- to our myth of who we are as a nation?  Is the word taxpayers a loaded term?  See Elizabeth Stoker Bruening, Dear Politicians, Stop Calling People "Taxpayers" (New Republic), here.

Excerpts
Though addressing people as “taxpayers” is common enough to appear politically neutral, it tends to carry more argumentative weight than it’s typically credited with. The House budget is full of examples of seemingly straightforward deployments of the term which are, upon closer inspection, clearly furthering a particular ideology. “There are too many scenarios these days in which Washington forgets that its power is derived from the ‘consent of the governed,’” the plan reads in one instance of the term’s use. “It forgets that its financial resources come from hard-working American taxpayers who wake up every day, go to work, actively grow our economy and create real opportunity.” In other words, Americans’ taxes are parallel with taxpayers' consent, suggesting that expenditures that do not correspond to an individual’s will are some kind of affront. The report goes on to argue that   
food stamps, public housing assistance, and development grants are judged not on whether they achieve improved health and economic outcomes for the recipients or build a stronger community, but on the size of their budgets. It is time these programs focus on core functions and responsibilities, not just on financial resources. In so doing this budget respects hard-working taxpayers who want to ensure their tax dollars are spent wisely. 
Put simply, taxpayers should get what they pay for when it comes to welfare programs, and not be overcharged. But, as the Republican authors of this budget know well, the beneficiaries of welfare programs tend to receive more in benefits than they pay in taxes, because they are in most cases low-income. The “taxpayers” this passage has in mind, therefore, don’t seem to be the recipients of these welfare programs, but rather those who imagine that they personally fund them. By this logic, the public is divided neatly into makers and takers, to borrow the parlance of last election’s Republicans. 
* * * * 
Whereas "taxpayers" is strewn throughout political documents, “people” is associated with populist and revolutionary movements, and not for nothing. Power to the people, the evergreen revolutionary slogan trumpeted by popular fronts around the world, has a ring that power to the taxpayers does not precisely because it demands an inclusive view of public goods. The same could be said about the first line of the U.S. Constitution: "We the Taxpayers" would have been an odd construction for a nation born from a revolt against British taxation. So let's leave "taxpayer" to the IRS and remove it from everyday speech. With every thoughtless repetition of the word, we’re carrying political water.

Two Courts' Approaches to Taxpayer Culpability in the Son-of-Boss Bullshit Tax Shelter (3/26/15)

I posted this blog entry on my Federal Tax Crimes Blog, but the topic is also applicable to Federal Tax Procedure:

I write today on two recent cases that evidence different approaches to taxpayer culpability for tax underpayment from "investing" in bullshit tax shelters.  These cases are CNT Investors LLC et al. v. Commissioner, 144 T.C. No. 11 (2015), here, and Kerman v. Chenery Associates, Inc. (WD Ky NO. 3:06-CV-00338-CRS 3/23/15), here.

For context, readers will recall that the Son-of-Boss ("SOB") tax shelter and the Custom Adjustable Rate Debt Structure ("CARDS") tax shelter are variations on the theme of no-cost (except promoter fees and reams of paper and commotion) tax benefits from thin air.  They have been the basis for several  prominent criminal prosecutions.  Courts have routinely called them too good to be true.  Most courts have reached that conclusion with respect to the type of sophisticated taxpayers who entered these shelters.  All of these shelters not only involved sophisticated taxpayers but required that those sophisticated taxpayers represent to the promoter and the issuers of the legal opinions that they had a profit motive independent of the tax motive.  In the context of the tax adventure in which that representation was made (tax benefits created from nothing except paper shuffling and payment of large fees to the promoters), that representation was bullshit.  That's my opinion and probably the opinion of most courts that have dealt with the issue.  I am some readers will disagree and I welcome their comments/corrections.

So, let's turn to the cases.  First, I will discuss the Kerman case.

Kerman was a suit by a taxpayer - "investor" against promoters of the adventure.  The originally named defendants were prominent players in the bullshit shelter industry:  Chenery Associates, Inc., Chenery Management, Inc., Sussex Financial Enterprises, Inc, Sidley Austin Brown & Wood, LLP, R. J. Ruble, Roy Hahn, Bayerische Hypo-Und Vereinsbank, HVB U.S. Finance, Inc.   The HVB defendants moved for dismissal of the remaining claims against it.

The IRS had prevailed in the Kerman's Tax Court case. here, and appeal, here, which had, successively, imposed the tax and the 40% accuracy related penalty.  (I will discuss this in more detail in discussing CNT Investors.)  For my blog discussion of the appellate case, see A Self-Proclaimed "Simple Man," "Utterly Uneducated" in Tax and Finance, but Still a Self-Made Multi-Millionaire Loses his Bullshit Tax Shelter Case (Federal Tax Crimes Blog 4/13/13), here. As a result, the Kermans conceded in their suit against the HVB defendants that:  "[i]ndisputably, the[y] participated in the abusive tax-shelter in conjunction with HVB."  Seizing on that concession, "HVB now contends that this admission is fatal to the Kermans' remaining claims against it under the theory of in pari delicto."

The Kerman court opened its discussion as follows:
The common law docntrine in pari delicto is a phrase that is short for the maxim in pari delicto potior est condition defendent is, which means: "In a case of equal or mutual fault . . . the position of the [defending] party . . . is the better one." Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299, 306, 105 S. Ct. 2622, 2626, 86 L. Ed. 2d 215 (1985) (quoting Black's Law Dictionary 711 (5th ed. 1979) (alternation in original)). When applied, it serves as a defense that prevents two parties whose wrongdoing are found to be in pari delicto from recovering from one another for any damages that arose from that joint wrongdoing. Bateman Eichler, 472 U.S. at 306, 105 S.Ct. 2622 (footnotes omitted). Courts apply the doctrine based on "two premises: first, that courts should not lend their good offices to mediating disputes among wrongdoers; and second, that denying judicial relief to an admitted wrongdoer is an effective means of deterring illegality." See id.; see also In re Dublin Securities, Inc., 133 F.3d 377, 380 (6th Cir.1997) ("'No Court will lend its aid to a man who founds his cause of action upon an immoral or illegal act.'"). 
In one germane application of the doctrine, a Kentucky court found that when two parties participate in a tax evasion transaction, they are deemed to be in pari delicto. Eline Realty Co. v. Foeman, 252 S.W.2d 15, 19 (Ky. 1952)(citing Stacy v. Williams, 253 Ky. 353, 69 S.W.2d 697; Middlesboro Home Telephone Co., v. Louisville & N. R. Co., 214 Ky. 822, 284 S.W. 104). This is true even if the plaintiff was induced to enter the transaction. Id. Here, the Kermans' admit that "[i]ndisputably, [they] participated in the abusive CARDS tax-shelter with HVB and the other Defendants." DN 227, p. 5. Moreover, they do not even dispute that, as a result, they are in pari delicto with HVB. Id. Instead, they argue that, regardless of whether they are in pari delicto with the Defendants, the defense does not bar their claims for rescission or under KRS §446.070 in this instance. We address these arguments in turn.

Saturday, March 7, 2015

Seventh Circuit Opinion on Role of Notice of Deficiency and Last Known Address Requirement (3/7/15)

In Gyorgy v. Commissioner, ___ F.3d ___, 2015 U.S. App. LEXIS 3100 (7th Cir. Feb. 27, 2015), here, the Court addressed certain key aspects of tax procedure relating to the key role of the notice of deficiency.  For practitioners (other than novice practitioners), this is perhaps redundant to information they already know.  In some way, it is probably redundant for students also.  Still it is a pretty good summary of the process, so I offer it here.  In most cases, I will eliminate most case or other citations, except when I think they are important:  I include the Code sections because the Code is important.  The excerpts are:
We begin with an overview of the CDP process and the taxpayer's right to appeal. The Internal Revenue Code (the "Code") directs the Treasury Secretary—acting through the IRS—to determine, assess, and collect federal taxes. See I.R.C. §§ 6201(a), 6301. It also requires taxpayers to file returns as prescribed by the IRS. See id. § 6011(a). If the IRS finds that a person has unpaid taxes for a given year, it must notify him of the deficiency before it can collect the debt. See id. §§ 6212(a), 6213(a). Once the IRS mails notice, the taxpayer may petition the tax court to redetermine the correct amount of the deficiency. Id. §§ 6213(a), 6214(a). If he does not file a timely petition (normally within ninety days), then the deficiency "shall be assessed, and shall be paid upon notice and demand." Id. § 6213(c). 
If the taxpayer does not pay, then his tax liabilities become a lien on his real and personal property. Id. § 6321. To protect the government's rights against other secured creditors with respect to the encumbered property, the IRS must generally file a notice of the tax lien with the appropriate state authority. See id. § 6323(a), (f). It must then inform the taxpayer that it filed the lien notice. Id. § 6320(a). 
The taxpayer is entitled to challenge the lien in a CDP hearing before the Appeals Office, which is an independent bureau within the IRS. Id. § 6320(b). The "hearing" is informal and may consist of correspondence, telephone conversations, or in-person meetings. Treas. Reg. § 301.6330-1(d)(2), . In general, the taxpayer may raise any relevant issue. I.R.C. § 6330(c)(2)(A). That includes a challenge to his underlying tax liability if he did not receive any statutory notice of deficiency for such tax liability or did not otherwise have an opportunity to dispute such tax liability. Id. § 6330(c)(2)(B). The appeals officer must consider the issues raised by the taxpayer and verify that the IRS followed proper procedures. § 6330(c)(3). 
After the hearing, the Appeals Office issues a notice of determination containing its findings and conclusions. Treas. Reg. § 301.6330-1(e), Q&A-E8. If the taxpayer is dissatisfied, he can appeal the determination to the tax court. I.R.C. § 6330(d)(1). If his underlying tax liability was properly at issue in the CDP hearing, the tax court reviews that issue de novo. It reviews the Appeals Office's other determinations for abuse of discretion. Jones v. Comm'r, 338 F.3d 463, 466 (5th Cir. 2003) ("In a collection due process case in which the underlying tax liability is properly at issue, the Tax Court ... reviews the underlying liability de novo and reviews the other administrative determinations for an abuse of discretion." (citing Craig v. Comm'r, 119 T.C. 252, 260 (2002))). 
The tax court's decision is in turn subject to review in the appropriate court of appeals. I.R.C. § 7482(a)(1). We review tax court decisions "in the same manner and to the same extent as decisions of the district courts in civil actions tried without a jury." Id. 
With this background in hand, we turn to the two issues on appeal. 

Tuesday, October 21, 2014

Thoughts on Estate of Elkins and Valuations (10/21/14)

I write today on the Fifth Circuit's opinion in Estate of Elkins v. Commissioner, ___ F.3d ___, 2014 U.S. App. LEXIS 17882 (5th Cir. 2014), here.  In that case, the Fifth Circuit reversed the Tax Court in a valuation case involving discounts for fractional interests in valuable art.  The Fifth Circuit opens with a summary of its reasoning, such as it is (footnote omitted):
In the Tax Court, the Commissioner steadfastly maintained that absolutely no fractional-ownership discount was allowable. This presumably accounts for his failure to adduce any affirmative evidence—either factual or expert opinion—as to the quantum of such discounts in the event they were found applicable by the court.
The Tax Court rejected the Commissioner's zero-discount position, but also rejected the quantums of the various fractional-ownership discounts adduced by the Estate through the reports, exhibits, and testimony of its three expert witnesses—the only substantive evidence of discount quantum presented to the court.1 Instead, the Tax Court concluded that a "nominal" fractional-ownership discount of 10 percent should apply across the board to Decedent's ratable share of the stipulated FMV of each of the works of art; this despite the absence of any record evidence whatsoever on which to base the quantum of its self-labeled nominal discount.
We agree in large part with the Tax Court's underlying analysis and discrete factual determinations, including its rejection of the Commissioner's zero-discount position (which holding we affirm). We disagree, however, with the ultimate step in the court's analysis that led it not only to reject the quantums of the Estate's proffered fractional-ownership discounts but also to adopt and apply one of its own without any supporting evidence. We therefore affirm in part, reverse in part, and render judgment in favor of Petitioners, holding that the taxable values of Decedent's fractional interests in the works of art are the net amounts reflected for each on Exhibit B of the Tax Court's opinion. This, in turn, produces an aggregate refund owed to the Estate of $14,359,508.21, plus statutory interest.
Just a few paragraphs down, the Fifth Circuit continues:
This entire appeal thus begins and ends with the question of the taxable value of Decedent's fractional interests in those 64 items of non-business, tangible, personal property that were jointly owned in varying percentages by Decedent and his three adult children at the instant of his death. And, the answer to that one question begins and ends with the proper administration of the ubiquitous willing buyer/willing seller test for fair market value: "Fair market value is defined as 'the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts.'"
The context for the Fifth Circuit’s opinion is the Tax Court’s opinion below.   In Estate of Elkins v. Commissioner, 140 T.C. No. 5, 2013 U.S. Tax Ct. LEXIS 6 (T.C. 2013), here, the issue was the familiar one of the appropriate discounts for fractional interests.  The IRS generally disfavors fractional interests, due in no small part to taxpayers’ frequent – perhaps even common – use of aggressive discounts which will either prevail because they win the audit lottery or, if caught, will be recognized as improperly inflated and reduced accordingly.  (Most practitioners would say that it is entirely proper to assert aggressive discounts -- but not so aggressive that serious penalties would apply in the full expectation that, if contested, there will likely be some adjustment; that is the way the game is played.) Essentially, as I read the opinion, the Tax Court judge, Judge Halperin, found the estate's proffered too aggressive and found an alternative discount.  The estate, of course, had "experts" to testify as to the discounts.  The IRS essentially had no "experts" to testify that no discount or any discount less than testified by the estate's experts was appropriate.  So, on the record presented, Judge Halperin found that the proper discount was 10%, substantially below the discounts claimed by the estate.  He based that on the entire record before him.

Wednesday, October 8, 2014

Failure of Taxpayers' Proof of Value Loses Case (10/8/14)

In Cavallaro v. Commissioner, T.C. Memo 2014-189, here, the Tax Court held that the parents owning a company merged with a company owned by the children had not received enough value in the merged companies and thereby made a gift to the children.  The court also held that the parents had reasonable cause to rely upon their tax advisors and thus avoided penalties.

I focus here on the valuation issue of whether a gift was made.  The law is clear that a gift can be made under such circumstances if one party shifts value to other related parties.  The Court resolved the actual value issue on the basis of the burden of proof.  Most of the time, valuation issues are decided after each side has proffered expert testimony with the Court finding a value somewhere in between.  Even where the parties are reasonable in their valuations, they are usually reasonably aggressive positions and the value really is somewhere in between.  In Cavallaro, however, the Court found the value the Commissioner claimed because, it found, that taxpayers had failed to meet the burden of proof imposed upon them.  Basically, the potential for a shift in value from the parents to the children occurred only if the parents' company did not own certain valuable technology.  The parents' claim was that the children's company owned the valuable technology, hence the parents did not receive less than they contributed to the merger and did not make a gift to the children.  The parents' experts made their expert reports assuming the validity of the claim that the parents' company did not own the technology.  The Court found, however, that the parents' company did own the technology, thereby rendering the parent's expert witness reports irrelevant.  All the Court then had was the claim by the Commissioner (which had been reduced from the amount originally asserted in the notice of deficiency), supported, of course, by the Commissioner's expert report.  The Court thus had no basis for doing anything other than sustaining the Commissioner based on the taxpayers' failure to meet the burden of proof.

Key components of the holding are:

1.  The Court first held that the taxpayers had the burden of proof even though the IRS had substantially reduced its valuation from the amount originally asserted in the notice of deficiency.  The Court reasoned.
In general, the IRS's notice of deficiency is presumed correct, "and the petitioner has the burden of proving it to be wrong". Welch v. Helvering, 290 U.S. 111, 115, 54 S. Ct. 8, 78 L. Ed. 212, 1933-2 C.B. 112 (1933); see also Rule 142(a). The Commissioner has conceded that the taxable gifts totaled not $46.1 million (as in the notices of deficiency) but instead $29.6 million (as yielded by Mr. Bello's analysis). Where the Commissioner has made a partial concession of the determination in the notice of deficiency, the petitioner has the burden to prove that remaining determination wrong. See Silverman v. Commissioner, 538 F.2d 927, 930 (2d Cir. 1976) [**52]   (holding that the burden of proof does not shift where the Commissioner's change of position operates in favor of the taxpayer), aff'g T.C. Memo. 1974-285; cf. Rule 142 (shifting the burden "in respect of * * * increases in deficiency").
2.  The Court then rejected the argument that the reduction shifted the burden under Tax Court Rule 142(a)(1) which imposes the burden of proof on the commissioner "in respect of a new matter."  For much the same reason as Silverman, the Court rejected the argument.  The Court did say that the IRS's assertion of the accuracy related penalty rather than the fraud penalty was a new matter (even though the taxpayer's claim of reasonable cause would have been a defense to the fraud penalty originally asserted); and in any event, the Court found the defense proved so neither penalty applied.