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.

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.

UH Tax Procedure Class 2014

Tonight the class for tax procedure starts.  I will periodically post updates and errata here for students and mark those with a keyword "UH TPC 2014."  So, click on that keyword to retrieve the entries relevant for the class.  Not all entries will be relevant to the case, so students may not want to spend their valuable time with those entries.

Please note the errata page in the column at the right.

BASR Briefs On Issue of Unlimited Statute of Limitations for NonTaxpayer Fraud (8/27/14)

I have previously written on the Allen issue -- whether Section 6501(c)(1)'s unlimited statute of limitations may be triggered by fraud on the return that is not the taxpayer's fraud.  See Allen v. Commissioner, 128 T.C. 37 (2007), here.  (For my blogs on the issue, see here.)

Since Allen, the courts addressing the issue have been  sparse, but seemed to accept the validity of Allen's holding that fraud on the return triggers the unlimited statute of limitations even if it was not the taxpayer's fraud.  Allen involved a run of the mine fraudulent preparer, but the more prominent instances where the holding could apply involves the plethora of bullshit / fraudulent tax shelters that were popular with the wealthy in the 1990s and in the early 2000s.  Apparently not anticipating the holding in Allen, the IRS walked away from making adjustments to taxpayers investing in those shelters where it could not find an open statute of limitations under the other rules.  The IRS did try to get some relief by asserting the 6 year statute, but came up short on that in  U.S. v. Home Concrete & Supply, LLC, ___ U.S. ___, 132 S.Ct. 1836 (2012), here.  (See The Supreme Court Blesses Taxpayers Sheltering and Hiding Income from Six-Year Statute of Limitations (Federal Tax Crimes Blog 4/25/12), here.) Then, the IRS belatedly discovered the implications of Allen.

In BASR Partnership v. United States, 113 Fed. Cl. 181 (9/30/13 Filed; As Revised 10/29/13), here, the Court of Federal Claims rejected Allen and held that the unlimited statute in Section 6501(c)(1) required the taxpayer's fraud.  That holding, of course, warmed the hearts of taxpayers who invested in bullshit / fraudulent tax shelters -- a win on the audit lottery they willing and  joyously played.  For prior discussions of BASR, see Court of Federal Claims Holds that Unlimited Civil Statute of Limitations Requires Taxpayer's Fraud (Federal Tax Procedure Blog 10/3/13), here,  and Judge Holmes of the Tax Court Sets up the Allen Issue Conflicts (Federal Tax Crimes Blog 11/14/13; revised 11/16/13), here.

The  Government appealed BASR to the Court of Appeals for the Federal Circuit.  That case is now pending.  But it has been briefed.  I offer today in this blog entry the briefs of the parties and of Amicus Curiae (arguing that the Allen holding is incorrect).  Those briefs are:

• Government Opening Brief, here.
• BASR Answering Brief, here.
• Amicus Curiae Brief, here.
• Government Reply Brief (Responding to BASR Brief and Amicus Brief), here.

I will cut and paste the Summaries of the Arguments in the Briefs:

Eleventh Circuit Holds Clear and Convincing Evidence Required for Section 6701 Penalty; Can Reasoning be Extended to FBAR Willful Penalty? (6/14/14)

In United States v. Carlson, ___ F.3d  ___, 2014 U.S. App. LEXIS 11001 (11th Cir. 6/13/14), here, the issue was the plaintiff's liability for " aiding and abetting understatement of tax liability in violation of I.R.C. § 6701."  Section 6701 is here.  In relevant part, Section 6701 imposes the penalty upon a person:

(1) who aids or assists in, procures, or advises with respect to, the preparation or presentation of any portion of a return, affidavit, claim, or other document,
(2) who knows (or has reason to believe) that such portion will be used in connection with any material matter arising under the internal revenue laws, and
(3) who knows that such portion (if so used) would result in an understatement of the liability for tax of another person.

Section 6701 may be viewed as the civil penalty analog to the tax crime of aiding and assisting, Section 7206(2), here.

One issue on the appeal was the appropriate burden of  proof the Government must bear.  Carlson argued that it was by clear and convincing evidence; the Government argued that it was by a preponderance.  The Court held that the standard of proof is by clear and  convincing evidence.  Here is the Court's discussion:

I. The Government must prove violations of I.R.C. § 6701 by clear and convincing evidence. 

At trial, the parties disputed the correct standard of proof. Carlson contends the correct standard should be clear and convincing evidence while the Government contends the correct standard is a preponderance of the evidence. The district court agreed with the Government and instructed the jury that the Government must prove its case by a preponderance of the evidence. We conclude that this instruction misstated the law. 

Under the Eleventh Circuit's longstanding precedent, the Government must prove fraud in civil tax cases by clear and convincing evidence. See, e.g., Ballard v. Comm'r of Internal Revenue, 522 F.3d 1229, 1234 (11th Cir. 2008) ("The Commissioner has the burden of proving allegations of fraud by clear and convincing evidence."); Korecky v. Comm'r of Internal Revenue, 781 F.3d 1566, 1568 (11th Cir. 1986) ("The IRS bears the burden of proving fraud, which must be established by clear and convincing evidence."); Marsellus v. Comm'r of Internal Revenue, 544 F.2d 883, 885 (5th Cir. 1977) (holding fraud must be proved by clear and convincing evidence); Webb v. Comm'r of Internal Revenue, 394 F.2d 366, 378 (5th Cir. 1968) (same); Goldberg v. Comm'r of Internal Revenue, 239 F.3d 316, 320 (5th Cir. 1956) ("The Commissioner has the burden of proving fraud by clear and convincing evidence."); Jemison v. Comm'r of Internal Revenue, 45 F.2d 4, 5-6 (5th Cir. 1930) ("Fraud is not to be presumed, but must be determined from clear and convincing evidence, considering all the facts and circumstances of the case."). Our sister courts of appeals follow the same rule. See, e.g., Grossman v. Comm'r of Internal Revenue, 182 F.3d 275, 277 (4th Cir. 1999) (holding that a finding of fraud must be supported by clear and convincing evidence); Lessmann v. Comm'r of Internal Revenue, 327 F.2d 990, 993 (8th Cir. 1964) (same); Davis v. Comm'r of Internal Revenue, 184 F.2d 86, 86 (10th Cir. 1950) (same);Rogers v. Comm'r of Internal Revenue, 111 F.2d 987, 989 (6th Cir. 1940) ("Fraud cannot be lightly inferred, but must be established by clear and convincing proof."); Duffin v. Lucas, 55 F.2d 786, 798 (6th Cir. 1932) (same); Griffiths v. Comm'r of Internal Revenue, 50 F.2d 782, 786 (7th Cir. 1931) ("Fraud is never presumed but must be determined from clear and convincing evidence, considering all the facts and circumstances of the case.").

Procedural Predicates for Setoffs in Refund Suits (7/2/14)

In Lewis v. Reynolds, 284 U.S. 281 (1932), here,modified in 284 U.S. 599 (1932), the Supreme Court held that, in a refund suit, the Government can raise a previously unasserted basis for denying a taxpayer a refund.  The notion is that, in a refund suit, the issue is whether the taxpayer overpaid the tax and therefore is entitled to a refund.  If there is some other basis to conclude that the taxpayer did not overpay the tax, the taxpayer is not entitled to a refund.  The issue usually arises after the IRS has audited an issue and assessed a deficiency.  The taxpayer pays the assessed tax and sues for refund, asserting that the taxpayer does not owe tax with respect to that issue.  Lewis v. Reynolds holds that, in that refund suit, the Government can assert any other basis that shows the taxpayer is not entitled to a refund for that year or is entitled to less than the taxpayer assert.  This is often referred to as a setoff.

The setoff concept is important in tax practice.  One significant issue is what the Government must do to assert the setoff.  This issue arose in a recent case, Lockheed Martin Corp. v. United States, 973 F. Supp. 2d 591 (D. Md. 2013), where the Court addressed the pleading requirements for the Government to raise the setff as a defense.  In Lockheed, the Government pled the following under a caption titled "Second Defense":

Should the Court determine that Plaintiff raised a meritorious argument that would otherwise establish that Plaintiff overpaid its taxes, the United States is entitled to reduce that overpayment based on any additional tax liabilities that the Plaintiff may owe, whether or not previously assessed or alleged. The United States is entitled to such reduction because the redetermination of the Plaintiff's entire federal income tax liability for the litigated tax years is at issue in this refund suit.

Note that the Government pleads nothing except its theoretical right to the setoff.

Of course, the taxpayer in a refund suit does not want the Government to be able to assert the right to a setoff at all.  And, the theoretical assertion of the right may raise concern that the Government will use the refund suit litigation to re-audit in search of something to setoff.  So, in Lockheed, the taxpayer moved to strike that portion of the pleading, alleging that setoff should be pled like an affirmative defense, which, as Lockheed read the cases, would prohibit this type of conclusory pleading without a factual basis for the claim.  The Government argued that, although labeled a defense, it is not an affirmative defense at all, but merely goes to the issue of whether this taxpayer has proved that it is entitled to the refund the taxpayer claims.  The Court does not engage on this theoretical difference between a setoff and an affirmative defense, but treats the setoff as being subject to the affirmative defense pleading requirements.

Focusing on those pleading requirements for affirmative defenses, the Court notes that there is a split of authority over whether any notice of factual predicate for the legal claim is required to be pled.  The Court first identifies the split of authority and then turns to rationale for the majority and minority views as follows:

Another Bullshit Shelter Bites the Dust Even with Variations (5/15/14)

I write today on the defeat of another bullshit tax shelter of the Son-of-Boss ("SOB") variety.  The Markell Company, Inc. v. Commissioner, T.C. Memo. 2014-86, here, decided yesterday.  If it were just another ho-hum SOB, it would be worth noting only in passing.  But, it has a twist -- both the twist and the outcome is projected in the opening two short paragraphs:

This case began when the Commissioner found the remains of a corporation on an Indian reservation in an extremely remote corner of Utah. The tribe claimed not to know how the corporation's stock had ended up in its hands. And there was little or no money or valuable property left inside the corporate shell. 

All signs pointed to the corporation's manager, a sophisticated East Coast moneyman, as the key person of interest. And his method was a series of complex transactions that bore a striking resemblance to Son-of-BOSS deals already examined many times before by this Court -- but with a corporate-partner twist.

The last sentence of the first paragraph resonates with the equally bullshit intermediary transactions.  One of the strategies in shelters is to push tax consequences to an empty shell of a company, so that the IRS is left without anyone to collect tax clearly due.

The Son-of-Boss transactions in their pure bullshit form seemed to promise to the gullible or complicit that the taxable income disappearing from the taxpayer's tax ledger would just go away.  But, every one I know that gave a hard and knowledgeable look knew that, even if the imagined scheme worked to push the income from the original taxpayer (always a doubtful proposition), some taxpayer down the line would be liable for the tax.  Enter the intermediary gambit to make sure that taxpayer down the line had no assets to pay the tax because the taxpayer and the promoters would have sucked all the value out of the company.  Thus, this intermediary was designed to deal with an inherent and blatant flaw in the SOB transactions.  (Of course, SOB transactions had flaws in them before reaching this stage, but the intermediary was a fine artistic touch to put on the bullshit.)

The Merits