The Mitigation Provisions of the Code - An Example of How They Work to Open an Otherwise Closed Year (4/3/14)

All taxpayers facing a tax liability hope that the IRS will fail to assess within the applicable period of limitations.  For example, the IRS often requests a Form 870, Waiver of the Restrictions on Assessment, which, because it waives the notice of deficiency which, in turn, would have suspended the statute of limitations, hope that the IRS will not get around to assessing in time.  (That is vain hope in the overwhelming number of cases.)  There are a myriad of other circumstances where a similar situation occurs.

One such circumstance applied in El Paso CGP Company, L.L.C. v. United States of America, ___ F.3d ___, 2014 U.S. App. LEXIS 5090 (5th Cir. 2014), here.  In this case, the facts are complex, but I think I can distill them for purposes of the point I want to make in this blog entry. Normally, when a year is closed, it is just closed.  If the taxpayer got a benefit he was not entitled to, that is just the IRS's tough luck; and vice versa.  However, various Code provisions and judicial doctrines may apply to mitigate the effect of the improper benefit in the closed year.  Indeed, the most beautiful such provisions are called the mitigation provisions of the Code -- Sections 1311-1314.  Essentially, the effect of those mitigation provisions in most of  the circumstances of adjustment to which they apply is to take away a double benefit to a taxpayer from achieving a tax benefit for the treatment of an item in a correct open year when the taxpayer has previously achieved a benefit in an incorrect otherwise closed year.

Without getting into the facts into too great a detail (read the opinion), the taxpayer claimed credits in 1986 which because of limits were carried forward to some later years.  After some audit activity, the parties agreed that the taxpayer had overstated the credits in question but was entitled to other credits so that, for the year 1986, the taxpayer was still entitled to a refund.  However, because the credits in question had been overstated in 1986, the carry forward of those credits to post-1986 years was wiped out, meaning that the taxpayer had deficiencies in those post-1986 years which were then closed.  This apparently was a circumstance of adjustment under the mitigation provisions.  (I have not chased down that issue, but the Court and the parties seemed to assume it.)  Under the mitigation provisions of the Code, the IRS has a one-year window from the time of the determination to assess, collect, refund or credit the tax, as appropriate for the type of adjustment.  See Section 1314(b), here.

The IRS netted the agreed upon deficiencies for the post-1986 years in the aggregate against the refund due for 1986 and refunded the difference (with appropriate interest).  But, as best I understand the opinion, the IRS did not assess the netted amount to the particular post-1986 years within the one-year period.  In other words, the IRS had collected the tax by offset but had not made the assessments for the particular years involved in that one-year period.  The taxpayer argued that, therefore, the IRS had not met the procedures required for mitigation and therefore, must treat the collection via netting as an overpayment for the post-1986 years that must be refunded.

A taxpayer making that argument or any argument that the IRS has not timely assessed does not want to launch the argument when the IRS still has time to assess.  Therefore, for example, it is common practice -- albeit perhaps not the best form -- to file a claim for refund for a year when there are not previously adjustments that would increase the tax liability near the end or after the assessment period of limitations.  (I say that is perhaps not the best form, because it may be difficult to sign a claim for refund under oath when the taxpayer knows that the unspotted adjustments wipe out the claim for refund; but that's a subject for another day.)

At any rate, this taxpayer did a mitigation variant of this timing strategy.  "A year after the Closing Agreement was executed, in August 2006, El Paso sent a precisely timed memorandum to the IRS claiming that the deficiencies for 1987-1990 must be refunded to El Paso because the IRS had failed properly to assess those deficiencies before the just-expired one-year statute of limitations."  (Bold-face supplied by JAT.) That memorandum was treated as a claim for refund.

The IRS Levy Power (4/4/14)

I have recently had email discussions with Leslie Book and Keith Fogg, authors of the Procedurally Taxing Blog, here, regarding some aspects of the levy power, particularly levy on right to receive future payments.  As a result of that discussion, I have been better educated about the levy and have made some revisions to my text.  I thank Les and Keith for their contributions to my education.

I cut and paste below the section revised and note in red-line the revised portions.  I do not include the footnotes.

VIII. Administrative Levy and Judicial Enforcement. 

A. Administrative Levy and Sale. 

  1. General Rules of Levies.

Levy includes the power to seize and sell the taxpayer's property (including interests in property and personal service compensation, such as wages).  § 6331(b) (levy); § 6335 (rules for sale).  A levy – often referred to as a seizure – is a “summary, non-judicial process, a method of self- help authorized by statute which provides the Commissioner with a prompt and convenient method for satisfying delinquent tax claims.”  The Supreme Court has said: “The IRS need never go into court to assess and collect the amount owed; it is empowered to collect the tax by non-judicial means . . . without having to prove to a court the validity of the underlying tax liability.”   

The IRS levy can involve a direct seizure of the property but more often the levy is accomplished by notice of levy to the taxpayer or third parties requiring them to turn over the taxpayer’s property in their possession.  Thus, the IRS can serve notice of levy a bank to obtain the funds in the taxpayer's bank account or can levy a brokerage firm to obtain the investments in the taxpayer's bank account.  The IRS can also levy persons or entities who appear to be third parties, asserting that they are nominees or alter egos of the taxpayer.  (I cover nominee and alter ego liability later in the text.) 

As noted, the IRS often levies on third parties by issuing “notice of levy,” which, like the IRS summons studied earlier, is simply a form that the IRS collection officer fills out and delivers to the person upon whom levy is made.  Once the person is given the notice of levy, the United States has the right to the property levied.  As to the property, the person receiving the notice of levy holds the property in a form of custodial relationship to the United States. 

The person receiving the notice of levy takes substantial risks in not responding to the levy.  The person receiving a levy is liable for the value of the property levied upon and not turned over, plus a penalty of 50%.  § 6332(d).  The defenses available to the party levied to avoid the levy are quite limited.  Nonpossession of the taxpayer’s property is a defense.  However, the “validity of the levy and competing claims to the ownership of the funds are not valid reasons for refusing to honor a levy.” The person can be relieved from the 50% penalty for reasonable cause, which would be something beyond the person's control that prevents compliance.  The IRM advises the agent to be judicious in assertion of the penalty, and courts also may give a liberal application of reasonable cause where the taxpayer is already penalize by liability for the value of the property that he may have turned over to the taxpayer. In order to protect the levied party, the levied party responding to the levy by delivering the property to the IRS is “discharged from any obligation or liability to the delinquent taxpayer and any other person with respect to such property or rights to property arising from such surrender or payment.”  § 6332(e).  As a result, practically speaking, the levied party “has two, and only two, possible defenses for failure to comply with the demand: that it is not in possession of property of the taxpayer, or that the property is subject to a prior judicial attachment or execution.” 

Writ Ne Exeat Republica to Restrain from Foreign Travel as Tax Collection Tool (2/11/14)

Readers might like to read two good discussions of the writ ne exeat republica, which courts may issue in tax cases under 7402(a), here.  The writ, if issued  in a tax case, will restrain the defendant from leaving the jurisdiction (or some subset thereof) pending payment of some or all of a tax debt.  The two excellent discussions were prompted by a case, United States v. Barrett, 2014 U.S. Dist. LEXIS 10888 (D. CO. 2014), where the writ was granted.  The two discussions are:

• Keith Fogg, Holding People Hostage for the Payment of Tax – Writ Ne Exeat Republica (Procedurally Taxing Blog 2/11/14), here.
• Jay Adkisson, A Wedding And The Writ Of Ne Exeat Republica (Forbes 2/7/14), here.

I have done a prior parallel blogs on the issue in which I quoted from my text.  See Restraining Taxpayers for Tax Debts (Federal Tax Crimes Blog 8/19/13), here; and Restraining Taxpayers for Tax Debts (Federal Tax Procedure Blog 8/19/13), here.  I offer the following of my text as I have revised it (footnotes omitted):

The United States does not generally allow imprisonment – or, more broadly, constraining a person’s liberty -- for the nonpayment of debt.  The exception for purposes of tax matters is the statutory approval in § 7402(a) for the writ of ne exeat republica.  The Latin is “let him not go out of the republic,” and was developed in England as a chancery writ.  The exercise of the writ implicates constitutional protections, including the “right to travel” which is “a constitutional liberty closely related to rights of free speech and association, * * *.”  Notwithstanding this implication of constitutional rights, in extraordinary cases it can be granted.  

The writ is sometimes used in domestic relations contexts to restrain someone from leaving the jurisdiction.  In tax collection contexts: 

The writ ne exeat republica is an extraordinary remedy and should only be considered when all other administrative and judicial remedies would be ineffective. In appropriate cases, the writ ne exeat may be used as a collection device against a United States taxpayer who is about to depart from the territorial jurisdiction of the United States, or who no longer resides but is temporarily present in the United States and who has transferred his assets outside of the United States in order to avoid payment of his federal tax liabilities. The writ ne exeat is a court order which generally commands a marshal to commit to jail a defendant who fails to post bail or other security in a specified amount. The authority for the United States District Courts to issue writs ne exeat in tax cases is found in I.R.C. section 7402(a) and 28 U.S.C. section 1651.  

The debt relied on to support the writ must be enforceable against the defendant, be of a pecuniary nature and be presently payable. Thus, in tax cases, an assessment should be outstanding against the taxpayer.  

The purpose of the writ in tax cases is to prevent taxpayers from defeating the collection of tax liabilities by removing themselves and their assets from the territorial jurisdiction of the United States. As a practical matter collection by administrative means is ineffective where the taxpayer has either secreted his assets or removed them from the United States. If the taxpayer leaves the United States, judicial remedies may be likewise defeated since the court would then be powerless in most cases to enforce its orders or judgments against the taxpayer or his property, if located outside of the United States. Thus, the writ ne exeat ensures the continuing submission of the taxpayer to the jurisdiction of the court.

Revised Opinion in TFRP Case Involving Flora Full Payment Requirement (1/29/14; 2/21/14)

I recently blogged on the Court of Federal Claims' Kaplan case, Kaplan v. United States, 2013 U.S. Claims LEXIS 1530 (10/9/13) application of the Flora rule in the Section 6672, TFRP contextg.  See Litigating Trust Fund Recovery Penalties -- the Flora Rule, Divisible Taxes and Unfairness (Federal Tax Crimes Blog 10/11/13), here.  Readers unfamiliar with the contents of that blog entry might want to review it.  The essence of the concern discussed was a dismissal because of the taxpayer's inability to prove sufficient payment of the TFRP divisible tax for one employee per quarter and show that the amount he paid ($100) was sufficient.

Judge Wheeler has a revised the opinion, Kaplan v. United States, 2014 U.S. Claims LEXIS 24 (2014), here.

Here is the basis for the new opinion:

However, in order to establish the Court's subject matter jurisdiction, Mr. Kaplan must prove by a preponderance of the evidence that he has paid the assessed tax for at least one employee. Cencast Servs., L.P. v. United States, 94 Fed. Cl. 425, 435 n.7, 439 (2010), aff'd, 729 F.3d 1352 (Fed. Cir. 2013). More precisely, he must show that his payments of $100 were sufficient to cover the full assessment attributable to at least one employee in each quarter. This, of course, cannot be done without some record of the amount of payroll taxes assessed per employee per quarter. In his motion for reconsideration, Mr. Kaplan relates in detail his diligent but futile efforts at obtaining these records. Pl.'s Mot. for Recons. 6-11. He then explains that he is unable to provide this evidence for exactly the same reason he is not liable for the assessed taxes, that is, he is not a responsible person under § 6672. Id. at 12. 

Thus, assuming these representations are true, Mr. Kaplan is caught in an "evidentiary Catch-22." In order to prove the merits of his argument that he is not a "responsible person," he must first produce the evidence for which he is not responsible. This inequity is magnified by the fact that the Government is itself unable to state what minimum payment would be sufficient. See id. at 9-10; Def.'s Resp. to Pl.'s Mot. for Recons. 7.\ 

In the end, the merits of this case will turn on whether Mr. Kaplan is liable for the full $86,902.76 penalty, and the divisible amount at issue is merely representative of that full amount. Indeed, "[w]hen a taxpayer sues for a refund based on a divisible refund claim, it is meant to 'test the validity of the entire assessment. '" Cencast, 729 F.3d at 1366 (quoting Lucia v. United States, 474 F.2d 565, 576 (5th Cir. 1973)). Under the circumstances of this case, the Court is not inclined to prevent Mr. Kaplan from challenging that full assessment in this forum simply because the representative amount he paid might not be representative enough. Accordingly, the Court accepts the three $100 payments as sufficient to establish subject matter jurisdiction. See, e.g., Schultz v. United States, 918 F.2d 164, 165 (Fed. Cir. 1990) (accepting plaintiff's payment of $100 toward the $20,691.38 penalty assessed against him); Cook v. United States, 52 Fed. Cl. 62, 66 (2002) ($97,760.00 penalty).

I don't have time to develop the concept here, but I think this is a further holding in a line of cases that responsibly mitigate the full bore and inequitable application of the Flora rule.  Congratulations to Professor Rubinstein, counsel for the taxpayer, and kudos to Judge Wheeler.

Addendum 2/21/14 11:30 pm:

Professor Rubinstein has written two outstanding guest blogs for Procedurally Taxing.  They are:

• Refund Suits, Divisible Taxes and Flora: When is a representative payment representative enough? Part 1 (2/17/14), here.
• Refund Suits, Divisible Taxes and Flora: When is a representative payment representative enough? Part 2 (2/19/14), here.

Fifth Circuit Allows Tax Court Discretion in the Application of the Cohan Rule (1/28/14)

In Shami v. Commissioner, 741 F.3d 560 (5th Cir. 2014), here, the Fifth Circuit affirmed the Tax Court's denial R&D credits claimed by the taxpayer.  One of the taxpayer's arguments was that the Tax Court should have applied the Cohan rule, named for named for Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930), here,  to allow some credits.  In rejecting the argument, the Fifth Circuit explained the "venerable" Cohan rule and its limitations, including the discretion allowed the trier of fact (bold facing supplied by JAT]:

Petitioners next assert that "[t]he use by [FSI] of [estimates of the amount of time Shami and McCall spent performing qualified services] was indisputably permissible" and that the type of documentation provided was adequately supportive. We disagree. 

First, Petitioners' claim is waived. In their initial brief, the extent of Petitioners' argument is the sentence quoted above and a citation to this court's precedent in United States v. McFerrin [570 F.3d 672 (5th Cir. 2009)], which, following the venerable Second Circuit case Cohan v. Commissioner, held that "[i]f the taxpayer can establish that qualified expenses occurred . . . , then the court should estimate the allowable tax credit." Aside from a parenthetical to the citation, Petitioners make no effort to explain the Cohan rule or how it would apply to their case. Petitioners make only the bare assertion that their use of estimates was appropriate. Petitioners therefore have waived this issue by failing to brief it adequately. 

In the alternative, Petitioners' claim fails on the merits. A line of case law—beginning with the Second Circuit's decision in Cohan—holds that if a taxpayer proves that he is entitled to a tax benefit but does not substantiate the amount of the tax benefit, the court "should make as close an approximation as it can, bearing heavily if it chooses upon the taxpayer whose inexactitude is of his own making." The underlying logic of the rule is that allowing no benefit at all "appears . . . inconsistent with [the finding] that something was spent." In McFerrin, this court held that the Cohan rule applies in the context of the § 41 credit. 

Cohan did not compel the Tax Court to make an estimate in this case. As the preceding discussion makes clear, the Cohan rule is not implicated unless the taxpayer proves that he is entitled to some amount of tax benefit. In the context of the § 41 credit, a taxpayer would do so by proving that its employee performed some qualified services. In this case, a careful reading of the Tax Court's opinion reveals that the Tax Court made no such finding. 

Even if the Tax Court had determined that Petitioners proved that Shami and McCall performed some amount of qualified services, Cohan and McFerrin are not the only case law on this issue. As the Tax Court observed, another decision of this court issued between those two cases explains that the Tax Court has discretion to make an estimate under Cohan. In Williams v. United States [245 F.2d 559 (5th Cir. 1957)], this court made clear that, even though the Tax Court "might have considerable latitude in making  estimates of amounts probably spent," the Cohan rule "certainly does not require that such latitude be employed." Our decision in Williams explicitly held that the Tax Court "may not be compelled to estimate even though such an estimate, if made, might have been affirmed." This was so because "the basic requirement is that there be sufficient evidence to satisfy the trier that at least the amount allowed in the estimate was in fact spent or incurred for the stated purpose," and "[u]ntil the trier has that assurance from the record, relief to the taxpayer would be unguided largesse."

Tax Court Holds It Lacks Jurisdiction to Review Interest Suspension Under 6404(h) (1/28/14)

Professor Leslie Book has another great blog on a recent tax court case, Corbalis v. Commissioner, 142, T.C. ___, No. 2 (2014), here.  See Corbalis v Commissioner: Tax Court Holds it Has Jurisdiction to Review Interest Suspension Decisions (Procedurally Taxing Blog 1/28/14), here.

The Tax Court's summary of the decision is:

Petitioners seek judicial review of Letters 3477 denying their claim for interest suspension under I.R.C. sec. 6404(g) and stating that the determinations are not subject to judicial review under I.R.C. sec. 6404(h). Respondent has moved to dismiss for lack of jurisdiction. 

Held: The Court has jurisdiction under I.R.C. sec. 6404(h) to review denials of interest suspension under I.R.C. sec. 6404(g). 

Held, further, the Letters 3477 were final determinations for purposes of I.R.C. sec. 6404(h) even though petitioners' concurrent claims for abatement under I.R.C. sec. 6404(e) were still pending.

I refer readers to the Procedurally Taxing Blog entry for a further rounded discussion of the Corbalis decision.

I want to bore down on a subsidiary question addressed in the Corbalis decision -- the deference, if any, to be accorded Revenue Procedures.  The Revenue Procedure made a distinction between types of 6404 relief, stating that one type may be entitled to judicial review and not the other, but provided no reasoning.  The Court said:

In many cases, we have discussed the deference due to pronouncements of the IRS. See, e.g., Taproot Admin. Servs., Inc. v. Commissioner, 133 T.C. 202, 208-210 (2009) (dealing with a disputed revenue ruling), aff'd, 679 F.3d 1109 (9th Cir. 2012). Revenue rulings are "an official interpretation by the Service". Sec. 601.601(d)(2)(i)(a), Statement of Procedural Rules. By contrast, section 601.601(d)(2)(i)(b), Statement of Procedural Rules, states that "[a] 'Revenue Procedure' is a statement of procedure that affects the rights or duties of taxpayers or other members of the public under the Code and related statutes or information that, although not necessarily affecting the rights and duties of the public, should be a matter of public knowledge." A statement of procedure does not purport to be an official interpretation, and respondent does not argue here that the procedure is entitled to deference as an interpretation of section 6404. The revenue procedure, in respondent's terms, "provides guidance for circumstances" in which taxpayers may file a claim for abatement of interest that should have been suspended. Respondent argues only "an intuitive interpretation" of the procedural guidance. 

There is no reasoning in support of the conclusion stated in the revenue procedure, and we discern none for distinguishing between section 6404(e) requests and section 6404(g) requests. Thus, the revenue procedure is not entitled to deference. See Exxon Mobil Corp. v. Commissioner, 689 F.3d 191, 200 (2d Cir. 2012), aff'g 136 T.C. 99, 117 (2011). A procedural pronouncement cannot restrict or revise section 6404(h). See Commissioner v. Schleier, 515 U.S. 323, 336 n.8 (1995); Estate of Kunze v. Commissioner, 233 F.3d 948, 952 (7th Cir. 2000), aff'g T.C. Memo. 1999-344. The wording and context of the statute, supplemented by more general legal principles, control.

Yet Another BullShit Tax Shelter Goes Down Flaming (1/25/14)

In NPR Investments, LLC v. United States, ___ F.3d ___, 2014 U.S. App. LEXIS 1320 (5th Cir. 2014), here, following the Supreme Court's lead in United States v. Woods, ___ U.S. ___, 134 S. Ct. 557 (2013), here, the Fifth Circuit applied the 40% gross valuation misstatement penalty to the partnership's bullshit tax shelter (the Son-of-Boss (SOB) type shelter).  For discussion of Woods, see Supreme Court Applies 40% Penalty to Bullshit Basis Enhancement Shelters (Federal Tax Crimes Blog 12/3/13), here. The 40% penalty will, of course, be applied to the partners, which will then permit them to assert in a separate refund proceeding any partner level defenses they may be entitled to.

I could perhaps leave it at that, but there are some interesting features of the case.

Let's start with some the facts recounted by the Court:

Harold Nix, Charles Patterson, and Nelson Roach are partners in the law firm of Nix, Patterson & Roach, LLP. They represented the State of Texas in litigation against the tobacco industry and in 1998 were awarded a fee of approximately $600 million that is to be paid over a period of time. They also received fees totaling approximately $68 million in connection with tobacco litigation in Florida and Mississippi. Nix, Patterson, and Roach share the fees 40%, 40%, and 20%, respectively. 

Nix and Patterson have participated in at least two "Son-of-BOSS" tax shelters. BOSS stands for "Bond and Options Sales Strategy." Courts, including our court and the district court in this case, have described a Son-of-BOSS transaction as "a well-recognized 'abusive' tax shelter." Artificial losses are generated for tax deduction purposes. 

Before creating NPR and engaging in the transactions at issue in this appeal, Nix and Patterson invested in another Son-of-BOSS tax shelter, known as BLIPS. It involved sham bank loans, and our court considered various tax issues related to Nix's and Patterson's transactions with regard to that shelter in Klamath Strategic Investment Fund ex rel. St. Croix Ventures v. United States.

Further, here is a critical fact conceded apparently for strategic reasons:

The joint pre-trial order in the district court reflects that NPR, Nix, Patterson, and Roach conceded that NPR lacked a profit motive during 2001.

 All of the "investors" in SOB shelters claimed that their profit motive inhered in some long-shot investment razzle-dazzle which they called the "sweet spot," wherein the economic circumstances would line up to generate a profit from the adventure. Some of the taxpayers involved, although having large otherwise uncovered income, claimed that they did not consider the tax consequences at all but focused instead solely on the sweet spot opportunity.  However, the taxpayers in NPR (the ultimate taxpayers were involved by the attorney R.J. Ruble (since convicted of tax crimes for his participation in tax shelters, including SOB shelters) apparently did consider the tax consequences (duh!):