New Third Circuit Decision on Suits to Recover FBAR Penalties and on Expanded Meaning of Willfulness (11/23/18)

Tax Procedure Enthusiasts might be interested in this posting on my Federal Tax Crimes Blog:  Bedrosian on Appeal; Interesting and Potentially Important Opinion on Jurisdiction in FBAR Penalty Cases (Federal Tax Crimes Blog 12/21/18; 12/22/18), here.  I discuss Bedrosian v. United States, ___ F.3d ___, 2018 U.S. App. LEXIS 36146 (3rd Cir. 2018), here.

Quick summary with more detail in the linked blog:  In this case, the Third Circuit:

1. Discusses important jurisdictional issues with respect to a suit by a person imposed the FBAR penalties (there the willful penalty) to recover a partial payment of the penalty.  It has been conventional wisdom among practitioners is that the FBAR penalty recovery suit is not a suit to recover taxes and thus not subject to Flora's full payment requirement.  The Third Circuit opinion might cast doubt about that.

2. Discusses appellate venue in FBAR willful penalty recovery suits.

3. Raises at least the possibility that the refund suit predicate requirements (claim for refund and either denial or lapse of six months) may apply to FBAR penalty recovery suits.

4. Discusses the expanded meaning of FBAR willful penalty into reckless conduct.

Note to Federal Tax Procedure Blog readers, I generally discuss the FBAR penalties on the Federal Tax Crimes Blog, so look for more detail there.

New IRS Voluntary Disclosure Procedures and Civil Resolution Framework (11/29/18)

A vital part of the tax practitioners' toolkit is awareness of the IRS voluntary disclosure procedure and knowing when and how to invoke it (as well as the alternatives to it).  I have just posted on the IRS's changes to its voluntary disclosure practice.  See New IRS Voluntary Disclosure Procedures and Civil Resolution Framework (Federal Tax Crimes Blog 11/29/18), here.

Federal Tax Procedure Supplement Published (11/28/18)

I have posted the first supplement to the Federal Tax Procedure Books, here.

Readers should be aware that I provide the supplement only to provide key updates or corrections that I think will be helpful to tax procedure students using the Student Edition of the book (although I do include the footnotes for the items I include).

The actual working draft of the Editions contain hundreds of revisions (for updating, better wording or corrections).  I only include a few in the supplement.  All will be included in the 2019 editions which I will release in August 2019.

A Strong Defense of Auer Deference (10/30/18)

A lot of judicial and commentator angst has surfaced in recent years about so-called Auer deference.  Auer deference is accorded to sub-regulatory interpretations of ambiguous regulations text.  It is analogous to Chevron deference regulations interpretations of ambiguous statutory text.  It basically says that reasonable agency subregulatory interpretations of ambiguous regulations will be respected.  Auer deference is named for the case, Auer v. Robbins, 519 U.S. 452 (1997), but it is also referred to as Seminole Rock deference named for an earlier case, Bowles v. Seminole Rock & Sand Co., 325 U.S. 410, 414 (1945).  In a nutshell, arguments against Auer deference are that (i) conservatives don't like agencies to have much power (I am not sure this is a legal argument rather than an ideological one to limit the big state); (ii) Chevron deference is one thing, but allowing the agency the power to promulgate ambiguous regulations that it can then manipulate by subregulatory power is just too much, and (iii) some subthemes within these themes.

In United States v. Havis, ___ F.3d ___, 2018 U.S. App. LEXIS 29628 (6th Cir. 2018), here, Judge Stranch in concurrence has a short and robust argument for Auer deference.  Since I am an Auer (and Chevron) fan (because I believe that Auer like Chevron is reasonably constrained), I offer here Judge Stranch's argument (cleaned up):

I write separately to explain why Auer deference presents no constitutional problem. See Auer v. Robbins, 519 U.S. 452, 461 (1997). As we note here (Lead Op. at 4, 5), Mistretta made clear that the Sentencing Commission is not at odds with the principle of separation of powers because Congress may delegate complex matters to coordinate Branches as long as it clearly delineates the general policy, the agency to apply it, and sets the boundaries of this delegated authority" Mistretta v. United States, 488 U.S. 361 (1989). We also reference Stinson v. United States, 508 U.S. 36 (1993), which established that commentary promulgated by the Sentencing Commission is authoritative unless it violates the Constitution or a federal statute, or is inconsistent with, or a plainly erroneous reading of, that guideline. Supreme Court authority thus established the boundaries of deference. Violation of these boundaries resulted in our acknowledgement that the Sentencing Commission may not escape its statutory mandate, which requires that new Guidelines be adopted through notice and comment rulemaking, subject to Congressional review.  

It is true that the Government asked us to defer to Commission commentary instead, but its request is not evidence that Auer, Mistretta, and Stinson create some irreparable problem. We can hardly fault the Government for advancing an argument that seeks to enhance its position. That is the job of attorneys who represent parties in litigation. Instead of creating a constitutional problem, the Government's argument mobilized a constitutional principle that Auer deference anticipates: regardless of what interpretation the Government proposes, it is the court that ultimately decides whether a given regulation means what the agency says. 

Nor does it appear to me that immense power has been granted to agencies pursuant to Auer. Agencies do not get to decide within a vacuum: they operate within a complex system of checks and balances. To begin with, agency power is derivative of the statutory grant that creates the entity and defines the scope of its power. Our deference doctrines are thus an application of the authority that the legislature chose to grant in particular circumstances. And while the scope of the granted authority may be broad, it operates within specified limits. An agency's rulemaking must comply with the statute, and the agency's interpretation must comply with the rule. It is the courts that ultimately determine whether the agency has acted within the scope of its statutory grant. Perez also reminds us that not only do agency statutes often contain their own safe-harbor or other limiting provisions, but the APA itself contains a variety of constraints on agency decisionmaking—the arbitrary and capricious standard being among the most notable. 

Finally, I am perplexed by the argument that Auer has led agencies to regulate in a way that is broad and vague with, apparently, the goal of creating maximum leeway to define the meaning of a regulation somewhere down the road. That claim assumes a world of political continuity and agency longevity that we would be hard pressed to find today. It also ignores multiple incentives and constraints. Consider the internal pressures within the agency and throughout the governing executive branch to implement the agency's program and the external pressures from those regulated and their lobbyists to obtain predictability, both of which encourage clear regulations. These stakeholders are focused on bringing their own expertise to bear on highly complex, policy-driven issues that play out on a very practical level. This argument relies on one more dubious assumption—that agency action is driven by the views of the courts on Auer deference. It seems to me that the immediate pressures listed above are far more salient. Research supports this conclusion. One recent study showed that barely half of agency drafters responding to a survey even knew what Auer was, and even fewer considered it when drafting rules.  

Since the 1930s, courts have recognized that in our increasingly complex society, replete with ever changing and more technical problems, Congress must be able to delegate power according to common sense and the inherent necessities of the government co-ordination. The Supreme Court has long recognized the need for some level of judicial deference to the agencies that, guided by empirical research and experience, focus on mastery of a particular set of complex issues. The current arguments for curtailing agency deference risk dismissing a system that Congress created out of a need to employ the significant expertise held by agencies and their stakeholders in complex areas of the law and instead substituting courts that are ill-equipped for the task. Our carefully developed doctrines of deference strike the proper balance among our three branches by respecting both the exercise of legislative authority and the judiciary's right to make the ultimate decision whether a given regulation means what the agency says.

By the way, the argument is also an argument for Chevron deference.

Judge Stranch is an Obama nominee.  See Wikipedia, here.

GAO Report on IRS Whistleblower Processing and Improvement of Data Controls (10/30/18)

The GAO issued a report titled "Whistleblower Program: IRS Needs to Improve Data Controls for Some Award Determinations (GAO-18-698 published 9/28/18 and publicly released 10/29/18).  The fast facts, highlights and recommendations are here.  The full report is here.

I cut and paste the highlights below:

What GAO Found 

Prior to February 9, 2018, when Congress enacted a statutory change requiring the Internal Revenue Service (IRS) to include penalties for Report of Foreign Bank and Financial Accounts (FBAR) violations in calculating whistleblower awards, IRS interpreted the whistleblower law to exclude these penalties from awards. However, GAO found that some whistleblowers provided information about FBAR noncompliance to IRS. In a sample of 132 whistleblower claims closed between January 2012 and July 2017, GAO found that IRS assessed FBAR penalties in 28 cases. It is unknown whether the whistleblower's information led IRS to take action in all of these cases. These penalties totaled approximately $10.7 million. Had they been included in whistleblower awards, total awards could have increased up to $3.2 million. Over 97 percent of the FBAR penalties collected from these 28 claims came from 10 cases with willful FBAR noncompliance, for which higher penalties apply.

Report of Foreign Bank and Financial Accounts (FBAR) Penalties and Potential Whistleblower Awards for Selected IRS Whistleblower Claims Closed between January 1, 2012, and July 24, 2017

FBAR penalty type	Number of claims	FBAR penalty amount (dollars)	Maximum potential whistleblower awarda(dollars)
Willful penalty	10	10,485,847	3,145,754
Non-willful & negligent penalty	18	263,039	78,912
Total	28	10,748,886	3,224,666

Source: GAO analysis of IRS data. | GAO-18-698
a Maximum potential award is defined as 30 percent of the FBAR penalty amount.

IRS forwards whistleblower allegations of FBAR noncompliance to its operating divisions for further examination. However, IRS Form 11369, a key form used for making award determinations, does not require examiners to include information about the usefulness of a whistleblower's information FBAR and other non-tax issues. After Congress enacted the statutory change, IRS suspended award determinations for 1 week, but resumed the program before updating the form or its instructions, or issuing internal guidance on new information required on the Form. As of June 28, 2018, IRS had not begun updating the Form 11369 or its instructions. The lack of clear instructions on the form for examiners to include information on FBAR and other non-tax enforcement collections may result in relevant information being excluded from whistleblower award decisions.

IRS maintains FBAR penalty data in a standalone database. It uses these data for internal and external reporting and to make management decisions. Because of the change in statute, IRS will need these data for determining whistleblower awards. GAO found that IRS does not have sufficient quality controls to ensure the reliability of FBAR penalty data. For example, IRS staff enter data into the database manually but there are no secondary checks to make sure the data entered are accurate. Without additional controls for data reliability, IRS risks making decisions, including award determinations, with incomplete or inaccurate data. 

This is a public version of a sensitive report issued in August 2018. Information on the FBAR Database that IRS deemed to be sensitive has been omitted. 

Why GAO Did This Study 

Tax whistleblowers who report on the underpayment of taxes by others have helped IRS collect $3.6 billion since 2007, according to IRS. IRS pays qualifying whistleblowers between 15 and 30 percent of the proceeds it collects as a result of their information. However, until February 9, 2018, IRS did not pay whistleblowers for information that led to the collection of FBAR penalties. 

GAO was asked to review how often and to what extent whistleblower claims involve cases where FBAR penalties were also assessed. Among other objectives, this report (1) describes the extent to which FBAR penalties were included in whistleblower awards prior to the statutory change in definition of proceeds; (2) examines how IRS used whistleblower information on FBAR noncompliance, and how IRS responded to the statutory change in definition of proceeds; and (3) describes the purposes for which IRS collects and uses FBAR penalty data, and assesses controls for ensuring data reliability. GAO reviewed the files of 132 claims closed between January 1, 2012, and July 24, 2017, that likely included FBAR allegations; analyzed IRS data; reviewed relevant laws and regulations, and IRS policies, procedures and publications; and interviewed IRS officials. 

What GAO Recommends 

GAO recommends IRS update IRS Form 11369 and improve controls for the reliability of FBAR penalty data. IRS agreed with all of GAO's recommendations.

JAT Comments:

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 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), GS here, rev’d 926 F.3d 1061 (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. [Note the 9th Cir. denied rehearing en banc and the Supreme Court denied petition for writ of certiorari - reh. en banc den. 941 F.3d 1200 (9th Cir. 2019), cert. denied, 591 U.S. ___, 141 S.Ct. 131 (2020).]
• Good Fortune Shipping SA v. Commissioner, 148 T.C. 262  (2017), here, rev'd  897 F.3d 256  (D.C. Cir. 2018), GS here.  Good Fortune was a Government loss on appeal.  I write on this below.
• Slone v. Commissioner, T.C. Memo. 2016-115,  GS here, rev'd 896 F.3d 1083 (9th Cir. 2018), GS 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. 

District Court Holds that Santander's Arguments to Avoid Penalty for Bullshit Tax Shelter (No Substance) Lack Substance (7/24/18)

Here is an entry that I posted a few days ago on my Federal Tax Crimes Blog.  It is equally interesting to Federal Tax Procedure enthusiasts.

In Santander Holdings USA, Inc. v. United States (D. Mass. Dkt. 09-11043-GAO Dkt Entry 344 7/17/18), here, Santander previously lost the merits of its bullshit tax shelter on appeal, with the Court of Appeals holding that the shelter lacked economic substance.  Santander Holdings USA, Inc. v. United States, 844 F.3d 15 (1st Cir. 2016), here, cert. denied sub nom. Santander Holdings USA, Inc., & Subsidiaries v. United States, 137 S. Ct. 2295 (2017).  See my discussion of the Court of Appeals decision, First Circuit, Reversing the District Court, Rejects Santander's Bullshit Tax Shelter (Federal Tax Crimes Blog 12/17/16), here.

Santander argued that, although its tax shelter lacked economic substance -- i.e., was bullshit -- it should be able to avoid the accuracy related penalty.  Well, basically, the district court held that that argument too lacked substance -- was bullshit.  The opinion is short and, I think, predictable, so I forego addressing it further.

However, the district court did include a quote from the Court of Appeals' decision that I had included in my prior write up but was in a larger quote so that I had not focused on it.  The district court did focus on it as follows.  This is the quote (cleaned up):

When a transaction is one designed to produce tax gains not real gains—such as when the challenged transaction has no prospect for pre-tax profit—then it is an act of tax evasion that, even if technically compliant, lies outside of the intent of the Tax Code and so lacks economic substance.

The district corut did not quote the whole paragraph from the Court of Appeals which includes "tax evasion" twice, so I offer the whole paragraph (cleaned up):

The economic substance doctrine is centered on discerning whether the challenged transaction objectively lies outside the plain intent of the relevant statutory regime. A transaction fails the economic substance test if, though it actually occurred and technically complied with the tax code, it was merely a device to avoid tax liability. Courts may disregard the form of transactions that have no business purpose or economic substance beyond tax evasion. In other words, when a transaction is one designed to produce tax gains not real gains -- such as when the challenged transaction has no prospect for pre-tax profit -- then it is an act of tax evasion that, even if technically compliant, lies outside of the intent of the Tax Code and so lacks economic substance.

Readers of this blog will recognize the term "tax evasion."  At least in this blog and in other authorities on criminal tax matters, tax evasion is a term of art.  Narrowly, it means the specific tax evasion crime in § 7201, but is often used to cover the panoply of tax crimes where tax was evaded (e.g., the Sentencing Guidelines require that for a tax loss as the first step in the sentencing calculation).  But, the term usually does connote conduct that is criminal.  See e.g., the Wikipedia entry for Tax Evasion, here.

Developments - Federal Tax Procedure Book 2018 Editions and Altera (7/25/18; 7/27/18)

The 2018 editions of the Tax Procedure Book (Student Edition and Practitioner Edition) are available for download on SSRN as of 7/17/18.  The SSRN postings are linked on the page to the right titled "2018 Federal Tax Procedure Book & Supplements (7/17/18)."  

I am posting on this blog today a dramatic new development -- the Ninth Circuit's decision in Altera Corp. v. Commissioner, ___ F.3d ___ (9th Cir. 2018), here, sustaining the relevant § 482 regulations and reversing the Tax Court decision which struck them down.  I did not include this Ninth Circuit decision in my new editions of the book, so will include it in the new cumulative update that I provide from time to time to

In Altera, the Court decided 2-1 that the IRS's regulations requiring the inclusion of of employee stock-based compensation in cost-sharing arrangements which, if valid, avoid Section 482 adjustments.  The opinions (majority and dissenting) are quite good.

In high level summary, the majority concludes (i) from the APA procedural perspective, the regulations are valid (promulgated with the appropriate notice and comment and reasonable consideration as to the final contents of the regulations); and (ii) from the substantive perspective, the regulations are entitled to Chevron deference (Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984)), thus upholding the inclusion of employee-stock based compensation.

These types of issues are discussed in some detail in the new editions of the Federal Tax Procedure Book and in the article.  The genre of issue is fairly standard in administrative law.  Readers who are not familiar with the issues, should read the majority and dissenting opinions.

The two issues in a little more detail are:

1.  APA Procedure.

The majority opinion concludes that the notice and comment and regulations pre-amble discussion did fairly cover the final content of the regulations and thus the regulations were procedurally valid.  The dissenting opinion disagrees and, like the Tax Court, does not think that there was sufficient notice or reasoned explanation for the final regulation to be sustained procedurally under the APA.

2.  Substantive Interpretation.

The majority opinion concludes that the regulation is entitled to Chevron deference.  The dissenting opinion concludes that no Chevron deference at all is warranted because of the procedural defect the dissenting judge found (see paragraph 1 above).  This permits the dissenter to then reach a substantive interpretation unfettered by Chevron deference.  In Chevron parlance, the reviewing court unconstrained by Chevron deference can then reach its own most reasonable interpretation of the statute even if the IRS interpretation is reasonable, albeit less reasonable than the Court's most reasonable interpretation.  But, the dissenting judge goes one step farther -- she concludes that the IRS's interpretation was not even a reasonable interpretation and was inconsistent with the "plain language of the statute."  She then states:  "For at least this reason, I also disagree with the majority’s conclusion that Treasury’s reading of § 482 satisfies the second step of the Chevron test."  It is not clear whether the dissenting judge would stop the Chevron inquiry at Step One or would get to Step Two and hold the IRS interpretation unreasonable.  Either way, for the dissenting judge the IRS would lose on the substance because she interprets the substance differently than the IRS.  But, of course, the dissenting judge lost the battle of ideas on the panel.

Whistleblower Matters - Update (4/21/18)

I have made updates to the working draft of the Federal Tax Procedure book based, in part, on a recent posting on the Procedurally Taxing Blog -- Keith Fogg, Don’t Expect a Whistleblower Award for Giving the IRS Privileged Information and General Information from the Judicial Conference on this Issue (Procedurally Taxing Blog 4/16/18), here.  Also included in the updates are the recent statutory changes to the whistleblower awards program.  I link here a pdf of a red-line of the Whistleblower chapter -- Chapter 19.  Whistleblower Awards -- showing the changes in the working draft from the 2018 edition.  This is a footnoted edition of the draft of the chapter.  The principal new items covered are:]

• The change in the statute from "collected proceeds" to "proceeds" with a broadening of the base for whistleblower awards to clearly encompass non Title 26 collections (such as FBAR penalties and criminal fines related to tax crimes).
• The scope of review for Tax Court whistleblower cases.
• Appellate venue to the D.C. Circuit Court of Appeals for Tax Court whistleblower cases.
• The WBO's fye 2017 statistics for whistleblower cases.

Congress Amends Tax Whistleblower Section, § 7623, to Clarify Broad Reading of the Award Base (2/24/18)

Earlier this month, Congress amended the mandatory minimum tax Whistleblower award program to make clear that proceeds for purposes of the award base includes non Title 26 collections for fines, forfeitures and reporting violations (such as FBAR penalties).  See § 41108 of the Bipartisan Budget Act of 2018, P.L. 115-123, here.  The change is effected by using the term "proceeds" rather than "collected proceeds and adding § 7623(c) to provide as follows.

(c) Proceeds.—For purposes of this section, the term ‘proceeds’ includes—
   (1) penalties, interest, additions to tax, and additional amounts provided under the internal revenue laws, and
   (2) any proceeds arising from laws for which the Internal Revenue Service is authorized to administer, enforce, or investigate, including—
      (A) criminal fines and civil forfeitures, and
      (B) violations of reporting requirements.

The expanded definition is both for the award base and for the minimum proceeds for § 7623(b).


I have revised my discussion of the Whistleblower Chapter, Chapter 19, in my working draft of my Federal Tax Procedure Book (pending the next publication) to incorporate these changes and attach a red-lined version of it here. 

Good History Lesson on the Interface of Civil Procedure and Tax Refund Suits (2/2/18)

In United States v. Stein, 2018 U.S. App. LEXIS 2392 (11th Cir. 2018) (en banc), here, the Eleventh Circuit unanimously held that "an affidavit which satisfies Rule 56 of the Federal Rules of Civil Procedure may create an issue of material fact and preclude summary judgment even if it is self-serving and uncorroborated."  For civil trial lawyers, this seems an unexceptional holding, which is why it was a unanimous en banc opinion.  But there is some trial procedure intrigue behind the holding which explains why the panel opinion predicate to the en banc opinion held otherwise.  See United States v. Stein, 840 F.3d 1355 (11th Cir. 2016), here.

The background was Mays v. United States, 763 F.2d 1295 (11th Cir. 1985), here, which was the authority cited in the panel opinion.  In Mays, the court granted summary judgment on the following basis (emphasis supplied by JAT):

In a tax refund suit, the Commissioner's deficiency determinations are presumed correct, and the burden of proof is on the taxpayer to show that the Commissioner's findings were erroneous. Helvering v. Taylor, 293 U.S. 507, 514-15, 55 S.Ct. 287, 290-91, 79 L.Ed. 623 (1935); Anselmo v. Commissioner, 757 F.2d 1208, 1211 (11th Cir.1985). A taxpayer seeking a refund must show not only that the Commissioner erred, but must establish the correct amount of the refund due. King v. United States, 641 F.2d 253, 259 (5th Cir.1981)*; Crosby v. United States, 496 F.2d 1384, 1390 (5th Cir.1974). The claim must be substantiated by something other than tax returns, Lunsford v. Commissioner, 212 F.2d 878, 883 (5th Cir.1954), uncorroborated oral testimony, Griffin v. United States, 588 F.2d 521, 530 (5th Cir.1979), or self-serving statements. See Gibson v. United States, 360 F.2d 457, 462 (5th Cir.1966). 

Mays does not dispute that the computer printout he submitted with his response to the government's interrogatories was prepared after the tax audit; indeed, the "amount allowed by auditor" appeared on the face of the printout. His net worth statements did not refer to any original records, and he presented no contemporaneous documentation of his expenses or other evidence to establish that the Commissioner's tax assessment was wrong or to establish the correct amount due. In sum, Mays did not overcome the presumption of correctness due determinations of the Commissioner. Rather, he has submitted only self-serving documents which do not substantiate his claims. Accordingly, the government was entitled to summary judgment.

The Stein en banc opinion reverses Mays on straight-forward trial civil procedure grounds. Uncorroborated properly submitted affidavit testimony on a key factual issue can avoid summary judgment.  The effect of denying summary judgment is that the party opposing summary judgment can go to trial on that issue.  Trial can be either to a jury (if requested and the type of fact issue triable to a jury) or to a judge.

In tax cases, refund suits may be tried to a jury.  The majority en banc opinion does not get into the particular tax issue, other than to say that there is nothing unique about taxes that would require a different result than compelled by the ordinary civil procedure rules.  But, the tax setting is an entre for Judge William Pryor to talk in a concurring opinion about the unique historical role of taxes, procedure and jury trials.  I want to focus on Judge William's concurring opinion, but first I conclude the discussion of the majority opinion: