More on Litigation and IRS Raising Civil Fraud New Matter (7/11/19)

My last post involved the IRS raising the civil fraud penalty as new matter by amended answer and prevailing. IRS Raises Fraud In Tax Court Amended Answer and Prevails (Federal Tax Procedure Blog 7/9/19), here.  The key point of the blog entry was the danger of unspotted issues after an audit and the risks of petitioning the Tax Court for redetermination. 

First, on that issue, I offer the relevant portion of the working draft of my Federal Tax Procedure Book will be published on SSRN in early August 2019 (footnotes omitted):

New Matters [In the Tax Court]. 

The IRS can raise new issues in its answer that seek to increase the amount of the deficiency on a basis not asserted in the notice of deficiency or to justify the deficiency asserted (or part thereof) on some basis not asserted in the notice of deficiency.  Jurisdictionally, the Tax Court case is a case to redetermine the correct amount of tax liability for the year(s) involved, thus permitting it to determine a higher deficiency amount or an overpayment.  § 6214(a) & 6512(b). So the IRS can seek additional taxes and penalties not previously asserted.  The statute of limitations will be open because, to reprise what we learned earlier, the statute is suspended during the period the Tax Court case is pending.  §§ 6213(a) and 6503(a).   This is one of the dangers in proceeding in the Tax Court where the IRS has not previously spotted an issue.  Since the statute of limitations is suspended upon issuance of the notice of deficiency (§ 6503(a)), all new matters may be raised, assuming that the statute of limitations did not bar the notice of deficiency in the first place. 

The IRS's ability to raise new issues after its original answer is, however, limited by rules of fairness.  If the IRS does assert new matters after filing its original answer, it will formally do so by moving to amend the original answer.  The Tax Court rules, like the Federal Rules of Civil Procedure applicable in district courts and the Court of Federal Claims' Rules, permit amended pleadings, usually requiring the approval of the Court which is liberally granted to promote justice on the underlying merits. New issues cannot be inserted too late in the process so as to deny the taxpayer the effective opportunity to respond.  And, as to “new matters,” the IRS bears the burden of persuasion.  (Of course, if the new matter is the civil fraud penalty not asserted in the notice of deficienty, the IRS would have the burden of persuasion anyway to prove civil fraud by clear and convincing evidence, so asserting civil fraud as a new matter has no affect on the burden of persuasion.) 

The IRS is allowed to raise a new theory or ground in support of an issue raised in the notice of deficiency without the theory or ground being a new matter.  Depending upon how much variance the new theory or ground has with the notice of deficiency, the variance might be considered a new matter subject to the foregoing new issues discussion.  Certainly, if it is raised so late that the taxpayer cannot fairly respond with evidence addressing the new issue, the Court should deny the IRS’s attempt to assert the new issue. 

If the IRS asserts an affirmative defense (such as estoppel), it will be deemed denied and the taxpayer need not file a responsive pleading, which is usually called a “reply.”  If, however, the IRS raises “new matter” either in an answer or an amended answer, the taxpayer should file a reply providing the IRS notice as to the taxpayer's position on the new matter.  This is frequently done via a simple denial of the various matters pled with respect to the new matter. 

I think it would be helpful to illustrate the new matter issue.  Recall that § 6662 provides a 20% substantial understatement penalty that is then increased to 40% if the understatement is attributable to a gross valuation misstatement.  If the notice of deficiency asserted the 20% penalty but, in its answer, the IRS asserts the 40% penalty, the IRS will have the burden of proof on the increase in the penalty.  That seems to be the straight-forward reading of the rule shifting the burden of proof to the IRS.  But, let’s focus on one issue raised in this setting.  The taxpayer can avoid the accuracy related penalties if there was reasonable cause for the position on the return.  This is like an affirmative defense to the penalty.  Thus, as to the 20% penalty asserted in the notice and contested in the petition, the taxpayer bears the burden of proving reasonable cause even after the IRS meets its production burden under §7491(c); as to the increased 40% penalty, however, the IRS bears the burden of proof, including establishing absence of reasonable cause. 

Finally, an even worse case for the taxpayer who improvidently petitions for redetermination is that the IRS can raise as new matter a civil fraud penalty.  Say in the above example, the notice of deficiency asserted either the 20% or 40% accuracy related penalty in § 6662 and then in the answer (or amended answer), the IRS asserts the 75% civil fraud penalty in § 6663.  Note in this regard that, if the IRS raises the civil fraud penalty as a new matter, its burden of proof is not affected because, as to civil fraud, the IRS bears the burden of persuasion by clear and convincing evidence anyway, just as it the civil fraud penalty had been asserted in the notice of deficiency.  So,  if the IRS prevails, the taxpayer will be even worse off for having filed a petition for redetermination.  Thus, taxpayers and practitioners should think carefully about unspotted potential issues before filing a petition for redetermination in the Tax Court.

Now let's work this a little more.  This IRS favorable result works because the statute of limitations is still open in Tax Court proceedings.

Tax Court Sustains § 6701 Penalty Against Preparer (7/10/19)

In Kapp v. Commissioner, T.C. Memo. 2019-84, here, the Tax Court sustained § 6701 penalties of $3,218,000 (after certain IRS concessions per slip op., at 114-115).

Section 6701 imposes a penalty on any person who (1) aids, assists, procures, or advises with respect to the preparation or presentation of any portion of a return, affidavit, claim, or other document, (2) knows (or has reason to believe) that the document will be used in connection with any material matter arising under the internal revenue laws, and (3) knows that the document would result in an understatement of another person's tax liability.   The penalty is $1,000 (increased to $10,000 for corporate returns) for each false document for each taxpayer for each tax period affected by the document (but no more than one penalty per period).  This penalty is the civil penalty analog to the tax crime of aiding and assisting, § 7206(2).

Kapp was a return preparer with a specialized client base as follows:  "(1) 75% were deep sea mariners, (2) 18% were tugboat mariners, (3) 5% were offshore mariners, (4) 1% were offshore oil rig workers, and (5) 1% were marine ferry drivers."

Basically, on many returns he prepared, Kapp deducted claimed miscellaneous itemized deductions for unreimbursed employee business meals and incidental expenses, computed by using the full Federal per diem rates for the meals and incidental expenses (M&IE rate) referenced in Rev. Proc. 96-28, 1996-1 C.B. 686, superseding Rev. Proc. 94-77, 1994-2 C.B. 825, multiplied by the number of days traveling for work.

The problem was that the employer paid the meal expenses.  In Tax Court litigation for two of his clients (although he did not represent them in the Tax Court), the Tax Court held that the taxpayers could not deduct the per diem for meal expenses that the employer rather than they incurred.  Kapp read those decisions shortly after they were issue in September 2000.

Kapp then "began advising his tugboat mariner clients and some of his other mariner clients that they were allowed to claim meals expense deductions even if meals were provided by their employers."  (Slip op., at pp. 20-21.) Kapp set up a website advertising the ability to obtain large income tax returns, falsely stating "that he successfully sued the IRS in the Tax Court and won “his cases”.  (Slip op., at pp. 21-22.)  He also published articles and documents with the same claims.  (Slip op. pp. 23-29.)

Kapp then prepared returns for his large base of clients claiming the meal expense without questioning whether the employer paid the meal expenses (as was industry practice).

The IRS objected on audit.  Throughout the audit, Kapp argued that the Tax Court opinions were favorable to his position.  (Slip Op. at pp. 42-51.) He was wrong on that point.  Not just wrong, but clearly wrong.  And he kept it up.

DOj then filed a suit for injunction and prevailed. (Slip op., pp. at pp. 55-61.)

After the injunction, the Tax Court rendered opinions for two of Kapp's petitioners denying their claimed per diem deduction for meals paid for by the employer.

The IRS then issued its § 6701 penalty assessment against Kapp.

The Tax Court's "Opinion" section (beginning on Slip Op., at p. 75) then decides the following key issues (I omit some issues, such as some evidentiary issues, I don't deem important for most readers, although they were certainly important for Kapp):

Taxpayer Advocate Service Issues Tax System Roadmap (7/10/19)

The Taxpayer Advocate Service (TAS) has issued a "Roadmap" -- also called a "subway map" -- for the taxpayer's journey through the tax system.

The TAS page for the roadmap is here.  On that page, the roadmap itself in pdf format may be viewed and downloaded and a short video introduction may be viewed.  I include below a jpg format version of the roadmap, principally for overview.  The pdf version is better for study.

The roadmap explains:

The map below illustrates, at a very high level, the stages of a taxpayer’s journey, from getting answers to tax law questions, all the way through audits, appeals, collection, and litigation. It shows the complexity of tax administration, with its connections and overlaps and repetitions between stages. As you can see from its numerous twists and turns, the road to  compliance isn’t always easy to navigate. But we hope this map helps taxpayers find their way. A project of the Taxpayer Advocate Service.

The graphic is very good.

The caveat is that, I think, most nonpractitioners may not spend a whole lot of time working their way through this roadmap of our complex tax system.  (In my own brief visual overview of the roadmap, I am reminded of a maze or a bowl of spaghetti or some such commotion.)  I suppose that those nonpractitioners (including taxpayers qua taxpayers) who get caught up in IRS tax enforcement might want to take the time to work through the maze.

I think the roadmap will be helpful for practitioners who want to check their knowledge about the processes or to study the process.  Like many such summary overviews, the graphic lacks nuance, but still that should not take away from its educational use for practitioners and even taxpayers with the stamina to work through it.

One question that must be asked is whether all the complexity hinted at via the roadmap is necessary.  That is a good question.  I don't have an easy answer, except that those of us who have practiced in the system understand the reason for the complexity (each component of the roadmap).  Whether the complexity is necessary is a different question.

IRS Raises Fraud In Tax Court Amended Answer and Prevails (7/9/19)

In Wegbreit v. Commissioner, T.C. Memo. 2019-82, here, the taxpayer husband went through some deceptive shenanigans to hide the income from the sale of his interest in a business.  There were some other issues.  The numbers are large.  I won't get into the detailed facts, but what caught my eye was this (slip op., at 2-3, 44-45):

After the petitions were filed, respondent filed an amended answer asserting that Samuel Wegbreit (S. Wegbreit) and Elizabeth J. Wegbreit (E. Wegbreit) were each liable for penalties for fraud pursuant to section 6663 for 2005 through 2009. 

See also slip op. 44-45 for some more detailed on the amended answer allegations of fraud.

The Opinion section starts with general discussion and swings to the fraud issue as follows (slip op. 47-49):

The Commissioner has the burden of proving by clear and convincing evidence that (1) an underpayment exists for the year in issue and (2) some portion of the underpayment is due to fraud. See sec. 7454(a); Rule 142(b). The Commissioner also has the burden of producing evidence in relation to other penalties. Sec. 7491(c). Thus in analyzing the evidence in this case we have considered whether it is clear and convincing as to the elements of underpayment of tax for each year and of fraudulent intent. We conclude that the evidence is sufficient under that standard. 

Many of the critical documents in the record reflect “effective as of” dating and do not reveal when they were executed. Most of the documents were also prepared or notarized by Palardy. Palardy admitted that at Agresti’s request she would backdate documents and notarize documents stating incorrect dates. That any backdating occurred suggests a willingness to manipulate the relevant chronology in a way that undermines the credibility of petitioners Wegbreit’s evidence. 

The “effective as of” dating and the backdating of relevant documents also impede our review of the substance of the transactions involving SWTF, Threshold, and Acadia and lead us to conclude that the chronology reflected in those documents is not credible. The number of documents in the record that are on their face unreliable has made this case considerably more difficult. Our chore is compounded because the parties included numerous duplicate copies of key documents without explanation or analysis. Notwithstanding the Court’s comments and directions at the conclusion of the trial, the briefs of the parties failed to focus on the material facts. Respondent’s proposed findings of fact merely summarize testimony and documents and generally fail to analyze the transactions and entities involved. See Rule 151(e). Respondent continues to use the shotgun approach to theories of the case rather than selecting the strongest arguments and focusing on them. Petitioners Wegbreit’s briefs misstate the record and are unreliable. After dealing directly with the record with little aid from the parties’ briefs, we conclude that the reliable evidence is clear and convincing as to unreported income and fraudulent intent.

Well, the IRS prevailed despite the shortcomings of the cohort of IRS lawyers.

General Lesson

The obvious general lesson from a case like this is to remember that filing a case in the Tax Court can open upon issues not previously set up by the IRS in the notice of deficiency.  This can be substantive issues involving additional tax or can be penalties, both of which, if asserted as new matter, can draw interest from the due date of the return.

Beyond the General Lesson

There is more in the details as lessons to trial counsel.  As noted above, the Court found that the "Petitioners Wegbreit’s briefs misstate the record and are unreliable."  Presumably those briefs were submitted by their trial counsel.

Moreover, beyond misstating the record, the case should remind trial counsel to vet the evidence the taxpayer introduces through the lawyer (or if by testimony, upon cross-examination).  Let's go back to the opinion.

Even More on Skidmore (Including Equipoise as to Interpretation)(7/7/19)

I have discussed so-called Skidmore deference on several occasions on this Federal Tax Procedure Blog.  I list the principal discussions at the end of this blog.  As traditionally formulated, Skidmore tells a court that an agency interpretation of law not entitled to Chevron deference can prevail if the interpretation is persuasive.  In Chevron parlance, Skidmore would involve Chevron-like steps as follows:  Step One would require that that the statutory text be ambiguous within the scope of the agency interpretation.  That would mean that the agency interpretation must be reasonable within the scope of the ambiguity but there must be other reasonable interpretations (otherwise the statutory text would not be ambiguous).  Then at Step Two, the agency interpretation of the ambiguous statutory text would apply if it is "persuasive."  But, if the interpretation is persuasive, then no deference is needed to apply it over any other reasonable interpretation that is not persuasive.  For this reason, many believe that calling Skidmore a deference concept is an oxymoron.  (See the quote from a recent article at the end of this blog.)

Now, this model of competing reasonable interpretations does raise an interesting issue.  In the fact-finding model, where there are competing interpretations of the facts and none prevail over the others, the fact-finder is said to be in a state of equipoise.  In the state of equipoise, under the preponderance of the evidence standard (more likely than not), the party bearing the burden of persuasion loses.  Of course, most observers of triers of fact (juries or judges) feel that the state of equipoise is rare, so that the assignment of the burden of persuasion is rarely outcome determinative.  But, obviously, assigning a winner or loser based on equipoise is outcome determinative when there is a state of equipoise, however rare.

The question I ask is whether the state of equipoise is a useful model in the deference context.  Let's assume that the court determines that an agency interpretation is reasonable but is at least one other reasonable interpretation and that none of the interpretations are more "persuasive" than the other.  This would mean that the court is in a state of equipoise as to the most persuasive interpretation.  Of course, if the agency made that interpretive choice in a Chevron-entitled regulation, Chevron would compel that the agency interpretation prevail.  But assume that the agency adopts the interpretation of the ambiguous statutory text in subregulatory guidance not entitled to Chevron deference.

What happens?

Well, if, after applying all available tools of statutory interpretation, the court really is in equipoise as to the most persuasive interpretation, I suppose the court could use the time-honored tie-breaker--flip a coin or some other arbitrary factor to reach a decision.  Or alternatively, the Court could default in equipoise to the reasonable agency interpretation.  I have not seen any court articulate such a default tie-breaker rule, however. Perhaps there has just been no need to default to such a tie-breaker because, like the fact-finding analog, equipoise is rare.

Justice Gorsuch asserts such positions of equipoise in interpretation are rare, perhaps nonexistent.  A good judge, he asserts, applying available interpretive tools should be able to determine that one interpretation is more persuasive than others, without a condition of equipoise between or among the interpretations.  In Kisor v. Wilkie, 588 U.S. ___, 139 S.Ct. 2400 (2019) [Sup Ct Slip Op here; Google Scholar with S.Ct. pagination here], Justice Gorsuch in concurring in the judgment (but not accepting the plurality analysis) addressed equipoise as to a regulations interpretation as a basis for Auer deference, saying (Slip Op. 9-10 and 139 S.Ct., at pp. 2429-30, one footnote omitted):

To be sure, JUSTICE KAGAN paints a very different picture of Auer, asking us to imagine it riding to the rescue only in cases where the scales of justice are evenly balanced between two equally persuasive readings. But that's a fantasy: "If nature knows of such equipoise in legal arguments, the courts at least do not." n31 In the real world the judge uses his traditional interpretive toolkit, full of canons and tie-breaking rules, to reach a decision about the best and fairest reading of the law. Of course, there are close cases and reasonable judges will sometimes disagree. But every day, in courts throughout this country, judges manage with these traditional tools to reach conclusions about the meaning of statutes, rules of procedure, contracts, and the Constitution. Yet when it comes to interpreting federal regulations, Auer displaces this process and requires judges instead to treat the agency's interpretation as controlling even when it is "not . . . the best one."
   n31 Scalia, Judicial Deference to Administrative Interpretations of Law, 1989 Duke L. J. 511, 520. 

I think the following from Justice Scalia's remarks captured in the article (a must read in this area, here) gives a fuller description of his meaning (521):

Auer Deference and Treasury and IRS Policy Statement on the Tax Regulatory Process (7/6/19)

In the  revised working draft for my Federal Tax Procedure editions (Student and Practitioner) which I will publish in final in August 2019, I have revised the section titled "Deference to Subregulatory Interpretations."  This is generally called Auer deference, after Auer v. Robbins, 519 U.S. 452 (1997).  (Auer deference seems to overlap what was formerly called Seminole Rock deference, after Bowles v. Seminole Rock & Sand Co., 325 U.S. 410 (1945).)

Auer deference may be stated as deference to agency interpretations of agency regulations.  As I analyze it, the agency regulations being interpreted may be legislative regulations which are the law but, like statutes, can be ambiguous and thus subject to reasonable agency interpretation.  The agency regulations more commonly may be Chevron-entitled interpretive regulations that are ambiguous and thus subject to agency interpretation.  In either event, the agency interpretation appears in subregulatory guidance not entitled to Chevron deference.

Kisor v. Wilkie, 588 U.S. ___, 139 S.Ct. 2400 (2019) [Sup Ct Slip Op here; Google Scholar with S.Ct. pagination here], approved a restricted version of Auer deference.  The plurality opinion written by Justice Kagan (concurred in by Justices Ginsburg, Breyer and Sotomayor), had a robust support for Auer deference as restricted.  See e.g., Cass R. Sunstein, Justice Kagan’s Powerful Defense of the Administrative State (BloombergOpinion 6/28/19).  Keep in mind that the plurality portion was written and concurred in by the two administrative law experts on the Court (Justices Kagan and Breyer).  [For earlier discussion on Kisor, see Supreme Court Yet Again Weighs In At the Edges on Legislative and Interpretive Rules (Federal Tax Procedure Blog 6/26/19; 7/2/19), here.]

Kisor approved Auer deference to subregulatory interpretations of regulations but reined in its application.  Under Kisor, Auer deference for subregulatory interpretations (or more generally interpretations not entitled to Chevron deference) may draw deference and thus be the law.

In a tax context, however, the recent Treasury and IRS Policy Statement on the Tax Regulatory Process (3/5/19), here, informed the public that, as a policy matter, regardless of whether subregulatory interpretations might qualify for Chevron or Auer deference, the Treasury and the IRS (and presumable DOJ Tax) would not assert either Chevron or Auer deference for subregulatory interpretations.

This is odd.  Can Treasury and the IRS do that in light of the Supreme Court approval of Auer?  Well, of course, in one sense Treasury and the IRS certainly can avoid asserting deference.  The question is whether, if Chevron deference or Auer deference is otherwise applicable, a court can ignore either form of deference?

Here is the relevant portion of my current working draft on that issue (footnotes omitted):

D.C. Circuit Holds Equitable Tolling May Apply to Time Limit in Whistleblower Case (7/4/19)

In Myers v. Commissioner, ___ F.3d ___, 2019 U.S. App. LEXIS 19757 (D.C. Cir. 2019), here, the Court applied the jurisdictional/nonjurisdictional distinction to determine that the time period in § 7623(b)(4) to petition the Tax Court with respect to an IRS whistleblower determination is nonjurisdictional, thus allowing the potential for equitable tolling of the time period.  The Court of Appeals remanded the case to the Tax Court to determine whether equitable tolling applied.  (See also Carlton Smith (Guest Blogger), D.C. Circuit Holds Tax Court Whistleblower Award Filing Deadline Not Jurisdictional and Subject to Equitable tolling (Procedurally Taxing 7/3/19), here.

Based on Myers, I have just revised the section of my tax Federal Tax Procedure book working draft and offer it here.  (I remind readers that the next updated version of the book will by in early August.)  Here is the revised discussion of equitable tolling (without footnotes, although I do offer the text and footnotes in a pdf available here, but do caution readers that the quote has been "cleaned up" which I note in the footnote in the pdf version):

VII. Smoothing the Harsh Effects of Statutes of Limitation.

* * * *

C.  General Equitable Principles (Herein of Jurisdictional/Nonjurisdictional).

The Code’s time limits (often called statutes of limitations) are classified for some purposes as either jurisdictional or nonjurisdictional.  This issue is presented for time limits throughout federal law, including applications of time limit in the Code. In the tax context, this distinction has been in issue most importantly where there are time limits for a taxpayer to obtain court review of IRS action (such as the 90-day period to petition for redetermination of a notice of deficiency or the periods for filing claims or suits for refund).  The question is how rigid the time limits are.  If the time limits are rigid time limits that must be met without exception, they are called jurisdictional because failure to meet the time limit will deprive a court of “jurisdiction” to consider the dispute between the taxpayer and the IRS.  By contrast, if a time limit is nonjurisdictional, it may not be quite so rigid, and may permit relief by way of “tolling” or suspending the time limit in certain cases.  Ultimately, the question the distinction is based upon the court’s interpretation of the time limit (both the text and the context) as evidencing Congress’s choice that the time limit to be rigid or, alternatively, to permit some tolling or suspension of the time limit based on traditional equitable considerations.

In a tax case in 2019, The D.C. Circuit explained:

The Supreme Court in recent years has pressed a stricter distinction between truly jurisdictional rules, which govern a court's adjudicatory authority, and nonjurisdictional claim-processing rules, which do not.  Key to our present decision, the Court has made plain that most time bars are nonjurisdictional; they are quintessential claim-processing rules which seek to promote the orderly progress of litigation, but do not deprive a court of authority to hear a case.  Therefore, although the Congress is free to attach the jurisdictional label to a rule that we would prefer to call a claim-processing rule, we treat a time bar as jurisdictional only if Congress has clearly stated as much.  The Supreme Court has explained that this clear statement requirement is satisfied only if the statute expressly refers to subject-matter jurisdiction or speaks in jurisdictional terms. It is not enough, for instance, that a statute uses mandatory language.

The issue of jurisdictional/nonjurisdictional as to when the Code’s time limits must be met or might be tolled or suspended based on equitable considerations is not fully fleshed out.  As noted in the quote above, the Supreme Court “in recent years” began pressing a stricter distinction; that process of pressing the distinction generally has resulted in many time limits throughout the law to be nonjurisdictional so that rigid compliance is not required.  As with much of federal law, most of the time limits in the Code were adopted at a time before the jurisdictional/nonjurisdictional distinction became prominent, so Congress did not make its “intent” clear as to whether the time limit is to be rigid or not.  The courts thus have to consider closely the text and context, the statutory language and its context in the tax system involving millions of taxpayers where, at least in some cases, not imposing rigid time limits could impose its own inequities and impose unacceptable administrative burdens on the IRS.