The Effect of Violation of the Statutory Requirements for a Notice of Deficiency (8/15/13)

Leslie Book has a good blog entry titled What Happens When The IRS Violates a Statutory Requirement Relating to Notices of Deficiency? (Procedurally Taxing 8/13/13), here.  His general topic is when courts will treat a failure to meet the statutory requirements for a notice of deficiency as invalidating the purported notice of deficiency.  The statutory requirements for the notice are:

1. The date to file a petition for redetermination in the U.S. Tax Court.
2. Notice of Taxpayer Advocate's Contact Information.
3. Notice sent to Taxpayer's Last Known Address.
4. Explanation of Basis for Deficiency.

I encourage readers to read Professor Book's blog entry for more detail than I offer here (except as to item 4).  The unifying theme is whether the taxpayer has been prejudiced by some IRS footfault in meeting these statutory requirements.  Professor Book discusses that prejudice issue in the context of requirements 1 and 2.  It is also present in #3, for the cases hold that, if, despite not being sent to the last known address, the taxpayer actually receives the notice of deficiency in time to file a petition for redetermination, the notice of deficiency will not be invalidated (so that it will operate to suspend the statute of limitations and support the ultimate assessment if the taxpayer did not petition the Tax Court or even if he did petition the Tax Court and loses the last known address issue).

I would like to address briefly the Scar case (Scar v. Commissioner, 814 F.2d 1363 (9th Cir. 1987)) which Professor Book discusses briefly.  I offer the following from  my book (footnotes omitted):

As noted above, the deficiency notices must describe the basis for the deficiency but failure to do so will not invalidate the deficiency.  Thus, the taxpayer appears to have a statutory right to the information in the notice of deficiency, but no statutory remedy if he does not receive it in the notice of deficiency.  As we shall note, however, there may be some remedies short of invalidity of the notice for failure to meet this requirement of § 7522(a). 

Usually, there will be some explanation.  It may be summary or even cryptic because the determination usually follows an audit in which the taxpayer participated and was aware of the issues the IRS was raising.  Indeed, in such cases, usually the taxpayer will have been provided some type of report (often referred to as a Revenue Agent's Report (“RAR”)) that explains the proposed adjustments.  But again, although the Code provides that the taxpayer be notified of the basis for the deficiency, there is no Code remedy if one is not provided.

Cheating, Visibility and Return Preparers (8/8/13)

A new tax procedure blog, Procedurally Taxing, here, has a new blog entry written by Professor Leslie Book, here, titled Cheating and Visibility on Taxes: IRS Efforts to Regulate Tax Return Preparers Should Continue (Procedurally Taxing 8/6/13), here.

The blog entry opens with the following:

It comes as no surprise that people cheat on their taxes. There is a rich literature discussing tax noncompliance, analyzing its causes and discussing ways that the government can deter, detect and if necessary sanction those who would cheat or help others cheat. I too have contributed to the discussion, primarily considering the role that commercial preparers play in decisions to comply with our tax laws in research reports commissioned by the Taxpayer Advocate Service and made part of the National Taxpayer Advocate Reports to Congress in 2007 and 2008.

The blog entry then follows with some very interesting insight and research on cheating and how the findings of this research can be deployed by increasing visibility in tax settings.  I particularly commend to readers the Halloween research study.  Visibility is enhanced through information reporting and the IRS's return preparer initiatives, one facet of which is in play in the recent Loving case now on appeal to the D.C. Circuit.

Tax Court Tanks Another Taxpayer's Bullshit Tax Shelter (8/6/13)

This is almost ho-hum now.  At some point, I will quit posting these items.  But, for now, I post it because the Tax Court elevated it to a full T.C. opinion and devoted 244 pages of words to pouring out the taxpayer.  In John Hancock Life Insurance Company (U.S.A.) v. Commissioner, 141 T. C. No. 1 (8/5/13), here, the taxpayer invested in two bullshit tax types of tax shelters -- LILOs and SILOs.  I recommend that readers interested in other failed attempts to snooker the courts in these types of transactions do a search on this blog on SILO and LILO.  John Hancock met the same fate.

As with most of the more sophisticated bullshit tax shelter, the facts are mind-numbingly complex to disguise the odor.  So, I won't get into the details.  Readers interested can read the case and the pundits who will claim that the world is coming to an end because taxpayers can't get their way.

I do address a burden of proof question that the Court address, but which ultimately was not outcome determinative.  For some reason, in the notice of deficiency and in the answer, the IRS did not raise the economic substance basis for disallowing the claims; instead the IRS raised it for the first time in a pretrial memorandum.  The Tax Court assigned the burden of proof to the IRS on that issue.  The IRS had timely asserted the related concept of substance over form, so the normal taxpayer burden of proof applied to that issue.

After exhaustive analysis of the proof, the court held that the IRS had not met its burden of proof with respect to lack of economic substance.  The Court seems to have been particularly piqued at the IRS' principal expert and his lack of a net present value calculation.  The Court formulated its bottom line conclusions on failure to meet burden of proof as follows:

Respondent has failed to demonstrate that John Hancock had no realistic expectation of profit when it entered into the test transactions. Though John Hancock's ABC reports lack a net present value analysis and are therefore inconclusive, respondent bore the burden of proof on this issue. Respondent has failed to meet his burden of proof, and we are therefore not persuaded that the test transactions fail the objective economic substance inquiry.

* * * * 

Respondent has failed to meet his burden of proving that the test transactions fail either the objective or subjective test under the economic substance doctrine. Therefore, we do not find that the test transactions lack economic substance.

IRS Has No Authority To Settle Cases Referred to DOJ Tax Even After They Are Returned (8/3/13)

In United States v. Jackson, 2013 U.S. App. LEXIS 1674 (3d Cir. 2013), here.  This is a non-precedential opinion, but it has a interpretation of a key provision of the statute dealing with the interface of DOJ Tax and the IRS.

The facts are simply stated.  The IRS referred a case to DOJ Tax to obtain a judgment against a taxpayer on a tax assessment.  DOJ Tax obtained the judgment and thereafter seems to have sent the case back to the IRS for collection action on the judgment.  The taxpayer and the IRS interacted.  I am deliberately fuzzy about that interaction.  It seems, however, that the taxpayer filed returns for at least some of the relevant years indicating less tax due and made payments.  The IRS apparently accepted the returns and abated the tax (apparently the IRS just processed and abated without substantive consideration).  Importantly, the IRS abated without DOJ Tax consent.  The taxpayer claimed that the result of the interaction was that the IRS compromised or affirmatively abated he tax liability (which might mean that the only way the IRS could restore the assessment was to invoke the deficiency procedures if there were sufficient time on the statute).  The taxpayer then moved to have the judgment declared satisfied.

One issue was whether the IRS abated in the manner claimed (rather than just made a mistake that might be correctable).  But the predicate issue was whether the IRS even could abate or compromise the tax liability for less than the judgment obtained by DOJ Tax without DOJ Tax's approval.  Section 7122(a), here, provides:

(a) Authorization
The Secretary may compromise any civil or criminal case arising under the internal revenue laws prior to reference to the Department of Justice for prosecution or defense; and the Attorney General or his delegate may compromise any such case after reference to the Department of Justice for prosecution or defense.

Certainly, any action the IRS took was "after" the reference to DOJ Tax.  So  a straight-forward literal reading of the statute meant that the IRS lost the ability to compromise the tax liability, even after the judgment had been obtained and only the IRS was involved in the collection of the tax now reduced to judgment.  That would mean that any abatement was void and hence the assessments could be reinstated.  Here is the court's reasoning:

Jackson's main contention is that the IRS abated his tax liabilities. Under 26 U.S.C. § 7122(a), the IRS "may compromise any civil or criminal case arising under the internal revenue laws prior to reference to the [DOJ] for prosecution and defense; and the Attorney General or his delegate may compromise any such case after reference to the [DOJ] for prosecution or defense." However, "[o]nce a tax matter is referred to the [DOJ], only the Attorney General or a person to whom authority has been delegated by the Attorney General may settle the matter." United States v. Forma, 784 F. Supp. 1132, 1139 (S.D.N.Y. 1992); see also Slovacek v. United States, 40 Fed. Cl. 828, 833 (1998) (agreeing with Forma); Int'l Paper Co. v. United States, 36 Fed. Cl. 313, 321 (1996) (agreeing with Forma); Brubaker v. United States, 342 F.2d 655, 662 (7th Cir. 1965) (determining that excess tax "liabilities cannot be compromised by the Attorney General or the [DOJ] unless and until the Commissioner refers [the matter] to the [DOJ] for prosecution or defense"); cf. Bergh v. Dep't of Transp., 794 F.2d 1575, 1577 (Fed. Cir. 1986) (noting that a compromise is "within the discretion of the agency conducting the litigation"). 

Spousal / Marital Privileges (7/3/13)

In United States v. Brock, 2013 U.S. App. LEXIS 15574 (7th Cir. 2013). here, the Seventh Circuit offers a good summary of the marital privileges that can be invoked to prevent one spouse from testifying adversely to the other.  The opinion is a good succinct read.

After I read the opinion, I revised portions of my discussion of the privileges involved.  My discussion is more wordy, but covers more ground.  I recommend that readers read the opinion first and then, if still interested, readers might read the following which is the revised text without the footnotes (I do not indent the entire cut and paste, since all of it is from my books):

G. Spousal Privileges.

1. General Justification for Spousal Privileges.

The general societal value supported by the spousal privileges is the integrity of the marriage unit.  The justification for the particular subset of marital privileges are usually more fine-tuned than that, focusing on the nature of the testimony, its potential adverse effect on the marriage unit or marriage in general, and harm to society that justifies the privilege to deny access to information in dispensing justice.  For present purposes, readers should just recall that it is the marital unit and the societal value of fostering the marital unit that justifies these privileges.

2. Spousal Communications Privilege.

The spousal or marital confidential communications privilege covers “information privately disclosed between husband and wife in the confidence of the marital relationship" Trammel v. United States, 445 U.S. 40, 51 (1980).  The societal benefit is to ensure that spouses communicate confidentially without fear of exposure in court.  Either spouse “may invoke the privilege to avoid testifying or to prevent the other from testifying about the privileged communication.”  Either spouse may assert this privilege as to both that spouse’s communications to the other spouse and the other spouse’s communications to that spouse.

What are protected communications?  We all know that people – including spouses specifically – communicated by words and actions.  So, is everything one spouse learns about the other through words or actions communications?  The answer is that general verbal communications are what is protected rather than actions.  The following example is in a recent case [the Brock case linked above]:

[T]he protected subject matter includes only what one spouse communicates to the other, not what one spouse learns about the other in other ways, such as by observing the other's actions.  In Mr. Brock's  trial, the marital communications privilege could have applied to Mrs. Brock's testimony that he told her to take two guns from their home and put them in a car. It would not have applied to her testimony about Mr. Brock handling the guns or shooting possums.

New Policy Statement That Appeals Is Not to Raise New Issues (7/23/13)

The IRS released a Memorandum for Appeals Employees, here, on the subject of Implementation of the Appeals Judicial Approach and Culture (AJAC) Project.  "The AJAC Project is returning Appeals to a quasi-judicial approach in the way it handles cases, with the goal of enhancing internal and external customer perceptions of a fair, impartial and independent Office of Appeals."  For purposes of this blog entry, the approach should limit Appeals to deciding the controversies that the parties put before it, rather than raise new issues not previously spotted by Exam or re-visit issues settled or dropped by Exam.  In furtherance of that objective, the Memorandum advises of a new IRS Policy Statement as follows:

Policy Statement 8-2 (Formerly P-8-49) 

(1) New issues not to be raised by Appeals. 

(2) Appeals will not raise new issues. Appeals also will not reopen an issue on which the taxpayer and the Service are in agreement.

The memorandum implements this policy with new IRM provisions in various contexts -- Collection Due Process, Offers in Compromise, Collection Appeals Program, and Examination Cases.  I focus here on Examination Cases.  The effect of the new approach on Examination cases is set forth in Attachment 5 to the Memorandum.  Key points in attachment 5 are:

• The prohibition on raising new issues also applies in Appeals consideration of docketed cases.  (IRM 8.4.1.15.3).
• Guidance is given when the taxpayer raises new issues.  Id.
• Guidance is given when an issue not before Appeals is identified; although the Appeals  Officer cannot raise it on appeal, if it is a systemic issue, a process for the issue to be reported is provided.  "A systemic issue is an issue that requires a change or modification to an established procedure, process or operation (e.g., training issues, computer program, campus procedure for processing claims). These are issues that potentially impact more than one taxpayer."  IRM 8.6.1.6(1).
• "Reopening a previously agreed issue or raising a new issue has the same implications, and is, for all practical purposes, one and the same. Therefore, for purposes of this section, treat reopening an agreed issue the same as raising a new issue."
• "A new issue is a matter not raised during Compliance's consideration. (3) A new theory or alternative argument is not a new issue."
• "(1) Appeals will not raise new issues and will focus dispute resolution efforts on resolving the points of disagreement identified by the parties. The Appeals process is not a continuation or an extension of the examination process."  IRM 8.6.1.6.2(1).  "In resolving disputes, Appeals may consider new theories and/or alternative legal arguments that support the parties' positions when evaluating the hazards of litigation in a case. However, the Appeals hearing officer will not develop evidence that is not in the case file to support the new theory or argument."
• "In docketed cases, the Appeals hearing officer will consider a new issue affirmatively raised by the government in pleadings and may consider any new evidence developed by Compliance or Counsel to support the government's position on the new issue. The Appeals hearing officer's consideration of a new issue in a docketed case will take into account that the government has the burden of proof."

 The old version (currently on the web as of 7/23/13), here, is:

1.2.17.1.2  (Approved 01-05-2007)
Policy Statement 8-2 (Formerly P–8–49) 

1. New issues not to be raised unless material 

2. An issue, on which the taxpayer and the Service are in agreement, should neither be reopened by Appeals nor should a new issue be raised, unless the ground for such action is a substantial one and the potential effect upon the tax liability is material. The existence of unreported income, deductions, credits, gains, losses, etc. stemming from a tax shelter which is a listed transaction constitutes such a substantial ground with a material effect upon the tax liability.

Appeals raising of new issues was extremely rare under this old rule.  I have been practicing for over 35 years and have never had a new issue raised on Appeal.  But it was a possibility and a risk.

At least in some cases, the old policy gave incentives to avoid an appeal at the conclusion of which is probably the most efficient timing from an administrative perspective.  Some taxpayers would get to appeals after filing the petition in the Tax Court, with the thought that the press of the expected docket call would limit the time Appeals would be substantively involved and likely to spot new issues.  Other taxpayers pursued their refund remedies with careful attention to timing so that, if new issues were raised, the statute of limitations would foreclose any adjustment other than by offset.

This is a welcome clarification of Appeals' role.

Of course, the fact that Appeals will not raise new issues does not mean that, should litigation ensue in the Tax Court or a refund forum, the Government will not be permitted to raise new issues.  Then, the ability of the Government to raise and pursue new issues will be governed by the respective court's control of its docket.

Interview of Swiss Bank Whistleblower (7/17/13)

Der Spiegal has a great interview of Swiss Bank whistleblower, Herve Falciani.  Swiss Bank Leaker: 'Money Is Easy to Hide' (Spiegel Online International 7/16/13), here.  Some interesting excerpts are:

At the end of 2008, Hervé Falciani committed what is believed to have been the most portentous theft of banking data in history. The systems engineer and former employee at the Geneva offices of HSBC left Switzerland for France and took data from around 130,000 customers at the Anglo-Asian bank along with him. 

* * * * 

Falciani, 41, has also cooperated with the American authorities. Indeed, on the strength of the information he provided, HBSC was forced to pay a $1.9 billion settlement with the United States after a Senate committee found that failures in HSBC's money-laundering controls had enabled terrorists and drug cartels to gain access to the US financial system. 

* *  * * 

Falciani: Banks such as HSBC have created a system for making themselves rich at the expense of society, by assisting in tax evasion and money laundering. 

* * * * 

SPIEGEL: Many Swiss banks now profess to engage only in legal practices, kicking out any clients who don't disclose whether they have paid taxes. Do you find this shift credible? 

Falciani: No, I don't. Just the fact that they face international competition ensures that banks will continue to offer wealthy clients ways to evade tax authorities. 

SPIEGEL: The European Commission wants to create a comprehensive automatic system for exchanging information throughout Europe. How effective would such regulations be in putting a stop to shady practices engaged in by banks and tax evaders? 

Falciani: Banks have a strong self-preservation instinct and are quick to adapt to new regulations. Money is easy to hide. HSBC has a strategy division that takes care of such things. For example, a bank might bring in intermediary companies, sometimes at multiple levels, and make sure business isn't conducted through the bank's own accounts. They offer clients non-banking products, life insurance policies that exist for the sole purpose of tax evasion for example, or gold, which the bank stores in its safety deposit boxes for a fee. 

* * * *

SPIEGEL: The United States has taken tougher action against Swiss banks. Should the EU follow that lead? 

Falciani: At first glance, that appears to be true -- the US, for example, imposed a heavy fine against HSBC for money laundering. But I was surprised that the American authorities decided HSBC was "too big to jail" -- in other words, they shied away from imposing prison sentences on bank managers, although it's hard to imagine that top-level managers knew nothing of the bank's systemic participation in money laundering. 

Pay Attention to Court Filings Not Qualifying for the Timely Mailing-Timely Filing Rule (7/10/13)

Every tax controversy practitioner and student is aware of the time-mailing, timely-filing rule in Section 7502, here. The general concept is easily stated -- a document timely mailed to the IRS or a petition to the Tax Court will be deemed timely filed even if it arrives after the due date.  The rule is subject to some nuance and risks.  I won't get into the nuances and risks now.

But, I do want to remind readers that there is no such timely mailing-timely filing rule for other filings.  Perhaps the other most common filing that tax practitioners will deal with is the filing of the suit for refund, necessarily in a court other than the Tax Court.  There is a statute of limitations for a suit for refund -- 2 years from the date the refund claim is denied.  There is no timely-filing, timely-mailing rule for such suits.

I guess I could leave it at that, but I do call readers' attention to a recent case, Langan v. United States, 2013 U.S. Claims LEXIS 740 (Fed. Cl. June 28, 2013), here.  In this case, the claim disallowance was mailed on 12/16/09.  The taxpayer's lawyer delivered the envelope containing the Court of Federal Claims complaint to the USPS in Massachusetts late on 12/15/11, just one day before the statute closed.  The Court of Federal Claims received the envelope and stamped the complaint on 12/19/11.  Too late.

The taxpayer tried to save the day on some older authority from the court that could be read to say that a filing timely delivered to the USPS in time to be timely received by the court will be deemed to have been timely delivered even if was not timely delivered.  In effect, there would be some type of equitable relief if the timely mailing was prudent because of the expectation of timely delivery. This authority even if it were still good, did not apply because the late delivery in Langan to the USPS on the day before the complaint was required to be filed was not filed in time that, in due course, it would be timely delivered the next day.  (The taxpayer's counsel actually used a type of USPS service that would have promised timely next-day delivery had it been deposited with the USPS earlier in the day, but the late delivery (around 11pm) did not qualify for USPS assurance of next day delivery and thus taxpayer's counsel did not act prudently, a necessary condition for the special relief if it even continued to exist.)

This is a cautionary tale.  Just based on the bare facts, the taxpayer's lawyer appears to have botched this and, if so, the tax dollars paid are gone forever.  (As I read the rules, the IRS is  now forbidden to make a refund even if it were to discover that it was due.)

Cancellation of APA for Failure to Meet Terms and Conditions Reviewed on Abuse of Discretion Standard (7/10/13)

One of the major IRS initiatives for a number of years is to enter Advance Pricing Agreements ("APAs) with taxpayers to determine, in advance, transfer pricing methodologies.  APAs require taxpayer representations as to underlying facts and conditions and taxpayer economic studies justifying the methodology requested.  The IRS reviews the presentations, performs such testing and economic studies as it deems appropriate, and then attempts to reach an agreement with the taxpayer.  Those agreements are contracts, but do incorporate the terms of the relevant Revenue Procedure (currently Rev. Proc. 2006-9, 2006 IRB 1).  Among the provisions of the Rev. Proc. is the IRS authority to terminate the APA is the terms and conditions are not met.

In Eaton Corp. v. Commissioner, 140 T.C. No. 18 (2013), here, the IRS revoked the taxpayer's Advance Pricing Agreement.  Tax Court was presented the following arguments:

Taxpayer argument:  The APA is a contract and, if the IRS terminates for failure to meet the terms and conditions, the IRS bears the burden of establishing that the taxpayer failed to meet the terms and conditions.

IRS argument:  The taxpayer must show abuse of discretion for the IRS decision to terminate the APA.

Holding:  For the IRS.  Taxpayer must establish abuse of discretion.

Here are the key excerpts that show the line of reasoning (some footnotes omitted):

On Writing: Strunk & White's Elements of Style (7/1/13)

This writing is on Today's Writer's Almanac, here.  Since I recommend Struck and White's Elements of Style (4th Edition 1999), here (Wikipedia entry here) to my students, I thought I would pass the Writer's Almanac Entry on:

It's the birthday of American grammarian William Strunk Jr. (books by this author). (1869), born in Cincinnati, Ohio. He was an English teacher at Cornell for 46 years, and edited works of Shakespeare and James Fenimore Cooper. In 1918, he self-published a little book for the use of his students, called The Elements of Style. It was a 45-page volume intended, according to Strunk's introduction, "to lighten the task of instructor and student by concentrating attention ... on a few essentials, the rules of usage and principles of composition most commonly violated." He revised it in 1935; and in the late 1950s, one of his former students, the writer and New Yorker editor E.B. White, revised and reissued the 1935 edition. It's now colloquially known as "Strunk and White." 

The Elements of Style is full of helpful advice to aspiring writers and students everywhere. In it, one may find such wisdom as, "Instead of announcing what you are about to tell is interesting, make it so," and "Never call a stomach a tummy without good reason." 

American author Dorothy Parker once wrote: "If you have any young friends who aspire to become writers, the second-greatest favor you can do them is to present them with copies of The Elements of Style. The first-greatest, of course, is to shoot them now, while they're happy."